The Continuing Story in Greece, Europe, and the World

I’m not giving you a blow-by-blow account of events in and around Greece. I am trying to give you some perspective on the situation, which seems hard to find. I am beginning by offering you some stuff that I have found here and there that adds to the picture. They show that the possibility of Greece growing out of its current difficulties is impossible, because real growth is impossible. Read this article from the BBC to get an idea of how the government and business get along. It makes many of our state governments look brilliant by comparison (but not Obama). I found another article about a village that had attracted major industrial investment, but is now dying and businesses that can are moving out of the country (sorry, I proceeded to lose the address of the article). There is also plenty of evidence that money is fleeing from the country. Bank deposits are declining relatively quickly. None of that is good for the survival of Greece without major disruption.

For you one note medical issue people, read this note form a recent weekly email that I receive from John Mauldin (6-24-11):

“But there are very sad things going on. It is not just banks that are losers here. Pharmaceutical companies are starting to refuse to deliver to Greek hospitals, as they are up to two years behind on their payments. It turns out that Greece owes some €6 billion to private businesses like hospitals and simply cannot pay. Those costs are rising, and much of it is to hospitals for medical care supported by the government. They are issuing bonds (shades of California) for the debt in some cases, which sell for a discount of 50%, if they can be sold. And we thought finding €12 billion was a hard thing.  This is not just a Greek problem, it is a concern in many countries that are having financial difficulties.”

The Greeks are being asked to make some very tough decisions. These decisions would be difficult for brilliant, well-trained, market oriented professionals to make, but what the Greeks are depending upon are politicians who claim to be socialists. Their entire operating mode is making promises, throwing around government money (they have no idea where the money comes from), and taking graft (It would be sort of interesting, in a pathological sort of way, to do a study on the number of “socialists” who have become rich and expect luxury since they became politicians, like the Frenchman arrested on rape charges in NYC, Straus-Khan). If the world press was able to look beyond the superficial, and report more on actual events besides government pronouncements and “protestor” activities, we would see that the Greek economy is barely functioning. To me, the problems in Greece bring into question much of the current plan. For example, the Greeks are required to raise E50B by selling off nationalized businesses. But these companies are most likely very badly managed and their assets may have been looted, many of their employees are protesting the entire program in the streets, and the prospect of profitability in the Greek economy is bleak. Who would bid on these companies? Would the Greek government get more than 10 cents on the dollar?

The entire program is based upon premises that have not been substantiated. There is very little connection with reality in the entire effort. Part of the reason is that none of the countries, including the supposed healthy countries like Germany, could comfortably face the same reality oriented scrutiny that Greece should be facing. I am sure, as a semi-reality oriented premise, i.e., the German reputation, that German nationalized companies and German government management is better than that in Greece. But I’ll also bet that it does not rise to the standard of German private enterprise, let alone American private enterprise. So the problems that the Greeks face very likely exist to some significant degree in every European country and at some point down the road, they will each face default and depression.

If Greece defaults, do not be surprised if other countries don’t follow suit. Iceland is expected to walk away from its debt at any time. As for Ireland, from all I have seen, it is a country plunging down the economic hole. Portugal is pretending that it is functioning and will not need another bailout, but it isn’t growing. Spain is seeing massive internal dissent aimed at its austerity programs. But, back to Greece.

So, in the last week the Greek parliament voted to further reduce spending and sell off government “businesses”. This is just the briefest of stop-gap measures (the popular phrase is that they are just “kicking the can down the road”) and it is not considered to be sufficient. More cutting and so on will be needed next year.

Some commentators wonder if the actual events will occur. All that has actually been passed are general bills. The legislation that will provide the details will be offered later, including the specifics of the asset sales. It is noted that the current government originally built its power base on the employees of the government and these government companies, promising them heaven on earth, regardless of the cost, productivity, or sanity of their programs or “businesses”. To sell off these enterprises would be a complete reversal, and it is wondered if these politicians can do it. Politicians of this stripe are great at making promises, but recognize the difference between policies that will get them reelected or appointed and those that no one will pay any attention to. Since these politicians are hardly connected to reality, they could easily declare that they will not act against the “interest of the Greek people”, and say to hell with the bankers, and not sell the assets. It would be a disaster and fairly soon those “businesses” would have to close down, since no money would be available to subsidize them, but the politicians would probably be reelected.

But, even if all of that goes fine, the Greeks will still need over E100B next year. I don’t know how they figured that, but if they are depending upon the Greek economy to assist in the government’s efforts to remain solvent, they will be very disappointed. I expect that the Greek economy will decline faster than they expect. Relatively speaking, it is an advanced economy, probably one of the top 20 or 25 in the world. It is more advanced than the US was in 1930. It is more corrupt and probably more productive, but in terms of interconnectedness and of business practices, it is more advanced. When even a relative small, advanced economy begins to fail, things will unravel rapidly. The politicians in charge will be like military leaders, who are said to always be ready to fight the last war. The politicians (and the economists) do not really know what is going to happen. They are basing their reasoning upon assumptions that most likely have little to do with present day economies. (Since the last depression occurred 80 years ago, we have little actual experience for rational economists to base their expectations. No one knows what will happen. But the irrational people in charge now won’t even realize things aren’t going right for some time.) So the needs of Greece next year will most likely be larger than presently expected. Larger than the current leaders in Germany and France are telling their people they are committed to cover. Politics in those countries will be rather interesting to watch.

