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When, (the second dimension of the historical background), is the debt the destiny of the world?
It is told that nothing new happens under the sun and this is valid also when we talk about debts and sovereigns. Unlucky we tend too often to forget that there is a world long time before internet, the end of the cold war or Bretton Woods. Kingdoms and empires default and with them banks and bankers but despite it the world has been developing. In this chapter we will place in the right contest the actual crisis shortly talking about 35 years if debts from 2001 till 2035. A travel in the past, a past that starts in the year 1826, and into a plausible future..
This travel is possible thanks to three interesting studies and a conference:
- Joseph E. Gagnon, Marc Hinterschwiger: The global outlook for government debt over the next 25 years. Implications for the economy and public policy. (Policy analyses in International Economics N.94 /June 2011 – Peterson Institute for International Economics)
- Carmen M. Reinhart ,Kenneth S. Rogoff : A decade of Debt (Policy analyses in International Economics N.95 /September 2011 – Peterson Institute for International Economics)
- John H. Makin, Desmond Lachman, Alex J. Pollock, Global Currency War, and Endless Financial Crises: What’s wrong with the International Monetary System? (March 12th 2012, conference at the AEI)
- Marius Jurgilas and Filip Žikeš[i] , Implicit intraday interest rate in the UK unsecured overnight money market ,(Work Paper N. 447 ,March 2012 Bank of England)
It seems that the debt will be a continuing vulnerability and we add that sophisticated NSA like the rating Agencies will be key actors on influencing this fragility of the State Actors.
In the WWI and during the Great Depression the most used tools to solve the crisis were the default and restructuring when the WWII debts were solved through financial repression. The bailout approach started with the 1992 Japanese domestic banking crisis that was followed by the Mexican peso crisis,(1994-5),and later by the Asian crisis with the Korean package.
In the current crisis the bailouts a approach started in the USA in the 2007 .
Logically we assist alos to a more subtle form of debt restructuring and this takes the form of the so-called “financial repression”.. We use the term “financial depression” as described by Edward Shaw,(1973),and Ronald McKinnon,(1973),and the pillars are : explicit or indirect caps or celling on interests rates particularly but not exclusively these of sovereigns, the creation and maintenance of a captive domestic audience that facilitated directed credit to the government, others common measure associated with financial repression like ,for example, the direct ownership, (China, India, the UK),or their extensive management like in Japan as well restricting entry into the financial industry and directing credit to certain industries,(Beim and Clomiris,2000).
Debts, as told, were a constant throughout ages ,continents and form of government because at some point the government finances started to rapidly deteriorate. The most recurrent source of this deterioration was the war,(the last example the Vietnam War),and during peace time it was and it is the surges in public debts.
There are many reason for these surges and this is currently happens ,for example, with the BRICS and other developing countries and not only either to improve the welfare,( Brasil, China, Indonesia…),as tool to achieve the social stability required to preserve the political order as to support the economy, (China). But this is also happening in the developed one like ,for the example, irrational subsidies to the local farmers ,( ..and electors…), in the USA as well as in the EU.
To this we have also to add the (growing) tendency toward a direct government engagement in rescue operations in almost all sectors of the economy.
And last but not least the chronic inability to tax effectively or in other terms to find the money where it is. We can consider tow extremes on it. One is that of the growing illegal economy, ( we describe it as RCE = real crime economy), and the second is described as a privilege for low taxation of the elites that increases that gap between the “have/haves not”[ii] .
All the three but mentioned trends ,( with the exclusion of the illegal economy),can be easily explained as an effort of the Politically Elected Elites ,(PEE), to satisfy different segments of the society ,in other terms :their electors . This a bi-partisan aptitude as, for example, Parker, (2011), explains about the USA and Lenglet and Vilain,(2012), about France.
The final consequence is a gradual debt buildup but we have not to forget that this is a characteristic also of the aftermath of banking crisis and this for over a century,(a buildup that in a more than a century long period generates an average debt rise of 86%).
3.I – The past since 1826 …
As Reinhart and Rogoff have found the constant consequences of severe financial crises were and are deep and lasting effects on asset prices, output and employment, decline of housing prices, rising of the unemployment and this extends out for 5-6 years. Unlucky this situation spreads also in countries that did not experience a major financial crisis if we consider that for them during the period 2007-2010 the debt rose by an average of 36%.
