Sunday, July 22, 2012

Greece put through a "Great Depression" needlessly

The Telegraph reports that according to Greek Prime Minister Antonis Samaras Greece is in a "Great Depression".

Regular readers know that to the extent this Great Depression is the result of too much debt, it was completely avoidable.  Specifically, the modern banking system is designed to absorb the losses on the excesses in the financial system and protect the real economy.

By design, banks have deposit guarantees and access to central bank funding.  As a result, they are able to operate and support the real economy even if the banks have negative book capital levels.

The reason banks can continue to operate is that taxpayers are their silent equity partners.  They effectively are putting up the equity through the deposit guarantee while the bank has negative book capital levels.

To the extent that banks are not recognizing the losses on and off their balance sheets, they are effectively putting a burden on the real economy to carry the excess debt.  A burden that redirects funds from being reinvested into growing the real economy to being used to pay off the excess debt.

Starved of funds for growth, the real economy shrinks and the result is a Great Depression.

As I said, this Great Depression is avoidable if policymakers allow the banks to do what they are designed to do and absorb the losses on the excesses in the financial system.  With the real economy protected, funds are instead reinvested in growth and the Great Depression is ended.

Your humble blogger predicted that continuing to pursue the Japanese model under which bank capital is protect and the losses on the excesses in the financial system are placed on the real economy would lead to significant economic problems.

Greece is further along the road to these problems having entered into a Great Depression than Spain, but Spain is also traveling down this road.

There is a way to stop going down this road and it doesn't cost taxpayers anything.  That way is to adopt the Swedish model and require the banks to perform their function of absorbing the losses on the excesses in the financial system.

I know I have said this before, but I prefer that banks absorb the losses and banker cash bonuses are cut to zero well before the real economy and society suffers a Great Depression.

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