6 Options For Resolving The Global Debt Crisis
In 2008 the
global financial crisis began to morph into a global debt crisis. That's
because the massive money printing and bailouts undertaken by many of
the world's largest economies dramatically increased their debt burdens.
Today
the global debt crisis is perhaps the single biggest threat to our
economic future and therefore understanding how it might be resolved is
vital. This article examines six options for resolving the global debt
crisis.
Option one: Grow our way out
Normal
levels of economic growth simply wouldn't be sufficient to grow our way
out of such unprecedented debt. In order to get the kind of phenomenal
growth rate required, governments around the world would need to adopt radical economic policies.
The problem however, is that far from implementing radical economic
reform, the world's most indebted nations continue to pursue loose
monetary policy, big government and bailouts.
Another thing that
could bring about extraordinary economic growth is a major technological
breakthrough. A breakthrough in the area of energy generation, for
example, could create new industries, put millions of people back to
work and reduce the cost of energy. The problem here is that such
advancements typically take many years, or even decades.
Option two: Major interest rate cuts
With
interest rates already close to zero there is little or no room for
more cuts, and certainly major cuts are out of the question.
Option three: A bailout
An
indebted nation can be bailed out if it is small enough, and if there
are sufficient solvent nations willing to provide the funds. The problem
today is that the world's most indebted nations, which include the
U.S., the U.K., Japan, and France, are far too big to bail out.
It
is also not just one or two countries that are suffering from chronic
indebtedness. Take the eurozone for example. The Maastricht Treaty
requires that member countries maintain a budget deficit of no more than
3% of GDP. Today however, only 6 of the 17 member nations meet that
requirement and all 17 are running a budget deficit of some description.
When
so many nations are in trouble, providing bailouts for the likes of
Greece, Portugal and now Spain simply reduces the solvency of the
eurozone as a whole. Therefore bailouts are not a long-term option for
resolving the debt crisis.
These first three options are the easy
ones that cause little or no economic and political pain. Unfortunately
these options are either no longer available to us, or, in the case of
option three, they provide only short-term relief from the crisis whilst
making the eventual outcome worse. The three remaining options are all
difficult and painful.
Option four: Default
When
a nation defaults on its debt it is those holding that debt that incur
the losses. Typically this will include other governments, pension
funds, and bond/ mutual fund investors.
Due to the interlinked
nature of today's markets, an outright default by even a small country
would send tremendous shockwaves throughout the global financial system.
Having had a taste of this kind of financial chaos with Lehman
Brothers, we can be confident that this is one option that politicians
will do their best to avoid.
Option five: Austerity
Austerity
is designed to cut the budget deficit, reduce government spending and
ultimately reduce the level of outstanding public debt. However, as we
have seen in Greece and Spain, when government spending is cut
aggressively it plunges nations into a depression, especially if those cuts are not accompanied by the appropriate policy reforms.
Austerity is a painful option that typically brings about higher unemployment and lower economic growth for many years.
Option six: Money printing & inflation
In
order to understand how money printing and inflation can be used to
help resolve the debt crisis it is first necessary to understand what
inflation is and how it's created.
It's a commonly held belief,
even among many economists, that inflation describes rising prices. This
is misleading however, since rising prices are a symptom of inflation
rather than the cause. The true cause of inflation is an increase in the
supply of money and credit, which simply reduces the value of the money
already in circulation. However, as governments print new money they
not only destroy the nominal value of paper money, they also destroy the
nominal value of debt.
When you increase the amount of money in
an economy, but don't increase the amount of goods, you end up with more
money chasing the same quantity of goods. Sooner or later this leads to
inflation as new money competes with old in bidding up prices. Money
printing, for example through Quantitative Easing
This
is by far the most politically palatable option. For example, if a
government can maintain an average inflation rate of 4% for a period of
seven years, it will have eroded nearly 25% of its debt.
The bottom line
Over
the next few years I expect to see more nations default on their debt. I
also expect more countries to adopt austerity measures. Above all
however, I expect governments around the world to take the easy way out
and embark on more massive money printing in an attempt to inflate away a
good portion of their debt.
In this environment preservation of
wealth is paramount, therefore those invested in paper assets such as
cash, government bonds and bank CDs, should monitor this key macro story
closely. If inflation begins to pick up they should consider moving a
portion of their wealth into tangible assets such as gold and silver,
which have a history of maintaining their purchasing power over the long
term.
This is the subject of an excellent book by Claus Vogt.
