In Back to Mesopotamia? a now prescient report by the Boston Consulting Group (BCG) published in September 2011 it was argued that, while inflation is the unstated and preferred “solution” to the present debt crisis in the western societies, for a variety of reasons, among them the deleveraging pressure, low demand for credit and potential social upheaval, the inflation “solution” might not work or not be enough to solve the debt overhang in most western countries. Other “solutions” would have to be found. The report of the BCC explores what other options would western governments likely undertake to address the crisis, arguing and concluding that “it is likely that wiping out the debt overhang will be at the heart of any solution”.
This weekend we have found out that Cyprus is on the route to Mesopotamia.
Some excerpts from the BCG report:
“In ancient Mesopotamia, debt was commonplace; individual debts were recorded on clay tablets. Periodically, upon the ascendancy of a new monarch, debts would be forgiven: in other words, the slate would be wiped clean. The challenge facing today’s politicians is how clean to wipe the slates. In considering some of the potential measures likely to be required, the reader may be struck by the essential problem facing politicians: there may be only painful ways out of the crisis.”
“If the overall debt load continues to grow faster than the economy of the euro zone, at some point the politicians might conclude that debt restructuring is inevitable. For this to be effective, they would need to restructure all debt, probably at around a maximum combined level of 180 percent per country. This number is based on the assumption that governments, non Financial corporations, and private house-holds can each sustain a debt load of 60 percent of GDP, at an interest rate of 5 percent and a nominal economic growth rate of 3 percent per year. Given this assumption, the total debt overhang within the euro zone amounts to €6.1trillion.”
“The probability of economies growing out of their debt problem is therefore limited, and the authors conclude that “the debt problems facing advanced economies are even worse than we thought””
“These write-offs would have to lead to a real reduction of the debt burden of the
debtor, and not just to an adjustment on the creditor’s balance sheet. If governments chose this course of action, only true debt relief (and thus an end to the painful deleveraging process) could lay the foundation for a return to economic growth. To follow this path, they would need to convince themselves that the overall benefit of an economic restart outweighed the risk of moral hazard in some areas.”
“Writing off more than €6 trillion would have significant implications for lenders. Just look at the numbers. Assuming a proportional distribution between banks and insurers, banks in the euro zone would have to write off 10 percent of total assets (€3 trillion out of €36.9 trillion in total assets).”
“If politicians pursued this course, the losses would almost certainly exceed the equity of the banking sector— making it insolvent at an aggregate level.”
“Restructuring the debt overhang in the euro zone would require financing and would be a daunting task. In order to finance controlled restructuring, politicians could well conclude that it was necessary to tax the existing wealth of the private sector. Many politicians would see taxing financial assets as the fairest way of resolving the problem.”
“For most countries, a haircut of 11 to 30 percent would be sufficient to cover the costs of an orderly debt restructuring. Only in Greece, Spain, and Portugal would the burden for the private sector be significantly higher; In Ireland it would be too high because the financial assets of the Irish people are smaller than the required adjustment of debt levels. This underscores the dimension of the Irish real estate and debt bubble.”