Greek Debt Crisis Will Worsen: The Center Won't Hold

When the European Union voted to put up a $1 trillion fund to bail out indebted countries in the Eurozone, it implicitly rejected the alternative, which was to purchase the Greek debt outright, making it an obligation of the EU as a whole and no longer just a Greek affair.

By opting for the bailout, the European Union has taken a middle course between full debt assumption and abandonment that won't work. The markets will keep pressing until the EU throws in the towel and buys up all the outstanding Greek debt. Shortly thereafter, it will have to do the same thing for Portugal and perhaps for Italy and Spain.

Greece owes $400 billion. Portugal owes $175 billion. And, over the horizon lies Italy, which owes $2 trillion, and Spain is on the hook for $819 billion. Against these numbers, a $1 trillion fund doesn't inspire a whole lot of confidence.

Spain has kept its debt level low, 60 percent of gross domestic product, thanks to the fiscal responsibility of the regime of President Aznar. But Italy has had no such prudence and now owes 115 percent of its GDP in debt, a percentage only slightly less than in Greece.

This run on the Club Med countries will continue, and the $1 trillion fund will not be enough to stop it.

The key question is how will Germany respond? Ever since the 1920s and 1930s, Germans have had a national consensus that unemployment is tolerable but that inflation is not. Having seen Adolf Hitler take power in the wake of the inflation of the Weimar Republic, Berlin does not look kindly on inflation. But an aggressive German effort to save Greece -- and certainly one to save Italy -- would run afoul of this long-held belief and would undermine confidence in Germany's ability to pay its debts.

Berlin is caught between a rock and a hard place. If it props up Greece, it undermines confidence in German solvency. If it doesn't, it undermines it in the Euro. Either path will lead to inflation.

Already, Germany's debt to GDP ratio is 77 percent (not quite Italy's 115 percent or Greece's 125 percent, but getting up there). Last week, the cost of insuring $10 million of German government debt against default for five years rose to $47,000, as opposed to only $35,000 at the start of April. These insecurities are certain to rise the closer Germany gets to assuming Greece's debt.

But if a Eurozone nation is allowed to default, inflation will certainly come as faith in the Euro falls.

The meaning for the United States, immediately, is that the export-driven recovery, stoked by improvements in Europe, is likely to fade and the dollar will strengthen, making U.S. exports less competitive.

But the longer-term meaning is much more serious. Investors have gone from being nervous about small banks (the savings-and-loan crisis of the '80s) to being nervous about big banks to being nervous about non-bank financial institutions to being nervous about small countries.

The next steps are obvious. The worry will spread to medium-sized countries like Italy and Britain, and then to the biggest of all: the United States.

Obama has left us vulnerable to these concerns with his huge and unnecessary budget deficit. With our debt now exceeding 80 percent of our GDP (it was 60 percent when Obama took office), we are hostage to speculators and nervous investors. In 2011, we may well experience the same kind of international jitters that now bedevil Greece and find our hand forced by an international consensus, just as Athens' has been.

When Republicans stand against tax increases in 2011 and Democrats block spending cuts, the positions of both political parties may be irrelevant. Obama has so compromised our financial independence that the bond market may make the decision for us and jam both down our throats. Today, Athens. Tomorrow, Washington.

“After the inevitable shocks of finally being held to account, governments will have to get their fiscal and monetary houses in order, or never have access to debt. Which is just fine by me either way. No responsibility? No debt.” ~ Uncle Miltie

Bttt - Like New Zealand, we need to zero out all government programs and start over:

Date: Fri, 7 May 2010 10:56:46 -0400 (EDT)
From: Forbes Newsletters newsletters@forbes.com
To: [Matchett-PI]
Subject: The Gilder Friday Letter v.429.0
http://www.gilder.com/ | Issue 429.0/May 7, 2010

The Week /CuttingGovernment is All Upside

GILDER TELECOSM FORUM MEMBER # 1(05/05/10):

Marc Farber (Bloomberg): I can tell you, all governments will eventually have to be bailed out in the western world. It’s either going to be through money printing, as I think, or default. They are over indebted, especially if you consider the unfunded liabilities like future pensions, social security, medicare, medicaid and so forth.

