Gold bars. Since the United States removed linking of dollar to gold, there has been no anchor to money at all, says Coggan (photo: Tetra images/Corbis)
DEBT AND REFORM
If there is a single word that has defined the economic crisis in Europe and the United States, it is debt, Coggan says. Debt has been all consuming, drowning homeowners and mortgages, leaving cities and counties bankrupt, and forcing countries to make public cuts, even in the face of fierce opposition.
In his latest book, Paper Promises: Debt, Money, and the New World Order, Coggan, columnist for The Economist magazine, looks back in history at other debt crises in attempt to analyze the current situation.
In an interview with IMF Survey online, Coggan explains that this is not the first time in history unsustainable debt levels meant drastic changes for how the world does business.
IMF Survey online: Can you explain the premise of your book?
Coggan: The thesis of the book is that history is a battle between creditors and debtors, and the battleground is the nature of money. Over time, creditors have insisted on forms of sound money, whether the money is linked to precious metal like gold, or whether currencies are fixed in rates against each other.
Debtors have tended to want their value of money to be flexible. They have wanted more money to be created at times of crisis, or exchange rates to move, float on the markets so that they can devalue away their debts.
What has happened in history is that we have had a series of periods in which debts have built up. There have been crises—the 1930s, the 1970s, and now—and as those crises unfolded, the nature of the monetary system changed, and a new order came into place; that new order tended to be set by the creditor nation.
IMF Survey online: How did the levels of debt that we have accumulated in the past decade compare to other periods of high debt?
Coggan: We have much higher levels of total debt relative to economic output—gross domestic product—than we have before. There have been moments in history when governments have had higher ratios of debt to GDP than they have now. But, we have not had debt right across the economy in the consumer sector, in the corporate sector, and in the banking sector, in the same way that we have had today.
We are talking about most of the developed world having scenes of 300 to 400 percent debt levels of GDP; and of course we saw in Ireland and Iceland scenes of seven to nine times debt levels to GDP. These are pretty much unprecedented in history.
IMF Survey online: There are sure to be implications for such high levels of debt. What will they be?
Coggan: Well, the reason the book is called Paper Promises is debt, like paper money, really, is a paper promise. And I could also throw in the promises governments have made to citizens in the form of benefits, like pensions and healthcare.
Not all these promises can be honored. That is the implication of these very high debt levels. And so economic history going forward is all going to be about a battle to decide who gets the wrong end of the stick.
We will see taxpayers battling public sector workers, we will see the young battling the old, the rich battling the poor, and some countries battling—not in a military sense, but arguing—with other countries about how much debt they should pay off and how much should be forgiven.
IMF Survey online: How does your thesis about debt levels relate to what went on in the housing market in the United States in recent years?
Coggan: We have to go back to 1971 when the last link between paper money and metal was removed. When President Nixon got rid of the gold window, he removed the linking of the dollar to gold, and ended the era of fixed exchange rates. Since then, we have been in a unique era in history, in which there has been no anchor to money at all.
During that period, there has been no constraint on the amount of credit that could be created. In previous systems, there was, because you had to control the value of money. Money was generally used to buy assets and was lent against assets by the banking system. So, we had a huge rise in debt level to GDP, a huge surge in importance in the finance sector, and an unprecedented rise in valuations in the sector market. Then, when the stock market collapsed in early 2000 and central banks cut interest rates, the speculative activity moved to the housing market in the United States.
It moved there for a couple of reasons. One is that it was almost the last thing to buy, because there was an argument that house prices would never go down. There is no surer way of creating a bubble than to argue that the price of an asset can never go down. And the second reason was that there was a need for safe assets with an attractive yield, which had been created because the Asian central banks had been buying Treasury bonds and forcing down Treasury bond yields.
So suddenly, investors were looking for something else to invest in, and bonds linked to mortgage loans became that attractive factor. That is really why the pressure built up in the housing market in the United States.
IMF Survey online: The housing crisis did not stop in the United States. It spread to Europe, where it became a sovereign debt crisis. Why has Europe struggled to contain the crisis?
Coggan: The bargain in Europe has been that the northern Europe countries will lend the southern European countries money, provided that the southern European countries go for austerity programs.
The problem with that bargain is that southern European economies have been in recession. Those recessions have gotten worse in the face of these austerity programs, so debt-to-GDP ratios have tended to go higher, not lower. And of course, this makes the problem look even worse.
Now there’s a joke that we were sent at The Economist, which is: An Irishman, an Italian, and a Greek go into a bar. Who pays for the drinks? And the answer is, the German. In the end, the creditors will have to pay.
So, the Germans and the northern Europeans have two choices. They can actually send money to Greece and Portugal, or they can lend money to Greece and Portugal that will not get paid back. Either way, it does not really make much difference. They will not get their money back.
Eventually, the populations in northern European countries will have to realize that. But we are really in a democracy trying to sort out where the pain will fall. So how much can Greek voters suffer without revolting? How much will German voters suffer in terms of writing off debts without revolting?
IMF Survey online: What are the long-term consequences of all this debt?
Coggan: I think the long-term consequence of the debt crisis is a remade order. In the 1930s, the gold standard collapsed. When politicians came to remake the system in the 1940s —what was called the Bretton Woods agreement in 1944—they changed the parameters altogether. They abandoned the formal use of gold coins, which had disappeared for a while after the First World War, and they moved to fixed exchange rates against the dollar, with the dollar the only currency that was formally linked to gold. But it took ten or so years to do.
Then, when Bretton Woods collapsed in the 1970s, they moved to a new system of floating exchange rates. We had an immediate inflationary problem in the 1970s, and we dealt with that problem by having strong central banks with a mandate to control inflation.
And so, we eventually worked out a system whereby consumer inflation was under control, and creditors could have some confidence that their loans would not be inflated away.
The collapse of this system will again bring out a new order in the world.
Britain set the terms of the original gold standard when it was the creditor nation of the world. America set the terms of Bretton Woods. So any new order that emerges will be set by China, which is the largest creditor nation.
