The European welfare-state debt crisis is moving into its next phase. In a desperate attempt to save Greece, the European Central Bank has spearheaded a campaign for a debt swap. The goal is to convince Greece’s creditors to accept a 20-percent loss. In other words: if you own 100 euros worth of Greek treasury bonds today, you will only have 80 euros after the swap.
The whole purpose of this debt reduction is of course to reduce the debt burden on the Greek government’s budget. That in turn will allow them to minimize cuts in spending on entitlement programs and government employees. Since the only alternative on the horizon is that Greece leaves the euro and defaults on its euro-denominated debt investors have effectively been forced to subsidize the welfare state. Reforming away the social-democrat entitlement conglomerate is of course inconcievable – we are, after all, talking about a European country…
It remains to be seen whether or not this forced debt reduction will stabilize the situation in Europe. On the one hand, this will pull Greece out of the immediate risk of a complete debt collapse: its bonds will continue to hover just above junk status. On the other hand, investors in the treasury bonds of other European welfare states can now look forward to similar treatment.
Let us start with the efforts to stabilize Greece. From the Business Insider:
Fitch just downgraded Greece from “C” to “restricted default.” This designation hardly comes as a surprise, since the ratings agency had previously said that the country’s planned debt restructuring would throw it into restricted default. … Unlike a disorderly default, in a “restricted” or “selective” default Greece has not actually been declared insolvent. Fitch said it will raise Greece’s issuer rating from “RD” after its debt swap has been completed on March 12.
To put this in perspective, consider what a similar forced debt reduction would mean in the United States. As of December 2011 the U.S. government owed $15.2 trillion worth of debt. Of this, 57 percent or $8.7 trillion, was owned by the general public. This means everything from professional investors to middle class families who have bought Treasuries to save for their children’s college. But let us also keep in mind that the professional investors typically invest on behalf of, e.g., pension funds.
If, hypthetically, the U.S. government ended up in a situation similar to Greece and forced its creditors to accept a 20-percent writedown, then the American public would lose $1.74 trillion worth of savings. That is $5,700 for every man, woman and child in this country, or $22,800 for a family of four.
It is of course very unlikely that the U.S. government will ever come to a situation where it would default on even a tiny portion of its debt. But for every year that Congress keeps spending significantly more than they take in from taxpayers, we get closer and closer to the point where “unlikely” becomes “likely.”
Back to Europe. While Greek treasury bonds may stabilize as a result of the forced debt reduction, the crisis is by no means over. On the contrary, it is now spreading to other countries in the euro zone. From the Financial Times:
In the years of economic crisis since the collapse of Lehman Brothers in 2008, Spanish leaders have always been able to boast to nervous investors that Spain’s public debt burden – however bad its annual budget deficits – is smaller than Germany’s and well below the European Union average. Economists, business executives and even government officials, however, have started to sound the alarm about the rapid and unsustainable growth of the country’s public debt. … [It] is growing quickly with each successive annual deficit. This year will see a further €60bn added to the total, or 6 per cent of GDP, and it could be greatly swollen in future by contingent liabilities for everything from bank bailouts to guarantees for lossmaking toll road contracts managed by the private sector. Edward Hugh, a Barcelona-based economist who has studied the composition of Spanish public debt, concludes that by EU measures it has already reached about 70 per cent of GDP, to which must be added 7 percentage points for the unpaid bills of central, regional and municipal governments, 5 percentage points for the debts of public enterprises and a further 5 percentage points for public debt held by the state pension fund.
And as a further reminder of the similarities between the European welfare-state driven debt crisis and our government debt problems in America, the Financial Times also reports that the Spanish government is now using IOU’s to “pay” its bills – a practice we know all too well from California:
Mariano Rajoy, the centre-right prime minister, is acutely aware of the problem – not least because his government has announced it will pay €35bn in overdue bills owed to waste collection companies, pharmaceutical groups and other suppliers by municipalities and regional governments. The unpaid bills and the other extras take Spain’s actual public debt total to about 87 per cent of GDP – close to the €877bn estimated by the Bank of Spain as the amount of total public sector liabilities (although the items included by the central bank and Mr Hugh are slightly different).