But then, even before that point we have the French and German leaders coming up with another wrinkle, witch will cause great stress. They are saying that the “private sector” needs to participate in saving Greece. Now, considering that the “private sector” has already put itself out on a limb and bought a lot of Greek debt, it would seem the private sector has already engaged in significant participation. Why anyone in their right mind would do such a thing is beyond me. Then, much of that debt was purchased before the rating agencies really took the Greek government’s ineptitude into account and began lowering the credit rating of Greek debt, meaning that interest rates for Greek debt have gone up, a lot. Interest rates on the open market are now in the upper teens, say 16% or 18%. Say you bought Greek bonds at 8% and it is now 16%. You have lost half of your capital on the secondary market. Your only chance of getting your capital back is to keep the bond until maturity. It will probably still be a loss (due to the declining value of the currency), but perhaps not as much (figuring this out calls for some very complicated math). But now the French and Germans are telling the private sector that they will have to roll over their bonds, that is let the Greek government keep the money, with a new maturity date (I haven’t seen any indication of what duration.), but with interest rates probably lower than market. This is a clear loss for the bond-holder, and in any rational world, would be called a default, as the credit rating agencies have clearly stated.

Given a deserved black eye because of the goings on during the residential real estate boom, the credit rating agencies are trying to act like real credit raters. That is not what politicians want, actually. Welfare state politicians generally do not like letting people know the truth about things. Just in the last couple days, the leaders of Europe, especially that crazy lady in Germany, have attacked the credit rating agencies. It is an ad hominem argument, accusing the agencies of having a bias against Europe. Yes, if you don’t get your way, if someone calls your spade a spade, accuse him if bias. The best defense is a good offence. Offend every one you can.

Well, I can now get to one of my biggest reasons for writing this post. Greece is really small potatoes. I mean, Greece has a small economy, although if it does (which is to say that when it) defaults, the repercussions will be significant, because a lot of banks have significant amounts of Greek debt. But there are also two other small countries in the EU who might take the same opportunity to default on their loans, i.e., Ireland and Portugal. I’m not sure how seriously to take this, but Ireland is in dire straights and Portugal is not improving either. Then anyone who looks sees that Spain and Italy are both in situations not that much different than Greece. The “contagion” effect could go far, especially if these countries have major financial issues when Greece fails. I mean banks failing and soaring private bankruptcies will be dangerous in every country.

Then, hidden and ignored, is the plight of France and Germany (which is to actually say all of the European developed welfare states) that cannot sustain their own spending and borrowing as their populations age and shrink (and go Muslim). The problems in France and Germany are greater than that of the US in the long run, i.e., next few years.

That means that to the extent that France, Germany, and the other apparently healthier countries weaken themselves bailing out Greece, Ireland, Portugal, Spain, and Italy, they bring on their own problems that much sooner.

More broadly, the world is awash with debt. Every major economy that you can name that appears strong has got major debt, and rapidly growing debt. Japan, for example, with the reconstruction it now has to address, was beginning to feel overextended before the earthquake and tsunami. The Japanese economy is under great strain, yet the regional governments, businesses, and the population are all making new insistent demands on the national government to spend more money. The brics, Brazil, Russia, India, and China, that are growing fast depend upon the developed countries for markets, are themselves heavily controlled by their governments, are awash with government spending and debt (domestic and international), and at least three of the four (I don’t know enough about Brazil to say) are rife with corruption. In no way can we say that they are healthy economies, no matter how rapidly they are actually growing.

In spite of the international financial meltdown in 2008, there is little real difference in the way the international economy is functioning, except there is a lot more government debt worldwide and much more government interference. Consistently, they have all blamed the financial problems on the banks and, in fact, made the banks weaker.

The results from this will not be good. I am not predicting the end of the world nor utter catrosphie, I just don’t know enough to do so. But nothing good can come out of the current mix of debt, government controls, ignorance, and purposeful pursuit of policies that have never worked. It can not help but be worse than 2008.

We can avoid the meltdown here, but only by getting hold of things and making real change, to freedom, to capitalism. We will still suffer because there is no avoiding the problems of the rest of the world. But we can survive in fairly good order, if we do it.

Inflation Update: Mid 2011

The U.S. Bureau of Labor Statistics just released its monthly announcement of the CPI (Consumer Price Index). The index showed some modest growth in consumer prices, .03% over the previous month. These numbers did not meet expectations, but the differences are small. Then there is the “core” and the broader index. The core is supposedly more important because it represents consumer goods that are less susceptible to short-term market swings, and thus are more dependable as indictors of the direction of prices. Maybe. It is obvious that there is a lot of manipulation of the data that the Statistics Department uses for the CPI. If that manipulation is for political reasons, as many suspect, or not, the consequence is that the index tends to be far removed from what residents experience on a daily basis.

