G20: the debt solution

22 November 2020 by Michael Roberts


This weekend, the G20 leaders’ summit takes place – not physically of course, but by video link. Proudly hosted by Saudi Arabia, that bastion of democracy and civil rights, the G20 leaders are focusing on the impact on the world economy from the Covid-19 pandemic.

In particular, the leaders are alarmed by the huge increase in government spending engendered by the slump forced on the major capitalist governments to ameliorate the impact on businesses, large and small, and on the wider working population. The IMF estimates that the combined fiscal and monetary stimulus delivered by advanced economies has been equal to 20 per cent of their gross domestic product GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
. Middle income countries in the developing world have been able to do less but they still put together a combined response equal to 6 or 7 per cent of GDP, according to the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
. For the poorest countries, however, the reaction has been much more modest. Together they injected spending equal to just 2 per cent of their much smaller national output in reaction to the pandemic. That has left their economies much more vulnerable to a prolonged slump, potentially pushing millions of people into poverty.

The situation is getting more urgent as the pain from the pandemic crisis starts to be felt. Zambia this week became the sixth developing country to default or restructure debts in 2020 and more are expected as the economic cost of the virus mounts — even amid the good news about potential vaccines.

The Financial Times commented that: “some observers think that even large developing countries such as Brazil and South Africa, which are both in the G20 G20 The Group of Twenty (G20 or G-20) is a group made up of nineteen countries and the European Union whose ministers, central-bank directors and heads of state meet regularly. It was created in 1999 after the series of financial crises in the 1990s. Its aim is to encourage international consultation on the principle of broadening dialogue in keeping with the growing economic importance of a certain number of countries. Its members are Argentina, Australia, Brazil, Canada, China, France, Germany, Italy, India, Indonesia, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, USA, UK and the European Union (represented by the presidents of the Council and of the European Central Bank). group of large nations, could face severe challenges in obtaining finance in the coming 12 to 24 months.”

Up to now, very little has been done by the G20 governments to avoid or ameliorate this coming debt disaster. In April, Kristalina Georgieva, the IMF managing director, said the external financing needs of emerging market and developing countries would be in “the trillions of dollars”. The IMF itself has lent $100bn in emergency loans. The World Bank World Bank
WB
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

has set aside $160bn to lend over 15 months. But even the World Bank reckons that “low and middle-income countries will need between $175bn and $700bn a year”.

The only co-ordinated innovation has been a debt service Debt service The sum of the interests and the amortization of the capital borrowed. suspension initiative (DSSI) unveiled in April by the G20. The DSSI allowed 73 of the world’s poorest countries to postpone repayments. But pausing payments is no solution – the debt remains and even if G20 governments show some further relaxation, private creditors (banks, pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
, hedge funds Hedge funds Unlisted investment funds that exist for purposes of speculation and that seek high returns, make liberal use of derivatives, especially options, and frequently make use of leverage. The main hedge funds are independent of banks, although banks frequently have their own hedge funds. Hedge funds come under the category of shadow banking. and bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. ‘vigilantes’) continue to demand their pound of flesh.

In advanced economies and some emerging market economies, central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

ECB : http://www.bankofengland.co.uk/Pages/home.aspx
purchases of government debt Government debt The total outstanding debt of the State, local authorities, publicly owned companies and organs of social security. have helped keep interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
at historic lows and supported government borrowing. In these economies, the fiscal response to the crisis has been massive. In many highly indebted emerging market and low-income economies, however, governments have had limited space to increase borrowing, which has hampered their ability to scale up support to those most affected by the crisis. These governments face tough choices. For example, in 2020, government debt-to-revenue will reach over 480% across the 35 Sub-Saharan Africa countries eligible for the DSSI.

Even before the pandemic broke, global debt had reached record levels. According to the IIF, in ‘mature’ markets, debt surpassed 432% of GDP in Q3 2020, up over 50 percentage points year-over-year. Global debt in total will have reached $277trn by year end, or 365% of world GDP.

