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Spanish Debt, the European Central Bank, and the Maginot Line

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Thursday, 10 May 2012 04:54

The NYT had an article that reports on the high level of corporate debt and indebtedness in general in Spain. The article gives a measure of the total debt to GDP in Spain and then compares it to the ratios in other countries.

This is a confused way to assess the issue. Debt by itself will reveal nothing about the state of an economy. Debt is also an asset.

Suppose every household in the United States lent $300,000 to the household on its left. (We are going to make the United States a circle for purposes of this analysis.) With roughly 130 million households, the United States now has $39 trillion (@ 2.6 times GDP) more debt than it did previously.

However, as a country it is no poorer than it had been previously. In fact, every household is just as well off as it had been previously. It owes $300,000 more than it had previously, but it has $300,000 more in assets than it had previously.

Problems arise due to the distribution of the debt. If every third household borrowed $600,000, which was lent by the other two households, then this third household is getting deep in debt, with the other two are appearing to build up large amounts of assets.

This is what happened to Spain, the United States and other countries with serious housing bubbles. The other two households were willing to lend money to the third household because they thought it held an asset (a house) of great value. When this turned out not to be true, the third household found itself with an unsustainable debt burden and the other two households found themselves with assets of questionable value. If the third household can't repay its debt, then the loans are no longer worth their face value.

Central banks should be paying attention to the buildup of such unsustainable debt burdens. Unfortunately, the European Central Bank (ECB) was focused on building up its Maginot Line, being vigilant in its fight against inflation.

The problem now is to try to correct the imbalances created by growth of the housing bubble. Spain and the rest of Europe is getting little help from ECB which is still focused on reinforcing the Maginot Line rather than promoting growth in the euro zone.

Comments (20)Add Comment
...
written by AndyfromTucson, May 10, 2012 8:50
The military typically prepares itself to win the last war, and as a result they run into trouble when the next war is different. I guess central banks are the same way. The last major economic trauma before this was the inflation of the 1970s, and the Fed and the ECB are fixated on being able to beat it if it happens again.
excellent explanation
written by fairleft, May 10, 2012 9:58
Dean's 'no fear' explanation of debt is the clearest I've ever read.
bullseye
written by Peter K., May 10, 2012 10:35
Yes, the problem I have with the MMT-monetary mystic commenters is that they seem to believe all debt is bad.
...
written by anon, May 10, 2012 12:34
Dean, could you explain how a trade deficit might effect this?

You said before that a trade deficit means either a large budget deficit or a private sector deficit (or decreased savings).

If a country has a large trade deficit and a small budget deficit, what would this look like? You seem to be saying this is sustainable so long as the underlying assets are valued correctly.


It seems that inequality might effect this too, if interest income is not spent back into the economy then there would be more people defaulting of their debt.
debt, the fed & the mess we are in
written by mel in oregon, May 10, 2012 12:38
there are 2 issues i agree with ron paul on. everything else he says i disagree. 1. cutting the military budget & bringing the troups home, & ceasing invading countries when the always main reason is to make money for corporations that make their money from war. 2. abolish the fed. there are a number of reasons that rational, well informed folks can make to keep the fed. however i & many other people can give the number 1 reason to get rid of it. that is, it is corrupt beyond belief. it has no function except to protect the very wealthy financial enterprises & their beneficiaries in their gated communities. you can see with bernanke, greenspan & even volker, that the conscious effort to transfer money from the poor & middle class to the wealthy is the fed's sole function. they care nothing about unemployment or the misery they are meting out to the non wealthy.
http://ralphanomics.blogspot.co.uk/
written by Ralph Musgrave, May 10, 2012 1:10

Any central banker who had attempted to restrain borrowing and lending during the boom prior to the credit crunch would have been torn to shreds by politicians (backed by millions of dollars worth of lobbying and propaganda from the Wall Streets of this world). Thus there are problems in expecting central banks to restrain irresponsible borrowing and lending.

Moreover, it wasn’t obvious even to most impartial observers prior to the crunch than anything was wrong. How many economists predicted the crunch? One percent?

I suggest the main problem is how to counteract the reduced spending or demand emanating from the debtors and creditors who are in trouble. And that’s easy: just have government / central bank bump up demand.

