One thing to search for in the markets, is what entities are being unrealistic. We have a bevy of them now:
- Eurozone — “We can get many nations to behave like Germans.”
- China — “Our financial system is in great shape. We are ready to open up our economy to global capital flows.”
- US — “Eventually the government budget will be balanced, really!”
In the present environment, creditors are the unrealistic dreamers. They imagine that they will be paid back at par, when they made loans that were less than creditworthy.
In most cases, the right solution is to offer no more loans, and compromise on existing loans. The wrong solution is to extend more credit, hoping that the situation will turn, and that you will eventually be paid back at par. The result of extending more credit is that you will take much bigger losses later. Tough love produces better results than compassion, for all parties.
Yes, there may be more short-run pain, but there will be better recoveries after the crisis is over. Think of Eastern Europe — those that took the “Big Bang” did better. In this environment, creditors need to take their losses sooner, and the system will do better thereafter. To seek full payment is unrealistic.
[...] – In a word: unrealistic. [...]
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Very nice David, thank you. What about countries such as Greece which have a big primary deficit and may not have the ability to cut spending more in the short term without major upheavals?
On this note, it would be interesting to discuss the varying abilities of nations to deal with spending cuts (e.g. Ireland vs. Greece). What are your thoughts re the US in this respect?
“US — “Eventually the government budget will be balanced, really!”
What entities are making this claim?? I have not seen any.
More to the point, please explain how balancing the budget any time in the near future (say, 5 years) would be anything but disastrous.
China is going to liberalize capital mobility at precisely the wrong the time. Once a major bankruptcy triggers a crises of confidence, now not only will foreign investors start pulling their money, the domestics will start shipping their money out of the country. Wealthy insiders have already looted companies and taken their money out. This is confirmed by the research, showing financial liberalization is leading indicator of crises, says Rogoff and Reinhart.