Economists! Comments and Opinion on Greek Debt Article

[J]

The Spanish Empire declared bankruptcy three times in its existence. At the time this happened, the Spanish Empire was far more powerful and important to both world economy and civilization (being the most powerful state in existence by far) than the EU as a whole is today.

When it declared bankruptcy, it took with them the largest banks in Europe, including Fugger, whose earnings were far higher than what the Holy Roman Empire collected in tax revenue.

At no point did these societies collapse, nor did the overall economy. Bankruptcy is a normal instrument of business.

I could go on (The economy of the Netherlands crashed several times. The Thirty Year's war caused even more bankruptcies by wiping out nearly a third of the most important trading cities and 20% of the population), but the point is made. Bankruptcy does not lead to economic collapse nor to the collapse of society. That is why it is called bankruptcy - the orderly process of settling one's debts.

In theory. Neglecting the effects of our highly interconnected and interdependent modern finance system, and all the financial innovations we've made such as derivatives, credit default swaps, interest rate & currency swaps, collateralized debt obligations, CDOs2, and oh yes, an entire economy which functions on the movement of credit as opposed to paper bills or gold coins. That last one's a killer, and I'll explain why.

Let's start with the derivatives, swaps, and other instruments. What they allow banks to do is obtain extremely high leverage on their investments, so in addition to owning $10 billion in Greek bonds they can purchase a bunch of these products and get a nice 30:1 leverage ratio to really rake in the money on the upside. The leverage of course works against them if the value of their investments happens to fall, which it's doing now, at 30:1 a 3% drop in the underlying asset can completely wipe out a bank or other financial.

Which is connected & dependent on everything else in our modern system, which is why a dinky little investment bank like Bear Stearns going under can trigger a near collapse of the entire US financial system, and why a 2% currency move in Asia can unwind a carry trade and liquidate the entire North American commodities market. When countries went bankrupt in the old days it was contained to the region for the most part, if Germany, the UK, or America defaults now, it goes worldwide at the speed of light and every single trading exchange will be lock limit down within minutes.

Which brings us to credit. Everything runs on credit, commerce, shipping, everything. If there's a financial system panic thanks to say, the UK defaulting on its debts, the first system to lock up will be the credit system, since as you recall, debts are credits in our modern financial system. Without credit, goods don't move since shipping is done with letters of credit which are obtained and cleared through banks. Gas stations won't have their tanks refilled since all the fuel is purchased on lines of credit which are repaid as the fuel is sold. This brings trucking to a halt since truckers can no longer refill their tanks. In a matter of days you have a very serious problem.

This is why it's different this time. Our modern system isn't as resilient, has far more leverage & interconnectedness, and it has more possible points of failure. Will the worst case happen? I don't know, and I don't know how likely it is either since I can't get into the banks' books and audit their derivatives & structured finance holdings. But I can tell you that based on what I can see, the potential is there for a collapse that's worse than nearly everything we've seen in history.

[Fingolfin_Noldor]

I suppose the worst case scenario has always been governments nationalizing a good chunk of the economy if all things go to hell....... really.... Pretty much most things in the Medieval ages were in the hands of few men then anyhow.

[Big Phil]

I can't help but keep wondering something. Why is it that some people keep predicting apocalypse as a result of the current economic situation, and keep insisting that historical precedents are irrelevant? In the past, when economies have collapsed, civilization has kept chugging along, and yet THIS TIME it's The End Of The World As We Know It! Two years ago Duchess and Valdemar were predicting breadlines, $1000/barrel oil, and the conversion of the suburbs into uninhabited wastelands - it didn't happen. Given that, why should we continue to place any confidence in any more of these wild-eyed, sky is falling, predictions?

Things are likely to be shitty for a while; we get it. Some people believe it, others don't. But these end of civilization predictions just make you (J, in this case) look like a loon. OK, maybe some people lap this shit up, but I suspect most of us are just tired of the constant (and incorrect) predictions of impending doom.

[Starglider]

Why is it that some people keep predicting apocalypse as a result of the current economic situation, and keep insisting that historical precedents are irrelevant? In the past, when economies have collapsed, civilization has kept chugging along, and yet THIS TIME it's The End Of The World As We Know It!

