There are a couple of widgets I have loaded onto a page on my website. One tracks official UK public debt and the other official US public debt. I’m sure there are others I could load, Japan, China and the Eurozone for example, but these are the ones I like to keep an eye on. A few points before getting to the nub of this post. The debt trackers only measure public sector debt, not total debt; the latter including corporate debt and household debt. They also only track what I would term ‘realised’ balance sheet debt. In other words they are not tracking the aggregate future liabilities of social, health and pension commitments i.e. the net present value (NPV) of those liabilities. Add those and we are in 2008 Zimbabwe dollars numbers. I’ll stick to the hard numbers for this blog.
Debt as an absolute number does not really mean much to most people, me included. Economist therefore like to express it as a percentage of gross domestic product (GDP). That helps but is also not particularly useful. GDP doesn’t pay the interest, a country’s tax take does that. The debt to GDP ratio is the most favoured ratio but pretty useless when the exam question is about affordability.
So, to the numbers. The official UK debt now stands at £1.53 trillion and the US $19.06 trillion. Both are increasing at an eye-watering rate per minute. By the time the next US president is elected US debt will have hit $20 trillion with few signs of it getting under control. The US and the UK are in similar situations. Neither country has the means to repay the debt and only manages it on a day by day, week by week basis by revolving loans: new treasuries, gilts and bonds are used to repay older commitments now maturing. Over the past seven or eight years as interest rates have hit near or at zero and it has worked fairly well. The average interest rates on both US and UK has dropped somewhat as new securities have been issued at lower rates.
Alas in the UK’s case interest payments alone are now in the region of £50 billion a year. To put in into context total UK tax take is about £650 billion which means that 7.5% – 8% of our taxes are wiped out by interest payments (about 6% of the US budget is absorbed by interest). The fact that in both the UK and the US total interest payments have been flat over the past few years is the perverse result of interest levels being at the lowest levels since the Black Death. Interest rates rising from their current suppressed levels of 0 – 0.5% to more ‘normal’ levels of 3.5% – 5% will raise interest payments in the tens of billions in the UK and hundreds of billions dollars in the US – analysts estimate that each 1% upward movement in US interest rates translates into an additional $200bn in payments to external creditors.
In a growing economy, taxes will increase to service payments of existing debt. Growing economies also usually deliver price inflation which erodes the ‘value’ of the nominal aggregate debt accumulated over time. Debt commitments are therefore usually affordable.
However, the problem we currently have is that economic growth is not really reaching levels that is making much of an impact. The existing paradigm of over -supply of commodities, goods and services across the globe has created a price deflationary environment, discouraging new business start-ups. The money created by central banks found its way into the equity markets, recapitalised some of the banking system or has simply sat on central banks’ balance sheets. In the US FED’s case something in the order of $2.3 trillion still sits on its balance sheet as the ‘excess reserves’ of the commercial banking system. Commercial banks have been less willing to take risks and lend and entrepreneurs have been unwilling to borrow. What is the point when there is already over supply everywhere?
Having burrowed about as far as I want to into the background of public sector debt I think it’s time to surface and get to the purpose of the post. Despite the ominously financial/economic sense these initial paragraphs have conveyed, this is really a blog about change.
Our public sector debts matter. The cumulative effect of all the debt across the western world in my view has been impacting the micro-change management world for the past few years. Debts have to be serviced. Public sector debts are serviced by raising taxes or cutting public expenditure. Both approaches have economic and financial consequences. Organisations and businesses have to react to these changes.
If public sector expenditure falls, the companies relying on the revenues from public organisations need to adjust their behaviours and costs if profitability is to be protected. Falls in public sector expenditure represent a change in market conditions and it is not hard to make the case that recent changes are more structural rather than cyclical in nature.
Increases in taxation take income out of corporate and consumer pockets, income that might otherwise be applied to commercial and domestic expenditure. The theory is that taxes are just a reallocation of expenditure rather than a loss to the economy: the government can spend your money better than you can. Well, there may be some substance to this if taxes are reallocated to public infrastructure spending but the argument fails miserably when your taxes are taken just to service existing debt. This latter argument also compounds if and when interest rates go up (2020 now!) and we have a £2 trillion debt and interest rates at 3.5%. If that unpleasant prospect coalesces in our none-too-distant future it has the potential to deliver massive change management challenges for both the public and private sector. Gross UK taxes are already around 38%, the point at which economists and Treasury officials start to think about what a UK ‘Laffer Curve’ might look like. Laffer is all about the point at which increasing taxes impacts behaviours, and there is a point at which people lose interest in working. Thus, somewhere in the 40% range it is postulated that increasing taxes actually reduces total tax take.
So the real point about the blog is that debt really does matter. My own contention is that the relationship between debt levels and change management is far more tangible than it ever has been, primarily due to the enormous size of those public sector debts. Low interest rates have bought us some time but companies and public sector organisations really ought to be preparing now for the effects of these debts rather than wait for governments to effect tax increasing and spending reduction panic measures a few years from today. After eight years of emergency central bank measures we are no further forward. Even the hardened ‘cycle’ economists are starting to doubt. Equity markets have been buoyed by central bank largesse but the underlying economic conditions across both sides of the pond look more and more like structural changes are underway.
As I look at the world the big economic issues transmit into change management challenges almost immediately. In response to the banking crisis, the US FED created free money via quantitative easing (QE). Free money was thrown by the hundreds of $billions at US shale which promoted rapid technology development and in turn turbo-charged on-shore non-conventional oil production. In only a handful of years the US emerged to challenge Saudi Arabia as the biggest producer, taking tangible market share from OPEC countries. OPEC reacted by artificially increasing production to maximum output, which has hit Crude and Brent spot prices. Spot prices rapidly fell which created massive problems for the oil sector across the world. Companies have had to react quickly to an industry in financial distress. Dozens of organisations have created change programmes to address the revenue and cost problem – change management specialists with deep energy sector experience are at a premium at the moment.
Again, the point here is that big economic issues translate into organisation level change management challenges very quickly. And the ‘big daddy’ of these issues is almost certainly the level of public sector debt in western countries. When the cracks do finally appear in the current Ponzi like approach to servicing debt, it will likely affect every sector, not just one or two. All organisations and companies will be confronted by the challenge of how governments will react. Some strategic thinking and scenario planning may well be called for.
It would be nice to think that a crisis will never happen but hope has never really been much of a strategy in the past. Central banks have managed to suppress interest rates and put government debt on their own balance sheets for some years now (both the US FED and BoE own 35% – 40% of their respective governments’ debt) but at some point the jig will be up. We don’t know what the catalyst for a crisis will be but tangible signs of recession will be a promising candidate – recessions increase deficits and push public debt up at an even faster rate. Reactions to a crisis could involve printing yet more money or negative interest rates but these policies have not worked very well in the past and future effects could be even more muted.
So I’m going to continue to keep an eye on those debt trackers, despite the sceptics who see everything still working and have concluded that the financial and economic system must therefore be just fine.
For my part, debt matters.