Economics and politics - comment and analysis
30. December 2018 I Heiner Flassbeck I Economic Policy, Economic Theory

The debtor is always guilty

In German debt and guilt are the same word: Schuld. So, in Germany, debt has a morally negative connotation. Further, the state budget is referred to as “Haushalt”, which is the word for household. Germans equate state finances with those of personal finances, a concept that is reinforced by German political parties across the whole of the political spectrum.

Originally posted in German at Makroskop

Translated and edited by BRAVE NEW EUROPE

There are topics that obviously overwhelm the “normal” journalists of our “normal” media. The most important of these is the subject of debt. Here is a brief guide to help Germans understand the daily bunkum they are bombarded with in their media.

“200 billion dollars budget deficit – in November” the neo-liberal German broadsheet Frankfurter Allgemeine Zeitung headlined a Bloomberg report last Friday (here) with the implication that the American state has lost all inhibitions under Trump and is irresponsibly throwing money out the window. But what do 200 billion dollars in a month mean for the USA? Is it too much or too little? The article does state that this is 70 billion more than November 2017. But even that is not really enlightening. Are the figures so stable that one can extrapolate something from the comparison with the previous year? And even if that were the case, is it justified or unjustified, measured by the behaviour of all other sectors of the economy, that the state is incurring significantly more debt this year?

Another German newspaper the Süddeutsche Zeitung (here) makes a greater muddle of it, but at least tries to present some dissenting voices. In the end, however, it cites the usual figures concerning the world’s increasing indebtedness and Paul Volcker, who purportedly said that “there is a lot of debt in the world” and that the next financial crisis will certainly come. You can stop reading the article at this point, because the authors don’t even try to present a systematic analysis.

Spiegel-Online, renowned for inventing facts, is even more shambolic. There Ines Zöttl states that Trump is desperately in need of a debt consultant (here). That is just normal German journalistic idiocy, but then she falls off an intellectual cliff. She probably doesn’t even realise she’s doing it when she writes:

“In the meantime, however, Trump has discovered the philosopher’s stone: if the US trade deficit falls, then the budget deficit also falls, he claims. Even first-graders should be able to make this connection, ‘it’s that simple’. It’s a shame that he’s the only one who understands this point.”

There it is, the great confusion, summed up in a few words. Those who do not understand that there is a connection between savings and debts in sectors of an economy should never again pick up a pen to write about this stuff. This kind of journalism obviously manages to provide the German reader with fresh horror stories and a daily dose of much valued Angst. Especially in Germany, media debt phobia is increasingly turning into a kind of physical affliction. In any case, the brain remains completely switched off as soon as the word “debt” is even mentioned. It’s hard to put into words what the German media and the economists behind them can get away with when it comes to monetary macroeconomics. This intellectual bankruptcy is proudly repeated almost daily by the German people, media, and politicians.

I would like to use a few examples to show how the debt issue is being dealt with in German media. The situation was particularly bad in September. Ten years after the crash of Lehman Brothers, nobody wanted to miss out on the topic and so horror reports about new debts and the next crash accumulated. And of course the central banks were to blame again, who with their low interest rates had initiated the coming cataclysm. The fact that governments with their “excessive debts” are once again in the foreground of criticism is of course not surprising.

What is debt really?

With some easy tests it is quite easy for the reader to recognise whether nonsense is simply being perpetrated or the writer has a vague idea of what he or she is writing about. Whenever “debt” is written as an isolated fact, the text can be put aside and forgotten forever. If you don’t say whether you mean gross or net debt, whether the debts are those of the state, private households, or companies, or debts of one country to other countries, you can immediately write it off as “popular stupefaction” and move on to the next article.

This also applies to someone whose career would suggest he had a certain objectivity: William White, former chief economist of the Bank for International Settlements, has become a popular debt alarmist and is constantly quoted because the Germans believe they have finally found someone who is not German and yet has the “right insight”.

But what the man writes (to be found here, for example, in the FAZ) is for the most part utter nonsense. Also the connections highlighted again and again by the Bank for International Settlements are, as we have shown in our detailed statement (here), cannot in any way be justified. White writes in the FAZ that the “global debt ratio” continues to rise and that higher debts are a “headwind” for economic development (if not only productive investments are financed) and that this is mainly due to the asymmetric monetary and fiscal policy in the world.

The very fact that White uses the term “global debt ratio” without immediately explaining what it is – of course, gross debt – shows that this is not a serious analysis, but scaremongering. The gross debt or gross liabilities are always necessarily matched by the same gross assets for the world, which means that the world never has net debt, but always has a completely balanced economy.

Higher gross debt (also as a percentage of GDP) in one or more sectors may be offset by higher savings in other sectors that have made this higher debt necessary to avoid a global slide into recession. If, for example, the savings rates of companies and private households are rising together, as can currently be observed, the government’s debt ratio must also rise if it is to avoid a slump in economic activity and thus ultimately even higher debt (due to rising unemployment and impoverishment of the population).

Why in this case the debts mean “headwind” for the economic development is not only not obvious, it is exactly the opposite: It is thanks to the rising debts of the state that there is no economic headwind retarding growth caused by rising savings in other sectors.

