Debt Doesn’t Matter…

Last week, McKinsey Global Institute reported that the world’s total debt levels were twice what we thought — $200 trillion, or about three times the planet’s total output.

So, what a relief it was to discover…only a few hours later…that there was nothing whatsoever to worry about. Our concern was totally misplaced. It was nothing but a colossal misunderstanding or, as Nobel laureate economist Paul Krugman put it in the New York Times, a ‘bad analogy’.

So now, we can go back to our Portuguese lessons here in São Paolo without a care.

Mastering the Essentials

Are you curious about how much progress we are making in Portuguese?

We didn’t think so. But we’ll tell you anyway.

We pride ourselves on our ability to learn foreign languages quickly. Put us down in any city in the world…and after three days of intensive language lessons we’ll be able to walk into any bar in the city and order a beer. With confidence.

So it is in São Paulo. We can’t conjugate the verb conhecer yet. We can’t pronounce it either. But we have mastered the essentials — ‘please’, ‘thank you’ and ‘debt bomb’.

Only now there’s no further need to think about debt. Especially here in Brazil. Even after 13 years of socialist government, public debt is only 60% of GDP.

According to World Bank data, private credit was 70% of GDP as of the end of 2013 — or barely a third of America’s 192% level.

Of course, Brazil used to be a basket case of epic proportions…

At the start of 1980, for example, a hamburger cost about 4 cruzeiros (the Brazilian currency from 1942 to 1986). The same hamburger cost about 5 trillion cruzeiros by Christmas 1997.

Brazil had to bring in a new currency — the real — and a new government to set things right. That’s not the kind of thing you forget overnight.

Especially when there is a whiff of inflation in the air. Prices are already rising in Brazil at an annual rate of 7.1% — beyond the government target of 4.5% plus or minus two percentage points…and the highest rate since 2003.

But why bother to think about it?

‘Deficits don’t matter,’ said Dick Cheney. ‘Debt doesn’t matter either,’ says Paul Krugman.

 

‘Money we owe to ourselves’

What a pity. All these years, we’ve been labouring under the illusion that these things mattered. Thank goodness Krugman has finally clarified things.

From his piece in yesterday’s New York Times, modestly titled ‘Nobody Understands Debt’:

‘You can see that misunderstanding at work every time someone rails against deficits with slogans like “Stop stealing from our kids.” It sounds right, if you don’t think about it: Families who run up debts make themselves poorer, so isn’t that true when we look at overall national debt?

No, it isn’t. An indebted family owes money to other people; the world economy as a whole owes money to itself. […] Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer).

Let’s see. Debt doesn’t make us poorer. So we don’t need to worry about it.

But does it make us richer?

Ah, there’s the question… For if it makes us neither poorer nor richer, why bother with it at all?

What’s that you say, Paul, it CAN make us richer, if it is used intelligently? Isn’t that the whole point of lowering interest rates? Aren’t the lower rates supposed to encourage borrowing, spending…and greater wealth?

So, there is something about debt that can have a real effect on the bottom line, isn’t there? Debt, invested properly in wealth-producing assets, can make both borrower and lender richer.

And if that is so, isn’t it also likely that debt CAN make us poorer?

Don’t we all know that is also true?

You borrow money… you squander it…and you’re worse off. And so is the person to whom you owe the money.

You can’t pay. He can’t collect. You both lose. It doesn’t matter whether you are a family or a nation. You’re all worse off.

Debt does matter, after all.

An age of Wonders

According to the McKinsey report, world debt has grown by $57 trillion since the beginning of the crisis in 2007…raising the level of debt to GDP by 17 percentage points.

That — not real economic growth — explains why US stocks are so expensive. It is also why there is a house for sale in Florida for $139 million.

And it’s why a single painting — which was worth almost nothing when put on the market in the late 19th century — recently changed hands at auction for $300 million.

This reveals the true absurdity of Krugman’s ‘debt doesn’t matter’ argument… and the futility of central bank policies since 2007.

The financial crisis that began in 2007 came as a result of too much bad debt in the US housing and financial sectors.

Americans couldn’t pay down that bad debt. They had to put on the brakes. Suddenly, all those mortgage-backed securities proved to be worthless… and every bank on Wall Street was threatened with bankruptcy.

How did the feds respond?

They stepped on the gas!

Government debt grew by $25 trillion over the last seven years. And eight out of 10 households (mostly out of the US) have more debt than they did in 2007.

Meanwhile, China has quadrupled its total outstanding debt — from $7 trillion in 2007 to $28 trillion last year. China’s debt — approaching 300% of GDP — is now greater than that of the US or Germany. And half of it is collateralized by real estate.

Yes, dear reader, we live in an Age of Wonders…

We wonder what will happen to $200 trillion worth of world debt when the collateral gives way. We wonder why anyone would pay $300 million for a single painting by a dead Frenchman.

We wonder when the Nobel Foundation will reconsider…

Regards,

Bill Bonner,
for Markets and Money

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Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.


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