The game, I am afraid, is up. For most of this century, monetary authorities, faced with deep structural problems in the global financial system, have responded by kicking the can down the street. Their main trick was lowering interest rates to ludicrously low levels, eventually all but removing the cost of capital, which is central to how the free enterprise system operates. Central banks also invented various ways of printing money such as Quantitative Easing.
Private actors have been worse. The banks created too much money by over lending. Traders in the foreign exchange markets invented hundreds of trillions in derivatives (transactions derived from other financial assets such as bonds or currencies). And messianic crypto currency advocates invented new forms of digital money claiming it would solve the problem when in fact it just perpetuates it.
Now, we are saddled with a system of immense complexity that is dangerously indebted. In 2021, global debt reached a record $US303 trillion, up from $US226 trillion the year before, a disastrous jump. It represented the biggest one-year debt surge since the Second World War, according to the IMF.
A quick sum shows how problematic the situation is. The world economy is about $US85 trillion, meaning the debt is 350 per cent of global GDP. Notionally, if the interest rate on that $US300 trillion is 2 per cent, the interest payments equate with 7 per cent of the world economy. If the rate is 3 per cent the interest payments equate with about a tenth of the world economy: and so on. Of course, actual interest rates will always vary greatly by country and region; this is just to sketch out how big the debt overhang is and how much it has the potential to suppress world economic activity.
Monetary authorities are caught in an impossible situation. Inflation is rising: it is over 5 per cent in Australia and over 9 per cent in the United States. The conventional wisdom of central banking is to ratchet up interest rates to slow demand and push prices down, but this would run the risk of depressing economies and bringing on stagflation – a result that might be inevitable anyway. And in any case, the inflation is mainly being caused on the supply, rather than demand, side due to commodity price rises and the fragmentation of global supply chains in the wake of the pandemic.
'What is increasingly being discussed are ways to cancel the debt. Finding ways to contain usury, it seems, is coming back into fashion.'
Inflation is often seen as a way out of excessive debt because it erodes the real value of money and therefore the real value of the debt. But what is increasingly being discussed are ways to cancel the debt. Finding ways to contain usury, it seems, is coming back into fashion.
It is a very old problem, albeit with some new twists. The historian of finance, Michael Hudson, contends that in ancient Greek and Near Eastern society the role of leaders was ‘to protect the population from being reduced to debt dependency and clientage.’ He believes the Romans changed all that:
‘In creating what became the Roman Empire, an oligarchy took control of the land and, in due course, the political system. It abolished royal or civic authority, shifted the fiscal burden onto the lower classes, and ran the population and industry into debt.’ Hudson claims that tendency continues in Western oligarchic democracies, which have failed to ‘protect the indebted population at large’.
Hudson is, of course, skipping over a few things, such as the admonition against usury. Neither is it just a problem for the modern West. China has a massive debt problem too; their game of kicking the can down the street is also coming to an end. There are reports of a forced debt jubilee as homeowners refuse to pay their mortgages, a problem that is also spreading to property suppliers. China’s banks are state owned so the country can cancel debt more easily, but it would cause a massive economic upheaval and suggests that the Middle Kingdom’s economic miracle, which heavily depended on massive business investment, especially into property, is over.
In the West, debt forgiveness is far harder to achieve without bringing down the system. Most of the lending comes from fractional banking, whereby banks are allowed to hold in reserve only a fraction of the money deposited with them. If the debts that are cancelled exceed the amount a bank has retained, then it will collapse.
Despite this seemingly intractable problem, the prospect of debt forgiveness is increasingly being contemplated – or seen as inevitable. As the financial commentator Charles Hugh-Smith observes: ‘The only real solution to over-indebtedness since the beginning of finance is default. There are pretty names for variations on default that sound much less gut-wrenching – debt jubilees, refinancing, etc. – but the bottom line is the debts that can't be paid won't be paid and whomever owns the debt as an asset absorbs the loss.’
David James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.
Main image: Falling dominoes. (Getty Images).