When Lenders Stop Lending
The Dow shot up 152 points yesterday…following an announcement that Greek voters had approved more austerity measures.
So, the Greek crisis has been solved…Dominique Strauss-Kahn may not have raped that hotel maid, after all…and the Chinese are buying euros.
Whew… A close call! But now the Greek crisis is behind us. We can get back to work…and all get rich.
The French and Germans will pretend to fix the problem. The Greeks will pretend to cut spending. And lenders can pretend to get their money back.
But what happened to all that debt that Greece couldn’t pay?
Wait a minute… We know what you’re thinking. You’re thinking that now that the crisis is behind us, interest rates can return to normal. And at normal interest rates there isn’t any problem. After all, it was just a temporary problem caused by jittery and greedy lenders, right? And as long as the full weight and credit of the European financial authorities – with some help from their colleagues East and West – is behind the Greeks, everything should be all right. The Greeks can borrow money to plug holes in their budget and pay the interest on past loans.
And you’re right – sort of.
Well, you would be right if lenders were born yesterday. They would just lend more and more so the Greeks could borrow more and more, forever and ever, amen.
And don’t forget the rest of Europe’s debtors – Ireland, Spain, and Portugal, for example. They’re in the same boat, more or less. They need to borrow money now, largely to service the debt they borrowed before. And as long as interest rates don’t rise, this can go on for a long time.
But what if lenders had been around the block once or twice? It’s often said that the stock market is about the future. The bond market is about the here and now. But what if bond buyers suddenly recalled how they got mugged the last time they went around the corner? What if they remembered what happens when debtors borrow so much that they could never pay it back?
Wouldn’t that lead them to think that…
1.) Lending more would be a mistake
2.) Or, at least ask for higher interest rates…?
Well, you can imagine as well as we can.
The Greeks owe too much. So do a number of European countries…and so does the United States of America.
What do we mean by “too much?” Well, nothing precise. But if you add up all the debt, it comes to over 100% of GDP. Which means, you ‘normally’ would need to devote something like 5% of GDP or more to pay the interest on it. And if a government can collect 20% or 30% of GDP in taxes, it means it has to devote as much as a quarter of all tax receipts just to cover the interest on money it already spent.
Imagine that you were in that position. Theoretically, you could still be okay. You could stop spending beyond your means…and then ‘grow your way out of debt.’ But that’s not what happens. Crowds of zombies take to the streets. Political pressures force governments to keep spending. And if your deficit is greater than your growth rate, you’re going deeper into debt.
Let’s see…the US has a GDP growth rate (taking the feds at their word) of less than 2%. What’s the deficit? About 10%? Hmmm…not good.
But this math is obvious, isn’t it? Even to the people who buy bonds, right?
So how come US bonds have generally been going up, not down?
That’s the real question, isn’t it?
NB: the Chinese are buying euros.