In this edition of Q & A with BCA, we are pleased to offer a recent question posed by long-time BCA client, Mr. X. Making his first appearance in 1962, Mr. X has visited our offices at the end of each year to discuss the outlook for economic and financial markets. Please find below the first installment of what will be a five-part series recapping our December 2012 meeting.
Mr. X I don’t want to sound like a broken record, but for me, extraordinary levels of debt remain the biggest threat to global economic and financial stability. You have written extensively about how the U.S. Debt Supercycle has not ended – it has merely shifted from the private to the public sector. If private sector deleveraging is simply offset by more government borrowing, then nothing has really been achieved. At the end of the day, it is the private sector that ultimately must pay for the increased government debt anyway, either through higher taxes, reduced services or higher inflation. That is why I focus on total debt. In a way, it is just a matter of accounting whether the debt is attributed to the private or public sector. One could even argue that it is even worse to make the switch, because the private sector will generally use resources more efficiently than the public sector.
My question to you then is what is the end point regarding the buildup of debt throughout the developed world? It seems to me that the only possible ways to lower debt burdens are via rapid growth in real incomes, higher inflation, or defaults. Of course, the first route would be the best, but I suspect that higher inflation will be the most likely outcome. What do you think?
BCA While total debt probably is the best measure of overall economic and financial vulnerability, the problems relate more to public than private debt. Private sector debt will tend to self-adjust, albeit with periods of boom and painful bust such as we have been going through. If consumer and/or business debt levels get too burdensome, then borrowers will have no option other than to retrench. The public sector, however, has the power to tax and to print money, so there are few limitations on its ability to sustain rising deficits and debt, other than the ones imposed by the financial markets.
The end game for debt is an important question that consumes a lot of debate time within the economic and financial community. Given the magnitude of debt levels and the many headwinds to demand, it is a stretch to believe that the major economies can significantly lower debt ratios via faster real growth within any reasonable time period. Nor is outright default by one of the G7 economies a plausible scenario.
So that leaves inflation out of your list.
Stay tuned for more on this five part Q&A series with Mr. X!