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Tuesday, November 15, 2011

Die Creditor Die!

Felix Salmon links upon Krugman V/s Summers debate. One of the central point about the current crisis is that how can we solve the problem of excess debt by taking on even more debt? I propose to answer this question. We can't!

To put it simply, what the Keynesian remedy is to offset short term debt with a far longer term debt -  reducing the annual payout while retaining the liability for substantially long period. The process works when you can replace the current creditor (one who is rather short-term focused) with a visionary long term creditor (or someone whose liabilities tend to stretch out for equally longer term). The new creditor bails out the previous one backstopping the losses. The new creditor needs a pretty strong liability that they propose to take to match this super-long term assets.

But we realize the folly in this option immediately. The new type of creditor is absent. The conditions are not exactly conducive for emergence of this very long term liability holder. A typical condition could be found at the beginning of the baby-boomer generation.

In reality the visionary long term creditor is same as one has super-long term liabilities. Invisible hand forces them into heroism we attribute to altruist nature. Americans (and recently Europeans) love to imagine China in all its altruist glory donning this role. Folly again my friends. 

But there is another way to reduce this debt. Let the creditor die. It sounds horrible but it is one way that is still available. When the creditor dies so do the obligations and then we have a clean slate.

That is precisely why banks or creditors should not become too concentrated. History is rife with example of creditors impaled by the mob or forced to surrender their rights. It is in the interest of creditors that there are many of them, at least more than 1%. Alas, we have not heeded history. Creditors beware!