Us And Uk On Brink Of Debt Disaster

[Injin]

http://economictimes.indiatimes.com/News/I...how/4004567.cms

LONDON: The United States and the United Kingdom stand on the brink of the largest debt crisis in history.

While both governments experiment with quantitative easing, bad banks to absorb non-performing loans, and state guarantees to restart bank lending, the only real way out is some combination of widespread corporate default, debt write-downs and inflation to reduce the burden of debt to more manageable levels. Everything else is window-dressing.

To understand the scale of the problem, and why it leaves so few options for policymakers, which shows the growth in the real economy (measured by nominal GDP) and the financial sector (measured by total credit market instruments outstanding) since 1952.

In 1952, the United States was emerging from the Second World War and the conflict in Korea with a strong economy, and fairly low debt, split between a relatively large government debt (amounting to 68 percent of GDP) and a relatively small private sector one (just 60 percent of GDP).

Over the next 23 years, the volume of debt increased, but the rise was broadly in line with growth in the rest of the economy, so the overall ratio of total debts to GDP changed little, from 128 percent in 1952 to 155 percent in 1975.

The only real change was in the composition. Private debts increased (7.8 times) more rapidly than public ones (1.5 times). As a result, there was a marked shift in the debt stock from public debt (just 37 percent of GDP in 1975) toward private sector obligations (117 percent). But this was not unusual. It should be seen as a return to more normal patterns of debt issuance after the wartime period in which the government commandeered resources for the war effort and rationed borrowing by the private sector.

From the 1970s onward, however, the economy has undergone two profound structural shifts. First, the economy as a whole has become much more indebted. Output rose eight times between 1975 and 2007. But the total volume of debt rose a staggering 20 times, more than twice as fast. The total debt-to-GDP ratio surged from 155 percent to 355 percent.

Second, almost all this extra debt has come from the private sector. Despite acres of newsprint devoted to the federal budget deficit over the last thirty years, public debt at all levels has risen only 11.5 times since 1975. This is slightly faster than the eight-fold increase in nominal GDP over the same period, but government debt has still only risen from 37 percent of GDP to 52 percent.

Instead, the real debt explosion has come from the private sector. Private debt outstanding has risen an enormous 22 times, three times faster than the economy as a whole, and fast enough to take the ratio of private debt to GDP from 117 percent to 303 percent in a little over thirty years.

For the most part, policymakers have been comfortable with rising private debt levels. Officials have cited a wide range of reasons why the economy can safely operate with much higher levels of debt than before, including improvements in macroeconomic management that have muted the business cycle and led to lower inflation and interest rates. But there is a suspicion that tolerance for private rather than public sector debt simply reflected an ideological preference.

The resulting debt was only sustainable so long as economic conditions remained extremely favorable. The sheer volume of private-sector obligations the economy was carrying implied an increasing vulnerability to any shock that changed the terms on which financing was available, or altered the underlying GDP cash flows.

The proximate trigger of the debt crisis was the deterioration in lending standards and rise in default rates on subprime mortgage loans. But the widening divergence revealed in the charts suggests a crisis had become inevitable sooner or later. If not subprime lending, there would have been some other trigger.

WRONGHEADED POLICIES

The charts strongly suggest the necessary condition for resolving the debt crisis is a reduction in the outstanding volume of debt, an increase in nominal GDP, or some combination of the two, to reduce the debt-to-GDP ratio to a more sustainable level.

From this perspective, it is clear many of the existing policies being pursued in the United States and the United Kingdom will not resolve the crisis because they do not lower the debt ratio.

[b]In particular, having governments buy distressed assets from the banks, or provide loan guarantees, is not an effective solution. It does not reduce the volume of debt, or force recognition of losses. It merely re-denominates private sector obligations to be met by households and firms as public ones to be met by the taxpayer.[/b]

This type of debt swap would make sense if the problem was liquidity rather than solvency. But in current circumstances, taxpayers are being asked to shoulder some or all of the cost of defaults, rather than provide a temporarily liquidity bridge.

In some ways, government is better placed to absorb losses than individual banks and investors, because it can spread them across a larger base of taxpayers. But in the current crisis, the volume of debts that potentially need to be refinanced is so large it will stretch even the tax and debt-raising resources of the state, and risks crowding out other spending.

Trying to cut debt by reducing consumption and investment, lowering wages, boosting saving and paying down debt out of current income is unlikely to be effective either. The resulting retrenchment would lead to sharp falls in both real output and the price level, depressing nominal GDP. Government retrenchment simply intensified the depression during the early 1930s. Private sector retrenchment and wage cuts will do the same in the 2000s.

BANKRUPTCY OR INFLATION

The solution must be some combination of policies to reduce the level of debt or raise nominal GDP. The simplest way to reduce debt is through bankruptcy, in which some or all of debts are deemed unrecoverable and are simply extinguished, ceasing to exist.

