Monday, August 19, 2013

Why debt will not burn away

If the current monumental debt load refuses to be wiped out, why not set fire to the whole lot and the whole world would be free of the debt burden. It sounds so simple that it makes one wonder why politicians and policymakers are so dumb as to overlook this obvious solution. Well, as the old adage has it, "If it's too good to be true, it probably, no, make it, surely is."

Ambrose Evans-Pritchard, an economics columnist with Britain's Daily Telegraph has been suckered by this nostrum when he writes the following blog piece, "Just set fire to Japan's quadrillion debt", that was published on 9th August 2013:
As you may have seen, Japan’s public debt has hit one trillion quadrillion yen. That is roughly $10 trillion. It will reach 247pc of GDP this year (IMF data).

No problem. Where there is a will, there is a solution to almost everything. Let the Bank of Japan buy a nice fat chunk of this debt, heap the certificates in a pile on Nichigin Dori St in Tokyo, and set fire to it. That part of the debt will simply disappear.

You could do it as an electronic accounting adjustment in ten seconds. Or if you want preserve appearances, you could switch the debt into zero-coupon bonds with a maturity of eternity, and leave them in a drawer for Martians to discover when Mankind is long gone.

Shocking, yes. Depraved, not really.

It also doable, and is in fact being done right before our eyes. That is what Abenomics is all about. It is what Takahashi Korekiyo did in the early 1930s, and it is what the Bank of England is likely to do here (while denying it), and the Fed may well do in America.

Japan’s QE will never be fully unwound. Nor should it be. If a country can eliminate a large chunk of unsustainable debt without setting off an inflation spiral, or a currency crash, or the bubonic plague, there has to be a very strong reason not to do it. I have yet hear such a reason. Though I have heard much tut-tutting, Austro-outrage, and a great deal of pedantry.

It is also what the Romans did time and again over the course of the late empire, though less efficiently, since they did indeed inflate. And no, even that was not fatal. The Roman Empire did not collapse because of metal debasement. It revived magnificently under the Antinones. As Gibbon discovered deep into his opus — and too late to change his title — the Decline and Fall of the Roman Empire took an awfully long time, to the point where the concept is meaningless.

Money is hugely important, but also ultimately trivial. The productive forces of a society are what matter in the end.

Japan’s current debt is roughly the same level as that reached by Britain after the Napoleonic Wars, though Britain produced half the world manufactured goods and controlled half the world’s shipping in the early 19th Century (or at least by 1840), so it had a bigger shock absorber.

Does Japan’s debt matter? Yes, of course it does. A country with a shrinking workforce and surging old-age costs, cannot bear such a load.

The BoJ is currently buying 70pc of the total state debt issuance each month, and my guess is that it will be buying over 100pc before long since the economic rebound will lead to a surge of tax revenues that greatly reduces the fiscal deficit. It will soon enough to be able to carry out some really worthwhile legerdemain.
Now, has Japan burned its debt? On the surface, it appears so but it is really a sleight of hand. Its Japanese government bonds (JGBs) have been taken out of circulation and held by one branch of the government, the Bank of Japan, for debts owed by another branch, its Ministry of Finance. Even if we burn these debts, the Bank of Japan still owes the former holders of the JGBs the exact amount, in the form of BoJ deposits due to them. These cannot be wiped out. The holders of these deposits can even swap them en masse for the US dollars if they no longer have faith in the Japanese yen. That's why Korekiyo Takahashi imposed capital controls in the 1930s when he implemented similar QE measures.

Even assuming that the BoJ buys 100pc of all new JGBs, in return for which the Japanese government will initially own all the new deposits with the BoJ. The Japanese government is not going to sit on these deposits but will spend it to boost the economy. Once spent, the deposits will eventually end up with other financial institutions. So it makes no difference whether old or new JGBs are held by the BoJ because the flip-side of those JGBs, that is, the deposits, will still be held by the financial institutions.

And recent events have proven that Abenomics is really a load of bull. After an initial spurt in economic activity, which really was the outcome of Abe's ¥10.3 trillion stimulus package unveiled in January this year, and aided by a correction in the previous overvaluation of the yen, the Japanese economy will go back to its languid state. Even the yen has refused to depreciate further after finding its steady state. The proposed hike in sales tax next year will dampen the mood further.

There are only three measures that can wipe out the debt, and burning is not one of them. The first option is war and this is becoming a distinct possibility given the worsening economic conditions of both China and Japan. The US which is supposed to play the role of the world's policeman has abdicated this role in the Middle East simply because it is financially broke. The Far East is watching the Middle East with keen interest.

Inflation is an expedient to making the debt become small relative to the economy. Ancient Rome could do that because its productive capacity had reached its limits at a time when population was still growing. Now, Japan is demographically shrinking but its technological capability is not constrained by demographics as it increasingly relies on robots and automation. No, Mr. Evans-Pritchard, it's not just the productive forces of society that matter, it's also its consuming ability. So instead of inflation, it is deflation, which makes debt relatively bigger, that is plaguing Japan. Inflation still besets some countries but they are countries which have lost their productive capacity because of cheap imports from super-efficient producing countries. Do they get their debts whittled down? No, they need more debts to pay for the imports. Inflation is in local currency but debt is in foreign currencies. Talk about a double whammy.

The final option is of course economic growth. But this is no longer possible in the closing phase of a Kondratieff Wave. We can see that debt is growing faster than the economy in virtually all countries.

Can the world slog on in the present manner? Well, if it's too good to be true, it surely is.

No comments:

Post a Comment