The First Casualty as Debt Implodes Will Be …

A Raft of Coincidences

A glassblower’s shop. A used-furniture store. Luxury high-rise condos protected by double fences and electric wire. Neighborhood bars. Fancy restaurants. Sushi. Pizza. Bold glass office buildings.

The Itaim Bibi neighborhood of São Paulo seems to have been spared the zoners’ boring prescriptions. Offices, houses, shops all mingle promiscuously. A small house – modest, cheap, built in the 1950s – sits across from our hotel. It’s forgotten by time, surrounded by the commerce of the 21st century.

Another house on the Rua Floriano sits underneath an office complex. The owners refused to sell. So the developers built a huge, slick office tower right over it.

“It’s a great city,” says a colleague. “There are only a handful of cities like this in the world. London, Shanghai, Mumbai, Beijing. Paris is a small town in comparison.”

Little by little, we’re beginning to find our way around. But we’re not here for our own amusement. We’re not just drinking caipirinhas and ogling the Paulistas. No, that would be selfish. We’re here on your behalf, to learn. To study. To try to understand how this economy works.

It’s just a coincidence that it’s summer here. And that this weekend it’s Carnaval. And that we have a ticket to Rio in our pocket.

Photo credit: victorpalmer

Zero Impact?

Our subject lately has been debt. Paul Krugman says no one understands it. He proved his point in a recent New York Times column; at least he proved that he has no idea of how it works.

“We owe it to ourselves,” he wrote. That suggests that the net impact of debt is zero. But is it?

Meanwhile, colleague Simone Wapler in Paris tells us the “debt doesn’t matter” crowd is growing. France and Germany, among others, guaranteed Greece’s debt. If Greece doesn’t pay, it will fall – logically – to the taxpayers of those countries to shoulder the debris.

One calculation put the total cost per taxpayer in France at €731 ($827). But in the Old World, as in the New World, debt doesn’t matter anymore. Here’s Ivan Best at the Tribune:

“In France, as elsewhere, taxpayers never pay off a government debt. When it comes due, the government borrows more to pay it. Thus, in 2013, [the French Treasury] borrowed, medium and long term, €186.3 billion of which €106.7 billion were used to reimburse (amortize) the debts that were due, with the rest financing, principally, the budget deficit.”

So you see, government debts don’t matter, because they never pay them off. They just borrow more. But wait. Is it that simple? Some people owe. Some are owed. Does it matter who is owed what by whom?

You bet it does.

Meet one of the owners of Japanese government debt (whether directly or indirectly)

Photo credit: Corbis

Spent Money

It’s easier to pay off a little debt than to pay off a lot. So, the more you are owed, the less likely it is that you’ll get paid. Keep adding debt, and the likelihood of getting paid sinks to zero.

Then the creditors take a loss. You may say it doesn’t matter, because for every loss taken by the creditor the debtor benefits. But he’s already spent the money; it’s gone.

Alas, this is the same money the creditors were hoping to spend. They are people too – with bills to pay, retirements to finance and insurance, pension, lifestyle, health-care obligations. In short, people who are counting on the money.

When it turns out that the money isn’t there, it sends a shock wave of pain and suffering throughout the economy. Yesterday, Chris showed us where the shock wave was likely to strike hardest… and first – Japan.

Japan has more public debt than any other country relative to its GDP. On paper, it also has more assets! But take a look at those assets – Japanese government bonds – and you will see why the “we owe it to ourselves” idea is a scam.

The Japanese government has been on a borrowing binge for the last 34 years. Now, it owes more than 2.5 times its annual economic output. To whom does it owe the money?

Its citizens. Yes, if “we owe it to ourselves” makes any sense at all, it makes sense in Japan. But so what? This is not just double-entry bookkeeping; this is real life. And in real life it’s not only the quantity of debt that matters; it’s also the quality.

Government debt ratios compared, with projections, Bonner & Partners

Japanese retirees took their money and bought government bonds. They had “money.” Now they have IOUs from a bankrupt government. They think the government has their money. But they’re wrong. Their money is long gone.

Did the Japanese government take the money and invest it in new capital, so that now it earns dividends and capital gains… with which it can satisfy its obligations?

Of course not. It took the money and squandered it on (often unnecessary) infrastructure projects and other forms of “stimulus.”

And now, the poor Japanese retirees go to the cupboard. And what do they find?

It’s bare! All that money they thought they had saved is gone. The government has wasted it.

The savings rate is falling… the trade balance has turned negative… the yen has lost 14% against the dollar over the last 12 months… and millions of Japanese get older and older, depending on the government to make good on its promises to them.

It is just a matter of time before the truth comes out. The Japanese may owe their debt to themselves. But they’re about to find out that the debtor is a deadbeat and the creditor is a fool.

One of Japan’s infamous bridges to – literally – nowhere. It doesn’t continue beyond the part that can be seen in this photograph.

Photo via dailykos.com

Another bridge to nowhere near Kyoto

Photo credit: Pauline Guilbault-Corbeil

The above article is taken from the Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.