Global debt

Bill Bonner: “It’s 100% impossible for the value of stocks to be divorced from the economy”

bill bonnerDear Reader,

This is a Special Edition of the Diary. In this I speak to Bill Bonner, whose books and columns I have admired reading tremendously over the years. He founded Agora Inc. in 1979. With his friend and colleague Addison Wiggin, he co-wrote the New York Times best-selling books Financial Reckoning Day and Empire of Debt. His other works include Mobs, Messiahs and Markets (with Lila Rajiva), Dice Have No Memory, and most recently, Hormegeddon: How Too Much of a Good Thing Leads to Disaster.

Even though Bill writes largely on finance and economics, his writing style is close to literary fiction, and that is precisely what makes it so enjoyable to read him.

In this interview we talk about how the world of finance and economics has changed over the last few years. And how does Bill read the world that we live in. This paragraph summarises everything: “I just didn’t think it [i.e. the financial crisis] will go on this long but that’s also one of the realities that things that you think can’t last, actually do last longer than you expect and they get worse than you expect and then after they have gotten much worse and lasted much longer than you expect then you begin to think well maybe I don’t understand something about it and maybe there is something going on here that can last and then of course it blows up and you were right all along and then at that time of course you are not anticipating it.”

This is the first part of the interview. The second part will appear tomorrow.

Happy Reading!
Vivek Kaul

 

I guess the last time we spoke would probably have been sometime in 2011-2012.  So how have things changed?

It was surprising to me that the authorities were more aggressive than I expected coming in with the QE1, QE2 and QE3 and then the twist. And those things as expected didn’t do anything for the economy.

In fact, it may have actually slowed down the real economy.  But they did wonders for the stock market and the financial industry so they are very very popular and well those things were essentially reducing the cost of credit, making easy money even easier.

So naturally, there is more and more debt and it just seems to be a phenomenon or fact of life that when you make debt cheap, when you make it cheaper than it should be, you get people borrowing money for things they shouldn’t be doing and too much capacity, too many speculations, too many gambles, too many business expansions that don’t really make any sense.

And what did that lead to?

So we saw the effect of that in the commodity market, particularly the oil market which has been really laid low by this combination of cheap money which made it possible for American drillers to get out there all over the place and drill for oil and some marginal producers in Canada and otherwise in Brazil and everywhere to come up to increase the supply of oil. Meanwhile the actual demand for oil was going down because the world economy was actually not in a growth mode at all.

So we have those kinds of things happening and that’s all happening since the last time we talked and the huge expansion and explosion and implosion of the oil market, implosion of the commodity market and explosion in world debt which has gone up about 57 trillion dollars since 2008. So these things were really much bigger than I anticipated.

I just didn’t think it will go on this long but you that’s also one of the realities that things that you think can’t last, actually do last longer than you expect and they get worse than you expect and then after they have gotten much worse and lasted much longer than you expect, then you begin to think well may be I don’t understand something about it and maybe there is something going on here that can last and then of course it blows up and you were right all along and then at that time of course you are not anticipating it.

So why hasn’t all this debt lead to economic growth? Why hasn’t cheaper money led to economic growth because you know this was one of the beliefs that central bankers had and their actions in the last seven- eight years have been built on the belief that we will flood the markets with money, we will have low interest rates, people will buy, companies will do well and economic growth will return. Why hasn’t this happened?

Why doesn’t that happen?  And the answer is hard. I don’t really know. There is a Swedish economist named Knut Wicksell and Knut Wicksell noticed, that whenever the cost of money was too low, he said there were two interest rates.

He said there was a natural rate which is to say the rate that money should cost in a real properly functioning market and then there is the actual rate and the actual rate is jigged up by the authorities in the banking industry. Whenever the actual rate is too low, people do not invest in the kinds of things that will increase real production.

He said what they do, and I never have really fully understood this, but he said what they do when money is too cheap, they tend to go for easy things. So the banks take the easy money which is too cheap and then they invest it in US Governments Securities, you know the 10-year treasury bonds and that way they get guaranteed return, a guaranteed positive carry.

What else did he say?

And then he says that when money is too cheap people make cheap investments, one because they don’t really know what is going on.  You know the cheap money distorts the whole picture.  The cost of money is the critical number in all of capitalism You have to know what it will cost you really to borrow money. And once you know what the money really costs then you should decide whether you should build a factory, whether you should invest in this, buy that.  

