Tag Archives: Debt

Democracy and Debt, Michael Hudson

Has the Link been Broken?
*This article appeared in the Frankfurter Algemeine Zeitung on December 5, 2011.

Book V of Aristotle’s Politics describes the eternal transition of oligarchies making themselves into hereditary aristocracies – which end up being overthrown by tyrants or develop internal rivalries as some families decide to “take the multitude into their camp” and usher in democracy, within which an oligarchy emerges once again, followed by aristocracy, democracy, and so on throughout history.

Debt has been the main dynamic driving these shifts – always with new twists and turns. It polarizes wealth to create a creditor class, whose oligarchic rule is ended as new leaders (“tyrants” to Aristotle) win popular support by cancelling the debts and redistributing property or taking its usufruct for the state.

Since the Renaissance, however, bankers have shifted their political support to democracies. This did not reflect egalitarian or liberal political convictions as such, but rather a desire for better security for their loans. As James Steuart explained in 1767, royal borrowings remained private affairs rather than truly public debts [1]. For a sovereign’s debts to become binding upon the entire nation, elected representatives had to enact the taxes to pay their interest charges.

By giving taxpayers this voice in government, the Dutch and British democracies provided creditors with much safer claims for payment than did kings and princes whose debts died with them. But the recent debt protests from Iceland to Greece and Spain suggest that creditors are shifting their support away from democracies. They are demanding fiscal austerity and even privatization sell-offs.

This is turning international finance into a new mode of warfare. Its objective is the same as military conquest in times past: to appropriate land and mineral resources, communal infrastructure and extract tribute. In response, democracies are demanding referendums over whether to pay creditors by selling off the public domain and raising taxes to impose unemployment, falling wages and economic depression. The alternative is to write down debts or even annul them, and to re-assert regulatory control over the financial sector.

Near Eastern rulers proclaimed Clean Slates to preserve economic balance

Charging interest on advances of goods or money was not originally intended to polarize economies. First administered early in the third millennium BC as a contractual arrangement by Sumer’s temples and palaces with merchants and entrepreneurs who typically worked in the royal bureaucracy, interest at 20% (doubling the principal in five years) was supposed to approximate a fair share of the returns from long-distance trade or leasing land and other public assets such as workshops, boats and ale houses.

As the practice was privatized by royal collectors of user fees and rents, “divine kingship” protected agrarian debtors. Hammurabi’s laws (c. 1750 BC) cancelled their debts in times of flood or drought. All the rulers of his Babylonian dynasty began their first full year on the throne by cancelling agrarian debts so as to clear out payment arrears by proclaiming a clean slate. Bondservants, land or crop rights and other pledges were returned to the debtors to “restore order” in an idealized “original” condition of balance. This practice survived in the Jubilee Year of Mosaic Law in Leviticus 25.

The logic was clear enough. Ancient societies needed to field armies to defend their land, and this required liberating indebted citizens from bondage. Hammurabi’s laws protected charioteers and other fighters from being reduced to debt bondage, and blocked creditors from taking the crops of tenants on royal and other public lands and on communal land that owed manpower and military service to the palace.

In Egypt, the pharaoh Bakenranef (c. 720-715 BC, “Bocchoris” in Greek) proclaimed a debt amnesty and abolished debt-servitude when faced with a military threat from Ethiopia. According to Diodorus of Sicily (I, 79, writing in 40-30 BC), he ruled that if a debtor contested the claim, the debt was nullified if the creditor could not back up his claim by producing a written contract. (It seems that creditors always have been prone to exaggerate the balances due.) The pharaoh reasoned:

the bodies of citizens should belong to the state, to the end that it might avail itself of the services which its citizens owed it, in times of both war and peace. For he felt that it would be absurd for a soldier … to be haled to prison by his creditor for an unpaid loan, and that the greed of private citizens should in this way endanger the safety of all.

The fact that the main Near Eastern creditors were the palace, temples and their collectors made it politically easy to cancel the debts. It always is easy to annul debts owed to oneself. Even Roman emperors burned the tax records to prevent a crisis. But it was much harder to cancel debts owed to private creditors as the practice of charging interest spread westward to Mediterranean chiefdoms after about 750 BC. Instead of enabling families to bridge gaps between income and outgo, debt became the major lever of land expropriation, polarizing communities between creditor oligarchies and indebted clients. In Judah, the prophet Isaiah (5:8-9) decried foreclosing creditors who “add house to house and join field to field till no space is left and you live alone in the land.”

Creditor power and stable growth rarely have gone together. Most personal debts in this classical period were the product of small amounts of money lent to individuals living on the edge of subsistence and who could not make ends meet. Forfeiture of land and assets – and personal liberty – forced debtors into bondage that became irreversible. By the 7th century BC, “tyrants” (popular leaders) emerged to overthrow the aristocracies in Corinth and other wealthy Greek cities, gaining support by canceling the debts. In a less tyrannical manner, Solon founded the Athenian democracy in 594 BC by banning debt bondage.

But oligarchies re-emerged and called in Rome when Sparta’s kings Agis, Cleomenes and their successor Nabis sought to cancel debts late in the third century BC. They were killed and their supporters driven out. It has been a political constant of history since antiquity that creditor interests opposed both popular democracy and royal power able to limit the financial conquest of society – a conquest aimed at attaching interest-bearing debt claims for payment on as much of the economic surplus as possible.

When the Gracchi brothers and their followers tried to reform the credit laws in 133 BC, the dominant Senatorial class acted with violence, killing them and inaugurating a century of Social War, resolved by the ascension of Augustus as emperor in 29 BC.

Rome’s creditor oligarchy wins the Social War, enserfs the population and brings on a Dark Age

Matters were more bloody abroad. Aristotle did not mention empire building as part of his political schema, but foreign conquest always has been a major factor in imposing debts, and war debts have been the major cause of public debt in modern times. Antiquity’s harshest debt levy was by Rome, whose creditors spread out to plague Asia Minor, its most prosperous province. The rule of law all but disappeared when the publican creditor “knights” arrived. Mithridates of Pontus led three popular revolts, and local populations in Ephesus and other cities rose up and killed a reported 80,000 Romans in 88 BC. The Roman army retaliated, and Sulla imposed war tribute of 20,000 talents in 84 BC. Charges for back interest multiplied this sum six-fold by 70 BC.

Among Rome’s leading historians, Livy, Plutarch and Diodorus blamed the fall of the Republic on creditor intransigence in waging the century-long Social War marked by political murder from 133 to 29 BC. Populist leaders sought to gain a following by advocating debt cancellations (e.g., the Catiline conspiracy in 63-62 BC). They were killed. By the second century AD about a quarter of the population was reduced to bondage. By the fifth century Rome’s economy collapsed, stripped of money. Subsistence life reverted to the countryside as a Dark Age descended.

Creditors find a legalistic reason to support parliamentary democracy

When banking recovered after the Crusades looted Byzantium and infused silver and gold to review Western European commerce, Christian opposition to charging interest was overcome by the combination of prestigious lenders (the Knights Templars and Hospitallers providing credit during the Crusades) and their major clients – kings, at first to pay the Church and increasingly to wage war. But royal debts went bad when kings died. The Bardi and Peruzzi went bankrupt in 1345 when Edward III repudiated his war debts. Banking families lost more on loans to the Habsburg and Bourbon despots on the thrones of Spain, Austria and France.

