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Debt and the World Economy

Lord Tammerlain

DP Veteran
Jan 25, 2010
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North America, Japan and Europe have in general taken part in a debt fueled orgy of consumer, corporate and government spending. Total debt levels in most of the “Western Economies” have reached historic levels. Of course certain countries are worse than others, but given the interdependence of our economies it doesn’t matter too much that UK debt levels are at the 380% range while Germany is only at the 300% or so level for total debt to GDP. What really matters is that debt is now at the unsustainable mark overall. Greece can’t pay back its foreign debt owed to German and French Banks, the US government and US homeowners can’t pay back the debt they owe to other Americans or foreigners. The US government won’t be able to pay back the debt it owes because it has taken on the debt of the banks and the US consumers in addition to its own debt.

What does this mean? This means fiscal austerity will be forced on everyone and every government. It will not be just a voluntary German trait anymore, but something nearly everyone will have to practice for a good 10 years or more. A few countries have already taken this route in the 90’s as their economies and governments had a debt crisis in the late 80’s and or early 90’s. Sweden and Canada are the prime examples of this. Sweden had a large devaluation of the Kronar and saw many of its national companies be put up for sale, Volvo and Saab automotive divisions being the best known examples. Canada in the 90’s and early 2000’s saw the federal government cut back on spending drastically. Reducing the amount of money spent on social programs (health care for instance) and military spending. During this time frame increases in the Canadian standard of living lagged behind that of the US. Total debt levels in Canada is lower than that of the US as a % of GDP today, something that would not have been the case had the government deficit spending that was occurring in Canada in the early 90’s continued. If I recall correctly the last Conservative government left Canada with a deficit of around 10+% of GDP back in the early 90’s. Canada and Sweden took their hard medicine already, Germany never truly went on an orgy of excess spending and so will likely be ok (it does have a large amount of savings as a nation provided it gets paid back). Not that Canada, Sweden and Germany won’t see cutbacks in overall spending levels, they will but not as much as others.

Let’s look at spending in the US and how much will have to be cut back. The federal government alone has to borrow about 9% of GDP to fund its spending, or roughly 1/3 of its budget is borrowed money. This is providing a high level of stimulus to the US economy. The number of people who rely on money from the US government for their paycheck or check period numbers in the millions. From the military and the direct employees of the Pentagon, to the military contractors who would go out of business without government money. You also have about 40% of the medical industry being funded by the various levels of government. Last but not least you have social welfare programs from Social Security, unemployment benefits and welfare itself. Cutbacks in government spending to just bring the government budget into balance will not just result in a decline in the GDP of the 9% of GDP that the federal government borrows, but a level higher than that level as the economic multiplier will not take place as well. The Army Captain, who had his position made redundant will not be spending his salary on a new car or new furniture, that 75 year old widow will not be going to the hospital for that hip replacement which Medicare will not be able to pay for. Which means the doctor and the nurses will have less money to spend as well.

This is a process that will take place in much of Europe and Japan as well. Some will not have to cut back as much as others, some will make up for such cutbacks with increased trade with emerging markets. Resource based economies and those who make luxury/high quality specialized goods being the most likely to be able to take advantage of that growth opportunity. Those economies that saw most of their economic growth over the last 30 years come from internal debt creation or from property/asset bubbles will face a worse situation then most others (UK, Spain Ireland and the US among the most notable)

At the end of the day what does this mean?

A decline in the standard of living for most of the west ranging from 15-30% from what they have today. Those that had large government deficit and trade deficits before this economic crisis will see the larger declines while those with small or nonexistent government deficits and trade surplus’s will see the smaller declines. The countries of Asia that have been prolific savers over the last 10 years or so will see a relative increase in their standard of living compared to the west (not including countries like Pakistan of course which has been poorly managed economically)

Inflation. Certain countries are going to use inflation to make the debt payback and forced cutbacks less noticeable, to most individuals. Politicians know it is easier to inflate debt away rather then make actual cut backs in spending. Not that the actual level of service will be any more or less, it is just that the cutbacks are hidden from view as the spending will not be reduced in current dollars, but only in constant dollars. The US, UK and Japan are the country’s most likely to engage in this process. Germany I think might leave the Euro if the ECB tries to engage in this economic policy.

Overall if you are 70-90, be grateful that you will be dead soon enough, if you are 45-60, be afraid for your retirement, as your savings if you have any are likely to be reduced in real value. If you are just finishing school and have entered the job market with real job skills be happy, be very happy. When you start to enter the years of life when you will be buying a house and saving more money for retirement asset values will be far more rational then they are now. You will be making the best gains over your lifetime than those entering that phase of life now, or did so about 10 years ago
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