Flying PIIGS
by Gary North
Recently by Gary North: Busted Europe, Busted Dream
The Greek government is going to default on its interest payments to the bonehead European bankers and investors who thought that getting high interest rates on Greek debt was a great way to avoid suffering the low-interest rates on German government bonds. After all, Greece would pay interest in euros. No problem!
Then the incoming socialist government discovered that the outgoing government had cooked the books. As soon as the naive Greek socialists announced this, the crisis in the Eurozone began. That was in April 2010.
It keeps getting worse.
This is the central fact. It keeps getting worse. The experts keep holding meetings. They keep announcing plans to solve the problem. Nothing works. Interest rates on one-year Greek government bonds are over 100% per annum. That screams "inevitable default."
It is not that the Greek government will not repay the debt. No government will ever repay its debt. Apart from Austrian School analysts, there is no school of economic opinion that argues that national governments should ever pay off their loans. The debts are assumed to be permanent. And so they are.
What bothers bankers is when governments cannot make their interest payments. Then governments have their central banks inflate. So, to protect themselves, lenders insist that the interest payments are made in a foreign currency: either dollars or euros.
This was the situation with Greece. Greece is in the European Monetary Union. This means that it settles its debts – makes interest payments – in euros. But it has become clear to investors that Greece will not do this. It will instead default. The only question is when.
The salaried bureaucrats hold meetings. They announce tentative solutions. European stock markets rise. Then the interest rates on Greek debt rise. European stock markets fall. The salaried bureaucrats hold another meeting. Then someone who was in attendance tells a reporter that this or that scheme is "under consideration," and that something definitive is due in four or five weeks. Maybe six. This sends the stock markets up for a day. Then they fall.
This has gone on for a year and a half. Every plan faces these problems.
1. The Greek government is a bottomless pit.
2. Big banks in Europe are undercapitalized.
3. Big banks are loaded with Greek debt.
4. Big banks are loaded with other PIIGS debts.
5. The European Central Bank will bail out banks.
6. Other PIIGS will face default.
7. The size of the PIIGS debts is enormous.
8. German voters oppose more bailouts.
9. German politicians ignore German voters.
10. German voters will replace them.
11. A recession is looming.
12. Recessions increase government deficits.
13. More PIIGS will get into fiscal trouble.
14. More PIIGS will threaten default.
15. And the beat goes on.
16. And the beat goes on.
THE FUNDAMENTAL PROBLEM
The fundamental problem is this: bureaucrats designed the present system and then sold it to Europe's politicians two decades ago. The politicians worked in the 1990s to cobble together a new monetary system, which voters generally opposed. They could not get enough votes to put all of the national legislatures into one taxing and spending system. The voters would not have allowed it. So, they created a jerry-rigged system: a unified central bank but national legislatures that could run deficits.
There were rules against running deficits above 3% of Gross Domestic Product. There is no way to enforce such rules.
The result is what we now see, and which was predicted by critics in the mid-1990s. The present-oriented nations in the south of Europe, plus Ireland, ran up huge debts, while the bankers in the north bought the IOUs. Bankers pretended that the temporal perspective of the North – future-oriented – also governed the time perspective of the South: "Let's party! It's sunshine forever around here."
They have known for approximately 500 years that, with the brief exceptions of a handful of northern Italian city-states in the 14th through 16th centuries, the southern outlook was fundamentally different from the north. It was analogous to the time perspectives dividing Canada and the United States from the nations south of the Rio Grande. The operational phrase in the South was "stiff the gringos!" Gringo investors have never caught on.
The best solution is for governments to let the dummies take their losses. But big banks are the main lenders, so the central bank moves to bail them out. The unofficial #1 task of all central banks is to protect the largest domestic banks from the inevitable consequences of their high-risk folly: seeking high returns irrespective of risk.
The central bankers then warn the politicians of the looming bankruptcy of the big banks. There will be a disaster, they tell politicians. So, politicians consent to the bailout.
The voters have no say. They elect new politicians, but the central bankers remain the same, and the big commercial banks remain the same.
The bailouts kick the can down the road. That's all the bankers expect. It is a profitable road.
The politicians say they will not make that mistake again. But, as soon as the crisis of default reappears, the politicians buckle. They get scared, and they pony up more money to enable the debtors to make their interest payments on their IOUs to big banks.
JONAH MUST NOW SWALLOW THE WHALE
Or so it has been ever since 1946. But, these days, there is a major problem. The size of the debts of the PIIGS is greater than the available reserves of the northern governments. They have handled Greece so far. They could barely handle Ireland. But they cannot handle Italy and Spain. In May 2010, shortly after the Greek debt crisis began, the New York Times posted a handy graph of the size of each government's debts. The Greek debt situation is the tip of the iceberg.
The politicians of the North decided that the goal of European unification was so desirable that they discounted the possibility of anything like the Greek crisis. For a decade, their optimism prevailed. The Greek politicians took advantage of this continuing optimism. "Put it on our tab!" The North's bankers did. And why not? They knew that the ECB, the IMF, and the German politicians would come to their rescue.
Now the capital market is calling into question the ability of the Eurocrats to bail out the system. The salaried experts are hard-pressed to come up with a solution.
There was an annual meeting of the International Monetary Fund over the weekend. Out of this meeting came a vague assurance that the European governments and the IMF and the central bank are working on the problem. One official said there could be a plan in five or six weeks.
