Saturday, February 2, 2013

Economics Nobel laureate and Mario Monti have an idea for cutting deficits.

Christopher Pissarides, economics Nobel laureate, has an idea for helping with the deficit and national debt. It’s to tie specific tranches of national debt to the infrastructure and other assets that the latter debt finances, and then not count the relevant sums as “deficit”.
Well clearly a bond is more attractive to bond buyers if there are specific assets backing the bond than if there aren’t. But the first problem with the above idea is that every country’s national debt is to some extent backed by government owned assets ANYWAY!!!  And those paper tigers, the bond vigilantes know it. So formally tying specific bonds to specific assets won’t make a huge difference.
Put another way, regardless of whether specific bonds are tied to specific government owned assets, any country always has the option of flogging off its infrastructure in order to get out of difficulties.
Second, a country has to be in a dire state before it starts flogging off its infrastructure so as to get out of difficulties. Greece is an example. And the bonds of such a country will probably have lost a significant proportion of their value LONG BEFORE the “flog off” takes place. Greece again is an example.
In short, bond holders with their heads screwed on will pay much more attention to a country’s OVERALL economic performance than to whether its bonds are backed by specific assets.
To illustrate, suppose a bank manager has the choice of lending to two firms. One has a healthy order book and is making decent profits. The second is approaching bankruptcy but can offer assets to back a loan. Why would the bank manager bother with the second? Going thru bankruptcy proceedings is costly and time consuming.
And to add insult to injury, suppose foreign creditors do take over infrastructure, will residents of the problem country actually pay to use the infrastructure? Not if German built motorways in Greece are anything to go by: Greeks have simply torn down the toll booths and refused to pay.
Third, a country which issues its own currency and borrows in that currency cannot possibly fail to repay loans and for the simple reason that it can print any amount of money any time it wants. The fact that specific bonds are backed by specific assets has absolutly no bearing on that ability to “print and repay”. Of course if a country has to resort to IRRESPONSIBLE printing in order to repay, then inflation will take off, and bond holders will lose out (in “real” or “inflation adjusted” terms). And unfortunately, having those bonds backed by specific physical assets won’t make a blind scrap of difference to that inflationary loss.
And that’s just another reason why bond holders who know what they are doing look (to repeat) at a country’s OVERALL ECONLOMIC PERFORMANCE, not whether specific bonds are backed by specific assets.

Government borrowing is all nonsense anyway.
And finally, the great and the good, plus finance ministers, plus economics text books, etc etc all convey the message that government borrowing makes some sort of sense. Actually government borrowing is a big load of hogwash. Milton Friedman said so here. Warren Mosler said so here (2nd last paragraph). Claude Hillinger said so here(p.3). And I said so here.

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