Jun 13th 2016

A Tale of Two Debt Write-Downs

by Adair Turner

 

Adair Turner, Chairman of the Institute for New Economic Thinking and former Chairman of the UK Financial Services Authority, is Chair of the Energy Transitions Commission. 


SINGAPORE – At the end of 2015, Greece’s public debt was 176% of GDP, while Japan’s debt ratio was 248%. Neither government will ever repay all they owe. Write-offs and monetization are inevitable, putting both countries in a sort of global vanguard. With total public and private debt worldwide at 215% of world GDP and rising, the tools on which Greece and Japan depend will almost certainly be applied elsewhere as well.

Since 2010, official discussion of Greek debt has moved fitfully from fantasy to gradually dawning reality. The rescue program for Greece launched that year assumed that a falling debt ratio could be achieved without any private debt write-offs. After a huge restructuring of privately held debt in 2011, the ratio was forecast to reach 124% by 2020, a target the International Monetary Fund believed could be achieved, “but not with high probability.” Today, the IMF believes that a debt ratio of 173% is possible by 2020, but only if Greece’s official European creditors grant significant further debt relief.

Greece’s prospects for debt sustainability have worsened because the eurozone’s authorities have refused to accept significant debt write-downs. The 2010 program committed Greece to turn a primary fiscal deficit (excluding debt service) of 5% of GDP into a 6% surplus; but the austerity needed to deliver that consolidation produced a deep recession and a rising debt ratio. Now the eurozone is demanding that Greece turn its 2015 primary deficit of 1% of GDP into a 3.5%-of-GDP surplus, and to maintain that fiscal stance for decades to come.

But, as the IMF rightly argues, that goal is wildly unrealistic, and pursuing it would prove self-defeating. If talented young Greeks must fund perpetual surpluses to repay past debts, they can literally walk away from Greece’s debts by moving elsewhere in the European Union (taking tax revenues with them).

The IMF now proposes a more realistic 1.5%-of-GDP surplus, but that could put the debt ratio on a sustainable path only if combined with a significant write-down. Eurozone leaders’ official stance, however, continues to rule that out; they will consider only an extension of maturities and reduced interest rates at some future date.

If pursued to the limit, such adjustments can make any debt affordable – after all, a perpetual non-interest-bearing debt imposes no burden at all – while still enabling politicians to maintain the fiction that no debt had been written off. But the maturity extensions and rate reductions granted so far have been far less than needed to ensure debt sustainability. The time has come for honesty: A significant write-down is inevitable, and the longer it is put off, the larger it eventually will be.

Greece’s unresolved debt crisis still poses financial stability risks, but its $340 billion public debt is dwarfed by Japan’s $10 trillion. And while most Greek debt is now owed to official institutions, Japanese government bonds are held in private investment portfolios around the world. In Japan’s case, however, debt monetization, not an explicit write-off, will pave the path back to sustainability.

As with Greece, official fiscal forecasts for Japan have been fantasies. In 2010, the IMF described how Japan could reduce net debt (excluding government bonds held by quasi-government organizations) to a “sustainable” 80% of GDP by 2030, if it turned that year’s primary fiscal deficit of 6.5% of GDP into a 6.4%-of-GDP surplus by 2020, and maintained that surplus throughout the subsequent decade.

But virtually no progress toward this goal had been achieved by 2014. Instead, the new scenario foresaw that year’s 6%-of-GDP deficit swinging to a 5.6% surplus by 2020. In fact, fiscal tightening on anything like this scale would produce a deep recession, increasing the debt ratio.

The Japanese government has therefore abandoned its plan for an increase in sales tax in 2017, and the IMF has ceased publishing any scenario in which the debt ratio falls to some defined “sustainable” level. Its latest forecasts suggest a 2020 primary deficit still above 3% of GDP.

But the debt owed by the Japanese government to private investors is in free fall. Of Japan’s net debt of 130% of GDP, about half (66% of GDP) is owed to the Bank of Japan, which the government in turn owns. And with the BOJ buying government debt at a rate of ¥80 trillion ($746 billion) per year, while the government issues less than ¥40 trillion per year, the net debt of the Japanese consolidated public sector will fall to 28% of GDP by the end of 2018, and could reach zero sometime in the early 2020s.

The current official fiction, however, is that all the debt will eventually be resold to the private sector, becoming again a real public liability which must be repaid out of future fiscal surpluses. And if Japanese companies and households believe this fiction, they should rationally respond by saving to pay future taxes, thereby offsetting the stimulative effect of today’s fiscal deficits.

Realism would be a better basis for policy, converting some of the BOJ’s holdings of government bonds into a perpetual non-interest-bearing loan to the government. Tight constraints on the quantity of such monetization would be essential, but the alternative is not no monetization; it is undisciplined de facto monetization, accompanied by denials that any monetization is taking place.

