Posted by: Dr Churchill | July 28, 2015

The Sovereign Debt Trap is upon all of us…

Today we are all sworn enemies of debt.

We are considering it evil and a precursor to national slavery.

But that is mainly misguided optimism because we have already fallen for it.

Yet what we have is a global debt trap.

The combination of high debt and low economic growth is inherently unstable.

There’s very little room to maneuver…

And if you think of what has befallen countries like Greece, Spain, Italy and Portugal — as runaway Austerity takes control, you can see Why.

Because if all the countries with high debts simultaneously tried to reduce them through sizable spending cuts and tax increases, the collective effect would be a calamity since worldwide consumer purchasing power would plunge, as we’ve seen in Greece.

On the other hand, slower economic growth makes it harder for countries to service their debts, which are still mounting. From 2007 to 2014, worldwide government debt rose $25 trillion or roughly three-quarters, according to the McKinsey Global Institute. It’s not clear how much longer these increases can continue, but even a mild effort to stanch them might founder on opposition from retirees and near-retirees.

Yet for the moment we are sailing along because what makes the debt burden bearable — is the low interest rates, engineered by markets and central banks (the Federal Reserve, European Central Bank and Bank of Japan).

But we all know that we are holding up with the skin of our teeth.

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So if, for any reason, interest rates rose sharply; or investor sentiment soured — the existing equilibrium could collapse overnight. All governments could face steeper interest costs…

And it happens often times with little if nay warning. Events can spook markets. Climate Change. Wars. Failure of Agreements. Failure to secure Peace Deals. Asteroid impacts. Black swan events. Whatever…

Investors might get spooked from fearful markets and they can sound the horn of retreat, raising the white flag and realizing the much feared losses on their portfolios of government bonds. THe Chinese are already liquidating vast amounts of US sovereign debt in the form of T-bills and long term bonds.


More governments will find it harder to borrow on private markets. Economic prospects would weaken. Country currencies will collapse.

And when the tide goes out the ones who swim without swimming trunks; will be seen by all for what they always were: Naked.

All this exists as a possibility for all countries apart from Greece and the other early victims of the changing tides.

Yet, as with Greece, and it’s calamitous Great Depression and the attendant Austerity — there are really no good choices left.

There are only the less bad, the really Bad, the terrible, and the worse ones. The range of bad choices and bad moves can be endless when you are so deep in the hole.

Yet rule number One is still on: “When in the hole — Stop digging.”

Greece hasn’t got that memo. Yet…

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Still for the rest of us that we know this story, the defining characteristic of the global economy is that many nations are simultaneously grappling with similar problems, and the solutions are similarly severely limited.

Mainly because there is no compensating pocket of economic strength to help weaker economies recover.

High debts are so worrisome that some experts suggest inflation as a solution, because inflating the economy diminishes the basic value of debt. Or some want to simply write them down…

As an example the article “Does Europe Need Debt Relief?” asks the question in a rather large way through the insider magazine of the “International Economy.”

But these proposals raise huge practical and philosophical questions. And the fact that they’re being discussed at all, is an accurate measure of acute anxiety.

Yet in the details of how to deal with all this — we have the Greeks to thank for an elementary tutorial in what ails the world economy today. Somehow the willy Greeks managed to get inadvertently in front of the 8 ball and keep on running towards the hole — never quite falling inside of it.

It’s an exhausting race against Time.

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And Time is the ultimate Arbitrer.

Because Greece’s central problem is that it has too much debt and no economic growth (none actually) to service the debt. The country is caught in an economic cul-de-sac. It can’t seem to generate growth without spending more or taxing less, which makes the debt worse, while its creditors demand that it controls its debt by spending less, devaluing it’s economy, and taxing more — which in turn undermines growth further.

See Rule Number One above: “When You are deep in the hole — First thing is to Stop digging.”

But we all know that things aren’t that easy…

Because if there was an easy exit from this dilemma, Greece would have found it and taken it — to get out of the hole.

But there isn’t one.

So it’s important now for us to recognize that Greece’s predicament, although extreme, is shared by many major countries, including the United States, Japan, France, the UK, and most large economies around the world and all of the other European nations.

So in an effort towards reducing or stabilizing their high debt levels; they encounter the same stubborn contradiction: The effort to curb debt through higher taxes or lower spending initially weakens economic growth, and weaker growth — aside from its social consequences — increases the debt drastically.

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When only a few countries are over-indebted; meaning that they cannot borrow from private markets at reasonable interest rates, this isn’t necessarily true. Countries can dampen domestic consumption and rely on export-led growth to take up the slack and limit unemployment. Nor is debt automatically bad. It has obvious productive uses: to fight severe recessions; to pay for wars and other emergencies; to finance public “investments” in infrastructure and services like roads, schools, research, and social net.

Unfortunately, this standard view of government debt — we’re not talking about household and business debt — does not fully apply now. The reason is that numerous countries face similar problems. That is too many countries are on the brink of debt collapse and that’s the distinctive feature of the current situation.

