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Some newspaper fallacies
Apr. 16th, 2012 01:37 pmI've started reading David Graeber's excellent Debt; The First 5,000 Years. Graeber is an anthropologist rather than an economist (remember, Gillian Tett started out as an anthropologist) and I'm slowly coming to the conclusion that anthropologists have more to tell us about the current euro-crisis than do economists.
Graeber starts off by exploding one simple myth -- that debts have to be repaid. That myth is entrenched in the current euro crisis. "You borrowed the money. You must repay it", says Germany, the IMF, the ECB, and, indeed, some of the victims themselves. TO fail to repay a debt is somehow dishonourable, morally reprehensible.
But let's have a think about this. As Graeber points out (somewhat obviously) if all debts had somehow to be repaid, the lender would not need to check on the creditworthiness of the borrower, because the lender would know that he would be repaid. Similarly, interest rates would be virtually zero, because the lender knows that the debts are going to be repaid.
But it doesn't work like that. When a potential lender and a potential borrower come together, the lender prices in the risk that he will not be repaid, and sets the interest rate (and other matters, such as the amount he is willing to lend and the collateral) accordingly. Defaults, therefore, are all part of the game. That lenders take the moral high ground on this is interesting, in that, when looked at this way, the whole thing is a simple financial transaction where the lender takes on a risk and, if he gets it right, he gets paid accordingly. There's no moral "wrong" in defaulting.
There's a well-known saying; "Neither a borrower nor a lender be". This conceals a deep moral contradiction held within our society, which can see how lending and borrowing are very useful when it comes to oiling the wheels of capitalism, but which remains intrinsically uncomfortable at the concept of some people being designated as "in debt" and others being "owed".
Graeber spots another odd thing about debt, once that is also reflected in the saying "When you owe the bank a million dollars, you are in trouble; when you owe the bank a billion dollars, the bank is in trouble". It is this fact, writ large, which explains why the US is not, as we like to term it, the largest debtor in the world. The rest of the world is now in the situation where we are the bank that's owed a billion dollars. It's us (the rest of the world) that is in trouble, not the US.
But, to return to the eurozone crisis. The current groupthink is that, if Portugal follows Greece and then Spain follows Portugal and then Italy follows Spain, the result will be financial Armageddon. But, would it? History is littered with instances of debts being written off. Indeed, one could argue that most revolutions prior to the nineteenth century were about the indebted writing off their debts by the simple strategy of killing the rentiers. What we currently know is that billions of dollars which we thought existed (and which the rentiers therefore counted at 100%) didn't really exist at all.
Which brings us back to the pricing of risk and the fact that default is all part of the game. What happened here was that the lenders, quite simply, mispriced the risk. As such, they are upset not so much at the fact that Greece and Portugal are defaulting, as at the fact that when they lent the money they did not set the correct price for the risk.
Why was this? Because it was the eurozone. The lenders (many of them German, many of them French) assumed that a loan to Greece was not far short of as safe as a loan to Germany, because Germany was seen as an implicit guarantee of the loan.
The key word here is "implicit". It has come to pass that Germany insists that it is no such thing. The ECB insists that it is no such thing. When it comes to paying back its debts, Greece and Portugal are on their own.
And so the lenders are insistent that Greece and Portugal DOES pay back its debts. What in fact they are saying is "we lent to you at 3% a year, and therefore the debt must be as safe as if it was a real 3% a year debt".
But that puts the cart before the horse. It's like in poker when a player on tilt bets far too big with a hand on the spurious grounds that, since you bet big with really good hands, somehow by betting big you make your hand really good. The lenders lent to Greece at 3%, therefore it must be treated as a 3% risk, not the 20% risk that it really was.
The lenders have had their arms twisted when it comes to Greece. The write-offs last year came thick and fast, helped by profitable cash-flow. In other words, the current borrowers are paying off the Greek debt, rather than the original lenders (that's why base rates are 0.5%, savings rates are 2.7% and borrowing rates are 4.7% - that 2pp margin is in many cases going to Greece, or Ireland, or Portugal).
But the borrowers, and this includes Spain, should simply say to the lenders "look guys, you totally fucked up on this one. If we default on you, the world won't come to an end, although your company might. But that was your fault. What on earth were you thinking of, lending to us at such a low rate?"
That, as it were, is how debt works. Sometimes your gamble pays off and you get paid. Sometimes it doesn't, and you don't. The five years to 2008 were a period when lenders lost sight of this simple fact. They were awash with cash and they wanted to create debtors. I remember a conference where the head of lending at Alliance & Leicester BOASTED at how those people who had been shifted onto flexi-mortgages nearly all owed more at the end of the year than they did at the start. Risk management was, quite simply, thrown out of the window.
