Public Debt Dynamics of Europe and the US Public Debt Dynamics of Europe and the US Dimitris N. Chorafas AMSTERDAM ✬ BOSTON ✬ HEIDELBERG ✬ LONDON ✬ NEW YORK ✬ OXFORD PARIS ✬ SAN DIEGO ✬ SAN FRANCISCO ✬ SINGAPORE ✬ SYDNEY ✬ TOKYO Elsevier The Boulevard, Langford Lane, Kidlington, Oxford, OX5 1GB, UK 225 Wyman Street, Waltham, MA 02451, USA Copyright © 2014 Elsevier Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the publisher. 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To the fullest extent of the law, neither the Publisher nor the authors, contributors, or editors, assume any liability for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions, or ideas contained in the material herein. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record for this book is available from the Library of Congress ISBN: 978-0-12-420021-0 For information on all Elsevier publications visit our website at store.elsevier.com Preface Niels Bohr, the quantum physicist, once said that every statement should be taken by a scientist as a provisional hypothesis that has to be tested. This holds true not only of physics and engineering but as well of finance and economics whose theo- ries are too often accepted without scrutiny by chiefs of state, ministers of finance, central bankers, economists, analysts, and common citizens. An example is the theory (or, more prec isely the myth) that high leveraging is good for a person, a company, or even a nation. If accepted, this leads to the DEBT syndrome and its disastrous aftereffects. The fallacy that “debt is good” is the sub- ject of this book. In each of its 15 chapters, the evidence emerges that piling up public debt can lead to an unmitigated disaster. This is documented through case studies on Greece, Spain, Italy, France, and the United States—in short, those west- ern countries that nowadays lost control of their senses and of their economy. Bohr’s thought demolishes the generally held opinion that scientific, economic, or social “truths” and “theories” are forever. By extension, it dissipates the widely prevalent delusio n that books in science and in economics contain only eternal wis- dom. Books are learning tools written by people who are fallibl e. As such, they may include impractical theories like: ● The reign of debt, and ● The gates of nirvana. Written for professionals, academics, and researchers, the book the readers have in their hands provides the documentation and describes the implications of current policies by sovereigns and central banks, in dealing with the debt abyss .Inso doing, it brings in perspective the diversity of opinion reigning in modern econom- ics and finance. It also outlines themes which, among themselves, are defining the society in which we live. “Authors are the engineers of the human soul,” Stalin once said, adding that: “If you want to know the people you deal with learn about what they are reading.” 1 In this, the Soviet dictator was right. Ideas and arguments contained in books are basic to culture and civilization. They are eye-openers to the wisdom of the past and help in positioning one’s mind in a way confronting present challenges by making use of assumptions, interpretations, and extrapolations. Usually, though not always, when the auth or succeeds in his or her mission, books become living entities aimed to both inform and provide the ground s for a discussion where different, contradictory opinions can be heard. “I completely 1 Montefiore SS. Staline. Paris: Editions des Syrtes; 2005; London: Weidenfeld & Nicolson; 2003. disagree with you but will fight for your right to state your opinion,” said Voltaire to Jean-Jacques Rousseau. Like Voltaire’s writings, this book brings to the reader contrarian opinions, but its intention is not polemics. It is a reflection of the dynam- ics of social, economic, and financial life which are almost entirely built on contradiction. Contradiction and diversity enlightened the past centuries and permitted differ- ent philosophies to develop. By contrast, our world has been flattened by the steamroller of the nanny state. Margaret Thatcher was right when she said: “ too many people have been given to understand that when they have a problem it is the government’s job to cope with it. They are casting their problems on society. And you know, there is no such thing as society. There are individual men and women and there are families.” 2 There are individuals and families who in the post-World War II generations have been taught that “debt is good” and they are accumulating it crazily. Individuals and families depend on entitlements to enlarge their income, and if they are homeless, the government must house them. Run by politicians who are no better than second raters, western governments are happy to oblige no matter how illogical are their citizens’ demands. ● The cost goes to increase the already ultrahigh public debt, and ● Not even a thought is given to the fact that, at the end of the day, debt means slavery. Deception is far from being unheard of in politics and in society at large. In 1957, at the time of the Treaty of Rome, the “Europ ean dream,” embraced by the majority of the old continent, promised a middle-class lifestyle for most people. But delays and bickering made this almost impossible. The more public debt rose, the less was the prospect of secure jobs for the young as financial crises: ● Destabilized the politicians, and ● Created a widening gap between social classes. No wonder that the majority of Europeans have deep cynicism toward their gov- ernments, national institutions, and political leaders. To make educated guesses about how long this will last, we must appreciate what has happened and why. Part of the answer can be found in