Just Consider the following three trends:

First, high debt levels are widespread. No one knows what debt level is “right.” It varies by country, and what’s “right” today could be “wrong” tomorrow if investors’ attitudes change about a country’s bonds. Regardless, today’s debt levels are historically high. In 2014, gross debt as a share of GDP was 132% for Italy, 246% for Japan, 95% for France, and 105% for the United States. This is from the reports of the International Monetary Fund (IMF).

Second, economic growth has slowed in many countries. This is important because faster growth — producing more tax revenues — helps countries service their debts. Slower growth does the opposite. From 1997 to 2006, U.S. economic growth averaged 3.3% annually, says the IMF; from 2010 to 2014, the average was 2.2%. For the euro zone (the countries using the euro), the figures are 2.3% and 0.6%. Even China has slowed down significantly.

Finally, most advanced societies have aging populations. Already, the 65-and-over population is 15 percent of the total in the United States, 22 percent in Germany, and 27 percent in Japan, says the Organization for Economic Cooperation and Development. As more people qualify for old age and health benefits, there is built-in pressure for higher government spending, translated into higher deficits, and growing debt.

Keynesian Economics, is a complex economic theory, but its central insight is simple enough: If every institution stops spending, economic activity will decline. Self-evident though this may be, this insight has eluded such global economic institutions as the International Monetary Fund, the European Union, as well as Europe’s economic hegemon, Germany, when dealing with the great 7 year depression that has devastated southern Europe, and Greece in particular.

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In confronting the economic crisis that began with the 2008 implosion of Wall Street, nations such as Greece and Spain were unable to bolster their economies by devaluing their currencies, which would have made their products more competitive. They didn’t have currencies of their own; they had the euro, over which they had no control. The other way they could have bolstered their economies, at a time when their banks and businesses were reeling and had no capacity to invest, was to follow the Keynesian course of having their governments invest more by enacting a stimulus, as our government did at the outset of Barack Obama’s presidency. But the European Union, steered by Germany, blocked that option by threatening to cut off credit and loans to southern Europe unless those governments enacted major cuts in spending. Austerity was enforced upon the cowed southern governments and weak parliaments, and that’s what the governments of Greece and Spain did — entering an unending vortex of greater depression and unemployment, leading to continuously greater debt and less stability, in turn leading to greater depression and so on…

So the German enforced Austerity led to cuts on all Social Services and government spending and all of the economic activity thus devaluing the Economy as a whole.

The counter-Keynesian “logic” behind these cuts was that, by injecting more fiscal discipline into their systems, these nations would improve their competitiveness and eventually [some day] they would return to prosperity in the long term.

The consequence of these cuts, however, has been exactly what the Keynesians predicted: With both private and public spending drying up, the economies of these nations tanked. And with Germany continuing to insist on even deeper cuts, their economies stayed tanked. Austerity in the long term will kill everybody.

Or as Keynes himself used to say: “It doesn’t really matter because in the long term we are all going to be dead anyway.”

Greece has now experienced seven years of 1929 style Great Depression, with one third of its high value workers long term unemployed, and all unemployment stuck above the 50% mark, and occasionally spiking up to 65% for the young people.

The situation in Spain hasn’t been much better.

Italy follows suit, and France isn’t far behind.

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Revolutions happen with far less unemployment and thus we are now on the throes of one…

Of course if you were to hear the talking heads they would say that they didn’t budget for that.

Apparently this outcome came as a surprise to the Troika that imposed the austerity regime — Germany, the EU, and the IMF, that had predicted that Greek unemployment would peak at 12% — but, preferring their pet theory and ideology, to reality — they insisted that more austerity would turn the economy around…

So here we are faced with more Austerity to solve a problem of our own creation.

A “Mea Culpa” hasn’t been heard from any official lips yet.

Only Pope Francis has come out forcefully in favour of ending the idiotic Austerity ideology of Europe but who is listening to a Franciscan Father?

Dr Kroko


What is to befall all of us if this is a premonition of things to come?

Things are wrong on very many and different levels.

Yet we persist on following through with our stupidities — austerity economics being the major one…

Even the IMF’s research department has done authoritative and interesting work on the effects of fiscal policy and Keynesian economics, demonstrating beyond any reasonable doubt that slashing spending in a depressed economy is a terrible mistake, and that attempts to reduce high levels of debt via austerity are self-defeating.

And the current reality of devastated EUrope bears them out fully.

But the German led Troika and the Gauleiters of the European economies of the South, have slashed spending and demanded crippling austerity from the Greek, Italian, and Spanish debtors anyway; and the results speak for themselves.

Meanwhile, in the United Kingdom and in these United States, Tories and Republicans respectively, have responded to the utter failure of free-market orthodoxy and the remarkably successful predictions of much-hated Keynesians by digging in even deeper, determined to learn nothing from experience.

Pope Francis’ advise isn’t helping on this side of the pond either.

So where do we go from here is anybody’s guess…

Care to venture an educated one?

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