
The Next Recession Will Be About Sovereign Debt - joshuafkon
https://www.cassandracapital.net/post/the-next-recession-whenever-it-comes-will-be-about-sovereign-debt
======
tim333
>What made the recession in 2008 the Great Recession was the failure of the
Federal Reserve and the Treasury to prevent Lehman Brothers from collapsing.

I'm not sure that's true - what made it big was the epic borrowing to buy
property that pushed up prices to record levels before hand. The Lehman thing
was just the pin that popped the bubble. It was going to burst big one day
because of the size of the thing.

It makes you doubt the rest of the reasoning if the first sentence is
incorrect.

~~~
joshuafkon
Respectfully, I think that Lehman brothers was a major part of why the great
recession was the great recession. I’ll quote economist Allen binder:

People argue that if it wasn’t Lehman Brothers it would have been something
else,” ….“I don’t buy that. I don’t mean everything would have been great if
we had bailed out Lehman. We were in a financial crisis before Lehman. But it
had a shock value that just caused everything to fall off a cliff. If you look
at data on almost anything – consumer spending, investment spending, car
sales, employment – it just drops off the table at Lehman Brothers and I don’t
think we needed to have that.

~~~
leftyted
He seems to be saying that if we had known what was going to happen before it
happened, we would have been able to prevent it from happening. Well, maybe.
But isn't that like saying "if the French had defended the Ardennes, they
would have stayed in the war much longer"? That seems like a reasonable guess
(as does "rescuing Lehman could have taken the bite out of the Great
Recession") but I would say that, actually, no one knows what would have
happened in these imaginary scenarios.

The broader point here is that events like Lehman's collapse and its aftermath
(or the invasion of France) are essentially defined by their unpredictability.
If we could predict them, they wouldn't even be _events_.

And even if, somehow, these events were predictable, does anyone really think
that economists have some theory that lets them make decisions like "who to
bail out" or answer questions like "what will the consequences will be if they
don't bail X out?" I believe that economists make better calls than a man on
the street (me), but I have my doubts.

~~~
roenxi
> The broader point here is that events like Lehman's collapse and its
> aftermath (or the invasion of France) are essentially defined by their
> unpredictability.

Unpredictability is a dangerous word because it has two meanings here.

On the one hand, you are using it to mean nobody could possibly know ahead of
time that it would be Lehman and even if they were told that fact it would
still have been impossible to pick the date (or the year for that matter).
Nobody could argue.

On the other hand, billions to trillions of dollars of wealth that everyone
thought existed turned out not to be there. It didn't disappear; it was
discovered in the financial crisis that it never existed and the crisis was
when that fact became uncontroversial in the mind of the general money
manager.

That part was clearly predictable in an emperor-has-no-clothes fashion and
probably years in advance as well. It seems highly likely that if the people
with power didn't see it shaping up then they were choosing not to see. Much
like government debt-to-GDP in today's article. The people profiting cheer-
lead bad long term decisions and everyone else sits quiet hoping that they
won't have to pay for it. Which would be fine if the responsible people were
made to pay in the end, but 2008 showed that not to be the case; taxpayers
stepped in. The financial bloodbath was not matched by an equal sack-everyone-
involved-and-bankrupt-the-investment-banks bloodbath of sufficient magnitude.
A failure like that should have reamed out the entire sector; if they weren't
ready for it replace them with new blood and ideas.

I suppose the point I want to make is that there is a frame here that 'saving
Lehman' would have been a win. It wouldn't be a win. They were complicit in
mis-allocating resources; 'saving' them just gives them more time to redirect
real effort into bad causes, and makes the final reckoning more painful when
people need to call on real resources that turn out not to be there. The books
were misleading; protecting them would just have let more people make bad
decisions based on misleading figures. Markets work best when people don't do
that, and I understate by an order of magnitude or two when I say that.

~~~
leftyted
> On the other hand, billions to trillions of dollars of wealth that everyone
> thought existed turned out not to be there. It didn't disappear; it was
> discovered in the financial crisis that it never existed and the crisis was
> when that fact became uncontroversial in the mind of the general money
> manager.

> That part was clearly predictable in an emperor-has-no-clothes fashion and
> probably years in advance as well. It seems highly likely that if the people
> with power didn't see it shaping up then they were choosing not to see.

