THE ECONOMIST, JUNE 2010. Rich countries borrowed from the future. Paying the bill will be difficult, and so will living in a thriftier world
DEBT is as powerful a drug as alcohol and nicotine. In boom times Western consumers used it to enhance their lifestyles, companies borrowed to expand their businesses and investorsemployed debt to enhance their returns. For as long as the boom lasted, Mr Micawber’s famous injunction appeared to be wrong: when annual expenditure exceeded income, the result was happiness, not misery. For a long time debt in the rich world has grown faster than incomes. As our special report this week spells out, it is not just government deficits that have swelled. In America private-sector debtalone rose from around 50% of GDP in 1950 to nearly 300% at its recent peak. The origins of the boom go even further back, reflecting huge changes in social attitudes. In the 19th century defaulting borrowers were sent to prison. The generation that lived through the Great Depression learned to scrimp and save. But the wider take-up of credit cards in the 1960s created a “buy now, pay later”society. Default became just a lifestyle choice. The reckless lender, rather than the imprudent debtor, was likely to get the blame. As consumers leveraged up, so did companies. The average bond rating fell from A in 1981 to BBB- today, just one notch above junk status. Firms that held cash on their balance-sheets were criticised for their timidity, while bankruptcy laws, such as America’s Chapter 11,prevented creditors from foreclosing on companies. That forgiving regime encouraged entrepreneurs (in Silicon Valley a bankruptcy is like a duelling scar in a Prussian officers’ mess) but also allowed too many zombie companies to survive (look at the airlines). And no industry was more addicted to leverage than finance. Banks ran balance-sheets with ever lower levels of equity
capital; privateequity and hedge funds, which use debt aggressively, churned out billionaires. The road to riches was simple: buy an asset with borrowed money, then sit back and watch its price rise. Related items
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All this was encouragedby the authorities. Any time a debt crisis threatened the economy, central banks slashed interest rates. The prospect of such rescues reduced the risk of taking on more debt. Bubbles were created, first in equities, then in housing. It was a monetary ratchet, in which each cycle ended with much higher debt and much lower interest rates. The end-game was reached in 2007-08 when investors realised alot of this debt would not be repaid. As the credit crunch tightened, central banks had to cut short-term rates to 1% or below.
And now the reckoning Rich-world countries now face two sets of problems. The most pressing is how to pay off their debts. Many people who have cut back their credit-card spending and firms which have seen their credit lines slashed would be horrified to see howlittle the rich world’s overall burden has fallen. Much of the debt has merely moved from the private to the public sector as governments have correctly stepped in to support banks and save the economy from falling into depression. And in the future, even more money will have to be raised, because of governments’ lavish promises of pensions and health care for the retiring baby-boom generation. Allthis debt will have to be regularly refinanced and rolled over. Crises of confidence are likely, given that the rich world’s trend rate of growth (and thus the ability of debtors to service their loans) looks set to slow. Worse, much private debt is secured against assets; while the value of the debt is fixed, the value of the assets can fall. This can cause a vicious circle as debtors are forced...