So, sure, the banks didn't drag people off the street and force them to borrow. Hell, no, because in effect what they were doing was selling a $10 product for $5. No wonder people queued up to fill their boots.
Looked at in this way, the borrowers who are going to find inflation wiping out the money that they owe have done nothing "wrong", not in any economic sense. Hell, if I'm an unemployed junkie and a bank is willing to lend me $10,000 at 3% interest, who is the economic moron? The junkie, or the bank?
If you think of Greece in the 2000s as a kind of unemployed junkie, then it becomes clear that all the mistakes here were made by the lenders (who mispriced the risk) rather than the borrowers (who took advantage of the mispricing). Therefore the IMF, and Germany, and much of the media, take the moral line that "you have to repay your debts". But, as Graeber points out, this is a nonsense. Lending and borrowing are economic rather than moral transactions. If the borrower defaults, all that the lender can hope is that he priced the risk correctly in the first place.
Which brings us to Spain. As Wolfgang Munchau points out in this morning's Financial Times, you would think that the powers-that-be in Germany and the IMF and the ECB would notice that panics over Spanish bond yields and weakness in the euro have tended to come not after Spain tells the powers-that-be to fuck off, but when Spain actually announces tough new austerity plans as a "solution".
If Merkel was right in her analysis, the interest rates should fall when Spain announced plans to implement what Germany is urging. In fact, yields on Spanish bonds have only fallen when the ECB throws money at the markets (via the LTRO announced last December), indicating a possible expansion out of the crisis, rather than a bunker-like shrinkage of expenditure. In other words, the markets aren't worried about the Spanish deficit, they are worried about the austerity "solution". The euro, the markets think, can only be solved by inflating away the debts of the peripherals and restoring price competitiveness via money-pumping.
The paradox here, of course, is that pumping money into the economy theoretically reduces the value of that currency, so the euro should weaken as a result. Indeed, Merkel uses obscure science logic here to assume that, if this is the case, taking money OUT of the economy will strengthen the euro. But it doesn't work like that. The strength of a currency is a subtle balancing act that requires a mix of stimulation and caution. What we have at the moment as a "strategy" is too much caution and not enough stimulation.
Oh, and as for those debts -- write 'em off, let many of the banks go bust, and then stimulate your way out through good old Keynesian public works. This will absolutely slaughter the rentiers -- which is why, of course, they are all putting forward their "moral" arguments and insisting that this must not be allowed to happen.
Graeber starts off by exploding one simple myth -- that debts have to be repaid. That myth is entrenched in the current euro crisis. "You borrowed the money. You must repay it", says Germany, the IMF, the ECB, and, indeed, some of the victims themselves. TO fail to repay a debt is somehow dishonourable, morally reprehensible.
But let's have a think about this. As Graeber points out (somewhat obviously) if all debts had somehow to be repaid, the lender would not need to check on the creditworthiness of the borrower, because the lender would know that he would be repaid. Similarly, interest rates would be virtually zero, because the lender knows that the debts are going to be repaid.
But it doesn't work like that. When a potential lender and a potential borrower come together, the lender prices in the risk that he will not be repaid, and sets the interest rate (and other matters, such as the amount he is willing to lend and the collateral) accordingly. Defaults, therefore, are all part of the game. That lenders take the moral high ground on this is interesting, in that, when looked at this way, the whole thing is a simple financial transaction where the lender takes on a risk and, if he gets it right, he gets paid accordingly. There's no moral "wrong" in defaulting.
There's a well-known saying; "Neither a borrower nor a lender be". This conceals a deep moral contradiction held within our society, which can see how lending and borrowing are very useful when it comes to oiling the wheels of capitalism, but which remains intrinsically uncomfortable at the concept of some people being designated as "in debt" and others being "owed".
Graeber spots another odd thing about debt, once that is also reflected in the saying "When you owe the bank a million dollars, you are in trouble; when you owe the bank a billion dollars, the bank is in trouble". It is this fact, writ large, which explains why the US is not, as we like to term it, the largest debtor in the world. The rest of the world is now in the situation where we are the bank that's owed a billion dollars. It's us (the rest of the world) that is in trouble, not the US.
But, to return to the eurozone crisis. The current groupthink is that, if Portugal follows Greece and then Spain follows Portugal and then Italy follows Spain, the result will be financial Armageddon. But, would it? History is littered with instances of debts being written off. Indeed, one could argue that most revolutions prior to the nineteenth century were about the indebted writing off their debts by the simple strategy of killing the rentiers. What we currently know is that billions of dollars which we thought existed (and which the rentiers therefore counted at 100%) didn't really exist at all.
