Meantime, most of the issues we’ve looked at in the context of Wall Street hold equally true for London. The equity market in Britain is still too high. The housing market in Britain is way too high. The banks are overexposed to eurozone sovereign debt and mortgages in particular. The various structural weaknesses of the financial markets—a lack of transparency, weak accounting rules, insufficient regulation, and much more—are every bit as true in the Square Mile as in Manhattan.
So much for Britain. Now for the world.
Part Three
The Wider World
15
The rise and rise of Planet Ponzi
Planet Ponzi sounds like a great title for a book. It’s catchy, it’s shocking, it makes a point. The cost of that catchiness is that it sounds phony. A marketing trick. It feels akin to those books called things like How To Lose Twenty Pounds In Twenty Days And Never Even Feel Hungry. You might choose to buy the book, but you’re never dumb enough to believe the promise in the title. Planet Ponzi isn’t like that. The title might sound shocking, but I challenge you to locate a more precise two-word descriptor of the financial history of the past three decades. You’ll find it tough.
This chapter has a single mission. Its task: to demonstrate the growth of Planet Ponzi in country after country, decade after decade. Our principal data source is the McKinsey Global Institute, and all those data are available online. If you don’t want to trust McKinsey, you can ferret out the original data yourself. I’ve made some of those checks. I didn’t get exactly the same numbers as McKinsey—they may have used slightly different data sources or different exchange rates, or I may be looking at more recent data that have been slightly revised—but to an impressive degree my results converged with McKinsey’s. In other words, the data we’re about to look at are impeccable. If you’ve got a dash of the conspiracy theorist in you, you might wonder if the governments and central banks of the world are being altogether honest in their portrayals of debt, but if they’re not being honest, they’ll certainly be understating, not overstating, the real problem.
OK. Preamble over. Let’s look at the data. And though the US boasts arguably the most bankrupt government in the world today, the United States as a country is by no means the most indebted. The precise winner is a little hard to call, but the United Kingdom and Japan are currently duking it out for the title of World’s Most Indebted Country. Table 15.1 sets out the figures.
Table 15.1: The rise and rise of Planet Ponzi: debt as % of GDP
Source: ‘Debt and deleveraging: the global credit bubble and its economic consequences,’ McKinsey Global Institute, Jan. 2010.
I’ll talk a little about what precisely these figures denote in a moment, but for now let’s just read the headlines. In the US, total indebtedness is around 300% of GDP. In Britain and Japan, the figure is closer to 500% of GDP. In all three countries, indebtedness has grown hugely in the space of just twenty years. In the US, indebtedness as a percentage of GDP has increased by around half. In Britain, it’s more than doubled. Japan’s figures have risen by almost a quarter from an already very high base. Looking only at government debt in relation to GDP, Japan has seen an increase of 235%, the UK of 85%, and the US of 18%. In the latter two cases, the post-2009 explosion of borrowing is driving those totals up higher still.
These figures are shocking. Or at least, they would be shocking if the remorseless growth of Ponzi-ish thinking hadn’t driven us all senseless. In 1990, nobody in the world looked at America or Britain and thought, ‘Gee, you know what, these economies would be a whole lot stronger if only there was more debt floating round.’ On the contrary, any sane person in 1990 would have wondered why the heck government debt in America stood at 57% of GDP. We’d just won the Cold War, the economy was on a roll: debt should have been trending down to zero. Likewise, at the end of the 1980s, a decade when leveraged buyouts were all the rage on Wall Street, people were anxious that corporations had taken on so much debt that investment and growth would be inevitably impaired. People were worried about the incessant increases in credit card and mortgage debt, and the changes in culture that went along with that increase. These worries were neither flippant nor ill-founded. They were the right ones to have. Trouble is, our policymakers and regulators didn’t respond when it would have been easy and relatively costless to do so. They were too toothless, too inert, too dumb, too cowardly. The result: a train which could have been braked gently to a halt can now only be halted by blowing up the track, with all the ugly consequences that will involve.
