Debt crisis will continue for the foreseeable future

Thursday, September 27, 2012    

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IT is useful to look at the ongoing negotiations with the International Monetary Fund (IMF) in the context of the stubborn world economic recession.

The current crisis that began with the implosion of the United States sub-prime mortgage market in late 2007 is far from over and has escalated to levels that have not been witnessed in advanced economies since the 1930s and World War II debt defaults.

It is increasingly likely that the crisis will get worse before it gets better, making massive debt restructurings commonplace with debts being substantially written down from their book values to their market values.

Even with substantially reduced payment schedules in several of the stressed economies in Europe and developing countries, it will be many years before debtor countries return to sustainable economic growth. This is the gloomy forecast that emerged as consensus of a group of experts recently convened by the IMF.

It is often not known that the advanced economies have been in debt crises before because in recent decades these debt debacles were assumed to be a disease of emerging market economies and developing countries. Prior to 1940 advanced economies were involved in many debt restructurings and conversions of high-yield and short-term debt to low-yield, long-term debt.

More dire debts were forestalled by allowing Japan and Germany to not pay onerous war reparations. Indeed, the United States pump massive sums into war-ravaged economies through the Marshall Plan. Ironically, Japan and Germany are the least empathetic to countries in debt as is clearly evident in the attitude of Germany to assisting countries like Greece.

Because of globalisation a financial crisis in one country can easily and quickly become a contagion that engulfs many and even destabilise international financial markets. In an integrated Europe the debt problem of any country is the problem of all countries and can adversely affect the credit rating of groups of countries eg the EU or categories of countries such as emerging markets. Advanced economies comprise such a category because central government debt as a percentage of GDP exceeds 90 per cent for advanced economies as a whole.

Empirical studies have revealed that a country with a debt/GDP (gross domestic product) ratio exceeding 90 per cent cannot grow its way out of the crisis, hence it must restructure its debt.

Another disturbing conclusion of the conference is that nobody knows exactly how bad the debt tsunami is because private debt can mutate into government debt. This is what happened in Ireland and Spain where neither government had debt issues until they had to absorb the bad debt of their overextended banking sectors.

Contingent liabilities, such as unfunded pension obligations, and debts of regional and local governments as well as public enterprises, can also become the debt of the central government.

This is all familiar to us in Jamaica where successive governments over-borrowed then absorbed the bad debts of the banking sector and public enterprises.

Jamaica's debt/GDP ratio is over 100 per cent and we have already carried out the Jamaica Debt Exchange. We are not growing our way out of the debt morass at the current and projected rates of economic growth.





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