THE 1996 Nobel Laureate William Vickrey once wrote that nobody should be afraid of debt. He basically meant public debt, of course. Yet in his opinion, issuing debt was sort of akin to issuing capital. Capital-ism, I won’t hesitate to add, is better called debtism, if this view is correct. Nevertheless, we aren’t talking about old-style consumerism, etc. It is that bank debt for personal consumption-cum-credit card expenses have become sort of an integral part of the household budget. There is no way so many millions of households could accommodate even the most basic of expenses on food, etc. without recourse to debt and credit card payments that are deferred to a distant future. Even this doesn’t portray the big picture: firms are also indebted to such an extent that their working capital is lacking. Actually a good part of what we observe as commercial loans are in fact working capital itself. If there isn’t enough “working capital”, then there is always “working debt” in lieu of it. Well, that was so until now.
Back in 2010, Deirdre McCloskey compiled evidence from the British industrial revolution. No, there was no massive capital accumulation that took place before the industrial growth engine began marching on at high speed. For instance, the capital sunk into fixed assets in the cotton textile industry wasn’t even 25%. It was small at any rate, and the source of industrial investment was short-term loans for inventory management and working capital needs. Longer-term investments were funded by loans from relatives. Anyway, before the railway age, i.e. late 19th century, large chunks of bank capital weren’t available. In fact, equity capital was also scarce. Obviously anywhere else we find instances of large investments by the imperial state, in China, by the Romans, the Ottomans, who had access to huge funds in the form of taxes and so on. Even Mughal India sets an example of massive public works. Yet none of them enjoyed the benefits of rapid industrial development.
And in England probably neither enclosures nor the slave trade nor the allegedly low wages – which were already up by historical standards in 1840, so the modern economic history says – nor colonization provided the original impulse. Actually whether the original 1880-1914 style imperialism as Hobson put it in 1902 and Lenin reiterated in 1915 was as a whole a profitable business is unclear. It was a debt-driven, small-capital-led, innovation-push event that spread across many sectors in the form of gadgets within a short span of time. Obviously today, large funds are directed towards some industries; in fact the financial industry hypertrophied after 1975 at the expense of some real sectors. Nevertheless, improvements in technology, life quality and prosperity seem not to be linked to the availability of vast resources first. At least there are countries that can do the trick without large capital assets or huge chunks of credit available. ‘Accumulate first, grow later’ schemes don’t work anymore, even if they worked in the distant past for some countries and some growth strategies; maybe in the 1930s (Soviet Union) or in the 1950s (India).
PAST SUCCESSES DIDN’T INVOLVE DEBT-OVERHANG
Yes, there is a debt overhang now. The bizarre thing about it is that whenever consumer lending recedes either because interest rates are high or because people are already heavily indebted or there isn’t enough funding available to finance them, the growth rate ordinarily falls. Because as decade-long trend exports stagnate, the myth about replacing domestic demand with overseas markets doesn’t apply. Except for short periods the Turkish economy couldn’t rebalance through foreign trade alone. Add to this the upsurge in oil and commodities’ prices, and you come up with a falling, but perhaps not drastically falling, current account deficit. As consumer loans and credit card expenses recede to near-zero 8-week moving average levels – 0.23% the latest, down from 1.80% in August 2020- a strong economic activity signal doesn’t come from that front. Looking at GDP shares from an expenditure viewpoint, food, housing and transportation account for c. 30%. Government final consumption and gross fixed capital formation explain 16% and 26%, respectively. Although it has fallen, construction still accounts for more than half of gross fixed capital formation. This also means how capital is sunk via inefficient routes. I would rather say it is also debt rather than capital. Again there is also a drastic drop in the hours worked. It is better to look at hourly data rather than unemployed people because this statistic can be deceiving in the current climate. Loan rates stand at 22.3, 18 and 19.3 for consumer, housing and commercial. All of them were below 10% 8 to 10 months ago. They were artificially low, and it didn’t last because it couldn’t. Nonetheless, some demand was brought back because of this. Hence, although maybe weak equity capital doesn’t prevent some kind of growth from happening, an overall debt-overhang sure can.
IS THERE AN OPTIMAL PRIVATE SECTOR AND HOUSEHOLD DEBT LEVEL?
Many criteria have been proposed to render public debt sustainable. Yet these criteria aren’t uniform because there are countries that are FX-indebted and run large trade deficits. At some point, Belgium could sustain a debt-to-GDP ratio that exceeded the then heavily indebted Turkey’s post-2001 crisis ratio. I am talking about the early 2000s. Still what the threshold is for firms, and especially households, is unclear. Given that even vaccine research and patents obtained from it is largely financed via government support and not with the equity capital of medical firms, the situation is awkward at the global level, too. Yet I tend to think with c. two-thirds of disposable household income allocated to debt payments and with c. 15% drop in the hours worked, and with a generally low level of earnings, the potential for growth is weak and the image blurred at best.
WHERE DO WE GO FROM HERE?
Gross fixed capital formation data still signals that it is real estate that drives it, not machinery and equipment investments. Is the pattern that emerges one of ‘production with no new investments’? Awkward, some would think.
Given that the Fed’s further moves – actually it won’t move – have been largely priced in, and this is reflected in cross-border flows to EMs, to what extent can the manufacturing sector benefit? After all, markets and real economies diverge all too often. Maybe the reasons are many, but sustainability issues are obviously on the forefront. That fiscal deficit doubled, even tripled on a cash basis, in years of stupendous growth is indicative of the fact that without public expenditures and without Credit Guarantee Fund-fueled growth, and without public banks’ incredibly high commercial loan growth momentum, GDP growth would have been much lower. Then, addressing the sustainability issue may be critical because overseas investors look at the EM universe, and despite sporadic strong growth and cheapness arguments, and sufficiently high near-equilibrium TRY rates, they are not entirely content with either the quality of growth or with sustainability issues. Also, we can only hope that ‘political noise’ will be reduced soon.
STAY WHERE YOU ARE
The worst policy mistake during a recession is to believe that it is over: hence the Fed in 1936. They thought ‘the worst was over’, and raised the policy rate. As a result, there was a second slump in 1937. In fact, the U.S. economy fully recovered from the 1929 Great Depression only in Q1 1939. Yet this isn’t the only kind of error. One may also tend to think the worst is over, and begin fine-tuning. People may easily get the wrong impression after a few months of success and believe everything would turn to what was before. There is no way a return to old times is possible after a recession. Nor is it possible to return to low rates after eroding more than a hundred million of precious reserves. In fact, things always differed after major economic crises everywhere. Here there can be no interest rate that is low enough to rekindle loan demand and refuel consumption while at the same time stabilizing the exchange rate and incentivizing exports. The threshold is like 3-4% expected real interest assuming full credibility, which is where we stand exactly.
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