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 paperâ€™s findings in short: when a countryâ€™s gross debt-to-GDP ratio gets above 80%, and when itâ€™s accompanied by persistent current account deficits, that country enters a debt â€ścrunch timeâ€ť. It becomes vulnerable to â€śrapid fiscal deteriorationâ€ť, and suffers from â€śtipping-point dynamicsâ€ť 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 weâ€™re already in the theoretical danger zone Greenlaw and his colleagues describe. ButÂ Paul Krugman andÂ Matt Oâ€™Brien arenâ€™t convinced, and argue that America wonâ€™t ever become Greece. Oâ€™Brien looked at the authorsâ€™ data and noticed one rather large exception to the rule: countries that can print their own currency donâ€™t find themselves caught in a debt crunch. â€śThere is no evidence of a debt tipping point for countries that borrow in money they can print.â€ť 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 â€śtipping pointâ€ť theorem. Japanâ€™s 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. â€śJapan sticks out like a sore thumb that those preaching the unsustainability of government debt want to sweep under the rug,â€ť Duy writes.
But James Hamilton, one of the co-authors of the paper,Â says that â€śprinting money does not generate any magical resources with which to resolve a real fiscal shortfallâ€ť.
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 (weâ€™re looking at youÂ England!).Â Megan McArdleâ€™s solution is sensible: back â€śslowly and cautiouslyâ€ť away from the debt precipice, even if it may not exist. — Ryan McCarthy
On to todayâ€™s 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.