Matters changed with the Dutch democracy, seeking to win and secure its liberty from Habsburg Spain. The fact that their parliament was to contract permanent public debts on behalf of the state enabled the Low Countries to raise loans to employ mercenaries in an epoch when money and credit were the sinews of war. Access to credit “was accordingly their most powerful weapon in the struggle for their freedom,” notes Ehrenberg: “Anyone who gave credit to a prince knew that the repayment of the debt depended only on his debtor’s capacity and will to pay. The case was very different for the cities, which had power as overlords, but were also corporations, associations of individuals held in common bond. According to the generally accepted law each individual burgher was liable for the debts of the city both with his person and his property.”[2]

The financial achievement of parliamentary government was thus to establish debts that were not merely the personal obligations of princes, but were truly public and binding regardless of who occupied the throne. This is why the first two democratic nations, the Netherlands and Britain after its 1688 revolution, developed the most active capital markets and proceeded to become leading military powers. What is ironic is that it was the need for war financing that promoted democracy, forming a symbiotic trinity between war making, credit and parliamentary democracy in an epoch when money was still the sinews of war.

At this time “the legal position of the King qua borrower was obscure, and it was still doubtful whether his creditors had any remedy against him in case of default.”[3] The more despotic Spain, Austria and France became, the greater the difficulty they found in financing their military adventures. By the end of the eighteenth century Austria was left “without credit, and consequently without much debt” the least credit-worthy and worst armed country in Europe (as Steuart 1767:373 noted), fully dependent on British subsidies and loan guarantees by the time of the Napoleonic Wars.

Finance accommodates itself to democracy, but then pushes for oligarchy

While the nineteenth century’s democratic reforms reduced the power of landed aristocracies to control parliaments, bankers moved flexibly to achieve a symbiotic relationship with nearly every form of government. In France, followers of Saint-Simon promoted the idea of banks acting like mutual funds, extending credit against equity shares in profit. The German state made an alliance with large banking and heavy industry. Marx wrote optimistically about how socialism would make finance productive rather than parasitic. In the United States, regulation of public utilities went hand in hand with guaranteed returns. In China, Sun-Yat-Sen wrote in 1922: “I intend to make all the national industries of China into a Great Trust owned by the Chinese people, and financed with international capital for mutual benefit.”[4]

World War I saw the United States replace Britain as the major creditor nation, and by the end of World War II it had cornered some 80 percent of the world’s monetary gold. Its diplomats shaped the IMF and World Bank along creditor-oriented lines that financed trade dependency, mainly on the United States. Loans to finance trade and payments deficits were subject to “conditionalities” that shifted economic planning to client oligarchies and military dictatorships. The democratic response to resulting austerity plans squeezing out debt service was unable to go much beyond “IMF riots,” until Argentina rejected its foreign debt.

A similar creditor-oriented austerity is now being imposed on Europe by the European Central Bank (ECB) and EU bureaucracy. Ostensibly social democratic governments have been directed to save the banks rather than reviving economic growth and employment. Losses on bad bank loans and speculations are taken onto the public balance sheet while scaling back public spending and even selling off infrastructure. The response of taxpayers stuck with the resulting debt has been to mount popular protests starting in Iceland and Latvia in January 2009, and more widespread demonstrations in Greece and Spain this autumn to protest their governments’ refusal to hold referendums on these fateful bailouts of foreign bondholders.

Shifting planning away from elected public representatives to bankers

Every economy is planned. This traditionally has been the function of government. Relinquishing this role under the slogan of “free markets” leaves it in the hands of banks. Yet the planning privilege of credit creation and allocation turns out to be even more centralized than that of elected public officials. And to make matters worse, the financial time frame is short-term hit-and-run, ending up as asset stripping. By seeking their own gains, the banks tend to destroy the economy. The surplus ends up being consumed by interest and other financial charges, leaving no revenue for new capital investment or basic social spending.

This is why relinquishing policy control to a creditor class rarely has gone together with economic growth and rising living standards. The tendency for debts to grow faster than the population’s ability to pay has been a basic constant throughout all recorded history. Debts mount up exponentially, absorbing the surplus and reducing much of the population to the equivalent of debt peonage. To restore economic balance, antiquity’s cry for debt cancellation sought what the Bronze Age Near East achieved by royal fiat: to cancel the overgrowth of debts.

In more modern times, democracies have urged a strong state to tax rentier income and wealth, and when called for, to write down debts. This is done most readily when the state itself creates money and credit. It is done least easily when banks translate their gains into political power. When banks are permitted to be self-regulating and given veto power over government regulators, the economy is distorted to permit creditors to indulge in the speculative gambles and outright fraud that have marked the past decade. The fall of the Roman Empire demonstrates what happens when creditor demands are unchecked. Under these conditions the alternative to government planning and regulation of the financial sector becomes a road to debt peonage.

Finance vs. government; oligarchy vs. democracy

Democracy involves subordinating financial dynamics to serve economic balance and growth – and taxing rentier income or keeping basic monopolies in the public domain. Untaxing or privatizing property income “frees” it to be pledged to the banks, to be capitalized into larger loans. Financed by debt leveraging, asset-price inflation increases rentier wealth while indebting the economy at large. The economy shrinks, falling into negative equity.

The financial sector has gained sufficient influence to use such emergencies as an opportunity to convince governments that that the economy will collapse they it do not “save the banks.” In practice this means consolidating their control over policy, which they use in ways that further polarize economies. The basic model is what occurred in ancient Rome, moving from democracy to oligarchy. In fact, giving priority to bankers and leaving economic planning to be dictated by the EU, ECB and IMF threatens to strip the nation-state of the power to coin or print money and levy taxes.

The resulting conflict is pitting financial interests against national self-determination. The idea of an independent central bank being “the hallmark of democracy” is a euphemism for relinquishing the most important policy decision – the ability to create money and credit – to the financial sector. Rather than leaving the policy choice to popular referendums, the rescue of banks organized by the EU and ECB now represents the largest category of rising national debt. The private bank debts taken onto government balance sheets in Ireland and Greece have been turned into taxpayer obligations. The same is true for America’s $13 trillion added since September 2008 (including $5.3 trillion in Fannie Mae and Freddie Mac bad mortgages taken onto the government’s balance sheet, and $2 trillion of Federal Reserve “cash-for-trash” swaps).

This is being dictated by financial proxies euphemized as technocrats. Designated by creditor lobbyists, their role is to calculate just how much unemployment and depression is needed to squeeze out a surplus to pay creditors for debts now on the books. What makes this calculation self-defeating is the fact that economic shrinkage – debt deflation – makes the debt burden even more unpayable.

Neither banks nor public authorities (or mainstream academics, for that matter) calculated the economy’s realistic ability to pay – that is, to pay without shrinking the economy. Through their media and think tanks, they have convinced populations that the way to get rich most rapidly is to borrow money to buy real estate, stocks and bonds rising in price – being inflated by bank credit – and to reverse the past century’s progressive taxation of wealth.