I don't think it was predictable in any useful sense. First, I don't think
anyone knew that (or when) "the general money manager" would "become aware of
the facts". Second, I don't think anyone knew that would happen _if_ they
became aware of the facts.

So maybe it was predictable in a "there will definitely be a
recession...sometime" sense, but that's not helpful.

Even if some people did identify "billions to trillions of missing wealth" and
predict the crisis (and apparently some people did), there wasn't any way to
know which of those predictions was correct. There is no one who predicts
things who is always right and there is no agreed-upon theory to tell us when
these things are going to happen before they happen with any precision.

To put it another way: there are smart people who predict financial crises
that never happen all the time.

> I suppose the point I want to make is that there is a frame here that
> 'saving Lehman' would have been a win. It wouldn't be a win. They were
> complicit in mis-allocating resources; 'saving' them just gives them more
> time to redirect real effort into bad causes, and makes the final reckoning
> more painful when people need to call on real resources that turn out not to
> be there. The books were misleading; protecting them would just have let
> more people make bad decisions based on misleading figures. Markets work
> best when people don't do that, and I understate by an order of magnitude or
> two when I say that.

This is a different argument. I guess there are two things to worry about:

1\. Making the responsible parties pay for their malfeasance (justice)

2\. Making decisions that will benefit the economy (pragmatism)

It's entirely possible that bailouts ticked the second box but not the first.
But, as you argue, in the long run, not bailing out the lenders might tick
both boxes because it will teach them a lesson. However, that's a hard sell
for Americans living between 2008 and 2012, who probably _did_ benefit from
the bailouts, even if they were unjust and even those bailouts only deferred
some larger, inevitable crisis.

I don't envy the people who have to make these decisions.

------
jchook
Perhaps we all should have gone the route of Iceland in 2009 — let all the
banks fail, endure ferocious poverty for 5 or so years, but in that time
cultivate a rich humanity that results in:

\- peacefully firing the entire government

\- crowdsourcing a new constitution with the help of the Internet

\- putting the white collar criminals in corrections where they belong
(instead of giving them $25M bonuses)

\- getting women on equal footing in government and business leadership

— transitioning to 100% green energy

Seems the global economy tried to vomit up all the banksters and corporate
corruption but the governments all took a pill to suppress the purge and stay
ill.

~~~
andrepd
It's absurd that such a crucial function of society -- control of the money
supply and management of debt -- falls on the hands of an unelected,
unaccountable, largely hereditary elite. Yet nobody talks about this, when the
solution is obvious and in plain view of all: democratise banking.

~~~
gbersac
I'm not sure people are knowledgeable enough to know if someone is competent
to be a banker. How could such election not ending as a populist race.

~~~
r00fus
Why will democratization lead to demagogues?

The most popular _ideas_ should win, not the most popular people. We have no
real need to require representation anymore, we should have a fully auditable,
direct democracy.

------
RobertoG
>>"[..] but it has allowed deeply indebted nations like Greece, Japan, and
Italy to service their debts."

Anyone that put Japan, Italy and Greece in the same page and fail to point
that Japan is using its own currency, and the other two are not, don't
understand what he is talking about.

>>" [..] if the BOJ or the ECB was to simply buy bonds directly from the
treasury without removing an equivalent amount from circulation by holding it
as reserves it would be massively inflationary. [..]"

Why it would be "massively inflationary"? He fail to tell us.

>>" As tax revenues fall, debt to GDP ratios will rise. Rating agencies will
downgrade nations debt and investors will demand higher interest rates to
compensate for the risk. "

Why this has not happened to Japan already? They have been done this for years
and years.

Edit - recommended lecture: "Building bank reserves is not inflationary" (1)

1 -
[http://bilbo.economicoutlook.net/blog/?p=6624](http://bilbo.economicoutlook.net/blog/?p=6624)

~~~
joshuafkon
Japan, Italy, and Greece are in the same category of heavily indebted
countries as a percentage of their GDP. But, you’re absolutely correct that a
key difference between these countries is that Japan controls its own currency
(unlike Italy and Greece).

Having a central bank by bonds directly from the treasury is the very
definition of monetization. It would add a substantial amount of currency to
the economy and is very different from what is happening with QE.