It does not add up, they will all default or they will all print money. But the outcome won`t be pretty, that I can assure you.

GEORGE GILDER, Gilder Telecosm Forum (05/05/10): Or someone will try the New Zealand solution, the only real remedy, imposed by a Labor government two decades ago, when they shocked everyone by zeroing out all government programs. The result was an amazing boom, particularly in agriculture, where huge farm subsidies and regulations were abolished and the entire department dismantled. New Zealand moved from being a massive net importer of food to provoking Wisconsin to protect its dairy products from unfair competition from down under. Abolishing government programs turned out to be all upside.

This is not a problem. It is an opportunity. The key to doing it is rescission of pensions extorted from the government by public sector unions, which are unconstitutional self-dealers trading their campaign agitprop and contributions for runaway benefits and absurd early retirements.

GILDER TELECOSM FORUM MEMBER # 1(05/05/10): Any recommended reading on the New Zealand solution?

GEORGE GILDER, Gilder Telecosm Forum (05/05/10): The entire saga was told in detail in a Heritage Foundation tape that I gave to Steve Forbes (and he lost without mentioning). I bet Heritage could track it down and has paper records of the contents. It is the best libertarian story ever told. It is definitely worth chasing down. They zeroed out all the departments and all spending had to be justified from scratch. It changed New Zealand from a Third World basket case into a thriving economy for several decades.

Everybody expected disasters, but cutting government (except defense) is all upside.

Imagine zeroing out the department of agriculture, department of commerce, department of education, department of labor, etc. etc. Think anything bad would happen?

Friday Feature / Washington Possessed

DAVID MALPASS, Forbes.com: My Nov. 10, 2008 column warned that big government was walking away as the knockout winner over the private sector in the financial crisis. But it’s going much further than I’d feared. The federal government has accelerated its takeover of the economy, adding a mega-trillion-dollar health care entitlement, despite the damage to health care and the national debt this will cause. Washington is frenetically cutting unfunded checks. Capital is being channeled away from small businesses toward big government. Looming on the horizon is the bailout of state and local governments, which will concentrate more and more of the nation’s debt onto the diminishing base of federal taxpayers.

Washington’s excess spending is now running $1.5 trillion annually, and both the Treasury and the Federal Reserve are relying heavily on short-term credits for funding. The marketable national debt has ballooned to more than $8 trillion, but wait ... the Obama Administration has budgeted an increase to $20 trillion over the next few years, bringing it to more than 90% of GDP. Even that huge sum—$100,000 for every working-age American—doesn’t include the rapidly escalating debts of Fannie Mae (FNM) and Freddie Mac (FRE) or the government’s unfunded liabilities for Social Security and Medicare. And to keep the debt estimate down the budgeteers are making wishful assumptions that millions of high-paying jobs will reappear and health care reform will pay for itself.

Every month Congress adds more federal powers and debt, voting as if its allegiance were to Washington, city of cranes, instead of to the voters and taxpayers. The financial services reform bill does little to reopen lending to small businesses but adds huge new federal powers, including the imposition of corporate taxes, to create a giant new bailout fund (think Son of Tarp). And the President’s ten-year $45 trillion spending budget makes crystal clear Washington’s hunger for a value-added tax. After the health care law it’s the next huge step in Washington’s expansion.

Given temporarily low federal borrowing costs, the government can concentrate the nation’s debt onto federal taxpayers without properly recording the cost. This process is stimulative in the short run—more debt for less cost—but is clearly dangerous in the longer term. The government is not only choosing health care treatments and mortgage clauses but also has taken responsibility for allocating credit throughout the economy—this state versus that state, this industry versus that one.

Delaying the day of reckoning, the Fed has committed its institutional credibility to monetary supercharging, as it did in 2003. By arbitrarily pegging the interest rate near zero for big banks and the Treasury, we’re living in a surreal framework in which the more federal debt, the better for GDP. Except that there are three huge losers: savers earning 0%, small businesses not hooked into zero-rate loans and future taxpayers saddled with the debt when interest rates zoom . . .

READ ON:
http://www.forbes.com/forbes/2010/0510/opinions-david-malpass-current-events-washington-possessed.html?boxes=opinionschanneleditors
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