We can describe it as the financial crash-sovereign debt crisis sequence,(Reinhart & Rogoff 2011b),and this description is the consequence of the evaluation of 70 countries since 1826,( when the newly independent Latin Americas economies or the first time entered the global financial markets),through 2010.
According to Reinhart & Rogoff “the drama that has most notably engulfed Iceland and Ireland is novel only in the orders of magnitude of the debt, not in the causes and patterns of the crisis”
“Not the causes and the patterns of the crisis”… as we can see with the hidden debts or the private debts that become public as it was in Chile in the early ´80´s.
And this example introduces us to the situation were banking crises act as predictors of sovereigns debt problems. The historical experience confirms that baking crises most often either precede or coincide with sovereign debt crises.
Diaz-Alejandro,(1985),Velasco,(1987), have found the reasons for this temporal sequence in the contingent liability situation in which the government takes on massive debts from the private banks and doing so it undermines its own solvency. This is also found in Kaminsky and Reinhart,(1999),when the talk about the “twin crisis” phenomenon. The “twin crisis” is generated by banking crises that precede currency crashes and that undermine the solvency of both private and sovereign borrowers. This situation is contagious and other countries ,(like in a perverse domino), are effected. This initiates a casual chain from sovereign debt crisis to banking crisis that generates a financial repression and international capital controls and not mention that the government can force healthy banks to buy significant quantities of sovereigns,( or of debt if you prefer).
In this circumstances if a government defaults this will directly impact the banks and not only these of the interested country. At this point we faces a multidimensional crisis composed by a connected network of crises. The first dimension is national and affects the government in the country Alfa and the local banks. The second dimension is international due to the simultaneous consequences on the foreign bank´s balance sheets holder of sovereigns issued by Alpha. Their problems require the action of their governments in the countries Beta, Delta. ,Gamma that take care of their debts and this generates a growth of the debt. This growth generates an higher cost of the sovereign … . Additionally we have to consider that no one can escape the crisis because even if a bank in the country Alpha is not over exposed to sovereign it faces the “sovereign ceiling” and this means that as corporate borrower is not rated higher than its government and this implies a higher cost to borrow in the international markets. This higher costs is not only inside the international market if we consider, for example, the intraday market in the UK..,(Jurgilas and Žike, 2012). The result will be a credit crunch for the economy and that will generate more insolvencies in the economy and this will rise the bank insolvencies and with them the need for the government to increase the debt to intervene in the system. This will made worse either the rating of the sovereigns making not only more expansive to borrow but also and also the situation of international banks holding sovereigns of the country affected by a crisis. This will generate problem of liquidity for them and all will spread the effect into a multi-dimensional, (national plus international), scale.
How can we describe this situation?
Common fundamentals? Contagion? A mix of both circumstances?
To understand it we must make a clear distinction between two kinds of shocks that generate an international transmission.
One is the shock generated by a “common shock”,( for example the collapse of the “dotcoms” in the 2001 or that of the houses prices in the 2008).
The other is the “cross-linkages shock” and it is a shock generating a transmission that occurs primarily due the mechanism that are the results of an international contagion emanating from the epicenter..
We are living a “fast and furious” contagion originated by cross-linkages shock and we face a situation where the same borrowers have common creditors and this make all worst. And almost creditors that were surprised by the crises. This in a situation where short before the crisis we had a surge in capital inflow ,( a “capital flow bonanza”)and rapidly rising leverage with an abrupt if not a stop in the wake of the crisis.
This scenario shows the three pillars typically found in a “fast and furious” contagion as described by Kaminsky, Reinhart and Vegh,(2003).
The epilogue is a dramatic march from high public indebtedness to sovereign default, (worst case), or restructuring.
A trend that we describe using the conclusions of the mentioned book wrote by - Carmen M. Reinhart, Kenneth S. Rogoff and based on the analysis of 44 countries in a 200 years period with 3.700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements and historic circumstances : “ … high levels of debt dampen growth… the sharp run-up in public sector debt will likely prove one of the most enduring legacies of the 200709 financial crises in the USA and elsewhere. We examine the experience of 44 countries spanning up to tow centuries of data on central government debt, inflation and growth. Our main finding is that across both advanced countries and emerging markets ,high debt/GDP levels ,( 90% and above),are associated with notably lower-growth outcomes. Much lower level of external debt/GDO ,( 60%), are associated with adverse outcomes for emerging markets growth. Seldom do countries “grow” their way out of debts. The nonlinear response of growth to debt as debt grows toward historical boundaries is reminiscent of the “ debt intolerance” phenomenon developed in Reinhart,Rogoff and Savastano,(2003). As countries hit debit intolerance ceilings, market interests’ rate can begin to rise quite suddenly, forcing painful adjustment. For many if not most advanced countries, .dismissing debt concerns at this time are tantamount to ignoring the proverbial elephant in the room. So is pretending that not restructuring will be necessary. It may not be called restructuring, as not to offend the sensitivities of governments that want to pretend to find an advanced –economy solution for an emerging market style sovereign debt crisis. As in other debt crisis resolution episodes, debt buybacks and debt-equity swaps are a part of the restructuring landscape. Financial repression is not likely also to prove a politically correct term –so prudential regulation will probably provide the aegis for a return to a system more akin to what the global economy had prior to the 1980´s market –based reforms.