In both Greece and Japan, excessive debts will be reduced by means previously regarded as unthinkable. It would have been far better if debts had never been allowed to grow to excess, if Greece had not joined the eurozone on fraudulent terms, and if Japan had deployed sufficiently aggressive policy to stimulate growth and inflation 20 years ago. Throughout the world, radically different policies are needed to enable economies to grow without the excessive private debt creation that occurred before 2008. But having allowed excessive debt to mount, sensible policy design must start from the recognition that many debts, both public and private, simply cannot be repaid.



Copyright: Project Syndicate, 2016.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Sep 12th 2019
Extract: "The Republican Party has lashed its fate to an increasingly unhinged leader. Though three other presidential hopefuls for 2020 now stand in Trump’s way, none can defeat him. But they can damage his reelection effort, which is why the Republican Party has been scrapping some primaries and caucuses. How well Trump does in November next year may well depend on how his fragile ego withstands the coming months."
Sep 2nd 2019
EXTRACTS: "Most people think of revolutions as sudden earthquakes or volcanic eruptions that come without warning and sweep away an entire political system. But historians, political scientists, and even the odd politician know that the reality is very different: revolutions happen when systems hollow themselves out, or simply rot from within. Revolutionaries can then brush aside established norms of behavior, or even of truth, as trivialities that should not impede the popular will............ Only time will tell whether we are currently witnessing the hollowing out of British democracy. But Prime Minister Boris Johnson may well have crossed some invisible Rubicon by.......... Whatever happens now, British parliamentary democracy may never be the same again. It will certainly never again be the model that so many people around the world once admired."
Aug 29th 2019
EXTRACT: "Events such as prorogations and dissolutions happen when countries face difficult times. Therefore, because of the disastrous effects of Brexit: sterling in freefall; a recession looming on the horizon and Britain’s international standing at its lowest ebb since Suez, it is no surprise that the country is in this position now. The worrying thing is that using the monarchical power of prorogation does not solve problems – it has a history of turning them into frightening and often violent crises. There is a worrying relationship between the use of such powers and a complete breakdown in government."
Aug 28th 2019
EXTRACT: "Reminiscent of Don Quixote, Trump is tilting at windmills. His administration is flailing at antiquated perceptions of the Old China that only compound the problems it claims to be addressing. Financial markets are starting to get a sense that something is awry. So, too, is the Federal Reserve. Meanwhile, the global economy is fraying at the edges. The US has never been an oasis in such treacherous periods. I doubt if this time is any different. 
Aug 24th 2019
EXTRACT: "In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession. The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession."
Aug 21st 2019
EXTRACT: "Climate change is real, and it is a problem. According to the IPCC, the overall impact of global warming by the 2070s will be equivalent to a 0.2-2% loss in average income. That’s not the end of the world, but the same as a single economic recession, in a world that is much better off than today.  The risk is that outsized fear will take us down the wrong path in tackling global warming. Concerned activists want the world to abandon fossil fuels as quickly as possible. But it will mean slowing the growth that has lifted billions out of poverty and transformed the planet. That has a very real cost. "
Aug 20th 2019
EXTRACTS: "It is no exaggeration to say that Johnson has lied his way to the top, first in journalism and then in politics. His ascent owes everything to the growing xenophobia and English nationalism that many Conservatives now espouse................Johnson has chosen a government of like-minded anti-European nationalists. His principal adviser, Dominic Cummings, was described by David Cameron, Britain’s prime minister from 2010 to 2016, as a “career psychopath.” Cummings is, alongside Johnson, the most powerful figure in the new government; he is an unelected wrecker who earlier this year was ruled to be in contempt of parliament. Fittingly, if depressingly, he now is masterminding our departure from the EU with or without parliamentary approval."
Aug 19th 2019
EXTRACTS: "Back in May, a jury found Patrick Syring, a former State Department official, guilty of 14 counts of making threats against my life and my staff at the Arab American Institute. This week, a federal judge sentenced Syring to five years in prison to be followed by three years of court-ordered probation.................It gives me no pleasure to see this man going to jail for a long period, but it does provide us all with a sense of enormous relief. I've been threatened before. My wife, my children, and I have received death threats for the past 50 years – owing to my advocacy for Palestinian rights and the rights of the Arab American community. My office was fire-bombed and an Arab American colleague, whom I hired, was murdered. Two individuals who, in the past, made death threats against me and my children were convicted and sentenced to prison terms. But this case was different."
Aug 15th 2019
EXTRACT: "Gaslighting typically refers to intimate relationships. It’s a way of controlling someone by creating false narratives – for example, that they are irrational or crazy. If such lies are repeated constantly, victims may get confused and start believing there really is something wrong with them. Confusion, diversion, distraction and disinformation can similarly be used to gaslight an entire society. So how can you tell if you are being gaslighted, and how do you avoid it in the first place?"
Aug 14th 2019
