Greece, Italy and the Euro

John Creighto

Maybe but who decided that above 90% debt to GDP was a dangerous situation. I read somewhere else that 120% debt to GDP was sustainable. Japan was even able to sustain a higher debt to GDP then Greece but Japan has control over it's currency. What debt levels are sustainable is partly driven by Germany's fear of inflation
http://www.americanfuture.net/2011/1...yperinflation/



Interesting math but while 3+1 doesn't equal 7 part of the interest on the debt is paid of course from tax revenue. As to weather the debt is sustainable I have no opinion on this yet but here is what the German presendent of the Bundesbank Juegan Stark has to say:
"JW: You are rushing to conclusions in saying that the interest rate levels are unsustainable. Of course this level may not be sustainable in the long run if there is a lack of fiscal discipline and economic growth remains low. But in the short run I do not think it is such a big an issue. What we are facing in Italy is an acute confidence crisis, and only the Italian government can resolve that crisis by implementing what has been announced. Italy is very different from Greece in a lot of respects. I’m confident that Italy will be able to deliver."

http://www.americanfuture.net/2011/1...f-last-resort/

MarcoD

I always find the currency argument a bit silly. When it comes to government debt, there is no difference between a haircut, and devaluation of sovereign issued money. There is also no difference between lowering (government) wages and deflation of a currency. All in all, it doesn't matter. Most of the news about breaking up the Euro therefor is completely nonsensical. It'll only blow up a southern economy since they then need to invest in new IT, don't have access to the European market, and don't have access to European development funds.

The difference between northern and southern Europe is production and wealth; some of the southern European countries gambled on that they could grow their economies to compete with the north. Government debt isn't everything, I think if you look at private ownership of investments and banks, the truth -I expect- is that some of these economies (Portugal/Greece) just found out that they can't compete [at least not in the timeframe they thought they could], and now the north simply owns them. That's the real problem since there is no way out of that except for reforming the economies to make them competitive.

Maybe the only way out for Europe is to just implement a federal European army which mostly hires from the poor parts of the south. That manner the rich parts can send loads of money without anybody feeling bad about it.

(Then again, after the army we would need to start a war with, say, Iran, to defend the federal defense budget. And who would want that??? )

(Anyway, I estimate that Japan, like Germany, still has a trade surplus, so they are hoarding cash and buying up the rest of the world. Likewise, the US can run a large deficit since, as the world's reserve currency, more money doesn't drive government bond interest up, but down. What do the Greeks have?)

John Creighto

I did mean deflation. But I meant asset deflation through deleveraging not CPI deflation. The money has to to go somewhere, and if all assets are losing value than cash may be a safe place to keep ones savings. However, after rethinking it why not just stock pile cash if deflation is a fear? So perhaps the nominal risk free rate of return can't fall below zero percent. However, hording currency is illegal and one could still be robbed so perhaps even hording currency isn't risk free.

So even though deflation can help favor currency valued assets like low risk debt it is also true that inflation can reduce real debt. However, unless people have a way of making more than inflation on their investments, assets which yield less then inflation will not be attractive. Banks find government debt attractive at low yields only because they are able to borrow at cheaper then inflation and able to borrow at many multiples of their net worth. They are able to do this because of both governments insures depositors and central banks providing liquidity when needed. This is effectively a subsidy of the banking system.

John Creighto

This is true in some sense but one approach is much more gradual and politically palatable. There are also some technical differences which I'll discuss elsewhere.

Is there sort of a prisoners dilemma going on here. Everyone knows they can benefit from the European Union but everyone is looking for the most advantageous terms.

MarcoD

I think it's the growing pains of a union. Personally, I am not even that opposed to the current debacle, it forces the weak economies to restructure, and the debt position overall of Europe certainly doesn't seem worse in comparison to the US's.

I don't even like the idea of European bonds. I mean, to do what with them? Raise the overall government debt to 100%? A system in which debt is locally held, and in check with market forces, seems more robust in the long term.

