The Swiss-based Bank of International Settlements (BIS), the oldest international financial institution in the world, has functioned as the central bank of central bankers for 80 years. In a working paper written by three senior staff economists (“The future of public debt: prospects and implications”), released in March, BIS warns that Greece isn’t the only Western economy with hazard lights flashing.
Indeed, it names 11 more: Austria, France, Germany, Ireland, Italy, Japan, the Netherlands, Portugal, Spain, Britain – and the United States. Without “drastic measures,” BIS says, all of these countries will hit a wall of debt.
When the senior economists at BIS warn 12 of the richest countries on Earth that they must take drastic action to reduce debt, you know that it’s time to check the air bags. The only thing you don’t know, that you need to know, is the precise time of the crash. The lesson is already obvious: Governments can’t drive recklessly, use only the accelerator for braking and not eventually crash.
The BIS paper notes that the public debt of 30 OECD countries will (on average) exceed 100 per cent of GDP within the next year, “something that has never happened before in peacetime.” But it warns that conventional debt-to-GDP ratios are misleading – missing “enormous future costs” that are already authorized by past fiscal commitments that will inexorably inflate public debt further still.
By the end of 2011, the BIS economists calculate, U.S. government debt will have risen from 62 per cent of GDP in 2007, not quite three years ago, to 100 per cent. Britain’s debt will have risen from 47 per cent of GDP to 94 per cent. Italy’s debt will have risen from 112 per cent of GDP to 130 per cent. All together, the public debt of the 12 countries will have risen from 73 per cent of combined GDP to 105 per cent.
At this debt level, the risk of sovereign default rises rapidly. But the BIS analysis says this unprecedented debt level will itself increase “precipitously” in coming years. It will not, as each of these countries separately insists, fall.
For one thing, the BIS report says, countries that proclaim spending restraint generally do not actually do it. Normally, they hold the line – temporarily. Normally, they slow the rate of increase – temporarily. All pronouncements aside, the BIS report says, these 12 countries have made such grandiose spending commitments that they are predestined for higher debt. The U.S. debt-GDP ratio will hit 150 per cent in the next decade. Britain’s debt-GDP ratio will hit 200 per cent. Japan’s debt-GDP ratio will hit 300 per cent.
These increases in debt, the BIS report says, are untenable. The financial markets, of course, won’t permit them. The only mystery, the BIS report says, is exactly when the markets will intervene. History shows, the report says, that when the markets do rebel, they often do so instantaneously and decisively – often without much warning.
“When, in the absence of fiscal actions, will investors start demanding a much higher compensation for the risk of holding the increasingly large amounts of public debt that [these countries] are going to issue to finance their extravagant ways?” the BIS economists ask. “The question is when will markets start putting pressure on governments, not if,” they respond.
When the markets do require a much higher risk premium, the consequences will be felt around the world – on rich and poor countries alike, on the thrifty as well as on the profligate. These consequences will certainly fall on Canada as well. If it takes Europe to save Greece, what will it take to save Europe? Emerging economies have done a better job than the rich countries in controlling debt. Asian government debt stands at 40 per cent of GDP; Central European government debt stands at 28 per cent; Latin American government debt stands at 37 per cent.
In its most spooky, mind-boggling analysis, the BIS economists try to determine the share of GDP that interest rates would require – assuming, across the next 30 years, that the 12 governments kept spending as they are spending now. In the case of the United States, interest payments would cost 22 per cent of GDP in 2040. In the case of Britain, interest payments would cost 27 per cent. For Britain, this would shove the government’s share of GDP close to 80 per cent.
Prime Minister Stephen Harper and Finance Minister Jim Flaherty are right to press the more profligate countries for an exit strategy from stimulus spending. But what the rich economies actually need is an exit strategy from too much spending of all kinds and a return to some pragmatic recognition of the limits of government.
The writers of the BIS report are Stephen Cecchetti, head of the BIS monetary and economic department; M.S. Mohanty, director of the BIS macroeconomic analysis department; and Fabrizio Zampolli, BIS’s senior economist. Their report deserves both attention and action.