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Guest Post: Europe Needs Debt Relief And Structural Reforms, Not Hyperinflation

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Submitted by Philip Stive and Dennis Buitendijk

Europe Needs Debt Relief And Structural Reforms, Not Hyperinflation

Most developed economies are suffering from excessive debt burdens and are struggling to cope with this issue. The amount of debt is often so large that growth itself is hampered and the effect of any additional debt (to serve as a stimulus) is close to zero, or even negative. For governments and households to be in better shape in the future one part of the solution is to purge most of this debt from the system. There are various ways to accomplish this, but two are often being discussed lately.

The first option is to default on much of the debt. This will wipe out the current owners and management of most of the financial institutions providing a great opportunity to reform this sector to be beneficiary to society again, instead of merely extracting interest from credit that went to unproductive uses. Also it will be a long over due lesson that lending out money bares risk and that risk needs to adequately assessed by the creditorl only this way capital can be allocated to more productive uses and realise sustainable growth. And last but not least it will be beneficiary not only to debtors (which are relieved of much of their debt burdens), but also to savers. Since reducing the amount of credit outstanding is per definition deflationary, their savings will become worth more, and their prudent behaviour will finally be rewarded instead of the punishment they have been suffering for years by paying taxes on their savings, contrary to all the tax deductions available to interest payments. Critics of this approach say that this will lead to a deflationary spiral. However, GDP growth has been unsustainable for decades and we have just come out of the biggest credit boom in history which served to extend this unrealistic growth as long as possible. So, actually debt deflation is what we need: it is time to snip back to reality while avoiding the deflationary spiral. Allocating the previously mentioned savings productively can help to avoid this downward spiral. For instance reforms towards productive allocation of capital will open up opportunities for investment of these savings, especially if interest rates will no longer be manipulated through policy and investors are not ‘directed’ towards highly volatile and insecure markets.

Obviously there will never be a “good time” to purge the debt from the system, however, doing this at the top of a credit boom might actually not be a bad moment as it provides countries and households with a situation were they have more freedom to adjust to changes in the economy. For instance they can move closer to where there is work (because they can actually sell their house without being stuck with a huge amount of negative equity) or re-educate (because they are not burdened with student loans that prevent them from taking on new education), which should provide stimulus on its own to avoid a deflationary spiral. A study by the McKinsey Global Institute (Debt and deleveraging (2010)) shows that deleveraging through default is tough in the beginning, but that growth will quickly pick up at an increased rate and the subsequent 10 year GDP growth is the highest compared to all other solutions (and it will also yield the largest increase in GDP 15 years later, compared to when the deleveraging began). Worries about a deflationary spiral are mostly based on memories of the Great Depression, but the evidence of other default episodes shows that the outcome of the 1930’s is not the de facto result.

Another method is to turn on the printing presses. This will also relief most of the debtors from their debt burdens, because the real values of these loans will drop significantly. However, it leaves the current status quo and financial system intact, does not provide the much needed lesson on productive capital allocation, provides no incentive for governments to put in real structural reforms because of tighter credit conditions and it will only benefit debtors and not savers. Savers will be punished greatly, especially since there is no limit to printing currency and the central bank could carry on undisturbed for a long period of time. This will continue to ease the burden on debtors due to inflation, but looming hyperinflation will be devastating for everyone.

Until now both of the above options are off the table for politicians, and they have been kicking this choice down the road for a very long time now. They will, however, have to make this choice in the future as it is the only way out of the current situation. At the moment austerity combined with monetary policy that is supposed to spur growth is still believed to be the solution that can get us out of this mess. Only Swaziland in 1985 was able to actually grow its way out of an excessive debt burden (see ‘This Time Is Different’ by Reinhart and Rogoff). Assuming that Europe is like Swaziland and we can grow our way out of this mess, monetary policy actually seems to be the wrong tool to kick start it. Lose monetary policy is a supply side tactic that only sometimes works in cyclical down turns, however this is not a cyclical problem. This is a structural problem of too much debt and a lack of aggregate demand (especially for credit). On the other hand the austerity measures are aimed at short term revenue increases and expenditure cuts, which are unsustainable. This brutal form of austerity will send the economy in a downward spiral, making the debt problem even worse.

