IOU and YOU AND YOU AND…

There are now some $247 trillion in IOUs from governments, businesses and households sitting out there in the world economy. That’s over three times the value of all the goods and services produced by all of the world’s economies combined. The size of America’s government debt tops its GDP, a level that scholars say is associated with protracted slowdowns in economic growth. US companies will have to refinance $4 trillion of debt in the next five years. And emerging market countries such as Turkey, South Africa, Brazil, Mexico and Argentina will have to roll over about $4 trillion in debt by the end of 2020, with much of it denominated in dollars.A record $2 trillion of debt issued by governments and companies will come due for payment this year. Should we worry?

Some seventeen years ago Vice President Dick Cheney said “Deficits don’t matter,” bringing down on his head the derision of his political opponents whose enmity is so enduring that two decades after he left office they are cheering a new anti-Cheney film cunningly named “Vice”. Deficits allow us to party and leave the bills for our grandchildren. They trigger inflation and eventually recession. They crowd out private investment. That has been economists’ charge sheet. So certain are economists and politicians of these dire consequences that even Donald Trump, the self-styled “King of Debt”, felt it a vote-winner to campaign on a promise to eliminate the entire national debt in the eight years he planned to serve. In the event, it rose by almost $2 trillion.

Now, the received wisdom is challenged. The US is on the verge of trillion-dollar deficits, the national debt clock is ticking at full speed and guess what – the economy is growing; we have full employment, with half-million jobs added to the economy in the past two months; inflation is nil; and there is so little crowding out of private investment that companies are awash in cash they can’t profitably use, and are returning it to shareholders. The road to recession just might not be paved with deficits, but with a refusal to incur them.

Deficits have always been attractive to the left in America. Debtors at the turn of the 19thcentury hoped that cheap money, untethered from a gold standard, would end their crucifixion on a cross of the yellow metal and drive inflation up and the real cost of interest payments down. Later, during the Great Depression, liberal policymakers latched on to John Maynard Keynes’ call for deficit spending as a solution to the country’s – and world’s – economic ailment. (FDR believed the solution was to balance the budget.) Now, the ascendant left-wing of the Democratic Party is seeking to eliminate PAYGO, the rule that requires congress to offset spending increases with comparable reductions in other programs, or tax increases, both always politically difficult. They want to retain current entitlements and spend lavishly on new ones, financing the lot by increasing the deficit.

As for paying down the $22 trillion national debt, fuhgeddaboudit. Trump solved the over-indebted problem of several of his enterprises with serial bankruptcies, and isn’t losing sleep over the burgeoning national debt, perhaps because he believes “if the economy crashed you could make a deal…..The United States will never default because you can print the money”.

Democrats offer their own reasons for being unwilling to pay down debt. Former Treasury Secretary Larry Summers argues that with the government only paying 2%-3% on its debt, it is better to use new funds for investment in infrastructure than to pay down debt, since infrastructure projects have returns higher than 2%-3%. Never mind that many government projects prove to be loss-making white elephants, as politicians select projects designed to maximize voter approval rather than economic returns.

The left has a partner in its lack of concern about deficits. Trump and his Republican allies have massively cut taxes, driving up the national deficit and debt. Along with several respectable economists, they say the deficits will prove self-liquidating: they will stimulate such rapid economic growth that the total take of the Treasury will increase even though tax rates are lower. This theory has proved irresistible to politicians who tremble at the thought of reducing entitlement spending, and to Republican politicians loathe to cross the man whose core followers turn out in droves for Republican primaries.

Believers in the old-time religion of balanced budgets also face the problem that the austerity programs needed to bring deficits down have proven both economically debilitating and politically unsettling. In Greece, German-imposed austerity dealt such a blow to the economy and political stability that the country has yet to recover. In Britain, austerity cost Conservatives their reputation for sound economic management and gave the hard left a slogan that proved effective, “End Austerity”. Those and similar experiences have thrown debt-aversion into ill repute. The Economist, after conceding the blindingly obvious fact that “Governments cannot borrow without limit”, argues,

“Rich countries have spent far more time below their productive capacity than above it – at grave economic cost. An overdeveloped fear of public debt, nurtured by economists, is partly to blame. But experience suggests that governments face far looser budget constraints than once thought…”. Try selling that to German finance minister Olaf Scholz. The Wall Street Journal reports that in the face of a slowdown in the economy he proposes to increase taxes on the middle class (starting incomes $64,000) to prevent the downturn from reducing revenues and producing a deficit. Presumably, Herr Scholz is satisfied with the effects such a policy has had on Greece’s economy.

The bad news is that a new group of nonbank lenders has appeared that is willing to make unconventional mortgage loans using what might be called relaxed standards. Although less toxic, these loans are kin to those made by banks to NINJA borrowers (No Income No Job or Assets) before the 2008 financial collapse has reappeared. No pay stubs necessary, income from renting through Airbnb and taking in roommates counts in assessing affordability of the $34bn of unconventional mortgages written in the first three quarters of last year. The good news is that regulators have finally begun to look into the various nonbank mortgage lenders, a third of which are not profitable, to see whether they have the strength to withstand hard times.

On the corporate side, The Wall Street Journal reports that the same rating agencies that gave their AAA ratings to bundles of NINJA mortgages are allowing “larger companies … to load up on debt to fund acquisitions without taking away their investment-grade ratings … giving investors a false sense of security about the safety of their holdings.”

In the end, as Warren Buffett famously warned, “Only when the tide goes out do you discover who’s been swimming naked.” If the US or weaker economies stumble, the incomes of their already-indebted governments will fall, as will the incomes of many households. Or, lenders might demand higher interest rates from nations and companies trying to refinance existing loans. In either case, borrowers might be forced to cut other spending, triggering a recession.

Then, the tide will go out. The resulting sight might not be pretty.