Shifting the burden
Apr 8th 2010
From The Economist print edition
Governments have taken the debt strain, but can they get rid of it?
WHEN Hercules wanted to steal the golden apples of the Hesperides he offered a trade with Atlas, the titan who was holding up the heavens. Hercules would assume the burden for a bit if Atlas would fetch the apples, which were guarded by a many-headed monster. When Atlas returned, Hercules had to trick him into taking back his load.The story can be seen as an analogy for the debt crisis. In a bid to prevent economic collapse the public sector has taken on some of the debt burden of the private sector. But in the medium term governments need to persuade the private sector to become the engine of economic growth once more.
The latest news has been fairly encouraging. The purchasing managers’ indices for March were strong across the board, indicating that the global economy may be generating its own momentum. The recent strength in commodity prices, the rise in bond yields and the continuing stockmarket rally can all be seen as signs that a “normal” recovery is under way. With central banks in America, Europe and Japan unlikely to raise interest rates any time soon, the optimists believe the recovery can become firmly established.
But completing a successful handover from Hercules back to Atlas will still be tricky. Governments have traditionally been able to assume a heavy burden of debt because their taxation and money-printing powers give them an instant-overdraft facility that is not open to the private sector. It is hard (although not impossible) for governments to be subject to the kind of liquidity crisis that hit the banks in the autumn of 2008.
Markets will nevertheless react if they feel that governments have taken on too big a burden. In Greece the current cost of long-term government debt, at around 7%, is simply unsustainable given the likely growth rate of nominal GDP and the high debt-to-GDP ratio. It may need to transfer the load to other governments.
But you could argue that the Greek crisis is simply an example of predators picking off the weakest member of the herd. The wider issue is whether governments in general will come under pressure to cut their deficits. Sebastien Eisinger of Pictet, a Swiss bank, suggests that governments are in a race to revive their economies before the markets lose patience with the scale of their deficits. For those governments that lose the race the resulting fiscal tightening could choke off the nascent recovery.
If the public sector spends less, will the private sector take up the slack? There has been a revival in corporate-bond issuance, but the all-important small-business sector seems unwilling, or unable, to borrow. The end of the Federal Reserve’s scheme for purchasing mortgage-backed securities has already led to a jump in the rates paid by homebuyers. Broad-money supply is contracting in the euro zone and growing only slowly in America. A recent paper* by five leading economists concluded that there would be a “continuing, if modest, drag from overall financial conditions on economic growth during 2010”.
Dhaval Joshi of RAB Capital, a hedge-fund manager, says there is a close link between global economic activity and the sum of Chinese and American borrowing, albeit with a nine-month lag. With the Chinese government now trying to crack down on credit creation, that suggests a slowdown in global growth in late 2010 and early 2011.
The problem with a Keynesian (or indeed a monetary) stimulus is that it can become addictive. Governments never feel the economy is quite strong enough to withdraw it. But as a British election campaign begins, it is worth remembering that past governments have eventually been forced to change tack. In the 1970s the then Labour prime minister, Jim Callaghan, declared to his party conference that: “We used to think that you could spend your way out of recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.”
This time round the problem may not be inflation but market indigestion caused by heavy bond issuance by both governments and companies. The debt burden may be too big, even for the combined strength of Hercules and Atlas.
* “Financial Conditions Indexes: A Fresh Look after the Financial Crisis” by Jan Hatzius, Peter Hooper, Frederic Mishkin, Kermit L. Schoenholtz and Mark W. Watson
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