Five or six weeks is a long time when a nation is paying 100% on its one-year debt.
We have heard estimates of a default within weeks. These are merely guesses, but they are guesses from people with a lot of money on the line. Mohammed El-Erian, the head of PIMCO, the world's largest bond fund, predicted in June that Greece and other PIIGS will default.
On September 21, just prior to the annual IMF meeting, he reiterated his concern.
It is no longer just about the "outer peripheral" economies such as Ireland and Greece, but also the "inner peripheral" ones like Italy and Spain, the banking sector, and balance sheets at the very core of the eurozone – and worryingly at the European Central Bank (ECB).
Interest rates on Italian government debt are at alarming levels, despite visible buying by the ECB. Banks are having difficulties convincing other private institutions to lend them money. And the ECB's balance sheet is increasingly burdened, fueling internal divisions and turning this critical institution from being part of the solution to a part of the problem.
As in the fall of 2008, virtually no country will be spared if continued policy incoherence leads – as it inevitably will – to a recession in Europe, dysfunctional financial markets, and bank failures. When policymakers convened at the IMF/World Bank meetings three years ago to contend with this situation, they at least had a road map of sorts: a bold bank recapitalization plan that Britain brought to the meetings and that served as a catalyst for common analysis and joint policy actions.
This year, it seems that policymakers will have no such luck. The international community lacks an effective policy coordinator. Indeed, it does not even share a common analysis of what ails the global economy. And the sense of shared responsibility has fallen victim to bickering and finger-pointing.
He went on to outline what is necessary . . . and soon.
Instead of seeking to maintain an increasingly unstable and dangerous situation, policymakers must now attempt bold and coordinated approaches. As I have argued elsewhere, Europe must lead by recognizing the inherent inconsistencies of the current eurozone and opt for a smaller, less imperfect, and therefore stronger union. At the same time, national governments must embark on proper structural reforms that increase actual and potential growth and jobs. Banks must be forced to recapitalize and come to terms quickly with their weakening asset quality. And the rest of the world must help by providing focused capital injections and, in the case of some developed and emerging economies, more expansionary policies rather than austerity for the sake of austerity.
Yes, I see! PIIGS must fly! And it is the task of non-European governments, already running huge deficits, to pony up even more borrowed money from their bond investors to see to it that PIIGS do fly. "Policymakers face a stark choice. They can either lead an orderly economic response or be forced to clean up after a chaotic, ad hoc, messy one. Europe's problem is now the world's; and such a global problem requires a global solution."
"Global solution" is a code phrase for a multinational governmental bailout. That's always the solution recommended by investors who are sitting on a portfolio of government IOUs. More IOUs.
IT JUST KEEPS GETTING WORSE
Week by week, the news out of Europe gets worse. It is clear by now that the various mini-bailouts since the summer of 2010 have only delayed any fundamental resolution to the Greek debt crisis. There have been official assurances from Greek politicians that Greece will not default, that the government will cut spending, and that the country will remain in the European Monetary Union. These promises have not brought Greek interest rates to (say) a mere 30%.
The promises are political. The interest rates are free market. The twain do not seem to be meeting.
The promises escalate as the interest rates rise. The promises become more comprehensive as interest rates rise.
Bond market investors are only marginally less naive than stock market investors. But bond market investors have been hammered so badly by the collapse of Greek bonds that they are scared to lend more money to what appears to be a bankrupt nation. Stock market investors invest in companies. Bond market investors invest in Greek politicians. There is greater hope for European companies than there is for Greek politicians.
What did the G-20 conference held by the IMF announce after its weekend meeting? Not much. Things are taking shape. They are moving along. Have no fear.
The unofficial announcements led to a big increase in European stocks, then the USA.
The outline of a large and ambitious eurozone rescue plan is taking shape, reports from the International Monetary Fund (IMF) in Washington suggest.
It is expected to involve a 50% write-down of Greece's massive government debt, the BBC's business editor Robert Peston says.
The plan also envisages an increase in the size of the eurozone bailout fund to 2 trillion euros (£1.7tn; $2.7tn).
European governments hope to have the plan in place in five to six weeks.
It is all blather. The stock market fund managers cannot bear the thought of being left out for five or six weeks, in the hope that there will be a resolution of a problem that has gotten worse, month by month, since April 2010. "There has to be a solution! There must be a solution! Therefore, there will be a solution!"
There won't be a solution. Greece will default. Nothing bad will happen to the Greek economy that has not already happened. That was the lesson sent by Iceland three years ago, when it creased pegging its currency to the euro. The Eurocrats do not want to admit this.
When Greece gets no worse, the politicians on the other PIIGS will figure out that IMF-imposed "austerity" measures are not necessary.
This lesson will spread northward. The big banks in the North that were so foolish as to lend to PIIGS governments will turn to the ECB. The ECB will do whatever is necessary to bail out the big banks. It will inflate.CONCLUSION
Politicians really do believe that they are wiser than investors who have their money on the line. Investors are trusting. But at some point they decide that it is safer to sell their bonds than remain on a sinking ship. Bond prices fall, i.e., interest rates rise.
PIIGS will not learn how to fly. But they remain aboard the Eurozone's central bank-funded hot air balloon by fattening up on loans from governments and the ECB until they finally relieve themselves from on high.
Stay out from under.
http://lewrockwell.com/north/north1040.html
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