As for how Japan has been able to build up debt to their levels without seeing
bond yields rise and sparking a crisis - it’s because the Bank Of Japan has
used just about every outstanding government bond for QE. But they Japanese in
particular are reaching the limit of QE. I go more into this argument here:
[https://www.cassandracapital.net/post/quantitative-easing-
ha...](https://www.cassandracapital.net/post/quantitative-easing-has-
prevented-a-debt-crisis-but-we-re-reaching-the-physical-limits-of-qe)

~~~
RobertoG
If I understand you correctly, your argument is that QE is not inflationary
because the banks don't have bonds in their balance that previously they had,
instead they have reserves.

First, reserves are not inflationary (1). The quantity of reserves in the
system is not important if that money is keep in the Central Bank and it's not
spent. As the current QE exercise has show, adding reserves to the system
don't make firms and households ask for more credit. If the real economy don't
want to spend, you can add all the reserves that you want and nothing will
happen (except lowering the interest rate that it's already at minumum).

Now, fiscal policy, it's the right tool if you want to stimulate the economy,
but, for political reasons, it's not done.

Second, please, explain through what mechanism banks don't owning a quantity
of bonds equivalent to the reserves in the system will create inflation. All
the point of selling bonds (by the central bank to the banks) is to retire
reserves from the system.

Monetization of the debt don't cause inflation. What causes inflation is
spending in the economy. That it's precisely what the politics in, for
instance, the Euro-area refuse to do.

(1) -
[http://bilbo.economicoutlook.net/blog/?p=6624](http://bilbo.economicoutlook.net/blog/?p=6624)

~~~
joshuafkon
I think we agree that QE is not inflationary (and obviously despite years of
QE inflation is low)

However, monetization if the debt (which is very different from QE) is
definitely inflationary. Would you suggest that every country could simply
print fresh currency and pay off the national debt without causing inflation?

~~~
RobertoG
Please, note that I'm not saying that QE it's not inflationary (it's not), I'm
making a more general statement: adding reserves to the bank system it's not
inflationary.

You probably agree with me that what create inflation is the spending in the
economy.

One thing is the public deficit and another is the public debt. The deficit
happens when the government spend in the economy. If the government (or the
private sector) spend too much in the economy inflation will happen. The other
way inflation can happen is by some kind of supply shock.

The public debt is just the accumulated of the money that has been already
spent in the economy. So, the public debt can't be inflationary. That money is
already in the economy!

Paying the public debt it's just not emitting new debt and waiting until all
the debt mature.

Could that be done (if we forget for a moment the rules currently in place)?

Yes, the government just could spend what they need without emitting bonds.
The real restrictions in the government spending would be the same: don't
spend more than the economy can provide or you will get inflation.

The public debt number is basically irrelevant. This is true for countries
with its own currency and the debt denominated in its own currency, otherwise
the issue it's very different.

We are not going to see a crisis created by a public debt problem of countries
that have their own currency, but the public debt, of the countries in the
Euro, is a good candidate for the source of the next crisis.

------
aazaa
> Already the BOJ has begun to run out of eligible bonds to buy - or swap
> really - for reserves at the central bank. Ben Bernanke noted in late 2016
> that “…constraints on the availability of JGBs [Japanese Government Bonds]
> were seen in many quarters as limiting the BOJ’s ability to maintain its
> easy policies beyond the next year or two.” Japan is very close to
> purchasing all of the outstanding JGBs - at which point it will not be able
> to continue its QE program.

Japan has truly been the pioneer here. Its stock market went supernova first.
It experienced deflation first. It implemented QE first. At each stage, Japan
showed the rest of the world how this descent from free markets into something
else works.

Japan was also the first industrialized country to realize the vast potential
of direct stock purchases by the central bank. Today, the BOJ is a major
shareholder of Japanese stocks:

> The BOJ held over 28 trillion yen ($250 billion) in exchange-traded funds as
> of the end of March [2019] -- 4.7% of the total market capitalization of the
> first section of the Tokyo Stock Exchange.

> ...

> The BOJ has likely also become the top shareholder in 23 companies,
> including Nidec, Fanuc and Omron, through its ETF holdings. It was among the
> top 10 for 49.7% of all Tokyo-listed enterprises at the end of March.

[https://asia.nikkei.com/Business/Markets/Bank-of-Japan-to-
be...](https://asia.nikkei.com/Business/Markets/Bank-of-Japan-to-be-top-
shareholder-of-Japan-stocks)

There's always money in the banana stand.

