Who defaults first: Greece or the US?

http://www.bbc.co.uk/news/business-14025485

by andrewaylett • 15 years ago

23 46 15 years ago

bbc.co.uk

I find it hard to believe that some kind of agreement won't be reached, whether it'll be a sensible one or not, but it's certainly fair to say that there's a chance of disaster, and that a US default would be an awful lot worse than a Greek one.

thaumaturgy2• 15 years ago

An agreement absolutely will be reached, but that doesn't make the situation much better. It's quite likely that Congress will have to accept yet another increase of the debt ceiling, while we'll see even more cuts from social services at home.

nhaehnle8• 15 years ago

This whole discussion is very depressing, because it highlights how uninformed the people are about what government debt represents. At least that is what a poll with 70% against raising the debt ceiling tells me.

Government debt equals private assets, and so being against government debt is being against (at least one form of) private assets.

If you are against the accumulation of private assets for whatever reason (for example, because you're a communist - see what I did there?), there are still better ways of preventing that than making the government commit economic suicide.

Honestly, the US should just get rid of the debt ceiling altogether, and recognize that the size of the budget deficit needs to be benchmarked not against pseudo-religious standards, but against how much productive capacity is available in the real economy - because that is what you need to look at to prevent inflation (which is the only possible negative economic outcome from a budget deficit that is too large).

Edit: I would appreciate some feedback on why people vote me down. I try to reply to questions and criticism as to the contents of what I write in a calm and clear fashion. I hope people don't just vote me down because they disagree with something that I write, or find it politically uncomfortable.

nodata2• 15 years ago

Why does government debt equal private assets?

and another question: why does a huge thing like a country need debt at all, shouldn't it (on average) be debt free?

dexen• 15 years ago

> Why does government debt equal private assets?

Not that I fully agree with his assertion, but: Gov't debt usually takes form of `bonds'. Such bonds are issued for fixed terms and traded on free market. Both private and institutional investors (including other countries) invest in bonds, thus some of gov't debt will normally be in hands of private investors.

Government bonds are considered highly secure and reliable means of investment, if somewhat low-yield. That allows the issuing country to rely on bonds for matching income to expenditures any time it needs to, at rather low cost. Should a country declare bankruptcy, or just near it, this instrument is much harder to use for the govt.

Consider having a look at http://en.wikipedia.org/wiki/The_ascent_of_money which covers the topic pretty well.

tobylane4• 15 years ago

Government debt is apparently a good thing, it encourages internal private (businesses of that country) growth. I can't find more about it, it is something worth understanding properly.

nhaehnle8• 15 years ago

> why does a huge thing like a country need debt at all, shouldn't it (on average) be debt free?

Axiomatically, if you sum up over all worldwide assets and liabilities, they sum to zero. That is a fact that simply follows from accounting. So the world as a whole is (net) debt free (until we start trading with extraterrestrials, then things might change).

The US probably is roughly net debt free on average, summing over all domestic private and government assets and liabilities. I don't have time to run the numbers right now. Certainly, even if the US is not debt free on average, its net debt towards foreigners is much less than the government debt, and also less than the sum of government debt held by foreigners.

If people just stopped looking only on one side of the coin, they would realize that and chill out over the government debt.

mongol• 15 years ago

Why is it so good with private assets that most likely are outside the country? How does it help taxpayers?

nhaehnle8• 15 years ago

First of all, "most likely" is false. Actual numbers can easily be found, here's a secondary source: http://en.wikipedia.org/wiki/File:Estimated_ownership_of_tre...

So less than one third is held by foreigners. This is more than for most other countries, but keep in mind that much of world trade is still run in US$ - this is what people (hopefully) mean when they say that it is a quasi-reserve currency, which naturally drives up demand for US$-denominated financial assets.