Without knowing which sector asked for loans, what they were used for and what the overall net monetary position of the sector is (i.e. the offsetting of its debt against claims on other sectors), it is not possible to make relevant statements as to whether a certain degree of debt or a change in debt stock is problematic – for example whether it indicates higher instability in the economy. What use would it be for us to know that a government budget has high gross debt if we know nothing about whether it also has high gross claims against other states or its own citizens or companies?

Only the net debt position of a sector or an entire country provides reasonable access to assessing the economic situation of that sector or nation. This exercise is also carried out by any business economist or insolvency administrator who wants to get an idea of the economic situation of a company. He calculates the sum of receivables and payables, adding their specific risks (i.e. the probability that they can be collected) against each other, and thus determines the balance.

In a second step, the tangible assets are then valued in order to obtain an overall picture. A high net debt position does not have to be a problem with high non-monetary assets. Of course, valuation issues play an important role. But in general, high net debt cannot automatically be interpreted as “over-indebtedness”.

What is a nation’s debt?

I am often asked at events how a country comes to have debts or net assets. Is it true that countries with current account surpluses like Germany have to grant loans to other countries so that they can buy more goods in Germany than they themselves sell to Germany?

First, it should be noted that national statistics are always based on aggregated data, which in turn are backed by the usual sectors, namely private households, enterprises, and government. A nation as such is not actually an economic entity.

A look at the capital account statistics of the Deutsche Bundesbank (Table 9.a) shows that the majority of what appears as a counter entry to the current account balance (almost €280 billion in 2017), i.e. the balance of the capital account (or the increase in the net foreign assets of Germans), consists of an increase in securities investments (€200 billion). Thus, Germans bought 200 billion euros more foreign securities (government bonds or corporate bonds, real estate shares, shares, etc.) than foreigners bought in Germany. In second place at € 42 billion is the balance of so-called direct investments, which includes share purchases above a certain threshold as well as short-term loans and investments in real estate (see explanation in Table 9.c).

It is not possible to tell from these statistics who is the counterpart abroad and it is by no means clear whether this includes those who bought goods directly in Germany from abroad. In the national balance all sorts of very large gross transactions abroad and from abroad mix to a net value, which for logical reasons cannot exceed the current account balance, because we know that all economic entities of a country can only have bought more in another country than they themselves have sold in this country if the various economic entities in the other country have given them a loan in some way.

This is immediately plausible if one looks exclusively at government bonds. If Germans purchase 200 billion euros more in foreign bonds than foreigners buy in German bonds, then the current account balance is largely “counter-financed”, even if there has not been a single loan from a German carmaker to a customer abroad and all cars have been paid for in full. Since not all capital transactions can be recorded as easily as goods transactions, the capital account is usually completed with a residual component, which simply represents the difference between all captured transactions and the current account.

It also follows from these considerations that there can be no net capital flow from the surplus to the deficit country higher than the current account gap. Thus, there is never a net cash flow (a flow that balances all existing transactions) that would be freely available in the deficit country for other purposes than the purchase of imports. Nevertheless, there are gross flows for all sorts of purposes, so that from a gross perspective the impression can arise that the surplus country is also “financing”, a real-estate boom, as in the notorious case of Spain. But, if one sticks with a gross view, then one sees there is also “financing” of certain projects or activities in the surplus country by the deficit country. The figure becomes so blurred that it is meaningless. Ultimately, one must return to the net view in order to establish a meaningful connection between the flows of goods and capital.

The debt of “a country” as such to foreign nations is real only as far as the expectations of market participants in the financial markets are concerned. External debt is generally taken as an indicator of a country’s foreign trade problems. The aim is to assess whether and when a critical situation could arise whereby the country can no longer cope at the given exchange rate. If a nation has persistent current account deficits because it cannot get out of a situation of overvaluation of its currency, speculation arises in the markets about a possible devaluation, which could cost market participants a lot of money because they have invested money in the currency that is suspected to be due for a devaluation, or because they no longer trust the country to repay bonds in international currency in full.

But even here (as explained here and in the following pieces), the core of the problem is not the current account balance as such, but the problems behind it. These are usually currency overvaluations, loss of market share, and job losses in the sectors and companies exposed to foreign trade. These conditions cannot be sustained in a nation for long because no democratically elected government will survive these in the long run. In this respect, it is not so much the “debt” that causes the country difficulties (if it is debt in national currency, it causes no difficulty anyway), but rather what lies behind the debt.

Excessive credit growth or herd mentality?

A well-known German debt alarmist is Uwe Jean Heuser, head of the German weekly Die Zeit‘s economic editorial staff, who has often attracted our attention with his “astute analysis”. Of course, he also refers to White before he comes to the conclusion he always comes to: the evil Keynesians are among us, they have hidden themselves in the central banks from where they have been terrorising mankind ever since the fall of that last bastion of reason, the Deutsche Bundesbank.