~~~
lifty
Isn't that a slippery slope? If you extrapolate, the market gets used to easy
money from the central banks and we end up with most companies being owned by
the central banks. Price discovery and risk get totally screwed.

------
conanbatt
The first one in the line is Argentina, which is about to default the biggest
loan the IMF ever gave.

Argentina defaulting would not affect any other countries significantly: but
it holds over 60% of IMF's financial assets and has the will to default on
this debt.

The IMF losing more than half its holdings means that there wouldn't be a
lender of last resort for sovereign debt issues.

------
neuromancer2701
One aspect the article doesn't cover is that since Japans has been doing this
for decades they have effective run out the clock on QE.

BOJ has been buying ETFs for so long they are the majority of shareholders in
a large percentage of stocks in Japan. I don't think you can do that with
swaps so I am pretty sure they had to "print" money to do that.

Additionally I have heard that ECB buys corp bonds. Apple can go over to
Europe whenever it wants and sell a couple Billion in debt and it will be
bought immediately.

The question is when does it pop?

------
pjc50
The last financial crisis had a large sovereign debt element - but only in
those countries where a "bailin" of the local banking industry was
inconcievable and there was a bailout transfer instead.

If you want to look at debt, look at yields; just the other day we were
discussing negative yield bonds in some Western countries. You can't have a
sovereign debt crisis and negative yields in the same country at the same
time!

The most obvious trigger event for the next global recession is sovereign
idiocy. The UK's own prediction documents for no-deal Brexit show 5-10% GDP
loss within a year or so. The war in Syria rumbles on. The wave of tit-for-tat
tanker seizures could continue. Or the trade war with China could escalate.

~~~
AnimalMuppet
> If you want to look at debt, look at yields; just the other day we were
> discussing negative yield bonds in some Western countries. You can't have a
> sovereign debt crisis and negative yields in the same country at the same
> time!

I mostly agree with you. But I seem to recall reading that US Treasury
auctions had been recently failing, and only appeared not to fail because the
dealers stepped in and bought the rest of the bonds. That's what they're
supposed to do in that situation, but in a normal auction, they don't have to.

So I worry that all is not as it appears in the bond markets, and therefore
that your logic might not work. In particular, it might not work for long,
because the bond dealers can't keep buying half the issues for long -
especially not at the rate the US is having to issue bonds to fund the
deficit.

------
s_Hogg
There are a few candidates for a crisis, sovereign debt is one. At this point
corporate debt is no less scary.

My guess is it won't be about one specific thing, because there are so many
interlinked ways for things to jack up at this point.

------
bryanlarsen
Negative yields are a pretty strong indicator the people with skin in the game
aren't worried about sovereign debt.

What might kick off the recession will be the austerity measures countries
impose as an over-reaction to debt worries.

------
littlestymaar
> What made the recession in 2008 the Great Recession was the failure of the
> Federal Reserve and the Treasury to prevent Lehman Brothers from collapsing.
> Allowing the collapse of an institution that was too big to fail is what
> started…

One could argue that the problem started with the market believing there were
such things as an institution too big to fail… Or maybe even earlier, when
bankers decided they could lend money to any insolvent guy because the risk
was going to be born by others through CDS…

------
ArtWomb
Blackrock is also running a series: "Dealing with the next downturn"

[https://www.blackrockblog.com/2019/08/20/how-central-
banks-m...](https://www.blackrockblog.com/2019/08/20/how-central-banks-might-
deal-with-the-next-downturn/)

Direct stimulus (through universal basic income) may emerge as the best, if
not only, innovation for stabilizing aggregate consumer demand.

~~~
geggam
I always wondered why the folks doing QE didnt pump money into the people
letting them stimulate the economy by spending / paying their bills.

Banks still end up with the money but people would not be screwed quite so
during the process.

------
iamasuperuser
This site and the links per country makes for interesting follow up reading:
[https://commodity.com/debt-clock/](https://commodity.com/debt-clock/)

------
WilliamSt
How can an individual investor profit from the coming sovereign debt crisis?

~~~
conanbatt
Credit Default Swaps.

~~~
AnimalMuppet
If the counterparty survives...

