Sunday, January 22, 2012

The Rathole

  Here in America, we have a saying: "Don't throw good money after bad". It means don't put money into a situation that has no clear resolution. Apparently this phrase does'nt translate well into Italian.

  Mario Draghi, the head of the European Central Bank, and Mario Monti, Italy's Premier {together called the Super Marios} have asked that the EU's upcoming bailout fund, called the ESM {European Stability Mechanism}, be doubled in size to €1 trillion from it's current €500 billion. They say it's needed to restore confidence in Southern European {ie.. Spanish and Italian} debt. The ESM essentially will go into the secondary market and purchases Spanish and Italian bonds, which has the effect of lowering the interest rates that Italy and Spain pay when they need to borrow money. Spain's foreign minister Jose Manuel Garcia {not surprisingly} added his voice to those supporting this. 

  There are a few issues with this: first of all, for those investors who don't have confidence in Spain or Italy, they're going to sell their bonds to the ESM. In short, every time the ESM begins purchases, there is a wave of investor selling. All this really is doing is transferring risk from these investors to the European Central Bank. Hot potato, hot potato..  

  Secondly, this plan has been tried before-- the ECB's SMP Program was a big buyer of Greek debt as well as Portuguese debt. It did'nt save either nation, and now the ECB itself will be taking a big hit when Greek and Portuguese bonds go belly up. In short, this plan has helped only one group-- investors who were stupid enough to buy Greek debt years ago, but smart enough to unload it onto the ECB before it became worthless. It did'nt help Greece or Portugal or their people. 

  Thirdly, these nations-- including Italy and Spain-- have lived beyond their means for the better part of a decade. The ESM simply enables them to go on doing this; it simply delays the Day of Reckoning. These nations will, in one fashion or another, have to face the fact that their standard of living is going to be lower. It's not the end of the world for these nations-- far from it. These nations are, as nations go, fairly rich countries. Italy and Spain have per person incomes of roughly $35,000/yr. If they were to balance their budgets and live within their means, this would go down to, say, $27,500 or so. Painful yes-- but not the end of the world. For me {and China's leaders as well} it's the height of arrogance to ask China, who's citizens average $5,000/yr, to bailout much richer nations who refuse to live within their means and face reality.  Is globalization partially to blame ? Absolutely. Their powerful unions will have to bend to reality, something they absolutely have refused to do up to this point. Making painful cuts to pension plans and cutting the number of public employees is also needed. 

  It's long past time that the peoples of Southern Europe begin to face reality. They can start by balancing their budgets and enacting some labor laws which make it easier to hire people to produce goods and services. Throwing another half trillion into the abyss isn't the answer. Will they make the needed changes ? I highly doubt it. These nations, like Greece before them, are world class Ratholes on a one way train headed for a cliff, with Portugal next in line to cross the River Styx.

Update 7pm: Germany's Fin Min Wolfgang Schauble has already nixed this plan; it did'nt even make it to Monday morning. Wow. There is no plan. Iceberg dead ahead. 

Sunday, January 8, 2012

Economic War on Iran

  In the Middle East, there is a lot of things that go on that most Americans don't see or is under reported. Espionage games-- assasinations, spying, covert bombings by drones and spies.. these things have been going on for decades. It's all part of "The Game". As former CIA chief Leon Panetta said "kick 'em in the toes".

  But what's happening in the last week or so is a new, much more serious thing. On New Year's Eve, President Obama signed the defense authorization bill, which funds the military. However, in this authorization bill there was a provision which sanctions companies which use the Iranian Central Bank to purchase their oil. There was also an agreement among the EU nations to stop the purchase of Iranian oil, which is set for a vote on January 31st. The action by Obama was an attack on the Iranian currency; the EU action would seriously harm Iranian oil exports. These are serious economic sanctions. Iran itself contributed to the mess when it announced that it was cancelling all trade with the United Arab Emirates a few weeks ago.. a decision they have since rescinded.

  The effect was immediate. By Monday January 2nd, the Iranian rial was down 12% on the black market. The Mehr news agency reported that housing prices were down 20% in the last few weeks. There are reports that people are beginning to sell assets and then converting the rials for USD and other foreign currencies. On Tuesday January 3rd, the rial was trading at 17,800 per USD.. which compares with the official rate of 11,000 on the Iranian Central Bank's website. The Iranian Central Bank is holding meetings almost daily now. On Wednesday, the decline continued. I don't have any more information since then. Although this is only the last few days-- and the situation could very well reverse itself-- this has the feel of capital flight. If it goes on much further, the people themselves will lose confidence in their own currency. Prices of basic goods will soar. This is worth keeping an eye on. If it gets serious for Iran's economy, expect them to retaliate.

  This has happened before; Argentina in the 1990s to be exact:

Update 1/10 4pm: Seems like the inflation rate in Iran is continuing unabated. "TEHRAN, Jan 10 (Reuters) - Iran's currency has slid 20 percent against the dollar in the last week despite central bank intervention, and some Iranians concerned about the economy said on Tuesday that attempts to send text messages using the word "dollar" appeared to be blocked... On New Year's Eve, U.S. President Barack Obama signed into law by far the toughest financial sanctions yet against Iran, which if fully implemented could make it impossible for most countries to pay for Iranian oil. The Islamic Republic responded to the growing international pressure by warning last week that it could shut the Strait of Hormuz, the shipping lane for the Gulf's oil, if sanctions were imposed on its oil exports"