Bernard Hickey: Passing that potato compounds the pain

Some people think the global financial crisis is over and we have all dodged a depression because central banks printed money and slashed interest rates while governments spent up large to prevent a collapse.

But this simply delayed the inevitable clash of an irresistible force with an immovable object. The irresistible force is the need to service debt and the immovable object is the size of the debt relative to income.

The clash is what many call the "Minsky moment", where the incomes simply aren't enough to service the debt and the borrower defaults.

The term was coined in 1998 during the Russian sovereign debt crisis to describe the moment when Russian government income couldn't service its debts.

Named after an American economist called Hyman Minsky, the Russian "Minsky moment" triggered a currency collapse and a sovereign default.

In late 2008 and throughout last year, governments and central banks essentially shifted private debt, which was about to have its own "Minsky moment", to the public balance sheet.

Government guaranteed the debt of "too big to fail" banks and bought toxic mortgage bonds.

Central banks, particularly in the United States, Britain and Japan, also printed money to buy the government debt issued to pay for massive deficit spending to support the economy.

Nations passed the parcel of massive debt from the private sector to the public sector.

Now investors are worried that entire nations and governments could default, pushing up interest rates to compensate for the risk.

The faster interest rates rise, the faster the Minsky moment will arrive. Albert Einstein once said the most powerful force in the world is compounding interest.

The Minsky moment is the perfect illustration of the massive power of massive debts that get out of control.

First in the firing line are those European countries with monstrous public sector debts and faltering economies that cannot be boosted by currency devalution because they are locked into the euro. Interest rates for their government debt have spiked this year.

The simple fact is global debt is far above the historically high levels last reached in 1929, shortly before the Great Depression.

It has to come down by either consumers and businesses saving more and spending less, or by lenders forgiving debt and taking massive losses, a process called deleveraging. The size of the expected reduction of spending is monumental.

Global consultancy firm McKinsey studied 45 historic episodes of deleveraging since 1930 and found a long period of deleveraging almost always follows a financial crisis. Each period lasted around six to seven years and reduced the debt to GDP ratio by 25 per cent.

New Zealand's foreign debt rose by $138 billion or 35 per cent of GDP in the past 10 years.

Just imagine what the economy will look like without that stimulus over the next 10 years.

Fitch has estimated European governments will need to borrow 19 per cent of GDP, or €2.2 trillion ($4.3 trillion) this year to fund deficits and roll over debt.

The US Government will have to borrow at least US$2.1 trillion ($2.9 trillion) or 14 per cent of GDP in the next two years.

The realisation is setting in that not only will this require someone to buy an extraordinary amount of bonds, but interest rates are likely to rise, which in turn puts even more pressure on budgets.

Governments will have to raise taxes and cut spending globally. China and the Middle East can buy some bonds, but not enough.

At some point the world will have to spend and invest less. That's why a double dip recession and another financial crisis remain significant risks. Pain delayed can often compound the pain when it arrives.

This year may be one of a series of "Minsky moments" for global economy.

bernard.hickey@interest.co.nz