Another Greek Debt Default?

Three years have passed since Greece simply nullified part of its debt. In the last quarter of 2011 the Greek government owed its creditors 356 billion euros; in the first quarter of 2012 that debt had been reduced to 281 billion euros, a reduction of 75 billion euros, or 21 percent. The banks that owned Greek treasury bonds were strong-armed by the EU and the ECB into accepting the debt write-down; ironically, that only added insult to injury as banks in, e.g., Cyprus started having serious problems as a result of precisely that same write-down.

As some of you may recall, a bit over a year after the Greek government unilaterally decided to keep some of the property lenders had allowed them to use – in other words wrote down their own debt – banks in Cyprus began having problems. Having invested heavily in Greek treasury bonds they had to take a disproportionately impactful loss on their lending to Athens. As a direct result the EU-ECB-IMF troika began twisting another arm: that of the Cypriot government. They wanted the government in Nicosia to order the banks in Cyprus to replenish their balance sheets with – yes – money confiscated from their customers.

That little episode of assault on private property is also known as the Cyprus Bank Heist.

Both these events, which exemplify reckless disrespect for private property and business contracts, make Bernie Madoff look like a Sunday school prankster. Unlike Madoff, government is established to protect life, liberty and property. But in both Greece and Cyprus government has voided property rights simply because it is the most convenient way at the time for government to fund its operations.

In other words, to protect the welfare state at any cost.

There were many of us who thought that Europe’s governments had learned a lesson from the massive protests against both the Greek debt write-down and the Cyprus Bank Heist. Sadly, that is not the case. Benjamin Fox, one of the best writers at EU Observer, has the story:

With fewer than three weeks to go until elections which seem ever more likely to see the left-wing Syriza party form the next Greek government, the debt debate has returned to the centre of European politics. Syriza’s promises to call an end to the Brussels-mandated budgetary austerity policies … are not new … But what is potentially groundbreaking is Syriza’s proposal to convene a European Debt Conference, modelled on the London Agreement on German External Debts in 1953 which wrote off around 60 percent of West Germany’s debts following the Second World War

Apparently, Syriza does not think twice about the actual consequences of their proposal. If it was carried out, it would have the same kind of effects on Europe’s banks as the last debt write-down. While there are no immediately reliable sources on how much of the Greek government debt is owned by financial corporations, we can get an indirect image from other euro-zone countries in a similar situation. In Spain, e.g., banks owned 54.3 percent of all government debt in 2013; in Italy the share was 55.6 percent while 41.2 percent of the French government were in the hands of financial corporations.

Adding up actual debt for these three countries, both total and the share owned by banks, gives us a financial-corporation share of almost exactly 50 percent. Using this number as a proxy for Greece, we can assume that banks own 160 billion of 320 billion euros worth of Greek government debt.

A Greek debt write-down according to the Syriza proposal would, if it cut evenly across the total debt, force banks to lose 86 billion euros. And this is under the assumption that, unlike the last write-down, banks are treated on the same footing as everyone else. Back then banks had to assume a bigger shock than other creditors.

The 2012 write-down was worth a total of 75 billion euros.

Has Syriza even taken into account that families, saving up for retirement, own treasury bonds? In Italy they own as much as ten percent of all government debt, a share that would equal 32 billion euros in Greece. But even if that number is five percent – 16bn euros – and you ask them to give up 60 percent of it, the impact on remaining private wealth in Greece would be devastating.

To make matters worse, Syriza does not confine their confiscatory dreams to their own tentative jurisdiction. Benjamin Fox explains that Syriza hopes that a write-down in Greece…

would lead to a huge write-down of government debt for … other southern European countries. The idea was initially mooted by Syriza leader Alexis Tsipras in 2012 when the left-wing coalition finished second in the last Greek elections. Roundly dismissed as fantasy for almost all the two years since then, the proposal is at the heart of the party’s campaign manifesto and Syriza insists it won’t back down if it wins the election.

In the three countries mentioned earlier, Italy, Spain and Greece, banks own a total of 2.47 trillion euros worth of debt. A 60-percent write-down of that equals 1.58 trillion euros. Compare that, again, to the total Greek write-down of three years ago of 75 billion euros.

In Italy alone households own 215 billion euros in government debt. Is the socialist cadre leading Syriza ready to rob them of 89 billion euros just to improve their government’s balance sheets? That would be 1,500 euros for every man, woman and child in Italy. Obviously, all of them do not own government debt, but the more concentrated the ownership is the bigger the impact will be on their economic decisions.

This is, for all it is worth, an idea of galaxy-class irresponsibility. If it ever became the law of the land in Europe it would set off a financial earthquake far beyond what the continent experienced in 2009. And I keep repeating this: all of this is under the assumption that banks will not be discriminated against – an assumption that is not likely to survive all the way to a deal of this kind. Europe’s socialists have a tendency to despise banks and consider them unfair, even illegitimate institutions. It is possible that Syriza, at least as far as Greece is concerned, would force banks to eat the entire write-down loss.