Second, the fact that so much of those assets are held by foreigners has greatly benefited US citizens up to this point in time, because the foreigners holding those assets obtained them by selling their products to the US. So the US was able to receive a lot of real, physical goods that cost actual physical resources and work to produce, in exchange for the US simply running a computer system on which accounts are managed. If you ask me, that is a very good deal.

Now, once China gets their act together and becomes able to change their economy into one that is not so export-heavy, they will sell of their assets over time. This will force the US to become a nation with net exports again.

But from the perspective of US citizens, the worst case is that the US enjoys more physical resources (than it would be able to without trade) now at the cost of enjoying less (than they would be able to without trade) in the future. And in fact, they cannot even be forced to take that full hit in the future, because they could always choose to inflate the debt away.

Now you may say that you would rather suffer a decrease in resources that you can enjoy now than suffering that decrease in the future. That is a reasonable political stance.

However, the reality is that especially China is hell-bent on sending real goods to the US in exchange for paper. Trying to cut the budget deficit or to reduce debt directly is not going to change that. In fact, it will hurt US citizens long before it will hurt China.

The only way to stop the flow of financial assets towards foreigners is via a combination of trade barriers and helping China to turn their economy into a domestic-consumption-based economy.

nhaehnle8• 15 years ago

I should probably add some information on where my analysis is coming from. I am writing from a perspective of Functional Finance and Modern Monetary Theory. You can find a clear intro to the latter here: http://pragcap.com/resources/understanding-modern-monetary-s...

One of its most prolific proponent is economics professor Bill Mitchell who blogs here: http://bilbo.economicoutlook.net/blog/

See his Debriefing 101 category for more introductory posts: http://bilbo.economicoutlook.net/blog/?cat=11

borism2• 15 years ago

Thank you! MMT was very eye opening for me.

Steko• 15 years ago

Well I gave you an upvote for reaching the correct takeaways (public uninformed and we need to raise debt limit) but I can see a couple reasons you might be downvoted:

(1) Presenting a heterodox theory as fact or mainstream.

(2) Muddled argument. The whole "being against government debt is being against private assets" line is incredibly weak. The less forceful but less controversial version of this argument is simply that the debt is a (possible) long term problem but we have a real short term crisis that is more important. As Brad DeLong says if you have some corroded gas pipes that might explode in 10 years you'll want to fix that eventually but that doesn't mean you don't turn on the heat during a blizzard.

bad_user2• 15 years ago

So, this may be a stupid question but - What happens when a country defaults? What are the consequences of that?

jvdh2• 15 years ago

Basically, it renogatiates the terms of outstanding debts to a new interest rate, and longer terms.

bad_user2• 15 years ago

So that doesn't sound so bad.

Why are people freaking out on the US, Greece and Spain?

Sorry, I'm totally unfamiliar with these things.

borism2• 15 years ago

This is called restructuring, not a default.

tobylane4• 15 years ago

Their loans get more expensive, and everyone who loaned to them has to write off the loans, or extend them a lot. Greece's loans are currently 1 year, if I understood correctly the plan for their default is to turn them into 30 year loans, like South America did ~25 years ago.

Also, like Greece is now, the country has to have massive public service cuts, and tax hikes. Have the republicans been asked about the possibility of this?

StavrosK2• 15 years ago

I read an article the other day about how about 54% of an average salary goes to the government in one form or another. Unfortunately, it's in Greek, but, from what I saw, it was very accurate.

skarayan• 15 years ago

It depends on many things including the size of the debt and to whom. In the least, it will damage the reputation of the country, make it harder to borrow in the future, and hurt its relationships with other countries.

What happens when a company defaults on its debt? Its rating goes down, reputation is hurt, etc. Same deal, except it's more global with a country.

retube• 15 years ago

A lot of people lose a lot of money. Many institutions hold first-world sovereign debt as supposedly almost risk-free investments with guaranteed (fixed-income) returns. These institutions include banks, pension funds and other investment funds and vehicles into which both corporates and individuals will have invested their money.