Which brings us back to the pricing of risk and the fact that default is all part of the game. What happened here was that the lenders, quite simply, mispriced the risk. As such, they are upset not so much at the fact that Greece and Portugal are defaulting, as at the fact that when they lent the money they did not set the correct price for the risk.
Why was this? Because it was the eurozone. The lenders (many of them German, many of them French) assumed that a loan to Greece was not far short of as safe as a loan to Germany, because Germany was seen as an implicit guarantee of the loan.
The key word here is "implicit". It has come to pass that Germany insists that it is no such thing. The ECB insists that it is no such thing. When it comes to paying back its debts, Greece and Portugal are on their own.
And so the lenders are insistent that Greece and Portugal DOES pay back its debts. What in fact they are saying is "we lent to you at 3% a year, and therefore the debt must be as safe as if it was a real 3% a year debt".
But that puts the cart before the horse. It's like in poker when a player on tilt bets far too big with a hand on the spurious grounds that, since you bet big with really good hands, somehow by betting big you make your hand really good. The lenders lent to Greece at 3%, therefore it must be treated as a 3% risk, not the 20% risk that it really was.
The lenders have had their arms twisted when it comes to Greece. The write-offs last year came thick and fast, helped by profitable cash-flow. In other words, the current borrowers are paying off the Greek debt, rather than the original lenders (that's why base rates are 0.5%, savings rates are 2.7% and borrowing rates are 4.7% - that 2pp margin is in many cases going to Greece, or Ireland, or Portugal).
But the borrowers, and this includes Spain, should simply say to the lenders "look guys, you totally fucked up on this one. If we default on you, the world won't come to an end, although your company might. But that was your fault. What on earth were you thinking of, lending to us at such a low rate?"
That, as it were, is how debt works. Sometimes your gamble pays off and you get paid. Sometimes it doesn't, and you don't. The five years to 2008 were a period when lenders lost sight of this simple fact. They were awash with cash and they wanted to create debtors. I remember a conference where the head of lending at Alliance & Leicester BOASTED at how those people who had been shifted onto flexi-mortgages nearly all owed more at the end of the year than they did at the start. Risk management was, quite simply, thrown out of the window.
So, sure, the banks didn't drag people off the street and force them to borrow. Hell, no, because in effect what they were doing was selling a $10 product for $5. No wonder people queued up to fill their boots.
Looked at in this way, the borrowers who are going to find inflation wiping out the money that they owe have done nothing "wrong", not in any economic sense. Hell, if I'm an unemployed junkie and a bank is willing to lend me $10,000 at 3% interest, who is the economic moron? The junkie, or the bank?
If you think of Greece in the 2000s as a kind of unemployed junkie, then it becomes clear that all the mistakes here were made by the lenders (who mispriced the risk) rather than the borrowers (who took advantage of the mispricing). Therefore the IMF, and Germany, and much of the media, take the moral line that "you have to repay your debts". But, as Graeber points out, this is a nonsense. Lending and borrowing are economic rather than moral transactions. If the borrower defaults, all that the lender can hope is that he priced the risk correctly in the first place.
Which brings us to Spain. As Wolfgang Munchau points out in this morning's Financial Times, you would think that the powers-that-be in Germany and the IMF and the ECB would notice that panics over Spanish bond yields and weakness in the euro have tended to come not after Spain tells the powers-that-be to fuck off, but when Spain actually announces tough new austerity plans as a "solution".
If Merkel was right in her analysis, the interest rates should fall when Spain announced plans to implement what Germany is urging. In fact, yields on Spanish bonds have only fallen when the ECB throws money at the markets (via the LTRO announced last December), indicating a possible expansion out of the crisis, rather than a bunker-like shrinkage of expenditure. In other words, the markets aren't worried about the Spanish deficit, they are worried about the austerity "solution". The euro, the markets think, can only be solved by inflating away the debts of the peripherals and restoring price competitiveness via money-pumping.
The paradox here, of course, is that pumping money into the economy theoretically reduces the value of that currency, so the euro should weaken as a result. Indeed, Merkel uses obscure science logic here to assume that, if this is the case, taking money OUT of the economy will strengthen the euro. But it doesn't work like that. The strength of a currency is a subtle balancing act that requires a mix of stimulation and caution. What we have at the moment as a "strategy" is too much caution and not enough stimulation.
Oh, and as for those debts -- write 'em off, let many of the banks go bust, and then stimulate your way out through good old Keynesian public works. This will absolutely slaughter the rentiers -- which is why, of course, they are all putting forward their "moral" arguments and insisting that this must not be allowed to happen.
