Given that some countries, especially those in Europe , are in serious trouble because they face extreme
financial difficulties, it would be useful to imagine simple examples that
would illustrate the problems in which these countries find themselves, and
suggest possible solutions. Luckily, there are enough similarities between the
finances of ordinary people, of companies and of nations that we can make
comparisons between them all and paint a clearer view of what happens in the
areas of finance where clarity does not always exist. The following is an
attempt to use the simple workings of personal and corporate finance to shed
light on the more complex problems into which the troubled nations have gotten
themselves.
Let us imagine the example of an individual who borrows by
credit cards more money than he can afford, invests none of it and spends it
all on living the extravagant life. After a while, he discovers that he is in
deep trouble because he does not earn enough money to live on, and still make
the minimum monthly payments which are demanded by the various credit
companies. Because he does not know what to do except that he is certain he
does not want to declare bankruptcy, he goes to see a financial counselor,
expecting to get the kind of advice that will work for him in an area where he
now realizes his knowledge has been minimal.
Looking at where the borrowed money was spent, the counselor
is dismayed at the fact that none of it can be recovered. It is that the client
has spent the bulk of it on trips at home and abroad, on wining and dining his
friends, on buying custom-made clothes that cannot be returned, and buying home
entertainment gadgets that lose seventy-five percent of their value the moment
they leave the store. In the face of these realities, the counselor asks the
client if someone in the family would be willing to pay off the credit
companies and trust him to reimburse them. No, says the client, no one in the
family is in a position to do this.
In this case, says the counselor, the client has no choice
but to follow a dual policy: one part of it will aim to reduce his expenses;
the other part will aim to increase his income. If he can manage to do all
that, he will live well and be left with a surplus that is large enough to make
the minimum monthly payments if not exceed them – which is something he should
strive to do whenever he can so as to pay off the loans as soon as possible.
And when the debts are paid to the various credit cards, he must adopt and
maintain a level of lifestyle he can afford, and avoid the temptation to engage
in extravagant behavior.
Let us now imagine the example of a company (call it A) that
gets into financial trouble when things go contrary to the business plans that
were designed to modernize and expand its operation. These were plans that
looked good on paper when they were first commissioned, and that delivered as
much as was expected of them for some time at the start. Being in the business
of advanced technology, the company fabricates custom-made motherboards and
sells them to the makers of such products as ATMs, scanners, electronically
controlled appliances, video games and so on. It has had a good history up to
now but then something unexpected happened, and the company ran out of luck.
What started it all was the fact that the team of developers
at the research department of the company came up with a method that reduced to
half the cost of making the printed circuit board. Certain that this
breakthrough will help the company beat the competition, the directors
authorized the borrowing of large sums of money to buy the new equipment and
new machines requested by the engineers and technicians who worked on
overhauling the operation. They also hired a new team of highly skilled
employees to run it while retraining the existing employees to work on the new
machines. This part of the project went well; the good times started to roll
for the company and they kept on rolling for a while.
Then, one day, a competing company (call it B) came up with
a breakthrough of its own that dwarfed the advances achieved earlier by company
A. Observers called it a giant leapfrog forward because it was an entirely new
way to make the old products -- producing them in a way that was completely new
and different. Instead of making printed circuit boards to be assembled into
complex motherboards, what the engineers of company B did was borrow ideas from
the technology used in the existing computer-on-a-chip technology, and modify
those ideas so as to custom build a chip that mimics the operation of a
complete printed circuit board.
This chip could now be mounted on a much smaller version of
the motherboard which the various clients order, each according to their needs.
The chip has all the advantages of the printed circuit board in the sense that
its design can easily be modified if and when the client so orders. In
addition, it is a low cost disposable module that makes life easier for the
maintenance people who troubleshoot the products inside of which it goes. And
when the chip itself goes bad, it is pulled out of its socket and replaced by
another chip. The net result is that the new method reduces to a fraction the
cost of the motherboards as well as the cost of maintaining them. Thus, the
company's price list for the products it makes and the maintenance services it
provides compare favorably with the price list of the competitors, including
that of company A.
The new leapfrog was so revolutionary that the clients
abandoned company A in droves and moved to company B long before A had had the
time to reduce its debt load enough to be able to continue as a going concern
with a fraction of the clients it used to have. It fell behind in paying its
debts; and at some point the creditors began to demand payment. As it often
happens in a capitalist system, the once high flying company was reduced to
filing for protection from its creditors. The judge of the bankruptcy court
granted the protection but asked the managers and directors of the company to
submit a plan showing how they envisage making the company viable again, and
how they propose to pay back the creditors.
Upon this, the company retained the services of an expert to
help it put together a plan that will comply with the requirements of the
bankruptcy court. The first thing that the expert did was to tell the managers
and directors he had bad news for them because he saw no hope to get the
company out of its predicament unless they found a way to get a large infusion
of cash into the company coffers. He said they will need to do this because
what they have left that is worth something is a legacy of goodwill on which
they still have a chance to rebuild the company. Even then, he cautioned, they
will need a great deal of luck before they can pull it off.
