George Magnus’ most recent report on the upcoming global structural crisis to come is so good, we thought it was worth highlighting some additional extracts.
Consider, for instance, the charts below. According to the UBS senior economic adviser, these reflect the makings of a potential debt-trap in not one, but numerous over extended OECD governments the world over:
And here’s the average rate:
As he explains:
There is little on offer in the underlying details of most governments’ deficit and debt arithmetic moreover that would suggest these debt ratios are about to peak and then decline to more manageable levels in the period ahead.
Indeed on current policy settings the evidence suggests that debt-to-GDP ratios will continue to climb. The reasons are two-fold and relate to conventional textbook definitions of a ‘debt-trap1’
The first reason is that most governments will still be running a deficit on their cycle-adjusted primary budget balance in 2011 – the budget balance excluding interest payments that would appear if the economy was operating at full capacity. This is in large part a legacy of the large fiscal stimulus initiatives that were enacted in 2008 and 2009 and the structural erosion in tax revenues and increased government expenditures that that these initiatives have rendered.
The second reason concerns the relatively high real borrowing costs that governments are confronting at present, partly a function of low levels of inflation and – for some economies – the increasing premium that investors have been demanding to hold their sovereign debt. The ‘effective’ real borrowing rates for most OECD governments last year on their accumulated debt position was north of 3 percentage points (see charts below). For some economies it was north of 4 percentage points. Against an underlying backdrop where potential growth rates for most OECD economies are probably south of 2% and for many closer to 1.5%, this is deeply concerning.
Which essentially means governments will be pressed to pay down outstanding debt because it will cost ever more for them to simply service their interest payments.
It’s the old “we can consolidate your loans” scenario that regular retail borrowers are faced with. Yes, payments are bundled into one easy monthly payment via a bailout, but the rate charged for this ‘helpful’ service has shackled the borrower from then on. The borrower’s future productivity is then solely focused on paying off interest debt payments.
Now imagine if the borrower’s productivity falters or the borrower is dealt a pay cut?
The makings of a debt-trap or debt-spiral are in hand.
And unfortunately for OECD governments, the ‘real’ cost of borrowing is already spiking.
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Magnus further warns that ‘straightforward’ debt trap algebra would suggest debt-to-GDP ratios will continue to climb inexorably. This is especially the case if there continues to be a positive gap between the real interest rate on government debt and the pace of real GDP growth, and the deficit on the primary budget balance persists.
Which will most likely be the case for countries found in the lower right-hand quadrant of the following chart:
As Magnus explains:
The chart draws on recent research from the Bank for International Settlements2 and assesses this algebra for most industrial nations with the interest growth differential that is presently implied by OECD forecasts for potential output and the current level of real interest rates shown on the horizontal axis, and the ratio of the primary budget balance to government debt that is implied by OECD forecast arithmetic for this year shown on the vertical axis. Economies that are shown in the south-east quadrant of this chart confront potentially ugly debt dynamics in the absence of any policies that amend their fiscal stance in the period ahead.
Related links:
Behold the debt spiral - FT Alphaville
Towards a United States of Europe – FT Alphaville
What happens when the world defaults? – FT Alphaville