The Bennett Newsletter
"Misery April"
Charles Dickens’s Mr. Micawber famously remarked “Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery”. His strictures seemed odd to a generation but now command respect as the latest IMF Financial Stability Report indicates misery ahead, especially for the debt-laden developed economies.
The financial crisis is entering a second phase. Phase one was a panic contained by government rescues and guarantees. There were severe knock-on effects, with mounting unemployment and an average loss of output equivalent to 27% of GDP. The situation has been stabilised, as the global economy responded to stimulus. Financial havoc created shock: many people now feel repulsion about debt and dismay about declining assets.
The second phase will make many people miserable. Governments are repairing their balance sheets and deal realistically with their debt. Citizens will experience declining net real income for an expended period as taxes rise, government services decline, interest rates rise, and growth, in the developed countries, is sluggish.
Readers may reasonably ask why I can be so certain that the medium-term future will be painful. My reply is that the best analysis we have, especially from the IMF, has all the evidence necessary. Moreover, we have only to look to Greece or Ireland today to see the fiscal consequences of over-debtedness: the markets impose austerity. Moreover, there are many historic examples of governments not delivering the education and welfare services they desired because the debt burden was too crushing.
Debt in NZ history
In the first 100 years, there were only three years in which NZ reduced its debt, and even then by minor amounts. Raising capital for railways, immigration and public works etc always burdened budgets. In the period 1895-1908, for example, debt was the budget’s first charge, consuming 24%-36% of expenditure. In 1908 debt cost ₤2,187,000 which was 10 times expenditure on defense, ₤840,000 went on all education, ₤330,000 on pensions and a mere ₤140,000 on hospitals.(Source: 1908 year-book) Politicians wanted to spend more in these areas but could not without unacceptable increases in taxation. Taxes greatly increased in war time, and in 1945 the government again had to pay ₤22.5 million in debt service (some still from 1914-18), one third of expenditure. The total expenditure on health, pensions and education was ₤16.5 million, well below spending on debt. Debt was a terrible burden
then and debt servicing is looming over societies again, nowhere more than in Greece.
Greece
Greece can be regarded as a special case. We know Greece cooked the books, disguising debt, when it joined the Eurozone. And, it then went on a spending spree of roads to nowhere and lavish Olympic Games. It reduced unemployment by creating a bloated public service and caved into union pressures for high wages (which are now 30% above German levels). It is an amazingly corrupt society, where every little service like getting a school place or a driving license requires a bribe. This extends to health: a heart stent is four times dearer than Germany.
Its latest budget slightly reduces the deficit and introduced austerity measures including tax increases, a public-sector pay freeze, higher petrol prices and projected retirement age rise. The public have responded with violent protest, strikes in schools, hospitals and all transport. Many Greeks see no fault of their own, blaming foreign speculators. The world owes them good living standard not “barbaric” cuts.
Yet Greece’s unacceptably large budget deficit is merely an acute form of a more general malaise. Ireland had a 14% budget deficit; Greece 13.6%, Spain 11.2% .New Zealand has a budget deficit. The US, UK and Japan have monstrous deficits... the market is not imposing marked penalties upon them but it may do so if the Greek problem proves contagious.
The IMF has warned that the Greek problem may be contagious; indeed that biggest risk in the world is that 'if left unchecked- market concerns about sovereign liquidity and solvency in Greece could turn into a full-blown and contagious sovereign debt crisis”. Markets are stressed with a flood of debt issues and yields are increasing.
Last week, the Greek government was reportedly in a state of “nervous exhaustion”. It had enough money to get through April but insufficient to redeem a €9 billion bond in May.
This is crunch time. The debt-market wants 9% and Greece could never survive at that rate. It is hopeless to appeal to the EU as German public opinion is resolutely against helping. Greece depends now on IMF help. It will need special treatment next year to roll-over another €40 bn. Default or leaving the EU cannot be ruled out.
Gross debt
Budget deficits are normally quite acceptable in a recession as Government face falling revenue and increased demands of the unemployed. A mild stimulus to the economy is perfectly acceptable: normally. But the size of the budget deficits as well as the rescue packages has inflated government debt to dangerous heights.
The IMF predicts widespread austerity because many counties have “outsized deficits” and an “unsustainable debt trajectory”, and rely on foreigners to buy their bonds. A crisis can come quickly, especially when clusters of debt maturities fall due, as they did with Greece.
The World Bank’s Global Prospects Report projects global growth at only 2.7% this year, and warns that the effects of the recession will last for years. Present growth rates are “not strong enough to undo the damage” and be insufficient to absorb newcomers in the labour force, let alone reduce the unemployed. This means that “the hardship of the people will last a long time. The developing countries will grow at 5.2% this year, much lower than the 6%-7% needed to absorb new workforce entrants.
The Bank says the stimulus measures are losing steam and world industrial production is slowing. It also warns that rising borrowing costs and declining credit availability will cut developed countries growth rates by between 0.2% and 0.7% annually over the next five to seven years. Debt reduction, on the top of that will inflict a great deal of pain.
PS. My remarks about the banks getting their comeuppance last week were timely: the IMF is proposing a global “Financial activities Tax.”.
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