But is this really worth all the drama? After all, the Greek election is three weeks out. Benjamin Fox notes that “Syriza is so close to taking power that the proposal deserves to be taken seriously.”

This debt write-down is part of a broader plan that Syriza has put in place for the entire European Union. To work at the EU level the plan would have to be more complex and involve a series of transactions involving the European Central Bank that, frankly, amount to little more than macro-financial accounting trickery. At the end of the day, those who have lent money to Europe’s governments would make losses worth trillions of euros.

As things look today it is not very possible that Syriza would have it their way across the EU. But it is almost certain that they will go ahead and do it in Greece. What the ramifications would be for the Greek economy is difficult to predict at this point – suffice it to say that the storm waves on the financial ocean that is the euro zone will rise again, and rise high, if Syriza wins on January 25.

Sweden at the Crossroads

Sweden holds a national election on Sunday, September 14. The current parliamentary majority, a center-right coalition called The Alliance, is set to lose its majority. A three-party group of red-and-green socialists is expected to come in a few parliamentary seats short of majority, leaving the next prime minister and his cabinet dependent on nationalist, self-proclaimed “socially conservative” Swedish Democrats.

Not a lot has been said about the election outside of Sweden. This is unfortunate, because the country that American liberals used to tout as their role-model society is on the brink of a social and economic disaster up and above what any European country has experienced since the military coups in Greece and Portugal in 1967 (not counting the Balkan War).

I have covered Sweden in scattered articles, and my new book Industrial Poverty has an entire chapter on the crisis of the Swedish welfare state. However, time constraints have precluded me from analyzing the situation there in more detail on this blog. Therefore, I am grateful that the Economist reports on the pending election and its consequences. Unfortunately, the reporting is not entirely accurate:

For a decade Sweden could plausibly claim to be Europe’s most successful economy. Anders Borg, the (formerly pony-tailed) centre-right finance minister since 2006, likes to trot out numbers for his time in office: GDP growth of 12.6%, a rise in gross disposable incomes of almost 20%, a budget moving into surplus and a public debt barely above 40% of GDP.

I have no idea where they get these numbers from. But I also do not see what is so impressive with them. A GDP growth of 12.6 percent in eight years is less than 1.5 percent per year if you factor in the compounded growth effect. According to Eurostat National Accounts data, GDP growth has averaged just over 1.3 percent per year since the center-right government won the 2006 election. Private consumption has increased a bit faster, but only at the expense of a doubled debt-to-income ratio for Swedish families. In 2000 the debt-to-income ratio was approximately 90 percent; ten years later it had doubled. (By comparison, the U.S. debt-to-income ratio topped out at 140 percent before the Great Recession began.) In my new book Industrial Poverty, which has an entire chapter on Sweden, I adjust consumption growth for a constant debt ratio. The result is a staggering loss of spending (you will have to buy the book to get the details…) which shows that the only reason why the Swedish economy has grown a bit faster than the EU average over the past decade is that Swedish families have accumulated a lot more debt.

In fact, from 2006 to 2012 household debt as share of GDP grew by 22 percent, faster than in two thirds of EU countries. By 2012 Swedish households are the seventh most indebted in the EU; an extrapolation of the 2006-2012 trend would place Sweden among the top five in 2013 (for which no complete data has been reported yet).

Debt-driven growth is not the way forward, especially since the debt drive is based on an out-of-control real estate market. Swedes have access to mortgage loans that only cost them interest payments, and the Swedish central bank has the most aggressive in the EU – after the ECB – in pushing more cash out into the economy. Long story short: there is nothing to brag about in the Swedish economy.

The only sector that is thriving in Sweden is the exports industry. They, on the other hand, are increasingly operating as an isolated sector from which little more than tax revenue trickle down.

The Economist again:

[The center-right government] has overturned Sweden’s old image as a high-tax, high-spending Socialist nirvana. Twenty years ago public spending took an eye-watering 68% of GDP; today the figure is heading to 50%. Although the tax burden remains high by international standards, top rates have been cut, as have corporate taxes. Taxes on gifts, inheritance, wealth and most property have been scrapped.

This is a bad case of statistical trickery. The reason why government spending reached two thirds of GDP in 1994 is that the country’s GDP had been contracting for three years at that time, that unemployment exceeded 15 percent and that there had been no major cuts in income security programs. During the three years that followed that 1994 figure government spending was cut by an equivalent of five percent of GDP. That would be $850 billion here in the United States.  Later, the Swedish government laid off one fifth of the employees in its socialized health care system. Replacement ratios in income security systems were pushed down from 90 percent of your current income to 50 percent in the worst case and nowhere more than 80 percent. Student-to-teacher ratios grew in public schools and the number of hospital beds per 100,000 citizens was reduced to the lowest level in the European Union.