You don’t know until you know the real cost of money and by distorting the real cost of money as Wicksell points out what it does is it drives out everybody away from real investment where they don’t really know what they should be doing. They don’t want to invest real money in a project where the returns are uncertain and the value of money is uncertain and everything is uncertain. So they go for these cheap investments.  These easy investments such as US treasury bonds where they know they will get paid and so you get a big increase in these debt investments. Hence, just the quantity of debt goes up where everybody is just counting on being able to borrow cheap and lend a little less cheap in order to pocket the difference without any real risk.

Even though the economies as such haven’t recovered, the stock market and the real estate markets in parts of the world have done very very well.  So how do you explain that dichotomy? Has the link between economic growth and stock market returns broken down?

Oh! It has totally broken down. We have a chart that we use. We go back to 1971, where we believe something fundamental happened when they changed the US money system. Since 1971 what you see if you look at US GDP growth, it looks more or less normal.  I mean the growth rate was higher in the 70s and it gradually went down decade after decade, it got lower and lower.

But you are talking about going down from five to three to four to three to two and now probably about zero percent, but that growth is real…that’s the real economy…that’s Main Street…that’s where people work…that’s where they spend their money…that’s where they earn their money.

When you put that on to that chart, and you put a chart of what the value of America’s stocks and bonds are, then that chart just goes right up after about 1995.

Yes that’s what the chart shows…

And so there is something going on where the stocks and the value of assets is being cut off completely from the value of the real economy that supports them, which is impossible of course.

I mean it is impossible for that to continue because ultimately any asset is only valuable in as much as the economy gives it value.  It’s not valuable in itself.  If you have a blue jeans factory and you are producing five thousand pairs of blue jeans a day but that is not worth a penny unless you have got people who are willing to buy five thousand blue jeans a day and they can only do that if they are earning enough to buy five thousand blue jeans a day.

And you know that was Say’s principle which was that “Supply creates demand”, which is a funny thing. I mean it’s easy for people to misunderstand that.  But what it really means is that it’s only because you have an economy that produces wealth that people have the money to buy what you are making.

So there is no way, it’s absolutely hundred percent impossible for the value of stocks and bonds to be divorced from the value of the economy itself.  And what we have seen is a separation and we call it a divorce. But the two have been separated for a long time and my guess is that they are going to get back together.

In the book ‘The Age of Stagnation’ Satyajit Das makes a very interesting point about how lower interest rates have not led to increased consumption and he gives a very interesting reason for it. What he says is that when the return on fixed income investments comes down, people put their money in the stock market and when they do that the pressure on companies to keep increasing their earnings so that they can keep giving dividends increases.

You know people are looking at stocks as a mode of dividend [regular income] than a mode of capital gains because the money they used to earn through the fixed income investments has come down [dramatically].  So when there is pressure on companies to give dividends in a scenario where the sales are not really growing, they fire their employees. They [also] borrow money so that they can buy back their stocks and when they buy back their stocks the earnings per share goes up and the dividend per share [as there are fewer shares than before] also goes up.  So that is why even with cheap money, easy money and low interest rates, consumer buying hasn’t picked up and hasn’t translated into economic growth.  Does this makes sense?

Well I think it totally makes sense. I saw an example of that just in today’s press which unfortunately I can’t recall. The company announced simultaneously that it was laying off 10,000 employees and had a big [stock] buy-back program. 

I think it’s just a shift that in America has been widely described as the ‘financialization’ where the money goes from Main Street to Wall Street. You can see that shift very clearly, if you look at the salaries paid on the Main Street, which have gone nowhere for decades and the salaries paid on Wall Street which have gone straight up and you could also look at the profit share of the economy.

The whole of the financial industry earned about 10% of the US profits in 1980 and by 2007 it was 40%. This is wealth that is going from Main Street economy where people work, live, eat, earn their lives, earn their retirements to Wall Street where its speculation, gambling, investing of sorts.  And that change has transformed the entire economy and eventually that is what I keep saying—trees don’t grow to the sky. I feel this cannot go on forever and how much longer it can go on of course is a subject of great interest.  But I really don’t know.

