Photo: epsos.de

The global financial crisis has exacted a heavy toll on public finances around the world. Deficits have rocketed and in many developed countries, government indebtedness has soared to levels not seen since 1945.

Dealing with the perils of this has become one of the biggest policy issues of our time. The US economists Kenneth Rogoff and Carmen Reinhart have pointed out that high levels of public debt are associated with low growth and high inflation. Jittery bondholders might take flight if deficits in some countries are not swiftly curbed. Several eurozone countries have already been forced to seek assistance because of their inability to refinance their borrowings, and Greece now seems to be teetering on the brink of outright default.

It is not just problem countries like Greece and Portugal that are suffering. The entire developed world seems ill placed to bear the burden of all this debt. The economic outlook for some countries—especially in Europe—is poor thanks to a toxic combination of poor demographics and rising energy costs. The number of workers relative to dependent pensioners is declining. Yet, at the same time, the ability of those countries to offset a dwindling labour force by increasing productivity is being undercut by higher energy costs. This is due both to greater competition for resources and poor policy choices.

“In the last forty years, the world has been more successful at creating claims on wealth than it has on creating wealth itself,” writes Philip Coggan, the financial editor of the Economist, in his new book, Paper Promises. This is, he argues, partly the consequence of the adoption in the 1970s of floating exchange rates and the subsequent dismantling of capital controls. These removed any restraint on the creation of paper money other than the maintenance of public confidence.

When combined with financial liberalisation, they unleashed the conditions for the rapid and dramatic build-up of debt. “The economy has grown, but asset prices have risen faster, and debts have risen faster still,” he writes. Given this dynamic, it is all too possible that borrowers have made promises that they will ultimately be unable to fulfil. Greece may be just the first of a number of debt crises about to break over the developed world.

The debt numbers certainly make sobering reading. Heading the list of fiscal deadbeats is Japan with gross debts of 227 per cent of GDP. It is…

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