The Mother of All Bubbles Huge National Debts Could Push Euro Zone into Bankruptcy

AFP

Part 6: A Tough Course of Cold Turkey


But these rates are not always justified. 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.

Or they could limit government spending, which is the approach Ireland, for example, has taken. The government there has cut pay for civil servants by 7.5 percent on average, and recipients of social welfare have also seen their benefits reduced. ECB President Jean-Claude Trichet praises the efforts in Dublin as exemplary.

Throughout history, governments have often faced massive pressure to consolidate. It was the approach the United States took after World War II to eliminate its debt. But after years of deprivation, the Americans also had a lot of catching up to do, which translated into strong economic growth.

Uncomfortable Adjustments

Later on, European countries were repeatedly forced to balance their budgets. To do so, southern countries like Italy and Portugal generally increased their revenues, while northern nations like Denmark and Sweden preferred to reduce their expenditures, according to a new study by the Brussels-based Center for European Policy Studies.

In light of these examples, the task that now lies ahead for Greece is absolutely achievable, the authors conclude. Their only qualification is that "adjustments of this magnitude take time, typically at least five years."

For politicians, an austerity program is undoubtedly the most uncomfortable approach. "It's possible that we won't survive this," Irish Finance Minister Brian Lenihan concedes. Voters rarely reward efforts to save money, usually voting the politicians deemed responsible out of office instead.

This is why the second, supposedly pain-free strategy is so attractive to politicians: Confronting the mountain of debt with the help of inflation. In other words, governments simply print money.

Firing Up the Printing Presses

US President Barack Obama, in particular, is likely to be very tempted to fire up the money printing presses and, by devaluing the currency, to reduce the real burden of liabilities the United States has accumulated. Because foreign investors in China and Japan hold a large share of America's debts, they would be more adversely affected by depreciation than the Americans themselves.

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. For this reason, Paul Krugman, winner of the Nobel Prize in Economics, advised the president to try using the tool of inflation before raising taxes or cutting spending. His recipe for the crisis consists of "vigorous growth and moderate inflation."

In recent months, the American central bank, the Federal Reserve, has already availed itself of a modern version of printing money: It simply spent hundreds of billions of dollars to buy up government debt in the form of treasury bonds. The approach, known as quantitative easing, keeps returns and interest rates low.

The only question is when the Fed will flick the switch -- in other words, when and to what extent it will start re-collecting the money with which it has flooded the markets. If it doesn't do so, or does so only with hesitation, all the capital in the markets could stimulate demand to such a degree during the next recovery that prices would rise dramatically. If that happens, the debt would quietly be reduced through inflation. Savers and foreign investors, who would be partly expropriated, would be at the losing end of such an approach.

Spinning Out of Control

Besides, there are many hidden risks to this approach. Inflation is hard to manage and can easily spin out of control. Germany has had bitter experiences with out-of-control inflation in its history. In 1922 and 1923, an explosion in consumer prices ended in hyperinflation.

At the time, investors sought refuge in tangible assets: real estate, farmland and, most of all, precious metals. A similar trend is already taking shape today, as prices for gold and silver reach record highs.

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, 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

Article...
Comments
Discuss this issue with other readers!
5 total posts
Show all comments
Page 1
barryschatz 05/03/2010
1. Government does not expand output
"The economy has to grow, 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." Only private enterprise expands output. Government consumes output. Any money government manages to save (i.e., not consume) will be left in the hands of the private sector to expand output. Woolly assumptions like this one are largely responsible for the Greek tragedy and those which will shortly follow.
BTraven 05/05/2010
2.
Zitat von barryschatz"The economy has to grow, 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." Only private enterprise expands output. Government consumes output. Any money government manages to save (i.e., not consume) will be left in the hands of the private sector to expand output. Woolly assumptions like this one are largely responsible for the Greek tragedy and those which will shortly follow.
But in situations like now where enterprises and people do not want or are not capable of investing and spending money the government must do it for them. Saving money in the recession makes the situation worse.
barryschatz 05/08/2010
3.
Zitat von BTravenBut in situations like now where enterprises and people do not want or are not capable of investing and spending money the government must do it for them. Saving money in the recession makes the situation worse.
So where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
BTraven 05/11/2010
4.
Zitat von barryschatzSo where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
Fortunately, there is no rule which decisively says that a country overindebted therefore the psychological aspect decides whether a state can be regarded as trustworthy or not. In order to calm the markets the 3 percent rule was introduced. It seems, however, that nobody could imagine that such a rule could be an handicap since every violation will be interpreted distrustfully by analysts. And there is not even a paper which scientifically reasoned why we need such a rule. More tomorrow.
BTraven 05/11/2010
5.
Zitat von barryschatzSo where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
Concerning your example – despite the money central banks have printed to keep the economy running there is no inflation yet because ordinary people has not been given the money. The money provided have hardly reached normal consumers. I only know one measures where money was made available directly to customers – it is the car scrappage scheme. The "new money" circulates in the banking sector. As long as bankers do not speculate on raw materials I cannot see how they could cause an inflation.
Show all comments
Page 1

© SPIEGEL ONLINE 2010
All Rights Reserved
Reproduction only allowed with permission


TOP
Die Homepage wurde aktualisiert. Jetzt aufrufen.
Hinweis nicht mehr anzeigen.