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Characteristics of Extremely
Over-Indebted Economies
Over the more than two thousand years of
economic history, a clear record emerges regarding
the relationship between the level of indebtedness of
a nation and its resultant pace of economic activity.
The once flourishing and powerful Mesopotamian,
Roman and Bourbon dynasties, as well as the British
empire, ultimately lost their great economic vigor
due to the inability to prosper under crushing debt
levels. In his famous paper Of Public Finance
(1752) David Hume, the man some consider to have
been the intellectual leader of the Enlightenment,
wrote about the debt problems of Mesopotamia and
Rome. The contemporary scholar Niall Ferguson of
Harvard University also described the over-indebted
conditions in all four countries mentioned above.
Through the centuries there are also numerous cases
of less prominent countries that suffered a similar
fate of economic decline resulting from too much
debt as a percent of total output.
The United States has experienced four
bouts of great indebtedness: the 1830-40s, the 186070s, the 1920-30s and the past two decades. Japan
has been suffering the consequences of a massive
debt over-hang for the past three decades. In its
first of three thorough studies of debt, the McKinsey
Global Institute (MGI) identified 32 cases of extreme
indebtedness from 1920 to 2010. Of this group, 24
were advanced economies of their day.
The countries identified in the study, as
well as those previously cited, exhibited many
idiosyncratic differences. Some were monarchies
or various forms of dictatorships. Others were
democracies, both nascent and mature. Some
Six Characteristics
1. Transitory upturns in economic growth,
inflation and high-grade bond yields cannot be
sustained because debt is too much of a constraint
on economic activity.
2. Due to inherently weak aggregate demand,
economies are subject to structural downturns without
the typical cyclical pressures such as rising interest
rates, inflation and exhaustion of pent-up demand.
3. Deterioration in productivity is not
inflationary but just another symptom of the
controlling debt influence.
4. Monetary policy is ineffectual, if not a net
negative.
5. Inflation falls dramatically, increasing the
risk of deflation.
6. Treasury bond yields fall to extremely
low levels.
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24%
24%
20%
20%
16%
16%
12%
12%
8%
8%
4%
4%
0%
0%
-4%
-4%
-8%
-8%
-12%
-12%
-16%
-16%
1870
1880
1890
1900
25%
20%
20%
15%
15%
10%
10%
5%
5%
0%
0%
-5%
-5%
62
69
76
83
90
1960
1970
1980
1990
2000
2010
Chart 2
9.5%
97
'04
'11
-10%
Chart 1
9.5%
Monthly
average
(black line)
8.5%
55
1940
1950
25%
48
1920
1930
Sources: Federal Reserve Board, Bureau of Economic Analysis, N.S. Balke & R.J. Gordon, C.D. Romer.
Through Q4 2014.
Nominal GDP
-10%
1910
8.5%
203 bps
7.5%
115 bps
7.5%
151 bps
6.5%
84 bps
5.5%
6.5%
97 bps
104 bps
4.5%
3.5%
5.5%
201 bps
Annual
average
(blue line)
131 bps
4.5%
3.5%
2.5%
2.5%
1.5%
1.5%
0.5%
90
92
94
96
98
'00
'02
'04
'06
'08
10
'12
'14
0.5%
Chart 3
Page 2
5%
5%
4%
4%
3%
3%
2%
2%
Avg. = 2.2%
1%
1%
0%
0%
-1%
-1%
52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 '00 '03 '06 '09 '12 '16
Source: Bureau of Labor Statistics. Through Q4 2014.
Chart 4
16%
16%
14%
14%
12%
12%
10%
10%
8%
8%
6%
6%
4%
4%
2%
2%
0%
0%
-2%
-2%
-4%
65
69
73
77
81
85
89
93
97
'01
'05
'09
'13
-4%
Chart 5
Page 3
annual
2.25
2.25
1997 = 2.2
1918 = 2.0
2.00
1.75
2.00
avg. 1900
to present = 1.74
1.75
avg. 1953 to 1983 = 1.75
1.50
1.50
1.53
1.25
1.25
1946 = 1.2
GDP = MB*m*V
1.00
1.00
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Chart 6
Global Concerns
In our review of historical and present cases
of over-indebtedness, we noticed some overlapping
tendencies with less regularity that are important to
mention.
First, when all major economies face severe
debt overhangs, no one country is able to serve as
the worlds engine of growth. This condition is just
as much present today as it was in the 1920-30s.
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