Memorial Day & Greece

For most Americans, this is a day for backyard BBQ's and beer-- and in truth, this is exactly what I'm doing today as well. But before I did this, I visited the local VA graveyard and laid some wreaths for the fallen. For me, having seen wounded soldiers coming back from Beirut as a young Navy Corpsman and having to change the bandages of those who had suffered burns, I got a very up close and personal view of their sacrifices. Many of these young guys were badly burned; changing their bandages was a pilgrimage through pain for me as well as them. Many were upset that they'll never really have a chance to marry because of the scars and the limitations. I see that Google's home page is the normal-- no clever little tribute like they do for artists and earth day. As for me, I remember.

Now onto the economics of the world-- it seems that Greece is slipping into the abyss. Mish posted a link to a Greek site that says that bank withdrawls are picking up the pace. The Greek government and the Troika (IMF/EU/ECB) seem intent on pushing yet more austerity-- and get this-- foreign tax collectors-- onto Greece in the effort to ensure that every last dime is repaid. A default would have serious consequences for the ECB and a number of financial institutions and thus will NOT be tolerated. Unless the Greek people become so unruly that the Army steps in. By nearly all accounts, Greece will run out of money by the end of June. The Greek opposition seems hell bent to block any more austerity and is demanding tax cuts. Here's my guess-- a deal gets done, but when the Greek people begin to understand what it's going to mean for them.. well.. as my tagline says, poverty and serfdom for all.

PS 8pm: It looks like Germany has agreed to another bailout of Greece without bondholders having to take a hair cut. Details are few as yet, but what have they really accomplished other than kicking the can down the road a little further ? How often do we solve a problem of debt with more of it ? I'll be curious to see if foreign tax collectors and more austerity is included.. and whether the Greek opposition (nevermind the people) will buy this one. Also it remains to be seen if Angela Merkel keeps her job.

The Day Greece Collapses

I know, I know-- I seem to harp on Greece and the problems in Europe far more than I probably should. It's just that in my opinion, the EU Zone is in far worse shape than we are here in the States. Problem is, should something like another Lehman occur over there, it would, without a doubt, take us down as well. Simply put, those who cannot pay their debts won't pay their debts. The EU bankers and politicians come up with ever more clever ways to delay the Day of Reckoning thru various loan schemes and hot air, the $985 billion EFSF being the latest iteration of "kick the can down the road", which simply piles more debt onto the already insolvent. You cannot solve a problem of debt with more of it, which has been their prescription from Day One. The "bailouts" also apply strict budget cutting mandates for these governments. Worse, these nations are also (first and foremost) forced to guarantee the loans made by their own banks-- the bigger EU powers will not allow them to simply walk away from the collapsed bank debts like Iceland did. Ireland's bailout mandated that they cough up their government pension fund as a first step of their "bailout". Part of the problem is the size of these debts-- according to the Bureau of International Settlements, Greece, Spain, Ireland and Portugal together owe foreign banks (mostly European) well over a trillion dollars. Greece alone owes nearly $500 billion, although roughly half of it is to it's own banks and investment funds. There is no way these banks can take this kind of hit and survive. But there is no way these insolvent nations can possibly repay. Rock. Hardplace.

First the news from Athens: Since my last post on the German newspaper report of a Greek default, there have been some talks in Brussels about restructuring. They've even come up with some new names for it.. my personal favorite is "re-profiling", which is another way of calling insolvent loans something other than insolvent. Jean-Claude Junker, the chair of the EU finance ministers, came up with that one. But the reaction from the EU powers that be was swift and ugly: there will be no restructuring, default, re-profiling or whatever else it's termed.. they must be forced to pay it all back with interest. The president of the European Central Bank, one Jean-Claude Trichet, angrily stormed out of a meeting when Junker brought up the possibility of "re-profiling". Germany's Jurgen Stark pointed out (correctly) that any restructuring would be catastrophic for Greece's banks and opposed default in any way, shape or form. Many have suggested that in exchange for more bailout money, Greece should put up government owned companies and even land. Greece rightly rejected this. The talks are ongoing, but it looks like very little will get done. Then today, Norway and a couple of other small nations refused to cough up their part of development funds for Greece because the Greeks did'nt get to their budget targets in the bailout agreement. Another small torpedo came from the ratings agency Fitch, which (again) downgraded Greek Government debt from BB+ to B+.. which is still pretty generous. After hours, the other ratings agency S&P downgraded one of France's largest banks, Credite Agricole, due to "Greek exposure". Slowly but surely, the Europeans and Greeks are coming to the painful realization that this absurd notion of solving a problem of debt with more of it is bound to fail.

