From the 1970s until 2008, consumer debt has increased, almost unabated, year on year across the developed world. The UK, as just one developed world example, has seen consumer debt increase from 43% of GDP in 1973 to over a 100% of GDP in 2012. In the UK’s case, much of this consumer debt was spent on purchasing imported consumer goods and much was spent inflating a large middle class house price bubble across the UK, which sustains to this day. This phenomena was not unique to the UK however as huge increases in consumer debt levels fueled a consumption boom across the developed world. These same statistics can be seen across many developed world countries, including the United States of America.

Alongside this consumer debt phenomena developed world governments have, themselves, increased debt levels to historically high levels on a par with war time debt to gdp percentages. In addition many other “off balance sheet” methods have been used to finance expenditures in an attempt to hide how serious the debt explosion has become in the public sector.  A good example is the UK’s Private Finance Initiative or ‘PFI’. This scheme has encouraged (and enabled) a sale and lease back method to finance government expenditures. (According to recent research the UK’s “PFI” schemes would add an additional 239bn pounds to UK government debt or 20% of GDP).

Given this combination of an unsustainable increase in consumer and public sector debt it has become widely recognized by economic professionals that developed world economies have reached a structural headwind.  Debt levels cannot be increased further as the debt servicing costs would quickly overwhelm their finances should interest rates increase even marginally. The developed world system is on a knife edge due the over hang of debt on its consumers and governments.

In spite of this fact Western governments continue to make unfunded future commitments for health care and pensions. These future, completely  unfunded social welfare commitments, are coming due in the next few years as the ‘baby boom’ generation are about to retire.

The consequences of these combined factors of high consumer debt, high governmental debt as well as unfunded social welfare commitments that fall due in the next few years must result in a significant increase in taxes that are tax resident of the major developed world nation states.

This chart from of projected taxes needed from the US Budget Office, itself. This is repeated across the developed world however.

 

 

Professional analysis of balance sheets of most western states demonstrates many are close to insolvency at present. This is why we also see most western central banks monetizing debt, alongside continued high deficit spending, alongside low consumer savings rates and increasing taxes.

The welfare obligations, current and future, cannot be met mathematically no matter if unemployment levels were cut in half and tax revenues increased. Therefore, in addition to increases in taxes, inflation, or the debasement of paper money, is being employed as a tax method, in effect.  This means the value of the welfare commitments will remain unchanged but the purchasing power of these benefits will be dramatically cut via inflation.

The social unrest implications of governments being unable to honor the expectations of their societies is no less than earth shattering. Equally, the future capital losses for holders of government paper debts (bonds) will also be no less than earth shattering.

Debt monetization always eventually creates inflation.  Capital gains tax implications over the next few decades of this compounded inflation should be clear. Governments must rebalance their books. Inflation of asset prices will create notional capital gains of which a significant proportion will be taxed and spent on rising unfunded social welfare commitments. This process is already in motion across the developed world.

Decades of over consumption has transformed developed economies into consumption economies where nearly 75% of their economy is tied to consumer consumption. The government sector has ballooned as manufacturing has declined.

 

Here below a chart of US combined debt excluding future unfunded social welfare commitments (health and pensions, etc). Including future unfunded commitments the situation is even worse.

 

 

But it is not just a US phenomena. Here below a chart on the UK’s situation vs the g10. Care of Morgan Stanley’s economic research team 2012. (Note Morgan Stanley show the US in a better position vs her g10 rivals. This more positive US picture is a highly debated issue).

The UK’s situation, regarding her exposure to debt, is relatively bad due to her economy having the largest exposure to banking. The financial sector of the UK holds the largest GDP share of any developed world economy.

Developed world government fiscal budgets now represent a historically high, peace time, proportion relative to the size of their economies. The UK public sector expenditure, as one example, spends annually slightly more than 700bn pounds p.a. The entire UK GDP is 1.4trn. I.E. The public sector in the UK is over 50% of the UK economies GDP. Whats worse, currently 20% of the UK government’s fiscal budget is borrowed. Annually the UK adds to her public debt at the rate of over 9% of GDP (2012/2013 most recent projections of 140bn pounds public sector deficit).  This represents nearly 20% of the governments expenditure annually.

The only time the government represented a larger part of the UK economy, in the last hundred years was during world war II in fact. And these numbers exclude the off balance sheet commitments of the Private Finance Initiative.  (“PFI’ that is a scheme that replaces government capital expenditures with private sector capital expenditure which then the government pays for over the next 25 years. Schemes like “PFI” bring forward expenditure into the current year and distributes the costs to the government over many years. This has the effect of understating the role of government in the economy by representing this share of GDP as private. It is not as it is funded by government eventually).

