Freer trade and the advent of globalization over the last 30 years have made citizens of every nation around the world richer, particularly those in advanced economies. A report by Credit Suisse Research Institute indicated that there were 29.6 million high net worth individuals in the world in mid-2011 (namely, those with wealth between $1-million and $50-million U.S.). North America accounted for 37 per cent of the total, while Europe contributed 37.2 per cent. (Yes, there are more high-net-worth citizens in Europe than in North America!)
In the process, and driven by low interest rates, consumer borrowing increased to record levels. Governments around the globe also borrowed extensively to pay handsome wages and rich benefits and other support or transfer payments. In addition to record borrowing, the 2008 credit crisis hit advanced economies hard with huge amounts of debt transferred from overleveraged individuals and businesses to the government. Public debt expanded further through the various stimulus programs.
Some figures from The Economist’s Global Debt Clock help put this into perspective. In 2000, Greece’s public debt was $141-billion, public debt per person was $12,971 and public debt to GDP 111.4 per cent; in Canada, the corresponding figures were: $597-billion, $19,528 and 84.5 per cent, respectively; and in the U.S., $3,048-billion, $10,836 and 31.2 per cent, respectively.
Fast forward to 2011. Greece’s public debt has risen more than two and a half times to $377-billion, public debt per person has almost tripled to $34,304, and public debt to GDP is now 135.2 per cent. In Canada, the corresponding figures have also risen sharply -- public debt now amounts to $1,315-billion, public debt per person to $38,404 and public debt to GDP to 82 per cent.
The picture in the U.S. is also staggering with public debt at $10,458-billion, $33,555 in public debt per person and public debt to GDP at 68.9 per cent.
No matter how you look at it, public debt and public debt per person have skyrocketed around the globe, particularly in advanced economies. And all this is happening while luxury home and car sales are booming. End result: wealthy citizens, but not so wealthy countries.
Economies and countries around the world have now reached a wall. Public debt cannot continue to climb in this fashion. And governments know this. But does it matter that governments have too much debt on their balance sheets? Yes it does. Higher debt levels increase the risk of fiscal crises and hurt economic growth. Public debt has to be paid down.
But how? One option is by raising taxes - thus transferring wealth from rich citizens to poor governments. We have heard a lot around this issue recently in the U.S. and Greece. Another option to rein in debt is to cut spending. And finally, another option is to open up the money printing presses and in the process create inflation and reduce public debt in real terms.
In my opinion, governments will try to tax to the max. Non-payment of taxes has become an ongoing problem around the globe. While Greece has received most of the negative publicity about its inability to collect taxes, wealthy people in Germany and Britain hide much greater sums from tax authorities according to the Boston Consulting Group. But it seems that baby boomers want to hold on to what they have and they do not want to share it with others in their societies. Our mistrust of the government may have to do with efforts to hide taxes from the taxman – Greece again is a perfect example of this mistrust and to what extremes citizens will go to avoid paying taxes. Will higher taxes achieve the necessary increase in revenues to balance budgets and start reducing debt levels? There are many views on that, but no consensus.
Governments will also try to cut spending. Good luck on this too. Greece is a good example of how resistant people are to cuts to their entitlements and how difficult it is to cut the bloated public sector, including military spending. We are seeing daily the kind of social upheaval attempts to cut spending in “sensitive” areas can lead to. The Occupy Wall Street movement in the U.S. and the ongoing strikes and unrest we see in Greece are a testament to that.
For political reasons, the last option may be the most viable and the solution of least resistance, namely opening up the money printing presses and inflating the debt away. This fits well with my recent writings on the possibility of high future inflation and a world with slow growth and higher inflation.
For investors this has serious implications. The value of paper currencies will be worth less, and holding bonds (except for real return bonds) and cash in one’s portfolio will not make one secure and wealthy. Stocks will do better, particularly those of companies in good businesses with global reach that have pricing power. Moreover, the possibility of higher taxes is also inflationary. They are inflationary as investors demand higher before tax returns in their bond portfolios and workers demand higher before tax wages to make up for the higher taxes.
A prelude to this may be the recent unsettling inflation numbers around the world despite slow economic growth. In the U.S., U.K., Canada and, in general, across the 34-nation Organization for Economic Co-operation and Development, inflation has jumped while consumer spending and economic growth have flattened.
So, get used to it and get ready! Higher taxes and higher inflation will be the name of the game in the future. Both are unavoidable and are the effect of rich citizens and poor countries.
George Athanassakos is a Professor of Finance and holds the Ben Graham Chair in Value Investing at the Richard Ivey School of Business, The University of Western Ontario.