June 23, 2020

Comment: Forgive us our debts …

BY Russell Jones

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( 12 mins)
  • Total global debt has continued to burgeon in the ten years since the Financial Crisis.
  • The COVID-19 pandemic stands greatly to add to debt burdens.
  • Much of the additional debt that has been incurred is unlikely to be repaid.
  • Historically, ‘debt Jubilees’ played a key role in the maintenance of social and political stability.
  • It may be time for a managed modern-day programme of debt forgiveness.

The dead weight of debt

Total debt has continued to rise since the GFC …

As Britain’s National Institute of Economic and Social Research (NIESR) has recently detailed, as of 2019, the advanced economies had accumulated a total debt stock of around $130trn, up some 27% over the previous decade. 1 The emerging (EM) economies, for their part, had amassed gross financial liabilities of $58trn, a much lower absolute figure, but one that had increased a huge 200% over the same 10-year period.

These startling figures reflect a rising level of obligations across all three major sub-categories households, businesses, and sovereigns – and in almost all countries, although the extent of the increase and its composition differed considerably.

Debt burdens were particularly heavy in Japan and Italy, but Canada and Australia were more exposed to private debt issues than Japan or Italy, while France and Japan had greater exposures to company sector debt than to household debt. Canada and Australia stand out as countries in which household debt levels have surged higher since the Global Financial Crisis (GFC), albeit with some degree of stabilisation since 2016 (see the table on page 2).

… although the nature of the increase has varied …

The rise in non-financial debt, meanwhile, has been more substantial in the EMs than in the advanced economies although, with the conspicuous exception of China, non-financial debt ratios are still generally lower in the EMs than in the advanced economies.

For most economies, corporate debt ratios were higher than household debt ratios, and had been rising over recent years. However, the increase in corporate debt had been especially marked in the EMs, and in particular in China. Corporate default rates were edging above their long-term averages in many jurisdictions just before the COVID-19 pandemic struck.

… and debt servicing costs have fallen to very low levels

That said, management of this rising burden of debt was being aided by borrowing costs that were historically low, and by a cyclical upswing that, even if it was shallower than its predecessors, was some 10-years old, and showed few signs of drawing to a close.

The debt situation is now in a state of considerable flux.

Fuel to the fire

Recent events will raise debt burdens further …

The COVID-19 pandemic, and the policy reaction to it, stand sharply to boost the outstanding total of liabilities. Households, corporates, and governments have all been adding to their borrowings in an effort to ride out the associated storm, and this process is far from over. In April, for example, the IMF suggested that advanced-economy public debt would surge by some 20 percentage points of GDP. Latterly, it has suggested that even this may be an underestimate.

Borrowing costs in the aggregate have meanwhile fallen further, as central banks have cut official rates, and employed various unconventional tools to depress term and credit premia.

On the other hand, however, incomes have fallen sharply, and expectations of future incomes have been marked down, as lockdowns have deeply depressed economies, and uncertainty over the nature of the post-pandemic environment has increased, clouding the future.

… perhaps for some time to come

The lockdowns imposed to suppress the virus are now being unwound, and the worst seems now to be over in terms of demand and output. However, the fear is that, after an initial surge, economic activity will be slow to recover, vulnerable to further epidemiological and other setbacks, and that already-declining underlying growth potential has been reduced. Meanwhile, notwithstanding the best efforts of governments and central banks to provide temporary lifelines in the form of grants, loans, mortgage and other repayment holidays, and employment and income subsidies, cashflows have been deeply affected as the demand for goods and services has dropped off. Indeed, in some industries, such as aviation and tourism, losses have been nothing short of catastrophic.

Debt distress and defaults threaten to rise dramatically …

Many businesses have already been forced to downsize, if not forced to the wall. In the context of a hesitant and uneven recovery, many others face a similar fate. Underemployment will linger. Millions of jobs could be permanently lost. The ability to service loans, even at super-low rates of interest, has been significantly reduced. Defaults are bound to explode higher. Indebtedness has both exacerbated the downturn, and threatens to flatten the trajectory of recovery.

