Our economies are floating on a bubble of debt. Although US Federal Reserve chair Jay Powell has most recently downplayed his comments about the risks of high corporate debt, he has only said that any bursting of the bubble will not be as problematic and systemic as the financial crisis. That’s not a high bar. He still suggests that many companies will face “severe financial strain” if there is an economic downturn. High leverage — excessive debt — will do what it does and amplify performance, meaning that a downturn will be more painful than it might otherwise be. He implies the result will be lay-offs and business failures, about which he appears relatively calm.
Others may be less sanguine. Many believe that we are now facing just such an economic downturn. Its consequences could be severe.
But perhaps that is no more than we deserve. The amplification effect of debt has been used to create growth where there would have been none, and much of the economic success that we have recently seen, such as it is, has been built on the weakest foundations. Economies have remained puffed up by extremely low interest rates, and the further puffery of quantitative easing. The resulting debt binge has skewed our economies and inflated asset prices. This has exacerbated the gulf between the haves and have-nots, boosting the sense of unfairness that many feel. Central banks have ignored this huge asset price inflation (highlighted in The centre cannot hold) because their inflation targeting concentrates only on consumer prices.
But at least this debt binge has enabled the world economy to keep on growing, many will say. We did not grind to a painful halt in the financial crisis. Not least, most governments would express gratitude. We are all obsessed with growth, but governments feel that obsession more directly as they need growth so that the nominal value of debt erodes over time. Without growth, debt will feel a much greater and more immediate burden and it will be harder to justify delays in paying it off. Governments, like companies, are caught in a debt trap whereby they need expansion to make their debt burdens more manageable over time. With the global expansion of the debt load that BIS highlights, we’re all caught in this trap.
There’s a fairness aspect — or a lack of fairness aspect — to our obsession with growth. Henry Wallich, one of Powell’s predecessors as a governor of the Fed (from 1974 to 1986), said: “Growth is a substitute for equality of income. So long as there is growth there is hope, and that makes large income differentials tolerable.” (I should acknowledge that this quote was drawn to my attention by the marvellous Doughnut Economics).
Because of our obsessive need for growth, we seem prepared to believe myths. For example, our growth obsession is often used to trip up the financial markets — as we can see by the loss-making companies brought to IPO at inflated prices on the promise of continuing stratospheric growth. Lyft and Uber are the most recent examples of this damaging impact of our growth obsession, doomed to early share price drops as the market wakes up to the fact that they lose money and have little prospect of starting to make profits until they start charging an economic rate for their services, braking their stellar growth. It’s another example of the dangers of our focus on specific measures of performance. More than 80% of US IPOs last year were of unprofitable companies, able to offer only the promise of growth; US investors in particular seem content to see most of their returns come from share price appreciation rather than in dividends.
The bubble of debt and the growth myth are skewing our economies in other ways. I’d argue that the financial behaviours it brings about are also among the causes of unfairness. With money essentially free, those who are willing to take on sizeable debt burdens are able to outbid the more conservative, and the performance amplification effects of debt make them look like investment geniuses, able to charge more for their services. Because debt costs are taken out before tax charges, these heavy debt loads reduce companies’ tax burdens at the same time as making them more prone to failure. These behaviours build further unfairness into our economies.
Take as one example infrastructure businesses and utilities. Pension funds are keen to invest directly in such businesses because this enables them to get close to the underlying steady cashflows that they should offer, a good match for pension liabilities. Yet too often they have been unable to buy these businesses because they have been outbid by intermediary fund managers which have been willing to add significant debt loads to them, enabling them to pay more not least because the debt is structured to minimise the tax cost. Pension schemes can only then invest by paying significant fees to these intermediaries. These juiced up returns look like more economic activity, more growth, but really all that has happened is that more leverage has been added to the system, making it less able to withstand shocks and limiting incentives for long-term investment. Government finances have also been made less robust because more business activity has been shielded from the tax system by debt. In other words, our obsession with growth has been used as a mechanism that has generated further unfairnesses.
The damage done to Thames Water as a business — as well as to the Thames itself, which was the recipient of nearly 2 billion litres of raw sewage in 2013 and 2014 — by its former owners was not reflected in the returns that they enjoyed, even taking account of the million-pound fines they faced. Australian bank Macquarie made returns of 15.5-19% over the 11 years of its control of the business having bought it in 2006 for £5.1 billion and selling it in 2017, by which time it was loaded with £11 billion in debt (these are FT numbers; it is worth noting that Macquarie instead points to the 12.3% internal rate of return on its Macquarie European Infrastructure Fund, itself a generous performance from what are steady assets).
Because growth has been invented and has deliberately helped to skew the unfairnesses in our society, it is no longer working in the way Wallich said it should. It is for many no longer offering a “substitute for inequalities of income” because it doesn’t offer hope. For many, hope has been squeezed out and they see economic growth as something that happens to others and benefits others. In many cases, they are right to do so. This is making our current unfairness intolerable.
In a 1972 New York Times article, A World Without Growth?, Wallich wrote dismissively of ecologists’ criticism of resource depletion and damage to the environment from ongoing growth, putting it in the context of Malthusian views of the impending end of the world, which did not come to pass as imminently from 1798 as the English reverend predicted in An essay on the Principle of Population. Even Wallis might have been shocked from this confidence by the recent Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) report on the damage to ecosystems and impending mass extinctions with 1 million species under immediate threat; he might have wavered a little at the thought that some of our currently most productive land is predicted to offer no more than 50 or 60 years of harvests. Economic growth now, more than ever, seems to have reached fundamental limits.
Wallich argued in his article that the power of economics means that as resources are depleted their price increases and automatically they are used more wisely or substitutes are found. What we are finding is that we need a substitute for the growth myth. It no longer offers us an answer to unfairness, because people are seeing through the false growth that is the best we seem able to generate at the moment. And it is leading us to increasing instabilities, both in terms of debt and in terms of ecology.
“Somewhere in the dim future, if humanity does not blow itself up, there may lie a world in which physical change will be minimal … hopefully a much more humane and less materialistic world,” wrote Wallich. “We shall not live to see it.” Let’s hope he’s wrong about that.
Doughnut Economics, Kate Raworth, Cornerstone 2017