So-- this brings up the $64,000 question.. how and when ? Some of it depends on how-- there are two possibilities here.

Scenario One is a negotiated default whereby creditors are given the choice of accepting a large (50-60%) haircut or are asked to accept a smaller haircut and a time extension to repay what remains after the hair cut. If given enough time, the foreign banks can prepare by sufficiently capitalizing themselves (in other words, bracing for the losses). Greece itself would suffer tremendously; within months the (already high) unemployment rate of 15.8% would likely double. In this scenario, some sort of EU backing for some (not all) Greek banks would also become necessary. Believe it or not, this is the best of the two scenarios for the EU bankers.

Scenario Two involves a meltdown in Greece-- riots, protests and strikes reach a point where Greece becomes ungovernable, with the government unable to do anything to help the situation. Should this type of scenario play out, I look for the Greek Army to throw out the (incompetent) civilian government. The military only handed over power back to the civilians in the early 1980's. It could easily happen again. At this point, there begins a chain reaction: depositors will immediately empty out any money they have in Greek banks-- if the Army allowed them to even open for business. This will cause a large number of Greek banks (and the loans they took out from other EU banks) to go under. The Greek stock market probably would'nt even bother opening. In the rest of Europe, the stock markets will take a nasty fall, and the ECB (possibly with an assist from Bernanke's Fed) will have to take extraordinary steps to (very quietly) save some large EU banks. The Euro would tank as investors pile out of the Euro and into the US Dollar and Swiss Franc. Talks would begin with the Greek military junta. Ultimately, I think that the new military government will pull an Iceland-- they'll let their own banks go under & announce a 75% haircut of foreign owned debt or something like this. If the bankers can stall the junta for a few weeks, the EU banks will have had time to prepare themselves and will survive this. Greece will enter a depression; unemployment doubles within months. Because Greece instantly pitches so much of it's debt, this is the best scenario for the Greeks despite the Depression. Greece will recover; as prices of everything in Greece fall, tourists will flock there as never before.

My guess-- this happens before the end of 2012 and that it's Scenario Two. But rest assured.. one of the two are absolutely inevitable. A more grim scenario is detailed here by the Telegraph's Andrew Lilico: http://blogs.telegraph.co.uk/finance/andrewlilico/100010332/what-happens-when-greece-defaults/

While I'm on my European kick, I'm going to pile on a little more doom and gloom here, which comes from Spain, where the unemployment rate is already at a Hoover-esque 21%. There have been growing protests in large cities, so far not too large or violent, but indeed growing in size. Also this weekend there will be an election there, which will replace state level governments. You see in Spain, much of their debt is at their state level. What's feared here is that when the new governors take over these states, the first thing they'll do is to announce that the previous leaders left a far, far bigger debt pile than previously acknowledged. While Spain's bonds have held up pretty well so far this year, I'm thinking that some of it is due to undercover purchases of their bonds by other central banks and not the open markets... except for today, when they had what was essentially a failed auction, a serious event in the bond trading world. After this auction, their bonds sunk (meaning their interest rates went up). While Greece's collapse would be painful and dangerous to the EU banking system, Spain's collapse would be fatal due to the size of it's debts: http://themeanoldinvestor.blogspot.com/2010/05/update-523-worst-case-scenario.html

The US Economy Stumbles

In the last couple of weeks there have been a few discouraging reports on the US "recovery". But before we get to these, lets re-examine what The Fed and the US government have done since the Lehman crash. Shortly after the crash and the election of a new President, our government threw tons of money at the economy.. first was TARP (troubled asset relief program) which was an emergency $700 billion program designed to stop the banking system from collapsing. Shortly thereafter, as deflation was raging and the stock markets were sinking, the Fed initiated their "quantitative easing" program in November of 2008 which began the purchase of mortgage backed securities as well as US government debt as our government began borrowing vast sums of money, primarily the aforementioned TARP. Within six months, the Fed had purchased over $1.75 Trillion in MBS's and US Bonds. In addition, the Fed lowered the rate it charges banks to borrow money to essentially zero.