If you make such heavy spending cuts you will no doubt see a decline in the ratio of government spending to GDP.

On the tax side, the Economist perpetuates the mythology that Sweden has cut its top income tax rates. In 2013 the top rate was still 60 percent, a figure that anyone can find who is willing to examine Swedish tax tables. What has been cut is the tax burden at the lower end: Sweden now has its own version of the American Earned Income Tax Credit. However, its effect has been the same as the EITC, namely to increase the discouraging marginal effect in the income tax system. While it is cheaper to live on a low income, the price tag on a promotion or an education has risen significantly.

Ignoring reality on the ground in Sweden, the Economist is surprised that Swedish voters seem ready to hand government over to the green-socialist left. Needless to say, the magazine struggles to explain the predicted election outcome:

Although the polls have narrowed sharply in the closing days before the September 14th election, all the signs are that Swedes will toss out the centre-right alliance in favour of a centre-left government led by the Social Democrats. … Inequality has risen fast, as almost everywhere—but Swedes care about this more than most. Mr Reinfeldt boasts of the creation of 300,000 private-sector jobs, yet unemployment is stubbornly high at almost 8%, and far worse among immigrants and the young.

The number for job creation is flat wrong. According to Statistics Sweden, quarterly workforce data, a total of 227,000 jobs have been added to the Swedish economy from first quarter of 2007 to first quarter of 2014. Of those jobs, only 47 percent are full-time permanent positions. The rest are temporary, primarily low-wage service jobs. Furthermore, youth unemployment – which government has tried to manipulate down – persists around 25 percent, which is close to the EU average.

With all this in mind, there is no doubt that Sweden is better off today than it would have been under a left-wing government over the past eight years. The social democrats and their prospective coalition partners – the greens and an unapologetic communist party – have promised to raise a slew of taxes as soon as they get into office. Among the more controversial proposals is to return the payroll tax for young workers from its current rate of ten percent to the normal rate three times higher. It is difficult to estimate what the actual effect of this would be on the Swedish labor market, but the attempts made thus far point to 10-20,000 lost jobs for people between high-school age and 25.

Again, Sweden would be better off under the current Alliance government, but it is, frankly, not very difficult to provide better policy than socialists whose idea of growth and prosperity is a higher tax bill. What Sweden truly needs is a turn in the libertarian direction, with major reforms to dismantle the welfare state. Such reforms would start with privatization of the country’s anorectic health care system, proceed with a strengthened – and truly private – school choice system, then privatize the country’s costly and inefficient income security system, and top it all off with a major tax reform that would cut the current world’s-highest tax burden in half.

Such reforms, however, will have to wait until there are true libertarians in Sweden’s parliament. And that won’t happen over night.

When Is Government Big Enough?

Welcome to Year of the Lord 2014. (Forget that “Current Era” crap – we are on God’s calendar for a reason!)

A lot is at stake this year. For us here in America we have upcoming midterm elections in November. Republicans have the momentum and it is not impossible that they take the Senate. The Democrats are panicking over what the Obama presidency is doing to their party; they have already suffered costly losses in state legislatures and gubernatorial offices.

We will also see an emerging field of presidential candidates for 2016. There are already some interesting Republicans lurking behind the curtains. New Jersey Governor Chris Christie is often suggested as an early front runner. Senator Ted Cruz has won many informal polls recently, and let’s not forget Senator Rand Paul, a much more realistic libertarian politician than his firebrand father.

To make matters even more interesting, there could actually be some respectable candidates on the Democrat side as well, such as New York Governor Andrew Cuomo (though he might hold off until he’s done two terms).

We also have to get really serious about our budget deficit. Fortunately, Compact for America – I am on their advisory council – is making progress with a good, realistic proposal for a constitutional amendment to bring about a budget balance.

Overall, the outlook for the United States is moderately optimistic. That includes the economy, which is not exactly steaming ahead, but definitely crawling forward faster than the European economy. The fact of the matter is that Europe, or at least the European Union, is in much bigger trouble than the United States. Yes, our interest rates on such indicators as the ten-year Treasury bond may be a bit higher than, e.g., France, but unemployment, GDP growth, taxes and welfare spending are all moving in the wrong direction in the EU.

To make matters worse for Europe, the current crisis, which I have described as a state of industrial poverty, is far from over. In fact, it may very well make a big turn for the worse, a fact that very few people speak openly about. We find a notable exception in one of the world’s few remaining respectable journalists, namely Ambrose Evans-Pritchard at The Telegraph, who does not mince his words when discussing the mounting debt crisis in the industrialized world:

Much of the Western world will require defaults, a savings tax and higher inflation to clear the way for recovery as debt levels reach a 200-year high, according to a new report by the International Monetary Fund. The IMF working paper said debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, either negotiated 1930s-style write-offs or the standard mix of measures used by the IMF in its “toolkit” for emerging market blow-ups. “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point,” said the paper, by Harvard professors Carmen Reinhart and Kenneth Rogoff.