And this is where a director of the company asked the
obvious question: But why not embark on an austerity program by cutting to the
bone what is bleeding the company of its cash, and go from there? No, said the
expert because the cash is used to keep producing the motherboards and sell
them at a loss to stay in business. This is what maintains a small share of the
market and keeps the legacy of the company alive. As odd as it may sound, this
approach must continue till such time that a breakthrough is achieved. If you
take away what remains of the company's goodwill, the company will die a sudden
death. Thus, what must be done now is for the company to put its best inventors
to work on developing a new way to leapfrog ahead of the competition -- and
doing so while looking for a deep pocket that is willing to infuse cash into
the company.
What the expert has suggested they do is known as
reorganizing the company, an advice that the directors accepted but then
designed their own plan around it. This done, they submitted the plan to the
judge of the bankruptcy court who approved it. And so the company began to
implement the plan by giving the bondholders common shares in exchange for the
bonds they held. It also gave them and gave the existing holders of common
shares the option to buy new equity for immediate payment as well as an option
to buy more equity in the future at a fixed price should the value of the stock
on the exchange rise to a level that will make it worthwhile for them to exercise
the option. And the net result of the reorganization has been that the company
got back into business. It soon achieved the badly needed technological
breakthrough that helped it leapfrog past company B and past the other
competitors. The good times were back again.
Now, when we look at the finances of nations that get into
trouble, we see that they can do to some extent what the extravagant individual
has done to get out of his predicament, but we must be mindful that there
exists a difference between the two. Also, the nations in trouble can do to
some extent what company A has done but here too, we must be mindful that there
exists a difference between the two.
In fact, the difference between a nation and the individual
is that the latter can tell how much he may cut on expenses before suffering
adverse effects, thus reverse course if and when he must. By contrast a
nationally implemented austerity program -- however minimal it may be -- will
hurt the most vulnerable of the citizens right from the start. Moreover, it
will remain a program that is difficult to rollback even if it proves to be
wasteful and ineffective. To safeguard against this kind of trouble before it
materializes, the government can implement a parallel program to assist the most
needy of its citizens, and those most vulnerable to the effects of austerity.
This will catch the people who may fall through the cracks of the safety net,
and give the government time to rollback the wasteful program without
panicking.
As to the difference between a nation and a company; it is
that the latter can convert the debt into equity, thus turn the bondholders
(creditors) into shareholders (owners). In so doing, the company sells a
portion of its legacy to the buyers that come along and join the bidding
process. But this is something that a country cannot do because the legacy of a
country is a national heritage, something that no one will sell or even
consider selling to a private local interest or a foreign interest of any sort.
So then, what can a nation that is financially troubled do
when it needs a cash infusion to shore up its finances? To answer this
question, we need to understand something about economics. It is this: When the
treasury of a country issues bonds, it invites its own citizens as well as
foreigners to lend it money, promising to pay it back in full and on time. If
it fails to do so, it acquires a bad reputation and will find it difficult to
borrow again in the future. In fact, a country may already have a low credit
rating, which means it is not viewed favorably by potential buyers of bond. In
this case, the treasury can opt to sell the bonds to its own central bank, an
operation that is called “printing money.”
When this is done, it has the effect of reducing the value
of the money in the wallets and the bank accounts of all the citizens, a step
that the government takes to replenish its coffers and do the things it needs
to do. Therefore, the act of printing money can be thought of as a tax that is
levied on everyone; an act that transfers wealth from the citizens to the
treasury. It must also be said that the foreigners who hold money or securities
in that currency lose as well. Thus, a question must be asked: Can this
operation be justified economically and morally?
And the answer is yes, it can be justified because a
government that is in trouble represents a nation that is in trouble. When you
take from the citizen to give to the government, you place the citizen in the
role of the parent who bails the extravagant son knowing that the latter
learned his lesson and will behave better from now on by curtailing his
extravagant lifestyle.
But the government must not always be in trouble to want to
print money. It could still have the ability to collect enough in taxes or borrow
what it needs through normal channels to function effectively; and yet resort
to that method to get its hand on new money. The reason for doing so would be
that the country is suffering from a rate of unemployment that remains
stubbornly high. In a case like this, and if the right circumstances are
present, an infusion of printed money into the economy to stimulate it may
prove to be a sound move.
If and when this is done, the effect will be that of the
government borrowing from the public to give back to the public telling it to
get busy again producing more goods and more services, and consuming them to
create more jobs and thus help the unemployed get back to work.
Consequently, a good program that will help the finances of
a nation where the government is in trouble or the country suffers from a high
rate of unemployment, should contain some or all of the following elements:
First, implement a program of austerity that cuts back on
the non-essential and wasteful expenses while encouraging an increase in
economic activity by offering the sort of incentives that motivate people to
produce more of what is essential and consume more of it.
Second, print money and use some of it on the infrastructure
of the nation. Also use some of it to subsidize the employers that hire people
who may not be sufficiently skilled -- and train them on the job when
necessary.
Third, implement a modest program to help the most
vulnerable in society such as the unemployable and the temporarily unemployed.
Fourth, when the economy begins to grow again, and the
treasury collects more in taxes, it should turn the extra money to the central
bank, and avoid the temptation to allocate it somewhere else. This combination
of moves will restore value to the currency and avoid sparking future
inflation.
It will also please the citizens who will see value return
to their accounts, and please the foreigners who hold cash and securities in
that currency.