drift, which always accompanies a rich soci- ety misled to believe that the good times last forever. Another part of the answer is wrapped in the comic thinking that “debt is an asse t.” That’s the concept which led to wrong-way policies by chiefs of state and their cohorts, all the way to common citizens. We will see why. Hopefully, this wrong-way thinking could be corrected through decisions which are factual, motivating, and able of changing the direction of future events. The potential of a correction is increased by nonmainstream books able of showing how to think out of the box, inciting their reader to: ● Examine alternatives, 2 Financial Times, April 19, 2013. xii Preface ● Challenge the “obvious”, and ● Organize to get out of the trap. Along this line of thinking, this book provides a probing discussion on the state of the economy, the reasons why we came into the trough in which we reside for over 6 years, and what it takes in terms of effort to get out of it and get moving again. The text makes plenty of critical thoughts public, relying on the right to free- dom of opinion and of expression, as well as on the obligation to provide thinking people with contrarian arguments and information different to the one that so often is being heralded by politicians and the media. ÃÃÃ The book divides into six parts. Part One provides the reader with a snapshot of the economic, social, and financial world today which, as different commentators suggested, is a casino society. This includes the globalization without limits which started in earnest in the 1980s and the “kingdoms of debt” which it created, practi- cally in all western countries. No attention has been paid to the fact that both public and household debt is in the upside, and it is very difficult getting up from under if this could be done at all. The theme of Part Two is an answer to destiny by the land of Homer: The Greek economy and its fall to the abyss can teach very valuable lessons on what “not to do” if you wish to keep your freedom and your independence. But is any- body listening? Part Three presents to the reader more case studies on self-wounded economies: Spain, Italy, and France. These are brought to the readers’ attention in an as is way, with every effort made to avoid the political and bureaucratic romanticism that “the worst is behind us.” The worse is still ahead of us and nobody can tell for how long it will last. Part Four attempts to answer a daunting question: “Who killed the Golden Eagle?” When WW II came to an end, the US economy was supreme and it contin- ued being so for over a decade. But slowly its mighty weight was eaten up from within. Like ancient Athens, American citizens listened to the fallacy propagated by weak politicians that, no matter how fast you used them, your assets last forever. One thing that we learned during the past half a dozen years is that events which appeared unimaginable do sometimes occur. Therefore, we need to enlarge our mental map of how the world works and how conditions change. Part Five adds to the names of troubled economies those of the BRICs, even if a couple of them are still bystanders. Can anyone prognosticate what will be their future? The answer is “yes!” and this in several respects, from sovereign governance to the unexpected aftermath of an aging society. I strongly recommended paying attention to the words of Taro Aso, the Japanese minister of finance in Section 5 of Chapter 13, about longevity risk. xiiiPreface Part Six has two chapters complementing one another. The first is constrained by the fact that there are so few cases of economies which have been successfully deleveraging—and therefore improving their creditworthiness. Both are small coun- tries: Iceland and Latvia, but what they have accomplished can teach the big ones about what is required to take hold of oneself and change course while it is still time. I also added to this chapter case studies on Ireland and Britain (though with mixed feelin gs); as well as on Germany for being able to walk since 2007, the very beginning of the deep debt crisis, at the edge o f the abyss without falling into it. The book’s last chapter has a polyvalent objective, starting with the viewpoint of those who believe that the higher is the public debt, the better. True or false? Have this theory’s proponents duly considered the effects of ineptocracy when it comes to judge, for example, how unfunded liabilities will be managed? What will be the effect of higher public debt on our living standard? Why matters get worse because of the lack of ethics, all the way to sovereigns adopting the pol- icy of grabbing money out of common citizen bank accounts? And, not to be forgotten, what should be done with parliaments voting in favor of democratic cleptocracy? ÃÃÃ Because the best way to convey a message is through facts and figures whi ch can be understood and appreciated, this book is full of real-life examples. It has been a deliberate choice to depend on case studies as evidence of good and bad approaches to social, economic, and financial life. Live events also help as undisputable demonstrators of successes and failures in the search for solutions in getting out of the hole western governments find themselves. As Denis Healey, a former British chancellor of the Exchequer, once said: “The first law of holes is that if you are in one stop digging.” In conclusion, in the course of the last six years, political, social, and economic events have been crowding one another. A prolonged financial crisis opened the door to all insti ncts. At sovereign level, tragedy alternated with comedy, for the same reason that in life the sublime is mingled with petty and with self-deception. Governance admits errors, but errors are