As for irresponsible debtors and creditors they won’t make the same mistake for ten or fifteen years. Then, sure as night follows day, they WILL make the same mistake again.


...
written by skeptonomist, May 10, 2012 3:52
The rather foggy NYT article is not clear about how much of Spain's public and private debt is owned by foreigners, but it gives some anecdotal hints: "Credit Suisse, in a recent report, warned that 48 percent of the company’s cash flow comes from various Spain-related infrastructure projects." It also talks about Southeastern Asset Management, a US investment company which is heavily into ACS, the Spanish company which is the main subject. Didn't a lot of money for the housing boom come from out of Spain?
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written by skeptonomist, May 10, 2012 4:06
The debt situation in Spain is complex. Apparently the government is now bailing out banks which are overloaded with bad housing debt:

http://uk.reuters.com/article/2012/05/08/uk-spain-banks-idUKBRE8470UF20120508

In so doing the government is breaking its previous promises. So it looks like private debt is being transferred to national debt, and now the ECB must back up the Spanish government debt.
...
written by Calgacus, May 10, 2012 5:22
Peter K: Yes, the problem I have with the MMT-monetary mystic commenters is that they seem to believe all debt is bad.
Huh? As the most prolific "MMT-monetary mystic" commenter here at Beat the Press - huh? Money is debt. It is very good to have a debt owed you. It can be less good to owe a debt. The nicest kind of debt to have owed you is called "money", government money, cash. Debt problems are precisely as Dean explains. Excessive private debt can be a problem. But government debt never is in a normal country.

Anon: If a country has a large trade deficit and a small budget deficit, what would this look like? You seem to be saying this is sustainable so long as the underlying assets are valued correctly.

This situation is essentially the country exporting more dollar bills than it is printing. Safe, domestically held government debt is going down, so for GDP to be maintained, private debt has to be skyrocketing. This is the late 90s, Clinton Surplus USA. Very dangerous, and not sustainable.
Shredding
written by David, May 10, 2012 10:14
" Any central banker who had attempted to restrain borrowing and lending during the boom prior to the credit crunch would have been torn to shreds by politicians " says Ralph, but that's the board of directors, and shareholders, that were threatening to shred. Why would bankers be afraid of politicians, when the former own the latter?
...
written by liberal, May 11, 2012 8:25
skeptonomist wrote,
In so doing the government is breaking its previous promises.


What previous promises? (A query, not a challenge.) To the ECB? Or to the populace?

Are they handing money over to the bank(s) that they're not required to (by law or treaty)?

Best,

L
Land bubble
written by Matt, May 11, 2012 12:02
Land bubble.
Shame on you for that bogus strawman!
written by Wisdom Seeker, May 11, 2012 7:20
"Debt by itself will reveal nothing about the state of an economy. Debt is also an asset."

Hmm, then why is it that high debt/GDP ratios are tightly correlated with economic trouble?

The problem is that debt is NEVER evenly distributed (as your strawman example supposes). A strawman that never happens is an evil debating construct. Frankly, you should be ashamed of yourself.

In reality, debt "assets" are overwhelmingly held by the wealthy while the burden of the debt is held by those who are poorer. There is a point beyond which marginal borrowing is malinvested. So the end result of ever-higher debt is that "asset holders" (lenders) are paid more and more, and need not do anything useful or productive, on the one hand. And on the other hand, debtors (borrowers) have to pay interest (as well as principal) to the lenders, so the borrowers have less income with which to consume and less ability to accumulate real capital.

So, in the high-debt limit, both sides of the equation reduce overall production and therefore per-capita prosperity. (But it's nice to be a lender and not a debtor in such a world... at least until the borrowers become unable to pay you back with reasonable interest...)
...
written by Joe Emersberger, May 12, 2012 11:44
wisdom seeker wrote

"Hmm, then why is it that high debt/GDP ratios are tightly correlated with economic trouble? "

That's clearly false. Japan's public debt to GDP ratio is way higher higher than Greece's. Japan is not in a debt crisis at all but Greece is.

http://www.tradingeconomics.com/government-debt-to-gdp-list-by-country

Even if you consider private and public debt combined relative to GDP, that may or may not be indicative of trouble. One of the key questions that must be asked is "what is money being being borrowed for?".

