05/06/2010
The Mother of All Bubbles
Huge National Debts Could Push Euro Zone into Bankruptcy
Savvas Robolis is one of Greece's most distinguished economics professors. He advises cabinet ministers and union bosses. He is also a successful author and a frequent guest on the country's highest-rated talk shows. But for several days now, it has been clear to Robolis, 64, the elder statesman of Greece's left-wing academia, that he no longer has any influence.
Robolis told the IMF negotiator that radical wage cuts would be toxic for Greece's already comatose economy. He said that the Greeks, given their weak competitive position, primarily needed innovation and investment, and that a one-sided fixation on cleaning up the national budget would destroy the last vestiges of economic strength in Greece. The IMF, according to Robolis, could not make the same mistake as it did in Argentina in the early 1990s. "Don't put Greece on ice!" the professor warned.
But the tall Dane was not very impressed. He has negotiated aid packages with Iceland, Ukraine and Romania in the past, and when he and his 20-member delegation landed in Athens on April 18, they had come to impose a rigorous austerity program on the Greeks, not to devise long-term growth programs.
Thomsen's mandate is to save the euro zone. And any Greek resistance is futile.
This is a long and detailed piece. For reference to some of these comments, recall that 2008 Global GDP was ~$61Trillion. I have attempted to extract some of the most meaningful (and intriguing) statements into a quote format below:
A Huge Bubble
The national deficits of the 30 members of the Organization for Economic Cooperation and Development (OECD) have grown almost sevenfold since 2007, to about $3.4 trillion today. Their total debt burden has also grown dramatically, to a record-setting $43 trillion. In the euro zone, national deficits have even grown 12-fold in the same time period, with the euro-zone countries accumulating $7.7 trillion in debt.
Stagnating Economy
In fact, the Portuguese economy has been stagnating for the last 10 years. "We spend 10 percent of GDP more than we take in, year after year," says Portuguese economist António Perez Metelo.
Private households owe more than 100 percent of their annual income. Because the Portuguese save so little, banks are forced to borrow money abroad. Each of the 10.6 million Portuguese citizens owes foreign banks an average of €18,300 and paid €590 in interest in 2009.
The US budget deficit has now reached $1.6 trillion, or 10 percent of GDP. The national debt is now over $12 trillion and is forecast to expand to more than $20 trillion by the end of the decade. At that point, Americans will be paying $900 billion a year in interest alone.
How Empires Fall
In March, the rating agencies Standard & Poor's and Moody's warned that even the US's perfect triple-A rating could be jeopardized if the country's financial situation didn't change drastically soon. The third main rating agency, Fitch, had already issued a warning in January. So far, none of the three agencies has announced an actual downgrade of the country's credit rating. Economists suspect, however, that the fear of the incalculable consequences for the economy might have prevented them from doing so.
At any rate, experts like Harvard economic historian Niall Ferguson warn that confidence in the United States could be lost at some point, and that this could come as a complete surprise, with a single piece of bad news serving as a spark and potentially triggering a global conflagration.
Safe Haven
By studying financial crises over the centuries, US economists Kenneth Rogoff and Carmen Reinhart have calculated an average value at which the debt burden starts to become critical for a country: 90 percent of GDP. Above that level, economies achieve only half as much growth as those that are not as heavily indebted. This key indicator is currently at about 84 percent in the United States, but in two years the Americans are expected to surpass the 100-percent mark. In other words, time is of the essence.
Unless the United States takes drastic steps immediately, the public debt will amount to more than 300 percent of GDP by 2050, according to calculations by the Center on Budget and Policy Priorities, the leading fiscal policy think tank in Washington.
Relatively Unscathed
So far, Germany has come through the crisis relatively unscathed, compared with other Western industrialized nations.
But the absolute figures of German indebtedness reveal the true scope of the challenge. State institutions have borrowed some €1.7 trillion, with more than half of the total attributable to the federal government, which exceeded the €1 trillion threshold last year. The country's states owe a total of €526 billion and municipalities are €112 billion in debt.
Germany, with a triple-A rating, is considered a borrower with a credit risk of almost zero. German government bonds set the benchmark in Europe.
