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  1. Wealth
March 24, 2009

Controlling national debts

By Spear's

If over-borrowed countries are the question, inflation is the answer.

Barclays CEO John Varley, giving evidence to the Lord’s Treasury Select Committee, hit upon a macroeconomic management tool of a key ratio, in the context of future bank regulation: ‘When people’s collective debt reaches a certain level, the Government [regulators] could force banks to put the brakes on their lending.’

This could be a possible numeric gauge for controlling banking excesses, or even an early warning system for overall rising debt in an economy.

Here’s an attempt to define a new yardstick: take a country’s GDP’s ratio to total public and private debt, and assume recovery can only begin, and sustainable economic expansion continue, only when this definition of debt to GDP is within a certain ratio or range.

Debt here does not include the working capital debt required by local government, corporates, farms etc., which by and large are governed by the international credit markets which insist on repayment or bankruptcy, and have their own corporate lives beyond the control of either government or the people, that is unless they become part of public debt in a bail-out scenario, as is uncomfortably being experienced at present.

At that point, the corporate excess becomes part of the public debt and enters the calculation, but if the early warning system worked, then that breach becomes much less likely.

The point about GDP is that as it rises, a people and their democratic government can borrow against their increased output, but only up to an overall limit, beyond which ‘bankruptcy’ in the form of recession ensues. People tend to forget that recessions have a major function, namely to reign in excess debt in line with real economic capacity or ability to repay.

Take the US as a working example: GDP is $14 trillion pa, and total debt as defined is $25 trillion (of which public debt is $11 trillion), so the total debt to GDP ratio is nearly 1.9. The UK, on these yardsticks, appears to be in a similar position: GDP is £1.25 trillion pa, and total debt is £2.5 trillion (of which £1.5 trillion is private, and the public debt is assumed as £700 billion and rising to £1.0 trillion when the cost of current bail-outs etc. is included in).

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So the UK’s defined debt to GDP ratio is slightly higher at x2, but in the UK the private household debt is 120% of GDP, whereas it’s only 100% in the US. Both are far too high, but the UK is 20% worse.

Of course, the US’s ability to generate higher GDP, and hence its power to recover and go back to expansion, is also better than the UK’s, on account of its greater size.

On historical experience the architects of the Maastricht Treaty assumed that public debt should never exceed 60% of GDP, other than in exceptional circumstances, but they did not go the extra mile and ask what the maximum private debt should be, or at that maximum of public debt.

Current US private debt at $14 trillion is far too high and hence the lack of credit and the current recession. The US’s public debt is already at 80% of a falling GDP. So what should private debt be in relation to GDP? It’s impossible to say without detailed research, and also because that depends on the existing level of public debt (and on many other factors): the public pig and the private pig cannot both get more than is available from the trough and the public pig’s inherent greed will at its peak crowd out the private pig.

In trying to set an absolute figure on private debt, one can only say that when public and private debt combined exceed a certain total, it can then be said that the economy is into ‘excessive debt territory’.

Sticking a thumb in the wind, the barrier point seems to be at around 120-133% of GDP. On the higher rate of this assumption, US and UK excess public and private debt are possibly of the order of $6,333,333,000,000 and £866,667,000,000, or $6.3 trillion and £867 billion, respectively. Remember, this is excess debt.

To bring these giant figures down to human size, on the basis that the population of the US is 300 million and the UK is 60 million, the total of public and private debt per capita are $83,000 and £41,000, respectively; assuming 2.25 persons per household, the debt per household is $167,000 and £102,000, respectively.

These excess debt figures are as daunting as the Himalayas. So what else is there that can really make a significant hole in these gargantuan debt levels? Answer: inflation.

Inflation is the key, and Quantitative Easing is the best grease for this particular debt-shredder. That’s why many forecasters, including this site, are saying that Super-Stagflation will be the dodgy outcome to the last debt binge, so no wonder the Bank of England warned on 16 March of a ‘Thirties style slump’.

There are so many inter-active variables in the total picture here: P+P = TD – r +w/o’s x QE = Recovery x X +Y x Inflation x @!&?!, that clearly some serious maths research is called for, otherwise J. K. Galbraith’s scepticism might win the day: ‘The only function of economic forecasting is to make astronomy look respectable.’

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