2 Jun 2013

Debt Ratios and the Comparison with WWII

Recently I've seen a lot of people saying things like "UK has had higher debt for 204 of the last 250 year." This is true and it is part of the criticism of the present government. We should certainly be worried about high levels of public debt, but having looked at the arguments I agree with those who say now is not the time to cut public spending. As far as I can make out the govt continue to argue using the moronic household finances model, which ought to convince no one.

The fact is that the UK's immediate post-war government debt was about 260% of GDP and then fell sharply over the following decades to below 50%. And people who disagree with the government find this comforting.

However what they don't seem to factor in is the levels of private debt (figures on private debt are based on the 2013 Budget Report, but other estimates put private debt much higher). At the end of WWII we had very low levels of private debt - consumer credit had yet to be invented! Back then there was a real possibility that private enterprise would borrow to invest and get things growing. Back then there was huge demand for products created by shortages.

NOW the situation is very different. Household debt is about 100% of GDP. Far from having an excess of demand we have stagnant demand. Retail spending is steady but not growing. And in an economy predicated on steady but infinite growth this is a problem. Inflation is higher than growth and thus the value of everything is being eroded. People are also saving, but I need to cover what's happening in business before looking at this.

In business the situation is complex. Non-finance sector debt is about 105-110% of GDP. In the household finance model this would require drastic cuts. But the government is looking to business to invest, expand, and kick start "the recovery"/ On the face of it business is mortgaged to the hilt. With demand flat there is no incentive to invest in increasing supply. In addition banks are reluctant to lend more to business because they are already carrying a great deal of debt. And to top it off we know that they are supporting 100s of zombie companies - companies that cannot afford to service their debts, but that are being kept afloat because bankruptcy would mean an outright loss for the banks. So while good companies cannot get loans, bad companies are being being extended credit they can't afford.

And it does not end there. In the boom years many companies were bought by the buyer mortgaging the company they were buying (a so-called leveraged buyout). This has left a lot of companies carrying enormous debts. I have cited the case of Travelodge numerous times. Saddled with £500 million in debt by Dubai International Capital when they "bought" the company, it could not service it's debts despite making £50 million in profit. Thus is was handed back to Goldman Sachs et al. and immediately 40% of it's debt was written off. Many other companies have been less fortunate and have declared bankruptcy. A lot of companies are carrying such debt, which was barely serviceable in boom years, and is not in the Long Bust. And these loans are due to be re-negotiated soon.

In any case this simple analysis makes it seem very unlikely that the private sector will lead investment growth. The government is sadly mistaken in waiting for business to kick things off under these conditions. There is no demand at present. And if the government does not wish to get involved then we'll be waiting a long time for demand to increase.

The finance sector holds more debt than all the other sectors put together, including government, but this it owes mainly to itself. The workings of this sector are something of a mystery to me. But their debt servicing costs must be taken into account.

Now, although I've asked many economists what it costs to service our private debts, none has ever been able to tell me. Say the average interest on all the loans is 10% pa. That would mean the interest alone amounts to 44% of GDP every year! This is difficult to believe, but when are the experts going to explain it better?

So with the dearth of good investments and the high risk environment householders with cash are simply saving it. Capitalism is where people with leftover wealth invest it in the creation of new wealth. What we have at the moment is barely worth the name.

Now we got this way because successive governments removed controls put in place after the Great Depression to stop it happening again. Economic theorists apparently believed that they had found a way to avoid the consequences of banks being allowed to create money through issuing debt. At best this was misguided, but since some of them benefited financially (according to interviews in Adam Curtis's film The Trap), we must assume that it was partly deliberate. The rise of free market economics coincided with a rise of NeoLiberalism which sought to reduce the role of government in people getting rich, i.e. to removed other kinds of social safeguards enabling the rich to become richer. And thus not only have we seen repeated recessions and economic disasters culminating in the Long Bust, we have seen wealth inequality growing exponentially. The super rich have continued to increase their wealth despite the Long Bust, whereas most people have less wealth.

So the present cannot be usefully compared to the past just by looking at government debt. Other variables have changed. In particular private debt is very, very much higher than it was in 1945. And this means that we cannot expect a gradual return to prosperity with everyone's wealth keeping pace. We can expect something more like the Japanese experience. Many years of economic stagnation.

That said the UK is still one of the largest economies in the world. We still do £1.5 trillion worth of business each year. Inflation is relatively low. And compared to the rest of Europe unemployment is low. Standards of living are amongst the highest in the world. Things could be a lot worse. They may yet be worse, but for now we're afloat.