To put matters bluntly, the result has been junk economics. Its aim is to disable public checks and balances, shifting planning power into the hands of high finance on the claim that this is more efficient than public regulation. Government planning and taxation is accused of being “the road to serfdom,” as if “free markets” controlled by bankers given leeway to act recklessly is not planned by special interests in ways that are oligarchic, not democratic. Governments are told to pay bailout debts taken on not to defend countries in military warfare as in times past, but to benefit the wealthiest layer of the population by shifting its losses onto taxpayers.

The failure to take the wishes of voters into consideration leaves the resulting national debts on shaky ground politically and even legally. Debts imposed by fiat, by governments or foreign financial agencies in the face of strong popular opposition may be as tenuous as those of the Habsburgs and other despots in past epochs. Lacking popular validation, they may die with the regime that contracted them. New governments may act democratically to subordinate the banking and financial sector to serve the economy, not the other way around.

At the very least, they may seek to pay by re-introducing progressive taxation of wealth and income, shifting the fiscal burden onto rentier wealth and property. Re-regulation of banking and providing a public option for credit and banking services would renew the social democratic program that seemed well underway a century ago.

Iceland and Argentina are most recent examples, but one may look back to the moratorium on Inter-Ally arms debts and German reparations in 1931.A basic mathematical as well as political principle is at work: Debts that can’t be paid, won’t be.


[1] James Steuart, Principles of Political Economy (1767), p. 353.

[2] Richard Ehrenberg, Capital and Finance in the Age of the Renaissance (1928):44f., 33.

[3] Charles Wilson, England’s Apprenticeship: 1603-1763 (London: 1965):89.

[4] Sun Yat-Sen, The International Development of China (1922):231ff.


What is the morality of debt?

E. Hadas via Reuters (27/10/2011)

Debt is a moral matter. While most economic activity is concerned with the “is” of how things are (investment, consumption and so forth), debts are always entwined with an “ought” – to repay. In discussing controversial debts – for example government borrowing in the euro zone and the U.S. – the moral question should be addressed directly: should these debts be paid off in full, or is some forgiveness justified?

Aristotle can help frame the argument. The philosopher condemned all lending at interest because money cannot create wealth by itself; a loan is just a way for the lender to take advantage of the borrower. Some proponents of Islamic finance make a similar argument, but it is not quite right. Capitalism has shown that loans can indeed produce wealth. If the lent funds are invested well, enabling the borrower to improve his lot and the world’s, then interest payments are the lender’s just reward for providing the fruitful funds.

But Aristotle’s moral logic remains relevant; his condemnation is appropriate for loans that do not share wealth justly between borrower and lender. Unfair loans should not be made, and where they have been, full repayment only compounds the original injustice.

Libertarians, believers in the right of individual to make their own decisions, have another contribution to the moral discussion. They point out that loans are freely agreed contracts that should be honored. Both sides should understand the possible consequences of their free choices. Borrowers should repay, even if that requires making sacrifices, and creditors who make bad lending decisions should suffer losses.

In the euro zone, some libertarians (and most Germans) consider the borrowers’ obligations to be paramount. The governments of Greece and the other over-extended nations can and should repay all their agreed debts. The citizens just have to work harder and pay more taxes.

Other libertarians take the opposite moral line. Losses are the just punishment for the foolish creditors. And the Aristotelian logic may justify forgiveness. The lent money has mostly been spent unproductively, so the borrowers now have few gains to share with the lenders. The original loans turned out to be unjustly generous to the debtors, but the terms have become unjustly harsh.

Which side has the stronger moral logic? Forgiveness looks right for Greece, where the debts are particularly high and the government and economy are particularly inept. For the rest, it is a closer call.

Turn to the U.S. government, which is building up its own substantial debt pile. The American moral debate on the practice is as old as George Washington, who warned that such debts “ungenerously throw upon posterity the burden which we ourselves ought to bear.” Today, the National Research Council writes of “an unfair and crushing burden on future generations.”

Foreign debts are particularly crushing. Citizens get to spend now on consumption and investment but are obliged to repay foreigners later, with interest. This deferment has produced $4.5 trillion of foreign debt in the U.S., 30 percent of one year’s GDP. That is far less than Greece’s full year of GDP, but enough to worry about.

If the U.S. authorities were committed to full repayment of these foreign debts, they would strive to keep the dollar’s value constant and to avoid inflation. That way, the foreigners would receive not just the contracted dollars but the full agreed economic value. While American authorities may care in theory, they are not concerned enough to refrain from loose monetary policy, which pushes the dollar down.

In this case, pro-repayment libertarians have right on their side. The largest and one of the richest economies in the world – and the issuer of the global reserve currency – is honor-bound to make good on its debts. While the creditors should have noticed that the country was becoming less responsible, their neglect does not excuse American indifference.

For purely domestic U.S. government borrowing, Aristotelian scrutiny is more appropriate. Do the ultimate borrowers, the mostly poor beneficiaries of federal programs, gain enough from these loans to justify the higher taxes that will be needed later to repay the mostly rich lenders? There is no obvious answer to that question, but it is well worth asking.

More generally, philosophical arguments ratify what practical experience teaches. Lenders should be wary about lending to governments. The choice to borrow rather than to raise funds through taxes is usually a sign of political weakness. When the time comes to repay, governments may be unable or unwilling to persuade the people that the sanctity of contracts is a principle worth protecting.

Also, the proceeds of loans to such governments are likely to be spent foolishly. Then full repayment will fail the Aristotelian test of justice. The rioters in Athens may know little about the Ancient Greek philosopher’s doctrine on lending, but they could be protesting in his name.

La economía moral de la deuda

R. Skidelsky (21/10/2014)

Cada colapso económico viene de la mano de una demanda de condonación de deuda. Los ingresos necesarios para saldar préstamos se han evaporado y los activos presentados como garantía han perdido valor. Los acreedores reclaman lo suyo; los deudores piden ayuda a gritos.

Consideremos Strike Debt, un descendiente del movimiento Occupy, que se autodefine como “un movimiento nacional de opositores a la deuda que lucha por la justicia económica y la libertad democrática”. Su sitio web sostiene que, “como consecuencia de los salarios estancados, el desempleo sistémico y los recortes en los servicios públicos”, se está obligando a la gente a endeudarse para obtener las necesidades más básicas de la vida, lo que la lleva a “depositar su futuro en manos de los bancos”.

Una de las iniciativas de Strike Debt, “Rolling Jubilee” (Jubileo Permanente), financiada a través de donaciones populares en Internet, compra y cancela deuda en un proceso que llama “resistencia colectiva a la deuda”. El progreso del grupo ha sido impresionante: lleva recaudados más de 700.000 dólares hasta la fecha y canceló deuda por un valor de casi 18.600 millones de dólares”.