You know you talked about Wall Street, do you think Wall Street in 2015 -2016 has gone back to the way things were in 2006, 2005 and 2007. Would you say that?

Oh yes! I would say that that’s generally the case.  You don’t want to pin point and you don’t want to be too tied to historical rhythms but it certainly looks that way.  We don’t have a housing bubble of the same sort now in America.

But there is a bubble…

There is a bubble in housing but it is not the same sort.  But the bigger bubbles in the US today are the bubbles in the student debt and auto debt.  We have a heck of an auto debt bubble and the corporate debt bubble that we didn’t have before.

Corporate debt is huge because all the money that has been used to buy back shares…

It is mind boggling to think that a corporation would borrow money to buy some shares and you wonder what business is this corporation in.

Is the student bubble has big as the housing bubble?

No. It’s not that big. The housing bubble was worth $4 trillion or something and this is $ 1 trillion.

Which is big anyway. $1 trillion is not small.

It’s huge, but it’s not the same kind of huge.  It’s an entirely different thing because the housing bubble was exposed to the value of the collateral.  In the housing bubble there is something there and eventually it was obvious that what was there was not worth what they thought it was because at the end of it the typical house costs something like twice as much as the typical family could afford.  So it didn’t take a genius to figure out that cannot go on for much longer and by the way salaries were not going up.  There was no way that a person was going to catch up to that.  But now what is the collateral on a student loan?  It’s nothing.

There is some intellectual capital…

This student loan is interesting because the collateral is essentially worthless.  They have done studies to show that if people borrow money, get educated they don’t earn more money and it’s a bit of a fraud.  Its money that a bank lends, secured by the government, goes to the student, goes to the education industry, which is just lobbying Congress for the whole thing to continue.

How big is the auto bubble?

The auto bubble is big but I don’t remember the numbers. And there is a huge transformation of the auto sales system where it is all directed.

So essentially what we can say here is that low interest rates have had some impact on the auto industry, I mean people have been buying cars.

Big effect yes and without those low interest rates there wouldn’t be these car sales and the car sales like employment have been held up by the central bankers and the economists as evidence that the economy is healthy.

Why they are buying cars is because the interest rates are held down.  This is the equivalent of those low interest loans in the housing industry in 2007.  Now they have the auto industry that has loans that stretch out. The average loan goes more than four years.  And yeah four years for cars is a long time.

To be continued…

The interview originally appeared in the Vivek Kaul’s Diary on February 4, 2016

“The toxic effects of policies have now created conditions for a new financial crisis”

satyajit dasDear Reader

This is the second part of the interview with economic commentator and globally best-selling author Satyajit Das.

Das is an internationally respected commentator on financial markets and economics He is credited with predicting the current financial crisis. He has also featured 2010 Oscar-winning documentary Inside Job.

I would like to state here that I actually understood how financial derivatives caused a major part of the current financial crisis only after reading Extreme Money authored by Das. Until then my understand was shaky.

His first general book Traders, Guns and Money is a master class on derivatives, given that Das’s technical tomes on financial derivatives running into thousands of pages, remain a standard reference on Wall Street.

In this interview I speak to Das around his new book The Age of Stagnation—Why Perpetual Growth is Unattainable and the Global Economy is in Peril. Like his earlier books this book is also a terrific read and a must for anyone who seriously wants to understand how things haven’t really changed in the aftermath of the financial crisis, and why the future continues to remain bleak.

This is the second part of a three-part interview. The concluding part will appear tomorrow.

Happy Reading!
Vivek Kaul

 

Do you see all the debt that has been accumulated by governments over the years, ever being repaid? How do you see this playing out?

Interestingly, total public and private debt in major economies increased not decreased since 2008. The Table below sets out the changes in debt levels in the global economy:

Global Stock of Debt Outstanding

(US$ Trillion, Constant 2013 Exchange Rates)

 200020072014Compound Annual

Growth Rate (%)

Type of Debt   2000–20072007-2014
Household1933408.5%2.8%
Corporate2638565.7%5.9%
Government2233585.8%9.3%
Financial2037459.4%2.9%
Total Debt871421997.3%5.3%
Total Debt (as % of GDP)246%269%286%  

Source: Richard Dobbs, Susan Lund, Jonathan Woetzel and Mina Mutafchieva (2015) Debt and (not much) deleveraging, McKinsey Global Institute: 2

Total debt has continued to grow at a slower rate than before the GFC but remains well above the corresponding rate of economic growth. Higher public borrowing has largely offset debt reductions by businesses and households.