Much of the increase in debt among the so-called developing economies has been in China where state banks have expanded loans, while ‘shadow banking’ loans have increased and local governments have carried out increased property and infrastructure projects using land sales to fund them or borrowing.

Many ‘Western’ pundits reckon that, as a result, China is heading for a major debt default crisis that will seriously damage the Beijing government and the economy. But such predictions have been made for the last two decades since the minor ‘asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). readjustment’ after 1998. Despite the increase in debt levels in China, such a crisis is unlikely.

First, China, unlike other large and small emerging economies with high debts, has a massive foreign exchange reserve of $3trn. Second, less than 10% of its debt is owed to foreigners, unlike countries like Turkey, South Africa and much of Latin America. Third, the Chinese economy is growing. It has recovered from the pandemic slump much quicker than the other G20 economies, which remain in a slump.

Moreover, if any banks or finance companies go bust (and some have), the state banking system and the state itself stands behind ready to pick up the bill or allow ‘restructuring’. And the Chinese state has the power to restructure the financial sector – as the recent blockage on the planned launch of Jack Ma’s ‘finbank’ shows. On any serious sign that the Chinese financial and property sector is getting too ‘big to fail’ , the government can and will act. There will be no financial meltdown. That’s not the picture in the rest of the G20.

And most important, globally the rise in debt was not just in public sector debt but also in the private sector, especially corporate debt. Companies around the world had built up their debt levels while interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates were low or even zero. The large tech companies did so in order to hoard cash, buy back shares to boost their price or to carry through mergers, but the smaller companies, where profitability had been low for a decade or more, did so just to keep their heads above water. This latter group have become more and more zombified (ie where profits were not enough even to cover the interest charge on the debt). That is a recipe for eventual defaults, if and when, interest rates should rise.

What is to be done? One offered solution is more credit. At the G20, the IMF officials and others will push not just for an extension of the DSSI, but also for a doubling of the credit firepower of the IMF through Special Drawing Rights (SDRs). This is a form of international money, like gold in that sense, but instead a fiat currency valued by basket of major currencies like the dollar, the euro and the yen and only issued by the IMF.

The IMF has issued them in past crises and proponents say it should do so now. But the proposal was vetoed by the US last April. “SDRs mean giving unconditional liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. to developing countries,” says Stephanie Blankenburg, head of debt and development finance at Unctad UNCTAD
United Nations Conference on Trade and Development
This was established in 1964, after pressure from the developing countries, to offset the GATT effects.

. “If advanced economies can’t agree on that, then the whole multilateral system is pretty much bankrupt.”

How true that is. But is yet more debt (sorry, ‘credit’) piled on top of the existing mountain any solution, even in the short term? Why do not the G20 leaders instead agree to wipe out the debts of the poor countries and why do they not insist that the private creditors do the same?

Of course, the answer is obvious. It would mean huge losses globally for bond holders and banks, possibly germinating a financial crisis in the advanced economies. At a time when governments are experiencing massive budget deficits and public debt levels well over 100% of GDP, they would then face a mega bailout of banks and financial institutions as the burden of emerging debt came home to bite.

Recently, the former chief economist of the Bank for International Settlements Bank for International Settlements
BIS
The BIS is an international organization founded in 1930 charged with fostering international monetary and financial cooperation. It also acts as a bank for central banks. At present, 60 national central banks and the ECB are members.

http://www.bis.org/about/
, William White, was interviewed on what to do. White is a longstanding member of Austrian school of economics, which blames crises in capitalism, not on any inherent contradictions within the capitalist mode of production, but on ‘excessive’ and ‘uncontrolled’ expansion of credit. This happens because institutions outside the ‘perfect’ running of the capitalist money markets interfere with interest and money creation, in particular, central banks.

