Germany and the Euro Problems

I think that there is one interesting aspect to the turmoil in Europe. Well, okay, two. The one I am not referring to here is the revenge of reality. Borrowing to consume, especially as a national policy is stupid. It can only be done as a direct result of determined evasion of the fact that you are still going to be alive, or be a country, in the next minute. We should be very familiar with this trend. It is what is happening in Washington today.

What I want to discuss here is what is happening within and toward Germany: what the Germans are thinking and doing, and how people are acting toward Germany as Europe grapples with Greece’s very high government debt.

In more than one news article Germany has been called the paymaster, that is, ultimately, it is Germany who will provide the funds for bailing out every stupid government, that includes not just the Greeks, the Irish, the Spanish, and the Portugese, but also, when their time comes, the Italians and the French, although even German isn’t wealthy enough to save them all. In fact, the French have pushed policies recently that would have required the ECB, the European Central Bank, to fund recapitalizing the banks in France and elsewhere. That really means that Germany would be the source of the capital. The Germans said no, do it yourself.

There are other European governments besides Germany that have been more responsible in their fiscal habits that would have money to offer, but they are all small. Combined, the other governments would be dwarfed by problems in Greece. No, only Germany is large enough and wealthy enough to have the capacity to bail out a small country like Greece.

This recognition also includes the understanding that it isn’t just money that is required. This understanding comes from Germany. Others, many others, both within and outside of government, are calling for the ECB to just inflate their way out of the current mess. On some level Germany understands that doing so would destroy their wealth, and they aren’t willing to do that. So far, the ECB has been controlled by the Germans.

Then we have the people who explain the entire problem in terms of Germany’s scheme when the euro zone was established to construct it for their own benefit. The most consistent and clear statement of this view that I have seen comes from Stratfor, a private “intelligence” firm in the U.S. In a report, “Germany's Role in Europe and the European Debt Crisis”, published January 31, 2012, Stratfor argues that Germany engineered the agreements setting up the bloc and the common currency to make them wealthy.

[a cause] relates to Germany's status as the world's second-largest exporter. About 40 percent of German gross domestic product comes from exports, much of them to the European Union. For all their discussion of fiscal prudence and care, the Germans have an interest in facilitating consumption and demand for their exports across Europe. Without these exports, Germany would plunge into depression.
Therefore, the Germans have used the institutions and practices of the European Union to maintain demand for their products. Through the currency union, Germany has enabled other eurozone states to access credit at rates their economies didn't merit in their own right. In this sense, Germany encouraged demand for its exports by facilitating irresponsible lending practices across Europe. The degree to which German actions encouraged such imprudent practices -- since German industrial production vastly outstrips its domestic market, making sustained consumption in markets outside Germany critical to German economic prosperity -- is not fully realized.
True austerity within the European Union would have been disastrous for the German economy, since declines in consumption would have come at the expense of German exports. While demand from Greece is only a small portion of these exports, Greece is part of the larger system -- and the proper functioning of that system is very much in Germany's strategic interests. The Germans claim the Greeks deceived their creditors and the European Union. A more comprehensive explanation would include the fact that the Germans willingly turned a blind eye. Though Greece is an extreme case, Germany's overall interest has been to maintain European demand -- and thus avoid prudent austerity -- as long as possible.

This explanation is pure Maciovellan real politics and Marxist economics thinking that have been standard for a couple centuries. Supposedly, Germany could only become wealthy by sucking the wealth from others. Never mind that its best trading partners are other wealthy countries (or countries that are developing, like China). Never mind that the Greeks (and Spain and Italy, etc.) choose to borrow based on their own social welfare goals (that was the first cause that Stratfor mentions, but then ignores completely in its focus on Germany).

Also, in the same report, Stratfor states clearly that Greece and any of the others must stop this spending binge, without any hint of the supposed consequence to Germany. If they were consistent, they would be selling Germany short.

The Germans are well aware that they are going to be the paymaster. Even the man in the street understands the situation well enough to consider the wisdom of going ahead with the bailouts. The Greek bailout is especially irksome because the Greeks have pushed their wage rates above those in Germany (the monthly, legal, minimum wage in Greece is much higher than Germany’s, and all the other European countries), the Greeks have failed to follow through on the promises they made for the first round of the bailout, and the protestors in Greece have called the Germans names that no German can tolerate.

Which brings us to the attitude of the Greeks, themselves. A few have shown that they understand the situation. That seems to include a few politicians. To begin to move the government toward policies that Germany would accept, the Greeks had to make a man prime minister who was not a politician. When Germany demanded a lot more than promises, the politicians dithered for days. And when the vote was actually taken, many politicians in the largest parties voted against the bailout.

