This Time is Different
Debt-fueled booms often provide short-term affirmation of a government’s policies.
Unexpected increases in inflation are the de facto equivalent of outright default. Lenders pay back nominal values in less valuable currency units rather than paying back the real value borrowed.
Countries, institutions, and financial instruments may change over time, but human nature does not.
Commercial banks tend to borrow at short-term rates to issue long-term loans, which can set them up for long-term success but leave them with illiquid assets to withstand a bank run or unexpected liquidity crunch.
Most debt crises or sovereign defaults live and die with the confidence of creditors.
When the level of external debt in emerging markets is 35-40% above GNP, the risk of a credit event increases significantly.
Countries with a history of debt crises or restructurings tend to have more intolerance for debt (even when it isn’t at concerning levels).
While growth and austerity can solve the issues of excessive debt, such issues are invariably solved by default or restructuring, not actual debt reduction.
When a government defaults, it’s usually a strategic decision based on the assumption a full repayment is not worth the sacrifice.
There is a distinct difference between illiquid and insolvent. The former means you have the assets necessary to meet your liabilities but not in liquid assets to meet them right now. The latter, however, means you simply lack the assets to meet your liabilities.
The prevailing opinion that this time is different is precisely why it isn’t.
Based on the historical data around sovereign defaults, growth is almost never the reason a country escapes its debt burden. Rather, it is invariably through net debt repayments.
If a country abuses its currency monopoly by promiscuously printing currency, it will eventually drive the demand for its currency down so much that it actually takes in less real revenue from currency creation than it would at a lower level of inflation.
Domestic debt usually builds up in the aftermath of a sovereign default in part because the country is (ostensibly) cut off from foreign creditors/capital markets.
Governments’ reserve requirements for commercial banks are a way to finance their debts at lower interest rates.
Absent effective regulation, deposit insurance can encourage banks to take more risk.
In the three years following a financial crisis, countries experience, on average, an 86% increase in central bank debt.
Sustained capital inflows and large run-ups in housing prices have been particularly strong markers for financial crises.
The biggest driver in debt increases is the inevitable decline in tax revenues during economic contractions.
When a crisis is truly global, exports no longer offer a cushion for growth.
Financial liberalization simultaneously facilitates bank access to external (foreign) credit and more risky lending practices domestically.
There is nothing new but what is forgotten.