BACK TO MESOPOTAMIA THE LOOMING THREAT OF DEBT RESTRUCTURING PDF

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Subscriber Account active since. Which path will we take? If we could only grow our way out of our sovereign debt problems. But growing debt creates even more problems if not dealt with, making it even more difficult to deal with; yet getting the debt and deficit under control brings its own form of pain. As I keep pointing out, there are no easy choices left.

Some countries must choose between difficult and very bad, and others are faced with either disaster or calamity.

Greece simply gets to choose what it wants to be the cause of a depression. Long and slow or fast and deep? Choose wisely. It's that time of year when we start thinking about what the next may hold for us. I am reading and thinking a great deal about my annual forecast issue next week, taking some time off from my usual Friday missive; so this week we look at what I think is one of the best pieces of analysis I have read in the past few months.

It is from a private letter for the Boston Consulting Group, and Dan Stelter graciously allowed me to let my friends read it. Follow this thinking carefully and then think through their outline of what a country would have to do to leave the euro, which starts at the subhead entitled "What if…?

Then ask yourself what do you need to do. The short answer from me is that you need to consider more what you already own rather than what you should buy. At the end of the letter is a link to an in-depth review of what scenarios businesses should be considering, but it will also work for individual investors. Now, let me turn it over to Dan and David. This paper covers some familiar ground in order to remind readers of the interplay among the most important economic developments, considers the scenarios for which companies should prepare, and suggests some steps that prudent companies may wish to consider.

For those readers who are well acquainted with the economic scenarios described, we suggest that you start reading at "What Should Companies Do to Prepare? The economic travails of much of the West are reaching a decisive stage as the year ends.

In , we predicted sluggish recovery and a long period of low growth for the West in a two-speed world. This picture does not now properly reflect the downside risks. The policy of "kicking the can down the road" is failing, as the intensifying crisis in the euro zone and the failure of the G20 summit in late October clearly demonstrate. As to December's European summit, we describe its impact later in this paper. Such extreme uncertainty is challenging for companies trying to prepare their budgets for next year—or, more fundamentally, trying to plot their strategic course.

It helps to have a clear understanding of what may happen and why it may happen. So before we address the question of which scenarios to expect and how to prepare, let us remind ourselves about the root of the problem: the West is drowning in debt. Disaggregated and adjusted for inflation, these numbers mean that the debt of nonfinancial corporations increased by percent, the debt of governments increased by percent, and the debt of private households increased by percent.

But the costs of the West's aging populations are hidden in the official reporting. If we included the mounting costs of providing for the elderly, the debt level of most governments would be significantly higher. See Exhibit 1.

Add to this sobering picture the fact that the financial system is running at unprecedented leverage levels, and we can draw only one conclusion: the year credit boom has run its course.

The debt problem simply has to be addressed. There are four approaches to dealing with too much debt: saving and paying back, growing faster, debt restructuring and write-offs, and creating inflation. Saving and Paying Back. Could the West simply start saving and paying back its debt?

If too many debtors pursued this path at the same time, the ensuing reduction in consumption would lead to lower growth, higher unemployment, and correspondingly less income, making it more difficult for other debtors to save and pay back. This phenomenon, described by Irving Fisher in in The Debt-Deflation Theory of Great Depressions, can result in a deep and long recession, combined with falling prices deflation.

This is amplified when governments simultaneously pursue austerity policies—such as we see today in many European countries and will see in the U. A reduction in government spending by 1 percent of GDP leads to a reduction in consumption within two years of 0.

Saving or, more correctly, deleveraging will reduce growth, potentially trigger recession, and drive higher debt-to-GDP ratios—not lower debt levels.

Indeed , during the early years of the Great Depression, President Hoover—convinced that a balanced federal budget was crucial to restoring business confidence—cut government spending and raised taxes. In the face of a crashing economy, this only served to reduce consumer demand. For the private sector and government to reduce debt simultaneously would require running a trade surplus.

So long as surplus countries China, Japan, and Germany pursue export-led growth, it will be impossible for debtor countries to deleverage. Martin Wolf put it trenchantly in the Financial Times: "The Earth cannot, after all, hope to run current account surpluses with the people of Mars. Saving and paying back cannot work for 41 percent of the world economy at the same time. The emerging markets would have to import significantly more, which is unlikely to happen. Growing Faster. Historically, this has rarely been achieved, although it can be done—for example, in the U.

Attacking today's debt mountain would require reforming labor markets or investing more in capital stock. Neither is happening.

