A Tight Grip on the Excessive Debt Grenade

Japan…wither thou goest…

The US and other developed countries continue to follow Japan.

The Dow rose 131 points yesterday. The 10-year note fell, to yield 1.9%.

Gold rose $25.

What to make of it?

Some reports tell us that Europe is getting close to a deal that will save Greece and other ‘Olive Country’ debtors. Maybe, but IMF chief Christine Lagarde says they have a $3 trillion hole to fill. That’s probably the one and only thing she is right about. The size of the problem is big…bigger than anyone realized.

Some of the biggest banks, for example, have tried to buy time by underestimating the size of their losses. Societe Generale has written off 21% of its Greek debt. But Mr. Market says it’s down more than 50%. And what about the rest of them? Spain, Italy, Portugal…they’ve got big losses too.

“You can’t trust Greeks,” said a friend last night. “That’s just the way they operate. It’s probably some Mediterranean genetic code. The Southern Italians are just as bad. It’s crazy to think that they can operate with the same currency and the same interest rates as the Dutch and the Germans.”

“Well, I’m not so sure…” we replied. “People from California and New York share the same currency.”

“Yeah…and you can’t trust either one of them, either.”

“And what about Ireland? They don’t even have olive trees. But they’re probably in as deep a hole as anyone.”

“Yeah…but you can trust the Irish. They’re not crooks. They’re just stupid.

“I don’t know…but this whole mess is going to explode. People owe too much money. You can talk about bailing them out, but that doesn’t make the debt go away. It just moves it around. And even if the Germans could and would pick up the whole tab, so what? It’s still got to be paid or written off.

“I don’t know what they can do…except what Japan has done. The Japanese savers lent money to the government so it could keep spending and keep the economy going.”

Our friend was making a good point. Debt doesn’t go away. Even if you succeed in managing it, you still have to take the debt and subtract it from someone’s balance sheet. Excess debt is a like a hand-grenade after you’ve pulled the pin. You can pass it around the table. But, it’s going to explode anyway.

In theory, it doesn’t matter who has the debt. Debt is debt. It is a claim on wealth. Current wealth or future earnings. When growth rates decline, debt gets heavier. Growth would make the debt seem lighter and smaller. Without growth, debt must be subtracted from current wealth…not future wealth. That’s what a write down or default is all about. The debtor admits he cannot pay. The creditor admits that he has been a fool…

Many economists have the wrong idea about debt. For every debit there is a credit, they say. Don’t worry about it.

But what about when the credit goes bad? The lender lent money. The debtor used the money to buy resources…and use them up. Then, the debtor has no more resources…the debt can’t be paid…and the creditor realizes that he should have held onto his money. The credit disappears…the debt disappears…the resources have long since disappeared…and the lender blows his brains out. He’s broke and disgraced.

Well, he would be taking this thing far too seriously. But sometimes people get more worked up about money than they should. C’mon…it’s just a game! It’s supposed to be fun…

Besides, the Japanese have been playing the game for two decades. Instead of forcing borrowers to admit they couldn’t pay, the Japanese feds lent everybody money…and spent a lot of money themselves. This kept the economy turning over.

Our Daily Reckoning best guess is that that is what Europe and America will do too… They will go where the Japanese went.

But wait…what happened to all that money that Japanese savers lent to the government? How will they get it back? Doesn’t the Japanese government get stuck holding the hand-grenade…and won’t those poor mom and pop savers have to admit that they were fools?

Yes…of course. But we’ll worry about that later…


Bill Bonner
for The Daily Reckoning

The Daily Reckoning