Thursday, June 03, 2010

If The Germans Can...

The Germans just cut their government spending in an attempt to decrease their budget deficit.

More than one person, reflecting on Greece, has asked me how a country can go into bankruptcy or why a country cannot just keep going the way it's going. Why all of the sudden decide that a country is in danger of economic collapse.

I think the easiest answer to this question is to look at an analogous scenario using any large corporation. If I go to a lending institution and ask for money to upgrade my property, plants, and equipment, an analysis of my ability to repay the borrowed funds is undertaken. If my balance sheets and other financial statements indicate high revenue with low costs, no other outstanding debt, and good management, then I will most likely receive the funds with a low interest rate.

If I continue going to financial institutions asking for more funds, without retiring my previous debts, I will likely have to pay an increasingly high interest rate. At some point, a lending company may decide that my company can not repay outstanding debt, let alone any new debt. At this point I will be unable to finance continued operations of my company and be unable to pay off existing debt because I was using new loans to pay off old ones.

My best bet to obtain new loans is to demonstrate that I have cut costs (goverment spending) and expect my future profits (economic growth) to improve dramatically, enough to where, in time, I will catch up on all the old debt and be able to pay off the new as well.

Germany is doing this now, before intrnational lenders are calling for their heads. It's too late for Greece, according to most headlines. But, perhaps Ireland, Italy, Portugal, California, New York, and Illinois can still learn a lesson from our German friends.

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