The world’s largest economies are mired in debt. I have written about the scale of the problem before and this subject is covered frequently in the Debt Watch category so I won’t go into it again here. Today I want to focus on the options for dealing with the debt crisis, and with that in mind I examine six options for getting out from under our colossal debt burden.

Option one: Grow our way out

To grow our way out of debt would take something of an economic growth miracle – normal levels of economic growth simply wouldn’t be enough. The problem is, such a miracle isn’t on the cards. No country within the G20 (or beyond) has implemented the kinds of radical growth-promoting policies that would be necessary in order to achieve a growth miracle. About the only option would be for some kind of radical technological breakthrough in the area of energy generation. This would drive new industries, putting millions to work and dramatically reducing the cost of energy.

Option two: Major interest rate cuts

With interest rates already close to zero there is little or no room for more cuts, and certainly major cuts are out of the question.

The policy of ultra-low interest rates is designed to incentivize spending versus saving. This is considered desirable since such a high proportion of GDP comes from consumer spending – around 61% in the UK and about 74% in the US. This policy has failed to stimulate much in the way of spending because the policy assumes that consumers are both willing and able to spend. Today however, the average adult in the UK owes £29,875 (which is 126% of average earnings) and therefore simply isn’t in a position to spend. Businesses too are reluctant to spend and instead are hoarding cash and hunkering down, and those businesses that are willing to spend are finding bank loans increasingly difficult to come by.


Ultra-low rates provide relief for those making debt repayments, such as mortgage holders, and in this regard the policy is providing Britain and other nations with considerable economic life support. In fact, if interest rates in the UK were to suddenly return to their historical 4 to 6% range, we would see a dramatic repricing of property prices, and a substantial drop in economic output.

Option three: A bailout

This option is possible only if the country to be bailed out is small enough to save, but it is definitely not an option large countries such as the UK, the US or Japan. A bailout also works when only one or two countries are in trouble – today the situation is the exact opposite. Take the eurozone for example: The Maastricht Treaty requires that member countries maintain a budget deficit of no more than 3% of GDP, however only 6 of the 17 members meet that requirement, and all 17 are running a budget deficit.

When it’s the majority rather than the minority that are in trouble the risks associated with bailouts are very considerable indeed. In this scenario the money being provided to the likes of Greece, Portugal and now Spain does not come from savings, it is essentially printed into existence and thus becomes a future liability for the nation or group of nations providing it.

These first three options are the ones that aren’t painful. Unfortunately these options are either no longer available to us, or, in the case of option three, they provide only short-term relief from the crisis whilst making the eventual outcome worse. The remaining options are all painful.

Option four: Default

When a nation defaults on its debt those holding the debt incur the losses. Since much of the outstanding government debt is held by the financial sector (by banks and insurance companies), an outright default by even a medium-size country would send tremendous shockwaves through the global banking system, the immediate aftermath of which would no doubt cause a string of high profile banks to collapse. Clearly this option is one that politicians want to avoid.

Option five: Austerity

Austerity is all about reigning in profligate spending. As it applies to governments, austerity is a policy, or collection of policies, aimed at reducing spending, cutting the budget deficit (i.e. the amount by which our annual expenditure exceeds our annual income), and ultimately reducing public debt. However as we have seen with the recent elections in Greece and France, implementing austerity is extremely difficult since without the necessary policy reform it brings about high unemployment and dramatically lower economic growth.

Here in Britain it is alleged that we are also pursuing austerity. However, only last month I exposed the fact that Britain’s so-called “savage” spending cuts have been hugely exaggerated, and that public spending actually increased in all but the last financial year, and even then it only fell by 1.5%. The reality is that at this pace it will take as much as a decade to put our fiscal house in order.

Option six: Money printing & inflation

Money printing, or quantitative easing as it is now known, involves using the modern electronic equivalent of the printing press to create money in order to service and repay debt. The problem with printing money is that it almost always leads to inflation. This is because if you increase the amount of money in an economy but don’t increase the amount of goods and services, the price of those goods and services will sooner or later begin to rise. As Milton Freidman puts it, inflation can be described as “Too Much Money chasing too Few Goods”. This gives the appearance of rising prices.

Once we understand the true cause of inflation, we see that as governments print new money they destroy the value of the money already in circulation. Holders of this money lose their purchasing power and their wealth diminishes, particularly when money velocity begins to pick up as a result of inflation expectations.

This is by far the most politically palatable option, since in the same way that inflation erodes the value of paper money, it also erodes the value of debt. Indeed, if a government can maintain an average inflation rate of 4% for a period of seven years, it will have eroded nearly 25% of its debt. I believe this is why we are seeing the widespread adoption of financial repression.

There is of course a seventh option, which is to simply step back and do nothing and let market forces bring about a rebalancing of the global economy, however this would involve a depression not unlike that of the 1930’s.

The bottom line

Over the next few years I expect to see a mixture of austerity, default and especially money printing. As a result those holding their wealth in paper currencies, i.e. dollars, euros, or pounds, are likely to see a large portion of their wealth destroyed through inflation. Investors need to be mindful of the fact that while cash is ok in the short-term, over the longer-term holding it could cost them dearly.

The fact is all currencies are being devalued in a kind of ‘race to the bottom’ however investors do have a choice. Rather than holding their wealth in increasingly worthless paper, they can seek protection in gold which has a history of maintaining its purchasing power over long periods.

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