EXTRACT: "Trump has once again painted himself into a corner. Since the latest massacres, he’s been at pains to present himself as a reasonable fellow who can get behind gun reform (and perhaps mollify suburban women, his most dangerous foes on this issue). But he’s also noticeably (and typically) anxious to maintain the loyalty of the rural voters who form an important part of his base. Trump has also taken the gamble of using racial politics and white supremacy as instruments for winning in 2020. When faced with the dilemma of trying to assuage suburban voters or keeping the base close, time after time his instinct has been to shore up the base. (That didn’t work very well in 2018.)"
Aug 5th 2019
Extracts: "it is impossible to model many of the most important risks. Global warming will produce major changes in hydrological cycles, with both more extreme rainfall and longer more severe droughts. This will have severe adverse effects on agriculture and livelihoods in specific locations, but climate models cannot tell us in advance precisely where regional effects will be most severe. Adverse initial effects in turn could produce self-reinforcing political instability and large-scale attempted migration........Achieving a zero-carbon economy will require a massive increase in global electricity use, from today’s 23,000 TW hours to as much as 90,000 TW hours by mid-century. Delivering this in a zero-carbon fashion will require enormous investments, but as the Energy Transitions Commission has shown, it is technically, physically, and economically feasible......Added up across all economic sectors, however, it’s clear that the total cost of decarbonizing the global economy cannot possibly exceed 1-2% of world GDP. In fact, the actual costs will almost certainly be far lower, because most such estimates cautiously ignore the possibility of fundamental technological breakthroughs, and maintain conservative estimates of how long and how fast cost reductions in key technologies will occur. In 2010, the International Energy Agency projected a 70% fall in solar photovoltaic equipment costs by 2030. It happened by 2017."
Jul 31st 2019
Extract: "I admire the US for its culture, entrepreneurialism, and universities, and I have many American friends. Furthermore, I know how grateful the rest of the world has to be for US leadership after World War II. Never before had a victorious power behaved so generously toward others, including the defeated. We owe so much to US policy in the second half of the twentieth century. But although I am no declinist regarding American economic, intellectual, and military power, the country’s soft power has certainly decreased, and its positive influence around the world has declined. The reason for this is simple: US President Donald Trump is a bad man surrounded by a bad team of incompetent and dangerous ideologues."
Jul 30th 2019
Extract: "This pattern holds true in every extremist movement I have studied, whether from the past or the present, or the West or the East. This abuse of religion that provides security and certainty to those who are experiencing a loss of control is a universal phenomenon. If merely left there, it would not be a danger. But when it masks a political agenda or when it justifies violence either by groups or state actors, it becomes a danger."
Jul 30th 2019
Extract: "......the day before Mueller testified, the current FBI director, Christopher Wray, told the Senate Judiciary Committee, “The Russians are absolutely intent on trying to interfere with our elections.” And the day after Mueller testified, the Senate Intelligence Committee issued a report stating that Russia would be involved in the next presidential election, and that countries like Saudi Arabia, Iran, and China have the capacity to interfere in US elections as well. Despite these warnings, Senate Majority Leader Mitch McConnell blocked Senate consideration of two bills aimed at strengthening US election security,....."
Jul 15th 2019
".....one of the most accurate recession indicators, known as the yield curve, has recently been flashing warning signs. Every postwar recession in the US was preceded by an inversion of the yield curve, meaning that long-term interest rates had fallen below short-term interest rates, some 12 to 18 months before the outset of the economic downturn."
Jul 6th 2019
Extract: ".........growing poverty even when working, the collapse of stable and safe social identities linked to work, the increasing instability of employment security, and the rapid change of local communities due to emigration, migration, collapsing housing affordability, and redevelopment initiatives that displace communities. These provide precise and urgent electoral rallying points. They are particularly effective given that so many mainstream politicians ignore these basic grievances. In recent years, the lineup of politicians opposing the New Right – Hillary Clinton, the Remain campaign, Emmanuel Macron and Matteo Renzi – have been unwilling to even recognise these structural problems. This provided the New Right the opportunity to appear credible, simply by acknowledging them."
Jul 6th 2019
".........an openly Russophilic administration in the US may be one reason why Putin’s domestic support has been declining so sharply."
Jul 3rd 2019
"Extract: .........in a world of rapidly expanding automation potential, demographic shrinkage is largely a boon, not a threat. Our expanding ability to automate human work across all sectors – agriculture, industry, and services – makes an ever-growing workforce increasingly irrelevant to improvements in human welfare. Conversely, automation makes it impossible to achieve full employment in countries still facing rapid population growth........The greatest demographic challenges therefore lie not in countries facing population stabilization and then gradual decline, but in Africa, which still faces rapid population growth."
Jul 1st 2019
Trump’s personal style – vocal, expertise-averse, scandal-prone and driven by a focus on his partisan base – may be unusual, but aspiring Democratic presidential contenders may be making a serious error in allowing Trump’s “Wizard of Oz” act of big claims and small achievements to pass unchallenged. There is a massive gap between the pledges he made to voters and the reality of an outsider presidency thoroughly co-opted by its party. So far, the “Trump revolution” turns out to be an ordinary Republican presidency.
Jun 25th 2019
"Trump’s vindictive bluster has steamrolled economic-policy deliberations – ignoring the lessons of history, rejecting the analytics of modern economics, and undermining the institutional integrity of the policymaking process. Policy blunders of epic proportion have become the rule, not the exception. It won’t be nearly as easy to spin the looming consequences."