These demographic, social and accounting “workarounds” have all contributed to creating ballooning annual public sector deficits, or debts, as well as serious trade imbalances. De-industrialisation and unemployment have accompanied the rise in debt fueled consumption that has been the trend of the last few decades. Research and development as well as capital and machinery investment have declined year on year in developed world economies for the last few decades.

Another consequence of artificially low interest rates has been a collapse in developed world savings rates.

 

 

Japanese, UK and other developed market consumers have responded in exactly the same way to artificially low interest rates.

 

 

Bubbles in asset prices caused by artificially low interest rates have deepened the problems as capital (human and material) has been misallocated to needless industries. A good example is Spain’s property boom where nearly 1m housing units stand empty and hundreds of thousands of workers with construction skills now have no economic use as they were misallocated from an unsustainable bubble caused by the mispricing of risk and interest rates by central bankers.

 

 

As we can see, since the 1970s debt (public and private) has brought forward consumption from the future to sustain artificial demand in the present. Governments entered into this gamble willingly and with full knowledge as no one likes to live within their means. Democratic political leaders (of all colours) always want to be reelected so its normal that the hard budget choices get put off and debt is increased.

We have many indicators suggesting to us that the day of reckoning is now fast approaching us. The consequences of this monetary mission impossible must result in a transference of wealth from one group to another. Quite simply the western governments are, on the whole, approaching insolvency. The usual, historic, response by governments when they reach this insolvency is to monetize their debts. This historically results in very high and in some cases hyper inflation. The people who pay the price are pensioners, savers and or capital holders.

A similar set of circumstances developed in the 1970s across the developed world. At the start of the 1970s however consumer debt in many developed economies was relatively very low at around 40% of gdp vs where we are today. In the two decades from 1970 to 1990 consumers doubled their debt levels. This cushioned the effects of inflation (or money debasement) and lead to real income growth though this was merely achived through increase of debt to gdp. This strategy cannot be employed now as debt is so high for western consumers.

It has taken decades to get to this level of combined debt to GDP at a time when the “baby boomers” are retiring with all the social welfare costs that this will entail.

We can see all around us that the ‘rich’ are increasingly being seen as the saviors for this liquidity trap. Some simple mathematical analysis demonstrates that the ‘rich’ are insufficient to plug the hole in western government’s finances. The middle and upper middle class will be forced to pay the bill eventually as they always do historically.

Current private capital holders are to have to pay the bill for the last five decades of public and private sector debt accumulation. It is vital to recogise this fact and then to take action in exploring the options available to you to protect as much of your wealth as possible from these coming monetary and fiscal trends.

There are many options available to wealth holders depending on the jurisdiction you live in, as well as allocation of wealth etc, etc. Its a complicated and detailed matter than requires professional assistance in most cases.

Tax havens are not simply about avoiding income taxes, capital gains taxes, inheritance taxes and sales taxes. They are also about protecting the property and capital rights of resident high net worth individuals. Tax havens pride themselves on allowing residents the free reign of their capital to invest across the world as they see fit. Tax havens do not have large segments of working class and un-capitalised people. They therefore offer a crime free, light regulatory and tax efficient base from which their residents can feel safe that their capital and right are protected and not about to be withheld by the arbitrary wishes of political leaders and segments of their electorate.

If you accept the above then you have an obligation to your capital to investigate what is on offer from a tax and or tax efficient methods of protecting your capital from monetary and fiscal (capital gains tax) expropriations.  The devil is always in detail on these matters, of course. And these details are of the utter most importance at present due to the escalating issues facing the developed world. Tax revenues must rise to meet the rising social welfare needs of the developed world nations. This has serious implications for those lucky enough to currently have “wealth”.

Residency change and even citizenship changes may be needed in the near future to protect private wealth from increasingly desperate governments.

Andorra, as one example, has a long history of offering a safe haven to the people that reside within her borders. She should be at or close to the top of all international capital holders list of residency options to investigate. We here at Capital Synthesis would urge all wealth holders currently resident in developed world indebted nations to rapidly investigate tax wrapper and residency options (if appropriate to your own situation).  As events unfold residency places will become a “crowded trade” and waiting lists and entry criteria will increase and “raise the bar” for laggards.

An outstanding and ‘must read’ report that explains the secular and cyclical trends in terms of this debt and inflationary phenomena can be found here:

http://www.capitalsynthesis.com/wp-content/uploads/2012/12/SP-Dec-2012.pdf

A brilliant concise report that goes a long way to explaining matters for those puzzled by economic world events.