Could you tell us a little more about that?

Between 2007 and 2014, the ratio of public sector debt to GDP in advanced economies increased by 35 percent of GDP, compared to an increase of 3 percent between 2000 and 2007. The increase in government debt reflected the effects of the GFC. It was designed to support the financial system. Government spending sought to boost demand and growth. The increase in debt predictably was highest in the worst affected countries, such as the UK, Greece, Spain, Portugal and Ireland.

Given slow growth, low inflation rates and the balance between tax revenues and expenditure and inflation rates, government debt to GDP ratios are forecast to rise for the foreseeable future in the US, Japan and many European countries. In many countries, government debt has reached levels which are unsustainable. It is unclear how these highly indebted economies will reduce the level of government debt.

Why do you say that?

Debt can only be reduced through strong economic growth. Many economies in the world today have debt-to-GDP ratios of 300 percent. If the average interest rate is 3 percent, then to meet interest payments the economy would need to grow at 9 percent (300 percent [debt] times 3 percent [interest rate]), an unlikely nominal rate of expansion.

The alternative is debt forgiveness, defaults or inflation. But all these steps, other than growth are not without consequences. Savings designed to finance future needs, such as retirement, are lost. This in turn results in additional claims on the state to cover the shortfall or reduce future expenditure which crimps economic activity. Significant write-downs on sovereign debt would trigger major crises for banks and pension funds. The resulting losses to savers would trigger a sharp contraction of economic activity. National governments would need to step in to inject capital into banks to maintain the payment and financial system’s integrity.

In One Lesson: The Shortest & Surest Way to Understand Basic Economics, Henry Hazlitt summarised the problem: “Everything we get, outside of the free gifts of nature, must in some way be paid for. The world is full of so-called economists who in turn are full of schemes for getting something for nothing. They tell us that the government can spend and spend without taxing at all; that it can continue to pile up debt without ever paying it off, because ‘we owe it to ourselves’.” It is useful to remember that.

One of the things you write is that the stock markets have decoupled from the real economy. Why do you say that?

Equity prices now do not correlate to fundamental economic factors, such as nominal gross domestic product or economic growth, or, sometimes, earnings.

Writing in the Financial Times, James W. Paulsen, chief investment strategist at Wells Capital Management, advised Investors not to be too concerned about slower earnings growth. Mr. Paulsen forecast a 2,600 target for the S&P 500, or an annualised five-year return in excess of 10 per cent, including dividends. He warned investors about “becoming too myopically focused on these mainstream issues lest [they] miss what could be the second confidence-driven bull market of the post-war era”. Given that shares represent claims on the earnings derived from the real economy, this is puzzling.

It indeed is…

Veteran Legg Mason fund manager Bill Miller once observed that: “The common view [is] that the weak stock market reflects a weakening economy. But we think the converse is more likely: the weak stock market is causing the economy to weaken”.  Equity analyst Laszlo Birinyi supported this view of causality: “The relationship between the stock market and the economy is tangential, not causal”. It is not clear why the equity market should drive the real economy, rather than the other way around.

There may be some possible explanations for the divergence between the real economy and equity prices. First, share values are increasingly affected by opaque accounting and what one observer termed the ‘expectations machine’; that is, manipulating and beating expectations rather than absolute performance criteria. Then there are higher levels of corporate activity such as share repurchases and mergers and acquisitions which affect values.

Second, equity markets have become instruments of economic policy, as policy makers try to increase asset values to generate higher consumption driven by the ‘wealth effect’. Monetary measures, such as zero interest rate policy and quantitative easing, distort equity prices. Dividend yields that are higher than bond interest rates now drive valuations. Future corporate earnings are discounted at artificially low rates.

Any other reasons?

Third, the increased role of high frequency trading (“HFT”) has changed equity markets. HFT constitutes up to 70% of trading volume in some markets. The average holding period of HFT trading is around 10 seconds. The investment horizon of portfolio investors has also shortened. In 1940, the average investment period was 7 years. In the 1960s, it was 5 years. In the 1980s, it fell to 2 years. Today, it is around 7 months. The shift from investing for the long run has fundamentally changed the nature of equities, with momentum trading a larger factor.

