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主权债务和超越:走向一个新的大宪章?

Source: The Globalist

Alexander Mirtchev and Norman Bailey, Thursday, March 31, 2011

The global debt burden appears to have gathered an unstoppable momentum, prompting divergent reactions. The world economy cannot count on growth to solve the global debt problem — and stimulus measures are not a sustainable solution. In the second installment in the series “The Search for a New Global Equilibrium,” Dr. Alexander Mirtchev and Dr. Norman Bailey explain why the solutions currently being offered are wholly inadequate to the scale of the problem, and argue the time is ripe for a “new Magna Carta” — a redefinition of the social contract among the government, Main Street and Wall Street.

“Debt, n.: An ingenious substitute for the chain and whip of the slavedriver.” — Ambrose Bierce, The Devil's Dictionary

In the year 1204, the doughty knights of the Fourth Crusade entered Constantinople by stealth and thoroughly looted what was then the wealthiest city in the world. Their plunder allowed them to pay their debts to the Venetians, who had financed the endeavor, as well as to line their own pockets. The knights took huge quantities of gold, silver and precious stones with them when they returned to Western Europe.

For the first time since the collapse of the western half of the Roman Empire in the fifth century, considerable bullion began to circulate in the “barbarian” west. This newfound wealth led to the development of merchant banking, starting in Italy and continuing over the centuries with important developments in modern state finance that persevere to this day, including sovereign defaults.

In the same period, facing increasingly acute financial problems, King John of England’s efforts to dig out his government from a massive hole of debt (in modern terms, approaching sovereign default) by imposing onerous fiscal demands on his vassals, contributed to a rebellion that led to the signing of the Magna Carta in 1215.

Among other innovations, its provisions transformed the social contract that underpinned British society and provided important precursors to the emergence of the Western world as we know it.

Eight centuries later, governments worldwide are sinking in an ocean of debt — extensive, and in some cases untenable, liabilities and strained balance sheets. The countries that are most visibly plagued by a combination of excessive indebtedness and low-growth prospects appear to be the developed democracies of the West and Japan.

U.S. debt held by the public today stands at over $9.6 trillion (not including debt held by foreign central banks), and total debt is approaching 90% of GDP. In much of Europe, the circumstances are even worse — Greek long-term bonds are trading at a nearly 10% premium over the benchmark German bunds, with Portugal not far behind.

Even Spain, where public debt is considered relatively sustainable, is saddled with a banking system that, according to the credit agency Moody’s, would require more than €40 billion to restructure its liabilities. In Japan, meanwhile, debt amounts to almost twice GDP and is likely to get much worse as a result of the recent earthquake, tsunami and nuclear crisis.

Similar debt issues are haunting a number of emerging markets, from Argentina, perpetrator in 2002 of the largest sovereign default in history, to Dubai.

The perils of this debt maelstrom are framed by structural distortions and systemic imbalances — from protecting the “too big to fail” institutions to pension and investment commitments. These problems are exacerbated by the lack of structural solutions — not just the structure of the debt itself, but also the divergence of fiscal strategies in a global financial system that has evolved beyond the means of states to manage it.

Overwhelmingly, the debt burden of a number of stakeholders is predicated on the existence of large-scale and long-term commitments that are at the core of the overall social contract prevalent in the Western world and beyond.

In U.S. parlance, the most prominent parties to this aspect of the social contract are the government, Main Street and Wall Street (as a symbol of the global financial sector). The commitments embodied in these social contracts — in American terms, consider Social Security, Medicare and Medicaid — reflect economic and financial arrangements that are increasingly becoming unsustainable.

To paraphrase famed economist James Buchanan: Once a democracy starts down the path of deficit financing, it will continue on that path until the path is no longer viable, as it is always easier for politicians and governments to satisfy constituencies today at the expense of tomorrow.

It should be noted that the reasons for various iterations of this bleak picture in other parts of the world are diverse. For the rapidly developing economies in Asia and Latin America, for example, the social contract is different and less comprehensive than in the West — and therefore requires less from the government to sustain it.

Nonetheless, even though personal and sovereign debt levels are relatively low in Asia, it remains an ongoing policy consideration. And for a number of emerging and less-developed economies in Africa, Asia and the Caribbean, the underlying reasons include insufficient resources, inefficient use of financing and government mismanagement.

As a result, the global debt burden appears to have gathered an unstoppable momentum, prompting divergent reactions. Some respond with grand plans and declarations, as well as immediate measures that, at the end of the day, amount to punting — sure, the painful steps should be taken, but perhaps not yet. Others argue that the longer the remedies are delayed, the more painful the solution will feel.

