Who Pays Bad Debts?
A front-page photo in Tuesday’s Financial Times shows lightning striking near the Parthenon. Zeus must be reading the paper.
Greece is supposed to cut its public spending by an amount equal to 10% of its GDP. Even so, its public debt is expected to rise to nearly 150% of GDP by 2016 – or three times the level of Argentina when it defaulted in 2001.
It should be obvious that the Greeks owe too much. But so does almost everyone. Every kind of debt is so heroic it poses an affront to nature and a challenge to the gods. Much of it is unpayable. Private debt. Public debt. Short term. Long term. US. England. Europe. All kinds of debt in all kinds of places. In America’s private sector, for example, debt exploded 6 times faster than GDP since 1950. And today, the whole world staggers under debt, with more than $3.50 of debt for every dollar of GDP.
Today’s global economic problem is breathtakingly obvious: too much debt. The solution is obvious too; debt that cannot be repaid must be destroyed – by defaults, foreclosures, bankruptcies, write-downs, and restructurings.
Nouriel Roubini, writing in The Financial Times this week, is on the right track. Greece cannot bear the weight of all its debt, he says. Since it will default sooner or later, better to restructure the debt now…reducing it to a level the Greeks can actually pay. Fair enough. Creditors would take their losses in an orderly way.
When the debtor cannot pay, the creditor should take the loss. But practically the entire burden of modern economics over the last 3 years has been a scammy effort to shift the losses to someone else.
To bring the readers fully into the picture, the great debt build-up began with Reagan in the White House and Thatcher at #10. Reagan added to deficits. Thatcher cut them. On the west side of the Atlantic, economists called on Reagan to stop spending. On the east side, 346 economists implored Maggie Thatcher to spend more.
Reagan’s young budget director, David Stockman, resigned in protest when the Republicans wouldn’t bring deficits under control. Meanwhile, Maggie Thatcher was told that her austerity policies would “deepen the depression, erode the industrial base and threaten social stability.” She should do a U-turn immediately, said the august economists. “This lady’s not for turning,” she replied.
It didn’t seem to matter what anyone thought or did. Markets do what they want. Back then, interest rates were coming down. The US 10-year Treasury yield fell from 15% in 1980 down to under 3% today. In that tender, delightful world, debt was no problem for anyone. Even if you wanted to default, the banks wouldn’t let you. They offered to refinance your debt at a lower rate. Both Britain and America grew; their debts grew too.
Private sector debt peaked out in 2007. Households and corporations have been de-leveraging ever since. But as the private sector taketh away, the public sector giveth more debt. And again, markets are doing what they want. Interest rates are already at the lowest levels in a generation. This time, economies cannot cut rates and grow their way out of debt. Instead, someone will have to pay. Who?
The world’s economists have no better idea what is happening in the 21st century than they had in the 20th. They neither saw the crisis coming, nor knew what to do when it arrived. Their panicky ‘rescue’ attempts wasted $10 trillion. They claimed they had put the world on the road to ‘recovery’ and claimed victory over the credit cycle. They might just as well have claimed to have conquered sin or exterminated cockroaches.
Neither governments nor their economic advisors can make bad debt disappear. They know that as well as we do. All their sweating and grunting has another purpose – to decide who gets stuck holding the bag.
Taxpayers, for example. That is the general drift of the Germano-Anglo-Canadian proposal. ‘Austerity,’ as they call it, means higher taxes, fewer services, and bailouts of the financial sector. The big banks won’t pay for their mistakes. The public will. Martin Wolf and Paul Krugman are wrong about many things, but they’re probably right about the side effects of this bitter medicine; it will probably deepen and prolong the slump. It will cause a ‘third depression,’ says Krugman.
On the other hand, Krugman, Wolf and the other neo-Keynesians have a bad proposal of their own.
“…governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending,” writes Krugman.
If too little spending were the real problem, it would invite the most agreeable fix since sex therapy. Every government would lend a hand. Alas, the real problem is the opposite. It is the consequence of too much spending – debt. More government spending means more debt.
Who will pay it?
Taxpayers? Consumers? Savers? Investors? Lenders? The young? The old? Nobody knows for sure. But everybody is surely going to find out.