La existencia de un mercado de deuda secundario es lo que le permite a Rolling Jubilee comprar deuda a tan bajo costo. Las instituciones financieras que dudan de la capacidad de sus prestatarios para saldar sus deudas venden la deuda a terceros a precios bajísimos, muchas veces de hasta cinco centavos por dólar. Los compradores luego intentan ganar dinero rescatando parte o la totalidad de la deuda de los prestatarios. Sallie Mae, una entidad crediticia que otorga préstamos a estudiantes en Estados Unidos, admitió que vende deuda reempaquetada por hasta 15 centavos por dólar.

Para llamar la atención ante las prácticas muchas veces perversas de las agencias de cobro de deuda, Rolling Jubilee recientemente canceló deuda estudiantil de 2.761 estudiantes de Everest College, una escuela con fines de lucro cuya empresa matriz, Corinthian Colleges, está siendo demandada por el gobierno de Estados Unidos por otorgar préstamos predatorios. La cartera de préstamos de Everest College estaba valuada en casi 3,9 millones de dólares. Rolling Jubilee la compró en 106.709,48 dólares, o casi tres centavos por cada dólar.

Pero eso es una gota en el océano. Sólo en Estados Unidos, los alumnos deben más de 1 billón de dólares, o aproximadamente el 6% del PIB. Y la población estudiantil es apenas uno de los muchos grupos sociales que viven endeudados.

Por cierto, en todo el mundo, la crisis económica de 2008-2009 aumentó la carga de la deuda privada y pública por igual -al punto de que la distinción público-privado se volvió borrosa-. En un discurso reciente en Chicago, el presidente irlandés, Michael D. Higgins, explicó de qué manera la deuda privada se convirtió en deuda soberana: “Como consecuencia de la necesidad de pedir prestado dinero para financiar el gasto actual y, por sobre todo, como resultado de la amplia garantía extendida a los activos y pasivos de los principales bancos irlandeses, la deuda general del gobierno de Irlanda aumentó del 25% del PIB en 2007 al 124% en 2013”.

El objetivo del gobierno irlandés, por supuesto, era salvar al sistema bancario. Pero la consecuencia no intencionada del rescate fue destrozar la confianza en la solvencia del gobierno. En la eurozona, Irlanda, Grecia, Portugal y Chipre tuvieron que reestructurar su deuda soberana para evitar un incumplimiento de pago rotundo. Los crecientes ratios deuda/PIB empañan la política fiscal, y se convirtieron en la principal justificación para la implementación de las políticas de austeridad que prolongaron la crisis.

Nada de esto es nuevo. El conflicto entre acreedores y deudores ha sido la sustancia de la política desde los tiempos babilonios. La ortodoxia siempre ha defendido los derechos sagrados del acreedor; la necesidad política frecuentemente exigió el perdón para el deudor. Cuál es el lado ganador en determinada situación depende de la magnitud de la aflicción del deudor y la fuerza de las coaliciones opositoras de acreedores y deudores.

La moralidad siempre ha sido la moneda intelectual de estos conflictos. Los acreedores, al afirmar su derecho a cobrar la totalidad de la deuda, históricamente han creado todos los obstáculos legales y políticos posibles para el default, insistiendo con sanciones duras -embargo de ingresos, por ejemplo, y, en situaciones extremas, cárcel o hasta esclavitud- por la imposibilidad de los prestatarios de honrar sus obligaciones de deuda. Siempre se pretendió que los gobiernos que incurren en deuda en guerras costosas aparten “fondos de amortización” anuales para poder saldarla.

La moralidad, sin embargo, no siempre estuvo enteramente del lado del acreedor. En idioma griego del Nuevo Testamento, deuda significa “pecado”. Pero, aunque pueda ser pecaminoso endeudarse, Mateo 6:12 respalda la absolución: “perdónanos nuestras deudas, así como nosotros perdonamos a nuestros deudores”. La resistencia social generalizada a los reclamos de los acreedores sobre la propiedad de los deudores por no pagar implicó que rara vez se llevara la “ejecución” al extremo.

La posición de los deudores se vio aún más fortalecida por la prohibición de la usura -cobrar un interés irracionalmente alto por el dinero-. Los topes a las tasas de interés fueron abolidos en Gran Bretaña recién en 1835; las tasas casi cero de los bancos centrales prevalecientes desde 2009 son un ejemplo actual de los esfuerzos por proteger a los prestatarios.

La verdad de la cuestión, como señala David Graeber en su majestuoso Deuda: los primeros 5.000 años, es que esa relación entre acreedor y deudor no encarna ninguna ley de hierro de moralidad; más bien, es una relación social que siempre debe ser negociada. Cuando la precisión cuantitativa y una estrategia inflexible frente a las obligaciones de deuda son la regla, lo que sobreviene de inmediato es el conflicto y la penuria.

En un esfuerzo por frenar las crisis de deuda recurrentes, las sociedades tradicionales abrazaron la “Ley de Jubileo”, un borrón y cuenta nueva ceremonial. “La Ley de Jubileo”, escribe Graeber, “estipulaba que todas las deudas se cancelaran automáticamente ‘en el año del Shabat’ (es decir, después de que hubieran pasado siete años) y que todos los que languidecieran en cautiverio debido a esas deudas fueran liberados”. Rolling Jubilee es un recordatorio oportuno de la continua relevancia de una de las leyes más antiguas de la vida social.

La moraleja del cuento no es, como aconsejó Polonio a su hijo Laertes, “no seas ni prestatario ni prestador”. Sin ambos, tal vez la humanidad todavía estaría viviendo en cavernas. Necesitamos, más bien, limitar la oferta y la demanda de crédito a lo que la economía es capaz de producir. Cómo lograrlo y al mismo tiempo mantener la libertad de empresa es uno de los grandes interrogantes sin resolver de la economía política.

“Helicopter Money to the Rescue” by Frank Hollenbeck (Mises)

Following the unconventional monetary policy of negative interest rates, central banks are now considering an even more desperate measure: “helicopter money.” Milton Friedman is credited with this idea:

Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.

The goal of such a policy is to put money directly into people’s pockets to boost aggregate demand. The post-2008 QE policy had similar objectives. The lowering of interest rates was intended to boost bank lending and indirectly consumer spending. Instead, the result was a boom in asset prices and a surge in excess reserves. The idea of helicopter money — in contrast — is to bypass the middleman, the banks, and provide funds directly to consumers.

How would such a policy be implemented? One idea is for a tax rebate financed by more government bonds purchased by the central bank. The tax cuts would be financed by printing money. The only real difference between helicopter money and the QE implemented since 2008, is that the private sector would be spending the money instead of the government. A large part of the debt issued since 2008 to finance government spending has been purchased by the central bank. It now holds $2.5 trillion of the $19 trillion dollars of US debt, effectively monetizing much of the additional borrowing since 2008. The effect on aggregate demand would simply be for the private sector to spend the money instead of the government sector. It would be a continuation of the current policy of financing expenditures by creating intrinsically worthless pieces of paper.

There’s Never a Shortage of Demand

Of course, this is a very Keynesian perspective that the economic problem is a lack of aggregate demand. The reality is that we never have a shortage of demand. The reason we work, we produce, is to consume; there is never a lack of demand. The primary function of prices is to ration output against an insatiable desire to consume or demand. As Ricardo said in 1820, “men err in their production; there is no deficiency of demand.”

