May 10, 2012 · 0 Comments
Source: Beat the Press
By Dean Baker:
The NYT had an article that reports on the high level of corporate debt and indebtedness in general in Spain. The article gives a measure of the total debt to GDP in Spain and then compares it to the ratios in other countries.
This is a confused way to assess the issue. Debt by itself will reveal nothing about the state of an economy. Debt is also an asset.
Suppose every household in the United States lent $300,000 to the household on its left. (We are going to make the United States a circle for purposes of this analysis.) With roughly 130 million households, the United States now has $39 trillion (@ 2.6 times GDP) more debt than it did previously.
However, as a country it is no poorer than it had been previously. In fact, every household is just as well off as it had been previously. It owes $300,000 more than it had previously, but it has $300,000 more in assets than it had previously.
Problems arise due to the distribution of the debt. If every third household borrowed $600,000, which was lent by the other two households, then this third household is getting deep in debt, with the other two are appearing to build up large amounts of assets.
This is what happened to Spain, the United States and other countries with serious housing bubbles. The other two households were willing to lend money to the third household because they thought it held an asset (a house) of great value. When this turned out not to be true, the third household found itself with an unsustainable debt burden and the other two households found themselves with assets of questionable value. If the third household can’t repay its debt, then the loans are no longer worth their face value.
Central banks should be paying attention to the buildup of such unsustainable debt burdens. Unfortunately, the European Central Bank (ECB) was focused on building up its Maginot Line, being vigilant in its fight against inflation.
The problem now is to try to correct the imbalances created by growth of the housing bubble. Spain and the rest of Europe is getting little help from ECB which is still focused on reinforcing the Maginot Line rather than promoting growth in the euro zone.