Default or experience austerity then default
Default or experience austerity then default

There is something inevitable about feckless politicians being unwilling to tell the truth to their people. Perhaps even to confess it to themselves. No matter how much we may dislike reality, running from it is futile. Reality always wins, normally on the battle field.

Some problems become bigger if not addressed. No one likes being cut open, irradiated and injected with noxious substances. Yet many have opted for exactly that. As a consequence they have lived for many years more than they would otherwise.  Cancers tend to get worse over time if left untreated. Debt problems do as well. In an overly indebted society shifting excessive debt from one component of society to another does not solve the problem. The absolute magnitude is the problem. Shifting the debt around may mask the problem, and can delay the inevitable. But it does so at the cost of making the inevitable adjustment worse.

Interest accumulates on debt. New debt creates interest obligations. The principle has to be repaid. If the country has too much debt then shifting it around is akin to rearranging the deck chairs on the Titanic. Overly indebted consumers cut back on consumption. Overly indebted producers cut back on investment Overly indebted governments cut back on essential services and suck the life out of the other sectors of the economy. You do not want to become overly indebted as an individual or society. When you are there are no pleasant options. Politicians may seek to defer the pain, but it comes at the cost of the debt cancer growing and metastasizing or an inflationary destruction of price signals.

The optimal solution for a nation is not to become overly indebted.  A nation like an individual needs to keep an eye on the rate of growth of total debt to GDP. Having become overly indebted, the sooner one accepts the fact and sheds the excess debt the better. This means restructuring and defaulting, not borrowing more. Strangling consumption, investment and essential services to service the unserviceable simply puts off the default. It also devastates society and tries the patience of the people. In a democracy it greatly increases the chance of later slipping into anarchy or depression.

So what countries are overly indebted? In examining the following table of debt/GDP remember that with their level of debt, Greece defaulted:

Greek total debt/GDP was below the median. They defaulted before others because a high proportion of their debt is government debt and they have a cultural bias against paying taxes. Greece also do not have control of their currency and consequently can not just print money. Given the levels of total debt/GDP across the developed world as illustrated in the BIS table above, does anyone doubt others will follow?

There are historical precedents suggesting that sovereign defaults tend to be associated with many years of poor performance:

Having much of the Western world simultaneously in crisis can be expected to increase the effects compared to when problems are less widespread. The historical precedents could well be best case estimates given the extent of over indebtedness this time. The same applies to past great stagnations:

Decreases in absolute terms such as can be expected during depressions require proportionally greater increases to make good the loss:

The mathematics of loss followed by gain explains why it could be decades before we are as wealthy as we recently thought we were. Sadly much of the Western world has been living in the bezzle for years.

Our countries have been through experiences that are worse than an economic downturn. Our system need not lose legitimacy if it behaves in a legitimate way, even in a depression. But if the costs of the bust are put onto those who benefited least from the bubbles there could well be disorder. Defaulting on debt at the correct point, rather than when it has all been taken on by the government helps maintain the legitimacy of our system. Allowing vested interests to pass the losses onto government while keeping their gains undermines legitimacy, increasing the propensity to violent revolution.

Governments need to explain reality to their people, that they can’t meet their commitments, that they have been lied to. In effect eh Western social welfare state is a ponzi scheme and it is running out of new money. Printing money just disguises the problem for awhile at the cost of making it worse. But governments seem unable to explain reality to the people and implement sustainable policies:

Oops, German austerity fail: There’s an interesting article in Der Spiegel on Tuesday about how Germany has failed to reach its own austerity goals in 2011…

“SPIEGEL reports this week that the German government didn’t reach even half of its planned savings in the federal budget. Only 42 percent of the spending cuts named by Merkel’s coalition government, comprised of the conservative Christian Democrats and the business-friendly Free Democratic Party, were actually not implemented.”

Even the  Germans are having trouble implementing austerity. How do you think the likes of Spain and Italy will go? Governments should have been prepping their people and hording their treasure to assist those in real need during the times ahead. As for trying to avoid the issue through printing or borrowing more money, this needs to stop. Politicians need to start living the serenity prayer:

God, grant me the serenity to accept the things I cannot change, Courage to change the things I can, And wisdom to know the difference.

 



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