Plus you also have those that have insurance against a sovereign default, largely through credit default swaps (CDS). However unlike many forms of insurance, you don't need to actually own the bond to take out a CDS on it. In this way many people will trade the risk of a Greek default without actually going anywhere near the physical asset. Being a derivative product, the size of the CDS market on Greek debt is likely to be many, many, many times greater than the size of the underlying basket of bonds.

So if Greece defaults - or even "technically" defaults, which could include the proposed rollover into longer-dated bonds - this could have huge implications for people who are short this insurance. They're all going to have to pay out.

Apart from the direct financial impact, with Greece you have the additional embarrassment and complication due to being part of the Euro. Greece may be forced to leave the single currency, which is going to be a costly and messy exercise, and severely damage the reputation and credibility of the currency.

nhaehnle8• 15 years ago

Since other commenters focus on the negative effects of the default, let me explain the potential positive effects for the citizens of the country of a default combined with an exit of the Euro in the case of Greece. (There are no potential positive effects of a default for the US.)

The major problem that is facing Greek citizens these days is that because the Greek government's hands are tied in monetary things, the country cannot achieve its full potential.

Since Greece was a net importer for a long time, money has been leaving the main part of the Greek economy [1]. Now Greeks no longer have as much money to afford imports - which would be only fair in some sense - but worse than that, they no longer have money to pay each other. This is what causes the very high unemployment in Greece.

Now you would say, if you have person A who would like to sell to person B, and person B who would like to sell to person A, and neither of them have any money, they could still do their transaction, and so not having any money to pay each other is not a problem. That is true in this very simple scenario.

The real modern economy is much more complex than that, and situations where two people genuinely just trade with each other almost never occur. So Greece has become stuck, people are unemployed, which means that the country is not reaching its productive potential.

By re-introducing its own currency, the Greek government could restart the spending cycle.

It is without doubt that a new Greek currency (NGC) would immediately drop in value compared to other currencies. There is nothing that can be done about that, and it is the reason why a reintroduction of NGC needs to go along with a default (or a technical default where the debts are revalued once in NGC, so that the exchange rate no longer matters).

It is also true that the short-term pain for Greeks would not go away immediately. Imports would be very expensive in NGC and difficult to afford, but this is not that much different from the current situation where imports are difficult to afford because the money is missing.

Most importantly, the Greek government would be able to introduce an economic expansion program to put people to work, so that the real capacity of Greece itself would be used fully to the benefits of Greek citizens.

Edit: I should add that this scenario has already played out in the case of developing countries and particularly many times in South America, e.g. in Argentina.

[1] Of course, there are also very rich Greeks. However, they save their money and don't invest in Greece at this time (because the economy is bad), so their money does not enter into the picture.

turbojerry• 15 years ago

Yes something similar has happened in Argentina as you mention, however perhaps you are not aware of the negative side, I would recommend you read FerFals blog-

http://ferfal.blogspot.com/

You'll note the current entry, 4th July 2011 is "10 Things you must know about Home Invasions" proceeded by "Survival Kits" and a little further down "Armoured Vehicles", or perhaps if you're interested in how business is conducted after such a collapse you might read this article about doing business in Argentina-

http://www.inc.com/magazine/201106/doing-business-in-argenti...

Andrew_Quentin2• 15 years ago

I am not sure if this is correct, but I think one consequence would be that the lenders will take over the assets of the country such as public industry, forestry, etc, as it happened in Russia and sell them at any price to whoever wants to buy them.

blumentopf• 15 years ago

Hilarious typo in a headline in the middle of that article:

"Pubic opinion"

stayjin3• 15 years ago

An honest, yet a little bit provocative, question: The "mainstream" explanation regarding Greek dept is because Greeks are bon viveurs who spent all the money they could put their hands on on drinking and gambling without financial control. Does anybody know any explanation regarding the US debt?

Who defaults first: Greece or the US?

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