Much of being made of the profligacy of southern European countries, their unsustainable levels of debt. It is worth asking how big this debt is in the overall scheme of things. You get some interesting answers. According to McKinsey & Company, global public debt last year was about $41 trillion. Private debt, consisting of financial institution bonds, non-financial corporate bonds, securitised loans and non-securitised loans is estimated at $117 trillion. So how big are these European debts in that context? Italian debt is $2.4 trillion, about 118% of GDP. It is 1.2% of global debt. Spain’s $900 billion, or 60% of GDP is 0.5% of the global total. Germany’s $2.6 trillion (78% of GDP) is 1.6% if the total. France’s $2 trillion (80% of GDP) is 1.8% of the total and the UK’s $1.8 trillion (80% of GDP) is 1.1% of the total. Add up them all and it is only 6.1% of the total global debt. The US has $15 trillion in debt, a touch over 100% of GDP and Japan as $12 trillion in debt or 225% of GDP.
And the profligacy is where, again?
The bigger point is that sovereign debt is only 25% of the total, most of it American and Japanese, both of which are special cases. The US has the world’s reserve currency, so can rack up debt with relatively little risk of being punished, until such time as there is a genuine alternative to the greenback as the reserve currency — for which read the floating of the yuan, assuming that the euro stays intact in some form. Japan is hermetically sealed off, owing the debt it itself.
So the picture that we are getting, that European debt is massive and unsustainable is plainly wrong. What is rather happening is that the real culprit, the explosion of private debt, much of it the fictions of what I call “meta-money” rests on a foundation of the “real” economy and when that “real” economy cracks from the strain then the whole edifice starts to sink.
Think of it like this. Imagine the global financial system as a block of flats. The first floor is conventional economics transactions plus the cash flow of those economies. The second floor is conventional forms of finance, such as government bonds, equity markets, corporate bonds, bank lending and confected forms of new finance: securitisation, new forms of new debt creation, debt/equity hybrids and so on. The third floor is extreme meta-money: $600 trillion of derivatives and who knows what else. None of it on balance sheet and much of it untraceable. Over $3 trillion of it spins around the world each day — Europe’s entire debt in about two days. That third floor has been the price of allowing financial “de-regulation” — that is, letting traders make up their own regulations.
Now, as we see, the second floor is getting pretty large. It is about 300% of the global annual GDP. Not cause for panic, but cause for concern. But the third floor …. Wow. At face value it is 12 times global GDP. Even if it “nets out” at at a quarter of that amount, it is still another 300% of global GDP. Because it is meta money, it does not use conventional debt with conventional interest rates, but it requires massive amounts of leverage to work because the trades are on such fine margins, as Long Term Capital Management (LTCM) displayed back in 1998 when the hedge fund’s debt threatened to undo the world’s financial system, requiring a bailout of the investment banks.
Now here is where I think much of the current analysis over the last few years of the series of crises has missed the point. It has focused on cracks in the first and second floors — the housing market (floor 1) in the US that “caused” the GFC; the bond market crisis in the EU that will “cause” a global slowdown now — when it is parts of the second floor and the third floor that are the real problem. If the upper floor of a building is too big relative to the ground floor, we all know what will happen. It is threaten to crack and at best be rickety. Yet rather than looking at that insanity, most of the attention goes on what is happening in the first floor — and especially what governments are “doing” about the management of their economies. There is also some concentration on the need to deleverage on the second floor, but that, too, is conventional analysis. It is easy to concentrate on the familiar, but these circumstances are very far from familiar.
Many observers are looking in the wrong place; the symptom and not the cause. It is classic post hoc analysis — “what did happen must have happened” an inversion of cause and effect. The problem is the massive expansion of debt, which has resulted in the excessive financialisation of developed economies, and the absurd, Dr Strangelove activities in the meta markets: derivatives, high frequency trading, and other madnesses. Meta money has also created massive leverage, although whether one calls it debt is a moot point.
The lesson for governments is the lesson that the developing world brutally learned over the last decade. Don’t get exposed to the international capital markets (in the case of developing economies, the $US). It is no accident that Australia, which has very little government debt, is skating through all this. You can do what Japan has done, and owe all the debt to yourself, or just balance the public books. Either way, sovereign states need to stay away from the third floor.