Sovereign debt bubble thread

[The Minsky Moment]

So fiscal deficits are not the cause of rising sovereign yields? 

Was the European economic crisis cause by rising yields on sovereign debt?

Or are rising sovereign debt yields one of the adverse impacts of the European economic crisis?

[Admiral Yi]

Was the European economic crisis cause by rising yields on sovereign debt?

There was no crisis when Greece was paying 12 bps over Bundt cakes.

[The Minsky Moment]

There was no crisis when Greece was paying 12 bps over Bundt cakes.

And?
Is the theory that Greek government debt levels caused the collapse of the real economy of the entire Eurozone?  Because that would be backwards.

Greece in itself is a non-issue.  The EU could have assumed the entire stock of Greek public debt at any time without breaking a sweat. 

[MadImmortalMan]

No Greece started a wave of skepticism in the debt market that caused higher levels of investor scrutiny on previously ignored problems, which caused higher bond yields for others as well. Which then caused greater weakness in the balance sheets due to higher debt service costs.

It's not particularly Greece's fault. They're just a catalyst. The problem was the underlying debt all along. It's a question of potential energy waiting to be unleashed. When I say underlying debt I mean everyone's. Banks, consumers and especially sovereigns since that's who winds up holding the bag in the end.

[citizen k]

Re Krugman - I'm not going to slog through a two hour video.

At around 39:00, the Spanish professor addresses the demand-side description of the world

Krugman's less-than-happy response (which sparks quite a rowdy argument) begins around 48:20

[Admiral Yi]

And?
Is the theory that Greek government debt levels caused the collapse of the real economy of the entire Eurozone?  Because that would be backwards.

Greece in itself is a non-issue.  The EU could have assumed the entire stock of Greek public debt at any time without breaking a sweat.

The theory is that the bond market woke up one morning, realized that PIIG debt levels were unsustainable, and started demanding substantial risk premia.  The PIIGs responded by cutting deficits, which is tautologically contractionary.

[Martim Silva]

The theory is that the bond market woke up one morning, realized that PIIG debt levels were unsustainable, and started demanding substantial risk premia.  The PIIGs responded by cutting deficits, which is tautologically contractionary.

Nah, not really. That wasn't the problem, and Germany knows that.

Very short version of the problem:

- The current economic system requires ever-increasing amounts of debt to keep going;

- Banks eventually had to lend to people they shouldn't, and also developed financial instruments that were quite risky.

- The burst of the housing bubble in the US put an end to all this.

- The increase of bad loans eventually turned the tables on the banks, which started to incur huge losses; their capital ratios were wiped out repeately;

- Banks thus became unable to fufill their role and stopped lending to anything but the safest options; Whithout aid, most ever effectively dead in the water.

- The US had to do a 1st bailout after the collapse of Lehman shown that the financial system is so interconnected that it cannot survive the shock of so many institutions failing;

- As a result, governments in the West now have to hand out large sums to the banks, while at the same time facing increasing costs due to unemployment, facing reduced revenues, etc. the US deficit explodes and has no chance to be reduced, despite the politicians' claims.

- Central Banks have no option but to create money to give to the banks, whilst at the same time keep their lending rates low, so as to allow banks to (far too slowly) recapitalize themselves, by borrowing at very low rates and loaning at higher rates (often investing in sovereign bonds). The Banks are now zombies.

- This made investors abandon countries with weaker finances (starting with Greece, who was lying about their deficit for a long time). Effectively these became incapable of financing themselves and have no chance of escaping bankruptcy.

- Their bankruptcy, thanks to the 'miracle' of the multiplication of money made possible by the derivative markets, would also bankrupt the vast majority of European banks (those that are not already effectively busted, that is). That would destroy the european economy, and THAT would crush the US one in just a few days should it happen. Which would bring down the current economic system.

- Bottom line, the money that banks will need to survive exceeds by an awful lot the GDP of the entire planet, so governments can't just handle this like they would a normal crisis.

- Realising this, and knowing it would have to pay dearly just to try to keep things afloat (as the odds of success were never really over 50%, as Berlin effectively does not have the financial capability to do everything that would be demanded of it) Germany decided the best way to go is to push forward with european integration, not only because a single currency without a common government doesn't truly work, but also because this is an unparallelled chance to end up with the corruption and cronysm that were always so rampant in Southern Europe. Trying to get some good out of an incredibly bad situation, really.

- So, coupled with several bailouts that cost hundreds of billions, Germany is also pushing for an unprecedented integration, while asking fror cuts in southern europe that should allow these countries to actually be competitive should this crisis be defeated - it's the region's chance to get rid of excess fat.

