Monday, November 14th, 2011
10

Will We Learn The Lessons Of The Current Crash?

I would like to think that if we make it through the persistent financial troubles of our age and eventually return to some semblance of economic prosperity, the inevitable crash that follows on a few years after will be met with the knowledge that austerity is not a solution to recession, because we have run that experiment this time around it is impossible to argue otherwise, but I know that it's not gonna be the case. Because we're not gonna make it through the persistent financial troubles of our age. It's all downhill from here, folks! Watch out for those fires.

10 Comments / Post A Comment

deepomega (#1,720)

Why can't the lesson be, we can't as a global economy afford to give everyone pensions?

HiredGoons (#603)

@deepomega: CLASS WARFARE!!!!!!!!!!!!

deepomega (#1,720)

Also I mean, causing the eurozone crisis a "recession" is misleading. It's a bursting bubble.

jfruh (#713)

Can someone explain a thing to me, because I am dumb? One of the things I've heard thrown around is the statement that "the problem isn't deficits, it's debt." Italy actually has had low budget deficits, lower than Germany's (which I understand to mean that the Italian government spends fairly close to what it takes in in taxes and fees, and here "spends" includes spending on interest on its national debt). Spain too! Yet both countries have a lot of debt outstanding, and as interest rates on that debt go up, shit gets hairy.

My question is, if Italy and Spain have low budget deficits, how'd their debt get so big? Is this just a case of them having spent like crazy in the '70s or something? Conversely, why *doesn't* Germany have a big debt to service? I want to think that it's a simple matter of "do you take in more than you put out or vice versa" but this Economist article brings in all sorts of stuff like trade imbalances and private citizens' savings that seem not directly relevant.

OR (since debt is usually expressed as a percentage of GDP) is the problem not the absolute size of the debt but its size relative to the economy, i.e., Germany has a debt just as big but through German workaholism grew its economy so that its debt is easier to service?

Flaneur (#998)

@jfruh I believe part of the problem is that as members of the euro zone, Spain, Italy, Greece and the others can't pursue the normal remedies available to sovereign central banks (i.e., printing money). As for how the debt got so big, I think generous employee and retiree benefits played a part. But I'm no expert myself.

Flaneur (#998)

Or we can let the Economist explain it:

"Debt in these countries has become a burden not because of government profligacy but because each enjoyed a decade of low interest rates and was then hit by the financial crisis. Easy credit fuelled debt in households and the financial sector. The European Central Bank oversaw a binge of cross-border lending. In the crisis unemployment and hardship have deepened, increasing the bill for welfare. Some countries, such as Ireland and Spain, have needed to find money to prop up their banks. These new expenses fell on the state just when tax receipts collapsed—catastrophically in countries that had seen a property boom.

"At the same time interest rates surged. Before the crisis investors assumed no euro-zone government would default on its debt. However, as Peter Boone and Simon Johnson of the Peterson Institute in Washington, DC, explain, Germany then signalled that defaults could happen and that investors would have to bear a share of the losses—a reasonable demand, but a hard one to introduce in the middle of a crisis. Some investors asked to be rewarded for the extra risk and others, unwilling to start paying for credit research, just walked away. This set off a spiral of falling bond prices, weakening banks and slowing growth.

"Even where troubled euro-zone countries had not been profligate, they have been running unsustainable current-account deficits…."

SeanP (#4,058)

@Flaneur Another part of the problem is that the Eurozone is partly like a nation (in that it issues its own currency) but partly like a group of independent states (in that there's no EU level taxation and spending authority). So whereas the US has federal level programs that tend to (gasp) redistribute income from rich areas to poorer areas, in Europe, no such thing is happening. Also, related to the money supply: the ECB is controlled by Europe's richer countries (read: Germany) who have an incentive to keep interest rates high and inflation low… but that punishes the poorer, debt-ridden countries.

I don't think Europe can keep on going in this intermediate state that's less than a federation but more than just a grouping of friendly countries. They're either going to have to achieve real political union, or (more likely) the euro is going to collapse.

jfruh (#713)

@Flaneur Yes, I actually did read the Economist piece, but the very parts you quote are the ones I don't get, because, as mentioned, I am dumb!