The assumption seems to be that when a credit logjam occurs, people will cease all business activity, throw up their hands in horror, and go off to join a post-apocalyptic biker gang. Instead of say bending the rules and assuming accounting can sort things out later. In reality people do want to keep working (certain strike-happy union idiots excepted) and do care about continuity of business. In the face of shortages most people will prioritise, go to backup and contingency plans, and make do with best-efforts. Of course 'OMG the local supermarket is out of frozen food END OF CIVILISATION' is more fun for the doomsday crowd and stirs up more traffic for the media that caters to this viewpoint. I can just imagine these people in 1939 Britian saying 'OMG we must surrender to the Nazis because if just 10% of our merchant shipping is sunk END OF CIVILISATION'.

[J]

Things are likely to be shitty for a while; we get it. Some people believe it, others don't. But these end of civilization predictions just make you (J, in this case) look like a loon. OK, maybe some people lap this shit up, but I suspect most of us are just tired of the constant (and incorrect) predictions of impending doom.

Do some reading up on Iceland. When their credit was cut their international trade went belly-up. Commerce essentially died there for a short time as the exchange rates & credit lockup froze them out of world markets. And that was one little country, and not even a full credit freeze.

The assumption seems to be that when a credit logjam occurs, people will cease all business activity, throw up their hands in horror, and go off to join a post-apocalyptic biker gang. Instead of say bending the rules and assuming accounting can sort things out later.

The problem is how do we reroute around a frozen credit system? 30 years ago we weren't nearly as dependent on credit and a lot more people used physical currency for day to day commerce & business transactions. Most businesses had a healthy amount of cash on hand so they could continue to function for some time after a credit shutdown, banks actually had to keep a certain reserve of bills in their vaults to clear customer & business transactions. This is no longer true since our society has moved a fair ways towards a cashless system with most customers paying for the purchases with debit or credit cards and the same is true of businesses & banks. If the credit system gets zapped, transactions do not clear as the funds to back them aren't there.

To get things running again we'll have to nationalize the system and run it by government fiat, which blows the credit derivatives sky high and nukes the financials in every other country. Which means a co-ordinated global nationalization plan of some sort is required to run the world's commerce system in the event of a credit freeze.

The other issue is a frozen credit system does not happen in isolation, see fall 2008 when the system nearly locked up. When credit gets tight the interest spreads blow wide open which sets off the interest rate swaps and any financial on the wrong side of them gets blown up. Like, I dunno, AIG.

Sure there are ways to mitigate the damage from a credit lockup, but we do not have the contingency plans laid out for them, we're barely doing any research to determine the possible scenarios. We are not prepared, at all. We don't have plans for taking down the big banks and running them to keep essential commerce going. We more or less hope everything magically works out, there is no Plan B.

[recon20011]

In my humble opinion credit seems to be the backbone of this problem. Credit itself isn't a bad thing, for centuries credit has allowed economic expansion and technological development. It is the relatively recent abuse of credit by individuals that seems to be the ultimate problem. The way I see it, too many people spend more money than they possess a any given time. They don't save enough money for retirement on their own, which is why they require government pensions and other programs (Medicaid, Medicare, Social Security). Yes, some people save. But not enough money is saved. The growth of government debt, as expressed by others in this thread, is not new. And governments have gone through bankruptcy. But there really doesn't seem to be a solution other than bankruptcy to me. Why? Because the governments cannot tax their citizens for money that the citizens themselves don't have, if they had the money they'd be spending it instead of using their credit cards. But government bankruptcy can't be allowed because of the global nature of today's economy, and, as J pointed out, it could freeze the entire nation's economy. Additionally, its not just one country... its almost every country. Expansion isn't really much of an option either, there is very little unclaimed land with unclaimed resources, one large section of which lies underneath the world's oceans and the other is far far away in space. I'm positive that there are plenty of materials in both places, but the costs would be unbelievable. But maybe it would be worth it rather than see the entire global economy spiral out of control?

[Big Orange]

I've got a scary, complex chart on the whole Euro fiasco:



Greece looks pretty bad and seems to get most of the media attention, though Italy alone seems to be in about two to three times as much trouble.