The problem is never one of insufficient demand, but of supply being misaligned with demand. This faulty widespread educational indoctrination about aggregate demand is the poison eating at the heart of macroeconomics and similar to past universal beliefs in truisms that were never true — like the sun revolving around the earth.

The economic literature has focused on the permanency of such a helicopter drop. Such a policy is seen by contemporary economists as more effective if it was permanent. If so, people would expect inflation and advance their purchases to take advantage of current lower prices. In a Keynesian framework, this is viewed as beneficial since it would move demand forward. A similar but opposite argument has been promulgated to demonize deflation (see here and here). Of course, people are not lab rats, and they formulate their expectations on a multiple of different factors. They may even pay higher prices if current purchases better align with the timeline of needs. This is why few buy Christmas presents during January sales.

Another excuse for helicopter money is to allow the central bank to reach its 2 percent inflation target. As though 2 percent was some magical number that would allow the economy to reach its economic sweet spot.

Problems with Money Creation

Of course, 2 percent growth over 35 years cuts the purchasing power of money in half. It is a wealth transfer from the late recipients of the money, wage earners and the poor, to the early recipients of the money, the government and the banking sector: the central bank acting as a reverse robin hood. Also such monetary shenanigans simply interfere with the function of prices to allocate resources where society deems most urgent (see here). The reality is that there is no empirical or theoretical justification to support a 2 percent target. The period of the greatest growth in the US during the nineteenth century, from 1820 to 1850 and from 1865 to 1900, was associated with significant deflation. In those two cases, prices were cut in half.

Common sense states that you cannot repeal the law of scarcity by printing intrinsically worthless pieces of paper to finance private or government expenditures. If that were true, counterfeiting would be legal and Zimbabwe would be like heaven. The initial effect of such printing is a temporary illusion of prosperity which begets more printing leading to ever increasing amounts of distortion to prices.

Friedman’s comments about helicopter money included an important caveat: it is unlikely that the helicopters would fly only once.

The United States Of Insolvency

James Grant  

$13,903,107,629,266. Can the nation afford this much debt?

This much I have learned about debt after 40 years of writing and study: It is better not to incur it. Once it is incurred, it is better to pay it off. America, we have a problem.

We owe more than we can easily repay. We spend too much and borrow too much. Worse, we promise too much. We conjure dollar bills by the trillions–pull them right out of thin air. I won’t insist that this can’t go on, because it has. I only say that it will eventually stop.

I don’t know the date, but I believe that I know the reason. It will stop when the world loses confidence in the dollars we owe. Come that moment of truth, the nation will resemble Chicago, a once prosperous polity now trying to persuade its once trusting creditors that it is actually solvent.

To understand our financial fix, put yourself in the position of the government. Say you earn the typical American family income, and you spend and borrow as the government does. So assuming, you would earn $54,000 a year, spend $64,000 a year and charge $10,000 to your already slightly overburdened credit card. I say slightly overburdened–your outstanding balance is about $223,000.

Of course, MasterCard wouldn’t allow you to run up that kind of tab. At an annual percentage rate of 15%, the cost to service a $223,000 balance would absorb 62% of your pretax income. But the government is different from you and me (and Chicago). It has a central bank.

The Federal Reserve is the government’s Monopoly-money machine. It sets some interest rates and influences many others. It materializes dollars. It regulates–now regiments–the nation’s banks. It pulls levers to make the stock market go up.

Congress is the source of the Fed’s power. The Constitution is the source of Congress’s power. The parchment enjoins Congress to coin money and regulate the value thereof. The founders viewed money as a scale or yardstick, something that measures value. The Fed views money as a magic wand, something that creates value.

Dollars aren’t so much minted these days. Rather, they issue from the Fed’s computers in billowing digital clouds. The cost of producing them is only the energy expended on tapping the keys. The Fed emits these electronic greenbacks to attempt to control the course of economic events. It’s a heaven-sent monetary system for a big-spending government.

You may struggle to pay that midteens rate on your outstanding credit-card balance. The Treasury gets by paying an average of just 1.8% on that portion of the debt, held by savers and investors both here and abroad. Defined in this way, we owe $13.9 trillion. The $19 trillion figure ticking upward on the famous National Debt Clock adds the debts the government owes itself. (How does this pseudo bookkeeping work? The Social Security Administration takes in–temporarily–more than it pays out. With the surplus it buys Treasury bonds. The bonds enlarge the debt clock’s debt.) It’s not so important that the government pays itself on time. What is important is that the government pay its public creditors on time. So cast your eyes on the exact numerical rendering of that slightly smaller sum: $13,903,107,629,266. It is unmanageable.

One can assume that the creditors trust the currency in which they expect to be repaid. I wonder why, and for how much longer. The Fed once fought inflation. Now it actually sets out to cause it–about 2% a year is the target. Striving to inflate, it presses down interest rates and rustles up new dollars.

From the nation’s 18th century founding until 1971, the dollar was defined as a weight of gold or silver. Americans did business with paper, of course. But these commercial bills and banknotes were convertible into monetary bedrock, the precious metals. The expression sound as a dollar derives from the ring of a gold piece when you plunked it on a counter.

Sound money coincided with balanced budgets. Government borrowings climbed in wartime and subsided in peacetime. The pattern was disarranged by depression in the 1930s and war in the 1940s. It was broken by the Johnson Administration’s guns and butter and entitlements programs in the 1960s. Richard Nixon administered the coup de grâce on Aug. 15, 1971, when he announced that the dollar would derive its value from the say-so of the government. The Fed could print as many green bills as the traffic would bear.

Many applauded that sea change, then and later. Easy money rarely fails to please–at first. It buoys stocks, bonds and commercial real estate. House prices jump, and car sales zoom. (Average auto-lending rates, now 4%, have been nearly sawed in half since 2007.) Politicians, noticing how a bull market fattens public pension funds, ratchet up the benefits they promise to retirees (a fact that state and federal pensioners are encouraged to remember on Election Day).

Periodically, the buzz wears off. What remains is a hangover of debts and promises. The proliferating dollars facilitate heavy borrowing. Ultra-low interest rates mask the cost.

I don’t ask that we return to some long-lost fiscal and monetary Eden. None has ever existed, even in America. Crises and business cycles are always with us. I merely observe that sound money and a balanced budget were two sides of the coin of American prosperity.

Then came magical thinking. Maybe you had a taste of modern economics in school. If so, you probably learned that the federal budget needn’t be balanced–it’s nothing like a family budget, the teacher would say–and that gold is a barbarous relic. To manage the business cycle, the argument went, a government must have the flexibility to print money, to muscle around interest rates and to spend more than it takes in–in short, to “stimulate.”

Oh, we have stimulated. Between the fiscal years 2008 and 2012 alone, federal deficits totaled $5.6 trillion. The public debt nearly doubled in the same span of years, to $11.2 trillion. The Federal Reserve tickled $1.6 trillion in new digital dollars into existence. True, our Great Recession proved no Great Depression, but the post-2008 recovery is the limpest on record.

A thin cheer went up in January when the deficit (calculated over the 12 preceding months) weighed in at a mere $405 billion, the lowest over any 12-month period since 2008. Only $405 billion. It’s not so much, as Washington strums its calculators.

