According to the Bank of International Settlements, the central bankers’ central bank, "The question is when markets will start putting pressure on governments, not if...in some countries, unstable debt dynamics – in which higher debt levels lead to higher interest rates, which then lead to even higher debt levels – are already clearly on the horizon." Their report, which doesn’t mince words, is available here.
The worst basket case, working on the BIS’s central forecast, is the UK. If we continue with current policies, the British face a rise in the public debt/GDP ratio to over 500% by the year 2040, by when interest payments on existing government debt will reach nearly 30% of GDP.
The only way to stabilise the debt/GDP ratio at 2007 levels, says the BIS, would be to run a primary budget surplus of 11% over five years, 6% over ten years or 3.5% over twenty years. In fact, we’re still well in the red and heading for a primary deficit of nearly 10% in 2011.
According to UK chancellor Alastair Darling’s recent budget, public sector revenues in the 2010-11 fiscal year will be £541 billion. Expenditures will be £704 billion, a cool £163 billion more.
So for the UK to hit a target of stabilising the debt ratio over five years, expenditures would have to be cut by £217 billion (assuming constant revenues). Either that, or revenues would have to rise to £781 billion (assuming constant expenditures).
Given that most UK residents already feel taxed to the pipsqueaks (to use an old phrase), the second scenario of conjuring up an extra £240 billion in taxes seems unlikely.
On the other hand, the current pre-election controversy over cutting the public payroll by a mere £2 billion (which might mean 40,000 public sector job losses) shows that no one is talking about expenditure cuts even remotely of the scale the BIS says are necessary.
So what is going to happen?
Perhaps we can sail blithely on, interest rates remaining low, and somehow miraculously grow our way out of recession, easing fiscal pressures. This seems to be the market’s current mindset. Crisis? What crisis?
Perhaps equity market investors are making their third huge mistake in a decade, on this occasion by failing to understand the inexorable logic of debt and compound interest and the potential impact of a rise in real interest rates on public finances.
Or perhaps the UK will in the next decade or two redenominate its currency and by fiat cut monetary values, savings and debts by a factor of two, five or ten (for example), something old communist regimes used to specialise in. That might also be why equities are going up.
But it’s not hard to see why some believe that the end of the bull market in precious metals is still years away.