- This is recessive and hurts those countries, but the reality is that the reverse option (as defended by Dr. Krugman) would make the deficits of those countries explode beyond all proportion, shutting them out of the markets. The ECB would have to intervene, and what effectively guarantees the ECB is the German taxpayer. The level of debt needed to stave off collapse (like the Fed is doing in the US) would eventually make people realise that it is more money than Germany can possibly have within a lifetime. Eventually, ALL european states would be shut out of the markets, a catastrophe that not even the IMF, World Bank or the US could avoid.

- Also, this increase in debt and avoidance of austerity is not sustaineable even by America; while the Fed can do more QE for some time - as the US does not have the same restrictions Europe has - eventually the debt would bring the economic system crashing down.

(although in this case, the european collapse will probably cause that, so future americans will blame Europe for what happened, when in fact the original cause was the american banks and the american-sponsored economic system. This was what made the President of the EC so angry last time the US tried to lecture Europe on the crisis, reminding them that all this started in North America, not Europe)

[Admiral Yi]

Very short version of the problem:

(although in this case, the european collapse will probably cause that, so future americans will blame Europe for what happened, when in fact the original cause was the american banks and the american-sponsored economic system.

[Iormlund]

...Germany decided the best way to go is to push forward with european integration, ... because this is an unparallelled chance to end up with the corruption and cronysm that were always so rampant in Southern Europe.

Yeah, that's why they were so intent on a Samaras victory. To get rid of corruption and cronyism in Greece.

[The Minsky Moment]

No Greece started a wave of skepticism in the debt market that caused higher levels of investor scrutiny on previously ignored problems, which caused higher bond yields for others as well. Which then caused greater weakness in the balance sheets due to higher debt service costs.

But this account flies completely in the face of the facts.  The economic crisis commenced in 2008 - in that year GDP plummeted across the Eurozone. But as of New Year's Day 2009, Greek bond yields were barely over 5 percent and Greek bonds still carried the same A rating they had since 2004.  In fact Greek bond yields actually fell below during the latter half of 2009, and did not commence their veritginous rise until around 10/09. 

Here's another way to look at the issue - let's start with the situation in 2008, just as the crisis gets under way.  Here are the Total Government net Debt/GDP ratios for 5 selected European countries:

Country A - 61%
Country B - 58%
Country C-  50%
Country D- 30%
Country E- 23%

Country A is Portugal, Country B is France, C is Germany, D is Spain, E is Ireland.  Basically there is zero correlation between pre-crisis fiscal position and what would happen in the financial crisis.

What about Italy?  Italy's debt/GDP was high (89%) but Italy was already running the austerity playbook and running primary fiscal surpluses. 
What about Greece?  Greece's debt/GDP was over 100% but that was no different than what it had been back in 2001/2002.  Greece was always Greece but that played zero triggering role in the crisis.

This is not a matter for argument or equivocation.  The facts are unambiguous.  Fiscal deficits and government debt levels did not cause the European economic crisis - the causal arrow goes 180 degrees in the other direction.  The sharp decline in the real economy drove down tax receipts and forced governments to incur massive debt to bail out their private sector banking systems.  That's what drove up debt levels, particularly in Ireland, Spain and Portugal, but clearly also Greece, Italy and the rest of the Eurozone.

To say that government spending and debt caused the crisis is economic flat earthism.  Private sector spending and debt levels (particularly over-extension in the financial sector) caused  the crisis. 

The theory is that the bond market woke up one morning, realized that PIIG debt levels were unsustainable, and started demanding substantial risk premia.  The PIIGs responded by cutting deficits, which is tautologically contractionary.

yes, sure that happened, but that was two years into the process.

[The Minsky Moment]

At around 39:00, the Spanish professor addresses the demand-side description of the world

He makes the following points

1. Krugman focuses on short run economic growth not long run.
Response: Krugman is focusing on the short run because there is an immediate crisis.  This is like saying that when the Fukushima crisis occurred, Japan should have delayed releasing the sea water into the plant until the legislature passed a full-scale nuclear regulatory reform law to deal with long-run implications.  It also creates a false conflict between short and economic growth.  Economic growth is compound - if a country reduces its growth rate in the short run, it reduces the economic base on which to grow in the long run. Iis like stopping running on a treadmill while increasing the speed.

2.  "Aggregate demand expansion got us here"
If one is talking about aggregate demand expansion in the Krugman/Keynes fiscalist sense that is obviously false.  In fact, Schwartz is talking about the effects of monetary policy on demand, not fiscal policy.  Looking on a Euro-wide basis, the point is still wrong because on average pre-crisis, the ECB took a moderate restrictionist policy stance.  Where Schwartz is correct is that ECB rates were nonetheless arguably too low for Spain and thus contributed to the local private sectors bubbles in real estate and finance.  But that is not product of deliberate policies to boost demand a la Krugman, rather it was an artifact of Spain's membership in the Euro and its one size fits all monetary policy.

