Thursday, May 10, 2012

Europe and "Total" Debt ... Lessons for Us

The developing story of accumulated debt in European countries, both public and private, and its debilitating impact on those countries and their citizens, is a cautionary tale for We the People.

To begin the story, let's acknowledge that too much total debt in relation to income will lead to bankruptcy. So how much debt is too much is always the right question to ask.

But what shall we consider as total debt? That's what we'll address herein.

Simpy put, it's all the debt owed in whatever form, private as well as public, contingent (unfunded pensions, for instance) or explicit. After all, we're all on the hook for its repayment, one way or another.

However, when talking about the evils of excessive debt, we often and incorrectly tend to focus the discussion only on the nation's explicit debt obligations, but that's only a part of our overall indebtedness.

We the People owe the money we've previously borrowed, whether it's been borrowed explicitly on our behalf by government officials or by us, directly or indirectly. That's because all sources of funds to make interest payments and pay off the loans must come from individual citizens and taxpayers, whether acting as local, state or national payers, or whether acting as individuals or as part of our broader society.

Accordingly, we are not only obligated to repay local, state and federal debt, as well as school district, water, sewer bond borrowings and such. Individual credit card debts, student loans, home loans, car loans and such are also part of our cumulative debt equation.

How will we repay the money?  Only with accumlated wealth or by future economic growth driven by the private sector. There's no other way.

The Value of Money

In the meantime, stable money is something creditors require to continue to loan funds at low interest rates to solvent borrowers.

When the currency becomes unstable and inflation ensues, creditors charge more in higher interest rates or withdraw from lending more money to unacceptable credit risks.

In that regard, loaning new money to governments, especially in Europe, is becoming a most risky endeavor.

Yet governments today need low interest rates to be able to continue to make the mandated interest payments on their massive borrowings. And they can't repay the principal owed on current loans outstanding. Thus, they need to "roll over" existing borrowings and assume new loans in their place, often at much higher interest rates. This assumes the lenders are willing to "roll over" existing loan, by no means a certainty these days.

As a result, governments try to keep the lid on interest charges by something called "financial repression," a way to gradually weaken the value of their currencies while keeping current interest payments low.

This clearly unsustainable game can only go on as long as creditors believe in the ongoing solvency of the government borrower and that low inflation and stable money will continue. We're in risky times.

Summing Up

The foregoing overview was meant to set the stage for a more in depth discussion of the cumulative debt and deficit debacles now facing European countries in general and Spain specifically. Ours, too.

And much of that enormous debt debacle relates to big government spending, entitlements and real estate. Sound familiar?

The U.S. has many lessons we can take from Europe and Spain. So let's get on with it.

The easy economics KISS method can help us better understand what may be Europe's biggest problem of all. Too much debt---everywhere and owed by virtually everyone--- accompanied by high unemployment, an uncompetitive economy and too little private sector economic growth.

How to stop total debt from growing exponentially is the real issue. 

That said, remember the hole theory. To get out of the hole, we must first stop digging.

In simple terms, the private sector is the key.

Thanks. Bob.