Then came President Obama's stimulus package, passed in Feb 2009, called the "American Recovery and Reinvestment Act". It was a $787 billion package (most of it debt added onto your children) that included tax incentives, an expansion of unemployment benefits and other social welfare provisions, and spending on domestic education, health care and infrastructure. By March of 2009, the stock market began to rise again, though unemployment remained stubbornly high.

By June of 2010, the Fed had purchased over $2.1 Trillion in MBS's and US Bonds. And still the economy was weak. In November 2010, the Fed announced that they were going to purchase another $600 billion in US Bonds. By early 2011, unemployment had stopped rising and there were signs of both job and economic growth, though prices of commodities began a serious rise. This new program, called "QE2", is set to end this summer. One of the problems of this program is that the Fed has essentially become the buyer of first and last resort for US Bonds.. they do it in the secondary markets instead of direct purchases, which is actually illegal. In early 2011, the Fed had essentially (re)purchased nearly 75% of all US Bonds issued. Their plan is to sell their MBS portfolios and keep up the purchase of US Bonds, which by one estimate should be able to fund the US Government's needs thru the end of this year anyways, though the US government will still have to find buyers for their short term Bonds and Bills when they need to be repurchased.

In summation, our government has thrown (well, printed really) about $3.8 Trillion between various QE's, stimulus packages and bailouts since the end of the Lehman disaster. This money did do some good.. it stopped a deflationary banking collapse in its tracks and has led to a rising stock market and a minimal growth in jobs. It's an indication of just how serious the situation really was in 2008 that it took so much money just to halt the decline.

But last week, two reports came out quantifying what we serfs already knew.. prices are rising for gas and food and there are still no jobs. First came the Initial Jobless Claims report, which had been on a downward slide for about six months.. most had come under 400,000. This one was different.. it came in at 434,000 for the week ending May 7th.. and it followed the previous week's very ugly one of 478,000. The talking heads were spinning these two weeks as best they can, but statistics don't lie. Second came the Producer Price Index, which measures the cost of various goods. Again the rise was ugly.. overall it came in at an annual adjusted rate of 6.8%, with food and gasoline leading the way. For us serfs, gasoline hit $4.00/gal, much to the grumbling of nearly everyone I see at gas stations. In a supremely surreal statement, the Finance Minister of Zimbabwe, which of late printed the ZD100 billion note, has today criticized the US Fed Chairman Bernanke for money printing and said that in light of this, Zimbabwe should should consider going to a gold standard.

For me, it seems to indicate that there is a limit to the amount of good that printing vast quantities of money can accomplish.. and it's my belief that we've arrived at this point. Both Obama and Bernanke were not pleased to say the least.. especially about the initial claims report. Two weeks in a row of bad employment reports is a bad portend. Lets hope it reverses. The Fed has said that fixing unemployment is part of it's mandate. While I dont think we'll see any more QE's for a while, I do believe that between the stumbling unemployment numbers and the need to finance the US Gov't, another round of it will become necessary; I look for it around the end of the year.

In other recent news. there has been a lot of talk recently about a Greek default, especially last Friday when an emergency meeting was apparently held and the German newspaper Der Spiegel ran a story suggesting that Greece was threatening to pull out of the Euro and go back to it's old currency, the drachma. This report was immediately denied by all involved. Make no mistake-- Greece is feeling the pain. Their unemployment rate hit 15.8% and their gas and food prices are rising-- a toxic mix. This weekend another meeting is being held to discuss changing the terms of Greece's bailout. Greek police are doing battle with strikers and protestors in many Greek cities. My hunch is that where there's smoke, there's fire-- I'd wager that there has been much talk from the Greeks about defaulting, and rightly so-- in the end, it's only a matter of when. In all honesty, the sooner the better.. but the EU and IMF seem intent on pushing the Greeks to honor the arrangement by continue to cut expenditures. If there were to be a negotiated default of some sort, the banks and other creditors would have a chance to better prepare and the default would not be a total one. If the people of Greece are pushed too far and the situation becomes desperate, the default will be both sudden and total-- and this risks another crisis. Unfortunately, Mssr Strauss-Khan of the IMF decided to attack a maid in a New York hotel room and now the leading candidate for the French Presidency and current head of the IMF is in the dock awaiting arraignment. This will undoubtedly stall any progress on the IMF's part.