What is needed, in combination with the debt relief we talked earlier about, are structural reforms. The austerity or structural reforms should have the goal of preventing that countries will in the future end up in the same situation as they are now, but should not try to solve the current debt problem. Strong changes to entitlement programs are needed, as well as health care and housing overhauls, but these structural changes should be gradually implemented alongside a long term plan to reform. This gives society time to adjust, employees to re-school, homeowners and house prices to adjust and families time to switch to a more debit financed system of health care and education instead of one based on credit and student loans.

These structural reforms will require hard work, a long-term vision and a lot of patience, because they differ greatly from the often applied strategy of 'temporary palliatives' to keep citizens satisfied in the short run (e.g. tax breaks, 'cash for clunkers' and other such temporary stimulus-programs). Also the political climate in the United States and most countries in the European Union is limiting the pace of these reforms greatly. Congress in the USA has been gridlocked for months now over all kinds of legislation and the lead-up to next year's elections only shows more and more polarisation and extreme views being expressed. The advent of populist parties in Europe (most notably in Denmark and the Netherlands) leads to more extremist views and legislation there as well, but additionally the multi-party system in Europe is slowing down progress even further. Recent parliamentary votes in Greece, Italy, Slovakia and Germany showed the ongoing bargaining and discussion between parties on for instance the EFSF contributions: these deals were ratified months after the original plans and reforms were drawn up and have become almost obsolete already in the process. This shows how fragile the system is and it can (easily) lead to government break-ups even in times when strong leadership and swift reform is needed the most. So there seems to be an ongoing conflict between the limited time span of elected (multi-party) governments (say 4/5 years) and the horizon needed for structural reforms (beyond 5 years and most likely beyond 10 years).

A technocratic government could be very well suited to implement these structural reforms. However, technocratic can have different meanings, from the one-party China model to the technocratic-military hybrid-model in Egypt where strong military power is coupled with civilian expertise with respect to social and economic issues (The Economist, 19/11/11). These models are far from desirable in Europe of course, citizens simply would not accept them. Technocratic governments could however be successful for short periods of time and the situation as described in the previous section might be one: technocratic governments might be the tool to overcome the difficulties of implementing structural reforms and give countries a good fresh-start and long-term vision for the coming decade. This would be a very noble cause for any technocratic government, but as ever things are not so simple, since even technocratic governments have an "agenda".

The current governments in place in Italy and Greece are puppets of the banking system, making sure that countries do not default and pay as much interest for as long as possible by implementing short term austerity measures. This is not the type of technocratic government these countries need. They need a technocratic government that sees that the current debt burden is unsustainable and cannot be serviced, acknowledging that defaults are necessary. They should seize this opportunity to change the financial system and implement structural reforms, while exercising their powers to facilitate orderly defaults for both governments and household debt. This way countries will be able to start from a situation where there is breathing room to implement much needed structural reforms throughout society.

 

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Mon, 11/21/2011 - 11:45 | 1898590 GeneMarchbanks
GeneMarchbanks's picture

That made too much sense, you sir, are on notice.

Mon, 11/21/2011 - 12:01 | 1898648 eureka
eureka's picture

It takes a cool mind, say, like an Icelandic one, to exercise logic, here, the logic that when equity is gone investors do, and should and must, lose.

Investing is called "risk-reward" positioning for a reason - it is for adults, not babies.

Stop whining, all investors all over the world, and take your loses like men.

Your positions, anyway, are invariably leveraged up by fiat and fiat-game inflation/deflation strategies - i.e. you created nothing, but gambled. With the livelihoods of billions of people.

Multi-lateral defaults to follow. Cheers.

