«We all are in a Ponzi world right now. Hoping to be bailed out by the next person» — interview with DANIEL STELTER
Daniel Stelter is the founder of the German think tank Beyond the Obvious (http://think-beyondtheobvious.com/ ) focusing on strategic and macroeconomic issues. Previously, he worked from 1990 to 2013 as a consultant at The Boston Consulting Group (BCG), most recently as Senior Partner and Managing Director and member of BCG’s Executive Committee. From 2003 to 2011, he was in charge of BCG’s Corporate Strategy and Finance practice area. He co-authored BCG’s “Collateral Damage” series and the book “Accelerating Out of the Great Recession”. In April 2013, he published “Die Billionen Schuldenbombe” (The Trillion Debt Bomb), in which he describes the overindebtedness in the Western world, how politicians are evading the problems and what measures can point the way out of the crisis. More recently he published in German “Die Schulden im 21. Jahrhundert: Was ist drin, was ist dran und was fehlt in Thomas Pikettys «Das Kapital im 21. Jahrhundert»” (Verlag Frankfurter Allgemeine Buch, September 2014).
Interview by Jorge Nascimento Rodrigues (c) JNR, November 2014
Your most recent book “Debt in the XXI Century,” [Die Schulden im 21. Jahrhundert] is a reply to the “Capital” of Piketty, considered best book in Business for 2014, or it is the normal follow up of your “Trillion Debt Bomb”?
Both. In my view we have to deal with a major economic crisis in the western world: too much debt. Since 1980 the leading industrial economies have more than doubled their debt load relative to GDP from 160% of GDP to more then 320% in 2008. This is the debt load of governments, non-financial corporations and private households together. If you go by these sectors, governments have in real terms (means corrected for inflation) more than four times as much debt, corporations more than three times and private households more than six times as much debt. These additional debts allowed us to grow faster than we otherwise would have. A big party! Unfortunately debt cannot grow faster than income forever. In 2008 the party came to an end when it became clear, that a big part of these debts will not be served in an orderly way. The crisis was amplified by the fact that not only the real economy took on too much debt but the financial system as well and all sectors worked with ever lower equity and therefore capacity to absorb losses.
«You have to think about a huge tower of debt on shaky foundations where central banks pump concrete in the foundations in an emergency effort to avoid the building from collapsing and at the same time builders are adding additional floors on top»
The policies taken at the time were the right ones?
The reaction of politicians and central banks since 2008 was simple: fighting a crisis due to too much debt with even more cheap money and even more debt. In global terms, since 2007 the debt have grown by $45 trillion and the debt to GDP ratio is 20 percentage points higher than in 2007. You have to think about a huge tower of debt on shaky foundations where central banks pump concrete in the foundations in an emergency effort to avoid the building from collapsing and at the same time builders are adding additional floors on top. All this is discussed in my “Billion Debt Bomb”.
How we dismantle the debt bomb?
I discuss the different options: austerity, growth, inflation, default, or orderly debt restructuring. 1) Austerity does not work in a world where everyone has high debt levels and especially not in a system like the Euro. The more you try to save, the more you owe, a dynamic already described by American economist Irving Fisher [“The Debt-Deflation Theory of Great Depressions,” Econometrica,1933]. 2) Growth would be nice but unfortunately high debts dampen the economic activity and demographics and slow productivity growth limit the growth potential. 3) Inflation requires growth in credit and therefore is impossible to achieve if everyone is already over indebted. You can only achieve it by ruining the trust in the currency. But then it is totally out of control. 4) Remain defaults, which could amplify the crisis or orderly debt restructuring which is in my view the best way of how to deal with the situation.
Why you refer to French economist Thomas Piketty in your recent book? Where “enters” Pikety’s thesis developed in his “Capital”, considered Best Book in Economics and Business of 2014?
I thought he is contributing to a solution to the crisis with his “Capital in the Twenty-First Century” in linking the debt problem with his analysis of global wealth levels and distribution. But after reading it I was disappointed: he is giving a very interesting overview of wealth but he is totally overlooking the effects of debt. He only looks at government debt, which he sees as a result of poor distribution of wealth between the private and the public sector. He does not mention the high private debt at all. Debt is for Piketty neutral but for me it is a key-driving factor for asset prices and wealth concentration. This is the reason why I wrote the book on Piketty.
But do you disagree with the policies he suggested?