Or perhaps there is an alternative: the Japanese option. Japan’s debt figures have hit a ceiling and are no longer rising. The country simply can’t bear more debt. Banks can’t lend, companies won’t invest, the workforce is shrinking. Although interest rates are rock-bottom, the economy still isn’t reviving. Indeed, the real tale in Japan is the way the government is simply running up larger and larger debts in the ludicrous hope that ‘something will turn up.’ We’ll look at the hollowness of that hope in a while, but for now let’s just acknowledge that there is an alternative to the track-blowing-up option. You can always try the zero-growth, rising-debt, ghost-economy option. Me, I’d blow up the tracks.
We’ll look at some more scary numbers from around the world in a few moments—I know, I’m Mr Fun—but before we do so I should be a little more precise about what the figures mean. We also need to be very careful about what is and isn’t scary about these numbers.
Table 15.1 shows gross debt in the economy broken down into the four main sectors: households, governments, corporations, and financial institutions. Crucially, the term ‘gross’ debt means that we’re ignoring any assets. So although Japanese banks (for example) have debts equal to 110% of the country’s GDP, they also have financial assets offsetting those debts. In fact, given that Japanese banks (to go by their published accounts) have got plenty of underlying capital, Japanese banks own assets that are greater than their overall liabilities.
Likewise, although households in America and Britain owe an amount equal to around 100% of their national GDP, those households will also hold a variety of offsetting assets: houses, bank deposits, stocks and bonds, pension assets. Those assets are, in both countries, considerably greater than the stock of debt. In the UK, for example, although the gross debt of households is roughly equal to 2009 GDP—an amount equal to approximately £1.4 trillion—the total stock of household assets was equal to around £6.3 trillion. The difference between the two figures—total household assets less total household debts—is close to £5 trillion, or well over three times the size of British GDP. A similar kind of equation holds true in the US, in Japan, and in the other countries we’ll survey in this chapter.1
At this point, your reaction is likely to be one of confusion. After all, if households in all these countries are sitting on mountains of assets, who cares if they also happen to owe some money? OK, so banks may owe a lot of money, but if they hold assets that are worth more than their debts, then what’s the problem? And corporations: some corporations may owe large amounts of money, others have got stacks of cash. Microsoft alone holds almost $40 billion of cash and short-term investments. It has nearly $90 billion in total assets. Although it does have some long-term liabilities, they’re trivial in comparison.2 In short, it can easily look as though these high levels of debt aren’t a problem, given the amounts of assets floating around.
We’ll come to that—perfectly reasonable—challenge in a moment. But first it’s important to realize that, if you’re looking at things on a global level, there will always be more assets than debt. Unless you happen to owe money to Martians or the Man in the Moon, your financial debt is bound to be somebody else’s financial asset. The two things will always cancel out. At the same time, the world is full of lots of proper, tangible, valuable assets: houses, factories, offices, oil wells, power stations, and so on. It’s also full of lots of highly valuab
le assets that have very little to do with tangible things. Apple, for example, has a market capitalization that is about $300 billion in excess of the net assets (mostly cash) on its balance sheet.3 That doesn’t mean that Apple is running some kind of huge Ponzi scheme; it simply means that Apple has some wonderful products, a terrific brand, and a dominant position in some of the hottest consumer segments of the moment. There’s nothing phony about its market valuation.4 In short, once you’ve canceled out the thicket of financial debts and financial assets, you’ll be left with a whole heap of physical things (houses, offices, factories, and other stuff) and a whole heap of intangible things (patents, designs, brands, and so on), with loads of solid value in both piles. Taken as a whole, therefore, the world is not insolvent. That’s not the issue.