Mon, 11/21/2011 - 12:20 | 1898750 DaveyJones
DaveyJones's picture

and don't forget to take over your corrupt government and run your criminal bankers out of your country

Mon, 11/21/2011 - 12:32 | 1898841 GeneMarchbanks
GeneMarchbanks's picture

You too! On notice you logician you...

Mon, 11/21/2011 - 12:02 | 1898657 JR
JR's picture

The disappointing results of central planning...

Mon, 11/21/2011 - 11:47 | 1898601 transaccountin
transaccountin's picture

too honest. must rape the sheep with price stability

Mon, 11/21/2011 - 12:10 | 1898688 Libertarian777
Libertarian777's picture

"zee price stabilateee"

 

there corrected for you

Mon, 11/21/2011 - 11:48 | 1898603 Long-John-Silver
Long-John-Silver's picture

The Bankers no longer worry about installing puppet leaders. Italy now has Bankers in direct control of the country.

 

Mon, 11/21/2011 - 11:56 | 1898619 dwdollar
dwdollar's picture

"Another method is to turn on the printing presses. This will also relief most of the debtors from their debt burdens, because the real values of these loans will drop significantly. However, it leaves the current status quo and financial system intact, does not provide the much needed lesson on productive capital allocation, provides no incentive for governments to put in real structural reforms because of tighter credit conditions and it will only benefit debtors and not savers."

This is why, this will be the "solution" to our problems. Most people will "benefit" for awhile. Does it hurt savers? Of course... but who actually saves anymore? Not many. There isn't enough savers to stand up against the debt horde, that's for sure.

Mon, 11/21/2011 - 14:06 | 1899297 JR
JR's picture

Who actually saves anymore?

The Fed’s artificially low interest rates not only have robbed savers for the benefit of Wall Street, but the minuscule returns on fixed income are stifling consumption. There cannot be a functioning free market economy without sound money, nor future investment without savings. And contrary to Bernanke’s statements, savings in CDs, etc., are not “investments” and should not be there for the taking by central bankers and Wall Street risk takers.

Todd E. Petzel, chief investment officer at Offit Capital Advisors, a private wealth management concern, characterized the Fed’s interest rate policy last year as an invisible tax that costs savers and investors roughly $350 billion a year (based on the Fed’s artificially-low manipulated inflation numbers), according to No Money, No Worries.

He notes that this invisible tax is more than 2 percent of gross domestic product and almost 3 percent of disposable personal income. That is robbery, pure and simple.

 

Mon, 11/21/2011 - 11:53 | 1898620 RSDallas
RSDallas's picture

The market participants have already started the default process.  The governments and financial firms that try to buck the market will be wiped out.  The banksters (Bernanke) think that they can mask over the effects of too much bad debt.  They won't be able to, just like they couldn't do it in 1929.

Mon, 11/21/2011 - 11:54 | 1898622 jm
jm's picture

Should have been harping about this over a year ago.  We are at the point where monetization is needed to prevent collapse.

Mon, 11/21/2011 - 12:14 | 1898710 CPL
CPL's picture

Sometimes the object isn't worth saving.

Mon, 11/21/2011 - 11:54 | 1898627 Azannoth
Azannoth's picture

You are only looking at the perspective of the Drug Dealer(the Banks) but what about the Drug(debt) addicted populace?!

Regardless to what the solution is debt forgiveness vs. not, austerity will come home to roost and that means social upheaval no matter what,

I suggest you shore up all your assets preferably in a no EU/US jurisdiction and ride out the storm that is coming no matter what in a friendlier climate

Mon, 11/21/2011 - 11:54 | 1898628 kito
kito's picture

Europe Needs Debt Relief And Structural Reforms, Not Hyperinflation

 

yes, and that means........................downnnnnnn goes gold and silver.......downnnnnn goes everything not naliled to the floor, except physical cash.............