As for how the debt got so big, I think generous employee and retiree benefits played a part.

Right, but as aforementioned everyone keeps saying that Italy (for instance) isn't really spending more (or much more) than it takes in, so why does it matter if some of that spending is on employee/retiree benefits? Or is the problem that future retirement benefits aren't actually figured into the whole "spending vs. income" budgeting calculus (as they SHOULD be in any sane world, though I know the world we live in isn't sane!).

Debt in these countries has become a burden not because of government profligacy but because each enjoyed a decade of low interest rates and was then hit by the financial crisis. Easy credit fuelled debt in households and the financial sector. The European Central Bank oversaw a binge of cross-border lending. In the crisis unemployment and hardship have deepened, increasing the bill for welfare. Some countries, such as Ireland and Spain, have needed to find money to prop up their banks. These new expenses fell on the state just when tax receipts collapsed—catastrophically in countries that had seen a property boom.

This is the core paragraph I don't quite understand. If I'm reading it right the debt in question is not government debt (as the Economist says, these governments were not living beyond their means pre-crash) but rather debt held by citizens and banks. And yeah those people/institutions who were left standing when the music stopped now owe a shitload of money and have no obvious means to pay it back. It's not clear to me how that private debt suddenly became sovereign debt, though, except I guess in Ireland where the government had to just step in and take on the debts for the country's bankrupt banking sector? But nothing like this happened in Italy, right?

myfanwy (#1,124)

@jfruh I'm going to lay my Econ 110 on you and hopefully get it right. The next paragraph from the article answers your question:

Even where troubled euro-zone countries had not been profligate, they have been running unsustainable current-account deficits. Low interest rates fuelled domestic spending and spurred inflation in wages and goods, which in turn made their exports more expensive and left imports relatively cheaper. But it was also because Germany was recycling the surpluses produced by its export machine, financing their consumption.

Private and corporate debt affects governments, as well as interest rates. Interest rate goes down -> people borrow more money to buy stuff, either goods or houses or land or whatever -> inflation goes up, since everyone wants/can buy a new house (cf. housing bubble) -> everything gets more expensive, even for governments -> government needs more money to operate.

Governments get money in a couple of ways: if they have their own currency, they issue bonds (which they must repay at an agreed-upon date with interest), they print money. To stimulate spending (getting Keynesian in here) they can also lower the overnight lending rate to banks, since banks borrow money from the central government reserve in order to have enough to turn around and lend it out to citizens. If they do not have their own currency or control over interest rates, they have to raise taxes and user fees. (This is why cutting taxes counts as gov't spending.)

Now, with inflation already rising, people are getting squeezed. But, as long as other people keep buying (Germany, in this scenario), things will be OK – for a bit. But add in more taxes and fees, things start to get a little unseemly. And once banks start raising their interest rates to cover their own asses, things get downright outrageous. People start defaulting on things – mortgages, bank loans, taxes. Businesses become nervous and stop hiring, or downsize, or just stop borrowing money in general. Since inflation is high in your country, other people don't want to buy your stuff. Everyone starts buying imports, since they're cheaper than domestic products. (As a Canadian, every time the CAD goes above par, our deals with the States drop.) So exports/productivity drop. People lose their jobs. Government revenue drops. Bank revenue drops. Welfare and other social safety net demands increase. If this gets bad enough, banks start demanding bailouts. (As to why government bails out banks, you'll have to ask the US government.) People start trying to sell stuff – land, houses – in order to make money. Now everyone's trying to sell things – the price drops. Your assets are worth much less, and you can't borrow as much against them – this applies to private as well as public entities. Your exports are dropping, you have no money to buy imports, and more and more people are becoming unemployed. Recession!

As for how you get out of this: Er. That depends on what school of economics you subscribe to and I don't have enough time to go into this since I have spent an awfully suspicious amount of time typing this out on my computer when my job requires very little typing at all. Hope it's been useful.

Private and corporate debt affects

myfanwy (#1,124)

Gyaaah! Ran out of time! Disregard that sentence fragment! Now imagine your banks have been flirting around with derivatives and mortgage-backed securities and other lovely terrifying things and you see how things got so bad in the States.

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