[Fingolfin_Noldor]

To get things running again we'll have to nationalize the system and run it by government fiat, which blows the credit derivatives sky high and nukes the financials in every other country. Which means a co-ordinated global nationalization plan of some sort is required to run the world's commerce system in the event of a credit freeze.

I would imagine that would happen. A Clean Restart. Of course it leaves lots of people unhappy, but it's definitely not the end of the world.

[The Big I]

To get things running again we'll have to nationalize the system and run it by government fiat, which blows the credit derivatives sky high and nukes the financials in every other country. Which means a co-ordinated global nationalization plan of some sort is required to run the world's commerce system in the event of a credit freeze.

I would imagine that would happen. A Clean Restart. Of course it leaves lots of people unhappy, but it's definitely not the end of the world.

So how would a "clean start" work? Does that mean only governmental debt is wiped out or does everyones debt get wiped out ie personal, business and governmental.

[Fingolfin_Noldor]

I would imagine that would happen. A Clean Restart. Of course it leaves lots of people unhappy, but it's definitely not the end of the world.

So how would a "clean start" work? Does that mean only governmental debt is wiped out or does everyones debt get wiped out ie personal, business and governmental.[/quote]
Probably something of that order. If every one is bankrupt, nothing much one can do.

[Thanas]

In theory. Neglecting the effects of our highly interconnected and interdependent modern finance system, and all the financial innovations we've made such as derivatives, credit default swaps, interest rate & currency swaps, collateralized debt obligations, CDOs2, and oh yes, an entire economy which functions on the movement of credit as opposed to paper bills or gold coins. That last one's a killer, and I'll explain why.

Eh....the entire bankhouse of the Fugger was solely built on credit at that moment.

When countries went bankrupt in the old days it was contained to the region for the most part, if Germany, the UK, or America defaults now, it goes worldwide at the speed of light and every single trading exchange will be lock limit down within minutes.

It went worldwide when Spain went down. Society survived.

But I can tell you that based on what I can see, the potential is there for a collapse that's worse than nearly everything we've seen in history.

I disagree. We will not have thirty percent of the global economy to be suddenly unable to pay its debts and we will not see a collapse of the international banking system.

Do some reading up on Iceland. When their credit was cut their international trade went belly-up. Commerce essentially died there for a short time as the exchange rates & credit lockup froze them out of world markets. And that was one little country, and not even a full credit freeze.

And they survived and went on. Nobody died of starvation, there was no collapse of society.

[J]

Do some reading up on Iceland. When their credit was cut their international trade went belly-up. Commerce essentially died there for a short time as the exchange rates & credit lockup froze them out of world markets. And that was one little country, and not even a full credit freeze.

And they survived and went on. Nobody died of starvation, there was no collapse of society.

Sure, thanks to the emergency loans & aid from their northern neighbours and the IMF. Which only works for smaller countries since a)the amount of money required to save a major economy such as Germany, Japan, or the UK does not exist (unless someone has at least $5 trillion floating around somewhere) and b)unlike Iceland, the damage can't be contained in time.

When countries went bankrupt in the old days it was contained to the region for the most part, if Germany, the UK, or America defaults now, it goes worldwide at the speed of light and every single trading exchange will be lock limit down within minutes.

It went worldwide when Spain went down. Society survived.

But how long did it take? And how dependent was society on credit flows? Is a farmer in France going to be bankrupt overnight and unable to farm & sell his crops? I rather doubt it, but that's the way it is now.

But I can tell you that based on what I can see, the potential is there for a collapse that's worse than nearly everything we've seen in history.

I disagree. We will not have thirty percent of the global economy to be suddenly unable to pay its debts and we will not see a collapse of the international banking system.

One bank, in one country, holds more in derivatives products than the entire yearly global GDP. What do you suppose happens if those derivatives blow up? Given that JPMC is one of the too big to fail banks and has the implicit backing of the US government, what do you suppose this does to the balance sheet of the US Treasury? And how's that debt going to be paid off? Now, assume that the implicit backing isn't there, what do you think happens to the counterparties on those derivatives contracts when JPMC is bankrupted and they're unable to collect? Bit of a problem isn't it?

