Debts Make a Deal

Yesterday, we thought we made a breakthrough. For a second, it seemed as if the clouds had lifted. We had an illusion of comprehension; we thought we saw clearly what was going on.

After a certain point, debt becomes toxic – for a household as well as for a nation. For a nation, Professors Reinhart and Rogoff put that ‘point of no return’ at 90% of GDP. Greece, Japan, and the US – all are beyond that point. America’s gross debt is 100% of GDP. Greece has debt of 120% of GDP. And Japan is off the charts, at 229%.

Reinhart and Rogoff say that once you get past 90% your GDP growth declines by 1%. Sure enough, the US used to run at about 3% annual GDP growth. Now it is down around 2%. Greece, the last time we looked, would be lucky to get any growth at all this year. And Japan, the biggest debtor of all, is actually going backwards…with negative growth.

When you are in this situation, by the way…you can’t “manage” it. You can’t ignore it. You can’t turn knobs or adjust levers to make the problem go away. And you can’t grow your way out of it either…because the debt suppresses your growth.

All you can do is to get out of debt…as soon as possible. Default. Go broke. Chapter 11. Chapter 7. Turn your pockets inside out and your mouth down.

Let it be.

Borrowing more money to keep from admitting the truth is disastrous. Europe just proved it.

Word got out yesterday morning that Europe had solved its Greek debt problem. As predicted, the authorities cobbled together an odd boot. And now they use it to kick the can further down the road.

But the nice thing is this: it’s now a smaller can. After resisting the inevitable for more than a year, the authorities are finally giving bondholders a 20% haircut. The New York Times:

The pact, negotiated in Brussels, is part of a rescue package of 109 billion euros, or $157 billion, for Greece, the most troubled economy in the euro zone. It will force many investors in Greek debt to accept some losses on their bonds.

The deal would also provide substantial debt relief for Ireland and Portugal. And by giving the main European rescue fund increased powers to assist countries that have not been bailed out – like Spain and Italy – leaders are betting that the program, described by some as a new Marshall Plan for Europe, will serve as a firebreak against the contagion that has threatened to engulf some of the region’s largest economies.

Officials have long shunned proposals that would make banks and other creditors share some losses on Greek debt. But European leaders are taking the calculated risk that they can avoid spooking investors by expanding the aid package to include other troubled countries on Europe’s periphery.

By afternoon, investors were buying heavily. They couldn’t be bothered to read the fine print or think too deeply about what the bailout meant. All they knew was that the trouble was behind them.

The Dow rose 152 points. Oil went up too…close enough to $100 as to leave a smudge. And gold went down $9, closing at $1,587.

Gold seems ready for a rest. It’s been marching uphill for the last 11 years. Time to sit down and have a drink, no?

The debt deal in Europe doesn’t solve the problem. The can will be kicked again. But at least the 20% loss to bondholders reduces its size. It’s now back to about where it was when the euro geniuses first started to kick it down the road!

Naturally, reports of salvation in Europe turned attention to America’s budget troubles.

“Hope for US debt deal,” says The Financial Times headline.

In Washington, of course, the problem is a little different. It’s the central government that needs to be saved – from itself.

And here we find a political movement The Daily Reckoning can stand…far…behind. Yes, we support that narrow fringe of the Tea Party, the tiny part of it not invited to share the cakes and sandwiches, the part that actually wants the US government to default.

Whoa! We know what you’re thinking. A default would be dangerous. Suicidal. Unthinkable. Ben Bernanke. Tim Geithner. Larry Summers. They all said so! The old folks wouldn’t get their medicine. The soldiers wouldn’t get their ammunition. Tops would go back onto honey pots all over the Washington DC area. The whole system would fall into anarchy and pandemonium. There would be riots. Revolution. Bourbon would disappear from the liquor store shelves. The dead would rise from their graves and the living would fall into the open holes. A man would be happy to see his dead wife alive again. Another would be even happier to see his living wife dead!

Well, maybe they’re right. It would probably be a catastrophe. A disaster. But let’s take the chance anyway!

Because the real problem is debt. The quicker it is eliminated…the faster the economy can get back to work.

So, don’t raise the debt ceiling. Let the feds figure out how to get by like everyone else – spending no more than they take in as income. Is that really so tough?


Bill Bonner,
for, The Daily Reckoning

The Daily Reckoning