On the practical side, debt problems are currently being addressed in the main by focusing on important but not decisive matters and often tackling the symptoms (liquidity, primarily) rather than addressing the underlying cause (lack of solvency).

Pumping liquidity in the ocean of debt in this manner, instead of reducing the level of the waters by improving solvency, is actually exacerbating the seriousness of debt problems. Even more importantly, despite the immediate political imperatives driving much current decision making, the weakening of solvency reflects the true nature of the global financial crisis and the impending global debt disaster.

Indeed, as the rating agencies downgrade one country after another (most recently Spain), the cost of borrowing increases exponentially and adds to the future burden. Adding liquidity to a solvency crisis only makes matters worse, the equivalent of giving morphine to a person with cancer. He feels better until he dies.

In addition, neither does “quantitative easing” help to lower the debt waters — indeed, it has made matters worse. Instead of “quantitative lowering” of these waters, at least in the United States, private banks and corporations are using their excess liquidity to re-leverage at a feverish pace, thereby assuring that future financial crises will be worse than the present one.

The respected Boston University economist Lawrence Kotlikoff calculates that, in terms of present value of likely and foreseeable future debt, the true measure of the debt tsunami is around $200 trillion.

Other approaches that have emerged range from fiscal integration of regions — which for cases such as the European Union are constrained by the monetary straitjacket of the eurozone — to negotiated debt forgiveness.

These approaches could bring relief, but more likely and tragically, the resolution of the debt issues will come through defaults and/or rampant inflation.

As always, the ultimate hopes of addressing the issue of debt appear to be pinned on growth as a way out of the rising waters of debt. Rightfully so. And yet, in the current economic circumstances, growth seems more likely to come from a divine miracle than from mere mortals making the difficult choices that must be made.

In reality, the prospects of global economic growth in the context of prevailing indebtedness are faced, on one side, by the Scylla of austerity measures and the Charybdis of stimulus packages that invariably lead to higher states of indebtedness. Essentially, a damned-if-you-do, damned-if-you-don’t conundrum.

The threat posed by Scylla entails accommodating, on one side, the imperatives for sometimes draconian austerity measures, which could, however, have a dampening effect on growth by restricting demand.

In Portugal, the government has cut state pensions by up to 10%, cut public sector salaries by 5% and increased the value-added tax to 23%, one of the highest rates in the world. Subsequently, the government fell.

Similar measures are being taken in Spain, Ireland, Greece and elsewhere. Furthermore, the reactions to such measures should not be overlooked — witness the demonstrations that regularly take over the streets of Athens, Paris or Lisbon (and Madison, Wisconsin).

On the other side is Charybdis — the prospects for inducing growth via stimulus packages confronted by mounting debt that can lead to stagnation. When total debt in Japan rose beyond 90% of GDP, for example, the effect of adding further debt was to restrict growth. In other words, in the current situation, chasing growth to breach the surface of the ocean of debt does not break the vicious circle — it reinforces it.

We are unlikely to navigate safely between these two ancient monsters. There is no evidence that the prospects for a debt tsunami would dissipate in their own right. Now that Social Security payouts exceed income — more than $200 billion this year and trending towards $1 trillion within the decade, according to the 2009 Financial Report of the U.S. Government — entitlement programs in the United States are reaching the point of no return, adding significantly to the debt service burden each year.

Many developed and developing economies are also exposed to increasing demands on the state to finance a range of social commitments, from pensions to infrastructure-development financing. U.S. states such as California, New York, Florida, New Jersey, Ohio, Indiana and Wisconsin are tackling budget shortfalls of up to 30%, and cities such as Chicago are facing deficits of close to 10%.

In Europe, cities like Lisbon, with its 7.3% deficit, are urgently looking for ways to cut costs, while entire regions in Spain, Britain, Belgium and elsewhere are themselves insolvent, adding their buckets of water to the debt ocean.

The examples of the devastating effect of the debt burden range from the unsustainable premiums countries like Greece and Portugal must incur when raising funds, to the case of Iceland, where the whole country went bankrupt.

This is where one must ask: What are the other options?

The key to achieving a breakthrough in the short term is to address the issue of solvency as a guiding light among the “grand strategies,” and tactical measures pursued by policymakers. It has been said that no one learns anything from history, except that no one learns anything from history.

Indeed, the debt crisis that struck less-developed countries in the 1980s was made progressively worse by additions of liquidity until finally, years later, solvency was addressed through the so-called Brady bonds.

Even though such approaches will entail sacrifices on both individual and global scales, mechanisms with the same impact, if not of the same ilk, should have been put in place as a form of exit strategy on the eve of the global economic crisis. Now they are an imperative.