A Tough Course of Cold Turkey
Many local governments are highly indebted. For example, Kiel, the capital of the northern state of Schleswig-Holstein, has liabilities of about €900 million. "My city is just as unable to repay this debt by itself as Greece," admits Kiel Mayor Torsten Albig, a member of the SPD who was also the German Finance Ministry's spokesman until last year.
Albig says that he can only borrow new money under preferential terms because Kiel is backed by Germany's good reputation, and because the city does most of its borrowing from the local savings bank and the state-owned bank. "I certainly wouldn't be getting such attractive interest rates from a foreign bank," says Albig.
If his city were treated the way Greece is being treated, the consequences would be catastrophic. Instead of €24 million in debt service, the city treasury would be required to pay five times as much. Public swimming pools would have to be closed, and the city wouldn't even have enough money to pay for kindergartens and schools. "This isn't a likely scenario," says Albig, "but it is possible."
Three Possible Scenarios
So what's next? The world's economies, who were addicted to constant new injections of debt, can expect a tough course of cold turkey. And if they don't undergo the treatment, they will face what amounts to a lingering illness, and some could even collapse.
There are three conceivable scenarios, distinguishable mainly by who will ultimately bear the greatest burden: taxpayers, savers or creditors.
In the first strategy, the national economies embark on a strict course of austerity measures. To do so, they will have to demand higher taxes from citizens.
The second, supposedly pain-free strategy is attractive to politicians: Confronting the mountain of debt with the help of inflation. In other words, governments simply print money.
Inflation has other advantages from the government's perspective. When prices rise, the government collects more revenue. This improves its ability to repay its debt, because the value of the debt also declines daily.
The third strategy countries can employ to reduce their national debt also has unpleasant consequences: They stop making payments, either in full or in part. Such cases have happened hundreds of times throughout history, and yet no guidelines exist on how debtors and creditors are to proceed. "There is no legal framework for national bankruptcies," says Klaus Abberger, an economics with the Munich-based Ifo Institute for Economic Research.
As far back as 1776, Adam Smith, the father of modern economists, pointed out the need for a legal system to deal with national bankruptcies. "A fair, open and avowed bankruptcy," the moral philosopher wrote, "is always the measure which is both least dishonourable to the debtor, and least hurtful to the creditor."
Restructuring Debts
More than two centuries later, Greece would undoubtedly be a candidate for such a bankruptcy proceeding -- that is, if the politicians in the euro zone weren't so terrified of the consequences. If that were to happen, the government in Athens would have to sit down with its creditors and negotiate how much of its debt it could repay.
It is high time to think about how this would work, says Clemens Fuest, an economist at the University of Oxford. "We have to prepare a debt restructuring, so that the creditors are at least involved in the costs," Fuest insists. On the other hand, he says, if the Greek bonds were serviced in full, "taxpayers would be short-changed once again, just as they were in the banking crisis."
In the end, some governments will probably put all three strategic levers into motion to overcome the debt crisis. Even if they don't actively fuel inflation, at least they won't be fighting it rigorously. They will restructure the debts of hardship cases like Greece. Most of all, however, they will seek to balance their budgets by raising revenues and reducing expenditures. When that happens, at least everyone will suffer: not just taxpayers, but also savers and lenders.
Only then could states be able to get their affairs back in order. However, one key element is still missing: The economy has to grow (emphasis added), so that the government can collect enough tax revenue and thus reduce its debt. The trick, in other words, will be to save money while at the same time expanding aggregate output. This is the dilemma that governments face: debt and cutbacks curb growth, but debt reduction cannot succeed without growth.
Whether there is in fact a way out of this quandary will soon become apparent -- in the case of Greece.
BY ALEXANDER JUNG, ARMIN MAHLER, ALEXANDER NEUBACHER, CHRISTOPH PAULY, CHRISTIAN REIERMANN, WOLFGANG REUTER, HANS-JÜRGEN SCHLAMP, THOMAS SCHULZ, DANIEL STEINVORTH AND HELENE ZUBER
Translated from the German by Christopher Sultan
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