Fourth, the increasing effect of HFT has increased volatility and the risk of large short term price changes, such as that caused by the ‘flash crash’, discouraging some investors.

Fifth, alternative sources of risk capital, the high cost of a stock market listing, particularly increasing compliance costs, increased public disclosure and scrutiny of activities including management remuneration as well as a shift to different forms of business ownership, such as private equity, have changed the nature of equity market. New capital raisings are increasingly viewed with scepticism as private investors or insiders seek to realise accreted gains, subtly changing the function of the market.

Sixth, financialisation may facilitate market manipulation, whereby the corrosive impact of insider trading and market abuse erodes investor confidence.

Financial instruments, such as shares and their derivatives, are intended as claims on real businesses. Over time, trading in the claims themselves have become more rewarding, leading to a disproportionate increase in the level of financial rather than business activity.

You write: “politicians and central bankers gambled that growth and increased inflation would over time correct the problems”. But things did not turn out as they expected. What went wrong there?

Policy makers assumed that the Great Recession of 2007/8 was a cyclical downturn not a structural change. George Soros got it absolutely right: “[It] resembles other crises that have occurred since the end of the Second World War at intervals ranging from four to 10 years…there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.”

And what happened because of the mis-diagnosis?

Given the mis-diagnosis, policy maker reacted with their usual responses: fiscal stimulus and looser monetary policy (low rate and then QE). This was never going to work as the debt overhang meant private economic activity did not recover to pre-crisis levels. Low rates did not actually encourage borrowing and spending.

The GFC left a legacy of large debts, forcing households to reduce spending so as to repay borrowings, with low-income households reducing spending by twice as much as richer households. The debt overhang and caution about borrowing has reduced the impact of low interest rates. Households are unwilling or unable to increase debt. The fall in house prices in some countries, and the resulting decline in household wealth, has made borrowing difficult; lending against home equity has decreased. Banks have also tightened lending standards, in response to loan losses. These factors mean that a consumption-based economic recovery is unlikely without income redistribution to households with a higher propensity to spend, or finding a new source of demand. The lack of demand has resulted in weak investment, also slowing growth.

As result, the global economy is locked into a path of low growth and low inflation tending to disinflation or deflation. That would be fine if it were not for the high levels of debt which will spiral out of control in such conditions.

So what was really needed?

What was needed were major structural changes: dealing with the excessive debt, dealing with global imbalances, addressing the unfunded entitlements which affect public finances and rebalancing between the real and financial economy. Then, there were other issues like demographics, slowing productivity and innovation as well as the problems of inequality, environment and scarce resources. But no government has had the political courage to tackle these issues to the degree necessary.

So what they did was make a bad situation worse by increasing debt. The toxic effects of the policies have now created the conditions for a new financial crisis.

In essence, they tried to do the wrong things better rather than do the right things badly.

To be continued…

Disclosure: Satyajit Das wrote the foreword to my book Easy Money: Evolution of Money from Robinson Crusoe to the First World War

The interview originally appeared in the Vivek Kaul Diary on January 28, 2016

“The build-up of debt over last 25 years has been excessive, beyond repayment capacity.”

satyajit das
Dear Reader,

This is a special edition of the Vivek Kaul Diary. This is the first time I am interviewing someone for the Diary. In this interview I speak to Satyajit Das, an internationally respected commentator on financial markets, credited with predicting the current financial crisis. He has also featured 2010 Oscar-winning documentary Inside Job.

I would like to say here that personally I have learnt a lot from reading what Das has written over the years. His two books Traders, Guns and Money and Extreme Money have been a master class on derivatives as well as how they caused the financial crisis.

Honestly, if you were to read only one book on the financial crisis, it has to be Extreme Money.

In this interview I speak to Das around his new book The Age of Stagnation—Why Perpetual Growth is Unattainable and the Global Economy is in Peril. Like his earlier books this book is also a terrific read and a must for anyone who seriously wants to understand how things haven’t really changed in the aftermath of the financial crisis, and why the future continues to remain bleak.

This is the first part of a three-part interview. The other two parts will appear over the next two days.

Happy Reading!
Vivek Kaul

I would like to start with a clichéd question. Why did very few economists and experts see the economic crisis coming?

