I need to stress “never ever” because there are many economists who require patronage from the state and therefore are inclined to push the idea that private debt is the problem rather than focus on public debt. Many intelligent non-economists do not like to challenge the expert economist who explains that it is private debt proliferation that is a problem. This is wrong and as I need no one`s patronage I will explain why.

The reason that public debt is the problem is firstly that it is concentrated in one place at one point in time and secondly it grows without concern for how it can be financed as the taxpayer (current and future) provides the backstop. The reason that private debt is not a problem of the same magnitude is that it is dispersed throughout the economy and most of it has been costed against future income. The private debt that turns into bad debt will be written-off at different times in different places and will not become a macro-problem.

There are two main types of debt fuelled crises. The first is the slow burner and the second is the explosive type. The slow burner has been found in Japan, UK, EU, USA, while the explosive type is found in Argentina, Turkey, Zimbabwe and Venezuela to mention but a few. Type 1, the slow burner, we will call the Japanese crisis as it has been going on longer than in any other country and will soon reach its third decade. The explosive type we will call the Argentinian crisis putting it first, of the countries referred to previously, and placing it in an alphabetical order.

The Japanese type crisis

The growth of government debt in Japan started in the 1990`s following a Keynesian fiscal stimulus to kick start the economy to higher levels of growth. I have explained in another article on this blog why this policy will never work: “Are demand management policies the solution or a mass delusion” The problem is that when the policy is seen not to work it is assumed the stimulus was not big enough and the solution is to increase the stimulus. In Japan this problem continued into the next decade with the public debt to GDP ratio growing to over 200%. (It has always amazed me that after seeing that stimuli of this sort do not work countries continue to expand using this failing policy).

Why does the policy fail? Governments never spend money efficiently, they just spend money. It is accepted by all economists that government needs to spend money on the collective consumption product that we all want but none of us is willing to buy because we cannot exclude other people from its use. Examples of this are street lighting, law and order, defence etc. This does not mean that government will spend that money efficiently it is just that no one else will spend it on these essential products. When government spending increases on goods and services other than these essential products it will continue to spend inefficiently and misallocate resources, slow and negate economic growth and create many of the characteristics that we associate with recession. Even worse is the government`s response to these conditions which is to make things worse by spending even more and borrowing even more to stimulate the economy further. The result is that the only thing the government ends up stimulating is the recession. You can read more about this in the article “Government spending does not cause the economy to grow…” The USA, UK and most, but not all, EU countries have followed the same pattern as Japan since the Global Financial Crisis and their government`s debt has grown to more than 80% of GDP and up to 150% of GDP. This is fuelling a slow burning debt crisis that is feeding recession across much of the developed world. This crisis may implode, but is unlikely to explode as long as the countries achieve their 2% inflation target and remain strong enough to sell debt in their own currency and service debt sold abroad without damaging the exchange rate.

The Argentinian type crisis

Here we are dealing with countries that have weak governments and weak currencies but still want to spend their way into growth. Overspending their budget builds up debt which needs to be financed. A weak government will find it difficult to raise taxes and even borrow in its own currency without attracting criticism so it is always tempted to issue debt and buy it back with printed money. The result of doing this will be to cause inflation to rise and continue to rise which is the beginning of the end of a stable currency.

The next stage in this destructive process is for the country to start borrowing in foreign currency, usually the dollar as this is the world`s reserve currency. It is at this point that the citizens of the country will do their best to get hold of a foreign currency which, to them, becomes a hard currency as their own is losing value. A friend who just returned from a good value holiday in Turkey said the main currencies now used by tourists in Turkey are sterling, dollar and euro. This then heralds the end for the domestic currency and eventually forces the government to introduce a new or revalued currency. Initially the new currency is likely to be stable, often pegged against the dollar, but bad habits reappear and a government debt fuelled spending spree either repeats the process just described, as in Argentina, or if the country can keep its currency stable then it is likely to join those countries that are going through a Japanese type debt fuelled crisis.

Conclusion

They say that history repeats itself and that certainly seems to be the case with the explosive debt fuelled crises in weaker economies. In the more developed world the debt fuelled crisis is relatively new and as Japan has shown almost impossible to shake off. Is there a solution? The answer is yes. Will the solution be adopted? The answer is probably not as it still requires a lot of education for people to understand that governments should balance their budgets, Central Banks should not manipulate interest rates and a regulated capitalism should be promoted wherever possible.

Further reading from jbhearn.wordpress.com:

“The cause of the Eurozone/EU/worldwide continuing crisis”

“The bubble will burst (just don`t ask me when?)”

“A reappraisal of interest rates and market interest rates”

“A balanced budget: goodbye fiscal policy”

 

John Hearn 28/9/18