magnified when they are hidden. Th e first requisite for success is to hide nothing—weaknesses least of all—and to call every- thing by its right name. This book has been written on that principle. The evidence is provided through the case study presented to the reader as a Conclusion. The trickery associated to the birth of the Euro. ÃÃÃ I am indebted to a long list of knowledgeable people, and of organizations, for their contribution to the research which made this book feasible; also to several senior executives and experts for constructive criticism during the preparation of the manuscript. Dr. Heinrich Steinmann, Dr. Nelson Mohler, Eva Maria Binder, xiv Preface and Souzy Capoyannopoulos-Biris have made a significant contribution of out-of- box ideas, double-checking on facts, and review of text samples. Let me take this opportunity to thank Dr. Erin Hill-Parks for suggesting this project, Dr. Scott Bentley for seeing it all the way to publication, and Vijayaraj Purushothaman for Production. September 9, 2013 Valmer and Schlo ¨ ssli Dr. Dimitris N. Chorafas xvPreface 1 Globalization of a Casino Society 1.1 “My Lord,” Answered Solon to King Croesus, “You Are Asking Me What I Think of Human Life” “My Lord,” answered Solon (640À599 BC), the Athenian lawmaker, to a question by King Croesus of Lydia, “You are asking me what I think of human life. How can I answer you otherwise than by judging people only after their life is over, when I know that divinity is jealous of the happiness of human beings and it makes it pleasure to upset it. Man is subject to a thousand accidents.” 1 How true. Established by Solon, the laws of the Republic of Athens formed the basis of what we are used to call Western civilization. Solon did much more than setting the code of social morality and of social order. Through laws which were tough but more liberal when compared to the laws of Dr acon, who prec eded him as lawmaker of ancient Athens, Solon aimed to assure social and financial stability. He also ini- tiated important monetary reforms, including: ● The introduction of coinage into Attica, ● Rules against female luxury to reduce luxury imports, 2 and ● Monetization of agricultural commodities to offset usury’s destructive effect on farmers. To a large me asur e, Drac on had a dopted He braic la ws, a dapting the m to th e e arly society of Athens. 3 The concepts on which he based himself followed the legal policies of Hammurabi of Babylon (1792À1750 BC), particularly in establishing severe sanctions for violation of the laws. This is a practice our society has more or less abandoned (pre- sumably for “humanitarian reasons”) replacing it with nearly tot al impunity. In restruc- turing Dracon’s laws, Solon took a broader and somewhat more lib eral approach an d also set the basis for evolution of economic thought. 4 Contrasted to the ancient times when law setters were philosophers, today’s law setter, and not only in monetary policies and finance, is the financial elit e: City of London and Wall Street. (The latter is also known as Eastern Liberal Establishment. 5 ) According to Anthony C. Sutton, this is populated by American corporate socialists. 6 The Eastern Establishment has also been: ● The motor behind the virtual economy, and ● An important promoter of globalization. As in ancient Carthage, the Eastern Establishment’s criterion of excellence is wealth and competitiveness—the latter being based on financial systems, private Public Debt Dynamics of Europe and the US. DOI: http://dx.doi.org/10.1016/B978-0-12-420021-0.00001-4 © 2014 Elsevier Inc. All rights reserved. institutions, infrastructures, skills, educational performance, flexible labor markets, and (until recently) moneta ry stability. Together, these make the “free economy,” though rules, beliefs, and criteria vary widely by country and so does the per capita gross domestic product (GDP). If at the time of King Croesus a huge amount of wealth was rare exception, today from America to India and China there is no lack of billionaires. 7 In 2010 (latest available statistics), global GDP amounted to over 60 trillion dollars, an income divided up in the most unequal way between 7 billion souls on planet Earth— to each, according to his or her effort and (sometimes) to his or her connections. Using per capita gross domestic product 8 per year as basic criterion, a study by UBS divided the world population into three layers: The top 1 billion people are largely living in Western countries, including Japan. The next billion people is a class on its own interfaci ng between the top and bottom layers. The lower layer is populated by 5 billion people, those of low income and the really poor. 9 This strati- fication makes it easier to compare not only annual earnings but also: ● Investments, ● State of development, ● Products in demand, and ● Externalities, for instance CO 2 emission. 10 On an average, the wealthier people in the first billion enjoy a per capita GDP of close 40,000 US dollars per year. People living in the richest countries of this first bil- lion, such as Luxembourg, Norway, or Qatar, enjoy an average per capita GDP close to 100,000 dollars per year. 11 South Korea, the bottom country in this first billion has a per capita GDP of 17,000 dollars. Always talking of averages, the per capita GDP in the United States is 45,000 dollars and that of Europe and Japan is 40,000 dollars. 