Some telling examples of what we are talking about:

  • The EU, with 28 member states, had a gross government debt of 86.8 percent of GDP in the second quarter of 2013, up from 84.8 percent in Q2 2012;
  • The 17-member euro zone’s debt ratios were 93.4 percent in Q2 2013 and 89.9 percent in Q2 2012;
  • Greece: 169.1 percent, up from 149.2;
  • Spain: 92.3, up from 77.6;
  • France: 93.5, up from 90.8;
  • Italy: 133.3, up from 125.6;
  • The Netherlands: 73.9, up from 68.4.

Very few EU member states show a falling debt ratio, and when they do, the decline is marginal compared to the rise in other countries.

There is an implicit premise in the IMF report about the relation between the private sector and government. Before we get to it, let’s hear more from Evans-Pritchard:

The [IMF] paper said policy elites in the West are still clinging to the illusion that rich countries are different from poorer regions and can therefore chip away at their debts with a blend of austerity cuts, growth, and tinkering (“forbearance”). The presumption is that advanced economies “do not resort to such gimmicks” such as debt restructuring and repression, which would “give up hard-earned credibility” and throw the economy into a “vicious circle”. But the paper says this mantra borders on “collective amnesia” of European and US history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end.

Very important indeed. Remember the Greek partial debt default? Not to mention the Cypriot Bank Heist when the government of Cyprus confiscated private savings deposits to pay for a bank bailout. Both these measures are now part of the legislative toolkit as the governments of the EU continue to fight their hopeless fight against the debt.

In reality, this fight is about something else than the debt itself. It is about the very heart and soul of the European economy. If the EU chooses to deal with its current crisis the way the IMF hints at, then it will automatically put government above the private sector. The measures proposed will save government at the expense of the private sector. This is the implicit premise in the IMF report, one that Evans-Pritchard does not address. However, as we return to his column we get some hints of how this premise would inform actual policy:

While use of debt pooling in the eurozone can reduce the need for restructuring or defaults, it comes at the cost of higher burdens for northern taxpayers. This could drag the EMU core states into a recession and aggravate their own debt and ageing crises. The clear implication of the IMF paper is that Germany and the creditor core would do better to bite the bullet on big write-offs immediately rather than buying time with creeping debt mutualisation. The paper says the Western debt burden is now so big that rich states will need same tonic of debt haircuts, higher inflation and financial repression – defined as an “opaque tax on savers” – as used in countless IMF rescues for emerging markets.

Aside the implied acknowledgement that the private sector will have to give in order for Europe’s welfare states to take, this paragraph is an effective IMF acknowledgement that Europe is now in a state of long-term economic stagnation.

The two issues actually connect. If there was any prospect of strong economic growth in the EU, there would not be any need to push for practically authoritarian measures to “save” governments from their own debts. Yet the IMF report cleverly opens for precisely that, namely debt defaults on a much wider scale than happened in Greece, as well as inflation and widespread use of so called “financial repression”:

Most advanced states wrote off debt in the 1930s, though in different ways. … Financial repression can take many forms, including capital controls, interest rate caps or the force-feeding of government debt to captive pension funds and insurance companies. Some of these methods are already in use but not yet on the scale seen in the late 1940s and early 1950s as countries resorted to every trick to tackle their war debts. The policy is essentially a confiscation of savings, partly achieved by pushing up inflation while rigging the system to stop markets taking evasive action.

We hear more and more about inflation as a “solution” to the debt crisis. This is disturbing, especially since when the inflation genie is out of the bottle, he is mighty reluctant to get back in there again. While it is difficult for politicians to cause inflation, it is not impossible, and if they are delusional enough to believe that they can turn off the inflation faucet just as easily as they can turn it on, they are going to use it.

Again, inflation is but one of the measures that politicians would resort to in order to save the welfare state from its own debt. The measures to save the welfare state would by necessity tax the private sector in every way possible, thus forcing voluntary economic activity – the heart and soul of a free society – to take the back seat while coercive economic activity – the welfare state – lives on unperturbed by the weight of its own debt.

The comparison to World War II debt is an egregious way to elevate the welfare-state crisis above the responsibility of statist politicians who built and nurtured it. World War II was an exceptional, disastrous event. The current debt crisis was not caused by a disaster. It was caused by deliberate, long-term political action to take one man’s money and time and give to someone else, for no other reason than that the recipient was considered “entitled”.