[Thanas]

Sure, thanks to the emergency loans & aid from their northern neighbours and the IMF. Which only works for smaller countries since a)the amount of money required to save a major economy such as Germany, Japan, or the UK does not exist (unless someone has at least $5 trillion floating around somewhere) and b)unlike Iceland, the damage can't be contained in time.

The larger countries also show no threat of going under. It is only the small countries which had ridiculous amounts of overspending or a stupid business model that find themselves in such a trouble.

But how long did it take? And how dependent was society on credit flows? Is a farmer in France going to be bankrupt overnight and unable to farm & sell his crops? I rather doubt it, but that's the way it is now.

It took, depending on indicator, 1-5 years.

One bank, in one country, holds more in derivatives products than the entire yearly global GDP. What do you suppose happens if those derivatives blow up? Given that JPMC is one of the too big to fail banks and has the implicit backing of the US government, what do you suppose this does to the balance sheet of the US Treasury? And how's that debt going to be paid off? Now, assume that the implicit backing isn't there, what do you think happens to the counterparties on those derivatives contracts when JPMC is bankrupted and they're unable to collect? Bit of a problem isn't it?

No, not really in my book. Worse come to worse there will be more debt that will seriously hurt future budgets. But it is not going to collapse society. If everything fails, there will be a currency reform or inflation. Which will still not collapse society.

[J]

The larger countries also show no threat of going under. It is only the small countries which had ridiculous amounts of overspending or a stupid business model that find themselves in such a trouble.

The UK's looking ripe for picking these days, how long do you suppose it'll last with a ~10% annual compounded growth rate on its debts? Given that their oil & gas revenues are drying up, given that they're now a net importer as opposed to an exporter of natural gas, then add in the rest of their financial problems, how are they going to balance their budgets and continue servicing their debts?

One bank, in one country, holds more in derivatives products than the entire yearly global GDP. <snip> Bit of a problem isn't it?

No, not really in my book. Worse come to worse there will be more debt that will seriously hurt future budgets. But it is not going to collapse society. If everything fails, there will be a currency reform or inflation. Which will still not collapse society.

Let's say all those derivatives liabilities end up on the books of the US government, it now has a ~$100 trillion debt problem. Given that the average interest cost is currently 3.2%, that's quite a bit more in interest payments than the US government's entire revenue stream, leaving two choices; the Zimbabwe model or defaulting on their debts.

Inflation does not work because it blows the forward cost of liabilities such as social security & medicare through the roof (see here), and I doubt Americans will take too kindly to having their benefits eliminated. It's also next to politically impossible, ranking right up there with removing the 2nd Amendment. Default blows up the rest of the world, given that the USD is the world's reserve currency and the international currency of trade, and that a default leaves it worth about as much as the paper it's printed on, you now have a problem. Oil isn't moving into the US, grain & other food shipments aren't moving out. How does the US function with over 2/3 of its oil gone? And you'll have some starving countries on the other side of the world as the food surplus provided by the US is now gone forcing the rest of the world to ration according to their needs. Countries which are doing fine now will find themselves in serious trouble as their current trading partners can't make up the shortfall left by the removal of the US from world markets.

[Thanas]

The UK's looking ripe for picking these days, how long do you suppose it'll last with a ~10% annual compounded growth rate on its debts? Given that their oil & gas revenues are drying up, given that they're now a net importer as opposed to an exporter of natural gas, then add in the rest of their financial problems, how are they going to balance their budgets and continue servicing their debts?

The interest rate will stabilize once the current problems are fixed, for example once there is a stable Government in order and the more outrageous financial stuff is finished. They can also take austerity measures etc. Furthermore, if push comes to shove, the German banks will be ordered to provide the UK money at a lower interest rate. Or at least the Bundesbank and KFW will act on this. Risk can and will be spread around in Europe. Also, note how countries with far larger debt have lower interest rates, like Japan.

Let's say all those derivatives liabilities end up on the books of the US government, it now has a ~$100 trillion debt problem.

Why should they end up on the books of the US Government? You are also making the assumption these liabilities will be called in.

Look, at the end of the day it is just credit. It is nothing tangible that really hurts us. If all fails, we'll just end up with a concentrated EU/US effort to nationalize the banks.

[J]

The interest rate will stabilize once the current problems are fixed, for example once there is a stable Government in order and the more outrageous financial stuff is finished. They can also take austerity measures etc.

