Global Economics 101 #2

Debt Relief

Debt Relief

Measures of health

We can judge our financial health by both, our Income profile, and our Balance Sheet. If we have a decent income, and spend less than we earn, then our savings will in time repair a bad balance sheet. Likewise if the balance sheet has good assets on it, we can sell those to generate cash to cover a gap when incomes stumble.

But what to do when the Income picture declines at the same time as the balance sheet is devoid of assets or has too much debt? This is the great question of our time.

In turning around a troubled business, we first trim our money losing activities (closing stores, or discontinuing unprofitable products), and cut expenses such as marketing and capital spending  to repair the cash income picture. Then we trim out debt by disposing of assets to retire debt. If there are no assets to sell, then a negotiated truce with lenders is needed to grant time to gradually pay off debts. The key is to generate income – that will (in time) cure all issues.

But the West has done a great job – through Globalisation – of hollowing out our middle class, so the nation as a whole is battling a poor income growth picture, at the same time as we are debt heavy, and with few assets in the bank to raise cash.

The final step often is to partially or totally default on debts – to restructure the balance sheet – to fit within the new income profile that the business or individual or country can service on its now lower income position.

And this is where we are at today – the story of Greece and its rolling efforts to extend its debt just does not face the fact that its income profile has declined dramatically. There is no silver in the cupboard left to sell, short of its Greek islands. They have little alternative to a default, and withdrawing from the EU and the Euro. That too will mean no banker will lend to them again for a very long time. But that is the case already – short of borrowing from their tired friends in France & Germany, who are striving to save their beloved Euro.

Contrast this to the survival strategy of Iceland, who chose to default in 2008. They stiffed the various foreign investors in Iceland, mostly from England, and this triggered serious international relations issues between friendly countries. Yet they are now able to service their remaining debts, and appear to be bouncing back rather quickly in economic growth terms. They put their sovereign interests first, out of necessity. And they have not sold off national assets (such as their prolific hydro energy sources) to get there.

The USA does not really have the alternative to default – and any suggestion of this, will trigger serious issues with their international lenders, the Chinese, Japanese and Middle East.

The best path forward is to bite the bullet and quickly restore the budget balances of all deficit countries. From that starting point, aggressively work to improve the income pictures (competitiveness) of each country in trouble, including devalue currencies to gain trade revenues. This is the approach of the Swiss in defending their national interests. And there will be some protectionist measures as well – similar to German and Singaporean industry policies – to foster long term interests where a country cannot afford the short term destruction of key employment arenas.

Other countries need to start putting their self-interests ahead of expensive grand standing on peripheral issues like global warming, and work to improve the incomes of their middle class. From that position, we will – in time – restore our balance sheets to better health.