The process where debts are being “placed” at below-market interests rates in pension funds and other more captive domestic financial institutions is already under way in several countries to drive central banks in many emerging markets to purchase US government bonds on a large scale. In other words, markets for government bonds are increasingly populated by nonmarket players, calling into question the information content of bond prices relative to their underlying risk profile –a common feature of financially repressed systems”
This for the past and the for the future?
3. B) The worst scenario till 2035…
According to Gagnon and Hinterschwiger,(2011),this crisis is only accelerating the fiscal deterioration of a lot of countries generating worrisome trajectories for a number of years.
In the 2008-2009 we had a crisis generated by speculation that required a coordinate response that as lasting consequence has not the solution of the crisis but the rising of deficits to records level for peacetime.
We avoid a new Great Depression to find not growth but the Great Indebtedness that will last for years.
The core problem is a lack of credibility that takes the form of higher and higher interest rates for the sovereign. A trend that is spreading and that will also include a country like Germany as logic consequences that its markets are going down and with “Agenda 2010” the growth is export and not by the internal demand generated. In other terms : till the world buys Made in Germany Agenda 2012 can work but it the world will buy less the system will get on troubles.
Additionally the demography seems to play against even if we do not agree with the negative forecasts by Gagnon and Hinterschwiger in the “Global Aging Preparedness Index” published by the Center of Strategic International Studies and the insurance company Jackson,(2010)[iii]
As the table show even in the worst scenario we can consider that the mentioned countries have the resources to pay their welfare and this despite a lot of alarmism. It is hard to believe that Italy cannot afford to pay for it the 6.7% of its GDP or that the USA the 11.1%.
This authoritative study made by Jackson, Howe and Nakshima concludes that:” Clearly, global aging poses a daunting economic and social challenge. Many fast-aging countries, especially in the developed world, seem to face a choice between relieving the growing fiscal burden on the young and maintaining adequate incomes for the old. meanwhile, in many developing countries, the choice seems to be just the opposite: whether to impose a new fiscal burden on the young in order to relieve the growing vulnerability of the old.Yet just as clearly, there are many strategies available to address the challenge and not all involve painful trade-offs. Two in particular, extending work lives and increasing funded retirement savings, can be win-win solutions that help provide the old the security that they have earned while ensuring the young the future of expanding economic opportunity that they deserve.
Although this report has focused on the importance of government policy choices in confronting the aging challenge, businesses also have a critical role to play—by educating workers about retirement security, by encouraging long-term savings, and by restructuring their workplaces to accommodate older workers. As our societies age, individuals and families inevitably will also have to take greater personal responsibility in planning for old age.
With much of the world still reeling from the global economic crisis, many policy leaders may conclude that now is not the right time to address the long-term challenge of global aging. This would be a mistake. In fact, the economic crisis has made timely action even more urgent than before. On the one hand, the crisis has drastically reduced the room that many countries have to accommodate rising old-age dependency costs, and so has brought their day of fiscal reckoning forward. On the other hand, the market meltdown has left many elders more vulnerable. There is also the critical issue of confidence. Both the public and the markets increasingly worry that governments have lost control over their fiscal future. Taking credible steps to address the long-term aging challenge may thus be a necessary part of addressing the near-term economic challenge as well.”
This report evaluates one of most lasting consequences of the economic crises that is seems started on 9/15 that is related to the new political roles of the Credit Rating Agencies, (CRA), that we consider as a Not State Actor ,(NSA) ,described as one of the 24 forms of NSA´s according to the Paolo Dealberti’s ´s classification[i].
We do not believe that this crisis started with 9/15 but that 9/15 was the moment where the system imploded.
