Friday, December 30, 2011

"In the Real World Creditors will Always Have the Whip Hand with Debtors"

The lesson that never seems to be learned in the real world: “In the real world creditors will always have the whip hand with debtors.” (

John Plender writes in the Financial Times, “From the wreck of the sovereign debt crisis Germany has unquestionably emerged as Europe’s pre-eminent power.  And a central tenet of the German solution to the crisis—for it is primarily a German solution—is that other eurozone members must be recast in their mold of fiscal orthodoxy and financial conservatism.”

He concludes his essay, “So Germany rules and southern Europe should prepare for austerity, followed by deflation, unemployment and, eventually, civil strife, if the eurozone holds.”

Europe…and the United States…have experienced roughly fifty years of Keynesian-type credit inflation.  The public debt in these areas expanded at a pace at least double the rate at which the real economy has grown.  Private debt in all of these areas grew at even faster rates than did the public sector debt. 

During this period of credit inflation, risk-taking increased, financial leverage exploded, and financial innovation and financial engineering accelerated at a pace never before seen. 

And, in the end, the weight of all these developments proved to be unsustainable.

While it was going on, the credit inflation was delightful…especially in the country owning the reserve currency of the world.  Oh, there were cyclical swings during this time period, yet, all-in-all, everyone grew together.

Where was the pain connected with being a debtor?

Well, until the music stops, everyone, especially the debtors, keeps dancing and everyone has a pretty good time. 

There were some undercurrents of pain.  Underemployment in these Europe and the United States more than doubled from the 1960s to the 2000s.  Income inequality increased dramatically as the more astute or wealthy took advantage of the credit inflation whereas the less wealthy could not. 

But, as “Chuck” Prince, the Chairman and CEO of Citigroup, put it: “As long as the music is playing you have to get up and dance.”

And, what about the financially prudent?

Well, they had to bend to the times…for they had to dance as well.  If the way to increase or maintain ones return on equity comes from assuming riskier assets, increasing financial leverage, or financing long-term assets with short-term liabilities, the prudent had to play the game to some degree or face the real fact that money was going to move to those producing the greater return.

Even Germany played the game! 

As Plender points out, “Germany was the first in the European monetary union to break the stability and growth pact rules on deficits and debt.”

But, the Germans pulled it together…and now they are in the driver’s seat.

And, we see this to be true in the banking sector…and in the manufacturing sector…and with individuals and families.  When the bubble bursts, those with their balance sheets in the best shape control the future. 

“In the real world…”

Those that did not get their act together face the pain…and, they even come to resent…and dislike…those that did get their act together.  This is where civil strife can come into the picture, where the discontented can attempt to “occupy” the other.

The lesson for the new year…and for every new year…is that one needs to be careful about the debt one accumulates.  Too much debt can always come back to haunt you.  I know that the phrase “too much debt” is only relative, but, it seems that over time, having less debt than others can be to the benefit of the prudential. 

Remember, the general rule for winning the Super Bowl is to have the superior defense!

Happy New Year!

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