Those aren't interest rates, those are the annual growth rates of the debt with respect to GDP. Austerity measures would reduce the GDP in the short term, and unless the measure are such that the government can run a surplus in the medium to long term the ratio will continue to grow until the debts can no longer be serviced. I believe Canada's the only OECD country to run consistent budget surpluses in recent history and pay down its debts so I'm not holding my breath here.

Furthermore, if push comes to shove, the German banks will be ordered to provide the UK money at a lower interest rate. Or at least the Bundesbank and KFW will act on this. Risk can and will be spread around in Europe. Also, note how countries with far larger debt have lower interest rates, like Japan.

If they can. If the German people allow it. Neither of which is a given.

Let's say all those derivatives liabilities end up on the books of the US government, it now has a ~$100 trillion debt problem.

Why should they end up on the books of the US Government? You are also making the assumption these liabilities will be called in.

Never said they will. But they can. Your claim is that the banking problems won't collapse society, I'm showing a possible scenario where it can do so. Will it happen? I don't know and neither does anyone else because there's no way to find out what's on those derivatives contracts nor the actions which the US government may take.

Look, at the end of the day it is just credit. It is nothing tangible that really hurts us. If all fails, we'll just end up with a concentrated EU/US effort to nationalize the banks.

Sure, and at the end of the day money's just a piece of paper, we take it for granted and let it do its thing and work its magic every day. Because it's just a bunch of ones and zeros in a a worldwide network of computers it doesn't seem all that important. But it is. It would be a very different world if every credit card, loan, line of credit, mortgage, bond, Treasury bill & note, and other credit product suddenly vanished. Credit is a lot more important than most people believe.

[Thanas]

Those aren't interest rates, those are the annual growth rates of the debt with respect to GDP. Austerity measures would reduce the GDP in the short term, and unless the measure are such that the government can run a surplus in the medium to long term the ratio will continue to grow until the debts can no longer be serviced. I believe Canada's the only OECD country to run consistent budget surpluses in recent history and pay down its debts so I'm not holding my breath here.

Ah, okay. In any case, debt like that can be curtailed. Raise taxes, screw over civil servants etc. Won't be pretty, but doable. 10% debt increase is not really that much.

If they can. If the German people allow it. Neither of which is a given.

They can and they will. If necessary we will increase sales tax to 25%, thus making a surplus of our current deficit.

Never said they will. But they can. Your claim is that the banking problems won't collapse society, I'm showing a possible scenario where it can do so. Will it happen? I don't know and neither does anyone else because there's no way to find out what's on those derivatives contracts nor the actions which the US government may take.

If it did, it would be the first society collapsed by credit. I do not think that will happen. All historic precedent is against it. To be honest, this reeks of the same predictions as "PEAK OIL" and "BREADLINES" which turned out to be just hot air.

[J]

Ah, okay. In any case, debt like that can be curtailed. Raise taxes, screw over civil servants etc. Won't be pretty, but doable. 10% debt increase is not really that much.

Run the math. With the UK, let's split the difference on the chart and assume their debt is currently at 400% of GDP, a 10% growth rate means the debt grows by 40% of GDP the first year, and it compounds and goes up exponentially from there. A 10% increase on a debt of that size is a much larger problem than it appears at first glance. It would only eat up the entire revenue stream of the nation to close the gap.

[Admiral Valdemar]

If it did, it would be the first society collapsed by credit. I do not think that will happen. All historic precedent is against it. To be honest, this reeks of the same predictions as "PEAK OIL" and "BREADLINES" which turned out to be just hot air.

I've been holding off replying to this thread again, since I was already misquoted by someone assuming I meant the Eurozone crisis meant the end of the world (any talk of society problems at large, by their nature, are NOT down to a simple credit problem, as anyone who's read what I've posted over the years will know), and frankly, the essay I had regarding Tainter and Diamond and Greer regarding societal collapse from the Mycenaean to Western Roman Empire was off-topic as the posting of the whole "Spain was bankrupt once, therefore it's okay" thing.

But as for the breadlines being non-existent, you're quite wrong. The SNAP participation rate in the US is at record levels, and you can see similar metrics for other things elsewhere e.g. fuel poverty growth in the UK, rationing of electricity in African or Far Eastern nations unable to pay higher commodity rates and so on. Saying peak oil is hot air is also hilarious. And wrong.

