Does debt matter anymore?

Feb 11, 2015

- By Bill Bonner

Bill Bonner
Sao Paulo, Brazil

Dear Diary,

A glass blower's shop. A used furniture store. Luxury high-rise condos protected by double fences and electric wire. Neighborhood bars. Fancy restaurants. Sushi. Pizza. Bold glass office buildings.

The Itaim area of Sao Paulo seems to have been spared the zoners' boring prescriptions. Offices, houses, shops...all mingle promiscuously. A small house, modest...cheap...built in the '50s, sits across from our hotel, forgotten by time, surrounded by the commerce of the 21st century. Another house on the Rua Florian sits underneath an office complex. The owners refused to sell, so the developers built a huge, slick office tower right over top.

"It's a great city," says a colleague. "There are only a handful of cities like this in the world. London, Shanghai, Mumbai...Beijing. Paris is a small town in comparison."

Little by little, we're beginning to find our way around.

But we're not here for our own amusement. We're not just drinking caiprinhas and ogling Sao Paulistas. No, that would be selfish. No, we're here on your behalf, to learn. To study. To try to understand how an economy works.

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It's just a coincidence that it is summer here. And that this weekend is Carnival. And we have a ticket to Rio in our pocket.

Our subject lately has been debt. Krugman says no one understands it. He proved his point in his New York Times column; at least he proved that he has no idea of how it works.

"We owe it to ourselves," he wrote. That suggests that the net impact of debt is zero. But is it?

Meanwhile, colleague Simone Wapler in Paris tells us the "debt doesn't matter" crowd is growing. France and Germany, among others, guaranteed Greece's debt. If Greece doesn't pay, it will fall - logically - to the taxpayers of those countries to shoulder the debt. One calculation put the total cost per taxpayer in France, for example, at 731 euros.

But in the old world, as in the new, debt doesn't matter anymore. Here's Ivan Best at the "Tribune."

    In France, as elsewhere, taxpayers never pay off a government debt. When it comes due, the government borrows more to pay it. Thus, in 2013, [the French Treasury] borrowed, medium and long term, 186.3 billion euros of which106.7 billion were used to reimburse (amortise) the debts that were due, with the rest financing, principally, the budget deficit.
So you see, government debts don't matter, because they never pay them off. They just borrow more.

But wait. Is it that simple?

Some people owe. Some are owed. Does it matter who is owed what by whom? You bet it does. It's easier to pay off a little debt than to pay off a lot. So, the more you are owed, the less likely that you'll get paid. Keep adding debt and the likelihood of getting paid sinks to zero.

Then, the creditors take a loss. You might say it doesn't matter, because for every loss taken by the creditor, the debt gets a benefit. But he's already spent the money; it's gone.

Alas, this is the same money the creditors were hoping to spend. They are people too -- with bills to pay...retirements to finance...insurance/pension/lifestyle/healthcare obligations...in short, people who are counting on the money. When it turns out that the money isn't there, it sends a shock wave of pain and suffering throughout the economy.

Yesterday, Chris showed us where the shock wave was likely to strike hardest...and first - Japan. The Japanese have more debt than anyone. On paper, they also have more assets! But take a look at those assets - Japanese government bonds - and you will see why the 'we owe it to ourselves' idea is a scam.

The Japanese government has been on a borrowing binge for the last 34 years. Now, it owes more than 2 and a half times GDP. Who does it owe the money to? Its own people. Yes, if 'we owe it to ourselves' makes any sense at all, it makes sense in Japan.

But so what? It's not just double-entry bookkeeping; this is real life. And in real life it's not the quantity of debt alone that matters. It's the quality. Japanese retirees took their money and bought government bonds. They had 'money.' Now they have IOUs from the government. They think the government has their money. But they're wrong. Their money is long gone.

Did the government take the money and invest it in new capital, so that now it earns dividends and capital gains...with which it can satisfy its obligations? Of course not. It took the money and squandered it on in (often unnecessary) infrastructure and other forms of 'stimulus.'

And now, the poor Japanese retirees go to the cupboard. And what do they find? It's bare! All that money they thought they had saved is gone. It has been wasted by the government.

The savings rate is falling...the trade balance has turned negative...the yen lost over the last 12 months...and millions of people get older and older, depending on the government to make good on its promises to them.

It is just a matter of time before the truth comes out. They may 'owe it to themselves.' But they're about to find out that their debtor is a deadbeat and their creditor is a fool.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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