Thursday, July 2, 2009

Debt Dillema

The relationship between lender and borrower can be analyzed by Greek philosophy. This idea was first originated by Economist Henry CK Liu. Hegelian dialectic, usually presented in a three-fold manner, comprising three dialectical stages of development: a thesis, giving rise to its reaction, an antithesis, which contradicts or negates the thesis, and the tension between the two being resolved by means of a synthesis. For example, British Columbia government total gross debt reached 31 billion at the end of 2008.

Source:Government of British Columbia Website

As we see from the picture, most of the funding sources are from Canadian public and private sector. Among the, CPP and other pension funds takes 16 percent. Canadians financed 82 percent of its total debt.

Let's take a quick look at the biggest pension fund management firm at BC and check its asset allocation.

Source: bcIMC

From the chart, we see bond takes 27%. It's a little big surprising that mortgage-backed securities takes only 4%. ( Two years ago, the number was 30 percent or so I believe). It seems that they dramatically increased equity stakes recently comparing to the past.

We live a dilemma. On the one hand, individuals and governments are loaded with debt burden which could not possibly be increased especially in recession while all sources of revenues are shrinking. On the other hand, pension funds and private investors reply on the income from debt securities to maintain their asset value and fund the standard living of all employees.

Ironically, Canadian public and private sector has pulled the plug and abandoned debt securities during the financial stress. Housing prices were falling while funding sources were drying up. The government steped in to reduce interest rate and mortgage rate. As if only we go back to the previous debt level and fund all debts, our economy will go back on track again. The government's answer is to keep the party going. By going into more fiscal deficit, the government hopes to spend money out of recession. This recipe seemed to work pretty well in the part, so they hope it's going to work well this time. Unfortunately, the crisis is "the mother of all crisis" (Paul Volcker) and we are "at the end of credit bubble that has lasted for nearly fifty years" (George Soros). The recipe to carry on more debt may not work this time.

The synthesis perhaps is to reduce the debt level orderly over time and let the real productivity growth to take charge of its economy.

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