The U.S. government has more credit padding than small European countries, and so far they have not missed a single payment. However, the same U.S. government that has borrowed an exorbitant amount of money, especially over the past few years, is also ultimately on the hook for state deficits and debt. The ARRA Stimulus Bill could be seen as an attempt by Congress to stave off increasing risks of debt defaults at the state level; let us not forget that California has been using IOUs off and on for a few years, and there have been hints in other states of using the same practice. Once governments start using IOUs there is a glimpse of a possible debt default on the horizon. The Financial Times again:
“Once they get past 90 per cent [of GDP in debt] they could have a problem at any moment,” says Mr Hugh. Even using the more narrowly defined EU numbers, it is hard to see how Spain can obey its own, EU-compliant fiscal stability law and cut its debt to 60 per cent of GDP by 2020.
It is to some degree relevant to compare the crises in European states to U.S. states. This puts the Spanish and the California IOU practices in a new light.
But there are even more parallels. American politicians spend recklessly, not only on their welfare states, but also on grand projects like convention centers, sports arenas, golf courses, amusement parks, public pools and other “recreation” facilities. Not to mention the totally irresponsible waste of money on “green energy” (and we are not talking about Solyndra or the Chevy Volt…). Spain is no different:
Spain’s burgeoning debt problem has its roots in the housing construction boom that came to an end shortly before the collapse of Lehman. Ephemeral tax revenues from the building bonanza encouraged high expenditure in municipalities and regional governments on public swimming pools, hospitals and more, including several airports that now lie empty. Among actions that have come back to haunt the authorities was a decision to suppress inflation by keeping electricity prices down in spite of costly renewable energy subsidies. That meant tolerating the build-up of what is now a €24bn “tariff deficit” underwritten, yet again, by the government.
The Spanish economy is considerably bigger than the Greek. A debt default there would have much larger ramifications than if it happened in Greece. As a result, investors are a lot more apprehensive of all signs of minor trouble, far short of a default – an apprehension that is now putting an even heavier burden on Portugal and Italy to get away from the dungeon of debt. The Daily Telegraph reports:
Europe has ring-fenced Greece’s debt crisis for now but its escalating recourse to legal legerdemain has shattered the trust of global bond markets and may ultimately expose Portugal, Spain, and Italy to greater danger. “The rule of law has been treated with contempt,” said Marc Ostwald from Monument Securities. “This will lead to litigation for the next ten years. It has become a massive impediment for long-term investors, and people will now be very wary about Portugal.”
And here is yet another reminder that when politicians say that government debt default is unthinkable, it is time to start running for the hills:
At the start of the crisis EU leaders declared it unthinkable that any eurozone state should require debt relief, let alone default. Each pledge was breached, and the haircut imposed on banks, insurers, and pension funds ratcheted up to 75pc. Last month the European Central Bank exercised its droit du seigneur, exempting itself from loses on Greek bonds. The instant effect was to concentrate more loss on other bondholders. “This has set a major precedent,” said Marchel Alexandrovich from Jefferies Fixed Income. “It does not matter how often the EU authorities repeat that Greece is a ‘one-off’ case, nobody in the markets believes them.”
The U.S. government will probably never come within eyesight of any default threat. However, if states start defaulting – or take to the California IOU resolution on a broader basis – the federal debt will suddenly be compounded with a much more urgent debt situation. This could leapfrog the United States past other countries and much closer to the dungeon of default and Greece, Spain, Italy and Portugal.
There is only one permanent solution to government debt: end the welfare state. So long as we continue to believe that government should define, fund and manage our needs, we will continue to live under the burden of massive government debt and perennial deficits.