posted on 29 January 2016
Former BIS Chief Economist Warns Of Massive Debt Defaults, Need For Debt Jubilee Fingers Europe As First In Line
by Yves Smith, Naked Capitalism
Appeared originally at Naked Capitalism 26 January 2016
When you hear an orthodox economist, particularly one who was early to warn of the dangers of real estate bubbles around the world, speaking of a debt jubilee as the best of bad option, you know a crunch is coming.
Here is the key quote from William White, former chief economist of the Bank of International Settlements, in an exclusive interview with Ambrose Evans-Pritchard of the Telegraph:
White gives a dire set of underlying causes, and one of them is what economists would call a lack of policy space, which in layspeak means "no remedies available to treat the disease." Yet even though White is almost certainly correct as to the endgame, which is that many people who hold financial assets will find that they are worth a lot less than they believe, one of the reasons is that even people like White, as he exhibits in this interview, subscribe to economic beliefs that are part of the problem. In other words, there are treatments that would work, even now, but mainstream economist reject them and thus look as if they will have to relearn the lessons of the Great Depression.
Mind you, White is largely correct, most of all in his pointing out that debts need to be written down, and if they aren't in a formal manner, they will be forcibly written down, via default. But where he errs is in deeming debt always and ever bad, and in further not acknowledging (or recognizing) that for a fiat currency issuer like the United States, using debt to finance government spending is a political requirement, not an economic one. The federal government could simply deficit spend, but our funding procedures are a holdover from the gold standard era. Thus some of the lack of policy space he complains about is due to self-imposed constraints, like the perverse and self-destructive fear of running deficits in economies that are tipping into deflation and have plenty of underutilized resources.
Let's parse the interview.
What White Gets Right
Losses are baked in; the question is when and how loss recognition takes place. From the article:
Yves here. This passage reveals the real problem: the upheaval, specifically the recognition of losses by lenders and investors, which is mistakenly perceived as a transfer to borrowers, as opposed to a coming to terms of creditor bad decisions and/or bad luck, is what the political classes have been desperately trying to avoid. It not only will end the delusion among the wealthy that the ZIRP-inflated value of their financial assets was real. It will also create a crisis among retirees who have been forced by policy to rely less on government-run retirement programs and into private retirement programs, where studies have shown that the viability of those accounts is determined almost entirely by investment results in the decade prior to retirement. In other words, unless we see serious intervention, expect the neoliberal "Die sooner" prescription to be in operation in a bigger way than ever.
Europe is likely to be where the storm hits first. Again from the article:
A Chinese devaluation would be destabilizing. Not news, but important to keep in the mix:
What White Gets Wrong
White depicts debt as always bad. This is a crock and here is why:
Now with that caveat, there are plenty of parties who ought to be careful about borrowing. For instance, household debt levels are negatively correlated with GDP growth. State governments like New Jersey and countries that don't control their currency (like member states of the Eurozone or countries that run currency pegs) do have to be mindful of their borrowing levels. But even that idea puts the shoe on the wrong foot. It's lenders who are supposed to not make stupid loans since they are the ones at risk. Borrowers are too often overly optimistic or even crooked. The "blame the deadbeat" meme of the post crisis era shifts blame away from reckless or incompetent lenders and crooked securitizers who were confident they could dump their crappy credits on unsophisticated investors.
But White's aversion to borrowing of any sort is tantamount to ruling our more fiscal spending, when that is precisely what the economy will need more of, particularly as credit losses are realized, voluntarily or not. We've said since the crisis that the medicine that was needed was debt restructuring coupled with aggressive deficit spending to counter the economic downdraft. This formula is not magic but the same bad orthodox thinking that helped produce the crisis rules it out as a policy option.
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