More importantly, so what? What both the average economist today and most hyperinflationists tend to think is that if prices are going up there is inflation. What it means for that average person, on the other hand, depends upon whether his own income is rising at least as rapidly as the price increases. If a person’s income is not increasing as rapidly, it means making some difficult choices and seeing a constant drop in living standards. It a person’s income is increasing as fast, it means that one isn’t any better off. It is only an illusion.

But inflation is not increasing consumer prices. Inflation is the expansion of the money supply by a government. The expansion of the money supply is a form of taxation, making our incomes and savings worth less, It also makes government debt easier to pay off and defrauds the lender. That is one of the reasons it is popular with governments.

Looking at the data available from the Fed, it appears that our two-year hiatus from the threat of increases in the money supply is coming to an end. First, business loans, after a dive, have begun increasing. We will have to keep a careful watch on this, but the seeds of destruction are beginning to take root. If the interest rates were something near a market level, an increase in business loans would be a good sign. With interest rates as low as they are, the new loans could be anything from meaningless to bad news. Again, we have to watch.

The money supply indicator that I watch, MZM, has also begun to climb upward again. This isn’t surprising since the Fed has been trying to get it going upward for a couple years now and it was bound to happen sooner or later.

I want to point out a couple things about that chart that are important. I want you to avoid the knee-jerk response that many will have that the sky will fall immediately. This is a thirty-year chart, ranging from $1T to $11T. The dollar increments are evenly spaced per $1T steps. The slope of the recent increases is closely in line with the slope on the chart from 1995 to the present. (Admittedly, it is a little difficult to tell how steep short-term changes are on this small chart. The actual data is available, but it is too soon for us to tell the actual trend. For the sake of this discussion, let’s go with the appearance.) An increase of, say, $100M dollars in the money supply in 1985 moves the slope up at the same rate as an increase of $100M today. But the base from which it increases is considerably higher today. A new $100M today has much less impact than it did in 1985. Today, such an increase wouldn’t be noticed. The rate of increase we see beginning in 1995 and running nearly continuously through today, with two brief recessionary periods, has resulted in modest amounts consumer price increases, relatively speaking (you will find that I have damned even small levels of continuous consumer price inflation elsewhere in my blog, but here we are making comparisons to hyperinflation). For the rise in the money supply to have the impact it did even ten years ago, it is going to have to be an increase of a larger amount and a steeper rate of climb on the chart. For it to cause hyperinflation, the increase in the money supply, as shown on the MZM chart, will have to be nearly straight up.

The Fed wants to see a rate of price inflation (what it mistakenly calls inflation) running around 2%. This is already a betrayal of the American population. Any inflation is a disaster for all savers and those on fixed incomes. For many years, the Fed policy was to be willing to accept inflation of between 1 and 2%. Now it wants 2%. In a couple years it will be 3 or 4%. Such is their level of intellectual honesty and responsibility. Anyway…

So the Fed wants 2% of price inflation. The money supply is moving up, business loans are moving up, the Federal deficit is moving up, and, although commodity prices have backed off a little, they are still very high. Employment is not improving. What makes the Fed think that when price increases hit a two percent annual rate they are going to do anything but continue to increase faster and faster. We don’t have to postulate hyperinflation (20% or more annually) to suggest that increasing prices aren’t going to become a prominent news item. The Fed is going to have to react and the only thing it can do is to raise interest rates and take money out of the system. It is going to have to work hard and fast on the money removal program because of the amazing overhang of Fed member reserves that are just sitting there. If (I mean, when) prices begin to increase faster than the Fed wants, its curative actions will take some time to have any impact, even by its standards of the last twenty years, because of the $1,4T in excess member reserves just sitting there. The Fed is going to show itself as unprepared, intellectually ignorant, and ineffective. It will not be pretty. They do have one amazing, strong, successful capability: they blame everyone besides themselves. Ultimately, as has happened every time things have not gone well in the last century, it will be capitalism that will be blamed.

As I have often suggested, continue to watch your own situation. Be prepared for higher prices (these increases will not occur evenly, but in certain segments of your budget), and try to not be exposed to rising interest rates, i.e., don’t own bonds, have long-term fixed debt obligations if you can.

I don’t see this disruption from the Fed’s difficulty with interest rates as necessarily a step toward an economic depression. Government figures may show a recession (in the real sense, we haven’t left recession, not with our high unemployment).

My list for depression triggers is the Federal debt (higher interest rates could bring that issue to a boil), the default of one or more of the Eurozone countries (that situation could make the residential real estate mortgage meltdown of 2008 look modest), or the disruptions and craziness of the implosion of the China real estate market (who knows what kind of rioting, mayhem, crackdowns, and blaming of capitalism that could happen in that country).

Since the end of 2008 and that meltdown, the U.S. economy has kind of been drifting, not recovering, not being obviously self-destructive. That period couldn’t last for long. Since the powers-that-be weren’t willing to let the economy heal, our only real choice for the future will be difficulties. The possibilities range from painful to the worst depression in history. To some extent what will happen is in our hands. Let’s see if we can turn things back toward reason, freedom, and prosperity.