In the USA, much like in EU, huge debts were accumualted for specualtive purposes based on dumb assumptions about aseet bubbles (most recently in real estate) being sustainable.

As for the distribution of debt, that, again, depends on what exactly is being borrowed for (and from whom and at what interest rate). After WWII, the USA and other rich countries had built up massive debts with very different outcomes for growth (and distribution) compared to the debts run up during the recent bubble years.








Yeah but the solutions around here...
written by James, May 14, 2012 1:34
Why don't you beat up your buddy Krugman? The solutions to the debt problem, he keeps asking for, is providing more debt.

How does that help? If household number three got in over it's head and was blowing the money on expensive vacations, premium vehicles and other toys; the solution is for the rich bankers to give that guy another loan? Which is paid for out of household two and three's losing out to inflation. Not to mention devaluing their income.

Meanwhile, me in household 4, can't afford a place because you keep devaluing my income so i don't have any discretionary funds or accumulated savings.

Then bailing out Mr Banker to keep making big loans... exponentially increasing debt load promoting stupid activity while gouging the productive.

We keep an eye on the debt to GDP because it means something about future valuations of the debt and it is a social comment on the value of the activity of those societies.
Debt is the only possible solution to a debt problem
written by Calgacus, May 14, 2012 4:38
James: The solutions to the debt problem, he keeps asking for, is providing more debt. This is true, because it is the only possible solution. The only solution that the human mind can conceive. The only thing that fits into its categories of understanding a la Kant. If you don't understand this, you don't understand how simple it all is. How can one pay off a debt but with a debt going the other way, or something that can & should be interpreted as that?

The best way to pay off a debt in a modern monetary economy is with cash. Government money = government debt. The biggest piece of modern stupidity is making a crazy distinction between government bonds & government money. As FDR said to the nation, they are one & the same thing. More understanding of economics there than the whole Harvard & Chicago "Economics" departments put together.

If household number three got in over it's head The answer is the FDR / New Deal / WPA / JG answer. Give the guy who needs money a guaranteed government job. Have him pay his debts with cash money = government debt, not by a new loan that makes them even more unpayable.

Sure, debt/gdp means something. Just not very much. Ratio of private debt / public debt means more. And the maximally moronic mainstream as usual gets it backwards. Consistent with Joe's reply to Wisdom Seeker above, very grosso modo, high public debt / GDP = lotsa hard, stable money out there = good. High private debt / GDP or private/public debt = bad, unstable = what we had in 1929 or just before the GFC. Private debt is the disease, public debt = money - in the hands of the ordinary guy & gal - the cure.
...
written by James, May 14, 2012 6:15
@Calgacus,

It is the banana republic solution. Basically the debt is so large that normal velocity of money isn't high enough to pay it down. So, you have to keep running larger and larger deficits at an exponentially growing rate to sustain growth.

Feedback mechanisms would be the bond markets anticipating devaluation, see the Euro. So a yield spike causes more money to flow into debt service. Again, you can cause growth with mild inflation, but run away inflation coupled with large amounts of entitlement growth will actually push larger swaths of the economy into the gray or underground market.

Not to mention it has the government picking winners. The household that over spends, winner. Unsustainable and rather silly Green businesses, winner. GM, union interest, winner. That is an ever larger interventionist market, not to mention the Japan problem with bridges to nowhere and other malinvestments. Eventually trade dies away because no one takes your currency seriously anymore.

If the only solution is much higher debt growth, and not market solutions like bankruptcy and write downs; then we are finished as a free society.

I guess, given Dean's nature, I should point out the long standing history of socialist Utopia's. We are talking about social collapse after social collapse and financial collapse after financial collapse. Don't you silly progressives have any sense of history? Soviet collapse of only 20 years ago?

I would guess part of the world economic bubble occurred primarily because of all the new money printing in Europe with a "fresh start" a smile and saying "it's different this time" they started to march off the same cliff.

It's all about deciding who takes the losses at this point. Obama and his cronies have been sucking up the bad debt. At what point do they intervene with the Fed and force more base currency printing? Who bares the bulk of that devaluation? The bondholders or the rapidly being crushed middle class? It's probably all academic at this point.

