The debate over the effects of heavy government debt loads on an economy is back in the forefront as economists wrestle with a flaw found in the work of Ken Rogoff and Carmen Reinhart, the foremost economists on the matter.
The Telegraph’s Leo Hickman recently conducted a lengthy interview with investment legend Jeremy Grantham. And during the interview, Grantham discussed his position on debt, monetary policy and austerity.
Fiscal and monetary policies are extraordinarily difficult at the moment. The history is not clear as to what works. The theory is even less clear. My guess is that you want to be careful about how quickly you tighten the austerity screws and that the more austerity-orientated approaches look to me more dangerous and seem to be delivering greater pain on the economy.
Eventually, you have to address the question of debt, but I’m on the record as saying that I think the world in general exaggerates the significance of debt.
That isn’t to say it’s insignificant, but what it is to say is that it’s a paper world and it takes our attention away from the real world of the quality of education and training and the quality and quantity of capital investment and legal structure.
We don’t build things on paper and yet we’ve begun to talk as if we do. People say that the Chinese have built all their railroads on debt, to which I say, “no, they haven’t”. They’ve built them with real Chinese people and real cement and real steel that are part of the real world.
When you run out of people and capital capacity then you can’t increase any more. America conducted the world’s greatest experiment in debt. It tripled the debt-to-GDP level from 1982, where it was 1.25x GDP, up to 3.5x over the next 30 years. And during this time what effect did this have on the long-term growth of the system? And that’s the only reason they do it, just to get more growth?
Everyone says that, of course, the financial burst caused devastation and brought us to our knees. Yes, it was a terrible idea and eminently avoidable, but if you look at the breaking of the housing bubble in America and you realise how many trillions of dollars would evaporate if it went back to the trend line of the ratio of house price to family income, you must realise that people are going to feel devastatingly poorer than they were.
They still have the same house, but, in perception terms, they thought they had a pension fund stored up in their house and it went away. They feel poor and they are going to spend less and it will be a drag on the economy.
It was a well-behaved bubble. It went extraordinarily high then all the way back in three years to trend line, and slightly below, and is now moving back up to trend. It was a huge hit to the economy and guaranteed the recovery would be slow. And if that was not enough there was a second factor — the price of oil quadrupled and the price of other assets, such as metals and food, tripled from 2002-2008.
Every time that had happened before, like 1974 and 1979 in the two oil crisis, it was followed by global recession. That alone should have been enough to cause a recession. Add that to the housing bust and you don’t need to create any space to explain why we had a recession and a slow recovery.
I remain open to persuasion that debt is that big a deal. We have had it foisted upon us that the general idea that finance is so incredibly important that, if a corner bank goes bust, the whole of civilisation grinds to a halt. It’s enormously helpful to the banking system to have believed such nonsense, but I think that’s what it is.