Let us pause to reflect that a billion is a thousand million, and that a trillion is a thousand billion–or, alternatively, a million millions. It’s a measure of the fix we’re in that the billions hardly seem worth talking about.

It’s tomorrow’s trillions–the ones we’ve grandly promised to pay ourselves–that lie at the heart of the problem. The granddaddy of far-off commitments was Social Security, which dates from the 1930s. Medicare and Medicaid in the 1960s and the Affordable Care Act in 2010 duly followed. The debt, as big as it is, is the measure of past spending in excess of tax receipts, a pattern of bad fiscal habits that traces its intellectual roots to John Maynard Keynes and has its dollars-and-cents origins with Lyndon Johnson and his Great Society. What awaits us and our children and their children is the unpaid tab of the future.

“Nobody knows anything,” screenwriter William Goldman wisely observed about the accuracy of Hollywood box-office forecasts. The economists, in general, are no better than the studio executives.

You can’t blame people for not paying attention. America has forever defied the doomsdayers. The very language of government debt is calculated to tranquilize the critical mind. We speak of the Department of the Treasury rather than the Department of the Debt. (There’s no net treasure in the Treasury.) We say entitlement instead of taxing Peter to pay Paul and Social Security trust fund when we mean just another ordinary government account at the Department of Debt. (There is no trust fund because there is no division of assets, no accounts containing funds earmarked for you, the citizen, who so faithfully “contributed” your payroll taxes.)

Today’s miniature interest rates constitute another form of public sedation. You’d suppose the doubling of the debt would jack up the cost of servicing the debt. Nothing of the kind. As the debt has doubled, the rate of interest has halved.

In 2007, we owed $5 trillion and paid an average interest rate of 4.8%. Net interest expense: $237 billion. In 2016 we’ll owe $14.1 trillion and pay the average interest rate I already mentioned: 1.8%. Net interest expense: $240 billion. It’s a wonder we didn’t think of this financial perpetual-motion machine about a thousand years ago.

Debt per se is neither good nor bad, though less is usually better than more. How it’s priced and how it’s used are what tips the scales. If chocolate cake cost a penny a slice, the best of us would be tempted to break our diets. Well, government debt is priced at less than 2%, and Washington fell off the wagon years ago.

The public debt will fall due someday. (Some of it falls due just about every day.) It will have to be repaid or refinanced. If repaid, where would the money come from? It would come from you, naturally. The debt is ultimately a deferred tax. You can calculate your pro rata obligation on your smartphone. Just visit the Treasury website, which posts the debt to the penny, then the Census Bureau’s website, which reports the up-to-the-minute size of the population. Divide the latter by the former and you have the scary truth: $42,998.12 for every man, woman and child, as I write this.

In the short term, the debt would no doubt be refinanced, but at which interest rate? At 4.8%, the rate prevailing as recently as 2007, the government would pay more in interest expense–$654 billion–than it does for national defense. At a blended rate of 6.7%, the average prevailing in the 1990s, the net federal-interest bill would reach $913 billion, which very nearly equals this year’s projected outlay on Social Security.

We always need protection against cockeyed economic experimentation. Once a national consensus on money and debt furnished this protective armor. Money was gold and debt was bad, Americans assumed. Most credentialed economists today will smile at these ancient prejudices. Allow me to suggest that our forebears knew something.

Keynes himself would recoil at 0% bank-deposit rates, chronically low economic growth and the towering trillions that we have so generously pledged to one another. (All we have to do now is earn the money to pay them.)

How do we escape from our self-constructed fiscal jail? According to the Government Accountability Office, unpaid taxes add up to more than $450 billion a year. Even so, according to the Tax Foundation, Americans spend6.1 billion hours and $233.8 billion each tax season complying with a federal tax code that runs to 10 million words. Are we quite sure we want no part of the flat-tax idea? An identical low rate on most incomes. No deductions, no H&R Block. Impractical? So is the debt.

So is the spending (and the promises to spend more down the road). We need to stop the squandermania. How? By resuming the principled fight that Vivien Kellems waged against the IRS during the Truman Administration. It enraged Kellems, a doughty Connecticut entrepreneur, that she was forced to withhold federal taxes from her employees’ wages. She called it involuntary servitude, and she itched to make her constitutional argument in court. She never got that chance, but she published her plan for a peaceful revolution.

She asked her readers–I ask mine–to really examine the stub of their paycheck. Observe how much your employer pays you and how much less you take home. Notice the dollars withheld for Medicare, Social Security and so forth. If you are like most of us, you stopped looking long ago. You don’t miss the income that you never get to touch.

Picking up where Kellems left off, I propose a slight alteration in payday policy. Let each wage-earning citizen hold the whole of his or her untaxed earnings–actually touch them. Then let the government pluck its taxes.

“Such a payroll policy,” wrote Kellems in her memoir, Taxes, Toil and Trouble, “is entirely legal and if it were universally adopted, in six months we would have either a tax revolution or a startling contraction of the budget!”

Black ink, sound money and the spirit of Vivien Kellems are the way forward. “Make America solvent again” is my credo and battle cry. You can fit it on a cap.

Jeff Gundlach: «I am surprised that people have lost their focus on the enormity of the debt problem.» 

Jeff Gundlach: «I am surprised that people have lost their focus on the enormity of the debt problem.» (Picture: Andrew Harrer/Bloomberg)

Jeffrey Gundlach, CEO of the investment firm DoubleLine, expects central bankers to capitulate on negative interest rates and is bearish on US stocks.

In the global financial markets the bulls have taken over once again. In the United States, stocks are even flirting with a new record high. Nevertheless, Jeff Gundlach doesn’t trust this recovery and expects a severe setback. «The riskiest things are now stocks and other investments perceived to be safe», says the CEO of the Los Angeles based investment firm DoubleLine. The star investor, who is celebrated on Wall Street as the new bond king, is surprised that nobody seems to care anymore about the worldwide growing mountain of debt. Especially in the junk bond market, he sees a massive wave of defaults on the horizon. Mr. Gundlach likes gold and thinks the Federal Reserve has given up on its plans to normalize interest rates. Next, he expects central bankers elsewhere to capitulate on negative interest rate policies.

 Gundlach is the Chief Executive Officer and Chief Investment Officer of DoubleLine. He was formerly associated with TCW where he was Chief Investment Officer and head of fixed income activities. He is recognized as an expert in bond and fixed income investments. In 2011, he was featured as «The King of Bonds» in Barron’s, and named one of «5 Mutual Fund All-Stars» by Fortune Magazine. In 2013, he was named «Money Manager of the Year» by Institutional Investor. He is a graduate of Dartmouth College summa cum laude holding a BA in Mathematics and Philosophy. He attended Yale University as a PhD candidate in Mathematics. 

Beyond his achievements in the investment industry he is also known to be a profound connoisseur and collector of art. DoubleLine managed $95 billion in assets as of the end of the first quarter of 2016. In Europe, the fast growing investment firm works together with Nordea and recently launched the US Core Plus Bond Fund which provides a diversified investment across different sectors of the U.S. bond market.

