The Joe Blow Report 2

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Who Really Rules the Word (World)

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What got Greek in trouble is already a plague on America.

Where we are all heading and why.

Is it too late to fix?

Lost opportunity:

“Instead of forcing the banks to join in the inevitable pain that Greek citizens are going to bear, the government has instead protected the banks from their own lending folly. As this crisis spreads to other countries, at some point one of these governments will seek the Icelandic solution, or the EU and the IMF will run out of lending capacity, and a sovereign default will occur. We will be right back to where we were in 2008 during the height of the credit crisis: no one will be lending to anyone else. Once again, as occurred in the 1930s, you will hear people lament “no one has any money”, because truly no one will. The average investor’s stock and bond holdings will be decimated, individuals will be selling hard assets to survive, and credit will be impossible to find (it is already in the US).”

Opa! Greek Government Announces Yet Another Bailout, But Who is Really Getting Bailed Out?

Just how many times is Greece going to announce yet another financial bailout? Even the markets are getting jaded by this never-ending game of brinksmanship. What would otherwise be greeted as good news is this time treated with skepticism, and rightly so. If you remember when this financial crisis first erupted months ago, Greece needed about $25 billion to stave off bankruptcy. It was also felt that the EU members would foot this bill alone, since Greece would never endure the shame of asking the IMF to participate in the bailout.

This week’s deal is announced as a three year loan program for €110 billion, or $174 billion, with the IMF joining in the loan to Greece. My how the debt has grown, and no one is saying whether this number well and truly incorporates the hidden debt that Greece took on with the connivance of Goldman Sachs in order to avoid EU restrictions. Whatever it is in the way of belt-tightening that is going to be demanded by the IMF, it probably shrivels in comparison to what Greece’s European partners are requiring.

Greek Prime Minister Papandreou is promising European governments that Greece will be entering into a long term recession, which most economists would label as a depression. Public sector wages and pensions will be cut, early retirement which can start at age 52 will be eliminated, the fixed retirement age will be raised to 63, the top tax rate will be increased to 40%, all sorts of excise taxes on substances like tobacco and liquor will be raised, and a clamp-down on tax cheating is being promised. These are deflationary measures which ensure the next three or four years will be dismal indeed for the average Greek.

When deflation is imposed on an economy, debt becomes more onerous because cash is in short supply and any other assets used to pay down the debt are depreciating. This is certainly going to be the situation in Greece as people start selling off their extra televisions, art, even gold coins – just to survive. Many economists doubt this solution will forestall bankruptcy, which is what the Papandreou government has been desperate to avoid.

Just why Papandreou would push so hard for an austerity solution is not clear. Once depression and deflation begin ravaging Greece, the Papandreou government is almost certainly doomed. Perhaps he doesn’t want his legacy to be the prime minister who brought Greece to bankruptcy. He has said many times that Greece doesn’t have any choice but to beg for loans and accept whatever harsh conditions are imposed. But is this true?

To be sure, Greece is unable any longer to borrow on the public markets. Its $300 billion of debt is rated as junk, and whereas EU member countries can borrow at an average rate of 3.5%, the bond markets are now trading Greek debt at an implicit borrowing rate of 20%. New debt is therefore out of the question, and anyway that has been part of the problem. For some time now, Greece has been making its interest payments on its debt by borrowing ever more debt – this is the Ponzi finance trap written about by the late economist Herman Minsky, who said borrowers in this situation are fast on their way to bankruptcy.

Bankruptcy is certainly not in the interest of the EU, and Papandreou knows this and has been negotiating with the EU member countries in the confidence that ultimately they must lend him the money. If they don’t, the risk of contagion grows sharply, and this would affect countries with much worse debt problems than Greece, like Portugal, Spain, Ireland and the United Kingdom. Already last week the S&P rating agency lowered the ratings on bonds of Spain and Portugal, which sent bond and stock markets into a fierce tumble on fears that contagion from Greece is already here.

The other element working in favor of Papandreou is that a Greek bankruptcy would almost certainly plunge the euro into a chaotic fall, and EU officials want to avoid this at all cost. In retrospect, Greece should never have been admitted to the euro in the first place, especially now that everyone knows they were deceiving the EU on their true amount of debt outstanding. But it is too late now, so every effort is being made to avoid the taint of bankruptcy on Europe’s currency.

Being in the euro means that Greece lacks one of the best tools for dealing with a debt crisis: a foreign exchange devaluation. Greece is stuck in a currency that prevents it from improving its export competitiveness, which may be essential if the country is going to ever reduce its deficits. This is another reason why many observers think Greece cannot really get its deficit spending down within EU standards – an inability to devalue the currency, combined with severe domestic deflation, almost dooms the country to declaring bankruptcy anyway.

