Lisa Simpson
Apr 30,2010
In: Finance

The Crisis of the Sovereign Debt

The crisis of the national or sovereign debt is staggering in America.

The crisis of the national or sovereign debt is staggering in America. Looking askance at the crisis of this debt in Greece there is a strong opinion gaining ground among the conservatives to reduce its size in both developed and developing countries of the world. The latest to sign to this appeal is Dominique Strauss-Kahn of head of IMF.

Speaking in a conference at the Institute for New Economic Thinking he said that the public debt in the developed economies is predicted to go up by nearly 35% (average) to 110% (GDP) by 2014. He said, “Reversing this increase will be a tremendous challenge let alone reducing debt to below pre-crisis levels, which may be needed to leave enough fiscal space to tackle future crises.”

This view has three segments. Firstly it is assumed that the core of the crisis is deficit in the budgets of the households and the corporate sectors. This has caused public debt to rise to unmanageable levels. Secondly this is threatening default in sovereign debts weakening the capability of the governments to tackle new problems that may arise in the private sector requiring correction. Thirdly the fear of this national debt has reduced availability of credit and increased borrowing costs for many governments.
To take the example of Greece it was having difficulty getting sufficient number of subscribers for issues on debt. The interests on which these debts are taken have risen sharply. This means it is getting more and more difficult to take new loans to repay old loans and keep the ball running by postponing redemption dates.

During the time of crisis the extra borrowing done by the government was not targeted at funding a monetary stimulus. The build up was to borrow good money only to throw it away. Government resorted to borrowing to purchase assets that were worthless, from banks and other financial entities. At that moment this step was thought to be essential to clear the balance sheets and allow the entities to remain solvent. Alternatively loans were made against securities of these assets at very low interest rates.
In brief it was actually exchanging papers issued by the government for poisoned assets in the private sector portfolio and then shifting those very same assets into the government balance sheet. It would be ridiculous to think that these assets would produce revenues!