The European debt crisis has dominated the headlines for the best part of the past 8 or 10 months. By now, it is hard to find a layman who is not an expert in the matter, nor is it easy to find an expert who doesn’t conflict with other experts or his own earlier analyses. Efforts are made to quantify the problem and efforts are made to qualify it. Quantification fails as a result of too many variables, where qualification fails for taking too narrow a view. The question is: How to avoid the Scylla of senseless quantification and the Charybdis of shallow qualification? An effort will be made here to avoid both dangers by creating a simple systems diagram of the debt crisis with an open eye for important factors in the context. But beware, I am a layman in many fields, including international finance and systems thinking. You may still appreciate the effort for the thought experiment it actually is. Let’s start reading the systemic concept map in the middle with the “debt burden”. The main problem with a debt burden is that it may be hard to repay, which ultimately may result in bankruptcy. This risk can be reduced by an increasing GDP, i.e. by economic growth. On the other hand, if growth falters or is reversed (recession) the risk will increase. Now, there is not much politics can do apart from avoiding this to happen. If it is happening, it is too late. Politics should keep an eye on the right balance between expenditure and revenue and it should be cautious instead of optimistic when it comes to future economic growth or even current economic growth. External finance can make economic growth look good for a while as was the case with the EU structural investment funds, but it may also mask underlying weaknesses. Bruxelles is to blame for this, it should address all the mechanisms that caused it to be so, and it should do so transparently. It would be good to take the local optimistic view of economic growth into consideration. What else is causing the economic melt-down to get worse? With the falling GDP, revenue is decreasing too, even when politics is doing its best to raise taxes. So the only way to reduce the debt burden is by cutting expenditure to the bare minimum, but this in turn will cause the recession to deepen. Meanwhile, the Moody’s and other credit rating agencies judge your repayment capacity to zilch and your debts to junk, which causes the interest rates to spike to dramatic heights. This diverts all your debt payments to interest payments, further reducing the your repayment capacity, if there is still some capacity left, that is. Two questions remain. The first and most important one is: How to get the economies to grow again? The second one is: What is the extent of the haircut necessary to make that possible? Only an honest, hard-nosed economist can answer that question. Probably David Bencek and Henning Klodt of the Kiel Institute are not very far off when they estimate that Greece will need a haircut of more than 80% and Portugal about 50%. Other countries still at risk include Ireland, Italy, and Hungary. Spain is safe, even when economic growth is marginal at best.
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