------
patientplatypus
The next recession will be caused by poor crop yields due to environmental
destruction. It will also cause famines and wars globally.

------
jbob2000
Every recession in history has been caused by two things: an overreaction by
the feds, or a screw up by wall street. Market crash in the 80s was because
the feds spiked the interest rate, dot com bust was because wall street didn't
do their due diligence.

Not saying that the upcoming recession will be caused by one of these things,
just that I doubt sovereign debt has the power (like overreactions or
financial mishaps) to move global markets.

------
Thorentis
If we reach the point where global stability depends on whether or not debt by
almost every first world country can be paid or not, we will be in a situation
where we have to evaluate whether or not keeping that debt around is worth the
risk of total economic collapse.

Consider - each country can either: a) mutually agree to cancel all debt (or
some large portion to mitigate the situation, say 50%) or, b) continue to
demand the debt, thus perpetuating the downward spiral of the global economy,
thus ushering in an era of civil unrest and large civilizational changes.

I'm not trying to sound all doom and gloom, but I think a large part of the
economy is very much "pretend money" that works fine with high levels of
productivity and economic output, but can very much just be done away with if
the alternative is total collapse.

The GFC wasn't a total collapse. It was just the loss of large amounts of
profit for some large bankers. This had severe consequences for some people
(mortgage foreclosures, jobs etc), but wasn't on the scale this article
describes, or anywhere close.

It's a bit like the worries people (rightfully) have around foreign ownership
of land, especially farmland. Yeah it's not ideal now, but you think private
property laws will be upheld in war time? If a country ever goes to war with
say, China, (a large owner of foreign farmland), you can bet that country will
simply seize it all and repurpose it for the war effort before you can say
"world war 3". Private property is nice on paper, but when push comes to shove
it's just that - paper. Easily rewriten.

~~~
narvval
> each country can either: a) mutually agree to cancel all debt

Sovereign debt doesn't mean that countries owe money to each other. Most of
the debt is owed to private investors (banks, funds, etc).

~~~
ses1984
And what gives private banks freedom to operate?

~~~
Thorentis
Bingo. You think the government will standby and watch the world economy
collapse because some investment bank won't cancel their debt, or uphold our
end of the deal to mutually cancel debt? Send in military, seize all assets,
wipe the records. Yes, it's a dystopia, and there will be sociatal and
economic consequences. But the alternative is far worse.

I think that the larger the world economies get, the closer we get to
totalitarian policy being the only thing that works to mitigate disaster.
Think economic collapse, climate change, viral epidemics. None can be solved
by individual initiative, slow moving government policy, etc. They require
large scale, immediate, dictorial action by large nation states.

~~~
pjc50
> totalitarian policy being the only thing that works to mitigate disaster

Totalitarian policy _is_ a disaster all its own.

~~~
normalhuman
You are right, and it is also the case that totalitarian policy can be
implemented in a variety of ways and for a variety of reasons. It can be a
last resort measure to save a society (e.g., when the UK canceled elections to
deal with the Nazi threat).

More importantly: it is perfectly possible to implement totalitarian policy
_while_ maintaining the aesthetics of freedom. There is a famous book about
this, 1984 something... Sorry for the cliché, but here we are.

Let's say, for example, that you convince the population of the most powerful
economy on earth that they are the most free, most amazing society ever, while
the rest of the developed world actually enjoys affordable health care and
vacation time. Meanwhile, most of your citizens not only spend the vast amount
of their time in an endless rat race that only benefits economically the top
.001%, send their sons and daughters to stupid wars, while aggressively
_demanding_ the continuation of this state of affairs.

Another important trick to maintaining this state of affairs is to create very
violent political debate about a very narrow and irrelevant set of topics
(e.g. bullshit topics such as "cultural marxism", "red pill", "cucks and
soyboys", "cultural appropriation", the corrupt blue guy vs the corrupt red
gal... you get the picture).

------
cylinder
You can feel the fatigue with central banks all around the world. It's obvious
this small group of people shouldn't hold this power and it's clear they have
no idea what they're doing and are just moving levers like our lives are their
video games.

This will not manifest as a revision of the system but rather the changing of
who is pulling those levers. The funny money will go to Workers not Bankers
and Shareholders and Homeowners next decade (which starts in four months btw!)

