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02/06/2012

What's Wrong with the Debt Debate


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This former banker, and now sustainability investor and humble blogger, will not offer grand predictions for 2012. Forecasting in a world of rising uncertainty suggests a lack of understanding about uncertainty. Instead, inspired by my holiday reading, Debt: The First 5,000 Years, by anthropologist David Graeber, I will take up the debate about the debt, and offer an uncomfortable third view: jubilee (in some form) is inevitable.

The debt debate as it rages on can be summarized as the “Krugman view” versus the “austerity view” (the latter having too many advocates both at home and in Europe to associate it with a person). The less popular Krugman view rests on a belief in Keynesian economics (“Keynes was Right”) that governments must increase deficit spending during slumps, and then tighten the spigot during booms, providing an automatic stabilizer to the economy. Failing to do so in times like the present turns recessions into depressions. This view rejects the analogy of government finances to household finances, since governments can, and do, print money. Krugman points to long-term interest rates in the United States and Japan being at historic lows as vindication that the market says he’s right—markets understand deficits don’t matter in the short run (at least when a country issues debt in its own currency).

The “austerity view” holds that, like households and firms, there is a relationship between cash flow (tax receipts in the case of governments) and debt capacity, and that the “bond market vigilantes” will pounce without warning when “they” determine the relationship is heading in an unsustainable direction—raising the cost of borrowing, thereby accelerating the downward spiral. In a word, Greece (a country trapped inside the Euro with only bad choices).

My personal opinion is that both views are wrong for two reasons, one common to each.

The Krugman view is probably right in the near term, that without increased and more intelligent stimulus, depression is a serious risk and perhaps inevitable. But he is wrong to be too confident that current bond market behavior invites more deficit spending without simultaneous and credible long-term structural reform. In my judgment, the two must go together, and it is the distinct privilege of governments with their own currencies to have such an option. Individual currencies may have seemed inefficient, but they allow resiliency.

The austerity view is wrong in its headstrong rush to austerity now, unless the consequences of depression—crushing unemployment and the associated physical and social ills that go with it as well as lost competitiveness in the global economy—are deemed necessary medicine to escape worse outcomes from the debt trap. But one consequence is also an explosion of the debt to GDP ratio that is such a focus as the denominator (GDP) drops, so it is a self-defeating approach even without consideration for the human effects of depression.

More importantly, however, both views are wrong in that they are predicated on the assumption that salvation lies in a return to exponential economic growth. Such an assumption may have made sense in Keynes’ day when the economy and human population was a fraction of its current scale, but it lies in direct conflict with our scientific understanding (fact, not theory) of the “safe operating space” for the global economy on a finite planet.

It is this simple but profoundly flawed assumption we will look back on from a future, uncomfortable perch, just as today we look with incredulity at the similarly flawed assumption that housing prices can grow exponentially ahead of incomes. The analogous “income” from the biosphere upon which our economic system (and much more) depends is referred to as “ecosystem services”, and they are in factual decline according to peer reviewed science.

The day of reckoning is coming, possibly in 2012 (there’s my forecast) and the implications for the debt are chilling.

If the assumption about new physical constraints on economic growth due to natural resource constraints (energy, water, quality soil in particular), and overflowing waste sinks (carbon in the atmosphere, phosphorus in rivers) is correct, then the arithmetic on our excessive debt levels leads to only one conclusion: jubilee.

When companies get over-leveraged, they are forced to restructure their balance sheets. When it comes to countries and people, there is no practical alternative to writing off unserviceable debts. This jubilee will not be driven by ethical necessity alone, but by physics and arithmetic.

Technological optimists will shoot down this “limits to growth” assumption on arguments of material efficiency and the inventive human spirit. There is a chance they are right. But those who argue that economic growth will naturally be decoupled from aggregate material throughput in a world of growing populations and rising living standards have yet to find facts that support their argument. Such an outcome is at best uncertain.

For different reasons, the jubilee conclusion has a long historical precedent with complex and poorly understood moral and religious underpinnings (as are well documented in Graeber’s book). 2012 may be the year we begin to contemplate the inevitable: history repeating itself.

Happy New Year.

–John Fullerton

John Fullerton is the founder and president of the Capital Institute. He is also the principal of Level 3 Capital Advisors, LLC, an investment firm focused on high impact sustainable private investments. This article originally appeared on his blog, The Future of Finance.

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