Of course, in Heuser’s world there is rising national debt, as well as rising overall world indebtedness (in absolute terms), again with reference to White. That the national debt must rise, if enterprises save, does not occur to him or the rest of German media. If they admitted that, they would also have to admit that the beautiful ideology of excessive national debt does not make sense. He does not, however, cite the debt in absolute figures, which – surprise, surprise – increased significantly between 1997 and 2017. In these twenty years all economic indicators increased: income, inflation levels, savings and, consequently, debt. What is the point of the whole exercise then? Why do journalists have to treat their readers as if they are stupid?

This time, however, Heuser has also armed himself with a young economist from Bonn, Moritz Schularick, who is said to have proved that all financial crises are preceded by “excessive credit growth” – ie too much money is lent. Creditors took risks that were too high, banks piled more and more loans onto their equity base, and at some point it turned out that nobody was paying them back anymore. Especially when the real estate market is booming and private individuals are throwing themselves into ever new debts to build houses and apartments, one has to expect a crash.

There is a lot to be said for that. But the most important thing is still forgotten. There is a herd mentality in the financial markets and this is primarily responsible for the crises. Herd movements systematically distort prices and ultimately end in panic, because at some point it has to become clear that prices have become completely unrealistic. The markets produce false prices because the mass of market participants are guided by exaggerated expectations. This is a fundamental market failure, but the Heuser´s of this world immediately blame it on the state again. One simply postulates the “irresponsible central bank policy” as the cause. Just because the central bank flooded markets with liquidity, until they no longer knew what they were doing, crisis ensued.

Of course this is nonsense, because many crises are caused by wrong prices which had nothing to do with a liquidity glut at all. Just think of the many episodes when currency rates were massively distorted by private banks and hedge funds without any irresponsible policy on the part of anyone. Currency speculation is triggered by interest-rate differentials, which are a perfectly normal part of a world where there are different inflation rates in different countries. By definition, this has nothing to do with a misguided central bank policy.

Have the central banks all gone mad?

Ultimately, the decisive factor in assessing the over-indebtedness argument is that it in no way fits the current market situation. This is a contradiction, especially for market believers with debt phobia (and that is most of them), which they can only resolve by force. If there were an ideal market for money and capital, i.e. a market that is not influenced by the central banks, the constellation of “over-indebtedness” and extremely low interest rates could obviously not occur at all. If there was “too much” demand for capital in this ideal market (compared to supply), the interest rate would be high – and not historically low (as it has been for many years).

Now, however, there are central banks, and they are indeed the most important players in the money and capital markets. In order to make sense of the Bank for International Settlements and Mr White’s complaint about too much debt despite the extremely low interest rates that have been in place for some time, one must assume that the situation in the credit markets is tight (demand for credit is said to be unreasonably high). But that means assuming that the central banks are reversing market conditions with their policies. So they did not adapt to the real conditions “in the markets”, but wanted to push through a certain agenda, apparently misjudging the “true” market situation. In extremely neoliberal-liberal circles this is a trope repeatedly used to circumvent the contradiction of their own argument. The world’s central banks, so to speak, have been collectively totally insane for ten years (the Japanese for 25 years) (and of course contaminated by Keynesians, see here an older piece).

This is absolutely ridiculous and is refuted by the clearly demonstrable weakness of the overall economic development and in particular the serious weakness of investment in the real economy – at least in the industrialised countries. It is precisely because there is too little willingness to borrow that the central banks are using every means at their disposal to stimulate lending by the banks. Because of the relatively new phenomenon of saving by companies, even at zero interest rates the old ideas about the state, which withdraws as soon as the “boom” (entrepreneurial debt) begins, no longer exists. Central banks at least implicitly acknowledge this and nothing else. If, however, there is a macroeconomic need to increase lending and the amount of debt, the diagnosis of global or general “over-indebtedness” is meaningless and dangerous from the outset.

Everyone must be as “stable” as Germany         

The worst thing, however, is the German arrogance, which resonates subliminally in almost all of these articles. Hasn’t Germany shown that it can also do without debt? Don’t you just have to pull yourself together a little so that everything will be fine in a few years’ time? Didn’t the German Chancellors Gerhard Schröder and Angela Merkel show that it’s only a question of political will whether one ends up standing there as a solid German oak tree or a Southern European weed, which is knocked down by a whisp of wind?

In the German daily newspaper Die Welt, Olaf Gersemann, head of the economic editorial office, explicitly writes in a commentary on France (here) that he had hoped that Macron would emulate Schröder. But instead Macron is now imitating Italy. Under pressure from the Yellow Vests, France is living above its means with even higher loans from the state and even higher wages for employees. Germany must therefore fear a coalition of irrationality between Italy and France.

The fact that in 2018 it is still possible to write such nonsense in a large nation that claims to have many good schools, universities and other educational institutions shocks me again and again. Don’t we want or can’t we understand the difference between the components and the whole? There are certainly some who don’t want to understand it, but where are the many others who can understand it? Why don’t they say anything?

Macron could not, even if he had wanted to, copy Schröder, because one nation can retrench only at the expense of the others, but not everyone can do this at the same time. Eventually there is no one left to enable them to tighten their belt in order to improve their national finances – where there is a saver, there has to be a debtor. Why can´t Germans understand this?