When it comes to the solution of the crisis I am again closer to Piketty although broader: we need to have a joint debt restructuring of private and public debt. For the Eurozone I calculate the debt, which cannot be orderly, repaid to be at least 3 trillion euro. These debt need to be restructured in a joint effort of debtors and creditors and these losses have to be somehow financed and there Piketty’s ideas of higher wealth taxes will become highly relevant again as politicians can use his arguments to tax wealth.
«In my view [Piketty] overlook the fact that only growing debt levels make it possible to have such a growth in measured wealth. Summing up, Piketty looks at symptoms – wealth – and not on causes – debt.»
Do you agree with his findings regarding the re-emergence of a “patrimonial capitalism”?
The part in Piketty’s book which deals with the historical data is the best of the overall book and clearly an important contribution to the economic and political debate. In spite of some criticism on the data the overall picture seems to be right. We have seen wealth grow faster than income for several decades and the concentration of wealth has gone up in most countries, mostly in the US. Here lies the risk of political influence and a constant shift of power in the society. These are the main points of Piketty and explain the success of his book in the US. On the other hand his “world formula” r>g meaning that the return on capital (r ) is always bigger than the growth of the economy (g) is correctly challenged. Over time the return on capital might be higher but not all is saved and adds to the stock of capital as a part is consumed or taxed. In addition it is not guaranteed to get a return of 4 to 5 per cent forever, just look at current returns in Europe. I struggle finding a save asset with a return of 4 per cent these days. But he is not alone in assuming ever-growing wealth; the bank Credit Suisse does the same. In my view both overlook the fact that only growing debt levels make it possible to have such a growth in measured wealth. Summing up, Piketty looks at symptoms – wealth – and not on causes – debt.
Some analysts said that Piketty deserves the credit for the revival in the Economics field of the historical narrative methodology and perspective, ending the hegemony of formal mathematical models. Would you agree?
Definitely! Economics should come back to become a logical science in the sense of observing and analysing what can be seen in the real world instead of building abstract economic models which by definition are incomplete and therefore describe a reality which has nothing to do with the reality. Like in the joke, where an engineer and an economist reach a river which they have to cross. The engineer thinks about how to build a bridge, the economist says: “Let’s assume we are on the other side of the river”. Most visibly was this in the run-up to the crisis. Economists assumed efficient and rational markets and for them money and credit are neutral. Both terribly wrong assumptions.
The low-growth regime of the world economy, and particularly the average growth rate decline in the developed countries, is due to a “secular stagnation” or to the debt overhang?
Clear answer: too much debt. First of all the growth rates of the past were higher than fundamentally justified due to cheap money and credit. Just look at the real estate boom in Spain. Now we have to deleverage and reduce debt levels, which by definition is bad for economic growth. On the other side the debt boom has generated artificially high asset prices and allowed people to speculate with cheap money leading to high levels of wealth, a symptom as I said. Therefore we do not have excess savings leading to the secular stagnation but too much debt bringing down our economies.
«Today central banks give money to institutions, which are not solvent, against doubtful collateral for zero interest. This is not capitalism.»
Financial bubbles since the 1980s are one of the pillars of an artificial growth? Present capitalism needs always a “good bubble,” as someone once said ironically?
I would not say capitalism needs it, I would say politicians wanted it and central banks tried to deliver it. Whenever we had an economic problem – crash 1987, Asia Crisis, LTCM Crisis, Russia Crisis, Dot-com Bubble, 9/11, Housing Bubble – central banks helped with more easy credit and lower interest rates. But this was a one way bet, leading to ever more speculation and debt. The problem is that we never allow a small fire to burn and therefore create ever bigger fires like in California where the main reason for the big forest fires is the fact that they not allow small ones to happen. This is not what capitalism needs. Capitalism needs failures of companies and banks for wrong decisions. If we do not let this happen it is not very “capitalistic” but destroys capitalism in the long run. Walter Bagehot the founder of the Economist magazine and big thinker on central bank policy said a central bank should only give credit to institutions, which are solvent against first class collateral and at punishing interest rates. Today central banks give money to institutions, which are not solvent, against doubtful collateral for zero interest. This is not capitalism.
The huge private and public debt overhang trend since the 1980s was a spill over from the financialization of developed economies and also since the 2000s of great emerging economies?
