Counterparties: When debt becomes a problem
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The recent econoblogspheric debate over this topic began withÂ this paper by David Greenlaw and three co-authors. The paperâs findings in short: when a countryâs gross debt-to-GDP ratio gets above 80%, and when itâs accompanied by persistent current account deficits, that country enters a debt âcrunch timeâ. It becomes vulnerable to ârapid fiscal deteriorationâ, and suffers from âtipping-point dynamicsâ in the debt markets. This basically what happened to countries like Greece during the last few years — the market begins to worry about default, making it more expensive to borrow, which, in turn, makes the deficit worse. And so forth.
US gross debt stood at 103% of GDP in 2011, the paper says, so weâre already in the theoretical danger zone Greenlaw and his colleagues describe. ButÂ Paul Krugman andÂ Matt OâBrien arenât convinced, and argue that America wonât ever become Greece. OâBrien looked at the authorsâ data and noticed one rather large exception to the rule: countries that can print their own currency donât find themselves caught in a debt crunch. âThere is no evidence of a debt tipping point for countries that borrow in money they can print.â If the market began panicking about US debt, the argument goes, the Fed could simply print more money.
Tim Duy argues that Japan is one big outlier to the âtipping pointâ theorem. Japanâs grossÂ debt-to-GDP ratio was was 220% in 2011, it has recently started printingÂ massive amounts of its own currency, and the cost of its debt has been steadily shrinking for the better part of a year. âJapan sticks out like a sore thumb that those preaching the unsustainability of government debt want to sweep under the rug,â Duy writes.
But James Hamilton, one of the co-authors of the paper,Â says that âprinting money does not generate any magical resources with which to resolve a real fiscal shortfallâ.
Sovereign debt markets can beÂ irrational — a debt panic need not be related to anything particularly precise or fundamental. But cutting debt too quickly can make economic problems worse (weâre looking at youÂ England!).Â Megan McArdleâs solution is sensible: back âslowly and cautiouslyâ away from the debt precipice, even if it may not exist. — Ryan McCarthy
On to todayâs links:
The London Whale is the “most dramatic recent example of poor internal controls” at JP Morgan – The Big Picture
The full Senate report on the London Whale – Senate Permanent Subcommittee on Investigations
Your Daily Outrage
Google decides it’s cool to be evil, kills beloved product because it can – Google Reader Blog
“Anyone who thinks social media is a valid replacement for an RSS reader, leave the room now” – YouTube
And, of course, there are many more links at Counterparties.