We think that all started in the 60´s, (George Packer is telling 1978[ii]),with an elite of brilliant “ eggs heads” that were advisors of the White House. In any case is a social trend before and beyond an economic one and it is deeper and more sophisticated as well as complex than so-called “neoconservative” and “neoliberal” revolution of the ´80´s. More sophisticated and complex because on worldwide bases with different forms and nuances that sometime has the form of political protests ,( from the Arab Spring to the Indignatos in Spain or the Referendari anti-nucleare,(also with the support of established political party like Italia Dei Valori), in Italy, the Occupy Wall Street Movement in the USA or Die Piraten in Germany[iii] or the around 280.000 riots in China[iv]), and sometime that of a deep rethinking of social aptitudes[v].
The emerging force inside the economic and political crisis is that of a social class that we describe as the “1st cosmopolitan and transversal new bourgeois”. Something “more and beyond the myth” of the world middle class[vi] and we develop it in a future report.
In our report we focus on the geopolitical dimension and we talk about actors that existed long time before the PWO and that are existing also today. : the Not State Actors. And inside the NSA´s we find an important part of the 1st cosmopolitan and transversal new bourgeois that we mentioned before.
We will evaluate the NSA´s inside the actual tensions with the PWO actors pour excellence: the State Actors.
[i] Paolo Dealberti, “ The 24 forms of NSA´s and their classification as genetically authoritarian/ not genetically authoritarian”, classified internal document 2009
[ii] George Packer, ”The broken contract”, Foreign Affairs Vol. 90 N. 6 2011 but also Suzanne Keller ,”Beyond the ruling class .Strategic Elites in modern society”, (note III) Hansfired Kellner – Frank W. Huberger ,(note XI)
[iii] Indignatos = Outraged a movement of the social inequality in Spain , Referendari anti nucleare = supporters of the referendum against the nuclear energy, Die Piraten = The Pirates a new party in Germany that is entering in one regional Council after the other.
[iv] Gordon G. Chang , “The Coming Collapse of China: 2012 Edition “, Foreign Policy Dec. 29 2011 http://www.foreignpolicy.com/articles/2011/12/29/the_coming_collapse_of_china_2012_edition?page=0,1&wpisrc=obinsite
[v] Monocle ,Issue 49 Vol 5 , Dec. 2011/ Jan.2012
Courrier International , Revolution ,revelation ou regression ? Tendences 2012”, Horse-serie Tendences Dec. 2011
[vi] Karen Harris, Austin Kim and Andrew Schwedel,”The Great Eight: Trillion-Dollar Growth Trends to 2020”,Bain & Company 2011 http://www.bain.com/publications/articles/eight-great-trillion-dollar-growth-trends-to-2020.aspx
Paolo Dealberti,” World middle-class : how a self-fuelling “myth” could be used by someone to affect our democracies “ ,Prosumerzen 2011 http://prosumerzen.net/2011/09/26/world-middle-class-how-a-self-fuelling-%E2%80%9Cmyth%E2%80%9D-could-be-used-by-someone-to-affect-our-democracies/
Homi Kharas.,”The emerging middle class in developing countries” ,OECD Report Oct. 2010
[ii] Hyens Johnsons “Divided we fall” W.W. Norton & Company ,New York 1994
Kevin Philips,”Arrogant Capital: Washington, Wall Street, and the Frustration of American Politics” Little Brown & Co, New York 1195
Joel Garreau , “The nine nations of north America” Avon Books Publishing, New York 1982
John King Fairbank ,” China A new history” Harvard University Press, Cambridge 1992
George Parker “The broken contract”, Foreign Affairs Vol. 90/6 2011
Herbert Prantl “Wir sind viele”, SDZ Edition ,München 2011
Mario Deaglio ,( a cura di), „ La ripresa il coraggio e al paura .XV rapporto sull´economia globale e l´Italia”, Guerini ed Associati, Milano 2012
Roger Lenglet ,Olivier Vilain “un puvoir sous influence “, Aramdn Collin, Paris 2011
Julia Fridrischs “Gestatten elite. Auf den Spuren der Mächtigen von Morgen”, Hoiffman & Cumpe Verlag, Hamburg 2008
[iii] Richard Jackson, Neil Howe, Keisuke Nakshima , “The global aging preparedness index “ , CSIS –Jacskon , Washington 2010 http://csis.org/files/publication/101014_GlobalAgingIndex_DL_Jackson_LR.pdf