Part 3. Standing on a mountain of debt

Will people in the future look back at current times and say it was obvious that we had a debt bubble? Hindsight bias is a powerful human characteristic and sometimes it’s striking how easy it is to see some things in hindsight. The fact that we had a tech bubble, a tulip bubble and a few other bubbles might appear obvious today but, for some reason, perhaps wasn’t as easy to see during those actual times. According to the 2016 semi-annual Fiscal Monitor published by the IMF, current global debt sit at an all-time record level of 225 percent of world GDP. We’re standing on a mountain of debt. How did we end up here? Let’s get some context.

Nice view. But how do I get down?

Part of the explanation might be that overall debt levels tends to be cyclical. As discussed in Part 2. The cyclical nature of debt, this might be true not only in the short term but also in the long term. However, another majorly contributing factor surely is central bank action. Current central bank doctrine is much influenced by historical events. Below follows some interesting quotes highlighting this, starting off with Milton Friedman in 1980.

“Although these events happened almost 50 years ago, many of our policies today derive directly from them. Central bankers throughout the world, government officials everywhere, are afraid of a new Great Depression. They have therefore moved in the opposite direction. Instead of the problem of too little money, we’re faced with the problem of too much money.”

Milton Friedman, 1980

Perhaps economist Paul Krugman was on point in 2002:

The basic point is that the recession of 2001 […] was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of PIMCO put it, Alan Greenspan needs to create a housing bubble to replace the NASDAQ bubble.

— Krugman, 2002

As Fed chairman, Ben Bernanke shaped much of the central bank response to the Global Financial Crisis. Below follows an excerpt from an interview with him made in 2009:

I spent a great deal of my academic career studying not just the Great Depression, but the whole general issue of how financial crises and financial distress effect the overall economy. […] One lesson to be learned is that monetary policy needs to be supportive in a period of crisis like this. And I’m sure everyone knows the Federal Reserve has taken this to heart. We’ve been very aggressive. We’ve cut rates now essentially to zero. We did that very quickly. Other countries are now following our lead. And we are now augmenting those conventional monetary policies with new creative unconventional policies, to try and have additional impact on financial conditions.”

— Bernanke, 2009

Central bank policy today is much influenced by what is perceived to have gone wrong during the Great Depression. The general opinion is that the severe credit contraction of 2008 would have been much worse had it not been for the unprecedented central bank action. But why was there a credit contraction to begin with? Today we have higher overall levels of debt in the system than ever before and many risks have been transferred from the private sector level to the government and central bank level. In a way, central banks have basically been upping the ante. Unfortunately, it seems to me that the Global Financial Crisis — which in many ways was triggered by too much debt and too much leverage — was simply “solved“ with even more debt. Perhaps central banks have “solved” a long string of needed, natural and cyclical credit contraction-driven downturns by artificially stimulating the economy and forcing more debt into the system at every turn. In which case, the result being a steadily increasing level of indebtedness toward unnatural levels.

Below follows two quotes regarding financial booms and busts; first one from Ben Bernanke and then one from Milton Friedman.

“[…] what we’re dealing with is a particular part of capitalism, which is the financial boom and bust, which has been around for a very long time. I think that we can use financial markets effectively to provide resources to new industries, new products, to be innovative, to drive growth. At the same time, that we can at least mitigate if not eliminate these booms and busts, and these adverse crises that we’ve had in recent years. […] I hope that we will learn what mistakes were made and we will figure out how to create a framework in which we can benefit from the vitality and creativity of the financial system without allowing it to create these highly destructive crises that we’ve seen.”

— Ben Bernanke, 2009

Don’t kid yourself. If you don’t have ups and downs in economic productivity and well being […] You are just kidding yourself if you think that somewhere in this world there is a fluctuation free society. The plain fact is that nobody of any stripe has been able to show how you get a perfectly stable, steady, certainty kind of world except in two places; a prison and a grave.

— Milton Friedman, 1978


So where might we go from here? That’ll be the focus of later parts.