Further Economic Considerations

Another discussion entitled The Evolution of Economics may be a useful prerequisite to this discussion, although it is not intended to be authoritative on the subject of economic theory, it might provide some useful information in the form of An Economic Model and a discussion entitled The Growth of Debt. In this wider context, the idea of growth is often aggregated into some composite measure, e.g. an increase in the capacity of an economy to produce goods and services, which can then be compared to some other period of time.

Note: Gross Domestic Output (GDP) is an estimate of the total value of goods and services produced in a given economic zone, e.g. nation-state. However, in isolation, GDP may not accurately reflect the overall economic state of a nation or the individuals within that state.

Most measures of economic growth also need to be qualified in terms of population growth and monetary inflation. As such, the idea of the GDP per capita is often introduced in order to account for population. Of course, growth fuelled by debt may distort the actual performance of an economy, such that we then need to account for the annual deficit and the accumulation of both national and total debt.

Note: The deficit is the difference between what the government takes in by way of taxes, and other revenues, and the amount of money it spends. In contrast, the national debt is the accumulation of the deficits year-on-year.

Although the a definition of the 'national debt' usually corresponds to the amount of money which a government owes its creditors, there is possibly an additional concept of the 'total debt', which is the combination of government, household, business and financial sector debt, i.e. the national debt plus private debt of the population as a whole. For example, the US government currently has a national debt of $18 trillion, while the total debt within the US economy is over 3 times higher at $59.4 trillion, which possibly begs the question:

How much debt is OK?

From a personal perspective, we usually believe that no debt is good, but sometimes it is necessary, e.g. few of us can save enough money to buy a home outright, so we have to take out a loan in the form of a mortgage. While we have to pay interest on this loan, which might exceed the original amount over 25 years of repayments, if the equity in our house increases, it may still be sound economics. In this respect, whether debt is good or bad can depend on what and where the money borrowed is invested. If a government's income, i.e. its tax revenue, is less than its outgoing, it really only has two choices to cover the deficit, either it raises taxes or borrows money from the market by issuing government bonds, which effectively acts as an IOU that has to be paid back at some future date. However, if the level of national debt is measured against GDP and GDP growth exceeds the debt interest, the level of national debt can appear to fall when measured against GDP.

Note: By way of an example, let us assume the national debt is some fraction of GDP and the government pays the interest on its debt and balances its books such that there is no further deficit increase to the national debt. Now let us also assume that interest rates, set by the central banks, are very low and the GDP growth exceeds this interest rate. Under these circumstances, the national debt will fall as a percentage of GDP. Of course, in part, savers end up paying for this reduction in the national debt in lost interest on their saving, which might be seen as another form of stealth tax, while any global downturn might cause the national GDP to fall, which would cause a worsening of the national debt. It might also suggest why government’s are so preoccupied with economic growth, real or illusionary.

So what amount of debt is considered acceptable can depend on the measure of this debt and the forecast for future GDP growth. In this context, the reader may wish to consider the finding of the Limits to Growth discussion, which reviewed a model used to study a number of possible futures based major 5 factors, i.e. population, output, pollution, production and resource depletion. The worry is that the model predicts falling output, which will affect GDP, as will a falling population.

The chart above is a simplification of the full results, showing only the values for the non-renewable resources, population and industrial output, which have also been normalised, such that only the general shape of the curves is important. While these results have been the subject of much debate, subsequent 30 year and 40 year updates still suggest that the model may not be that far off the mark. Of course, in the context of the current discussion, the model appears to suggest that the idea of ongoing growth into the future is questionable, although the effects of inflation can sometimes be perceived as growth.

Note: By way of an inflationary example, $1 lent at 5% interest becomes $2 in 14 years, which means the money supply has to double every 14 years, just to cover the interest owed on the money existing at the beginning of this 14 year cycle. Figures confirm that the money supply in the US has doubled every 14 years since 1959 and is linked to how private banks effectively create and introduce new money into the system see Private Bank Money.

At this point, it might be useful to return to an earlier issue related to debt as a percentage of national GDP, which typically affects most nation states within the global economy. As such, we might start by first reviewing some of the economic indicators on which we might judge their economy and possibly their political management.