I think Richard Breeden, a former chairman of the SEC, probably identified the reason best: “It’s probably a better question for a psychologist. There’s a group dynamic…nobody likes to be the person who sends everybody home from the party when they’re having a good time.”

People rarely see what is front of them because of a mixture of ideology, biases and incentive structures. Proponents of markets are never going to concede that the mechanisms had failed or were even capable of failure.

Most economists and experts are guilty of ‘groupthink’. People with similar backgrounds and largely insulated from outside opinions tend to make decisions without critically testing, analysing and evaluating ideas or evidence. They collective rationalise, convinced about the inherent morality of their views, their unanimity and invulnerability. They also hold stereotyped views of outsiders and do not tolerate dissent. People work in neat silos and don’t look outside their narrow specialisation.

People employed by financial organisations are deeply compromised, forced to propagate the party line. Upton Sinclair was correct in noting that “it is difficult to get a man to understand something when his salary depends on his not understanding it”.

What made you feel that a crisis was on the way?

My only advantage is that I am not beholden to anybody or any organisation. I don’t have strong ideologies. My interest is in facts and trying to understand them. I am extremely pragmatic, adhering to what works or doesn’t. It is a luxury.

But you also need to be lucky, especially on timing of events.

One of the first things you write in your book is “future generations may have lower living standards than their parents”. This I would guess is one of the key points of the book as well. Why do you say this?

Future economic historians may come to regard the last two centuries and especially the post WW2 period, as an exception in terms of large improvements in livings standards.

Ultimately, prosperity depends on economic growth. If growth is slower and more volatile in the future then future generations will have lower living standards. The reasons are fairly simple.

First, much of the recent prosperity was built on debt funded growth which is not repeatable. An unknown portion of this debt will have to written off either explicitly (default/ restructuring) or implicitly (through reduction in purchasing power through inflation or financial repression). A large amount of wealth will be wiped out.

Second, environmental damage will restrict future growth. This will be through acceptance of lower levels of economic activity as the world restricts the use of fossil fuels which is unlikely. The alternative will be lower growth as a result of the catastrophic costs of climate change, in terms of damage, dislocation or shortages of essential goods and services.

Can you give us an example?

For example, India will have to accept the problems of water shortages and lower food production as well as having to deal with the forced displacement of a large part of the population of Bangladesh. There are also ancillary costs like health costs from air, water and soil pollution.

Third, resources like water, food and energy will get scarcer and therefore more expensive.

Fourth, our model for dealing with these issues is simply to extend and pretend and kick the problem further down the road. In effect, past and present generations will have enjoyed the benefit but the costs will be borne by future generation, reducing their living standards.

The problem will manifest itself at an individual level in three ways. A large part of future generations will find employment, particularly secure and well-paid jobs, more difficult to obtain. A commentator in Greece argued, with black humour, that the government could save money on education because it was unnecessary to prepare people for jobs that did not exist.

Purchasing houses and large capital goods may become harder. Also, the idea of a finite working life followed by retirement will become a luxury for most. People will have to work till they die or are unable to work.

We see all these trends already in many societies.

Much of the world’s population (probably 5-6 billion of the 7 billion on earth) are already in the position that I have described. It is the other 1-2 billion who aspired to a better life for themselves and their children who will have to adjust their expectations, which have been set too high.

You write that “we may never know the real cost of the financial crisis”. Why do you say that?

Costs of crisis are always complex. There are measureable losses in the value of financial assets like equities, property and loan write-offs. There are structural effects which economist refers to as hysteresis; that is a single disturbance which affects the course of the economy. An example is the delayed effects of unemployment. As unemployment increases, more people adjust to a lower standard of living. There is reduction of potential output. There are complex questions about what period we measure losses over.

The 2007/2008 financial crisis illustrates this point. Large financial institutions throughout the world collapsed or suffered near fatal losses. Values of houses and financial assets, like shares, fell sharply. In the real economy, there was a sharp downturn in economic activity, unemployment often for prolonged periods, housing foreclosures and evictions and failures of businesses.

What is the biggest number you have come across with regard to the cost of the financial crisis?

