Here are two thought-provoking articles from The Guardian. They look at macroeconomic policy failures and at the likely consequences.
In first article, Larry Elliott, the Guardian’s Economics Editor, argues that Keynesian expansionary fiscal and monetary policy by the USA has allowed it to achieve much more rapid recovery than Europe, which, by contrast, has chosen to follow fiscal austerity policies and only recently mildly expansionary monetary policy through a belated QE programme.
In the UK, the recovery has been more significant than in the eurozone because of the expansionary monetary policies pursued by the Bank of England in its quantitative easing programme. ‘And when it came to fiscal policy, George Osborne quietly abandoned his original deficit reduction targets when the deleterious impact of an over-aggressive austerity strategy became apparent.’
So, according to Larry Elliott, Europe should ease up on austerity and governments should invest more though increased borrowing.
‘This is textbook Keynesian stuff. Unemployment is high, which means businesses are reluctant to invest. The lack of investment means that demand for new loans is weak. The weakness of demand for loans means that driving down the cost of borrowing through QE will have little impact. Therefore, it is up to the state to break into the vicious circle by investing itself, something it can do cheaply and – because there are so many people unemployed and businesses working well below full capacity – without the risk of inflation.’
In the second article, Paul Mason, the Economics Editor at Channel 4 News, points to the large increases in both public- and private- sector debt since 2007, despite the recession. Such debt, he argues, is becoming unsustainable and hence the world could be on the cusp of another crash.
Mason quotes from the Bank for International Settlements Quarterly Review September 2015 – media briefing. In this briefing, Claudio Borio,
Head of the Monetary & Economic Department, argues that:
‘Since at least 2009, domestic vulnerabilities have developed in several emerging market economies (EMEs), including some of the largest, and to a lesser extent even in some advanced economies, notably commodity exporters. In particular, these countries have exhibited signs of a build-up of financial imbalances, in the form of outsize credit booms alongside strong increases in asset prices, especially property prices, supported by unusually easy global liquidity conditions. It is the coincidence of the reversal of these booms with external vulnerabilities that should be watched most closely.’
We have already seen a fall in commodity prices, reflecting the underlying lack of demand, and large fluctuations in stock markets. The Chinese economy is slowing markedly, as are several other EMEs, and Europe and Japan are struggling to recover, despite their QE programmes. The USA is no longer engaging in QE and there are growing worries about a US slowdown as growth in the rest of the world slows. Mason, quoting the BIS briefing, states that:
‘In short, as the BIS economists put it, this is “a world in which debt levels are too high, productivity growth too weak and financial risks too threatening”. It’s impossible to extrapolate from all this the date the crash will happen, or the form it will take. All we know is there is a mismatch between rising credit, falling growth, trade and prices, and a febrile financial market, which, at present, keeps switchback riding as money flows from one sector, or geographic region, to another.’
So should there be more expansionary policy, or should rising debt levels be reduced by tighter monetary policy? Read the articles and then consider the questions.
I told you so. Obama right and Europe wrong about way out of Great Recession The Guardian, Larry Elliott (1/11/15)
Apocalypse now: has the next giant financial crash already begun? The Guardian, Paul Mason (1/11/15)
- To what extent do the two articles (a) agree and (b) disagree?
- How might a neo-liberal economist reply to the argument that what is needed is more expansionary fiscal and monetary policies?
- What is the transmission mechanism whereby quantitative easing affects real output? Is it a reliable mechanism for policymakers?
- What would make a financial crash less likely? Is this something that governments or central banks can influence?
- Why has productivity growth been so low in many countries? What would increase it?
New Look was founded in 1969 and is an iconic budget retailer found on most British high streets. In its history, it has been a family business; it has been listed on the London stock exchange; returned to a private company and then had the potential to be re-listed. Now, it is moving into South African ownership for £780 million.
90% of New Look will now be owned by Christo Wiese who controls Brait and who has been linked with other take-overs of British retailers in recent years. The remaining 10% will remain in the hands of the founding family. The company has been struggling for some time and in 2010 did have plans to relist the company on the London Stock Exchange. However, volatile market conditions meant that this never occurred and the two private equity firms, Apax and Permira, appeared very eager to sell. New Look’s Chairman, Paul Mason, said:
“This is an ideal outcome for New Look. The Brait team demonstrated to us that they have the long-term vision to help Anders and the team grow this brand.”
It is not yet clear what this move will mean for the retailer, New Look, but with an estimated £1 billion debt, it is expected that changes will have to be made. It is certainly an attractive investment opportunity and New Look does have a history of high rates of growth, despite its current debt. Furthermore, the debt levels are likely to have helped Mr. Wiese obtain a deal for New Look. Fashion retailing is a highly competitive market, but demand always appears to be growing. It is still relatively ‘new’ news, so we will have to wait to see what this means for the number of stores we see on the high streets and the number of jobs lost or created. The following articles consider this new New Look.