White puts the cause of the impending debt crisis at the door of the central banks. “They have pursued the wrong policies over the past three decades, which have caused ever-higher debt and ever greater instability in the financial system.” He goes on: “my point is: central banks create the instabilities, then they have to save the system during the crisis, and by that they create even more instabilities. They keep shooting themselves in the foot.”

There is some truth in this analysis, as even the Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank : http://www.federalreserve.gov/
admitted in its latest report on financial stability in the US. There has been $7 trillion increase in G7 central bank assets in just eight months in contrast to the $3 trillion increase in the year following the collapse of Lehman Brothers in 2008. The Fed admitted that the world economy was in trouble before the pandemic and needed more credit injections: “following a long global recovery from the 2008 financial crisis, the outlook for growth and corporate earnings had weakened by early 2020 and become more uncertain.” But while credit injections engendered a “decline in finance costs reduced debt burdens”, it encouraged further debt accumulation which, coupled with declining asset quality and lower credit underwriting standards “meant that firms became increasingly exposed to the risk of a material economic downturn or an unexpected rise in interest rates. Investors had therefore become more susceptible to sudden shifts in market sentiment and a tightening of financial conditions in response to shocks.”

Indeed, central bank injections have kicked the problem can down the road but solved nothing: “The measures taken by central banks were aimed at restoring market functioning, and not at addressing the underlying vulnerabilities that caused markets to amplify the stress. The financial system remains vulnerable to another liquidity strain, as the underlying structures and mechanisms that gave rise to the turmoil are still in place.” So credit has been piled on credit and the only solution is more credit.

White argues for other solutions. He says: “There is no return back to any form of normalcy without dealing with the debt overhang. This is the elephant in the room. If we agree that the policy of the past thirty years has created an ever-growing mountain of debt and ever-rising instabilities in the system, then we need to deal with that.”

He offers “four ways to get rid of an overhang of bad debt. One: households, corporations and governments try to save more to repay their debt. But we know that this gets you into the Keynesian Paradox of Thrift, where the economy collapses. So this way leads to disaster.” So don’t go for ‘austerity’.

The second way: “you can try to grow your way out of a debt overhang, through stronger real economic growth. But we know that a debt overhang impedes real economic growth. Of course, we should try to increase potential growth through structural reforms, but this is unlikely to be the silver bullet that saves us.” White says this second way cannot work if productive investment is too low because the debt burden is too high.

What White leaves out here is the low level of profitability on existing capital that deters capitalists investing productively with their extra credit. By ‘structural reforms’, White means sacking workers and replacing them with technology and destroying what’s left of labour rights and conditions. That might work, he says but he does not think this will be implemented by governments sufficiently.

White goes on: “This leaves the two remaining ways: higher nominal growth—i.e., higher inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. —or try to get rid of the bad debt by restructuring and writing it off.” Higher inflation may well be one option, one that Keynesian/MMT policies would lead to, but in effect it means the debt is paid off in real terms by reducing the living standards of most people. and hitting the real value of the loans made by the banks. The debtors gain at the expense of the creditors and labour.

White, being a good Austrian, opts for writing off the debts. “That’s the one I would strongly advise. Approach the problem, try to identify the bad debts, and restructure them in as orderly a fashion that you can. But we know how extremely difficult it is to get creditors and debtors together to sort this out cooperatively. Our current procedures are completely inadequate.” Indeed, apart from the IMF-G20 and the rest not having any ‘structures’ to do this, these leading institutions do not want to provoke a financial crash and a deeper slump by ‘liquidating’ the debt, as was proposed by US treasury officials during the Great Depression of the 1930s.

Instead, the G20 will agree to extend the DSSI payment postponement plan, but not write off any debts. It will probably not even agree to expand the SDR fund. Instead, it will just hope to muddle through at the expense of the poor countries and their people; and labour globally.




Michael Roberts

has worked in the City of London for over 30 years as an economist. He is author of several books on the world economy: The Great Recession, The Long Depression and World in Crisis. He blogs at thenextrecession.wordpress.com

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