Through the build-up of the welfare state, government spending ran amok, demanding far more money than taxpayers could afford, over a long period of time. I explain this in detail in my forthcoming book Industrial Poverty; the short story is that Europe’s welfare states allowed entitlement spending to creep up above tax revenues, little by little, until the combined effect of taxes, entitlements and work discouragement had pushed back the private sector to where it was structurally unable to pay for the welfare state.

At this point it was only a matter of time before the debt that the welfare state brought about would explode. The financial crisis came along and helped the debt balloon inflate – notably the financial crisis was aggravated by banks’ exposure to deteriorating government debt!

This means two things. First, it is high time to stop imposing more regulations on the private sector. The more governments regulate the private sector, the more hindrances they put in place for the only engine that can pull Europe out of its crisis. Secondly, there is no way out of the debt crisis unless we are willing to say farewell to the welfare state. Its entitlement systems and its taxes will continue to weigh down the private sector for as long as the welfare state exists. The same crawling debt crisis that exploded in 2008-09 will begin again as soon as governments all over Europe stop their austerity measures.

At the same time, austerity has only made a bad crisis worse. The design of austerity measures used thus far is clearly to save the welfare state and make it fit within a tighter economy. Yet the burden of entitlement programs has not eased – on the contrary, it has increased. For every new austerity measure that has increased taxes and cut government spending, the economic crisis has worsened, thus giving rise to the need for even more austerity.

Europe must break this vicious circle, and the only way to do this is to abandon the desperate hunt for the balanced budget. Instead, Europe’s political leadership must focus on structurally phasing out the welfare state. They must privatize health care, income security and education – and cut taxes proportionately to their structural spending cuts. They must let the private sector take over what government has failed at delivering, both in terms of producing services and in terms of funding those services. Permanent spending cuts coupled with well designed tax cuts.

Only then can Europe see growth and prosperity again. If they do not choose this path, but instead stick to the old recipe of keeping the welfare state and trying to starve it into a stagnant economy, they will perpetuate their debt crisis.

That, in turn, means static or even declining private-sector activity while more and more people will clamor to the welfare state’s entitlement programs just to be able to make ends meet every month. Government will continue to grow, both in absolute and in relative terms. That growth will continue ad infinitum, until there is nothing but a planned, Sovieticized economy left.

Europe does not need that. Europe needs massive doses of economic freedom.


EU Debt Problem Worse than U.S.

The latest news on the U.S. fiscal crisis is that President Obama is changing is mind on negotiations with Congressional Republicans. The man who would rather negotiate without preconditions with Iran’s Islamist thug regime than democratically elected American legislators has been pushed to the negotiation table by the looming threat of October 17. That is the date when, according to the Obama administration, the U.S. Treasury runs out of money and will default on its debt. Therefore, in order to avoid having to do the unconstitutional, namely to not make debt payments, Obama chooses to sit down with the only people on the face of the planet that he would never negotiate with.

In theory, if the president had ordered the Treasury not to make debt payments he could have been impeached. We will not know for a long time what has been going on behind the scenes in DC over the past couple of weeks, but it is noteworthy that the president suddenly decided that it was better to show a glimpse of leadership on the federal budget situation. It is an open question what the outcome will be, but at least there are talks and different views are being vetted, allowed to clash and then pave the way to an informed compromise. It may not be the best compromise in terms of fiscal policy, but the very fact that there is a vigorous debate in Washington, DC – and that the sides involved can take such harsh stances that the federal government shuts down for a while – is ultimately a sign that the American constitutional republic is in fact working.

As I explained recently, while the Europeans may be laughing at the American “bickering” and government shutdown, their own fiscal house is far from in good order. While there is a hot political fight over how to get the U.S. debt under control, the Europeans seem to have given up entirely on that front. Consider these numbers from Eurostat, reporting changes in debt-to-GDP ratio from first quarter of 2011 to first quarter of 2013:

EU 27 debt to GDP ratio change

Source: Eurostat; seasonally adjusted numbers.

Over the past two years, 23 out of the EU’s 27 member states (not counting rookie member Croatia) have increased their debt-to-GDP ratio. Portugal is worst: in the first quarter of 2011 their government debt was 95.1 percent of the Portuguese GDP; in the first quarter of 2013 it was 127.2 percent of GDP, an increase by 32.1 percentage points in two short years.

For the EU-27 as a whole, debt has increased from 80.2 percent to 85.9 percent. This is partly due to the fact that almost all of Europe’s economies are standing still, but the main reason is of course that the variables that drive spending in Europe’s welfare states are still in place. Much of government spending in a welfare state is on autopilot, driven by eligibility variables in entitlement programs. In Denmark, e.g., conventional wisdom among economists is that the legislature can directly affect about three percent of the annual government budget – the rest is governed primarily by welfare-state entitlement programs.

Needless to say, there is a connection between a GDP that stands still and a welfare state that has to dole out more money through its entitlement systems. But this only reinforces the point that Europe has a big debt problem: if structural spending systems run away with the government budget, you don’t sit around with your arms crossed. You dismantle those spending systems.

