Strange and amazing things happen when sovereign debt levels get out of hand. In Europe, the strikes, massive street protests, and riots build energy by the day. The US is not quite at that stage of affairs yet, but large deficits and debt still loom large, so large, in fact, that some pundits have the gall to claim that next year’s US deficit, now officially estimated at just $996 Billion, is what counts nowadays as “fiscal restraint” (I’m not making this up!).
I try to engage my students by saying, “hey, learn about monetary and fiscal theory, so you can understand why the riots are happening!” But it doesn’t even have to be that difficult; understanding the riots simply boils down to a lesson of spending too much of other people’s money, and not knowing when to say when. It’s really just a lesson in applied common sense.
Any person, family, or government that borrows heavily—whether to live extravagantly, gamble, or fight wars—will eventually come to a fork in the road. One path involves simply continuing on with high debt, oblivious to the fact that, one day out of the blue, the creditors will get antsy, cut off the flow of funds, and demand repayment. Since this is impossible, they will come for the home, the cars, even the furniture, repossessing anything of value to satisfy the debt. Down this road of default or bankruptcy, the debtor is at the mercy and whim of the creditors and the judge; and if he thinks they’ll let him get away with anything close to the nice debt-financed lifestyle he was used to living, he’s got another thing coming.
The other path involves a sharp U-turn, whereby the debtor realizes it is over-indebted and takes immediate action to halt the borrowing and pay down the debt as quickly as possible, lest the above scenario unfold. This is austerity. Austerity will, of course, involve some painful choices; some really fun things will have to be done away with, and others scaled back. The family might not get to eat out for a few years, and might have to swap expensive new car payments for a jalopy. Likewise the spendthrift government will need to scale back lavish entitlement programs, cut subsidies and bailouts to crony capitalists, abandon foreign military (mis)adventures, and perhaps even sell off assets.
Bankruptcy and austerity have a lot in common. Neither is pleasant—they both require painful and embarrassing cuts in spending, asset sales, etc. They’re both, in a sense, an admission of previous excesses—a form of “giving the devil his due.” But there’s one important difference: with austerity, the indebted entity gets to choose its own path back to solvency, whereas with bankruptcy and default, these choices are foisted upon it, like them or not. Thus an over-indebted country that wants to control its own destiny would be wise to go ahead and choose its own austerity program, make the most reasonable, acceptable cuts now and get the pain over with. For, surely, if it doesn’t clean up its act on its own, the creditors will force the issue. There’ll probably be riots either way.