The risk, of course, is that the whole of Europe may blow up... But I am gambling on the fact that there still is loads of money going round in most of northern Europe.

MarcoD

Hmm, this is the difference between historical financial fears of the US and Germany right? The US fear deflation, and the Germans fear inflation. The current rate of inflation in Europe was, last I heard, still in the 2%-3% range. I doubt deflation will be a problem anytime soon, but I may be mistaken.

(Anyway, wouldn't people buy government debt -certainly if it goes at 7%- if deflation is a problem?

To be honest, I am not an economist, and not from the US. I don't even understand the problems of deflation that well, seems it just isn't in my historical genes. Weird uh?)

MarcoD

Numbers are by Bloomberg, well, kind off.

Vanadium 50

Of course there is. A default affects those people who are holding bonds. A devaluation affects those people who are holding (or will be holding) cash.

MarcoD

Yeah, that's true, which is why I said: "When it comes to government debt, ...".

(Anyway, let's say Greece or Italy step out of the Euro. There is little to no chance that their external debt will be redefined it lires or drachmes - all creditors will want it in Euros. So leaving the Euro is hardly an option for them: they'll have external debt which will grow if they devalue their currency, their own assets evaporate, and the only good thing is that devaluing would help their export position but they'll have less export to Europe since their currency will be deemed unstable. There really doesn't seem any benefit to either the creditor or the debtor.)

AlephZero

I'm still not quite sure what John Creighto means by "deflation", but the standard defintion is usually a good way to start a depression, because when prices are falling there is no incentive for anybody to buy stuff they don't actually need right now. Why buy something today for $100, if you know can buy it tomorrow for $99 or next year for $90?

AlephZero

And in the long term, increased tax revenue comes from increased economic activity. QED.

Of course you can try to "screw the 1%" as a short term measure, but the likely result will be they just move themselves and their wealth to some place else.

MarcoD

Yeah, I think I got it, and I think I understand the liquidity trap now. There doesn't seem to be a real danger for that, at the moment.

Back to that Bloomberg report. Anybody else got the feeling that this is a great time to be a banker, and -provided banks don't blow up- (inter-)national banks are soon swimming in GIIPS cash?

AlephZero

A summary of "who owes what to whom": http://www.bbc.co.uk/news/business-15748696

MarcoD

Either I am an idiot, or financial markets are. I mean seriously, Spain has an ok-ish public, and a large private debt, which is owned by the UK. That's probably mostly housing, which is worth exactly nada since their housing bubble collapsed. Who has the problem? If anyone is bankrupt, it's the UK's financial sector. But the Spanish are paying an enormous interest???

But I guess I am the idiot.

DoggerDan

The 95% of countries who don't share in the miseries of the 5%?

AlephZero

Spain not only has an economic depression caused by the property bubble collapse, but also some insanely protectionist employment laws. Employers are requred to give up to 5 years notice of redundancies, or keep paying people their full salary for doing nothing for that length of time.

The consequence is that no Spanish company has much interest in hiring new employees (hence youth unemployment is about 50%, and rising) and certainly no new startup company is going to base itself in Spain if there is an alternative option.

Financial markets work on the basis of predicting the future, not just on the current situation.

MarcoD

Yeah, I know that. Housing bubble, expensive healthcare, lots of workers protection rights, large (youth) unemployment.

But that doesn't change the fact that the public debt is low, and that the (bad) private debt is probably owned by the UK. The country itself shouldn't have a fiscal, liquidity or solvency problem but only a structural problem, and the way to deal with that is mostly a political issue.

I mean, this is a scenario where some small Spanish banks will topple, private debt will be restructured, both at the expense of the UK, and Spain will be left with low public debt and a slow economy. That's not a bad position to end up with.

I don't know the cost of bailing out (the clients of) bad banks though.

(I really have the feeling that in this case, high Spanish interest rates are the by product of bad financial news from the UK which wants its investments to pay off, moreover, also dominate the international financial media. I can understand that a US firm went bust on this one, Spanish debt is okay but media coverage is 'irrational' about the situation.)