If you don’t, you will keep on borrowing. Which, again, is precisely what the welfare states in Europe do. Of the 27 EU states, 25 increased their debt in euros – only Hungary and Greece had a nominally smaller debt in Q1 of ’13 than in Q1 of ’11 – and the decline in the Greek debt was entirely due to the partial default almost two years ago. In terms of growth, their debt is back on an out-of-control path.

In total, the 27 EU states have borrowed another 1.1 trillion euros over the past two years. Five countries now have a debt that exceeds 100 percent of their GDP: Greece, Italy, Portugal, Ireland and Belgium. This is compared to two countries, Greece and Italy, two years ago. France is heading in that direction, with a ratio that has increased from 84 percent in 2011 to 92 percent today.

These are all bad numbers. But what is worse is that there is no debate in Europe about how to stop this debt growth. The austerity policies put in place by the EU, the ECB and the IMF have been embraced as fiscal policy gospel by Europe’s political leaders. Since austerity has been in place for four years now in some countries, and since the outcome has been utterly disappointing, it is high time for Europe to reconsider its current path.

For that to happen, though, you need an open and honest debate. America has an open and honest debate. Europe does not.

Guess who will prevail in the end…

Greek Debt Out of Control Again

I recently expressed my deep concerns regarding the unstable political situation in Greece, concluding that the government’s attempt to ban or otherwise neutralize the neo-Nazi Golden Dawn party is a very risky game. while morally the right thing to do, and politically probably necessary, the potential for a violent backlash is very high. One reason is that many Golden Dawn supporters appear to be supporting the party because they want Greece out of either the currency union or both the EU and the euro.

Their motive is not hard to understand: it has now been five years since Greece entered the economic crisis, and at least four of those years have to the average Greek been dominated by EU-imposed austerity. In package after package, the EU, the ECB and the IMF have dictated bone-crushing spending cuts and prosperity-destroying tax hikes. Since Greece is a welfare state, government is deeply involved in almost every aspect of people’s lives. When it goes on an austerity rampage the effects are by necessity both far-reaching and painful for Greek families.

Today, Greece stands with one foot in the EU and one foot in social and economic chaos. Political extremism is growing, both in the form of terrorizing socialist political violence and growing political intimidation from Golden Dawn. At the same time, unforgiving austerity policies, aimed at stabilizing government debt, have been a complete and utter failure, Greece’s government budget is suffering from chronic deficits, partly because one quarter of the tax base, a.k.a., GDP, has vanished during the austerity years, and partly because a much larger portion of the Greek population depends on the welfare state now than was the case before the crisis.

The question is what the EU-ECB-IMF troika is going to do next. Before we seek an answer to that, let’s take a look at the Greek debt trajectory. This figure shows the Greek government’s debt as percentage of GDP per quarter since 2008:

Greek Debt 1

The debt ratio rises steadily through 2011, then drops dramatically at the beginning of 2012. That is the point when the Greek government, aggressively “encouraged” by the Troika, wrote down its own debt.

When the write-down – effectively a partial default – was executed the Greek government owed 170 euros for every 100 euros of Greek GDP. That ratio was considered entirely unsustainable at the time, especially since the quarter-to-quarter increase in the ratio was at 3.3 percent. But the problem for the EU-ECB-IMF Troika is that the rise in the Greek debt ratio has not changed since the partial default – at least not for the better. Through the first quarter of this year the debt-to-GDP ratio has grown by 4.1 percent per quarter, putting the ratio at 160.3 for the first quarter of 2013.

Before the end of this year Greece will probably have a debt ratio that exceeds what it was at the partial-default point. Here are two scenarios:

Greek Debt 2

The blue line represents a scenario where the Greek debt ratio continues to grow as it has during 2012 and 2013 thus far. The red line extends with a growth trajectory based on the ratio growth rate from 2010 and 2011, namely 3.3 percent per quarter.

As we can see, the difference is negligible. And even if we disregard the exceptionally high debt ratio growth from the first quarter of 2012 (9.3 percent) we still end up with a post-default debt ratio growth of 2.5 percent per quarter. In other words, it is only a matter of time before Greece is back in the same situation as it was in 2011, only this time with an even more tense political situation, an even higher level of economic despair among the people and a youth unemployment rate at a completely destructive 60 percent.

So, back to the question: what is the Troika going to do next? Part of the answer lies in Angela Merkel’s decisive victory in last week’s German elections. Merkel wants to save Greece, keep the currency union intact and put a smiley face on every EU citizen. As far as she is concerned, the Troika should continue to help Greece.

At the same time, Greece’s self-proclaimed saviors are running out of options. The partial debt default was evidently a disaster that has, at best, bought the Greek government one year of breathable air. No one this side of a lunatic asylum would try another debt default. But austerity has also been utterly ineffective. The Greek economy simply refuses to produce the result that the designers of austerity expected.

