Friday, April 15, 2011

So is Strauss-Kahn right on Europe's debts?

Dominique Strauss-Kahn, head of the IMF, was quoted by the BBC as saying that "A lot more has to be done by the Europeans to fix the problem (of national indebtedness)".

He is not quoted as saying anything about HOW the debt problem should be addressed.

So let us consider the following.

"Modern" debt often happens when individuals or organisations borrow money to try to speed up growth.

This does contribute to national debt nowadays, and may even be a principal contributor, but national debt is created primarily because tax revenues and other incomes amount to less than the amount the government spends, for example on the military, on subsidies, research, infrastructure, health, education, employment or pensions.

Governments usually borrow by issuing securities, government bonds and bills., though less creditworthy countries also borrow from international institutions such as the IMF.

Government debt can be internal (lent by citizens and organisations within the country) and external (lent by foreign individuals or other entities).

In the US, it has become fashionable to include not only the actual debt at present, but also all future government liabilities, including future pension, health and other goods and services the government has in some way committed to pay. This is both reasonable and unreasonable, because one has no idea of whether a government will honour its commitments in the future or find some way of welching on its commitments, and one has no idea of the future value of money, and indeed of future government income. Future-oriented doom-mongering is usually created by right-wingers who wish to reduce spending in the name of “responsibility”. However, such doom-mongering should not be entirely dismissed because it comes from right wingers nor because their proposed “solutions” (draconian cuts to social spending) seem unpalatable. The warnings should be considered warnings, and kept in mind, without allowing one to be panicked into accepting right-wing or left-wing solutions.

Understanding public debt requires one to understand the risks posed by debt, which is a complicated subject that I can’t go into right now.

The extent to which debt crises may be caused by too much spending, by fraud, and by speculation is a matter of debate. However, European governments appeared to accept that speculation had some role because they banned “naked short selling” for at least a period. The role of credit rating agencies in contributing to the crisis is now well recognised, and there has been reasonable scrutiny of this issue.

However, if a country's debt is measured in a way that ignores that country's monetary policy, you get ridiculous results. For example, China's public debt shows up as something like 18% while Japan's debt shows up as something like 225%. Again, if one looks only at a country's debt to foreign lenders, the US appears incredibly indebted, as its external borrowings are 97% of its GDP, while China appears to be an extremely comfortable position because its external debt appears to be only some 5% of its GDP.

Whatever the actual levels of a country’s debt, and however those are measured, there are only four ways to handle national debt:
- devalue the currency
- control spending
- increase tax revenues
- borrow at more favourable terms and pay off those whose payment terms are worse (the last resort does not reduce the total amount of debt, but reduces the impact of debt because the cost of paying for the debt becomes more affordable).

European governments are pursuing a combination of the above, and they seem publicly confident that they are in control of the situation, whereas Strauss-Kahn seems to be publicly concerned.

My view continues to be that as long as debt is considered a “good” way of financing growth, we will continue to have the problem of debt spiralling upwards till it gets almost out of control, followed by draconian actions to get it back in control for a while, before the cycle starts again.

Breaking out of that cycle requires a reassessment of growth for the sake of growth, and asking questions about the nature of growth (is all growth good?).

If one follows that virtuous path, one ends up somewhere near my recommendations for a more responsible and just global order – which is the only way that we can get beyond currently dominant ways of patching things together with glue and tape, and mere delusions (such as calls for a global currency: even Europe can hardly make the Euro work, so how can any intelligent person think that a global currency will work?!) Sphere: Related Content

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