To handwave away problems like these and assume everything will carry on as it always has takes as much faith as it does to tell someone we'll all be Mad Max next year (something I have never actually endorsed, by the way).

[Uraniun235]

What would happen if a law were passed declaring all derivative contracts null and void?

[Broomstick]

But as for the breadlines being non-existent, you're quite wrong. The SNAP participation rate in the US is at record levels

It did occur to me recently that the US "breadlines" are well disguised these days due to the SNAP or foodstamps programs - those on such assistance shop at the same stores in the same manner as those not requiring assistance, the only difference is who pays for the groceries. If one in six Americans is receiving government assistance in buying food does that count as "breadlines"?

[Starglider]

If one in six Americans is receiving government assistance in buying food does that count as "breadlines"?

No, due to the glaring absence of actual lines, which are caused by shortage of foodstuffs themselves.

[Chris OFarrell]

Well I have to say this is one of the better explanations of the mess in Europe I've found...

http://www.abc.net.au/news/video/2010/05/20/2905304.htm

[Big Phil]

But as for the breadlines being non-existent, you're quite wrong. The SNAP participation rate in the US is at record levels

It did occur to me recently that the US "breadlines" are well disguised these days due to the SNAP or foodstamps programs - those on such assistance shop at the same stores in the same manner as those not requiring assistance, the only difference is who pays for the groceries. If one in six Americans is receiving government assistance in buying food does that count as "breadlines"?

Yay! Let's redefine the meaning of breadlines to prove a point! Tomorrow, I'm going to redefine the meaning of "murder" so that anytime someone dies, somebody has to be found guilty of their "murder." Then I can claim an epidemic of murders

I've been holding off replying to this thread again, since I was already misquoted by someone assuming I meant the Eurozone crisis meant the end of the world (any talk of society problems at large, by their nature, are NOT down to a simple credit problem, as anyone who's read what I've posted over the years will know), and frankly, the essay I had regarding Tainter and Diamond and Greer regarding societal collapse from the Mycenaean to Western Roman Empire was off-topic as the posting of the whole "Spain was bankrupt once, therefore it's okay" thing.

First, it's unreasonable to expect us all to track and remember everything you've posted over the years.
Second, if it's off-topic, why are you referencing it here?

But as for the breadlines being non-existent, you're quite wrong. The SNAP participation rate in the US is at record levels, and you can see similar metrics for other things elsewhere e.g. fuel poverty growth in the UK, rationing of electricity in African or Far Eastern nations unable to pay higher commodity rates and so on. Saying peak oil is hot air is also hilarious. And wrong.

Sorry, but as Starglider pointed out, breadlines require shortages in supply - there has been no substantial change in supply or demand. What has changed is the need for government assistance which, while unpleasant, is not the same as breadlines. Unless, as I pointed out earlier, you're choosing to redefine what a breadline is.

And I'm not sure there's anyone here who disputes peak oil, only the Mad Max-esque scenarios that made the rounds here a few years back.

To handwave away problems like these and assume everything will carry on as it always has takes as much faith as it does to tell someone we'll all be Mad Max next year (something I have never actually endorsed, by the way).

Hey, Mad Max!

Anybody reasonable who understands basic economic theory knows that things are bad right now, and likely to get worse; but the handwaving is coming into play because the constant predictions of the collapse of civilization are simply absurd. It's one thing to say, if I can represent your beliefs as follows, "we cannot sustain this level of consumerism, and in the future we can't all have SUV's, 4000 square foot homes, and 50" plasma screen TV's." It's something else to say "THE END IS NIGH!" as others have been doing for the past few years. And it's even more irritating when the constant predictions of catastrophe are wrong... time and time again. They're always "next year," but it's been two years now and civilization still hasn't collapsed.

[Thanas]

Hey, Valdemar, J. Let's make a bet. If society has collapsed one year from now, I'll be willing to give you 1000 EUR or, if you'd prefer gold/silver, some of my cufflinks/jewelry/wine/whiskey collection. If society has not collapsed one year from now, you will pay me the same amount.

Deal?