Nor is the issue that America has been secretly taken over by China, or that Brazil has bought the United Kingdom, or anything like that. As of June 2011, mainland China held a little over $1 trillion in US Treasuries, only slightly more than Japan. That trillion dollars is certainly significant as an indicator of which way the economic wind has been blowing in recent years, but it still only amounts to a month or so of American GDP. If you broaden the issue and look at all overseas investments held by Americans and subtract all US investments held by foreigners, you’ll find that the US has a net debt position of about $2.5 trillion. Clearly you’d prefer that the US wasn’t in a net debt position at all but, given the size of the figures we’ve been hurling around in this book so far, $2.5 trillion here or there is hardly critical.5
The same goes for most of the other countries on Planet Ponzi. British government statisticians, for example, reckon that the country has a net ‘international investment position’ of minus £180 billion. That’s equivalent to just over a month’s GDP, little more than a rounding error in terms of the sums involved. And that’s assuming you trust the figures. The government’s statisticians don’t possess the data to estimate a market valuation for all Britain’s overseas investments and all foreign investments in Britain. For reasons we don’t need to go into here, however, there are reasons to believe that if all investments, British and foreign, were estimated at their current market value, Britain would have a positive international investment position.6
All this leaves us with a puzzle. We’ve seen a frightening rise in the level of gross debt in the US, the UK, and Japan, but:
financial assets have also increased;
all three countries have a huge stock of valuable physical assets (houses, factories, offices, etc.) and of valuable intangible ones (brands, designs, patents, etc.);
although individual countries may or may not owe money overseas, the quantity of any external debt is relatively modest.
In effect, what’s happened in America is that a forest of financial debts has grown up, but those debts are largely owed to other American entities (individuals, banks, and corporations). To the extent money is owed overseas, American entities own offsetting claims so that the net position is more or less flat. The same is true of Britain. The same is true of Japan. The same is true of all the other countries we’re about to survey.
The question is: does this matter? If we’re owing money to ourselves, why the heck should we care? If it’s all just circulating within the system, maybe gross debts could rise to 1,000% of GDP and we wouldn’t have a problem.
You wouldn’t expect me to agree with that proposition and I don’t. It’s catastrophically false, a financial insanity. An elementary school kid would see through the deception—it’s only our policymakers who are fooled. The issue is not the net levels of debt. The net levels of debt are always going to be OK, those things will always cancel out. The issue is the structure. The quantity of debt we have in our financial system creeps through it like some deadly ivy: poisoning, choking, constricting, and killing.
The collapse of Lehman Brothers proves better than anything why it’s not the net levels of debt that count. As we’ve noted before, Lehman collapsed with net debt of ‘just’ $129 billion. In the context of the entire world’s financial system, that $129 billion was a pinprick, nothing more. But it wasn’t the net debt that counted. It was the gross debt. The gross debt of $768 billion. The derivative contracts with notional principal of a further $729 billion. When Lehman failed it caused a mass panic in the financial markets, because nobody knew where they stood.
Worse still, no one knew where other firms stood. So let’s say you were in charge of the First National Bank of Alligator Gulch. You were owed money by Lehman, but you’d done your calculations and figured you were going to be OK. You’d take a hit, but you’d be fine. Unfortunately, though, your bank had also lent money to the Guaranty Savings Bank of Crocodile Canyon. You happen to know that the folks over at Croc Canyon had also been lending money to Lehman Brothers and, for all you knew, they’d lent too much. Maybe Croc Canyon was now in trouble. Which would mean that maybe your firm was now in trouble too. You couldn’t take the chance. You’d have to play it safe. You’d have to wind down your loans to Croc Canyon and any other institutions which might have been weakened. Trouble is, you knew Croc Canyon—and every other bank which touched Lehman, or which touched banks which touched Lehman, which is to say pretty much every damn bank in the world—would be in the same position. So your ability to secure funds had just deteriorated, which meant …
Well, we know what it meant. It would end up meaning that the entire financial system ground to a halt. Even the really basic stuff that banks are meant to do—supplying cash to ATM machines, holding deposits, making mortgage loans—became uncertain. The problem arose because there was way too much debt, way too much complexity, way too little transparency, way too little oversight, no accountability.