The nation states on the left of the graph operate within the European Union, while nation states on the right are representative of other global democracies. On the scale of this graph, the national or public debt, in orange, appears generally comparable the national GDP, in green, while the total debt, i.e. public + private in red, can be seen to exceed the national GDP by a factor of 5 in some cases, which may appear to be a more worrying indicator of the economy . However, it may also be informative to see the GDP and total debt per capita as shown in the next graph:

 

Aspect of this data also appear to highlight some anomalies, e.g. Ireland has a GDP per capita comparable to the US, while its total debt per capita is much, much higher, being 6 times greater than its GDP per capita. However, Irelands national debt is only slightly higher than its GDP (123%), see next graph, which is the actual debt that the Irish government has to pay interest on, although such a large total debt must have an adverse effect on the Irish economy as a whole. Therefore, in the final graph, we shall return to perspective of quantifying the national and total debt as a percentage of GDP.

 

While the total debt of the US, at some $58.7 trillion, dwarfs the total debt of any other country, its national debt at $18 trillion is not necessarily excessive in relation to its GDP, at least, in comparison with other major economies in Europe, although this is not necessarily the best benchmark of a healthy economy. Clearly, at some level, the democratic, free market model may not be working as planned, such that we may have to eventually question whether it will ever be the right model to underpin the future of global politics. Therefore, we possibly need to outline the reasons for the current level of global debt, which has increased by $57 trillion in the seven years since the 2008 financial crisis. These reasons might be best explained as a sequence of knock-on events:

  • Bank Loses: As a result of the 2008 financial crisis, many commercial banks lost billions due to excessive exposure to bad debts, much of which might be traced back to the US subprime mortgage market.

  • Effects of Losses: Such huge banking losses then triggered a fall in bank lending and investment, which in-turn led to a much wider economic recession.

  • House Prices: The effect of the recession on the wider economy also caused a fall in house prices, which only exacerbated the losses of many banks and caused a further loss of investment confidence.

  • Government Deficits: As might be expected, the economic recession also caused a severe downturn in government revenues, i.e. taxes, such that most governments were forced to borrow to cover their year-on-year outgoings and implement severe austerity programs in some cases.

  • GDP Measure: Of course, the recession also hit the GDP figures, such the percentage of debt to GDP only got worst.

While the 2008 financial crisis might be cited as the trigger event in a long history of 'boom & bust' cycles, the sequence of events outlined above are only describing the 'bust' part of the cycle that were actually caused by an earlier 'boom' fuelled by increasing debt. Back in 2000, the general economy was again struggling to recover from an earlier boom & bust cycle, which we might labelled as the 'dotcom bubble', where the subsequent 9/11 terrorist attack only compounded the problems of recovery. So, in an attempt to stimulate the broader economy, central banks around the world effectively increased financial liquidity by reducing interest rates, while at the same time, investors were seeking higher returns through riskier investments. Given that money appeared cheap in the sense that interest rates were low, the wider public also took on greater risks in the form of ever larger mortgages, even though many had poor credit ratings. Credit cards might also be seen as another way that many took on more debt than they could really afford, albeit encouraged by a finance sector that thought it could only profited from growing household debt. By 2006, debt had spiralled out of control and was destined to end in what is called the 2008 financial crisis. However, there is one further aspect in this crisis that needs to be highlighted; in search for ever greater profits, US and other global financial institutions created products based on ever riskier mortgages, while finding ways to sell them as secure investments. One scheme devised was to bundle up mortgage loans according to credit rating, supposedly set by independent rating agencies, and sell them on to other financial institutions. However, once the risk was sold on, the original lenders were no longer concerned as to whether borrowers could actually afford to pay their debts in the form of mortgages. Equally, when freed of this risk, lenders started to use ever more dubious tactics to convince home buyers to take out mortgages without concern of the consequences from which they thought they would be immune. The net result of this process was that many financial institutions, e.g. banks, around the world ended up holding loans that could never be repaid.

So who was held accountable for the financial crisis that followed?

Now, some 8 years after the financial crisis, which it is normally described has being caused by reckless, irresponsible and excessive lending by major financial institutions, no senior executives have been charged or imprisoned. However, while many people may want to blame individuals, the greed of financial institutions and free-market capitalism requires more rigorous analysis, which might then suggest that the responsibility goes much wider. While the summary of this wider responsibility below is not necessarily central to the current discussion, it possibly illustrates the complexity inherent in the political governance of a global free-market economy, which is often driven by greed and corruption, i.e. the human condition.

