Toward a New Magna Carta (Part I)

By Dr. Alexander Mirtchev and Dr. Norman A. Bailey | Thursday, March 31, 2011

The global debt burden appears to have gathered an unstoppable momentum, prompting
divergent reactions. In the second installment in their series The Search for a New Global
Equilibrium, Dr. Alexander Mirtchev and Dr. Norman Bailey explain why the solutions
currently being offered are wholly inadequate to the scale of the problem.
Debt, n.: An ingenious substitute for the chain and whip of the slavedriver. Ambrose
Bierce, The Devil's Dictionary
In the year 1204, the doughty knights of the Fourth Crusade entered Constantinople by
stealth and thoroughly looted what was then the wealthiest city in the world. Their plunder
allowed them to pay their debts to the Venetians, who had financed the endeavor, as well
as to line their own pockets. The knights took huge quantities of gold, silver and precious
stones with them when they returned to Western Europe.

Adding liquidity
to a solvency
crisis is the
equivalent of
giving morphine
to a person with
cancer. He feels
better until he
dies.

For the first time since the collapse of the western half of the Roman
Empire in the fifth century, considerable bullion began to circulate in
the barbarian west. This newfound wealth led to the development
of merchant banking, starting in Italy and continuing over the
centuries with important developments in modern state finance that
persevere to this day, including sovereign defaults.
In the same period, facing increasingly acute financial problems, King
John of Englands efforts to dig out his government from a massive
hole of debt (in modern terms, approaching sovereign default) by
imposing onerous fiscal demands on his vassals, contributed to a
rebellion that led to the signing of the Magna Carta in 1215.

Among other innovations, its provisions transformed the social contract that underpinned
British society and provided important precursors to the emergence of the Western world as
we know it.
Eight centuries later, governments worldwide are sinking in an ocean of debt extensive,
and in some cases untenable, liabilities and strained balance sheets. The countries that are
most visibly plagued by a combination of excessive indebtedness and low-growth prospects
appear to be the developed democracies of the West and Japan.
U.S. debt held by the public today stands at over $9.6 trillion (not including debt held by
foreign central banks), and total debt is approaching 90% of GDP. In much of Europe, the
circumstances are even worse Greek long-term bonds are trading at a nearly 10%
premium over the benchmark German bunds, with Portugal not far behind.

Even Spain, where public debt is considered relatively sustainable, is

saddled with a banking system that, according to the credit agency
Moodys, would require more than 40 billion to restructure its
liabilities. In Japan, meanwhile, debt amounts to almost twice GDP
and is likely to get much worse as a result of the recent earthquake,
tsunami and nuclear crisis.
Similar debt issues are haunting a number of emerging markets,
from Argentina, perpetrator in 2002 of the largest sovereign default
in history, to Dubai.
The perils of this debt maelstrom are framed by structural distortions
and systemic imbalances from protecting the too big to fail
institutions to pension and investment commitments. These
problems are exacerbated by the lack of structural solutions not
just the structure of the debt itself, but also the divergence of fiscal
strategies in a global financial system that has evolved beyond the
means of states to manage it.

U.S. private
banks and
corporations are
using their
excess liquidity
to re-leverage at
a feverish pace,
thereby assuring
that future
financial crises
will be worse
than the present
one.

Overwhelmingly, the debt burden of a number of stakeholders is predicated on the

existence of large-scale and long-term commitments that are at the core of the overall
social contract prevalent in the Western world and beyond.
In U.S. parlance, the most prominent parties to this aspect of the social contract are the
government, Main Street and Wall Street (as a symbol of the global financial sector). The
commitments embodied in these social contracts in American terms, consider Social
Security, Medicare and Medicaid reflect economic and financial arrangements that are
increasingly becoming unsustainable.
To paraphrase famed economist James Buchanan: Once a democracy starts down the path
of deficit financing, it will continue on that path until the path is no longer viable, as it is
always easier for politicians and governments to satisfy constituencies today at the expense
of tomorrow.

The global
financial system
has evolved
beyond the
means of states
to manage it.

It should be noted that the reasons for various iterations of this bleak
picture in other parts of the world are diverse. For the rapidly
developing economies in Asia and Latin America, for example, the
social contract is different and less comprehensive than in the West
and therefore requires less from the government to sustain it.

Nonetheless, even though personal and sovereign debt levels are

relatively low in Asia, it remains an ongoing policy consideration. And
for a number of emerging and less-developed economies in Africa,
Asia and the Caribbean, the underlying reasons include insufficient resources, inefficient use
of financing and government mismanagement.
As a result, the global debt burden appears to have gathered an unstoppable momentum,
prompting divergent reactions. Some respond with grand plans and declarations, as well as
immediate measures that, at the end of the day, amount to punting sure, the painful

steps should be taken, but perhaps not yet. Others argue that the longer the remedies are
delayed, the more painful the solution will feel.
On the practical side, debt problems are currently being addressed in the main by focusing
on important but not decisive matters and often tackling the symptoms (liquidity, primarily)
rather than addressing the underlying cause (lack of solvency).
Pumping liquidity in the ocean of debt in this manner, instead of reducing the level of the
waters by improving solvency, is actually exacerbating the seriousness of debt problems.
Even more importantly, despite the immediate political imperatives driving much current
decision making, the weakening of solvency reflects the true nature of the global financial
crisis and the impending global debt disaster.
Indeed, as the rating agencies downgrade one country after another (most recently Spain),
the cost of borrowing increases exponentially and adds to the future burden. Adding
liquidity to a solvency crisis only makes matters worse, the equivalent of giving morphine to
a person with cancer. He feels better until he dies.
In addition, neither does quantitative easing help to lower the debt
waters indeed, it has made matters worse. Instead of
quantitative lowering of these waters, at least in the United States,
private banks and corporations are using their excess liquidity to releverage at a feverish pace, thereby assuring that future financial
crises will be worse than the present one.
The respected Boston University economist Lawrence Kotlikoff
calculates that, in terms of present value of likely and foreseeable
future debt, the true measure of the debt tsunami is around $200
trillion.

It is always
easier for
politicians and
governments to
satisfy
constituencies
today at the
expense of
tomorrow.

Other approaches that have emerged range from fiscal integration of

regions which for cases such as the European Union are constrained by the monetary
straitjacket of the eurozone to negotiated debt forgiveness.
These approaches could bring relief, but more likely and tragically, the resolution of the
debt issues will come through defaults and/or rampant inflation.