There’s another reason for strenuously opposing the rise in debt levels. Aggregate demand is made up of how much stuff we produce—that’s the only real measure of how rich we are—plus any change in overall debt levels. So if we produce stuff worth $100, but take out a $10 loan, we can end up purchasing goods worth $110. That sounds attractive—the magic of credit—but at some point you have to pay back the $10 along with the interest. That means that aggregate demand will at some stage retreat from $110 to $90 or less. Within a carefully planned family context, those things don’t need to matter. At the level of an entire economy, such swings in demand make for a crunchingly painful recession … and it’s no surprise, therefore, that the Western world has been hit with its worst recession since the 1930s and that many countries have never seen such a painful recession. The cause of the problem was way too much debt creation in the good years, a painful payback period now.7
So gross debt matters. In America, Britain, and Japan, debt rose to toxic levels over the course of two decades or more. And it’s the same elsewhere. Using the same source—the McKinsey Global Institute—you get the picture across Planet Ponzi shown in table 15.2. (I’ve included the data for the UK, the UK, and Japan from table 15.1 so the full horror can be seen all in one place.)
Table 15.2: Planet Ponzi goes global: total gross debt as % of GDP
Source: ‘Debt and deleveraging: the global credit bubble and its economic consequences,’ McKinsey Global Institute, Jan. 2010.
If I were being kind, I’d say that Canadian policymakers haven’t made too horrible a mess. It’s inexplicable to me how a resource-rich economy at peace with itself and its neighbors, with a colossal market lying just to its south, can possibly rack up government debt amounting to some 70% of GDP. Nor can I understand how policymakers thought it was sensible to allow the household sector to follow their American neighbors in rushing to take out mortgages, loans, and credit card debt. But let’s not be too hard on the Canadians. They’ve done a bad job, but they’ve done the least bad job of anyone we’ve looked at. Their banks are safe. Their economy is growing. If they wake up one day and remember to start paying back their government debt, their country will be doing just fine.
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Elsewhere, what can you say? The picture is so awful, it’s almost impossible to exaggerate the problems. Japan is so horrifically indebted, and has been for so many years, it looks like a shoo-in for the title of Supreme Ruler of Planet Ponzi. On the other hand, the British record is so alarmingly abysmal you’d have to say the champion of the East is about to be replaced by a new champion arising from the West.
But there’ll be competition for the title. Britain boasts a huge and internationally significant financial sector, which tends to push up its figures. Spain doesn’t have that excuse, yet has ramped up its debts to the same vastly excessive degree. South Korea has a penny-pinching government, but debt is running riot everywhere else in its financial system. In Germany, France, and Italy—in a period, please remember, when the Cold War ended, when there were no wars of existential consequence, when trade boomed, innovation flourished, and prosperity reigned—debt increased by trillions of dollars over and above the natural growth in GDP. That increase in debt amounted to more than an entire year’s output for all three of those European countries.
By these abysmal standards, you could be forgiven for thinking that the United States is not in too bad a state. Except that, as we saw in the first part of the book, the published data on US government debt wildly understate its true position. If we added in all the extras we took a look at—state and federal pensions, social security, Medicare, Fannie Mae and Freddie Mac—the US debt numbers would increase by hundreds of percentage points.
Other countries, too, have liabilities of this sort. The trouble is measuring them. Only one country in the world provides an honest set of accounts. The UK government recently published its first ever ‘Whole of Government Accounts,’ which sought to account honestly for every part of government and for all liabilities: pension liabilities, provision against future liabilities, and so on. It’s a stunning fact that Britain first did this in 2011 and that other countries don’t do it at all. If a private sector company drew up a set of accounts which didn’t consolidate all wholly owned subsidiaries and which didn’t honestly report all its liabilities (including nonfinancial ones), that company would likely be committing criminal fraud. In the UK, where people are soft-hearted about these things, those found guilty of fraud can go to jail for seven years. In the US, where we take a more bracing approach, fraudsters can be sent to jail for life. Bernie Madoff’s $18 billion racket saw him sent to jail for 150 years. The fraud currently being perpetrated by the US Treasury is at least a thousand times greater than that.
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