What to do? Well, the only workable solution is so radical it will never win even a remotely serious consideration from the Troika – at least not its two European comrades, the EU and the ECB. That solution would involve Greece leaving the EU, reinstating its own national currency, and a dedicated program to reform away the welfare state.

It is almost a given that the EU won’t let any of that happen. But that brings us back to what options the Troika has left.

Well, what options do they have left?

Another Welfare State Downgraded

Two months ago I explained how Argentina’s president, Cristina Kirchner, was pushing her country deeper and deeper into a spiral of inflation and government debt. I noted that Argentina’s economy…

is spinning out of control, and it is all driven by the same old leftist agenda to use government spending to eradicate “income inequality”. This statist agenda has led to endless problems with government debt. For almost 15 years now these problems have been chronic. In 2005-2006 the IMF basically made a fire-and-rescue emergency run to Buenos Aires to initiate a debt restructuring process and prevent a complete meltdown of the Argentine economy. That restructuring process was basically complete in 2010 and you would have assumed that the country’s political leaders had learned their lesson.

They have not. President Kirchner has spent months fending off mounting accusations that her government is simply manipulating macroeconomic data to conceal an embarrassing growth record and, even worse, accelerating inflation. Part of the reason why she has been so desperate to prevent the economic truth from getting out is that her country has been on the brink of a credit downgrade. That did not work. According to the Daily Telegraph, Argentina is now sinking into the Greek hole:

Fitch cut its long-term rating for Argentina to “CC” from “B,” a downgrade of five notches, and cut its short-term rating to “C” from “B”. A rating of “C” is one step above default, AP reported.

And the situation is pretty bad indeed:

US judge Thomas Griesa of Manhattan federal court last week ordered Argentina to set aside $1.3bn for certain investors in its bonds by December 15, even as Argentina pursues appeals. Those investors don’t want to go along with a debt restructuring that followed an Argentine default in 2002. If Argentina is forced to pay in full, other holders of debt totaling more than $11bn are expected to demand immediate payment as well.

Political leaders in Argentina don’t like this one bit, saying that the ruling puts the 2002 debt deal in jeopardy. However, the real threat to that debt deal does not come from some judge trying to protect investors’ rights – it comes from endless government spending. Government has tried to pay for that spending with taxes, and when they could not jack up taxes anymore they took to borrowing. When they had borrowed so excessively that they effectively defaulted in 2002 (that was when the country went through so called debt restructuring, i.e., partial loan default) they took to a good old Latin American classic: printing moeney.

They have now exhausted all their means to fund irresponsible spending. But instead of behaving like grown-ups and taking responsibility, the Argentine president and her administration double down and, again, try to manipulate economic data. One of the inevitable results is a credit downgrade.

The Daily Telegraph has more details:

Argentina is in a deepening recession and is grappling with social unrest. Besides the court case, Fitch cited a “tense and polarized political climate” and public dissatisfaction with high inflation, weak infrastructure and currency. Fitch also said that Argentina’s economy has slowed sharply this year. Of the two other major rating agencies, Standard & Poor’s has a rating of “B-” for Argentina, five steps above default, and Moody’s rates it “B3 negative”, also five steps above default.

In other words, we can now add Argentina to the pile of already fiscally dinosauric welfare states. That pile is getting uncomfortably high, and what we have seen so far is only the beginning.

It’s time to repent, folks. It’s time to absolve of past entitlement sins and seek forgiveness for years spent behind the blindfolding veil of socialist ignorance.

It is time to let economic freedom ring.

Can Europe Be Saved?

For a couple of days now I have been working on an article to answer this question. The problem is that the question is a moving goal post: things happen almost on a daily basis that makes it difficult to nail down a coherent, workable plan for the continent. I have an answer, but let me first give yet another example of why this is such a dynamic and difficult question to deal with. GoldMoney.com discusses the consequences of the French credit downgrade:

Despite the lack of agreement over the latest (insignificant) iteration of the Greek bailout, what has really shaken the Eurozone to its very core was the new rating downgrade for France, coming on the heels of headlines calling France the “timebomb at the heart” of the EU, it means that sovereign debt concerns are slowly working their way from the periphery to the euro-core. Officials rushed to downplay the impact and importance of the downgrade.

That would be the French Prime Minister who according to CNN said that:

despite the downgrade, French debt remains among the most liquid and reliable in the eurozone.

 This statement says more about the euro zone than it says about France… Anyway. Back to GoldMoney.com, who points out that the consequences of this downgrade are indeed very serious:

France is the second largest contributor to the European bailout mechanism (ESM) and hosts one of the largest sovereign debt markets in the world. The number of solvent countries that could serve as a safe haven can now be counted with one hand, and since many of them seem committed to tying their fates to their not-so-prudent neighbours, savers are left with a lot of uncertainty and few solid options to protect themselves against the ever-increasing probability of a currency collapse or a break-up of the Eurozone.

