A special report on debt: Repent at leisure | The Economist

I didn't think I would find this special report from this week's Economist all that compelling (after all, aren't we all reading daily stories about debt, fiscal crisis, etc.?) but it really was pretty interesting.

Here's an excerpt:

The problem with debt, though, is the need to repay it. Not for nothing does the word credit have its roots in the Latin word credere, to believe. If creditors lose faith in their borrowers, they will demand the repayment of existing debt or refuse to renew old loans. If the debt is secured against assets, then the borrower may be forced to sell. A lot of forced sales will cause asset prices to fall and make creditors even less willing to extend loans. If the asset price falls below the value of the loan, then both creditors and borrowers will lose money.

This is particularly troublesome if the economy slips into deflation, as happened globally in the 1930s and in Japan in the 1990s. Debt levels are fixed in nominal terms whereas asset prices can go up or down. So falling prices create a spiral in which assets are sold off to repay debts, triggering further price falls and further sales. Irving Fisher, an economist who worked in the first half of the 20th century, called this the debt deflation trap.

As I have been writing in several posts, I am still very concerned that current government policies are pushing us towards deflation, which will have very unhappy economic implications.


A special report on debt: Repent at leisure | The Economist

And it would seem that Paul Krugman also is thinking dour thoughts these days. From this morning's New York Times:

As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing...

...But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

http://www.nytimes.com/2010/06/28/opinion/28krugman.html?ref=opinion