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Everything Has A Limit

Poker, economics, and personal crises, a three-for-one deal

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Cry wolf and bring forth the dogs of more
peterbirks
Martin Wolf in the FT this morning, while pondering the sanity of Dominique Strauss-Kahn, observed that economic orthodoxy, which for the past 70 years (since Keynes) has assumed that public deficits are somehow "different" from private debt, was proving to be substantially incorrect. "Private debt becomes public debt and private deficits become public deficits very quickly" he wrote.

This is a cunning observation and it's a pity that it's buried at the back-end of a piece on DSK. It's cunning because it unveils an implicit assumption in the eurozone that Keynes was right and that government debt is somehow "different". This means (this thinking implies) that transferring German and French bank holdings of Greek debt to the European Central Bank somehow turns it into something else that is less toxic, less a piece of shit.

One can understand the assumption. After all, if the UK government's pension debt were moved in the other direction, into the private sector, the deficit would have to be made up fairly sharply and there would be a crisis. If moving a debt from government to private makes things worse, surely, by implication, moving it from private to public makes it better?

Not so. As Wolf writes, shifting the burden of past bad lending and borrowing from the banks to the taxpayer just means that shareholders (who made the decision to buy the bloody stock) lose less and taxpayers (who made no such decision apart from as a society electing the fools acting on their behalf) lose more. Nothing has been "magicked away".

And Wolf also concludes that there is one slight flaw in this brilliant ploy, one which bankers, with their legendary lack of imagination, cannot see (re yesterday's blog on bankers assuming that if something stops being the bankers' problem, it stops being a problem).
The problem with the strategy of imposing the burden on taxpayers in borrowing countries is that it is not going to work.


In other words, the private sector is going to have to take a hit. All that is up for debate is which part of the private sector takes that hit and how much of a hit it is going to have to take. The current battle lines seem to be structured in such a fashion that a few operations will take very big hits, while others will take no direct hit at all. In practice all that this will mean is that the secondary players will take a "derived hit" further down the line. It would probably mitigate the effect if they could all agree to take a fair share of the haircut at the same time (which in effect was how Lloyd's was rescued in the early 1990s) but the prisoner's dilemma comes into play here.

All of this ties in neatly with another piece by John Plender, cruelly tucked away near the back of "Companies and Markets" in a place which most people never visit. Plender's analysis is shockingly bleak, referring to a commodities bubble (true) a new asset price bubble (as in fine art), also true, and a new Internet bubble where one-trick ponies such as LinkedIn, Twitter and Facebook are given insane valuations, as if Friends Reunited and AOL had never happened.

It's also becoming easier to borrow money. Plender reiterates what Pimco's Gross said earlier this week that the European Central Banks are still offering liquidity solutions to solvency problems. Indeed in Europe this fundamental denial of reality is scaling greater heights of absurdity that the politicians have to invent new financial words ("reprofiling") to try to disguise the obvious fact that they have got it wrong. If one transfers this back to the Wolf analysis, the conclusion is that more and more debt will be transferred from the priovate sector to the public sector in the belief that this will somehow make it "better". That in turn will have one of two outcomes -- massive political upheaval when the voters decide that they won't take any more of it, or massive economic upheaval when it becomes clear that public debt is,. actually, not different from private debt at all, not in the current global interlinked economy.

So, one of the conclusions is revolution, while the other is a collapse in one of the fundamental building blocks of modern society -- that government-issued money is worth more than the paper it is printed on.

Plender seems to imply that the "Black Swan" will take the second form and that it could reveal itself through the collapse of a major clearing house. As Plender says, it's impossible to predict what will be the trigger or precisely when it will happen -- that's the nature of a Black Swan. But that does not mean that you cannot safely predict that a Black Swan will eventually make an appearance.

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Rather a nice one-liner from Wolf, that:

The problem with the strategy of imposing the burden on taxpayers in borrowing countries is that it is not going to work.

So, then. What was that "growth" thing all about? I'd be interested in a rough quantification of how much of the Eurozone growth over, say, the last ten years was in fact merely an accumulation of debt.

Even more interesting would be a comparison between different countries, or the banking sectors thereof. Germany would not come out well, I suspect, but then the good old UK would probably be shooting off the top of the charts.

An interesting question that. How much of our "growth" has been illusory, because we have borrowed from the future to pay for it? My guess would be at least 50%.

PJ

(And actually I have no problem whatsoever with debt, per se -- my own personal finances prove this -- so long as it is used to improve the infrastructure.

(Oddly, I see very little evidence of this.)

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