CHART OF THE DAY: HOW TO SOLVE A DEBT CRISIS
One of the great precedents for the current debt crisis was Sweden in the early 90’s. Of course, the U.S. chose to ignore the actions taken by Sweden and chose a strategy more akin to that of Japan in the 90’s. For those who aren’t familiar with the two outcomes – they were night and day. The Swedish economy and stock market soared in the mid/late 90’s while Japan’s economy remains sluggish to this day. What was the major difference between the two strategies? One fought high debt with more debt. The other extinguished the debts as we’ve been in favor of since the crisis began. The market is celebrating today’s announcement of higher future debts as if it’s a good thing….
Japan’s debt to GDP:
Sweden’s debt to GDP:
United States debt to GDP:
For more on this topic please see “what’s wrong with a Swedish Model?” and “pick your poison“.
I have always been fascinated by how Sweden handled their credit crisis. They also formed an RTC of sorts to sell the bad loans and commercial buildings onto the market throughout the 90’s. They essentially got rid of the bad debt in the system and let the market set the prices for it. I have faith we can get out of this mess, but I can’t believe we have chosen what appears to be the Japanese route.
It’s total insanity. Bill Seidman told us to do it the RTC/Swede way, but unfortunately he passed away and no one listened to him.
To think that the long-term problems will turn out differently for us than they have for Japan is just sheer stupidity. You can’t solve a debt crisis with more debt. And if it works we’ll likely just get historically high inflation and rinse wash repeat the bubble cycle….
TPC – Do you think we will actually get massive inflation? Japan has been in a deflationary spiral since the private sector began deleveraging and public secto began to issue more debt. One thing I’ve noticed here so far is nobody appears to be deleveraging yet. If we are able to continually grow our massive debt bubble than I can see inflation, we’ll see what the flow of funds report says in September. I think a likely scenario is low rates for a long time and lower prices. How else is the government going to be able to pay the interest on all these bonds if we have above average interst rates? It’s a mess to say the least.
No way we get inflation with such a weak consumer. The velocity of money should remain low for years. I am of the mindset that we will see low inflation, but not massively destructive deflation. Below trend growth.
Don’t underestimate the power of US consumers spending impulse….When you compare to Japan, one thing I see is that Japan had a high saving rates, US didn’t. We have been spending like crazy for the past 30 years or so. Old habits die hard. Yes consumers spending is down but some of the numbers in regard to consumer debts didn’t go down by much. In addition, you have helicopter Ben over here giving free money to the banks..Banks spent and leverage up even more…With the money Bernanke spent, we could afford the new S&P 500. I don’t believe that we will have hyper inflation in 2009-2010..but after that is anyone guesses.
Btw, don’t underestimate the power of sale pitch from the government and the major news outlet
Henry,
It’s damned if we do and damned if we don’t. If the consumer does actually come back to life, begin spending money and taking more risk then it’s likely that the velocity of money will ramp higher and inflation will pick-up. Does anyone trust the Fed to plug the hole in the wall before it floods the market with dollars? It’s a return to the boom bust economy of the 90’s and 00’s.
If we don’t see a recovery in the consumer we’ll continue to see mild deflation that will persist for years. We had a chance to begin ridding the system of its debts, but we didn’t seize the opportunity. Now we are destined for below trend growth either after high inflation or deflation. The debt is guaranteed to paralyze the U.S. economy for years.
While I agree that the Swedish crisis resolution was preferable to the Japanese one (and the US one so far), the graphs don’t reinforce your point regarding fighting debt with more debt very well.
Sweden’s debt-to-GDP (it’s not labeled but these numbers correspond to government only) shot up from ~43% to ~75% of GDP very quickly after 1990 when their crisis started, as shown on your graph, whereas Japan’s public debt grew much more slowly in those initial years. I suspect the key difference has more to do with the fact that Sweden’s private sector debt to GDP ratio started out much smaller (127% versus 219% as shown here for Japan) and the fact that private losses were estimated and dealt with up front rather than the Japanese and US approach of changing the accounting rules and pretending everything is fine.
hbl,
I would only add that Sweden’s debt topped out in the high 70s. We are already there and today’s news is that we are going much higher. The part that is missing from the U.S. chart is where we will be in 5 years. Will we finally start paying off the debt or will be continue to pile it on? It looks as if the administration is planning to pile it on in which case we continue to follow the Japan model as opposed to the Swede model.
Hi TPC,
I’ve been a reading your articles for quite some time. They are informative and insightful and i really appreciate and thank you for your efforts. Keep up the good work.
I’d like to make 2 points.
I’ve studied in Sweden ( study abroad/student exchange program during the early 2000’s). What i understood about their handling of the crisis is 1) They separated all the bad assets banks were holding, which obviously created a clean bank that was recapitalised to make a new start. 2) Much like the Banking elite as in us one of the oldest and powerful business families of Sweden owned majority of one of those banks, but sweden made them swallow some losses lose/dilute their ownership interests. It did net the exposure of all the banks and reduced double counting ( Ex: Some loans were transfered from one bank to the other bank by customers) as they were not as complex as we’ve in US.Since they paid very little for the bad assets without impairing the banks they eked out a profit (approximately 5% ROI if i remember correctly from my case studies). Moreover their leadership does not always put their short term ( reelection issues)interests ( i must point out that that a small fringe cannot skew the discussion as it some times happens here in US either it’s the left/right that does it.) Of note is that one party has been in power for a longtime as voters who go by sound bites ( without the nuanced arguments/debate) are rare (as for as what i’ve come across during my relatively short stay there) but were more patient if they trusted the leaders are doing a reasonable job (I feel they are patient to a fault).
Regarding Inflation, as you might agree though fed prints $ it does not have effective control on the flow as a portion of $ are beyond it’s control ( either with other countries banks and citizens), when it increases the flow it may go to far off places, but it can mop up later only a portion of that, reducing it’s control on it’s core activity. As noted by marc faber/jim rogers and many other in a globalised economy when money increases it can chase anything, compounded by the easy monetary policies of many other nations, this too much money can cause bubbles in commodities/emerging markets/treasuries anything? But if it goes to commodities as their supplies/reserves are finite would cause inflation. Of note is pig farmers in china stockpiling on copper/nickel e.t.c in china due to the free availability of money.
One important difference with the japanese experience is at that time only bank of japan loosened it’s monetary policy, and due to japanese culture and signs of deflation, they held on to cash. But today all central bankers are doing it and many would like to put that cash ( with no cost of capital) to good use even taking on huge risks as is happening in china/india ( stockpiling of fooditems to export especially by middlemen expecting shortages due to poor monsoons before the govt imposes restrictions on exports).
Great thoughts Marc. Thanks.
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