Policy Research in Macroeconomics

Dealing with the overhang of non-financial private debt

Photo with acknowledgment to International Student Blog, University of Bergen  https://internationalstudentblog.w.uib.no/gear-up-hiking/

Photo with acknowledgment to International Student Blog, University of Bergen

Building on the International Monetary Fund (IMF) Global Debt Database (GDD) comprising debts of the public and private non-financial sectors for  190 countries dating back to 1950, Mbaye et al (2018) identify a recurring pattern where households and firms are forced to deleverage in the face of a debt overhang, dampening growth, eliciting the injection of public money to kick-start the economy.

They observe that this substitution of public for private debt takes place whether or not the private debt deleveraging concludes with a financial crisis, and deduce that this is not just a crisis story but a more prevalent phenomenon that affects countries of various stages of financial and economic development. They also find that whenever the non-financial private sector is caught in a debt overhang and needs to deleverage, governments come to the rescue through a countercyclical rise in government defi cit and debt. If the non-financial private sector deleveraging concludes with a financial crisis, “this other form of bailout, not the bank rescue packages, should bear most of the blame for the increasing debt levels in advanced economies.”

Lastly, Mbaye et al (2018) note that their results suggest that private debt deleveraging happens before one can see it in the non-financial private debt to gross domestic product (GDP) ratio.

 Global Debt Overhang

Recent data released by the International Institute of Finance (IIF) indicate that debt overhang of the non-financial private sector is worse in 2019 than it was in 2007. According to the IIF, after reaching an all-time peak of about $248 trillion in the first quarter of 2018, despite contraction in the rest of 2018, and encouraged by falling interest rates, global debt rose by $3 trillion in the first quarter of 2019, reaching to about $246 trillion. Of this $246 trillion, while about $60 trillion is financial debt and about $67 trillion is government debt, about $73 trillion is non-financial corporate debt and about $47 trillion is household debt. Thus, at a total of about $120 trillion, the non-financial private sector dwarfs others in terms of its over-indebtedness.

Furthermore, these numbers are based mainly on bank loans and debt securities. The IMF GDD all instruments data available for 45 of the 190 countries imply that these numbers grossly underestimate the actual non-financial private debt. Given that the world GDP was about $85 trillion in 2018, the global non-financial private sector debt to GDP ratio must be way above 150%. In light of history, a global non-financial private debt deleveraging is therefore inevitable, and the coming round may be worse than the previous round that started in 2007.

 Orderly or Disorderly?

At this level of global non-financial debt overhang, the non-financial private sector will deleverage, and in the absence of other mechanisms, the two “bailouts” that Mbaye et al (2018) mentioned will come.

As the former chief economist of the Bank for International Settlements (BIS) William R White said in an interview in 2016 (Evans-Pritchard 2016):

“The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up … It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something … The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly.”

It is with this question in mind that I now turn to the German Currency Reform of 1948. A few years after the end of World War II, three of the Allied powers occupying the western zones of Germany, the United States (US), the United Kingdom, and France had started a currency reform in their zones in 1948.

 German Currency Reform of 1948

At the insistence of the US, they set up a decentralised central banking system consisting of independent state (land) central banks in the 11 states in their zone, and a joint subsidiary of the Land Central Banks, the Bank deutscher Länder (BdL), much like the Federal Reserve System in the US.

The original plan consisted of: (i) conversion of currency and debts at a ratio of 10 Reichsmarks (RMs) for one Deutschemark (DM); and (ii) a fund built with a capital levy for the equalisation of burdens (Lastenausgleich), which would correct part of the inequity between owners of debt, and owners of real assets and shares of corporations (Kindleberger 1984).

The DMs printed in the US were flown, and the reform began on 20 July 1948. To avoid moral hazard problems, the conversion laws from RM to DM were announced to be published a week later, on 27 July 1948. However, hardly does any project get implemented as planned. The announced conversion laws included provisions to cancel all accounts and securities issued by the Reich so that barring a future radical Lastenausgleich, the reform imposed the burden of war almost entirely on holders of paper claims against the Reich (Hughes 1998).

The first step in the currency change provided only for the surrender of the old RMs, which were thereafter valueless, merely enough new money for each individual and firm to meet their essential needs for about two weeks (Bennet 1950). Each individual received 60 DM in two instalments (40 DM–20 DM). Firms and tradesmen received 60 DM per employee. The recurring RM payments, including wages, rents, taxes, and social insurance benefits, as well as prices other than those of debt securities, were fixed at a conversion rate of 1:1. While the remaining debts were written down to 100:10, in the course of a few months, currency and deposits had been written down to 100:6.5, effectively.

The result was that about 93.5% of the pre-1948 savings of West Germans in their accounts were abolished. Since the less affluent had kept their savings in savings accounts mostly while the more affluent in mortgages and bonds, the less affluent paid more for the war burdens than the more affluent. Furthermore, real property holders fortunate enough to avoid war damages had escaped unscathed as the tax system spared profits to encourage self-financing, and corporations preserved about  96% of their real assets (Hughes 1998).

Although the notion can be traced back to 1943, the Lastenausgleich Law was passed after the establishment of the Federal Republic of Germany on 23 May 1949. Enacted on 18 July 1952, and effective from 1 September 1952, it increased compensation of the savers by an additional 13.5% so that their loss was reduced to 80% (Hughes 2014). The law also imposed a nominal 50% capital levy on capital gains, but allowed payment in instalments over 30 years, making the levies merely an additional property tax (Hughes 1998).

