I promised, without any reason, not to talk too much about what was said at the Financial Times party.  But surely Martin Wolf’s speech doesn’t count?  I mean, he was talking to a room full of journalists. And I thought it was a speech worthy of one of his million-click articles, and contained many points that Martin he might well make in print, about the future of macroeconomics, the unsustainable size of finance, whither the world, etc.

It is one statement in particular that I want to pick up on, however.  This is that the cost of the financial crisis lies behind only the Napoleonic War, First World War, and Second World War. Now, I think these statements are important, because they inform the social-justice debate that will break around our heads during the next ten years.  Who pays for this mess? is not going away. But I want to take issue with Martin’s statement.  It’s not true that this episode sticks out in such an obvious way.

First, look at this graph.  You will want to call me a fool.

Just eyeballing, the various 1776-1815 wars added about 150% of GDP debt.  WWI added over 110%.  WWII, before we had recovered from that, stuck another 140% on.   And now, sure enough, we look like going from 35% or so to 95% or so – 60%.  A clear fourth place?

But hold it a mo. Imagine your friend has told you they’ve just taken on debt of 2 times their salary.  Are they mad?  Well, it depends on the terms.  If its a morgage at 4%, then no problem.  If they have maxed out credit cards at 25%, then it’s a big problem.

The same applies to historical increases in debt – and taking into account the higher interest rates that other episodes have left us with, I think the various crises from the mid 1970s actually rank with this one.  The reason is that Dennis Healey (clearing up after Barber) and Howe (clearing up after Healey) had to pay really high rates for borrowing – well over 13%.   Furthermore, they did it at the same time as inflation was about to be beaten.  This last factor is of enormous importance – because by beating inflation, you also decimate your ability to harvest big revenues from booming nominal GDP.  An economy with NGDP rising at an average rate of 16% (like late 1970s) finds debts much less burdensome than one with the rate cratering down to 5%.

Here is how I have done my calculations.   I look at how much debt will have increased over the crisis period.  For 1975-83, debt went up from £52 to £132bn, or £80bn in total.  I estimate the average interest incurred: 12% in the case of that period.  Then I assume that the government repays that debt in a straight line over 15 years – around £5bn per year.    I then work out the net present value of the debt, discounting the future payments using a discount rate equal to the average growth rate of NGDP over the next 15 years.  For 1983-1998, I make this 8%.    I then calculate how much the discounted future burden of payments related to this debt compare to the GDP in 1983.

This is what I get:

Outstanding amount of inherited debt Interest cost Capital repayment Disc fac NPV of this
£80 £9.60 £5.33 1 £14.93
£75 £8.96 £5.33 1.08 £13.23
£69 £8.32 £5.33 1.17 £11.71
£64 £7.68 £5.33 1.26 £10.33
£59 £7.04 £5.33 1.36 £9.09
£53 £6.40 £5.33 1.47 £7.99
£48 £5.76 £5.33 1.59 £6.99
£43 £5.12 £5.33 1.71 £6.10
£37 £4.48 £5.33 1.85 £5.30
£32 £3.84 £5.33 2.00 £4.59
£27 £3.20 £5.33 2.16 £3.95
£21 £2.56 £5.33 2.33 £3.39
£16 £1.92 £5.33 2.52 £2.88
£11 £1.28 £5.33 2.72 £2.43
£5 £0.64 £5.33 2.94 £2.03
£0 £0.00 3.17 £0.00

The net result?  The cost of the seemingly paltry £80bn incurred during the shambles that followed the government losing control of its finances in the 1970s was about 35% of 1983’s GDP, if you assume that from 1983 things were back under control.

Returning to our current figures, what has been the cost?  Well, debt was projected to increase from about £600bn in 2008 to about £1400bn in 2014.   Some of this is held against assets: banking equity etc, but I’ll take £800bn as the debt that we were forced to take on as a result of the crisis*.  The interest costs I estimate at 4.5%, and nominal GDP growth for the next 15 years to be 5.5%.  As of 2015,  NGDP will be about £1800bn.