Mon, 11/21/2011 - 12:03 | 1898661 achmachat
achmachat's picture

Sure. You are right. Logic demands it. But for how long? Few weeks? Few days?
You really want to risk ending up with worthless paper just because you weren't able to time it right?

Mon, 11/21/2011 - 12:04 | 1898664 mayhem_korner
mayhem_korner's picture

 

 

Sure.  Wipe out all of the debt in just the right places so as not to crash the system, then re-start with the same ol' fiat that was used last go-round. 

I think you're a bit optimistic, Gen. Custer.  The numbers in play here have 4 commas in them.

Mon, 11/21/2011 - 11:55 | 1898634 Segestan
Segestan's picture

With no industry and no ponzi ... they will live in poverty... forever and ever .. amen.

Mon, 11/21/2011 - 12:17 | 1898731 linrom
linrom's picture

With landed-aristocracy living high in the Alps being entertained by Kyle Bass playing with his guns and gold coins.

Mon, 11/21/2011 - 12:06 | 1898636 CPL
CPL's picture

Debt relief?  Why?

 

No more of this dog and pony show, all that'll happen in that situation is we'll be right back to where we are in ten years.  People want Kenysian economic policy then jack up interest rates to where they should be.

 

Like 37.4%.

 

People discuss this like you get to pick from the salad bar of Keynesian and Austrian schools.  You can't they are diametrically opposed in terms of their capitalization.

 

Offering debt relief...how well do you think that will go over?  It'll be a exercise in cherry picking.  We all know it.  Who gets the hit, it'll be little people.  Who gets to keep the lions share of capital?  Largest dogs do.

 

So when people talk about the haircuts why?  Honestly why are they even considered?

 

One more inch, one more day to accumulate more debt?  Trillions of dollars of LABOUR, not money.  The Money is a direct reflection of the LABOUR put in to make the money.  So all that labour is now at a discount?

 

No, that is the path to hell that is paved with good intentions.  Just let it die.  Worse than the nonsense with the woman seven years ago that was a complete vegetable where the courts were getting involved on pulling her plug.

Mon, 11/21/2011 - 12:00 | 1898646 mayhem_korner
mayhem_korner's picture

Another method is to turn on the printing presses. This will also relief most of the debtors from their debt burdens, because the real values of these loans will drop significantly.

 

Not necessarily.  The real value of the loans only drops if the debtor is a beneficiary of the increased fiat.  There is no way of providing any assurance that the flow of fakebux will allocate according to the topography of the debt distribution. 

Mon, 11/21/2011 - 12:07 | 1898673 CPL
CPL's picture

That and we'll be right back to the same problem in ten years.

Mon, 11/21/2011 - 12:01 | 1898652 farmerjohn2112
farmerjohn2112's picture

The current government of the US seems, to me, also a puppet of the banking system.

Mon, 11/21/2011 - 12:08 | 1898677 CPL
CPL's picture

for the last 60 years...JFK was the last president to bitch about the banking system and look how well that turned out.

Mon, 11/21/2011 - 12:23 | 1898779 DaveyJones
DaveyJones's picture

and the dollar has no strings to hold him down

Mon, 11/21/2011 - 12:07 | 1898675 lynnybee
lynnybee's picture

The current government of the US seems, to me, also a puppet of the banking system.    ...gee, ya think so !   this is the most corruption i've ever seen in my lifetime, & i've seen a lot.     god deliver us from debt peonage.     a good time to repeat my signature statement:   

My grandma Jo (born 1915, god rest her soul) said :   Never trust the government & do not go into the stock market.    I get it now, grandma Jo ......... i finally get it.

Mon, 11/21/2011 - 12:14 | 1898715 slewie the pi-rat
slewie the pi-rat's picture

just how do you pronouce the author's name?

Buitendijk?

i thought so!

still, he may be qualified to run the europeon structural reform school.  it's up to the fuking nannies, now! 