So who is this bailout benefiting, and who would be hurt by bankruptcy? The answer is the big banks, and secondarily investors holding Greek bonds. Much of the debt is sitting with Europe’s largest banks, which underwrote the debt when it was first issued and which keep an inventory of it in support of the market. These banks all benefited handsomely over the years earning fees on this debt program (as did Goldman and JP Morgan Chase and Citigroup), so why isn’t anybody asking them to join in the pain?

It is certainly remarkable how afraid the governments are of these banks, and the “market” they say they represent. Papandreou is convinced if Greece defaults it will be an economic catastrophe, and that Greece will be frozen out of the debt market for years and years. This certainly wasn’t the case with Argentina when it defaulted in the last decade, nor Russia after its default. Bond holders and banks were forced to accept a certain amount of loss and were ultimately given new bonds as part of a settlement that reopened the bond markets to these countries. Besides, we’ve certainly learned that Wall Street is happy to sell any amount of “shitty” bonds to credulous investors.

It is also really difficult to fathom what sort of economic catastrophe is going to befall Greece that is worse than the depression and deflation they are now being promised by their government. You have to wonder, no matter how negative a view you have of the Greek unions, why it is that only the Greeks are being asked to suffer in this crisis, and the banks are once again being catered to with a bailout.

Perhaps the EU governments understand better than the public the parlous condition of the banks. In the 2008 crisis when banks stopped lending to each other altogether, the only source of finance in the global economy was government money, so the governments became the market and in a sense melded their purpose with that of the banks. Eventually interbank lending returned, though huge swatches of the lending market did not, like securitization. It is not unreasonable to assume a default of Greece would cripple the big banks, while any further sovereign defaults would doom many of them completely.

Mr. Papandreou said today “Our primary duty is to save the economy and reduce debt,” but he is doing neither. Greece’s economy is going to suffer calamitously no matter what Papandreou does, and as for the country’s debt, he’s just increased it from $300 billion to $474 billion. No wonder the unions continue to protest in Athens; the average person can see right through this ridiculousness.

First Iceland, and now Greece, has succumbed in this East-West struggle over globalization, in which rich, developed countries watch their living standards collapse while manufacturing and jobs shift to China and India. Iceland, however, refused to bail out the banks that ruined its economy peddling debt as a replacement for declining real wages, but Greece feels it must appease the banks. The Greek government does not appreciate that taking on more debt to solve a debt crisis is a fools’ errand. The only real answer is much lower living standards and ultimately a restructuring of the debt through default.

If you live in Australia or Canada or the US or any other large industrialized country, you are a member of the IMF and you are participating in this bailout, so this “solution” to the Greek financial situation is of personal interest to you. You can expect there will be lull in market anxiety over the sovereign debt crisis in Europe, but it will be brief. So many other countries are in much worse shape than Greece and pose terminally fatal damage to the banks should they default.

These are countries that are already borrowing to make interest payments on their debt, and among them is the United States, which hasn’t the taxing resources to pay the $400 billion annual interest it owes the world. It too must borrow to pay interest and keep its economy afloat. In fact, almost all of the V-shaped recovery experienced by the US is funded by the federal government, which has replaced around 10% of GDP lost permanently in the recession. This amounts to $1.9 trillion that the government is borrowing, certainly dwarfing the problems Greece is presenting.

The time will come when the global bond market, which means ironically the banks as well, will start worrying about the US debt, but there is no one big enough to bail out the US. The IMF is going through a big chunk of its reserves just by helping Greece. The only solution will be a debt restructuring, which will include the forced closure and restructuring of many of the big banks that haven’t the capital to absorb all these sovereign defaults that are in store (not to mention all the defaults of the large European banks caught in the financial crisis on the continent).

Unlike Greece, the US can devalue its currency, and will almost certainly seek this solution. Some economists fear that hyperinflation may be used as a way to devalue the debt as well, but the forces of deflation are just too strong for this to occur. Debt will have to be restructured as a the result of default, and this means defaults on government as well as private sector debts. This is not only the one solution available, it is appearing more and more inevitable. The contagion from Greece is already here and is due to infect many countries in Europe first, and eventually the US.

Mr. Papandreou and the Greek government have lost an opportunity to really deal with its debt problem. Instead of forcing the banks to join in the inevitable pain that Greek citizens are going to bear, the government has instead protected the banks from their own lending folly. As this crisis spreads to other countries, at some point one of these governments will seek the Icelandic solution, or the EU and the IMF will run out of lending capacity, and a sovereign default will occur. We will be right back to where we were in 2008 during the height of the credit crisis: no one will be lending to anyone else. Once again, as occurred in the 1930s, you will hear people lament “no one has any money”, because truly no one will. The average investor’s stock and bond holdings will be decimated, individuals will be selling hard assets to survive, and credit will be impossible to find (it is already in the US).

Governments will at first talk about the Great Recession, but most everyone else will know what it really is. Those in denial will be able to get the truth from the Greeks, because they are about to experience the depression and deflation that is the result of decades of reckless debt buildup. [picture]

–Joe

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Written by Joe Blow

May 3, 2010 at 10:51 pm

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