Bad Debts

This weekend it is Spain’s turn to get a bailout. The EU has promised to come up with €100 billion to be disbursed to the Spanish government as  a loan, which will then turn around and use it to make equity investments to re-capitalize Spain’s banks. There are no conditions on the bailout, so Ireland’s hand is already in the air demanding the same deal. Irish banks collapsed for the same reason as Spain’s – a collapsing property bubble – but stringent economic conditions were imposed. Of course this bailout immensely strengthens the hand of Greece’s Syriza party in the forthcoming election, inasmuch as there is now real reason to believe that the EU will blink.

The problem is that they’re bailing out the wrong people. We’re not running out of lenders – we’re running out of borrowers. Even today, borrowers have to be willing and able to make payments and not be overloaded with existing debts. But we’ve exhausted the supply of willing and able private borrowers – most are unable and the able are unwilling – and now even most of the sovereign borrowers, with a few exceptions like the U.S. and Germany. I would have said France, but now Hollande has set about wrecking France’s credit rating by lowering the retirement age to 60 and crippling what little labor mobility exists. We’re desperate enough for borrowers that we’re turning to super-sovereigns like the EU, in its various guises and funds, and of course the IMF.

Yet still the Keynesians howl for more spending and more debt, decrying the human misery that will be caused by the return to living on one’s means. It is true that reducing the acceleration of debt will force deflation and a reduction in consumption. But even governments and super-sovereigns have borrowing limits, points at which they destroy their currency, their credit, or both, depending. I glance over at my hundred trillion dollar Zimbabwean banknote. What will the Keynesians suggest when the money finally runs out?

On the other hand, the Baltic states, which took their medicine early and suffered through real austerity, are now growing fast. This success of course has horrified Keynesians, such as Paul Krugman, who took it upon himself to publicly and contemptuously disparage Estonia, leading to a well-publicized response on Twitter from Estonia’s President.

The US is facing a fork in the road, otherwise known as the “fiscal cliff,” where at the end of 2012 spending cuts and tax increases will take effect if nothing is done. Right now the US is funding nearly 10% of GDP through government borrowing. Which fork will the US take?

There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our ventures.

— Bill Shakespeare, Julius Caesar, Act 4 scene 3

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