12 As these statistics document, per capita G DPs vary from c ountry to country and, as well, within each of the three layers, f or instance, w ithin the top billion of the Eart h’s citizen. Always in average income terms, the population of this first billion people is homogeneous enough when compared to the ( country -by-country) income averages of the second billion and, most evidently, to those of the third layer of 5 billion people. In this lower stratum of 5 billion in terms of average per capita GDP, people live under conditions of poverty to extreme poverty compared t o western standards. Within each country, h owever, the rang e between hi gher and l ower income is wide. This h ap- pens even if in the course of the last t hree decades l arge stretches o f pop ulation have benefited h andsomely in t erms of per capita GDP—particularlyincountrieswhichare energy and mineral producers. At the top of the 5 billion people bottom layer is Iran, with average per capita GDP 4500 dollars; China, 3700 dollars; India, 1200 dollars. At the bottom’s bottom lies Niger with 300 dollars average per capita GDP per year and C ongo with 170 dollars. Yet, the Congo is a relatively r ich country in minerals, b ut its wealth distribution is awfully skew. The reader will be right if he or she thinks that a global comparison of per capita GDP averages resembles Fata Morgana. Average dollar values are illusory; they tell 4 Public Debt Dynamics of Europe and the US [...]... been the often repeated call for joint liability on government debt by European Union member states through eurobonds, which is explicitly ruled out in the Lisbon Treaty Article 125 Public Debt Dynamics of Europe and the US DOI: http://dx.doi.org/10.1016/B97 8-0 -1 2-4 2002 1-0 .0000 2-6 © 2014 Elsevier Inc All rights reserved 24 Public Debt Dynamics of Europe and the US forbids joint liability for public debt, ... the human donkey must see a carrot in the front and feel a stick in the back.” The carrot in the front is standard of living The stick in the back are the laws Dracon and Solon set in ancient Athens, and before them Hammurabi in Babylonia Let’s face it: society has turned against itself To be lasting, the change must be both: G G Cultural, and Legislative 8 Public Debt Dynamics of Europe and the US. .. important cause of sustained productivity (hence economic growth), originate from an intensive basic research effort Kingdoms of Debt 29 which nowadays has declined In the last couple of decades of the twentieth century and in the first one -and- a half decades of the twenty first: G G Innovation waned, and The rate of invention slowed because of lack of funding related to the accumulation of sovereign debt. .. and ill-thought-out system of income and expense, which will unavoidably crumble with the cost paid by the worst off common citizens Take Italy and its public debt at 127 percent of GDP as an example In early September 2012, Professor Johnson of MIT said that Italy’s debt is the most unsustainable of Euroland33 —in spite of the other basket cases at both shores of the North Atlantic On August 20, 2012... mass of bureaucrats,31 over and beyond the endowments and other free lunches it offers To make ends meet, even formerly serious sovereigns 14 Public Debt Dynamics of Europe and the US have joined the speculators in high gearing while the common citizens are crashed Euroland’s member states are now planning to leverage to euro 2 trillion, the euro 500 billion of European Stability Mechanism (ESM), the. .. airports, and other infrastructural projects Repayment 10 Public Debt Dynamics of Europe and the US conditions aside, the loans carry the requirement that contracts will be given to engineering, construction, and consulting companies from the country providing the aid Interestingly enough, disbursements are limited because money is simply transferred from the banks to the engineering and other firms, and then... objectives: appease the citizens and labor unions and, at the same time, satisfy the demands of the European Commission (EC)/IMF/ECB (the Troika) on pension reform That has been misguided Pensions, salaries, and public health care costs had to be downsized because they were unaffordable A weak Greek economy could not 12 Public Debt Dynamics of Europe and the US really honor them, as its virtual bankruptcy... 1980s and continuing into the 1990s and the twenty-first century all the way to the present day, the Western standard of living stagnated then fell, particularly for middle class households Income redistribution which benefited high income earners lifted the averages, and this gave a misleading picture of greater wealth The true condition is an increase in relative poverty The boom of the 1990s and of the. .. with debt and granting unsustainable entitlements to please the voters, then penalizing these same voters through austerity measures Sovereigns gear themselves up to pay the bills of the nanny state, and by so doing, they hurt the common citizen One of the risks with leverage, particularly with high gearing, is that it becomes addictive leading to the pyramiding of debt Sovereigns, companies, and households... as debt vultures, who actively prey upon people, companies, and countries likely to default, buying up significant portions of their debt and then storming in to demand that they repay their debts at 100 cents on the dollar If they are successful, debt vultures make impressive gains because they have bought the debt in the secondary market at huge discount, a price arrived under the assumption that the . Public Debt Dynamics of Europe and the US Public Debt Dynamics of Europe and the US Dimitris N. Chorafas AMSTERDAM ✬ BOSTON ✬ HEIDELBERG ✬ LONDON ✬ NEW. therefore, that the aftermath of this attitude is the global casino society and continued erosion of public confidence. 8 Public Debt Dynamics of Europe and the US In conclusion, the cultur e of too big. They do so because they appreciate that the sovereign, and its central bank, stand behind them. In fact, the sovereign does not really 10 Public Debt Dynamics of Europe and the US want that the