It clearly helped. Worldwide politicians thought that by incurring more debt or by encouraging more debt in the private sector it is possible to create more growth and welfare. Short term this is right. In addition banks produce the money in our world. Most people still assume they have to have savings first to give a credit but this is wrong. The banking sector creates the money itself and the central banks can only indirectly influence what is going on. As the bankers have a big interest in giving as much credit as possible as this drives their profits and bonuses. If now the central bank and the state give an implicit guarantee the sky is the limit. The more credit you give, the better! This also explains the drive for ever more liberalisation of financial markets. And again: politicians are more then happy to get easy credit. It is a close linkage between banks and politicians; probably Piketty should have focussed more on this relationship, which also explains the ever-increasing asset values.
The debt trend had a boost with the monetary QE policies from the main central banks?
Of course! It is the explicit goal of central banks to avoid the tower of debt to crash. Therefore they do everything to make money cheap and allow more speculation and even higher asset values. It is consistent with their thinking of the past 30 years. Unfortunately the debt levels are too high now and their instruments do not work anymore as good. They might bring up financial assets but they cannot revive the real economy. It is like in a bar, which is full. When the bartender offers beer for free, only those standing directly at the bar get the beer. Those further away not. Then the guys at the bar, ask for more because the guys at the other end of the room did not get anything – but drink it again themselves. In todays world the guys standing at the bar are the bankers and the governments, the rest of us is at the other end of the room and do not benefit. We can only see financial speculation going on but no revival of the real economy.
The fiscal euro area consolidation policies stopped, or will stop, the debt trend?
It is one of the big myths that we have managed to stop the debt trend. In all countries debt – private and public combined – continue to grow faster than GDP. In Ireland debt is 84 per cent higher as in 2008, Portugal 69%, Greece 55%, Spain 40%, France 34% and Italy 27%. I would not call this saving. The point is even if you try to reduce your debt, like the Italian government does which is running a surplus in its budget before interest expense, without economic growth it is impossible to reduce your debt load. The policy of austerity is doomed to failure. Especially if governments reduce investments and by doing this reduce the growth potential even further. It is impossible to save us out of the problem. Debts are just too high. And as inflation is not setting in we have two options: defaults or orderly restructuring.
«We could still sit together and do a debt restructuring. Pooling the bad debt, which I estimate in the range of three to five trillion euro, refinance these debts with a loan by the ECB and pay it back over a period of 20 plus years.»
What you would suggest?
I would prefer a European restructuring fund, pooling the excess debt and paying it back jointly over a certain period, i.e. 20 years. The stronger countries would have to help the weaker ones, particularly Ireland and Portugal to deal with the debt overhang. But I doubt politicians will go down this path as it is highly unpopular at least in the countries paying more. Therefore we will see the ECB trying ever more desperate methods to revive the economy. I doubt it will succeed.
What can be done?
We could still sit together and do a debt restructuring. Pooling the bad debt, which I estimate in the range of three to five trillion euro, refinance these debts with a loan by the ECB and pay it back over a period of 20 plus years, as I said. With some solidarity between the European countries. Combined with a package for European growth, which is not based on more deficit spending as some are suggesting but by labour market deregulation and major investments in education and innovation. We also need an immigration policy as in spite of the current high unemployment we are facing a major demographic crisis, which we need to address. The true liabilities of governments are much higher than the official numbers as we have no reserves for the cost of an ageing society. For example in Germany the true debt level of the government is above 400 % of GDP if we incorporate these hidden liabilities – not at 75% as the official data suggest. We urgently need a program for growth and the faster we deal with the debt overhang the faster we come to a position in which we can work on that.
What is wrong with the current Eurozone mix of fiscal consolidation policies with monetary non conventional measures in the ZIRP boundary from ECB?
Well, the current policy buys time without using it. The debt tower gets new stories every day and the fundament on which it rests is not getting better. Therefore it is only a question of time until the public in some countries will not be willing to accept these policies any more. I am surprised how willing people in Spain, Portugal and Italy are to accept a long period of economic depression. The longer it continues – and it will – the higher the probability of a political earth quake. And then everything is possible, even defaults and Eurozone exits. We trick our selves when we believe the crisis is over. That’s why I proposed a few weeks ago to give every euro-zone citizen 10.000 euro from the ECB. I would prefer a debt restructuring as I laid out before but if this is not possible, the ECB should stop serving the free beer to those standing at the bar but give it to everyone directly. In doing so it would support the real debtors to help them paying back and support demand. The risk is obvious: people might loose trust in our monetary system and this could start inflation – but we need to lower the debt load and if all other ways don’t work and no one is willing to do the necessary debt restructuring, this might still be the second best.