Mr. Gundlach, it is getting suspiciously quiet in the global financial markets. What is your assessment of the current situation?

What you see is that the same pattern has been in place since 2012: Hope for growth in the new year that ends up being revised downwards, over and over and over again. But now we have reached the point at which no one bothers anymore about the comedy of predicting 3% real GDP growth. Even nominal GDP growth isn’t probably going to be at 3% this year. Actually, nominal GDP is at a level that has historically been a recessionary level. It isn’t this time because the inflation rate is close to zero. But no one bothers anymore and the Federal Reserve has basically given up.

How serious is this slowdown? Could the US even fall into a recession?

We will be on watch for that in the coming months. But it doesn’t really matter. Recessions don’t drive financial markets. It’s the other way around. People are so focused on this «recession-yes-or-no-question». What really matters is that we are in a low nominal growth environment and global growth keeps getting marked down. It is going to be slower in 2016 than in 2015.

What does that mean with respect to monetary policy in the United States?

I have been waiting for about two years for the Fed to capitulate on their interest rate increase dreams. Now, I think they did. Federal Reserve Chair Janet Yellen basically capitulated on March 29th. So far she had been acting as if each voice at the Fed carried the same weight: One official would say this, and another official would say something different. And because there were contradictory statements being made, the markets were getting very confused. But Janet Yellen took control with her speech at the Economic Club of New York. She did a good job and said that she is not going to raise rates at the next Fed meeting in April despite all these other Fed officials saying that April is a possibility. But it’s not going to happen. We’re not going there. So you’ve gotten about as much capitulation as you can get.

But what about a rate hike at the more important Fed meeting in June?

The Fed has already reduced its forecast to two rate hikes. And that’s going to turn into one hike pretty quickly because we’re getting close to mid-year and I really doubt that they are going to do a rate hike in June. But what they are going to do is a rolling twelve month two hikes type of thing. So in June they will signal two hikes by June 2017 and then they will just keep pushing it forward. That’s a movie we’ve seen before. The Fed has pushed forward such decisions for years. We were always going to get to a Federal Funds Rate of 3% and it was always going to be starting in six months. But it never happened.

But actually, the Fed raised interest rates in December for the first time since the financial crisis.

Well, that didn’t work very well. The stock market crashed and the credit markets were a disaster. The Fed’s dots of four rate hikes this year made no sense and they’ve capitulated. The markets have humiliated the Fed into abandoning their pretty idiotic forecast.

So what’s next for the financial markets?

The capitulation of the Fed is pretty much fully priced in. But I think the next big thing will be that at some point central bankers in Japan and in Europe will have to realize that they need to give up on negative interest rates. Negative interest rates are the dumbest idea ever. It’s horrible. Look at how badly it’s been working. The day that the Bank of Japan went negative the Yen started strengthening like crazy and the stock market is down. That’s exactly the opposite of what they wanted. The same thing happened with the ECB. Around a year ago, the consensus recommendation was to sell US equities and to buy European stocks because of negative interest rates in Europe. That turned out to be the most common mistake that was made in 2015. It’s been a horrible outcome. So there is mounting evidence that negative interest rates do the opposite of what the central bankers were hoping for.

Why don’t negative interest rates work?

Negative interest rates are designed to fight deflation. But they are the very definition of deflation: Your money is disappearing. As an investor, you are going to have less money in the future than you have today with negative interest rates. That’s deflation! So negative interest rates are deflationary and they are tremendously negative for monetary velocity. For instance, in Japan they’re issuing huge amounts of high denomination Yen notes. That’s because of negative interest rates people don’t want to put their money in the bank and they don’t want to invest in Yen denominated bonds. That’s why I think eventually you are going to get helicopter money.

 Are you concerned about that?

I’m not concerned about anything. My job is not to set policies. I’m not an economist or a politician or a central banker. I invest people’s money. So I’m agnostic as to what’s good and what’s bad in terms of policy. I just deal with it.

So how do you deal with negative interest rates and central bank capitulation?

It’s all about capital preservation. If you can get a few percent return in a deflationary environment you’re doing fine. Because if you invest in European government bonds your base case is that you are going to have a negative return. The same applies if you invest in Japanese government bonds. So gold is a high yielding investment. You are getting zero yield versus negative yields in the case of short term European bonds and most Japanese bonds. Gold is doing fine. It’s preserving capital in the US, it’s been making money over the last couple of years for European investors. That’s why I own gold. Because in a negative return environment anything that holds its value or makes a little is good. Also US bonds look relatively good. You have a positive yield of 2 or 3% this year from a bond portfolio in the US. Of course, that’s not great for European investors because the dollar has been weakening.

And what about stocks? Especially in the US, equities have staged a surprising comeback since the heavy turmoil at the beginning of the year.

The US stock market seems egregiously overvalued versus other stock markets. Emerging markets look vastly better, Japan looks better and Europe does too. That’s because they’re all down. It’s remarkable that the US stock market is within about 2% of its all-time high and every other significant stock market is down substantially. Also fundamentally, it’s very hard to believe in US stocks. Earnings and profit margins are dropping and companies basically are borrowing money to pay dividends and to buy back shares. That’s completely non-productive borrowing and just creates a bigger debt burden. So it’s likely that you are going to see declines in the US stock market and since the correlations are so high this means that probably the junk bond market will go back down, too.

There’s also a strong correlation between junk bonds and oil. What’s your take on the recent rally in crude?

I predicted oil would make it easily to $ 40 and it did so very comfortably. But now it’s having a very hard time getting to $45. It bounces up a dollar, down a dollar and I think if oil is going back down to $ 38 people are going to be very concerned.

Energy companies are playing an important role in the junk bond sector. What would oil at $ 38 mean for the credit markets?

Just like oil, the high yield market has enjoyed the easy rally. I think it’s basically over. I don’t see how you are supposed to be all fond off high yield bonds, since they are facing enormous fundamental problems. I thought people would learn their lesson but the issuance in the years 2013/14 was vastly worse than the issuance in 2006/07. Also, in the bank loan market covenant lite issuance rose to 40% in 2006/07. In this cycle it climbed to 75%. The leverage in the high yield bond market is enormous and you’re about to have a substantial increase in defaults. I wouldn’t be surprised if the cumulative default rate in the next five years were going to be the highest in the history of the high yield bond market.

What would be the consequences of that?

We are now in a culture of default. There is no stigma about defaulting anymore. During the housing crash, homeowners walked away from their mortgages. That was the beginning of a massive tolerance of default. Today, people talk about Puerto Rico defaulting like it’s nothing. But if Puerto Rico defaults why won’t some clever person in Illinois say: «Let’s default, too! » Constitutionally, Illinois is not allowed to default, but Puerto Rico wasn’t either. For Illinois it just seems impossible to pay their pension obligations. And then, what about Houston, what about Chicago, what about Connecticut? I am surprised that people have lost their focus on the enormity of the debt problem. Remember, in 2010 and 2011 there was such a laser focus on the debt ceiling in the US and we were worried about Greece. Nobody is worried anymore. People are distracted by this negative interest rate experiment.