The Greek technocrat government does recognize that the country is bankrupt. The bailout offered by the other European countries is not to actually make them whole, but to give them the time to put themselves right. This isn’t a free lunch, just a little support. The support gives them the cash necessary to redeem debt falling due in March and the money to meet payrolls and continue operating without resorting to adding more debt to their total (and nationalize the banks). The Greek government must still find ways to spend less and income sources to pay off more debt. By 2020 it is suppose to reduce its debt from 160% GDP to 120%. For a country that does not produce much, in which the government accounts for about 40% of the economy, which has a culture of avoiding work and accepting corruption, and sees no connection between receiving money and production, getting the government to change its budget from a big annual deficit to a surplus is an overwhelming task. I don’t think that it can be done in a few months or a few years.

Then we have the Greek people. This is a democracy in the finest sense of the word. The population seems to think that it is fine for others to sacrifice and pay for the Greek life style. We have the government workers, who tend to not work, but spend their days shopping and sitting in cafes. We have the workers at government owned companies, who expect to be taken care of regardless of their lack of productivity and their willingness to cause disruption within the company and within the country. You have the employees of private companies who see government controls as the way to keep their job and income without regard to their productivity or the company’s financial health. You have the retired or the soon to be retired who were promised certain pensions and are angry that there is no money to meet those promises. These groups may not add up to the majority but they (and their relatives) are still a large enough portion of the population to be the deciding factor in elections. All of these groups have indicated they are angry about the changes required by the Euro Zone counties, led by Germany. What these elements of the Greek population think should be done hasn’t been reported that I know of. But, when interviewed, they all seem to think that their benefits should remain in place. How? Somehow!

So Germany is singled out for abuse. Memories (by people who weren’t there, for the most part) of past German sins are recalled. Ignoring the difference between sending troops to kill and providing money to maintain irrational finances, Germans are damned as dictators and Nazis. Some of the Greeks proclaim that the answer is communism, ignoring that it also failed the same way Greece is failing and that it has killed more people than the Nazis did.

One would expect that the Germans are angry about their treatment from the Greeks. I am sure that many Germans would prefer to just let the Greeks sink and be done with them. The more responsible of the Germans are not willing to do so. They do recognize that doing so would have very negative consequences for Germany for some time. I could argue that the long-run, self-interest of the Germans would be better served by unentangling themselves from their self-destructive neighbors, that their neighbors are going to continue to be problems and will require more and ever larger amounts of money. But that would be too selfish, and too painful in the short run, I suppose.

What Germany is looking at is that if Greece goes then Spain, Ireland, Portugal, and then Italy and probably France, too. They are thinking that solving the Greek problem will tend to prop up the others and they all can begin healing together. It is a pipe dream, but it is also the consequences of the premises with which Germany began. I do expect that Germany did expect the other governments to behave and control their fiscal budgets. That was a delusion and the Germans kept that delusion and tended to ignore what the other countries were actually doing. Germany is kind of an anomaly in that it is a social welfare state with a post WW2 tradition of some fiscal responsibility. It has even demonstrated how to absorb a backward country, East Germany, and grow. One has to have a certain respect for how Germany functions. Yet, they are still pretending that their own demographics problem doesn’t exist and they won’t have the same major debt problem as the rest of us. They still only pay attention to the next moment in time. They are still only a democracy that will tear itself apart under pressure. But they are holding themselves together much better than Italy or France.

So, to avoid the very nasty problems that letting Greece go to pieces, the Germans are willing to take on the obligations of bailing them out. The just completed bailout package includes sections intended to keep the Greeks on course, which the Greeks find insulting. Interesting isn’t it that the Greeks failed to follow through on their previous promises when they received money, and they are now insulted because their saviors don’t trust them.

The entire package is intended to assist the Greeks to lower their debt level from 160% of GDP today to 120.5% by 2020 (isn’t it interesting that they think that they can be so precise?). Usually, projections like this tend to have growth levels that can’t be maintained and the whole thing is fantasy. I expect that the projected growth levels in the bailout projections aren’t high at all, but I bet that the Europeans expect the Greek economy to begin growing sometime within the next couple years. I don’t know why. All of the capital within the country is either being soaked up by taxes or bonds, or has left the country. Who wants to invest in Greece? Is a Greek worker worth the effort? Has the Greek government actually made it easier or even possible for an investor to safely put his money there, let alone expect profits? According to online sources, manufacturing is only 18% of the economy. Production has been leaving Greece because of the business climate and the Greek worker. Why go back? As far as I can see, what has happened so far will not lead Greece to a growing economy and that means that it is going to continue to shrink, the government budget will not generate a surplus, debt will not decline (and will probably increase), the percentage of debt to GDP will not get anywhere near to 120%, and Greece will default with very messy consequences. Germany will have poured real money down a deep hole.