Politicians are unwilling to interfere in labor markets given today's elevated levels of unemployment. Moreover, empirical evidence shows that the initial impact of such reforms is negative, as job insecurity breeds lower consumption. Companies can afford to invest significantly more, as they are highly profitable. The share of U. GDP is at an all-time high of 13 percent as are cash holdings , yet corporate real net investment that is, investment less depreciation in capital stock in the third quarter of was back to levels.

But companies are reluctant to invest while demand is sluggish, while existing capacities are sufficient, and while the outlook for the world economy remains highly uncertain. The aging of Western societies will be a further drag on economic growth. By , the workforce in Western Europe will shrink 2. The inability to grow out of the problem is bad news for debtors. The current interest rate for new issues of ten-year bonds is 7 percent—up from 4.

If Italy had to pay 6 percent interest on its outstanding debt, such a high rate would materially increase the primary surplus that is, the current account surplus before interest expense that Italy would need to run in order to stabilize its debt level.

If we assume that Italy's economy grows at a nominal rate of 2 percent per year, the government would need to run a primary surplus of 4. Any effort to increase the primary surplus through austerity and tax increases runs the risk of creating a downward spiral. When investors start doubting the ability of the debtor to serve its obligations, interest rates rise even further, leading to a vicious circle of austerity, lower growth, and rising interest rates.

Debt in itself makes it more difficult to grow out of debt. Studies by Carmen Reinhardt and Kenneth Rogoff and the Bank for International Settlements show that once government debt reaches 90 percent of GDP, the real rate of economic growth is reduced. This also applies to the debt of nonfinancial corporations and private households. Exhibit 2 shows the current debt level of key economies by sector.

In all countries, the debt level of at least one sector is beyond the critical mark. Somewhat perversely, only in Greece are the two private sectors below the threshold. We argued that some governments might be tempted to fund this through a one-time wealth tax of 20 to 30 percent on all financial assets.

Given the unpopularity of such a tax, we are likely to see less incendiary taxes imposed. This means that politicians must resort to the last option: inflation. Another option to reduce Western debt loads would be financial repression—a situation in which the nominal interest rate is below the nominal growth rate of the economy for a sustained period of time.

In spite of today's low-interest-rate environment, we have the opposite situation: interest rates are higher than economic growth rates. As risk aversion in financial markets increases and a new recession in looms large, the problem could get even worse. So the only way to achieve higher nominal growth will be to generate higher inflation. Aggressive monetary easing has barely moved the inflation needle in the U.

Inflation is not being generated, because the expectation of inflation remains low and because there is still overcapacity and overindebtedness in the private and public sectors.

Continued monetary easing could and will lead to a substantial monetary overhang that could, if the public loses trust in money, lead to an inflationary bubble. Some argue that inflation is unlikely because of the oversupply of labor and continued competition from new market entrants like China.

Certainly we may see continued pressure on wages because of globalization, although the longer low growth persists in the West, the more likely it is that Western governments will resort to increased protectionism, leading to upward pressure on prices. Moreover, some observers believe that the inflation indicators do not give a true reading of the underlying rates of inflation.

It is also a matter of trust. Take, for example, the history of hyperinflation in Germany in the early s. The German Reichsbank funded the government with newly printed money for several years without causing inflation. But once the public lost trust in money, people started to spend it fast. This led to higher demand and an inflationary spiral. Today the velocity of money in the U. If the number of times a dollar circulates per year to make purchases returned to the long-term average of Some inflation is probably attractive to those seeking to reduce debt levels.

The problem is stopping the inflation genie once it has left the bottle. There are no easy solutions to the debt problem. At best, we expect a sustained period of low growth in the West. Even this would require the following:.

A coordinated effort to rebalance global trade flows, which would require the emerging markets, Germany, and Japan to import more, thereby allowing the debtor countries to earn the funds necessary to deleverage. Stabilizing the overstretched financial sector through recapitalization and slow de-risking and deleveraging—in contrast to today's new rules, which encourage banks to shrink their balance sheets rather than finance commercial activity it is worth noting that the effect of monetary easing during a period when ultra-low interest rates are below the rate of inflation is essentially to provide additional support to the banking system through the provision of low-cost liquidity.

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This is a story that should raise an eyebrow or two on every single face in Europe, and beyond. I saw the first bits of it on a Belgian site named Express. Looks like they just need to figure out by how much. Such debt levels are unprecedented, other than right after the world wars.

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Another POMO desk war casualty. I feel sorry for them because they were clear, and they were brave to say what they said. In a pre-whatever-it-takes world, it was a truism. They excel at that. In point of fact, they are the front-runner for something that will spread faster than Ebola. Such a course of action would not be new. In ancient Mesopotamia, debt was commonplace; individual debts were recorded on clay tablets.

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