… not least in the EM economies

EM companies are facing an additional problem because of the importance to them of fx debt often US dollar denominated – and the sharp depreciation of their currencies. This has significantly increased the domestic cost of repayment. Countries affected include: Argentina, Brazil, Turkey, Mexico, and South Africa. In Turkey, for example, some 25% of government and corporate debt is dollar denominated. In Brazil and Mexico, the figure is around 20%. In China, however, only some 10% of its outstanding liabilities are dollar denominated.

This has led to calls for a managed round of debt forgiveness

All this begs the question of whether or not some sort of programme of managed debt forgiveness – or ‘debt Jubilee’ – should be instituted.

Comment: Forgive us our debts … 1

Wiping the slate

Such debt Jubilees have a long history

Debt Jubilees have a long lineage. In many ancient societies, such as Sumer, Babylonia, and Assyria, the tendency towards rising levels of debt was contained by intermittent debt cancellations or Jubilees. These essentially involved three elements:

  1. The cancellation of agrarian debts owed by individual citizens. Mercantile debts between businessmen, however, were unaffected.
  2. Bonded servants were freed and allowed to return to their homes. This deliverance of the lower peasant classes from debt bondage was consistent with the notion that it was always meant to be temporary. However, slaves, who were in the main foreign captives, were not freed.
  3. The land or crop rights that debtors had pledged to their creditors were returned, enabling families to go back to supporting themselves, and thereby to pay taxes. They were also permitted to join the military, and labour on public works.

They were grounded in pragmatism rather than altruism …

These episodes amounted in significant part to the rulers of the time cancelling the obligations owed to themselves, their families, and their officials. They were based more in practicalities than in altruism. This was particularly the case early in their reigns. What might be lost in immediate funding could be recovered by encouraging and enabling a landholding peasantry to pay future taxes, and provide an army. Early action on debt forgiveness could also discourage foreign interlopers or local pretenders to the throne from promising to do so.

Sometimes, particularly after a bad harvest, the only way that the peasantry could repay their debts would be to sell their land, and or themselves, as bond-servants to wealthy merchants or landowners. This tended to change the structure of the state from one with a strong centre, underpinned by a layer of small loyal peasant landowners, to one with a relatively weak centre, surrounded by a series of subsidiary power centres, and an underclass of serfs and slaves. This latter configuration was more unstable, and prone to sedition, revolution, populism, and war.

Sometimes, particularly after a bad harvest, the only way that the peasantry could repay their debts would be to sell their land, and or themselves, as bond-servants to wealthy merchants or landowners. This tended to change the structure of the state from one with a strong centre, underpinned by a layer of small loyal peasant landowners, to one with a relatively weak centre, surrounded by a series of subsidiary power centres, and an underclass of serfs and slaves. This latter configuration was more unstable, and prone to sedition, revolution, populism, and war.

… to manage inequality and thereby maintain social stability

Then, as now, powerful forces could all too easily conspire to hollow out the middle of societies, to the benefit of the rich, the skilled and the powerful, and at the expense of the poor. Jubilees were a means to prevent this.

Such events died out over time, as other wealthy creditors beyond the ruling core accumulated sufficient power to end the custom. Power became concentrated among a few oligarchs, and the landowning peasantry declined. 3

Borrowing from the past

Fast forwarding back to the present day, perhaps the most obvious candidates for debt forgiveness are in the EM economies. According to the Brookings Institution, as the pandemic began, the EMs as a whole owed around $11trn in external debt, and faced $3.9trn of debt service obligations this year. With a further $83bn of EM debt raised on the international capital markets in May, these figures have already been overtaken by events. 4 Similarly, in April, the IMF estimated that the poorer EMs would require financial help of some $2.5trn. That figure too is now seen as too low. 5 Some limited debt relief was provided to many of these nations in April, and the G20 subsequently agreed a payment standstill, which set a marker for private sector creditors to do the same. 6

