The Myth of Insolvency

If one looks at how some countries get insolvent, thereby the IMF riding in to the rescue, that seems to be straightforward: they spent more money than they had, so the credit market shut them out.

As the case of Japan (or perhaps China, too) shows, as long as there are sufficient private savings and a surplus from international trade and capital flows, insolvency may not be an imminent issue.

Japan’s massive debt load has been a drag. And yet, they have been able to export into a global credit expansion period. As long as their exports hold up, their pretend and extend may continue, while they may have to live with the repercussions in the long term.

However, the world economy is sluggish and running on cheap credit is dangerous since sooner or later bubbles would pop. Japanese policy makers didn’t do enough to retool the economy and continue to “extend and pretend.” Who is suffering more from these policies?

The Korean economy crashed during the 1997 financial crisis. Most Korean banks went bankrupt technically during the 1997 financial crisis. Are Korean banks now solvent enough to weather the worldwide credit bubble?

This may be why we need moral leadership to make the hard choices.

Otherwise, the consequences of “extend and pretend” may be harsh.