The world debt bomb

The subprime and European debt crisis is the greatest threat/opportunity for mankind in a century.

Written by Martin Marmolejo

With virtually no exceptions, every debt crisis is a prime example of major errors and omissions in fiscal policy management. That was the case in the European subprime crisis, as well as in Japan. Although the monetary side has room for improvement, the major potential in most economies lies in the fiscal side of public management.

The persistent imbalance that generated the huge debt overload in Japan, the US and Europe has to do with improper funding of the social safety net. During the boom years after WWII, social benefits increased dramatically. These benefits became more widespread because they were funded with the new wealth generated by a healthy growth in productivity as well as in the overall economy – so the balance was maintained. In recent decades, however, retirement, health, and unemployment benefits have been consistently and progressively moving up, while the subpar rate of growth of the underlying economies has not been able to fully provide the funding needed for those entitlements.

That income shortfall has consistently been financed with new debt – as opposed to what should have been new wealth creation. This produced the current huge debt overhang. So far, no major political system has had the courage and determination to face its citizens with the sad truth, opting instead for “kicking the can down the road”. Thus, most economies in developed nations have ended up asphyxiated by the total debt overload.

The only sensible, lasting solution for this paramount challenge should be crystal clear. Reverse that pernicious trend by doing exactly the opposite of what created it in the first place—an outright reduction in social benefits to their populations. That reversion process has to be gradual, yet consistent. Given the short and medium-term social pain created by this reversal process, the social and political resistance for such a change is strong, but there is no other way out of this huge debt mess; this is an axiomatic truth. We must learn to look at it as a short-term pain for long-term sustainable gain.

That leads us into both the greatest contemporary threat and opportunity in a generation: the need for a profound restructuring of the socio-political system. It is evident that the built-in incentives in the current systems do not sufficiently reward good deeds nor sufficiently penalize major mistakes and omissions; otherwise, this horrible fiscal imbalance and the resulting debt mess would not have occurred. The world’s present socioeconomic and political system has to evolve continuously to be able to successfully cope with current needs and threats. If this profound virtuous change does not take place, the ongoing world economic stagnation will continue.

Throughout history there have been numerous examples of countries that have successfully overcome deep financial imbalances – including huge debt overloads. However, in the current global situation, the fact that many of the world’s leading countries are simultaneously immersed in debt, has never presented itself before. Although the solution to this global debt bomb continues to be the same, this fact poses a particular degree of difficulty.

All over the world, to a high degree, nations are controlled by a relatively small number of people behind the main political parties. The typical dynamics and inertia behind those political elites is mostly non-virtuous (essentially revolving around keeping power or regaining it). Furthermore, to a high degree, even that relatively small number of people are victims of the same system they “control” (the degree of control they exert upon the most important variables is negligible, given the numerous concessions granted along the way through the years). The influence of citizens is basically confined to voting parties in or out of office.

The sad truth, however, is at the end of the day, it doesn’t matter much which party is in power: all of them are essentially helpless. For a quick corroboration of this, take a look at Spain. In January 2012, the Spanish population, fed up with the escalating economic crisis, voted the Socialist party out of office and replaced Prime Minister Rodriguez Zapatero with Mariano Rajoy of the Conservative party. A major change at work? Not at all. And this has nothing to do with the best intentions of either of the two PMs. The Spanish political system, as well as most in the world, is worn out, exhausted, helpless. Reality is far more powerful than the limited capabilities that the political elites actually have. The need for a profound re-energizing of our current political systems is imperative. We cannot keep confronting increasingly global situations with local legislations.

Behind all this global human drama lies an unquestionable fact: the best (and only) way out of this debt mess is with high long-term, self-sustainable economic growth for the world as a whole. Only in that scenario, the major pieces of the economic puzzle will tend to fall into their right place, effectively defusing the world debt bomb. Debt has to be repaid and extinguished, not simply transferred to the future. Granted, no one ever expects it to go down to zero, yet, a noticeable and consistent reduction in the debt/GDP ratio is imperative.

The contemporary economic and political system has not experienced any major upgrade since the foundation of the United States. It is time for a drastic, virtuous change. How to go about it? There are no easy answers. The extremely complex situations within and among developed nations do not lend themselves well for major constructive change in the near term. There are many loose bolts that have to be tightened to open the way for what is required. Thus, it seems that from that angle, it may take a long time (maybe decades) for that virtuous evolution to materialize, if at all.

The urgency of the matter is unquestionable. With those ideas in mind, an original and provocative approach is offered in my book Globalization. In essence, it consists in jump-starting and fast-tracking economic growth in failed nations. The initiative is called the Turbo-charged Global Project (TGP)andis based on applying, in a systematic manner, the major factors at work in formerly very poor nations that have recently transformed themselves from rags to riches in just a few decades.

Those countries are the most powerful, uncontroversial testimony that a profound virtuous transformation from rags to riches can be accomplished anywhere, anytime, provided that the TGP system is appropriately implemented. Through a reverse/engineered analysis, those factors have been de-codified and the proposed TGP system has emerged.

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Martin Marmolejo is a global investment strategist based in Mexico City. He is author of Globalization, which offers an in-depth look at how our current global mindset can be a positive force in transforming societies and lives.