By: Dr Mitja Steinbacher, Dean of the Faculty of Law and Business Sciences (Catholic Institute)
In his latest commentary for Project Syndicate, Nouriel Roubini wrote that the great debt crisis, the mother of all crises, is upon us and we will not be able to avoid it. After a decade of super-easy monetary policy, significant borrowing by countries and easily accessible credit to the private sector, the world economy found itself in a state of heightened tension just before the debt bubble burst. In reality, we have a choice between a bad and a worse scenario. The bursting of the debt bubble is a bad scenario, the slide into an inflationary spiral is even worse.
The debt bubble may indeed burst. We found ourselves in a situation of need for new debt, which is characterised by a combination of high current budget deficits, high taxes, high levels of regulation, high household indebtedness and high corporate debt. In particular, the amount of national debt has grown so much in the last period that the state finances can no longer be regulated by tax financing alone, but a constant inflow of new debt is absolutely necessary. Tax revenues are no longer sufficient to finance current state expenditures. Regarding the total amount of debt in the economy, the picture in Slovenia is less acute than elsewhere, mainly due to the low level of corporate and household indebtedness compared to other developed countries within the OECD.
The bursting of the debt bubble would trigger a marked increase in bad loans in the banking system, which would plunge the banks into another banking crisis. At the same time, unemployment would increase due to bankruptcies of companies that would not be able to finance increased financial obligations. The costs of financing the national debt would also increase sharply, and similar problems could arise, as we observed during the debt crisis of the Greek state, when it was no longer able to finance its debt. Bursting the debt bubble would increase unemployment. If a debt burst occurs in the middle of the fight against inflation, monetary policy holders (the central bank) and fiscal policy holders (the government) may move away from the current goals of stabilising price pressures, characterised by a gradual increase in interest rates and a decrease in the quantity of money in circulation, to revive the policy of increasing the amount of cheap money. Such a turn would lead in the direction of persistent stagflation, a simultaneous state of (too) high inflation and (too) high unemployment. Such a situation would severely limit the economy’s ability to pay personal income and unfunded expenditures, such as pension expenditures.
The alternative to bursting a debt bubble in the middle of a fight against inflation is a slide into more permanent inflation. The cost of more persistent inflation is invisible and much more painful than the cost of adjusting real interest rates to the rates of long-term economic growth, i.e., around 2-3 percent (note: real interest rates are the return left after subtracting the inflation rate). A possible slide into permanent (too) high inflation, i.e., a spiralling increase in the general level of prices, would mean constant pressure to adjust incomes and pensions to inflation and to pay them out more frequently (several times a month). This pressure is manageable for now, as the economy is still at full employment, and of course the real value of personal income and pensions is visibly decreasing for the second year in a row with 10% inflation. An unsuccessful fight against inflation would affect retirees the most, and that is in those countries where retirees do not have their own capital base in savings but receive pensions according to a system of ongoing payments of contributions from actively employed people.
Pension expenses according to the current payment system, as implemented in Slovenia, are otherwise not classified as debt in the standard sense of the word. Payments for pensions are called unfunded financial obligations, i.e., financial obligations without an adequate basis in financial resources provided in advance. According to their form, unfunded financial obligations are a kind of shadow debt, but they can be the most defaulted. This shadow debt hits especially hard when the economy slips into an inflationary spiral. Every month, the pension system in Slovenia creates numerous invisible debt relationships between pension recipients (creditors) and pension payers (debtors). These relationships are not explicit, we do not see them. Creditors, in this case pensioners, always lose out in an inflationary spiral. In the worst-case scenario, an inflationary spiral could lead to a collapse of the current pay-out pension fund, which would push many retirees to the brink of poverty.
An inflationary spiral could occur if the European Central Bank does not resolutely follow through on its commitment to tame inflation below the target level of 2 percent, which means that it is necessary to continue with the policy of reducing the amount of money in circulation and with activities to increase interest rates. Also, for the sake of bursting the debt bubble in the form of increased unemployment. Slipping into an inflationary spiral would cause damage of unimaginable proportions.