Global Ponzi - IMF, EURO & US Prescription for Debt Woes

What is a ponzi scheme? Wikipedia terms as " fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from any actual profit earned by the individual or organization running the operation."

In simple words " Its like robbing paul to pay peter". This scheme works till you get enough money from new contributions to pay old contributions. The day that is exhausted, its bust.


Now lets look at current debt crisis.

1. European Banks have lent enormous funds to countries like Greece, Italy, Portugal & Spain. (but then that is normal practice. All governments do that)
2. If government runs surplus budgets, they reduce debts. (but then someone raises questions, doesn't government have efficient use of resources(read surplus) other than paying back debt?). So governments runs deficits. (blame J M Keynes to a certain level for this)
3. To cover the deficits, governments borrow more money.
   
4. Now this works fine till we have primary surplus that is interest is less than borrowings. If that is breached, then you borrow to pay interest. (In corporate lingo, you need to have Debt Service Coverage Ratio of 1 or more)

Many of the European nations, particularly PIGS have been having huge deficits and their interest costs soaring very high, which do not seem to be bridged by additional borrowing( means unable to service debt).

I have seen such kind of situation in small mircofinance entities, particularly called as co-operative credit societies. In such institution, you will always find that their loan recovery rate is almost 100%. The truth is nowhere near it. These institutions have their books window dressed to appear clean.
The mechanism works like this:

1. A microfinance institution, MFIN issues loan of 10,000 to Pawan. The interest rate is 2% per month, which translates to 240 in a year. the tenure of loan is one year
2. At the close of year, Pawan says, he is unable to pay. Now, the MFIN does not want to show any NPA (Non-Performing Asset).
3. So they work out scheme saying, Pawan paid 10,240 along with interest on last day of financial year.
4. MFIN issues new loan to 10,240 on the first day of new financial year or last day of current financial year.
   
5. Now this happens only in books, there is no actual money changes hands.
6. The books represent 100% recovery. Balance Sheet is good.
   

What happened?

• Income(I) which should have been reduced by non-recoverable 10,000 would reflect (I-10,000) now actually represents no losses and income of 240 i.e (I+240).
• What is the amount of mis-apprpriation - [(I+240)-(I-10,000)] = -10,240.
• What happens, if the is revealed or caught? criminal proceedings for fraud, misappropriation.

Now lets look at Debt Crisis:
1) PIGS is running deficit of mammoth proportions.
2) ECB, IMF suggest we should have EFSF (European Financial Stability Fund). The corpus was recently raised to 440 Billion Euro.
3) How are they gonna use it? Leverage the fund to generate the resources of 1.7 Trillion Euro and lend to nations with debt crisis to help repay debt.
4) So the banks, which will get repaid will be eager to subscribe these new bonds issued by EFSF, so that their existing loans get repaid and no losses are booked.

Does that not sound like the Microfinance institution explained above? Yes, only that was at a scale of 10,000 this is magnified by ratio to 1000 times.
So the misappropriation of profits, funds, mis-representation is of huge mammoth scale. and what happens because of this action? Markets rebound, feel confident of overcoming the crisis. reward the parliamentarians who perpetrated this fraud?

The crisis in the first place was because the Governments leveraged their future earnings by having fiscal deficit (deficit financing as called by Keynes). Keynes said, We are dead in long term. so look for short term solutions. So he said, if the economy is not growing, borrow money and spend it in the economy, which due to money multiplier effect grow the economy in multiples of spend and eventually recover that cost incurred from future tax income.
This is nothing but leveraging your future income(cash flow) with current borrowing with expectation that this will be cancelled out.

This theory was fine. Many countries implemented too. Deficits were norm of the day. Only people forgot was this was solution for short term. When that short term ended and long term started nobody cared. Everybody turned the keynes on his head... to cover one deficit another big borrowing program created. to cover that borrowing, still larger borrowing program created...

This works only till you are able to generate future income to compensate for the losses of current borrowings. What happens after that? Then everything crashes..

Are we in this mode now? or there is still steam left to leverage more? and how long will we able to keep on leveraging our assets?

Is somebody asking these questions?

Debt Worries, Unusual Problems- Unusual Solutions..

Since 2008, when the economic ills were being treated with generous does of liquidity, the core crisis of debt management was postponed for some time. Now those ghosts of the pasts have come back to haunt those economies.

Visit to any of the European countries, you will realise, how clean the roads are, how well built the infr

astructure is, how well maintained the entire country is. The question that I used to ask everytime is, where do they get such money from? how do they fund these projects? why there are so less people and so many facilities? Tell an European to work overtime (after work hours) & you will find a person scowling. Ask him to pay for his medi-aid and he will scream cruelty.

What they did not realise is that, while creating such benefits for the public, governments used debt route to finance it. These measure did help in increasing the government expenditure, which in turn multiplied the effect on the economy. At the same time, it also created huge liabilities for the governments.

These debts now have become the cornerstone of the current crisis. The governments do not have sufficient monies even to service those debts. They have been over-leveraged.

As the solution for it and they will discuss, how fiscal deficits have ruined the economy. what is not realised is that these deficits were financed to create assets (huge infrastructure), which have no or neglible returns. That was a terrible waste of money. How have they solved it? By pumping more money in the economy, which is again raised by debt.

Now everybody wants to reduce deficits, that too not by raising incomes rather by cutting down the expenditure.... Whatta logic?

You reduce expenditure and that leads to reduction in income (as private investment/expenditure is already in doldrums), this will in turn lead to reduced tax revenues of the government. The government responds by reducing more expenditure. (that's cascading)

After long time, really good move was seen in the markets, i.e. reduction of deficit by combination of reducing expenditure and increasing of revenues. This was done by Italy on August 14, 2011.

Raising revenue is a good option. This was further reiterated by calls from Warren Buffett to increase tax revenues from super rich.

Lets hope, such sense spreads to other European and US economists too. One has to know that you cannot get rich by reducing expenses but by increasing revenues.

Reducing expenses will have multiplier effect on economy. Increased revenues will provide room to governments for maneuvering. Mindless austerity measures will not lead us anywhere, it will just shrink the economy. governments not only need to service their debts, they also need to have planned expenditure.

EURO hogwash - Solving problem with a problem

The Greek crisis has the origins in the excessives of the public expenditure without eye on the proportionate returns from it. What does that mean?

It means the exchequer has spent far more than it can afford to do so. That means the government expenditure far exceeds the income it earns. The crisis-because the income now cannot take care of repayments of debt raised for expenditure.

Till this, we understand what is going on. Now what has EURO package proposed?

1. Balance of Payments facility to Euro members from 60 billion to 110 billion. that means more debt for the governments;
2. Increasing Euro guarantees upto 440 billion in the form of Euro stabilization fund. where will this come from? from more debt.
3. Finally IMF facility of additional 250 billion. this is not free aid. but more debt.

So what are we trying to do? we are trying to stave off the debt crisis by having more debt. so that we can roll over the debt. This means we are just trying to postpone the inevitability. But this is with the assumption that growth will return and the governments will have sufficient debt service coverage ratio.

Now what actions are we taking to make higher growth a reality:

1. Tightening the belts by reducing the expenditure (public). In any country more than 20% of the GDP is directly or indirectly funded by the government. this action will have impact on the GDP of the country (more probably negative)
2. This will have impact on huge liquidity surge in the markets as countries will be flush with funds (lower cost). This in return will result in high inflation.

Does anybody still think, we are resolving the issue? Comments please...

Recession Causes - More of change in Perceptions

Economics is not a pure science... it is a social sicence.

So while studying any economic condition, we need to understand the social part of it to gain more understanding of it rather than looking at the abstract (relatively) terms as money supply, demand, supply, etc..

Even while studying demand and supply economics(which also has become obsolete after emergence of indifference curve analysis), the concept of demand has undergone lot of change...

While studying effect of demand on price, we should not loook at demand but "effective demand" So what is effective demand?

Effective demand is that demand that has three features
(a) Demand for the product;
(b) Ability to pay;
(c) Willingness to buy

So when demand is backed by ability and willingness, then it constitutes effective demand, which means demand which can make a difference....

The purpose of explaining all this is that the terms like willingness(which is more of cognitive term) have crept in the field of economics(so called science). This type of analysis has led to emergence of term called behavioral economics....

Now back to causes of recession and boom. The perception of the general public that there is more probability of gain in future as compared to now, leading that speculation and Vice Versa is the root causes of boom and recession...

The term more appropriate for this is "Irrational Exuberance". in fact this phrase was first used by former Fed chairman Alan Greespan to explain the irrational growth in stock markets during 1996-97...

Later Yale professor Robert Schiller came out with the book with same title in 2000 when market fell heavily....

This phrase became a catch phrase to explain the irrational boom. The important part is that this term takes into account the sentiment of public and tries to explain that boom and bust are more because of the sentiment of the public rather than the function of the forces of economics...

I hope I have a made point to you all......

Crisis or a Revolution?

Crisis or not, times are turbulent, for sure.

The turbulence –one would agree - is not just economic; it is more of socio-economic nature. Insolvencies, recession, cash crunch, interest rates... everything is contributing to the mess to the fullest extent possible. So much so that most of analysts are tempted to go back to 1930s to establish the comparable... well, do we really need to go that much back? (I do not think anyone who would read this blog would have had witnessed the 30s) Does anyone find any such example in recent history?

Perhaps, I do!

Just two odd decades ago, there was similar situation. Well, it was not of this magnitude; still it was of same importance (the world economy at that time was, definitely not as much interlinked then as it is now). It was... crash Communist economies.
Germany reunion, fall of USSR, China’s turnabout on economic policies, crisis of Cuba...

Was the rise and strengthening of capitalism as a socio-economic system at almost the same time a sheer coincidence? Or was it a corollary of fall of Communism? Or was it an inevitable alternative?

The voice of leftists is rising from hush-hush to growl saying, it is not a fall of one or more economies but of capitalism itself (Impliedly they mean the re-rise of communism - or at least, socialism - as a stronger system).

No, I am no left sympathizer in any way. Still, the point made by them can just not be dismissed since, as yet, there has not come up a single strong model which can analyze the past, explain the present and guide the future with confidence.
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This is not an analysis. This is not an opinion. Perhaps just a mention of social vibrations I felt. Afterall, there is always a possibility of a “Third Alternative”!!

I invite your opinions, analyses, views and arguments on this.