 Equalisation Claims

There is no doubt that the 1948 currency reform distributed the war burdens among West Germans unfairly, favouring the propertied over the property-less. However, it made the non-financial private sector consisting of households and firms of West Germany start from an almost clean slate. Further, the London Debt Agreement of 1953 erased about 51% of its foreign debt, and the remaining debt was linked to its economic growth and exports such that the debt service to export revenue ratio could not exceed 3%. Then came the economic miracle of West Germany. West Germany had moved from being a large net debtor at the end of the war to a creditor by the middle of the 1950s (Buchheim 1988), although other factors too had played a role (Eichengreen and Ritschl 2009). What caused the economic miracle of West Germany has been a topic for hot debate. While some argue for the foreign debt relief of 1953, others argue for the currency reform of 1948, and some others argue for other reasons, the debates continue.

The original reform plan was to convert currency and all debts at a ratio of 10: 1, leaving everything else intact. Had that happened, the balance sheets of all financial institutions would have remained unimpaired, assuming no bad loans. However, the conversion laws of the actualised reform were such that they required all financial institutions to remove from their balance sheets any securities of the Reich and cancel all accounts and currency holdings of the Reich, the Wehrmacht, the Nazi Party and its formations and affiliates, and certain designated public bodies. This impaired balance sheets of nearly all of the financial institutions.

The solution that the conversion laws offered was the equalisation claims. One of the provisions of the laws contained the following statement (Bennet 1950):

 Financial institutions to receive state equalisation claims to restore their solvency and provide a small reserve if either or both were impaired by these measures.

The equalisation claims were interest-bearing government bonds of a then non-existing government and had no set amortisation schedules. They were just placeholders on the assets side of the balance sheets to ensure that the financial institutions looked solvent. They were just some numbers created by the Office of Military Government for Germany, US (OMGUS), headed by General Lucius Clay of the US Army. They later became bonds of the Federal Republic of Germany, established on 23 May 1949.

The OMGUS created approximately 22.2 billion DM of equalisation claims, of which 8.7 billion DM were allocated to the BdL, 7.3 billion DM to credit institutions, 5.9 billion DM to insurance companies and 66 million DM to real estate credit institutions. Interest rates on the claims allocated to the BdL, the Land Central Banks, and private credit institutions were generally 3%. Insurance companies and real-estate credit institutions received 3.5% and 4.5% respectively (van Suntum and Ilgmann 2013). These claims could only be traded among the financial institutions, and only at their face values, making them non-marketable (Michaely 1968).

Later in 1955, an agreement between the BdL and the government allowed the BdL to sell the equalisation claims at any price. After that, the equalisation claims came to also be called as the “mobilisation paper,” since the BdL “mobilised” them for open market operations. The equalisation claims were used a second time in 1990, during the German reunification, because unified Germany also faced a severe balance sheet problem in the financial sector, again resulting from an unequal conversion of assets and liabilities.

So, the equalisation claims are well tested, and historians have found no evidence that the equalisation claims imposed any long-term negative repercussions on either the viability of financial markets or economic growth (van Suntum and Ilgmann 2013).

Can we design a globally coordinated debt deleveraging mechanism using some version of equalisation claims, possibly in the form of zero-coupon perpetual bonds with no cost to anyone, so that we are able to look reality in the eye and face what is coming in an orderly fashion?

T. Sabri Öncü ([email protected]) is an economist based in İstanbul, Turkey. This article first appeared in the Indian journal, the Economic and Political Weekly on 16 November, 2019.

 Parts of this article are adopted from an article in process that T. Sabri Öncü is co-authoring with Ahmet Öncü, titled ” A Partial Jubilee Proposal: Deleveraging Agencies Financed by Zero-Coupon Perpetual Bonds.”


Bennet, J (1950): “The German Currency Reform,” The Annals of the American Academy of Political and Social Science, Vol 267, pp 43–54.

Buchheim, C (1988): “Die Währungsreform 1948 in Westdeutschland,” Vierteljahrsh Zeitgesch, Vol 36, pp 189–231.

Eichengreen, B and A Ritschl (2009): “Understanding West German Economic Growth in the 1950s,” Cliometrica, Vol 3, pp 191–219.

Evans-Pritchard, A (2016): “World Faces Wave of Epic Debt Defaults, Fears Central Bank Veteran,” Daily Telegraph, 19 January.

Hughes, M (1998): “Hard Heads, Soft Money? West German Ambivalence about Currency Reform, 1944–48,” German Studies Review, Vol 21, No 2, pp 309–27.

— (2014): Shouldering the Burdens of Defeat: West Germany and the Reconstruction of Social Justice, Chapel Hill and London: The University of North Carolina Press.

Kindleberger, C P (1984): A Financial History of Western Europe, London: George Allen & Unwin.

Mbaye, S, M Moreno-Badia and K Chae (2018): “Bailing Out the People? When Private Debt Becomes Public,” IMF Working Paper 18/141.

Michaely, M (1968): “Germany,” Balance-of-Payments Adjustment Policies: Japan, Germany, and the Netherlands, Michael Michaely (ed), New York: National Bureau of Economic Research, pp 58–84.

van Suntum, I and C Ilgmann (2013): “Bad Banks: A Proposal Based on German Financial History,” European Journal of Law and Economics, Vol 35, pp 367–84.

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