In the “Insight” segment of my series on the Five “I”s of History, I briefly introduced the idea of a new “Vectors” feature in the PHR blog. The basic theme I had in mind for this segment was that a proper study of history gives us “insight” into how the world around us came to be and the processes that govern how history is unfolding around us.
In that original post I also hinted that the first example of a “vector” that I would be discussing is what I call the “debt aggregation vector.” This “vector,” in my view, is a key mechanism governing how the ongoing global economic crisis is unfolding. Here is what it is and why it matters, using the obvious and instructive example of Spain–one of the global dominoes that is now falling before the US, and whose fate will be determined by the precise implementation of the debt aggregation mechanism…
Let’s start with the official Spanish Debt-to-GDP. This is the number that news agencies usually talk about when discussing the solvency of national governments. As per this article, and countless others, it hovers somewhere around 75 to 80%.
Not bad–compared to the US anyways, which is now over 100%–or Italy, at 137%–or Greece, somewhere around 170%.
The problem with these figures is that they do not incorporate the reality that is debt aggregation.
Every country that has a debt problem–there are no major economies that don’t!–has layers of private and public debt residing below those of its federal government, which–when push comes to shove–are being aggregated to the federal level by some mechanism or other.
In Spain, we see the reality of this with recent news about Catalonia demanding a bailout from the Spanish government.
As discussed on Mish’s Global Economic Trend Analysis (which Powell History recommends) –the federal response has been to propose to collectivize/aggregate regional debt into “hispanbonos,” or joint bonds, to facilitate debt financing. This will allow local governments to continued to live beyond their means for some time, avoiding any more “austerity” (in the form of cutbacks in government spending) at a time when the Spanish economy is already in a depression, and where the spending of local governments provides jobs and nominal GDP that no one can accept dropping any further.
But the debt aggregation mechanism keeping the Spanish economy afloat does not just pertain to local governments being bolstered by national ones. There is another axis of debt aggregation. Recently Spain announced it would nationalize the third largest Spanish bank, Bankia. This will add 24 Billion dollars or more to its debt–who knows, the figure increases almost daily. In a refrain that is familiar to Americans, Bankia is considered “too big to fail,” and Spain’s socialization of its debt is characterized by government officials as an “investment.”
Following not long after this bit of news, it became evident that not just Bankia, but rather the entire Spanish banking system was in need of a bailout. The latest of 19 EU emergency meetings on the European financial/debt crisis was focused precisely on the question of debt aggregation. Indeed the entire trajectory of the European Union over the next two-to-three years depends on the answer to the question: to aggregate, or not to aggregate.
That really is the question.
If Germany agrees to issue so-called “Eurobonds” and to supranationalize the banks in the European Union, then the market will be fooled into thinking a solution has been found, and there will be a sense of normalcy returning to the financial world for perhaps a couple years. What debt aggregation buys is time. It is what a lot of commentators call “kicking the can down the road.”
Of course, if Germany does not agree, then it’s financial Armageddon for Europe. Already, French journalist Pierre Jovanovic (sorry, it’s in French!) has been feverishly documenting the aggressive measures being taken by French banks to prevent bank withdrawals in that country. The bank runs in Greece and Spain being well documented already, it will only take the slightest indication that the banks are on their own, for them all to face the kind of mayhem we all remember from the movie “It’s a Wonderful Life.” It’s not just George Soros, who recently weighed in on Bloomberg, who thinks the Euro experiment is at the edge of a cliff.
The entire financial market is begging for debt aggregation. Spain’s debt financing, which is the measure of the market’s willingness to deal with Spain one-on-one, is becoming untenable. With yields on Spanish 10-year bonds reaching for 7%, Spain needs a bailout of its own. In the EU context national debt must be aggregated into supranational debt.
This is one of the favorite themes of new French president Hollande for propping up the Eurozone. In this theory, all European borrowers can benefit from lumping their debt together with Germany, as the core economic powerhouse whose debt financing capability is (relatively) solid. That way, profligate regions and nations can continue to pile on debt, while not having to pay the rates they otherwise would have to while bankrupting themselves.
Aggregation to this level in Europe is difficult, however, because the United States of Europe are not the federal equivalent of the United States of America. Germans don’t want so-called “Eurobonds.” Which is why different forms of more stealthy debt aggregation have been used already and will continue to be used. The EFSF (“European Financial Stability Facility”) is supposedly morphing into the ESM (“European Stability Mechanism”), which will runs alongside the ELA (“Emergency Liquidity Assistance”) and LTRO (“Long Term Refinancing Operation”), and other sundry mechanisms concocted by central banking philosopher kings that the general populace cannot possible keep track of. (Don’t think it’s just a European problem! How many Americans know the difference between QE1, QE Lite, QE2 and the Fed’s “Operation Twist”?)
Regardless, at some point, even though you can fool most of the people most of the time, you can’t fake reality. The games governments are playing with the debt they have accumulated and the debt they have encouraged others to accumulate which they are now socializing lead only to one place: default.
Right now this only seems to be a problem for Greece and Spain. But I invite every reader out there to go a little debt comparison shopping between the four largest economies in the world–Europe, the US, China and Japan. If you’re American, and you’re worried about America’s debt, think about what debt aggregation will do to that debt, and how quickly the situation in America could get out of control. California just voted to aggregate its debt to the federal level, by means of a phantom monorail. And America’s most cash-strapped cities are now proposing to pay your student loans for you! These and all the past and present debt-aggregation mechanisms that will pile more debt onto the federal government will eventually reach a dramatic end point.
Watch for it. You’ll know when the next phase of the financial crisis is coming when debt-aggregation ceases to work.