Is It Global Weimar?
Must debt restructuring and reduction occur for the West’s economies to truly recover?
February 24, 2011
After both World War I and World War II, let us recall, the European nations largely defaulted on foreign debt to the United States and other foreign creditors, while mostly paying domestic creditors.
This reduction in foreign debt service cost allowed the allied nations to import more goods and recover much faster than would have been the case had foreign holders of wartime debts been paid at par.
In contrast to the direct approach taken to debt restructuring in the 1920s and 1950s, today the response by the U.S. Federal Reserve and the other industrial nations can best be described as a weak effort at “Global Weimar.”
In other words, the U.S. central bank expands core money and provides credit to other central banks in the hope that reflation will occur. All this occurs in an effort to support the fiction of asset valuations on a global basis and delay the day of reckoning with respect to debt default.
But can any reasonable observer look at Ireland or Spain — or even the United States — and expect these nations to pay their accumulated debts at par?
Part of the dilemma facing Japan and our trading partners is that the mound of unpayable debt in the United States, Ireland, Spain and many other industrial nations is not shrinking even in real terms, even with quantitative easing (QE) efforts to date.
In that sense, QE and other monetary measures are not nearly big enough to achieve the apparent objective of Federal Reserve Chairman Ben Bernanke and other members of the Federal Open Market Committee, namely widespread global reflation.
If the cost of the debt in real terms cannot be inflated away via low real interest rates and direct intervention such as QE, then restructuring and default seem inevitable.
Few nations have taken the path of Iceland and told their creditors, in effect, to take a hike. Doing so isolated that tiny country from neighbors and the global capital markets, but this could be seen as a benefit.
In a nation that is energy self-sufficient and can survive on fishing and cash aluminum exports, default on oppressive foreign debt was the overwhelming choice of Iceland’s people.
The new Icelandic government, which is populated by a number of skeptical women, has declared an end to “macho” financial antics by the country’s predominantly male investment bankers, who are described in terms best suited for wayward children.
Some observers suggest that Japan and other heavily indebted nations, seeing their currencies appreciate vis-à-vis the dollar, need to themselves hyperinflate. In response to U.S. excesses in terms of debt, it is argued, other nations should imitate our example.
Adam Fergusson, in his classic 1975 book When Money Dies, describes “the nightmare of deficit spending, devaluation and hyperinflation in Weimar Germany.”
Then as now, liberal elements analogous to the Paul Krugman/Martin Wolf/Larry Summers school of economic policy justified deficit spending in the name of human compassion and national economic recovery.
Krugman and a majority of the Federal Reserve’s Federal Open Market Committee seemingly advocate further inflation to fuel public spending, but such measures also lead us all down the road to economic hell and political authoritarianism.
Despite the obvious failure of deficit spending in Weimar Germany during the 1920s, a decade later the example was mimicked by FDR in creating the New Deal. Conservatives are right to point out that the fiscal stimulus championed by Summers, and also by Democrats and Republicans in the U.S. Congress, resulted in little benefit.
But the fact that some very intelligent Americans are still arguing about the efficacy of deficit spending almost a century after the Weimar inflation suggests our collective ignorance of history.
“Money may no longer be printed and distributed in the voluminous quantities of 1923,” Fergusson writes in the note to the 2010 edition of his 1975 classic. “However, ‘quantitative easing,’ that modern euphemism for surreptitious deficit financing in an electronic era, can no less become an assault on monetary discipline.”
The moral of the story is that efforts to restore consumer activity and job creation in the United States and the EU may not be successful until debt service levels are reduced a la Iceland.
This political reality seems likely next to be put to the test in Ireland and Spain, where debt service is directly tied to horrible fiscal cutbacks in the public mind. But have no doubt that the less visible cascade of residential mortgage defaults in the United States is every bit as dangerous.
Today the response by the U.S. Federal Reserve and the other industrial nations can best be described as a weak effort at "Global Weimar."
The fact that some very intelligent Americans are still arguing about the efficacy of deficit spending long after the Weimar inflation suggests our collective ignorance of history.
Efforts to restore consumer activity and job creation in the United States and the EU may not be successful until debt service levels are reduced a la Iceland.