Imagine you have borrowed a million dollars – interest free – and you pay it back at the rate of $1 per second. It would take you 12 days to pay it back. That is not too scary. Now imagine you have borrowed a billion dollars. At $1 a second, it would take you 31 years to repay the money.
While beyond the means of most people except Bill Gates and most governments, it still sounds conceivable. Now let’s take a trillion dollars on the same terms. Repayment would take a staggering 31,688 years! With that number in mind now consider that the USA has a national debt of US$14.4 trillion.
Most investment markets have performed extremely well in the past year but much of this growth has been stimulated by the extraordinary injections of liquidity by central banks. It is still not clear that the real economy can take over when this liquidity is reduced.
Also, it is not clear when or how the borrowing associated with creation of this liquidity and the legacy of running deficits to pay for social welfare programmes will ever be repaid, with interest.
While the USA is a world leader in debt accumulation, Japan is not much better off with national debts of just under US$11 trillion. The UK, with debts of ‘just’ US$1.9 trillion is still going to have a hard job paying those debts off. New Zealand has a relatively modest debt of $46 billion, although this will still take some effort to pay off (1,426 years based on the assumptions above) Of course, it is easier to pay back a large debt when you have a large income. Therefore, the percentage of debt to annual income is an important measure.
Unfortunately, the major economies don’t look very good on this measure either. If a couple wishes to borrow money from the bank to buy a house, they are told payments on the loan should not be more than a third of their income.
Governments have the ability to increase their income at will through taxation and so it can be argued they can borrow a higher percentage.
However, the US government’s debts equal 53% of GDP, the UK’s is 69% and Japan’s is an intimidating 192%, none of which inspire confidence. New Zealand’s is a much more reasonable 27%.
Using GDP is a flawed idea because no government receives all that money as income. If we take as a benchmark that government activities represent around a third of economic activity, then US government has 150% debt to income, Japan has nearly six times and the UK more than double. Again, it is hard to see how these debts can even be serviced, let alone repaid.
The one saving grace is inflation. At 3% a year, much of this debt will be worthless in a few decades. On the other hand, the debt comes with interest that is designed to match and exceed inflation. Given this, the only way governments can reduce the value of their debt is if inflation rises faster than the rates it pays on its debts.
Given that interest rates are starting to climb in many countries, the nasty scenario of an inflationary spiral cannot be ruled out.
David is chief investment officer of Investment Research Group Ltd. www.irg.co.nz A disclosure statement is available free of charge on request.
WHY NEW ZEALAND CAN’T CATCH AUSTRALIA
I once worked for a brief period in Tanzania, East Africa.
At the time, the country was the fourth poorest in the world, despite having a wealth of base and precious metals and masses of fertile land.
I quickly learned that one of the country’s biggest issues was a poor transport system. Most of the country’s roads are unpaved and seem to consist of a series of potholes joined together by dirt. As a result, it is virtually impossible to move crops from the hinterland to the population centres on the coast or to ports to be exported.
On the other hand, wealthy economies like the USA and Europe have excellent transport networks. Where did that wealth come from and why do so many other countries not achieve it?
Political, economic, and military intelligence company Stratfor has looked into the geographical benefits of the world’s largest countries and believes the USA will always have the strongest economy.
The most important aspect of the USA is not simply its sheer size, but the size of its usable land, which is much larger than any other country.
Also, the USA has a fortuitous combination of an extensive river network in the mid-west, not least of which is the Mississippi River, and three of the world’s largest and best natural harbours. The result is a free transport system that allows crops to be moved quickly to much of the country or overseas.
Thirdly, with less wealthy and powerful neighbours in the form of Canada and Mexico, the USA has not required a large standing army to protect its borders, leaving more funds available for stimulating capitalistic endeavours.
Significantly, major nations such as Russian and China also lack America’s natural advantages. Russia, although large, suffers climatic conditions much more hostile to habitation and agriculture and it has no river network to allow for easy transport of products.
Russia also has no meaningful external borders and has Europe on one side and China on the other. Because Russia lacks a decent internal transport network that can rapidly move armies from place to place, geography forces Russia to maintain massive stand- ing armies on all of its borders to protect against external threats.
China also faces significant hurdles. China’s core is the farmland of the Yellow River basin in the north of the country, a river that is not readily navigable and is remark- ably flood prone. Simply avoiding periodic starvation requires a high level of state planning.
China’s geography also encourages separate development by various parts of the country so its rulers are constantly using carrots and sticks (in the form of cheap loans and a large army) to hold the place together.
Europe has a number of rivers that are easily navigable, providing a wealth of trade and development opportunities. But none interlinks with the others, retarding political unification.
Stratfor doesn’t mention Australia or NZ but there are a number of lessons we can learn from its report. One is that Australia (wide, with lots of resources) is likely to be continually more successful than skinny little NZ. All our attempts to catch up with the lucky country’s per capita income are doomed.
For this reason among others, investors should look to put a sizable portion of their money into Australia, then have a hard think about doing the same in the USA.