  • Regulators relaxed risk management regulations.
  • The US federal bank ignored the build-up of debt in the housing market.
  • Other world central bank simply followed the lead given by the US federal bank.
  • Other world financial regulators followed the US financial model and regulations.
  • Investment banks sold high risk subprime bundles to their customers.
  • Credit rating agencies overrated junk securities as investment-grade quality.
  • Economists ignored or did not understand the market indicators until after the crash.
  • Investment analysts used flawed risk models and theories.
  • Banking executives ignored risk to increase revenues and their bonuses
  • Directors did not protect their shareholders against excessive executive compensation.
  • Financial experts ill-advised their clients on bad investments.
  • Investment Fund Managers lost billions of dollars investing without adequate due diligence
  • Mortgage brokers sold loans to naive borrowers in order to collect more commission.
  • Borrowers took loans they could not afford and then blamed the banks.
  • The US Presidents for hiring former financial lobbyists as government policy makers.
  • The US supreme court for allowing corporations to lobby on the basis of financial influence.
  • A financial media that took no responsibility for promoting bad investments.

At this point, we might recognise that the institutions of government, irrespective of whether they are democratic or authoritarian in style, may simply seek to maintain the incumbent system through which they survive and profit. However, many democratic governments also understand that they will simply be voted out of office, if and when they do anything that might be seen to adversely affect the living standards of the majority, even if the action is necessary. As a consequence, many democratic governments simply do not tell the majority what they actually need to hear. Of course, while authoritarian governments may be able to ignore the views of it wider population, for a time, they may still be affected by internal pressures from powerful minorities, if their prosperity is also affected by a global downturn.

So how might we quantify the economic success of the various super-powers?

For comparative purposes, we might use the same graphical format as before in respect to the 4 super-powers in the world today, i.e. the US, China, Russia and the European Union (EU), where the latter represents the collective economies of some 28 countries. Again, we will start with graphs showing the actual GDP figures along with the national and total debt following by the rationalisation of these figures in terms of the population or per capita figures.

The first thing that may surprise many is that the EU, as a collective economy, exceeds the US in its GDP and dwarfs China, while the Russia economy barely registers on the scale shown. Switching to the per capita view, we see that the US still leads the EU in its GDP/capita, while Chinas per capita population still remains one of the poorest, even though China is now often perceived as a booming economy, especially in respect to Russia. Of course, we might well have to revise this initial assessment of the US/EU economies, in comparison to both China and Russia, when it comes to both national and total debt. For example, Russia's total debt may be as low as 25% of its GDP, while comparable debt in the US/EU is believed to be closer to 350%.

Note: The Russian government appears to have an extremely low debt of $512 billion. However, no reliable source of Russia's total debit can be found. However, it is highlighted that because Russia effectively defaulted on its debt in 1998, few major financial institutions have been willing to lend to them at attractive rates during the period that the US/EU economies saw their debts spiral out of control.

So let us consider both the national and total debt of these super-powers, who effectively dominate global politics today and ask ourselves how any of these systems, i.e. both politically and economically, might serve as a blueprint for solving the worlds problems in the near future.

Today, the US national debt per capita is in the order of $52,000, which is possibly some 8 times higher than the national debt per capita figure for China. However, it has been estimated that China's total debt may be more comparable to the US total, when measured in terms of % GDP, although the actual GDP figures suggest that the US total of $58 trillion is twice as large as the $28 trillion estimated for China. It possibly comes as no great surprise that debt in the EU is comparable to the US given the similarity of their economic and political systems. Of course, while Russia may be seen as the clear winner, when it comes to debt, it is not clear whether anybody, other than Russia's elite, would forward the Russia model as being the blueprint for the future of global governance.

So is there any alternative blueprint for global governance on the horizon?

Clearly, if political power is predicated on economic success, there will be powerful institutions trying to maintain the idea of economic growth irrespective of what measure it uses to quantify this growth. However, governments who cannot control both national and total debt may fail to maintain living standards to which their populations aspire and therefore may be subject to increasing social instability. Should such instability spread across the developed world, there may be no obvious future path other than the notion of 'Fortress World' as previously outlined, but repeated below:

Fortress World: Acknowledges the possibility that global problems simply get worst, such that powerful nation states enforce order in the form of authoritarian governance, which would possibly only attempt to control the global economy for the benefit of a minority within a few powerful nation states, possibly acting within various coalitions. To some extent, it might be argued that the world already effectively operates in this mode given that the most affluent 20% consume 80% of the world resources.