After the Sovereign Debt Crisis Comes the Deleveraging

EconMatters's picture


By EconMatters

Spain formally became the fourth country to ask for bailout aid from the euro zone on Monday, June 25. Spain's short-term borrowing costs nearly tripled at auction on Tuesday.  Market participants expect Moody's to further downgrade Spain's sovereign debt to Junk status.    

Meanwhile, Cyprus also beat Italy to officially become the fifth Euro Zone bailout nation as ‘‘negative spillover effects through its financial sector, due to its large exposure in the Greek economy,’’ according to a government statement.  


Although no specific amounts were determined yet, WSJ reported that two external consultancies estimate Spanish banks' actual capital needs could be at around €62 billion ($77.5 billion), and Cypriot Finance Ministry staff said they expect the total financing needs to come to €10 billion ($12.5 billion).


Between the two, Spain is the one causing a lot higher anxiety.  Spain is Europe's fourth largest economy, which is larger than the other four euro bailout sisters—Greece, Ireland, Portugal and Cyprus--combined.  And remember Spain already requested up to €100 billion ($125.7 billion) from EU bailout earlier this month to recapitalize its regional banks reeling from the collapse of its massive real estate bubble.  Sadly, judging from the current debt situation (see graph below), the Euro bailout train most likely will not stop here.  



Graphic Source:


Previously, we discussed how in the not so distant future, almost all countries in the world could end up in one of these three classes--bankruptcy, credit counseling or debt renegotiation due to decades of deficit spending.  That also means many nations, after the storm of debt/banking crisis, will need to implement various government austerity programs, and households will commence debt deleveraging--a long and painful process.  An analysis from McKinsey should illustrate this point more clear.  

Using the previous deleveraging cycle of Sweden and Finland post financial crisis during the 1990s as a baseline, McKinsey compared the current progress of US, UK and Spain.  What KcKinsey found is that the United States may have been half way through that process, while households in Spain and the United Kingdom have only just begun to deleverage. (see chart below). 

McKinsey reckons the US could return to trend as early as mid-2013, but cautions:

"... after US consumers finish deleveraging, they probably won’t be as powerful an engine of global growth as they were before the crisis. That’s because home equity loans and cash-out refinancing, which from 2003 to 2007 let US consumers extract $2.2 trillion of equity from their homes—an amount more than twice the size of the US fiscal-stimulus package—will not be available."

More despair would come to Spain:

"....Today, Spanish corporations hold twice as much debt relative to national output as do US companies, and six times as much as German companies. Debt reduction in the corporate sector may weigh on growth in the years to come."   

UK, even though not part of the Euro sovereign bailout discussion yet, its prospect is not that much better:

"....we find that the ratio of [UK] household debt to disposable income would not return to its long-term trend until 2020."

What's more, "Significant public-sector deleveraging typically occurs only when GDP growth rebounds, in the later years of deleveraging."  And since today’s deleveraging economies are larger and under more challenging circumstances, the current deleveraging process could take longer than the historical experience of five to seven years from Sweden and Finland in McKinsey's baseline.     


That suggests the world most likely could experience a long deflationary period.  Some economists are starting to worry about the U.S. and Europe could face a coming Japanese-style deflation cycle.  Although we don't believe that is in the cards, since Japan is unique in its demographics, banking and government systems, we do think darker days are ahead, and America's lost decade would at least get an extension.      


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OneTinSoldier66's picture

What is the logical conclusion/endgame of deflation to debt based pieces of paper that are being used as money?

Bubbles and Busts's picture

Spain should bailout households not banks (

Peter Pan's picture

The way i read it is that households and governments borrowed too much for unproductive purposes which means this debt is not self servicing and I suspect that the over indebted position of businesses is also due to investing in too much productive capacity which is now idle, mergers and acquisitions which did not turn out to be as profitable as hoped for as well as pension liabilities that are behind schedule.

The growth scenario is a sad fantasy. Who will fund it and out of what?

Furthermore it is all well and good to prolong life but this requires one of two things. Either a corresponding increase in working age or even more savings and contributions towards retirement.

Aging populations across the spectrum are not conducive to growth either and in fact will be increasingly reliant on the fewer remaing workers.

Wars and military expenditure are not conducive to growth either. You may not have noticed that war has not been paying much by way of dividends but certainly has been increasing debt and future burdens due to maimed and lost soldiers.