South African tycoon buys New Look fashion retailer BBC News (15/5/15)
South African tycoon enters UK retail fray with New Look purchase Financial Times, Andrea Felsted, Clare Barrett and Joseph Cotterill (15/5/15)
New Look snapped up by South African tycoon The Guardian, Sean Farrell (15/5/15)
New Look sold to South African billionaire for £780m The Telegraph, Elizabeth Anderson and Andrew Trotman (15/5/15)
- Why might a company become listed on the London stock exchange?
- How would volatile economic circumstances affect a company’s decision to become listed on the stock market?
- What do you think this purchase will mean for the number of New Look stores on British high streets? Do you think there will be job losses or jobs created by this purchase?
- How do you think the level of New Look’s debt affected Christo Wiese’s decision to purchase New Look?
- Which factors are likely to affect a firm’s decision to take-over or purchase another firm?
‘The world is sinking under a sea of debt, private as well as public, and it is increasingly hard to see how this might end, except in some form of mass default.’ So claims the article below by Jeremy Warner. But just how much has debt grown, both public and private? And is it of concern?
The doomsday scenario is that we are heading for another financial crisis as over leveraged banks and governments could not cope with a collapse in confidence. Bank and bond interest rates would soar and debts would be hard to finance. The world could head back into recession as credit became harder and more expensive to obtain. Perhaps, in such a scenario, there would be mass default, by banks and governments alike. This could result in a plunge back into recession.
The more optimistic scenario is that private-sector debt is under control and in many countries is falling (see, for example, chart 1 in the blog Looking once again through Minsky eyes at UK credit numbers for the case of the UK). Even though private-sector debt could rise again as the world economy grows, it would be affordable provided that interest rates remain low and banks continue to build the requisite capital buffers under the Basel III banking regulations.
As far as public-sector debt is concerned, as a percentage of GDP its growth has begun to decline in advanced countries as a whole and, although gently rising in developing and emerging economies as a whole, is relatively low compared with advanced countries (see chart). Of course, there are some countries that still face much larger debts, but in most cases they are manageable and governments have plans to curb them, or at least their growth.
But there have been several warnings from various economists and institutes, as we saw in the blog post, Has the problem of excess global debt been tackled? Not according to latest figures. The question is whether countries can grow their way out of the problem, with a rapidly rising denominator in the debt/GDP ratios.
Only mass default will end the world’s addiction to debt The Telegraph, Jeremy Warner (3/3/15)
- What would be the impact of several countries defaulting on debt?
- What factors determine the likelihood of sovereign defaults?
- What factors determine the likelihood of bank defaults?
- What is meant by ‘leverage’ in the context of (a) banks; (b) nations?
- What are the Basel III regulations? What impact will they have/are they having on bank leverage?
- Expand on the arguments supporting the doomsday scenario above.
- Expand on the arguments supporting the optimistic scenario above.
- What is the relationship between economic growth and debt?
- Explain how the explosion in global credit might merely be ‘the mirror image of rising output, asset prices and wealth’.
- Is domestic inflation a good answer for a country to the problems of rising debt denominated (a) in the domestic currency; (b) in foreign currencies?
According to a report by the McKinsey Global Institute, global debt is now higher than before the financial crisis. And that crisis was largely caused by excessive lending. As The Telegraph article linked below states:
The figures are as remarkable as they are terrifying. Global debt – defined as the liabilities of governments, firms and households – has jumped by $57 trillion, or 17% of global GDP, since the fourth quarter of 2007, which was supposed to be the peak of the bad old credit-fuelled days. In 2000, total debt was worth 246% of global GDP; by 2007, this had risen to 269% of GDP and today we are at 286% of GDP.
This is not how policy since the financial crisis was supposed to have worked out. Central banks and governments have been trying to encourage greater saving and reduced credit as a percentage of GDP, a greater capital base for banks, and reduced government deficits as a means of reducing government debt. But of 47 large economies in the McKinsey study, only five have succeeded in reducing their debt/GDP ratios since 2007 and in many the ratio has got a lot higher. China, for example, has seen its debt to GDP ratio almost double – from 158% to 282%, although its government debt remains low relative to other major economies.
Part of the problem is that the lack of growth in many countries has made it hard for countries to reduce their public-sector deficits to levels that will allow the public-sector debt/GDP ratio to fall.
In terms of the UK, private-sector debt has been falling as a percentage of GDP. But this has been more than offset by a rise in the public-sector debt/GDP ratio. As Robert Peston says:
[UK indebtedness] increased by 30 percentage points, to 252% of GDP (excluding financial sector or City debts) – as government debts have jumped by 50 percentage points of GDP, while corporate and household debts have decreased by 12 and 8 percentage points of GDP respectively.
So what are the likely consequences of this growth in debt and what can be done about it? The articles and report consider these questions.
Instead of paying down its debts, the world’s gone on another credit binge The Telegraph, Allister Heath (5/2/15)
Global debts rise $57tn since crash BBC News, Robert Peston (5/2/15)
China’s Total Debt Load Equals 282% of GDP, Raising Economic Risks The Wall Street Journal, Pedro Nicolaci da Costa (4/2/15)
Debt and (not much) deleveraging McKinsey Global Institute, Richard Dobbs, Susan Lund, Jonathan Woetzel, and Mina Mutafchieva (February 2015)
- Explain what is meant by ‘leverage’.
