Sunday, July 03, 2011

What to do with a Failed State?

In the NYT:

Europe’s unraveling is also a problem for Americans. A fracturing of the euro could drag down the global economy. A breakdown of NATO would mean the United States would have to bear an even bigger security burden. More than a year into their debt crisis, major European leaders are still unable to make the necessary tough decisions. The constructive way out would be to restructure excessive debt, recapitalize affected banks and relax austerity enough to let debtor countries — Greece, Ireland and Portugal are most at risk — grow their way back to solvency. No one country could afford to finance such a solution, but Europe as a whole could.
As it should. Having handed the Greeks Versailles-treaty-like terms, they will likely default unilaterally anyway, and if not, exhibit what I like to call "powerful weakness", wherein every time they suggest default, the public and private financial institutions of the EU get a chill in their neck. Politically, they could behave like Hamas.

Look at this shambles for what it is: a river in Egypt. The EU is effectively one sovereign state when it comes to finance, markets, and economy. Member state nationals can point to one another and tell them to "take one for the team", but what they need to do is print some Euros in a classic devaluation move, and use them to dissolve debts that are at a risk of default internal and international.

Greece then goes into financial receivership. Italy and Portugal might have to join them there too, but if you're a bum and owe people money, then too bad. The intervening years will turn these places into a great investment once prices align with value.

Remember that Greece has in its high-borrowing years used it to show a per-capita GDP figure as high as Germany, but with an economy akin to Bulgaria whose GDP/capita is a third of Germany. The borrowing and sprinkling of this moolah on the 'starving proletariat' is what did this. They need to own up to that by not doing it again, but "demanding reparations" will not work for them.

Consider for a moment the postwar German "Wirtschaftswunder". It is a direct result of the US dissolving their past debts, and was willfully done to restore their economy and feed people. Can these people who tell us that they are mature students of history actually take a lesson from their own history in this regard? Pshyeah right! They won’t, but the markets will.

Siemens' stock fell 4% this past week on the entirely founded suspicion that things will not be wonderful in approximately 90-120 days when the world as a whole stops buying their goods all at once, and the reparations for Greek government, Italian, Spanish, and Portuguese borrowing are considered.

Siemens is one of the bellwethers of the northern European economy, just as Kimberly-Clark is a bellwether of what the South American economy will do, and as the EUR-USD exchange rate almost always foreshadows what the S&P 500 will do. Things could certainly be looking better, and they may be trying to price in the stagnation that austerity and debt freezes in a number of European states will cost.

Nonetheless, the German financial entities will themselves do well by the implementation of this Versaiiles treaty in reverse. They will borrow from the Bundes-Godhead-dudes at about 3%, and lend to Greece at the bargain-basement rates of about 5%. Cha-ching, for them. Money for nothing, chicks for free.

That does not mean it will have any effect on a European economic contraction. In fact it might create stagnation where there isn't now. It's a disincentive to lend businesses operating capital, and to individuals for mortgages.

The same dynamic has been going on in the US to bolster the balance sheets of the banks when they were at risk of failure from 2008 onward. It resulted in them not lending money to people and businesses because it was riskier and less profitable than the return on buying government bonds with money borrowed from the Fed and near-zero interest rates.

Ultimately, this is also a socialization of cost associated with the effort. So the talk of “making Greece pay” and “not hurting the taxpayer” are mere distractions. The only way out is to eat the cost, and pass out free haircuts to all, either though default agreements where partial repayments are accepted, and/or a currency devaluation takes place.