When you suggested a €10K check per capita from ECB you are just suggesting an “Europeanization” of the famous Friedman “helicopter money”?
It is as you write an application of Helicopter money. The point is that Friedman thought about it mainly from the point of low demand, I see it to support over indebted real economy participants and to boost demand. In addition I think we should stop “funding” the banking sector/speculators and better help directly the real economy. An alternative would be by the way to introduce “sovereign money” which means to have only central bank money and the banks could only allocate these funds but not create money themselves. In the transition to such a system we could reap huge gains which could be used to deal with excessive private and government debt. Martin Wolf (Financial Times) has commented on this and thinks it might be a solution. I tend to agree
Do you think ECB will step further for a full QE, changing the composition of its balance sheet, including purchase of sovereign debt from its members? What could be Bundesbank and German reactions?
The ECB is the only working institution in Europe and it will do “whatever it takes” to rescue the Euro. Yes, they will go “all-in” trying to rescue the Euro. But in reality they will only buy time and give the guys at the bar a few more rounds of free beer. The ECB will not be able to fix the problem of too much debt and therefore we will see not only heavy buying of government bonds but also efforts to cancel these bonds on the balance sheet of the ECB. The ECB runs the risk of ending up as a debt redemption fund without any democratic legitimisation. This will cause trouble with the Bundesbank and Germany but in the end I believe that German politicians will prefer this way as it hides the true cost of “rescuing” Europe. I would prefer the open approach as by going via the ECB we still run the risk of political upheaval as this will be very slow and we will have to deal with depression for many years to come. It would be better to deal with the bad debt asap and then invest in making us more competitive and to support growth to get Europe in a position to compete on a global scale and to deal with the costs of an ageing society.
«We need to limit credit growth and make it tax-attractive to invest in the real economy not in financial speculation. This will happen automatically if we return to normal interest rates. The key point is, that we as societies should reduce consumption which includes social welfare and rather invest more in the future.»
A Keynesian “New Deal” in Europe, as the French calls considering Juncker’s 315 billion euros plan a fake promise, has a risk of debt addiction?
I participated in a discussion with French economists last week. What I found striking is the belief in the government to be able to fix all our problems. The French are truly socialist in my view. But the crisis we face is not a crisis of free market but of free markets in which the governments and central banks have taken away the risks and thereby changed the normal mechanisms of a market economy. The French believe we could just increase government spending and the problem is solved. Japan shows us, that this is by no means the case. The French also believe the government is the better entrepreneur and inventor. I doubt this as well. Only free markets can create innovation and new industries. The role of government is to ensure a good environment to make it possible. Now believing in 315 billion more spending of the EU to fix our problems is more than naïve. The only result will be even more debt which cannot be served.
Between austerity deflation plus some monetary stimulus and public fiscal spending plus a full QE, your’s is a kind of “third way”?
You are spot on. The starting point are the governments which in the crisis first cut their expenditures for the future: investment, education, innovation. This is totally wrong. We need to limit credit growth and make it tax-attractive to invest in the real economy not in financial speculation. This will happen automatically if we return to normal interest rates. The key point is, that we as societies should reduce consumption which includes social welfare and rather invest more in the future.
When do you think a new “Minsky moment” can arrive?
The late economist Hyman Minsky defined three ways of borrowing: hedge borrowing where borrowers were able to pay interest and principal out of income, speculative borrowing were the borrower could pay the interest but not the principal and relied on someone paying the same price for the asset like he did and Ponzi borrowing were the borrower could not pay the principal nor the interest and hoped that he be bailed out by the next buyer. We all are in a Ponzi world right now. Hoping to be bailed out by the next person. The problem is that demographics alone have to tell us, that there are fewer people entering the scheme then leaving. More people get out than in. Which means, by definition, that the scheme is at an end. The Minsky moment is the crash. Like all crashs it is easier to explain it afterwards than to time it before. But I think it is obvious that the endgame is near.
An edited partial version of this interview was published in Portuguese at EXPRESSO digital daily November 25th, 2014. (Required subscription)