It is unsustainable. Just a question of when the collapse occurs and how much suffering the PTB decide to inflict.
...
written by Calgacus, May 15, 2012 6:22
James, No. It, the "banana republic solution" is essentially the only solution - if you want, you can call writedowns a distinct solution. They are the only possible ones. Pay a debt with another debt, or discount/default it. Of course, I am for bankruptcies & writedowns of truly unpayable debts- frequently fraudulent - and the destruction of most of the financial sector, the resolution of the TBTF banks. But these are private debts - the problem. Government debt = money is the solution. Only problem is demand-driven inflation, which has zero probability. The US would have to print a hell of a lot more money, run much bigger deficits than the recent chump change ones to generate inflation.

I was speaking at a philosophical level. This is appropriate because the main problems in today's "economics" are philosophical, cognitive, psychological, logical, metaphysical. At the heart of modern nonsense quackonomics is an insane theory of money, the commodity theory of money, ( a la Menger /Austrian). It is much like http://en.wikipedia.org/wiki/T..._for_a_Hat . Austrian theory, mainstream theory is basically the theory of the world of someone who cannot distinguish between his wife and a hat.

All money everywhere was created by someone printing it. No exceptions. There is no alternative to "interventionism". The creation of a monetary economy is a government intervention. It is the responsibility of the government to remove the unemployment it caused by creating money.

Reinhart & Rogoff's work is a POS. If there were any intellectual standards in economics, comparable say to PhD programs in lawn maintenance, let alone animal husbandry, then it simply would not have been published.

A market solution is a government solution, because there is no market without a government. There are no historical examples. None. Governments-->Money-->Markets is the historical sequence, essentially.

force more base currency printing? Who bares the bulk of that devaluation? Centuries of evidence - see Japan nowadays - show that "base currency printing" compared to "government borrowing" is deflationary, not inflationary. The JCB printed a s***load of money & is fighting deflation & what it considers overvaluation. There would be no inflation caused by the US government doing all its spending by simply printing the money. So of course all the garbage economics theories and texts say the opposite.

Basically the solution is just to do what FDR, the New Deal & the War did - without the war of course, and better in the light of recent knowledge. But basically, return the economic system to an improved 1941-42. If we'd kept what we had then, the level of theoretic & applied knowledge, ordinary people would be taking vacations on the Moon, we'd be that much more advanced. Instead, as hard technology moved forward, social technology, economics, moved backwards. Now enough to make many / most Americans lives worse than their parents. Something that never happened before, in 300 years.

Some recent "scholarship" following the tradition of even the leftiest liberals denigrating what was achieved under FDR, has concocted truly insane Big Lies, like recovery coming after the war. The common man & woman knew that was insane, and they are right. That's what real economics, institutional economics, real Keynesian economics, MMT is - the things that everyone knows deep down, their "folk theory" - which is infinitely more advanced & scientific than modern mainstream moronic pseudomathematical economics. Austrian economics is a special case - starting from being utterly wrong at the beginning, it does have some interesting & fruitful insights. It's not "not even wrong", like most mainstream trash is.
...
written by Joe Emersberger, May 15, 2012 7:50
Jammes writes

"We keep an eye on the debt to GDP because it means something about future valuations of the debt and it is a social comment on the value of the activity of those societies. "

Really James? Denmark's public debt to GDP ratio is very close to ZERO. Sweden and Norway both have NEGATIVE public debt to GDP ratios.

Judging by the corporate media's reporting, absolutely no one is "keeping on eye on that". It leads to the wrong conclusions.

Debt to GDP ratios are only looked at in the corporate press - and by right wingers generaly - when they can be used as an excuse for policies that redistrubtute wealth upwards.






link for net public debt to gdp ratios
written by Joe Emersberger, May 15, 2012 8:02
here is a link for total government net debt to gdp ratios for countries around the world.

http://www.economywatch.com/economic-statistics/economic-indicators/General_Government_Net_Debt_Percentage_GDP/


As you can see

Norway's = - 156% of GDp

Sweden's = - 14%

Denmark's = 0.89%

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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