Bankruptcy would ensure the cost of resolving the debt crisis falls where it belongs. Investor portfolios and pension funds would take a severe but one-time hit. Healthy businesses would survive, minus the encumbrance of debt.

But widespread bankruptcies are probably socially and politically unacceptable. The alternative is some mechanism for refinancing debt on terms which are more favorable to borrowers (replacing short term debt at higher rates with longer-dated paper at lower ones).

The final option is to raise nominal GDP so it becomes easier to finance debt payments from augmented cashflow. But counter-cyclical policies to sustain GDP will not be enough. Governments in both the United States and the United Kingdom need to raise nominal GDP and debt-service capacity, not simply sustain it.

There is not much government can do to accelerate the real rate of growth. The remaining option is to tolerate, even encourage, a faster rate of inflation to improve debt-service capacity. Even more than debt nationalization, inflation is the ultimate way to spread the costs of debt workout across the widest possible section of the population.

The need to work down real debt and boost cash flow provides the motive, while the massive liquidity injections into the financial system provide the means. The stage is set for a long period of slow growth as debts are worked down and a rise in inflation in the medium term.

Hyperinlfationary depression. Fun.

[ImA20SomethingGetMeOutOfHere]

While both governments experiment with quantitative easing, bad banks to absorb non-performing loans, and state guarantees to restart bank lending, the only real way out is some combination of widespread corporate default, debt write-downs and inflation to reduce the burden of debt to more manageable levels. Everything else is window-dressing.

I think this is probably correct. To actually pay this off would take every penny we earned for four and a half years.

[mdman]

How exactly would a 'bad bank' work?

Non-performing loans should not be hidden - they should be exposed, with those holding such assets declared bankrupt if need be and their creditors forced to take haircuts

[GregG]

I don't understand the downside of defaulting.

Russia defaulted in the late 1990s. Couple of years of "pain" but investors were soon investing again. By the time I moved there 2002-2003 it was all water under the bridge and prices/wages were on par with London.

Once banks and investors smell a profit and new growth (green shoots) they don't give a shit who you screwed over a few years before.

In the case of the USA they are FAR too big to not trade with. So if they tell the Asians and Arabs can't pay, won't pay, on their debts what is the worst that can happen?

Same with big businessmen. You default on your mortgage and you won't get credit for 10-15 years. Alan Sugar defaults on £1b of debt and they'll be financing some new money spinner idea within 1 year to 18 months.

[ImA20SomethingGetMeOutOfHere]

How exactly would a 'bad bank' work?

Non-performing loans should not be hidden - they should be exposed, with those holding such assets declared bankrupt if need be and their creditors forced to take haircuts

The basic idea AFAIK if that the government should buy all the shit off of the banks and then pile it all up in one place - the so-called bad bank. This would involve massive expense for the taxpayer up front but the hope would be that over time most of that could be recouped as the well performing bits of the bad debt get repaid. The other problem is exactly how much the taxpayer should actually pay for these "assets". Some of them are nearly worthless at current market value and buying them at this price would not really help the banks.

[shindigger]

http://economictimes.indiatimes.com/News/I...how/4004567.cms

Hyperinlfationary depression. Fun.

Have you got a solar panel for your new PC?

[Injin]

I don't understand the downside of defaulting.

It's a loss of control over people. I think that's why they won't do it. To free half the country from their mortgages would mean that a lot of people would be much harder to bully around, coerce into the military and so on. People stand up for their rights when they are secure financially a lot more.

Russia defaulted in the late 1990s. Couple of years of "pain" but investors were soon investing again. By the time I moved there 2002-2003 it was all water under the bridge and prices/wages were on par with London.

Once banks and investors smell a profit and new growth (green shoots) they don't give a shit who you screwed over a few years before.

In the case of the USA they are FAR too big to not trade with. So if they tell the Asians and Arabs can't pay, won't pay, on their debts what is the worst that can happen?

Same with big businessmen. You default on your mortgage and you won't get credit for 10-15 years. Alan Sugar defaults on £1b of debt and they'll be financing some new money spinner idea within 1 year to 18 months.

While "Russia" might have defaulted, all the people who run the government are no changed and some of the old guard are in jail etc It's not wuite the painless process you paint it as for the individuals involved.

I'm fairly certain the Gordon brown isn't looking forward to a lifetime of being attacked by strangers and being spat at in public, which is what will happen at the minimum to him post collapse. He'd much rather stay in power and get a hefty level of protection.

[Injin]

Have you got a solar panel for your new PC?

It's powered by my own arrogant carelessness, so it's got a half life of about 12,600 years.

[shindigger]

It's powered by my own arrogant carelessness, so it's got a half life of about 12,600 years.