That’s also interesting with respect to the presidential elections. In contrast to 2012, this time there is not much talk about national debt and budget cuts.

What you see this time is only child’s play. The next election is going to be much more transformative than this one. Because in this election, both parties are kind of clinging to the belief that they can keep the genie in the bottle. But we’re on the cusp of big change and, unfortunately, it’s all wrapped up in generational problems. The big problem that is coming, of course, is the unfunded liabilities that have been promised to the baby boomers. According to one calculation, the unfunded liabilities of all these entitlements on a present value basis are $ 60 trillion in the United States, just at the federal level. But in this election, nobody is talking about addressing them. Donald Trump wants to keep social security the same, Bernie Sanders says make it even bigger, while Hillary Clinton represents more of the same.

So who do you think will win the race for the white house?

Trump is going to win. I think Clinton and Sanders are both very poor candidates. I know the polls are signaling the opposite. But the polls said the opposite four years ago, too.

How would the financial markets react should Trump win?

In the short term, Trump winning would be probably very positive for the economy. He says a lot of contradictory things and things that are not very specific. But he does say that he will build up the military and that he will build a wall at the border to Mexico. If he wins he’s got at least to try those things. Also, he might initiate a big infrastructure program. What’s his campaign slogan? Make America great again. What that means is let’s go back to the past, let’s go back to the 1960s economy. So he might spend a lot of money on airports, roads and weapons. I think Trump would run up a huge deficit. Trump is very comfortable with debt. He’s a debt guy. His whole business has had a lot of debt over time and he has gone bankrupt with several enterprises. So I think you could have a debt-fuelled boom. But the overall debt level is already so high that you start to wonder what would happen after that.

How do you explain that a guy like Trump might actually win the election?

His popularity is very similar to the popularity of unconstrained bond funds. About two or three years ago, unconstrained bond funds became the most popular thing in the United States retail market and in the institutional market probably, too. Because when investors analyzed all the bond segments they were familiar with, they didn’t like what they saw. They didn’t like treasuries, they were scared of the Fed, they didn’t like traditional strategies. So, if everything you think you know looks unattractive, you go for something that you have no idea about. And that’s an unconstrained bond fund. The thinking was: «Don’t even tell me what you are doing, I do not want to know. Because if I know, I won’t like it. » The same is true with respect to the elections: «Don’t give me a traditional candidate. Give me someone who I have no idea what he is going to do» – and that’s basically Donald Trump.

That shows that it is not easy to invest your money these days. What does it take in general to be a good investor?

I made a name for myself primarily because in March of 2005 I was convinced that there would be a complete collapse of the credit market. When it was still hypothetical, people argued with me. They said that this would never happen. But I was right. So you have to find a center piece idea that will be important in driving the market. And you have to have an intuition about how other investors will react if you’re right and they wake up to that idea. Such opportunities do not happen very often. It is not always so obvious. So you have to pick your moments. In the financial markets, 80% of the time it’s a coin flip. But the other 20% of the time you have very high confidence and it’s not a coin flip. For instance, I don’t think the stock market is a coin flip. Especially in the United States stocks are very expensive, particularly low volatility stocks.

What exactly is the problem with low volatility stocks?

The riskiest things are now stocks and other investments perceived to be safe. One of the most popular categories in US investing are low volatility stock funds. But there is no such thing! If you think that a stock like Johnson & Johnson can’t go down, you’re wrong. And if people own funds that invest in stocks which they think are immune from decline and they start to decline, all hell breaks loose.

The Post-Crisis Economy’s Long Debt Hangover


CAMBRIDGE – The meeting of G-20 finance ministers and central bank governors in Washington, DC last week concluded on a sour note. Small wonder: Global growth prospects have dimmed amid a variety of risks now emanating from both advanced and developing countries.

The meeting’s participants addressed – yet again – the need for greater policy coordination, more fiscal stimulus, and a variety of structural reforms. And that discussion has become more urgent, given the widespread view that monetary policy may not have much ammunition left, and that competitive devaluations would do more harm than good.

Saving the IMF

Following this year’s reform-free IMF meeting, former Fund official Ashoka Mody sizes up the best thinking about its post-crisis challenges.

 But with the largest economies, nearly eight years after the global financial crisis, burdened by high and rising levels of public and private debts, it is baffling that comprehensive restructuring does not figure prominently among the menu of policy options. Indeed, for the global economy, debt restructuring is the proverbial elephant in the room.

In the early stages of the financial crisis of 2008-2009, Kenneth Rogoff and I noted that recovery from severe financial crises are protracted affairs, as it takes time for households and firms to work down the debts accumulated during the boom. At the same time, banks, faced with a surge in nonperforming loans and compromised balance sheets, may be unable or hesitant to engage in new lending. Delays in cleaning up balance sheets are among the factors that impede recovery and make post-crisis recoveries different from typically sharper business-cycle rebounds.

In a follow-up study, we documented the trajectory of per capita income following the 100 worst financial crises since the 1860s. We found that it took a little more than seven years, on average, for the advanced economies (as they are defined today) to reach the pre-crisis level of income; the median recovery took about six years. The decline in per capita income from its peak at the onset of the crisis to its trough at the recession’s bottom averaged about 9.6% for this group. Crisis-related output collapses for emerging markets were worse.

How does the modern post-crisis experience compare to its historical counterparts? The International Monetary Fund’s latest World Economic Outlook, which offers projections for per capita GDP growth (among numerous other indicators) through 2021 for most of the world’s economies, facilitates the appraisal.

France, Germany, Greece, Iceland, Ireland, Italy, Netherlands, Portugal, Spain, the United Kingdom, and the United States all had systemic financial crises. Two of the 11 (Germany and the US) had a shorter road to recovery than the historical experience for the advanced economies. Ireland and the UK are next in recouping lost income (see table).

If the IMF projections are taken at face value, the median time it takes to reach the pre-crisis level of income for the 11-country group will be about nine years. By 2021, Greek and Italian per capitaincome will stand at about 14% and 9%, respectively, below their 2007 level. The Greek crisis, which is far from over, is tied for tenth place among the worst 100 historical crises.

Even setting aside the more charged and controversial restructuring of sovereign debt, the write-off of private debt incurred during the boom (often under a very rosy set of assumptions about borrowers’ future income and wealth) has been an integral part of the resolution of banking crises through much of known history. Notable exceptions include the “evergreening” of bank loans through the years in the aftermath of Japan’s crisis in the early 1990s and Europe’s ongoing crisis, which is fast approaching the decade mark.

The anemic recovery in many advanced economies (even when compared to other severe crises) owes much to the prevailing “extend and pretend” approach to debt. European banks since the crisis have largely been kept busy buying government debt and evergreening (in Ponzi-scheme fashion) private pre-crisis loans.

As difficult as the foreclosure episode was in the US, it enabled borrowers and banks to adapt to the collapse of the housing bubble and to move on. Earlier episodes, ranging from the Scandinavian crises of the early 1990s to the Asian crisis of 1997-1998, produced a much faster pace of deleveraging. One can only hope that China’s approach to dealing with its internal private and sub-sovereign debt does not adhere to the Japanese-eurozone timetable.