Mon, 11/21/2011 - 12:16 | 1898728 Sophist Economicus
Sophist Economicus's picture

They need a technocratic government that sees that the current debt burden is unsustainable and cannot be serviced, acknowledging that defaults are necessary.

Uhmmm, WRONG!    What is needed is governments, put in place by the people of the country, that actually look after the People's interest.   And while we're at it, the ONLY structural reform required is that governments NEVER, EVER spend more than they are willing to TAKE from their people.   And if a mandarin ever steps across that line, he/she will be prosecuted, imprisoned and all of their assets sold.

 

 

Mon, 11/21/2011 - 12:32 | 1898790 rufusbird
rufusbird's picture

Great timing with relevant topic!

 

Mon, 11/21/2011 - 12:28 | 1898807 guiriduro
guiriduro's picture

Well, aside from the endorsement of technocratic over democratic leadership, I would largely agree.

I think default appears less 'dirty' when some facts are realised, namely, that the huge overleverage of the financial system worked its way into prices of everything, from the cost of land to, e.g. the hospital a local government built, whose suppliers would not have had the pricing power had the demand side not allowed so much money printing (bank debt issue of fiat currency), necessitating competing public sector projects as price-takers to accept inflated costs they had to take on debt to finance.

The whole crumbling edifice of existing debt (existing obligations) needs a reset, and much the better if needed structural reforms both in the financial sector and in the political sphere occur simultaneously.  It won't be pretty of course, many investors will be burned, but that short term pain is hardly a reason to continue the current unsustainable debt burdens continue at par whilst seizing up economic activity solely for fear of the insolvency of counterparties (the trick will be, to borrow a poker metaphor, to 'call' all hands, eliminate the bluffers, eliminate obligations - debt - which inhibits growth, that will finally allow economic actors to re-engage in productive activity with confidence.)

Mon, 11/21/2011 - 15:44 | 1899746 ex VRWC
ex VRWC's picture

You are advocating jubilee.  It will have to be at all levels - you will not stop it at sovereigns or banks.  When debt is meaningless, it will be meaningless everywhere, at all levels, from governments down to the local grocery store credit line.   Once you do this, you devalue debt for a very long time into the future.  You basically kill the credit system, which is entirely predicated on confidence.  

If debt is meaningless where does confidence come from?  You cannot say 'just this one time, we will go ahead and restart the system, but we won't have a jubilee again'.   

Unfortunately, the end result of jubilee is not a return to a productive society that allocates capital effectively.  The end result is an entirely hard asset based financial system.  You are looking at a decades-long reset cycle. 

Just sayin'.  We need to assess the long term results of these answers that sound so easy.

 

 

Mon, 11/21/2011 - 16:25 | 1899888 Juan Carlos Cantu
Juan Carlos Cantu's picture

This posts talks nothing about capital mobility. Nothing about labor mobility and the problems Europe faces in those areas...

http://thechinonomist.blogspot.com/2011/11/new-baby-is-being-born-call-d...

And as far as monetization, I agree. Politicians are for short term fixes, which is I the situation with Europe in the short term is a game of chicken b/t Draghi & the vigilantes

http://thechinonomist.blogspot.com/2011/11/dont-call-me-chicken.html

And finally, to think that savers will be rewarded by cash worth more if deflation ensues, well, that assumes their savings were not deposited in a failed bank that went under with the depression ensued by letting debt be forgiven.

Tue, 11/22/2011 - 02:11 | 1901617 RiskAverseAlertBlog
RiskAverseAlertBlog's picture

Dudes, you are pitching weak tea to a nation whose first Treasury Secretary was Alexander Hamilton. There'll be a restructuring alright, along with sovereign currencies anchored in the productive might of national economies protected and developed with credit uttered from national banks: all in the inexorable need for return to a system of finance whose transparency restores confidence and whose accountability to the posterity of real, live human beings is unimpeachable. The adjustment time necessary to attain discipline will be instantaneous, as opposed to your decade or more. So, it's back to the King's drawing board for you...

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