- Why does a low-leverage economy do better in a downturn than a high-leverage one?
- What is the relationship between deficits and the debt/GDP ratio?
- When might an increase in debt be good for an economy?
- Comment on the statement in The Telegraph article that ‘In theory, debt is fine if it is backed up by high-quality collateral’.
- Why does the rise is debt matter for the global economy?
- Is it possible for (a) individual countries; (b) all countries collectively to ‘live beyond their means’ by consuming more than they are producing through borrowing?
- What is the structure of China’s debt and what problems does this pose for the Chinese economy?
An historic agreement has been reached between Argentina over outstanding debt owed to creditor nations. Creditor nations come together as the ‘Paris Club’ and at a Paris Club meeting on May 28, details of a repayment plan were agreed. Argentina hopes that the agreement will enable it to start borrowing again on international markets: something that had been largely blocked by outstanding debt, which, up to now, Argentina had been unwilling to repay.
The problem goes back to 2001. Argentina was faced with international debt payments of $132bn, equalling some 27% of GDP and over 300% of export earnings. But at the time the country was in recession and debts were virtually impossible to service. It had received some help from the International Monetary Fund, but in December 2001, the IMF refused a request for a fresh loan of $1.3 billion
As Case Study 27.5 in MyEconLab for Economics, 8th edition explains:
This triggered a crisis in the country with mass rioting and looting. As the crisis deepened, Argentina announced that it was defaulting on its $166 billion of foreign debt. This hardly came as a surprise, however. For many commentators, it was simply a question of when.
Argentina’s default on its debts was the biggest of its kind in history. In a series of dramatic measures, the Argentine peso was initially devalued by 29%. Over the next three months, the peso depreciated a further 40%.
The economy seemed in free-fall. GDP fell by 11% in 2002 and, by the end of the year, income per head was 22% below that of 1998. Unemployment was 21%.
Then, however, the economy began to recover, helped by higher (peso) prices for exports resulting from the currency depreciation. In 2003 economic growth was 9.0% and averaged 8.4% per annum from 2004 to 2008.
But what of the debt? In 2005, Argentina successfully made a huge debt swap with banks and other private creditors (see Box 27.1 in Economics, 8th edition). A large proportion of its defaulted debt was in the form of bonds. It offered to swap the old bonds for new peso bonds, but worth only 35% as much (known as a ‘haircut’). By the deadline of 25 February, there was a 76% take-up of the offer: clearly people thought that 35% was better than nothing! At a stroke, bonds originally worth $104 billion now became worth just $36.2 billion. Later the take-up of the offer increased to 93%. But still 7% held out.
Then in 2006 its debt of nearly $10 billion was repaid to the IMF. General government debt stock as a percentage of GDP fell from 172% in 2002 to 106% in 2006 and to 48% in 2010.
In September 2008, the government of President Cristina Kirchner pledged to use some of its foreign currency reserves of $47 billion to pay back the remainder of the defaulted debt still owed to Paris Club creditors. But negotiations stalled.
However, at the Paris Club meeting of 28 May this year, agreement was finally reached. Argentina will repay the outstanding $9.7bn owed to individual creditor countries. This will take place over 5 years, with a first instalment of $1.15bn being paid before May 2015.
Argentina hopes that the agreement will open up access to overseas credit, which, up to now, has been limited because of this unresolved debt. However, Argentina still owes money to the holders of the 7% of bonds who did not accept the haircut offered in 2005. Their claims are being heard in the US Supreme Court on 12 June this year. The outcome will be critical in determining whether Argentina will be able to raise new funds on the bond market.
Argentina clinches landmark debt repayment deal with Paris Club Reuters, Leigh Thomas and Sarah Marsh (29/5/14)
Argentina Will Repay Paris Club Debt 13 Years After Default Bloomberg, Charlie Devereux and Pablo Gonzalez (29/5/14)
Argentina and the capital markets: At least they have Paris The Economist (30/5/14)
Argentina’s Paris Club Deal to Bring Investment, Kicillof Says Bloomberg, Charlie Devereux (30/5/14)
Argentina Leaves Singer for Last in Preparing Bond Market Return Bloomberg BusinessWeek, Camila Russo and Katia Porzecanski (30/5/14)
Argentina in deal with Paris Club to pay $10bn debts BBC News (29/5/14)
Argentina debt deal could help ease re-entry to international markets The Guardian (29/5/14)
Argentina agrees deal to pay back $10bn debt The Telegraph (29/5/14)
- What is the Paris Club? Why did the recent meeting of the Paris Club concerning Argentina’s debt not include the IMF?
- What moral hazards are involved in (a) defaulting on debt; (b) offering debt relief to debtor countries; (c) agreeing to pay bond holders who did not accept the haircut?
- In hindsight, was it in Argentina’s interests to default on its international debts in 2001?
- Assume a country has a severe debt problem. What are the benefits and costs of using devaluation (or depreciation) to tackle the problem?