3.  "Saving is good - not some sort of mistake"
Keynes never argues that savings is a mistake - this is a serious misreading of the General Theory.  Keynes' key point is that investment drives savings (by increasing income), not the other way around and that if everyone attempts to increase their savings of economy-wide, it may have the preverse effect of reducing the stock of savings. 
Imagine 2 countries:  Country A has per capital income of 1000 and consumption of 500; Country B has per capital income of 5000 and consumption of 4000.  Country A has much higher savings rates but Country B has a much higher stock of savings.

4.  Aggregate demand expansion only works in the short run
True.  It's only designed for the short run (which was why retaining the Bush tax cuts after 03 was a bad idea).  See point 1 above.

5.  Public works investment failed in Japan
This is a common misconception.  Japan increased public works spending significantly from 1993 to 2000.  By the end of the period, debt/GDP levels were still a managable 60%.  But after 2000, Japan actually cut public works and total governement expenditures, particularly during the "reformist" ministries of Koizumi who opposed the demand pumpting strategy.  From 2000-2004, while this strategy was in effect, real GDP declined continuously.  By 2008, government spending was still 5% below the 2000 peak, but real GDP had not budged since that time, and despite the reduced level of spending, debt levels had increased to over 90% of GDP due to a massive collapse in tax revenue.  Ironically, given Schwartz's intended point, the Japanese experience in 2000-2008 is a pretty good illustration of the pitfalls of using state spending cuts to bring down public debt levels.

6.  Spain got screwed trying to run deficits
That is actually pretty true, but the reason is that Spain is effectively in a hard money monetary system and thus its state budget is subject to relatively strict constraints.  No question the policy-driven demand expansion will not work well outside a fiat money system.

Krugman's less-than-happy response (which sparks quite a rowdy argument) begins around 48:20

I don't know what Krugman was talkign about re credentials - I didn't hear anything from Schwartz about it.

His subsequent comment about the "natural experiment" is a correct analysis of the data.  Anti-keynsians in the US predicted that the stimulus program would cause interest rates to spike, and some hard monetarists predicted inflation.  The facts turned out quite to the contrary.

[Martim Silva]

Yeah, that's why they were so intent on a Samaras victory. To get rid of corruption and cronyism in Greece.

Samaras is hardly popular in Berlin. No Greek politician is; everybody is pissed at the fact that Athens did not do anything of what they promised (not even the reduction of civil servants; they secretly hired more to replace those that left, against all promises).

It's just that the alternative would by a SYRIZA win (with a probable alliance with the KKE), and that prospect terrifies politicians: they all fear a regime change that will jeopardize their priviledges.

Also, the troika is annoyed at some of the efforts made to reduce deficits, as they fall more on 'tax the people' than in 'cutting inefficient and corrupt organisms'.

Portugal, for example, is now required to report in August because the government is planning (AGAIN) to massively raise the taxes on the middle class (which will kill off consumption), instead of abolising the public institutes (we have 14,500, of which only 1,700 present their accounts; the rest just serves to pay huge wages to their highborn 'collaborators').

It is also asked why does the government does not renegotiate its 'Public-Private Partnerships' (PPPs), which cost the budget 15 billion euro per year (without those highborn-run 'partnerships', where all profits go to the private managers and all losses are taken by the State, Portugal would have a budget surplus and would easily pay off the bailout without any taxes on the poor. BUT those partnerships are ran by MPs and their families, so the Government doesn't touch them....)

[Admiral Yi]

Joan:  so you're saying if there had been no global downturn in 2008 lenders would have been happy to roll over Greek debt at 3% until the end of time?

Your narrative also doesn't fit my recollection of events as regards bank recapitalization.  Of course Irish banks went belly up and got nationalized (foolishly IMO) before yields started to rise in other countries.  But I'm unaware of any other bank recapitalizations that took place before the exit from Greek bonds.

[Zanza]

Joan:  so you're saying if there had been no global downturn in 2008 lenders would have been happy to roll over Greek debt at 3% until the end of time?

Your narrative also doesn't fit my recollection of events as regards bank recapitalization.  Of course Irish banks went belly up and got nationalized (foolishly IMO) before yields started to rise in other countries.  But I'm unaware of any other bank recapitalizations that took place before the exit from Greek bonds.

Germany recapitalized some of its biggest banks in 2008/2009 (roughly at the same time as Ireland). I am pretty sure that happened in other countries as well (Netherlands, Belgium etc.).

[Sheilbh]

Also Ireland didn't just bailout their banks. They guaranteed all of their banks' creditors. Madness, but at the time described 'as the cheapest bailout' ever.