All the relevant institutions — central banks and the International Monetary Fund especially — are only able to add liquidity to ailing private and public institutions. The governments and the private financial markets should have had in place plans to reduce the burden of debt-ridden borrowers and add to their capital base. When the financial crisis struck, this was done in a few cases (General Motors, Chrysler, AIG) — but on an entirely ad hoc basis.

Efforts have been made to utilize austerity strategies to engender a momentum toward competitiveness and cost-cutting that would go beyond the state and affect the private sector, thus increasing the overall solvency of a given country’s economy.

Some of these steps were hinted at in the cost-cutting plans of a number of European countries, and have been mooted for the United States, too. However, applying existing market mechanisms, such as bankruptcies, even for those entities considered “too big to fail,” would have had a much stronger impact on the private sector.

However, prioritizing solvency on its own will hardly provide a triggering mechanism for reversing the descent toward global indebtedness and returning to sustainable growth. A tangible input on a par with 13th century Venice and the bullion-rich knights from the Fourth Crusade has not appeared on the horizon, and the long-term solution cannot be predicated on the expectation of an external stimulus.

What’s more, even if such a stimulus were available, the interconnectedness of global markets today would inhibit equilibrium. These days, robbing rich Peter to pay poor Paul would in fact only invite more troubles for Paul. And, ultimately, it is not the right way, despite the attractiveness of King John’s famous subject, Robin Hood.

The realistic, forward-looking and hopefully sustainable solution would require a new Magna Carta. Such a solution would entail the redefinition of the social contract among the government, Main Street and Wall Street.

The commitments and entitlements of this social contract could be a major factor establishing the framework for domestic and global economic relations and determining not just today’s, but also tomorrow’s financial liabilities.

Shaping such a bold new arrangement — a Magna Carta redux — could prove to be the responsible way of dealing with a number of systemic imbalances and other pressing considerations. Such an advancement would entail a number of positive and negative strategic repercussions, depending on one’s point of view.

In the era of the new Magna Carta, winners would be the savers, the investors in capital assets and productive activities and those who respected the rules of the game. The losers would be the speculators, the reckless spenders and the crooks.

Importantly, it will provide the framework for successfully braving the ocean of debt, reversing the global slide toward pervasive indebtedness. Furthermore, it could provide the preconditions for a qualitatively new form of economic growth, fundamentally altering the incentives and impediments to economic activity.

Notably, it would also realign entitlements and rights away from the expectation that we have all, collectively and individually, become “too big to fail.” This would also enable the functionality of market risk, which the current social contract, in particular in the West, has endeavored to eradicate.

Such a transformation would allow markets to be more efficient. After all, imposing risk outcomes is the manner in which the market operates, infuses innovation and energy into the economy, and calibrates economic activity.

There is no argument that the build-up of the preconditions for the 13th century Magna Carta were, to a large extent, the result of the economic and financial nadir of the period emerging from the previous 800 years of social, political and economic exhaustion, often accompanied by rigid social structures, stifling intellectual repression and constant warfare.

We should start in earnest the redefinition of the existing social contract toward a new Magna Carta before getting into a comparable crisis.

It is not feasible to expect and wait too long for matters to somehow improve on their own and continue “business as usual,” or, alternatively, to anticipate that the social contract would redefine itself. Given the accelerated socio-economic developments, it should not be permitted that the evolving crisis force its own realities upon us.

From whatever perspective one considers such a choice, it will not be an easy one. The complexities of its implementation are mind-boggling, and going through the process would be painful and may lead to significant upheavals.

On a brighter note, being at this crossroads and choosing this path could lead to similarities with the exit from the financial and non-financial lows that presaged the European Renaissance — a new Renaissance, perhaps.

Dr. Alexander Mirtchev is president of the Royal United Services Institute for Defence and Security Studies (RUSI) International (Washington D.C.) and vice president of RUSI (London). He is a founding member of the Council of the Woodrow Wilson International Center for Scholars’ Kissinger Institute on China and the United States and a Board Director of the Atlantic Council of the United States. He is president of Krull Corp. USA, serves and has served as chairman and director of multi-billion dollar international industrial enterprises, and has had a distinguished public office and academic career, and is the author of four monographs and numerous articles.

Dr. Norman A. Bailey is an economic consultant, adjunct professor of Economic Statecraft at the Institute of World Politics — and president of The Institute for Global Economic Growth. He is professor emeritus of The City University of New York — and served on the staff of the National Security Council during the Reagan Administration and the Office of the Director of National Intelligence during the George W. Bush Administration. Mr. Bailey's degrees are from Oberlin College and Columbia University. He is the author, co-author or editor of several books and many articles.