What does $200 trillion of debt really mean for the global economy?
A few years ago, in the depths of the recession caused by the financial crisis, I began an investigation into the consequences of several economic trends that I thought were bound to put a permanent end to the boom times that my generation, the post-war ‘baby boomers’, had grown up in. These trends included the threat to jobs caused by fierce global competition, helped by the rise of digital technology; the financialization of the economy and the relative decline of real industry; the resulting rise in inequality, and also the excessive build-up of debt, which was of course the main cause of the crash.
But the crash didn’t put an end to the build-up of debt – the credit bubble just deflated slightly, as $20 trillion or so vanished off the face of the earth. This wealth never really existed of course – it consisted only of numbers in bank accounts or over-optimistic valuations of shares or property – but even so, a lot of people saw their pension funds and other investments reduced in value.
Despite all the concerns over debt since the crisis, the credit bubble has been growing again and is now bigger than ever, both globally and in some (though not all) ‘advanced’ nations, notably Japan and the UK, two of the most indebted economies. We don’t appear to have learnt much from the crash.
What does it mean when total world debt amounts to something in the region of $200 trillion, or roughly three times annual world output?
Does it all cancel out in a relatively benign way? Or are we building up trouble for the future in a way that will make the 2008 crash look tame?
Looked at one way, all debts must cancel out on a global scale, and some of these debts might never be paid, especially government debt: when a nation defaults on sovereign debt, hardly a rare event (about ten instances so far this century, from Argentina to Zimbabwe, and Greece could be next), it often works to that nation’s advantage, while a few wealthy banks and speculators lose out.
But the vast majority of debt these days is deeply entwined with the foundations of the global economy, and cannot be written off in this way. The whole system would collapse. So who will pay all this debt? The answer is simple – our children and grandchildren will have to pay.
Debts are always, above all else, a claim on future production, to be paid out of future earnings, either directly or through taxation. And if for some reason governments manage to keep on kicking these debts ever further down the road, as they tend to do, it will still be our children and grandchildren that pay the price, through lower earnings and a generally poorer world, because debts always have to be paid, one way or another. If this wasn’t the case, then we must have found a way to create something out of nothing. A miracle!
But there’s nothing miraculous about the current situation. It might be the case that banks do in fact create money out of nothing, in the form of credit, but unless that money is backed by real wealth creation in the underlying economy, all that credit creation must devalue the currency, which would normally lead to inflation. I say ‘normally’, because this doesn’t seem to be happening anymore, despite the best efforts of various western (and Japanese) governments, who are more concerned now with the opposite problem: deflation, or falling prices.
It’s not immediately obvious why price inflation remains subdued, but I think there are two main reasons. Firstly, all this new money hasn’t gone into general circulation, it’s stayed within the financial system, to the benefit of the wealthy, boosting asset prices and inequality.
The second reason, I think, is to do with the globalization of wages, which are being held down because over half of all real industry now takes place in China and other emerging economies. When we pay less for goods and services, we must expect to earn less ourselves, because ultimately all exchanges in the marketplace represent an exchange of labour. I go into more detail about this on my website, but the main point here is that because the majority of people are experiencing a relative decline in earnings, demand is low relative to supply and we aren’t seeing the usual inflation that governments want, and this is a problem because debt repayments become relatively larger when prices and wages fall, whereas inflation has the opposite effect of reducing debt repayments.
We can summarize the global economic problem in one sentence: Not enough people are doing the right kind of work anymore. By this I mean that the real wealth-creating sectors of the economy are employing fewer and fewer workers as a percentage of total population.
To understand why this matters, we need to think about wealth. What is wealth?
When we talk about wealth we mean material wealth, as measured in monetary terms. One can argue that there are other kinds of wealth and prosperity, such as human capital or well-being, but this ‘intangible’ wealth is a very different thing, and the value that it adds to the economy is already included in our monetary measure of material wealth, as far as it can be measured at all.
Money represents wealth, but wealth exists without money, which is only there for our convenience, to make trade easier. Wealth is all around us, all the stuff in the world, everything we make and grow. In fact, all wealth originates in the earth, as natural resources. We take nature’s raw materials and using our labour we add value to those resources by turning them into something useful. This is the wealth-creating process.
My investigation into the fundamentals of economics, which resulted in a book led me to conclude that over 60% of all wealth in the world today has come from oil.
The important point here is that the value comes from the industrial process, from the labour (hence the importance of energy – it ‘levers’ our labour). As we cut the share of real industry in the economy, in terms of employment, we cut the value added.
I started writing my book after I came across a chart in a UN publication about growth and sustainability. The report’s authors were puzzled by the fact that world economic output (total global GDP) had recently been growing much more than the use of natural resources would suggest it ought to have done, breaking the long-term trend. They thought this a hopeful sign, but couldn’t explain it because the gains in growth were far in excess of any recorded efficiency improvements, which would normally be the only possible explanation. It occurred to me, because I was already thinking along these lines, that the chart was showing the growth of the credit bubble.
We can’t really break the link between raw-material extraction and wealth creation. We can recycle more and waste less, but in the end we can’t create something out of nothing. The apparent creation of wealth without the need for resources was really just economic activity based on credit, much of it unproductive (hence no need for resources).
Upon further investigation into the sources of all wealth and what happens to all the money that ends up in the financial system, I worked out that around one third of all economic activity during recent years was fuelled by debt, rather than by real wealth creation, and this has led to a situation now in which around a third of supposed wealth, as represented by money, doesn’t actually exist, because it’s based on credit that is itself a claim on future production.
This huge claim on future production is bound to make the world a poorer place. For one thing, it means that a great many government promises, and possibly private promises too, will not be kept. By this I mean promises for future pension and welfare payments in particular, because the wealth that supposedly backs these promises doesn’t actually exist. I go into more detail in my book, excerpts of which can be seen on my website, but the main point here is that the world is not as wealthy as we think it is.
Another related point is that the wealth that does exist is increasingly concentrated in the hands of the very rich, to the detriment of society and, in the end, of civilization as a whole. The situation is unsustainable, and I think we might well be seeing the beginnings of the end of our current finance-dominated economic system, a system that depends on growth while at the same time killing the prospects of growth by increasing debt and inequality.
We should be prepared for another major crisis: It looks as though Marx, who pointed out the self-destructive tendencies of capitalism, might have been right all along.