Here are the workings:

Outstanding debt (bns) Interest cost Capital repayment Disc fac NPV of this
£800 £36.00 £53.33 1 £89.33
£747 £33.60 £53.33 1.06 £82.40
£693 £31.20 £53.33 1.11 £75.95
£640 £28.80 £53.33 1.17 £69.95
£587 £26.40 £53.33 1.24 £64.36
£533 £24.00 £53.33 1.31 £59.17
£480 £21.60 £53.33 1.38 £54.35
£427 £19.20 £53.33 1.45 £49.86
£373 £16.80 £53.33 1.53 £45.70
£320 £14.40 £53.33 1.62 £41.83
£267 £12.00 £53.33 1.71 £38.25
£213 £9.60 £53.33 1.80 £34.92
£160 £7.20 £53.33 1.90 £31.84
£107 £4.80 £53.33 2.01 £28.98
£53 £2.40 £53.33 2.12 £26.34
£0 £0.00 2.23 £0.00

The net present value of the debts works out at £793bn, or about 42% of the GDP we will have to help us pay for it.

What do I conclude from this? (the clock is ticking, so sorry for the rush).

  • the ‘cost’ of the increased debt we will have to bear from around 2015 when it might hopefully be stable can only be partially understood with reference to the absolute amount
  • Once you take into account that foolish Bennite debts were incredibly expensive in the light of subsequent NGDP growth slowing down (I like to use Tony Benn as the proxy for every overspending minister in the mid 1970s.  Throw in Barber if you find the partisanship offensive), the cost of us really losing control from that period was in the same ballpark as the loss of control now. Particularly if you assume that the government will claw back more from banking sales.
  • And even more if you assume that the government over 1975-83 raised money selling assets, so its increase in debt was probably much higher than £80bn
  • BUT – and I hope this is a ‘but’ that Martin Wolf would agree with – this time the debt has had a purpose.  We have had public sector debt increases in order to support a necessary, inevitable** and potentially calamitously chaotic private sector deleveraging.  This time, the debt has produced a return: a level of future GDP that would have otherwise been much lower (see Richard Koo on Japan) . . .
  • . . .whereas what did we get for that loss of control in the 1970s?  A government really crowding out business; state ownership of catastrophically inefficient enterprise; the putting-off of necessary structural reform.

Government spending cost us money in the 1970s, and made the economy less effective.  It did not support spending, because we were closer to supply capacity – it was not a demand-recession.   It was incurred at massive cost to future generations -10-13%.

This time, it has stopped our economy collapsing, and in that sense has been a wonderful investment.   So, while we will be having headaches in Westminster for years and years to come, no-one should regard our future debt burden in the same light as that one in the past. If you were to pick periods of mismanagement to rank above this one, I would definitely choose the 1970s (and the unnecessary 1st world war).

Though we still have a lot to blame the City for: on the subject of which, I need to read Martin Wolf’s latest column.

Apologies for the rushed nature of this column: it was conceived of and written in 1 hour, exactly.

UPDATE:  I am not sure whether I was right to include capital repayments.  Of course, debt has to be repaid, so it seems to make sense. I think it is right to, because otherwise you end up with the debt incurring high interest costs for ever.  If you just look at interest costs, the 1970s were way more expensive than now

*of course, debt was projected to rise anyway to £800-900bn  but since I can’t find similar projections in a rush from the mid 1970s I will take all the increase as what matters.

** with hindsight.  I didn’t go short myself.


4 thoughts on “Counterintuitive thought of the week: this isn’t the worst debt mess since the War

  1. Very much enjoyed reading this. So informative. Wish we had a Pitt now. We’d be getting more for our G Ex.
    You mention in another place your faith that the Tories have a Plan B. Remember that Barber and Heath were hawks for a couple of years before becoming boomers.
    For all their bullingdon japes, Camborne economics are Puritan and Public Debt is taboo

  2. Which Pitt? The elder, younger, or the horse rider?

    I think this is surprising nostalgia for a non-conservative . . .

  3. Both the elder and the younger did surprisingly well at managing unprecedented debt; but I do not recall any outstanding success in controlling the amount of or value for public expenditure

    On standards of economic mis-management, I was working in the Treasury in the late 1970s. I doubt if we did anything then as costly and silly as not intervening in summer 2008 to recapitalise the banks; but I welcome correction. The debt we took on was damn expensive though.

  4. I had no idea that I was being rude about your work – many apologies. But I think that by the late 1970s, you had a job on your hands just to hold the ship together.

    I think for political reasons we would have had to wait for a real crisis to do that recapitalisation – can you imagine how they would have sold it in the summer?

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