And Speaking of Bubbles

Ένας από τους καλύτερους Traders στον κόσμο αναλύει τα περί φούσκας και Ελληνικής οικονομίας.
This week the turmoil that is Greece continues. One of my favorite quotes comes from Donald Morris, writing in June of 1993 (hat tip to Dennis Gartman):
“If all of the Greek islands were merged with the mainland, it would be about the size of Alabama; there are 10 million Greeks – and perhaps another 4 million living throughout the world, who still think of themselves as Greek. They are, thanks to their history, magnificent patriots and nationalists – and abominable citizens, who deeply mistrust every government they’ve ever had. Essentially they are fierce individualists, who mistrust not so much whatever government happens to be in power as the very idea of government. The have almost no sense of civic responsibility – Pericles complained about this at length – and History has never given them much of a chance to work out a stable system of government. Democracy, yes (the Greeks invented it!!), but stability, no.”
Have things changed? From here it does not seem so. Greece apparently hid about 40 billion euros of debt from the public and EU governing bodies. (If the government can hide that much, is it any wonder that individual Greeks themselves can hide their income and pay so little in actual taxes? They have made it an art form!) In response to just the initial phase of belt tightening, unions are launching strikes and protests. What will happen when it gets serious? Stratfor estimates that Greek deficits may actually run as high as 15% of GDP rather than “just” the 10% or so publicly revealed. That will require far more than a little belt tightening.
Let’s look at the record. Greece has been in default for 105 years out of the last 200. They have never had a balanced budget, at least not willingly.
The EU is backed into a corner. They have this treaty that says governments will act in certain ways. Greece is flaunting that treaty. Everyone acts as if Greece defaulting on its debt would be the end of the EU. Will the EU force Greece to withdraw if they do not control their budget? Upon reflection, I am not so sure.
Let’s take that proposition to the US. What if Illinois defaulted on its debt? Would we kick them out of the Union? Hardly. A default would mean a severe loss of credit, a forced retrenching, and a severe economic crisis in Illinois. The losses would be serious for banks and investors. There would be negotiations on how to deal with the debt, who gets a haircut on their bonds, what pension assets and expenses would be cut, and so on. A crisis? Yes. End of the world? No.
So what if Greece does default? The banks and those who lent them the money would take a loss of some amount. The cost of borrowing for Greece would rise dramatically, if they could even get into the debt market. If they actually cut their budgets enough to deal with the deficit in a responsible way, it would mean, at best, a severe and prolonged recession. If Stratfor is right about deficits reaching 15% of GDP, it could mean a depression. They have no good choices.
It is doubtful that German and French voters will be happy with any bailout using their tax money that does not impose serious cuts in Greek budgets, with realistic controls as a condition for the bailout. Can Greece live with that? We’ll see.
(I am sure I have hundreds of Greek readers. I would love to hear from you as to your views, from the inside.)
But is it so unthinkable that Greece could simply default and then be forced by the market to get realistic about its deficits? The same market forces that work in Illinois can work in Greece.
But if the EU does bail out Greece, what then of Ireland, which is making the tough choices? Will Portugal be next? If Greece is allowed to fail, or better, actually shows some fiscal discipline, that bodes well for the EU in the long run. It will be a lesson that each nation is responsible to maintain its own house.
The data presented by Reinhart and Rogoff show clearly that adding yet more suffocating debt to a bloated debt crisis is not the solution. It simply puts off the inevitable. Greece is an intractable problem. From here it looks like default or a very serious recession, with large unemployment numbers.
But in the meantime the Greek situation is adding volatility to risk markets of all types. I have written before of the connection between what is called the euro-yen cross and risk markets all over the world. Right now, you can borrow money very cheaply in dollars and yen (the so-called carry trade). When investors want to reduce risk, they pay back those loans, which has the result of increasing the value of the dollar and the yen.
That is what is happening with the euro-yen cross as of this morning. It is in the process of falling out of bed. And so are risk markets. Markets do not like uncertainty. And Greece and Portugal and Spain are uncertainty in spades. If Greece defaults, who owns the debt? Which banks? My bank? Will they call my loan? This happened in 2008 a lot! Can it happen again? We still have banks all over the world that are too big too fail. Credit default swaps are not on an exchange (because to do that would make them less profitable for the investment banks that sell them, and thus the lobbyists have convinced Congress to ignore them).
Are we at the place where we can think the unthinkable? That sovereign nations can in fact default? I think we see a de facto default by Japan this decade.
Do not assume that we have weathered the storm. We may just be getting ready for the next one. Πρωτοσελιδα – Ειδήσεις