Table 3. The World’s Biggest Balance of Payments Deficits at the Height of the Boom in 2007
It is notable that all the eurozone countries experiencing a debt crisis — the “PIIGS” Portugal, Ireland, Italy, Greece and Spain — appear in this table and that the three worst deficits on a per capita basis are those of Greece, Spain and Ireland. The countries with a shaded background have their own currencies and are thus better able to correct their situations. Source: CIA World Factbook, 18 December 2008, with calculations by the author.
The debts incurred by the current account-deficit countries were of two types: the original ones owed abroad and the much greater value of successor ones owed at home as loans based on the foreign debt were converted to income. Internal debt — that is, debt owed by the state or the private sector to residents of the same country — is much less of a burden than foreign debt but it still harms a country by damaging its competitiveness. It does this despite the fact that paying interest on the debt involves a much smaller real cost to the country since most of the payment is merely a transfer from one resident to another. (The remainder of the payment is taken in fees by the financial services sector and the increase in indebtedness has underwritten a lot of its recent growth.)
Internal debt is damaging because a country with a higher level of internal debt in relation to its GDP than a competing country will have higher costs. This is because, if the rate of interest is the same in both countries, businesses in the more heavily indebted one will have to allow for higher interest charges per unit of output than the other when calculating their operating costs and prices. These additional costs affect its national competitiveness in exactly the same way as higher wages. Indeed, they are the wages of what a Marxist would call the rentier class, a class to which belongs anyone who, directly or indirectly, has interest-bearing savings. A country’s central bank should therefore issue annual figures for the internal-debt to national income ratio.
While internal debt slows a country up, external debt can cause it to default. In their book This Time Is Different, Carmen Reinhart and Ken Rogoff consider external debt in two ways — in relation to a country’s GNP and in relation to the value of its annual exports.
Table 4. How Oil Imports Commandeered an Increased Share of Ireland’s Foreign Earnings.
Source: CSO data with calculations by the author.
The second ratio is the more revealing because exports are ultimately the only means by which the country can earn the money it needs to pay the interest on its overseas borrowings. (A country’s external debt need never be repaid. As its loans become due to be repaid they can be replaced with new ones if its creditors are confident that it can continue to afford to pay the interest.) The book examines 36 sovereign defaults by 30 middle-income countries and finds that, on average, a country was forced to default when its total public and private external debt reached 69.3% of GNP and 230% of its exports.
Poorer Countries Lend to the World’s Richest Ones
GRAPH 2. Rich countries have borrowed massively from “developing” and “transition” countries over the past ten years. This graph shows the net flow of capital. The funds borrowed came predominantly from energy and commodity export earnings. Source: World Situation and Prospects, 2010, published by the UN.
As Table 5 shows, almost a dozen rich countries are in danger of default by the Reinhart-Rogoff criteria. The total amount of debt in the world in 2010 is roughly 2.5 times what it was ten years ago in large part as a result of the spend-and-borrow-back process. This means that there is 2.5 times as much money about, but not, of course, 2.5 times as much energy. If much of that new money was ever used to buy energy, the price of energy would soar. In other words, money would be devalued massively as the money-energy balance was restored. The central banks are determined to prevent this happening, as we will discuss in a little while.
Most of the world’s increased debt is concentrated in richer countries. Their debt-to-GDP ratio has more than doubled whereas in the so-called “emerging economies” the debt-to-GDP ratio has declined. This difference can be explained by adapting an example given by Peter Warburton in his 1999 book, Debt and Delusion. Suppose I draw
Table 5. The Most Over-Indebted Countries at the Height of the Boom in 2007
Countries that exceed the average level at which countries in the Reinhart and Rogoff study defaulted are marked in a darker shade.
World Debt More Than Doubles in Ten Years
GRAPH 3. Rich-country debt has grown remarkably in the past ten years because of the amount of lending generated by capital flows from fossil energy — and commodity-producing nations was used to inflate asset bubbles. The emerging economies, by contrast, invested borrowed money in increasing production. As a result, their debt/GDP ratio declined. Source: The Economist.
As Debt Increases, US Economy Grows by Less and Less
GRAPH 4. Because borrowings have been invested predominantly in purchasing assets rather than in production capacity, each increase in borrowing in the US has raised national income by less and less. The most recent bout of borrowing — to rescue the banking system — actually achieved negative returns because it failed to stop the economy contracting. Graph prepared by Christopher Rupe and Nathan Martin with US Treasury figures dated 11 March 2010. Source: