The Ponzi scheme called Europe

Compared to european governments, this guy is a beginner.

The burning question for the sovereign bondholders today seems to be: Can Greece and Italy pay us back? In reality, that’s a wrong question to ask (they can’t). The real question for a bondholder should be: Can countries such as France and Great Britain pay us back?

American economist Hyman Minsky distinguished between three types of finance:

– an organisation is in hedge finance group if it’s anticipated income is more than sufficient to pay both the interest and scheduled reduction in its debtedness

– an organisation is in speculative finance group if its anticipated income is sufficient to pay the interest on its indebtedness, however, the organisation must use cash from new loans to repay the matured loan

– an organisation is in Ponzi finance group if its anticipated income is smaller than the amount needed to pay all the interest on its indebtedness on the scheduled due dates, so the organisation must either increase its indebtedness or sell some assets to get the cash to these payments.

Hyman Minsky

Most of the eurozone countries as well as other big developed economies (United States, Great Britain) are clearly in the Ponzi finance group. The question that sovereign bond issuers ask themselves should be: “Can we pay it back?” Unfortunately, this is really the last thing on their mind right now. The major question they ask themselves is “Can we raise more debt?”. Everything that is going on right now (for example letting Greece to default de facto but not de jure) is just about making sure that there would be more credit available. It is like maxxing out your credit card at the end of each period and then, looking for a new card with bigger limit (instead of figuring out how to pay the balance).

Things are not getting any better. There is a huge amount of debt the countries hold that you cannot see in the balance sheet: the retirement duties. Considering the aging population and decreases in family sizes it is just not possible to see where the money to pay those pensions will come from. Also, as the number of retired people increases, the pension payments increase and the pension funds are much less likely to keep buying the sovereign bonds in the amounts they do at the moment. In addition to that, in some countries (France, Estonia) some parties are still playing on populist promises of decreasing the retirement age or increasing the pensions.

As for now, banks, retirement funds and other investors will keep on buying the sovereign bonds. Their hope is that there will be indeed a “greater fool” buying the next round of bonds, or maybe there will be a miracle which enables the bond issuers to pay the debt themselves. It is easier to pretend than to face the reality, after all.


6 thoughts on “The Ponzi scheme called Europe

  1. Interesting post, Lauri! One thing I would like to add is that in modern economy the debt is not supposed to be paid back entirely (rathen than rolled over), instead it is supposed to be held in sustainable level (like 60% of GDP for example). Inflation and economic growth allow countries to run a budget deficit (while keeping the actual debt at a certain percentage of GDP). So the utmost question for me would be “How to grow faster without adding to current debt levels?”

  2. Allan, exactly this kind of thinking (instead of paying back the debt but holding it at a maximum sustainable level) is what brought us to the current debt-crises in the first place. My message here is that it is a wrong way to think. Maxxing out your lending capacity and “rolling it over” gives you a short term-benefit (you can consume a bit more) but you will be worse off for the longer term: your actual disposable income decreases infinitely (because you have to keep paying interest) and you also do not have the opportunity to raise the indebtedness when you really need it (now).

    Do you, as a private individual, also follow the same strategy you suggest for the countries? I.e. you have your debt on loans, leases and credit cards at the maximum level where you can still barely pay the interests? If not, then why should countries do that?!

    • It comes down to whether investments today lead to higher growth in the future. In personal level it is very different whether you spend your loaned money to attend a university or go travelling. While the first might offer you much better salary in the future the other is just money spent that needs to be paid back. If we look at all the problematic countries then their current deficit comes from running costs that need to be paid rather than investments that lead to higher growth in the future. If Estonia took a loan and invested it in enhancing IT infrastructure or new transport routes we might achieve short-term boost to growth which for our society as a whole brings much more benefits than discounted interest costs that need to be paid in the future. So I guess there is an optimal level of debt you can and should take.

      The same goes especially for companies that can reduce their cost of capital by taking loans. If this capital is employed with a greater expected yield than the interest costs then debt makes sense. Once interest costs exceed the potential yield taking more debt does not make sense.

      • Yes, in theory this is really a good idea. So is communism. In practice, as we have seen, neither of those two works. It has to do with human psychology, I think.

    • I suspect it’s not our modern economy that is the problem here. It’s our thinking.
      We are maxing out many other (and perhaps far more important) things on this planet. Think of 200 000 persons population growth daily, usage of natural recources and wildlife.

      We really seem more like a virus as Mr. Smith suggested in movie “Matrix” rather than really reasonable equilibrium searching beings:)

      • Totally agreed. But there is hope: in the western countries, people are starting to think greener. I hope they will soon ACT greener, too.:)

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