Why is it important to watch Europe now?

With so many battles to fight today in the U.S., you might wonder why I am spending time watching and writing about Europe. You could also point out that the U.S. is a vastly different sort of place. Policies and doctrines common in Europe since the fall of the Roman Empire were rejected in the U.S. We just do not have the socialist history that they have.

Unfortunately, the argument that everyone else is socialist is becoming accepted in the U.S. That was a big point in the argument for ObamaCare. We are becoming more like Europe. Our government has become a democracy in that demands for government controls and redistribution of wealth are now openly accepted as reasonable political discourse. Our government is spending like a drunken social democrat. Certainly our entitlement commitments are like what is happening in Europe. The problems they are seeing result from the same policies pursed by our own politicians of either party. The concept that made the U.S. different, individual rights, is just as unknown here today as it is in Europe.

Further, the economic policies practiced in Europe are based upon the same economic theories as is used by Bernanke, the Treasury, and the advisors of either U.S. party. Government action, focus on spending (consumption) as the power in the economy, regarding jobs only as a way to acquire income, and ignoring any real issue of production is standard everywhere.

The consequence is that the U.S. is moving toward a situation like that found in Greece, Spain, and Italy just as rapidly as France and Germany. I don’t know which large country will reach disaster first.

It is the case that our economy is not as regulated as those in Europe, although we are moving that direction rapidly. There is a lot of attention being paid to the steps required in Greece and Spain to make it a little easier to hire and fire an employee. But the controls and even the availability of capital aren’t changing much. Many core, important European industries are state owned and the labor unions have more sway than managers.

What is becoming understood, by many modern economists who regard themselves as scientists in some fashion, is that there are limits to the amount of debt that a government can sustain. This point was substantiated in a book, This Time is Different, by Carmen M. Reinhart and Kenneth S. Rogoff. For anyone who is serious about economics and the consequences of debt, I recommend this book. It is written by two modern economists, which means that their understanding and conclusions are superficial. They completely fail to recognize the difference between individual actions and those based upon force. Nevertheless, they provide important information and do offer some insight as to what the problems are in Greece, and soon the rest of the social welfare states.

The historical record is undeniable. If a government amasses debt amounting to more than sixty percent of their total production (considering only consumer goods), then they are tending toward trouble. Governments with more than one hundred percent are in trouble and there will soon be a financial crisis of some sort. The book does not mention interest rates, but certainly, if rates raise, the trouble is greater. From other sources, many modern economists seem to be convinced that the national production will be lowered by about one percent when government debt reaches ninety percent.

The U.S. will reach a government debt of one hundred percent of national production of consumer goods (called GDP) this year.

The book does not suggest what the financial crisis will be like. The world has not experienced a government debt crisis in an advanced technological country like ours, with the power that our government has amassed.

So I watch Europe to see how they are dealing with their problems and to see reality take its course. I watch to see if anyone questions their premises. I watch to see if any of the politicians choose to act intelligently or only with regard to their confused voters (see this article about the German PM) It is interesting that the Germans are now trying to put off the pending big, Greek bailout until after the April Greek elections.

I am looking to see how France and Germany confront their own fiscal/debt problems. Will they do something to actually improve their economies or not. France is headed for another Socialist government, it seems. The Socialist party is offering straight contradictions as its platform. It should be interesting.

I am not ignoring the U.S. and its impending problems. I just note that the big battle waged on the occasion of the vote to raise the U.S. government debt limit was over nothing. The amounts of the so-called cuts and what programs those cuts were suppose reduce were all inconsequential. It was all for show. A show that is now generally forgotten and ignored.

The only way that this country is going to avoid the gapping pits that Europe and the rest of the world are staggering toward is for some new group to make the obvious real to people. That means we have to do it. There is no other source for that understanding.


P.S. I watched Yaron Brook’s presentation as to why our country continues to make the same mistakes repeatedly and doesn’t seem to learn. (It was one of the videos at the bottom of the email I got from ARI. Number 191, I think.) It was excellent, and even if you know the issue, Dr. Brook’s phrasing and brevity in this complex subject is worth hearing.

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.