In 2009, the IMF estimated the cost to that stage at around US$12 trillion, equivalent to around 20 percent of the entire globe’s annual economic output. In 2013, Tyler Atkinson, David Luttrell and Harvey Rosenblum, three economists at the Federal Reserve Bank of Dallas, tentatively quantified the loss to the US economy as between US$6 and US$14 trillion, around US$19,000 to US$45,000 per person. Under certain assumptions, they found that the loss could be higher – US$25 trillion or over 150% of GDP, almost US$80,000 per American. No one may ever know the full cost.

There are huge indirect costs like lost human potential and suffering, which we do not measure. A diary entry at the time of the Great Depression in Siri Hustvedt novel Sorrows of An American reads: “A depression entails more than economic hardship, more than making do with less. That may be the least of it. People with pride find themselves beset by misfortunes they did not create; yet because of this pride, they still feel a pervasive sense of failure… People become powerless.” We don’t measure that.

On page 34 you write: “everybody, it seemed, agreed with Oscar Wilde that living within one’s income merely showed a lack of imagination”. Why do you say that? Isn’t it a very fierce indictment of the Western World?

Developed economies are now 60-70% consumption.

If we look at the post war period then you see a persistent pattern of promoting consumption. Initially, it was about meeting unsatisfied needs. Over time, it shifted to manufacturing demand though a variety of strategies ranging from advertising to planned obsolescence.

Consumption driven economies require you to keep consuming to drive economic activity to provide employment to give you income to buy more things you don’t really need. There is a piece of graffiti art by Bansky which I have always liked. It reads: “join a hilarious adventure of a lifestyle – work, buy, consume, die”.

In Das Kapital, Karl Marx identified this inherent tendency of capitalism towards overproduction. Theologian Reinhold Niebuhr saw society as enslaved to its productive process, reversing the normal process of producing to satisfy consumption needs. Economists dismiss overproduction, arguing that supply creates its own demand (known as Say’s Law). They view consumer needs as essentially unlimited, with people wanting more and better goods.

It may be an indictment of Western economic system.  My objective was not judgemental. It was to describe what was happening. In essence, economic growth and prosperity were by-products of consumption, unsustainable resource exploitation and serious environmental damage. It would be fair to say in recent decades nobody was took the advice of 19th century philosopher John Stuart Mill “[seeking] happiness by limiting … desires, rather than in attempting to satisfy them”.

There is a great belief among economists that borrowing leads to economic growth. How true is that? Has the impact of debt on growth come down over the years?

There is nothing inherently good or bad about debt. It can be used to drive economic growth, allowing immediate consumption or investment against the promise of paying back the borrowing in the future. Spending that would have taken place normally over a period of years is accelerated because of the availability of debt.

The use of debt can be beneficial, where the economic activity generated is sufficient to repay the borrowing with interest. This requires borrowing to finance assets or investments which generate income or value to repay principal and interest. A significant proportion of current debt does not meet this test.

Only (around) 15-20% of total financial flows went into investment projects with the remaining 80-85% being used to finance existing corporate assets, real estate or unsecured personal finance to facilitate consumption. Borrowings were frequently used to finance pre-existing assets where anticipated price rises were to be the source of repayment.

Under these conditions, a slowdown in the ability to borrow ever increasing amounts can lead to a sharp fall in asset prices to levels below the outstanding debt creating repayment difficulties. This is precisely what happened in 2007/2008 and is likely to happen again, sooner than people think.

The build-up of debt over the last quarter of a century has been excessive, beyond repayment capacity.

Could you elaborate on that?

In the lead up to 2007/2008, there was a rapid build-up in debt in developed economies. Between 2000 and 2009 total global credit grew from US$57 trillion to US$109 trillion, equating to a growth of 7.5% per annum, around double the growth in economic activity. In many countries, debt reached three to four times Gross Domestic Product (“GDP”), levels not normally reached other than in wartime (i.e. 1914-1918 and 1939-1945) when the result was losses for creditors of the losing states.

The other problem is that you need to borrow ever increasing amounts to both repay existing borrowing but also to maintain economic growth. By 2007/2008, the US needed $4-$5 of debt to create $1 of economic growth, compared to an additional $1-$2 of debt per additional $1 of GDP in the 1950s.

To be continued…

Disclosure: Satyajit Das wrote the foreword to my book Easy Money: Evolution of Money from Robinson Crusoe to the First World War