Today, a Debt Jubilee could ease EM poverty …

… while preventing chaotic defaults in advanced economies

However, if poverty, and in particular acute poverty, is not to increase sharply, and wealth become more polarised, there remains a case for more comprehensive debt forgiveness for the poorest nations, and in particular a Jubilee for debts owed by them to the IMF, World Bank, other multilateral institutions, national sovereigns, and private creditors. 7 Such action could also be supplemented by the provision of ‘COVID grants’, conditioned on appropriate macro and structural policies, in a similar manner to Marshall Aid.

Where the advanced economies are concerned, central bank action to hold down borrowing costs as various fiscal support packages have been put into operation has been warranted, and will continue to be warranted as further fiscal stimulus is applied to encourage recovery. Indeed, closing output gaps fully in the years ahead may require more explicit monetary finance, perhaps even extending to the cancellation of some debt on central bank balance sheets, to provide a permanent boost to the monetary base.

One thing is clear: much of the additional debt incurred by the private sector during the pandemic, and especially that owed by SMEs, will have to be forgiven. In due course it will probably find itself on public sector balance sheets, including central banks, and a sizeable proportion of it is unlikely to be repaid.

To the extent that this encourages enduring equity shortfalls at central banks, Treasuries will quite possibly feel obligated to recapitalise them.

For publicly traded companies, the debt held by public creditors could be exchanged for equity. In order to minimise any sense of excessive public sector involvement in business, this ownership would best take the form of non-voting preference shares. It might even make sense for an equitization option to be embedded in all issued public debt.

Encouraging a more sustainable future

It would also make sense to reduce the dependence on debt …

Over the longer term, it would make sense to introduce further initiatives to reduce the global dependence on debt and associated inequalities. These include:

  • Help-to-buy schemes for housing. Governments could offer equity participation up to a given limit (say 10% or 15%) of the value of properties of first-time buyers. However, this would have to be combined with efforts to expand the housing stock, and/or the introduction of a land tax to prevent excess demand.
  • Student loans. Requiring the higher skilled and those on higher incomes to reimburse the state for its role in facilitating these outcomes makes sense. But arguably it should be done via equity participation rather than debt finance. Students could pay a share of their incomes over a specified minimum, which could not be avoided by paying tuition fees up front.
  • Universal grants. A capital sum could be allocated to all new-born citizens on an inalienable basis, half of which might vest at 18 to assist in funding an individual’s education, or work-related subsistence, and the rest at 25 to help in the purchase of a dwelling. Certain restrictions could be attached in the event of moving overseas or criminality prior to vesting.

… through a series of more enduring initiatives

Resetting the game

Global indebtedness is historically high, increasingly excessive, and certainly sub-optimal from the points of view of economic efficiency and the distribution of income. COVID-19 and the policy response to it has only exacerbated these tendencies, and the likelihood is that a significant portion of outstanding liabilities, whether private or public, will not be repaid.

As in the past, this would make sense for social stability

Just as in the distant past, and notwithstanding inevitable concerns about moral hazard, the encouragement of profligacy, and the political complexities of explaining the strategy to those with no debt obligations, a managed and coherent programme of debt-forgiveness makes some sense. It could act as a ‘reset’ for the global economy, while also helping to confront economic, social, and political instability.

This is particularly so for many EMs, but the case is also strong for the advanced nations. There are furthermore arguments for efforts more permanently to skew development models away from debt and towards equity finance if poverty and various inequalities are to be addressed.

Watch fors:

  • Central bank policies of formal yield curve control, if not outright monetary finance.
  • Growing absorption of private sector debts onto public sector balance sheets.
  • Finance ministry indemnification of central bank equity shortfalls.
  • Public-sector-led equity-for-debt swaps among publicly traded companies.
  • The development of new programmes to skew financing away from debt. ■

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