Debt has to be destroyed before it destroys us. The only question is which owners of debt will carry this write off?

ATG's picture

This 21st EZ bailout conference may shock global markets awake at once.

Austere EZ deleveraging just begun, reaching corporate America and central markets everywhere as Austrian economic credit cycle, free markets and Irving Fisher's debt default deflation rediscovered by this terminal 0 generation of government planners.

Another giant sucking sound as what is left of the economy goes into the toilet?


Puts bears' best friend at the tipping point as people suddenly realize the EZ is queasy, no mo' free lunch and the Twist is dead: 2:38

RichCash@RichCash8 Twitter 


bigwavedave's picture

Deflation. The enemy of savers everywhere.

Enceladus's picture

It's the other way around

Savers can buy more when price go down

Salt's picture

I think he was being sarcastic.

1100-TACTICAL-12's picture

Hard to "deleverge" without a decent paying job. More like not paying their bill's.

impermanence's picture

Delerveraging is underway by about six people out of 300+M. 



Fishhawk's picture

This is a serious puff piece, Tyler.  Did you put it up to remind us not to bother reading anything else EconMatters writes?  I don't mind the continuous recycling of popular memes, but EconMatters loses credibility when quoting McKinsey as if it were real analysis [your mention of their 72 Page Paperweight in the links provides your disclaimer of McKinsey].  Suggesting that US households are halfway through deleveraging is not excusable hopium peddling, it is an outright lie.  While the text discusses social changes which encompass the entire public share of GDP wasted, the author then puts up a chart (admittedly by another major hopium peddler) which soft-pedals the 'general govt gross debt as % of GDP'.  So the EU (and maybe the US and UK) are likely to see a decade of slow deflation, kind of like Japan...  yea, right.  Actual public expenditures are 5 to 8 times the values shown in the chart; the collapse of such a huge part of the flow will not look like 'slow deflation.'  


El Oregonian's picture

Bailouts now are the equivalent to using one gallon buckets to bail out the Titanic. There is just not enough buckets to go around...

duckarooni's picture

Do you have any idea how insulting it is for honorable spanish people to have their sovereign rated as 'Junk'?

Surely another term like 'not right now' would be less insulting? Fear and loathing in ibiza, amnesia later.

LouisHill's picture

For the last 30-years we have been living under the illusion that debt equals wealth.  I am think we are about to find out that it does not.  There is a good reason that Hayak titled one of his books; "The Road To Serfdom."

dizzyfingers's picture

Prepare for a long-term worst. Hope for the best.

Chief KnocAHoma's picture

Long live the EU!

Death to the EU!

I am so confused. Will someone explain this is dummy terms.

Ghordius's picture

Chief, I'll try: the article is talking about debt in the EU and EU household debt in specifics, though every EU country shows a different picture. Now, if you have a mortgage, and you decide to pay back some of the principal you owe (something you really should do when rates are so low) then you are decreasing your leverage: deleveraging. By doing this, you are destroying credit. I know, it's unusual to think in those terms, but you see, when you took up the mortgage, you pledged collateral and you created credit - by going into debt. It was not really the CB or the bank, in this case, it was you.

Now, as long as more credit is being destroyed than created, the assumption of most monetary theories is that prices can't go up.

The EU? It's a racket of 27 members. Now, my opinion: it's a counter-racket to what many call "NWO". Warning: this opinion flies against most opinions posted here on ZH.

lasvegaspersona's picture


I agree with you.

The current ZH 'evil bankers' theme is dominant here. At FOFOA it is also a recurring issue. Many in the EZ see it as a net negative but there are deeper views that see the potential of the Euro to be a force for liberty. If the ECB stays strong, protects the currency and by extension keeps prices stable AND forces a return to reasonable promises of social security (and healthcare promises) in the worst offending countries then it would be a force for good in my opinion. Only by excessive taxation and spending can the governments get so big as to become threatening. Since they hate to tax if the Euro forces them to reduce spending I will say YES!

OneTinSoldier66's picture

They hate to tax? You mean like Francois Hollande?

Ghordius's picture

Both the EU and the EZ are conservative. To be only slightly more exact, conservatives outnumber socialists two to one.

mrpxsytin's picture

The first is said when someone recieves free money.

The second is said when the person finds out that the money wasn't really free.