Sunday, July 18, 2010

The Debt Supercycle and the End Game

...And yet, and yet… While the Debt Supercycle may not yet have ended, I think we can begin to see a clear case that, like the sandwich-board-wearing cartoon prophet warning, “The End is Nigh!” Greece is the harbinger of fundamental change. Spain and Portugal are pointing to the same outcome, as their cost of debt keeps rising. And Ireland? The Baltics?

There is a limit to how much debt you can pile on. But as the work of Reinhart and Rogoff points out (This Time Is Different), there is not a fixed limit or some certain percentage of GNP. Rather, the limit is all about confidence, a theme I have written on many times. Everything goes along well, and then “Boom!” it doesn’t. That “Boom” has happened to Greece. Without massive assistance, Greek debt would be unmarketable. Default would be inevitable. (I still think it is!)

The limit is different for every nation. For Russia in the 1990s, it was a rather minor total debt-to-GDP ratio of around 12%. Japan will soon have a debt-to-GDP ratio of 230%! The difference? Local savers bought government debt in Japan and did not in Russia.

The end of the Debt Supercycle does not have to mean calamity for each country, depending on how far down the road they are. Yes, if you are Greece your choices are between very, very bad and disastrous. Japan is a bug in search of a windshield. Each country has its own dynamics.

Take the US. We are some ways off from the end. We have time to adjust. But let’s be under no illusions, we cannot run deficits of 10% of GDP forever. At some point the Fed will either have to monetize the debt or the bond market will simply demand an ever-higher interest rate. Why can’t we go the way of Japan? Because we do not have the level of savings they have traditionally had. But their savings levels are rapidly declining, which says that if they want to continue their deficit spending at 10% of GDP, they will have to go into the foreign markets to borrow money at a much higher cost, or their central bank will have to print money. Neither choice is good.
Read the rest of this excellent piece here.

1 comment: said...

The real question for me is this, "What does this mean?"

People talk about "The End" I think of something worse than Germany pre-WWII. I think of going to the grocery store and there being no food on the shelves or turning the light switch on and having no electricity or freeways collapsing from disrepair. I think of Mexico-eque (which is now looking more like Columbia) breakdown in social order.

Right now, what I've seen from "The End" is that we all have less stuff (most of which we didn't need) and some of us are experiencing class failure (falling from middle to lower class). Certainly we who are only wincing from this economic disaster should help the bleeding. And for those families the word "disaster" has a more substantial meaning.

But "The End" didn't happen in Japan in the lost decade. And from what is sounds like in Greece the worst thing is waiting until 65 to retire like the rest of the world (none of which should have retirement outside of disability, imho).

I need to reconcile the very real economic problems of millions of people, and the hyperbolic rhetoric about something we can only dream of calling "disaster".