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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Best of Doug Noland
July 20, 2011
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The empirical work of Carmen Reinhart and Kenneth Rogoff demonstrates conclusively that heavy debt loads negatively impact growth dynamics (they have found 90% of GDP an important threshold).  This is no earth-shaking revelation, especially if one comes from the analytical perspective that huge accumulations of public debt are generally associated with an extended period of private and public sector Credit excess.  And years of Credit-related excesses will almost certainly foment acute financial fragilities and economic impairment. 

It’s no coincidence that the greatest expansion of public debt comes late in the cycle when the economy’s response to additional layers of debt becomes both muted and uneven.  Indeed, a precarious dynamic evolves where enormous amounts of (non-productive) government debt are required just to stabilize increasingly fragile economic structures.  In the meantime, late-cycle stimulus will most certainly distort and dangerously inflate highly speculative securities markets – especially when higher market prices are the direct aim of policy.

There was a Financial Times column today that posited that Italy’s problem was that it was stuck with the ECB rather than the Federal Reserve!  If only the Fed were purchasing Italian sovereign debt as it does Treasurys, Italian debt service costs and deficits would be much lower.  Crisis resolved.  Well, monetary policy certainly does play a critical role in sovereign debt Bubbles and crises.   

Back in the autumn of 2009, Greece could finance its massive deficit spending program for two-years at less than 2%.  Portuguese yields were about 125 bps and Ireland 175 bps.  Spanish and Italian 2-year yields were around 1.5%.  The Fed’s, ECB’s and global central bankers’ moves to slash interest rates to near zero were instrumental in the marketplace’s accommodation of unprecedented government debt issuance at artificially  low yields.  The European “periphery” markets were part of the expansive Global Government Finance Bubble.  And the market perception that monetary policy would ensure ongoing low sovereign debt service costs was instrumental in the market disregarding – and mispricing - Credit risk throughout the eurozone.  Even last spring, after the Greek crisis’ initial eruption, markets held to the assumption that policymakers would sustain low sovereign borrowing costs and insulate bondholders from significant losses.

Not only has monetary policy fostered the rapid expansion of government debt at artificially low rates, it has also set the stage for a very destabilizing change in market perceptions.  Particularly after many years of interventionist policymaking (throughout the protracted private Credit boom), the markets naturally turn complacent when it comes debt crisis risks.  Yet as Europe is confronting these days, there are limited available options when crisis finally arrives at sovereign debt’s doorstep.  At some point, fiscal and monetary stimulus comes to the inevitable end of the road.  At some point, markets say “no mas,” "não mais," "non piu" or "no more." 

Piling on additional government debt is then no longer a solution, inaugurating the debilitating and depressing “austerity” cycle.  And, as we continue to witness here at home, having the central bank monetize federal debt only worsens market distortions and delays desperately-needed fiscal (and economic) reform.  As much as there was an element of certainty in the marketplace with regard to the mechanics of private-sector debt crisis resolution, sovereign debt Bubbles and crises just seem to foment uncertainty.  Policymakers are destined to look incompetent, while markets will appear fickle and unstable.  Meanwhile, fragile recoveries will turn increasingly vulnerable.  And throughout, there will be a growing disconnect between what the markets have come to expect from policymakers and what they can now realistically deliver.

As witnessed in Greece, Ireland, and Portugal, there comes a point where the market recognizes debt trap dynamics and begins to price in sovereign risk.  And it is not long into this process of risk re-pricing that the marketplace comes to view huge debt loads as unmanageable albatrosses.  This destabilizing process has now commenced with Spain and Italy.  Once unleashed, sovereign debt crisis momentum can prove difficult to contain. 

To be sure, the debt situation in these economies remains manageable only as long as the markets are content to finance sovereign borrowings at monetary policy-induced low rates.  Or, stated differently, Italy’s (and others’) debt load is viable only if the marketplace disregards risk.  Well, the market is today rather keen to risk and debt dynamics - and has been determined to push borrowing costs significantly higher.  This not only imperils the government debt and Credit default swap (CDS) markets, but casts an immediate pall on the Italian and European banking sector with their huge exposures to increasingly problematic sovereign debt.  As an analyst quoted in the Financial Times put it, “A banking sector is only as strong as its sovereign.”
European Credit and inter-bank lending markets are faltering.  The resulting de-leveraging and de-risking – and tightened general finance - will likely further pressure markets, overall confidence and economic activity – adding further pressure to the unfolding debt crisis.  And as China and Asian central bankers witness the spectacle of an unraveling Italy, they must view the unfolding U.S. debt debacle with heightened trepidation.  Perhaps this was on ECB President Trichet’s mind this past weekend when he referred to “the global debt crisis.”