The Ultimate High-Stakes Game?

Even more discouraging are the many signs that the true nature of the problem continues to elude those most concerned with rejigging the financial system. To the contrary, the overwhelming emphasis is still on finding ways to get the credit creation machinery back in action. That debt/GDP ratios are already stratospheric, and that most private sector borrowers are busily trying to reduce their indebtedness after the recent orgy doesn’t appear to concern them one whit. Understandable in a way, of course, since deleveraging brings previously hidden troubles into the open. It’s a painful and apparently destructive process for which no politician or public servant wants to be held accountable. Sinclair again perhaps?

The trouble is we only arrived at this desperately unhappy position because for as long as anyone can remember, economic policy has been driven by a constant unwillingness to endure short-term pain in order to re-establish sounder foundations.

Clearly the hope is that recent Herculean efforts by governments and central banks will enable us to once again dodge the bullet. In Australia, most now seem convinced we’ve managed to do exactly that. Even if we have, though (something I consider most unlikely), all we’ll have achieved is to once again postpone the pain. Given the unprecedented levels of private indebtedness, and rapidly escalating official indebtedness in the wake of the many cost no object efforts around the world to stem the downturn, there’s reason to fear some countries may have already used up most of their ammunition.

It’s hard to know if they truly realise it, but some governments are playing the ultimate high-stakes game. The UK and Japan for example (perhaps even the US?) are edging towards going all in, putting their sovereign credit at risk rather than allow the downturn to take its course. Should they fail, and some may, the ensuing collapse will be terrifying to behold, and not only on economic grounds.

Nor is it certain that a “win” would look that much better. Take Japan, which after almost two decades of resisting the fallout from their credit boom of the late 1980s is still limping, and now further burdened by the highest government debt/GDP ratio amongst developed nations. Estimates vary but figures for the gross debt cluster around 200%, much of which was accumulated through repeated stimulus efforts, many characterised as “bridges to nowhere”.

Without its exceptionally low interest rates (in large part a consequence of historically very high savings rates and the resulting external surplus), a burden this size could easily become unmanageable. With a rapidly ageing population and declining savings rates, rates may not stay down much longer and some observers believe Japan’s real day of reckoning is still to come.

Given its struggle for the most part took place against the backdrop of an expansive global economy, and given its historically high savings rate and external surplus, Japan’s experience in trying to resist the downturn and deleveraging that naturally tends to follow a credit boom ought to have been about as good as it gets.

That they’re still caught in the mire after twenty years, and perhaps facing a yet greater crisis, suggests there are few grounds for the many other nations now entering the third year of their own version of that struggle to expect a happy result.