What once could be dismissed as simply a Greek crisis, or simply a Greek and Irish crisis, is now clearly a eurozone crisis. Resolving that crisis is both easier and more difficult than is commonly supposed.Default, delusion and deceit (and other ways to spring the debt trap). Roger Bootle of Capital Economics, in the Telegraph.
The economics is really quite simple. Greece has a budget problem. Ireland has a banking problem. Portugal has a private-debt problem. Spain has a combination of all three. But, while the specifics differ, the implications are the same: all must now endure excruciatingly painful spending cuts.
The standard way to buffer the effects of austerity is to marry domestic cuts to devaluation of the currency. Devaluation renders exports more competitive, thus substituting external demand for the domestic demand that is being compressed.
But, since none of these countries has a national currency to devalue, they must substitute internal devaluation for external devaluation. They have to cut wages, pensions, and other costs in order to achieve the same gain in competitiveness needed to substitute external demand for internal demand.
The crisis countries have, in fact, shown remarkable resolve in implementing painful cuts. But one economic variable has not adjusted with the others: public and private debt. The value of inherited government debts remains intact, and, aside from a handful of obligations to so-called junior creditors, bank debts also remain untouched.
This simple fact creates a fundamental contradiction for the internal devaluation strategy: the more that countries reduce wages and costs, the heavier their inherited debt loads become. And, as debt burdens become heavier, public spending must be cut further and taxes increased to service the government’s debt and that of its wards, like the banks. This, in turn, creates the need for more internal devaluation, further heightening the debt burden, and so on, in a vicious spiral downward into depression.
So, if internal devaluation is to work, the value of debts, where they already represent a heavy burden, must be reduced. Government debt must be restructured. Bank debts have to be converted into equity and, where banks are insolvent, written off. Mortgage debts, too, must be written down.
There are five ways of escape [from the debt trap].
First, try to muddle through and hope that years of sustained economic growth will cause the weight of these debts to fall and for the burden to go unnoticed amidst increasing prosperity, so that it is unclear who has picked up the tab. This is far and away the best solution – if you can manage it. But in the vulnerable countries GDP is struggling – or even contracting.
Second, engineer a bout of inflation to reduce the real value of the liabilities. In this way just about everyone in society will pay – but hopefully no one will notice. (Being able to devalue your currency potentially helps you achieve both the first and the second routes.) The trouble is that even if this solution were available for the eurozone as a whole, for each embattled member country it is not, as they do not have their own money.
Third, force those who caused the problems and gained from the years of extravagance to cough up. That would mean the bankers, property developers and politicians. This seems the fairest solution, but it is also the least likely. And, believe it or not, even they do not have enough dosh.
Fourth, slash government spending and make current and future taxpayers pick up the tab. This is the way that Ireland and Greece are trying to go. The trouble is that the situation may be so far gone that attempting a solution this way is impossible. It may even be so deflationary that it proves to be counter-productive.
The fifth way is to default. Perhaps you can make someone not involved in the process by which the government gets elected take a good part of the hit. This is where Johnny Foreigner comes in. You say: "Sorry old chaps, but that money that you thought we owed you is now 'restructured'. In the words of Monty Python, it is an ex-loan."
This is what is going to happen. Huge amounts of money are going to be lost. At the moment, the prospective losers can afford it. But coming up in the lift are Portugal, Belgium and Spain. And then Italy. This looks eerily like the build-up to the financial crisis of two years ago. Perhaps the bail-out of Ireland is the Bear Stearns moment. Spain, or Italy, could be the Lehman moment.
Eclectica Fund: Manager Commentary, December 2010. Hugh Hendry.
subtitled "There are no policy remedies for debt deflation"
other fare:
The decline and fall of the American Empire. Alfred McCoy
also on Salon, provocatively but dumbly entitled How America will collapse (by 2025), and which led a colleague of mine to say, when grabbing the article off the printer, "Oh, this has you written all over it!" Well, maybe so, but I don't believe in collapse, per se; however, its hard to argue with the notion that the debt situation is onerous, or that unfunded liabilities will be a serious challenge, or that climate change and peak oil present potentially problematic possibilities, and that geopolitics and terrorism are serious risks, and even the internal socio-political-economic atmosphere, with high unemployment and the Tea-Partiers, etc., is difficult; so there are some very ominous impediments to the continuation of American "exceptionalism", and each of those issues are ones I find of significant (not just academic?) interest, even if only to acknowledge as risks to our outlook
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