The world is addicted to cheap money, and sovereign debt is at a level that just a few decades ago would have gotten finance ministers and treasurers ridden out of town on a rail, says US attorney Lee Buchheit, a man who probably knows more about sovereign debt than anyone else alive.
“The average of debt to GDP ration in Europe – an important measure of how much of a nation’s economy has to go to service old debts – is around 93%, and in a few countries it’s in excess of 110%,” he noted. It’s the equivalent of a household charging 10% more on its credit cards than it earns – a situation that no bank would tolerate for even one month, much less for the near-decade that easy money has flowed from central banks to “goose” the economies hurt in the 2008 recession.
As such, Israel stands out as a shining example example of fiscal probity. “The debt to GDP ratio in Israel is about 67%, a number that not too long ago would have raised eyebrows among financiers and investors – but today is considered very healthy, at least compared with the norm. The Israeli economy is performing quite well, and is attractive to international investors. If it wants to remain in that position, it must keep spending in check, or risk scaring off investors. The Bank of Israel isn’t the Fed (US Federal Reserve Bank), and can’t get away with what its American counterpart can.”
That norm was what got Greece into a deep financial hole in 2009, when a crisis of confidence rocked the country’s economy, nearly causing a default – and forcing Greeks to take a major “haircut” on investments, wages, benefits, and other components on the “give” side of Greece’s economy. And although the Greek people suffered, there was really no choice, said Buchheit – without the debt restructuring that led to those cuts, the Greek economy would have been in far worse straits, as no bank would have been willing to lend it a drachma (actually, euro, since Greece is a full member of the European Union).
Buchheit intimately knows Greece’s problems – and the problems of more than dozen other countries, including Russia, Mexico, the Philippines, Iraq, and Iceland, because he engineered the bailout for Greece and the other countries mentioned. There, the debt to GDP ratio got way out of hand (it’s still at a ridiculously high 174%); that, among other things, was the impetus for the panic that ensued, and forced the country – and its citizens – to submit to some very unpleasant steps, in order to ensure that Greece did not completely ruin its credit, cutting off its financial lifeline.
Buchheit is an attorney at New York law firm Cleary Gottlieb, and has been a point man on sovereign debt for the past twenty-some years, after he helped engineer the bailout of Mexico in the mid-1990s. Buchheit was speaking in Tel Aviv at a special event being held by the firm for its many Israeli clients (for example, Cleary Gottlieb engineered the Google buyout of Waze), presenting his thoughts about one of his favorite subjects, and mesmerizing the crowd of several hundred investors, attorneys, and CEOs who arr 22
When Mexico got itself into a jam (due, again, to unbridled spending) a sovereign debt crisis was a rare phenomenon – but since then, they have become alarmingly common. “Once if you said a country was solvent it meant that the country could pay its debts, but today it means that it is able to refinance its debts when they come due.” It appears, he said, that many officials in governments around the world can borrow today to pay off yesterday’s debts, and borrow even more for current spending, confident that the “tap” of international financing to pay for projects will never run dry.
Perhaps more than anything else, the super-low interest rates that are prevalent today have helped feed government’s addiction to borrowing, said Buchheit. “The increase of debt stocks in many developed countries has been breathtaking, but the reason it is not in the headlines is that money has not been diverted from other purposes to service debt.”
Low interest rates have been prevalent for several years now, and as a result governments have felt that it is “safe” to borrow ever-higher amounts of money. “As long as rates remain low they can get away with it, but when interest rates shoot back up and payments to service that debt start creeping up, governments are going to have to find more sources of funds to pay it off;” either by raising taxes or printing more money (in current parlance, it’s called “quantitative easing,” said Buchheit). Both solutions have traditionally been used by over-extended governments to solve their debt problem – but both have a negative impact on subjects of those governments, making them give up more of their money to taxes, or debasing the currency by flooding the market, creating inflation, said Buchheit.
That inflation has not yet become a major problem – if anything, governments over the past few years have reported that prices are actually going down – is an anomaly, but one that he does not believe will last too much longer, said Buchheit. “The truth is that we are part of a grand experiment. There has never been a period in which interest rates have been held down artificially for so long, and governments have borrowed so much money to stimulate their economies.”
That inflation has not soared out of control due to the flood of money on the market, or that a depression has taken hold as investors and corporations drop their investment activities over fears of the future, is no indication of what’s to come, said Buchheit. “Things can change in a heartbeat, and that change can be breathtakingly fast.” The old rules of economics still apply, he added, and the most dangerous thing for anyone would be to lull themselves into a false sense of security based on current circumstances.
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