An astute observation. Any search for a way out for Europe begins here, with the countries that are still operating within some kind of predictable parameters. But what countries can we count to that group? The United States? GoldMoney has its doubts:

US bickering over the “fiscal cliff”, an unfortunate phrase coined by Ben Bernanke, has prevented the EURUSD from weakening too much. It really is a race to the bottom as all major world currencies struggle to print faster than their neighbours. Unfortunately that is an almost inevitable development when you base money on political whim, as Ron Paul explains in this recent podcast with GoldMoney’s Andy Duncan.

Ron Paul is wrong about the virtues of returning to a gold standard. It would be a monetary-policy disaster. Other than that, though, the comment about the U.S. deficit problem is right on the money. Fortunately, there are signs that Congress and the president are moving closer together and may at least reach a patchwork agreement for the next couple of years. That will keep the United States in the small group of international safe-haven investment harbors.

That said, America cannot and should not participate in any European financial rescue efforts. The crisis is European in cause, nature and consequences, and any political solutions must emanate from European politics.

What, then, could the Europeans do? Again given the fact that the problem itself is a moving goal post, here are some recommendations:

1. Acknowledge that the crisis has two layers.

The upper layer, so to speak, is the immediate deficit crisis. Welfare states in southern Europe has gotten into a habit of borrowing to spend, and to borrow based on a credit rating backed by the euro. The euro, in turn, has been considered a trustworthy currency because it is ultimately anchored in Germany. When the euro zone was created this gave Greece, Italy, Spain and other less reliable countries a de facto German credit status. When they coupled their own spending habits with Germany’s credit rating they had created a perfect scenario with seemingly free money. The spending habits that this opened for have caused the urgent deficit crisis.

The lower layer is the structure of government spending. Whenever governments create entitlement programs, they make spending promises that are not backed by dedicated tax revenues. The long-term effect is a budget drift in the direction of persistent deficits. When legislators try to compensate by raising taxes they inadvertently increase demand for entitlements (high taxes reduce people’s standard of living and increase long-term unemployment) and reduce the very tax base they rely on. This budget drift has now conspired with the immediate deficit crisis to create a perfect storm of bad government finances.

If Europe’s political leaders acknowledged this two-layered problem they would open themselves to solving their problems productively as opposed to the haphazard approach that is currently more likely to guide them.

2. Reconfigure the euro zone. Ideally, the euro zone countries should abandon the euro entirely. That is however politically unpalatable, but at the same time the current configuration of the currency union is economically unsustainable. Since the common currency has worked like a supercharger on the structural spending problem plaguing Europe’s welfare states, it is absolutely necessary that the ECB disconnects this supercharger – or else the bank will be stuck with an endless assignment to print money.

Instead of bailing out failing welfare states with new money supply and new loans from German taxpayers, the Europeans need to realize that Greece, Spain and other debt-drenched countries no longer belong in the currency union. It would be more prudent to put those countries on a track to reintroduction of their national currencies. That would allow them a chance to re-establish a connection to reality under their own exchange rates, and it would allow the ECB and the remaining euro countries to return the currency to the strength it had prior to the current crisis.

3. Replace the budget balancing requirements with spending caps. Perhaps the most controversial part of any fiscal policy program, this idea has to do with the second layer of the European crisis. Even if Europe had not created its common currency, its welfare states would still have reached a point where they were drowning in their own debt. It would have been less dramatic and probably taken a bit longer, but they would have gotten there anyway.

This means that a solution to the problems related to the currency union will only remove the immediate crisis. Down the road, the troubled welfare states will inevitably be back in the deficit hole again. A reconfiguration of the euro zone will give Greece and its most troubled peers some time to solve their underlying, structural spending problems. In short, they need to dismantle their welfare states and allow people to take control over their own lives again.

This is a superficial three-step framework for putting Europe back on track again. The third step is of course the critical one, and it requires a lot of hard work based on carefully designed reform proposals.

Those proposals do not yet exist, but they will. Soon. I am working on a research paper where I discuss such solutions.

With all this in mind, I would point out that I am not optimistic about the prospect of saving Europe. I do not believe that there is enough political insight, let alone fortitude, to comprehend and act upon an understanding of the true nature of the continent’s crisis. I hope I am wrong, which is why I am working on a “solutions catalog”. But as the goal post keeps moving I grow a little more pessimistic that the Europeans can avoid sentencing 500 million people to a future in industrial poverty.

No Long-Term Solution to Greek Crisis

A reader recently asked what Europe should do to save itself. That is an extremely important question, and I am working on an article to address it. I should have it ready in a day or two.

In the meantime, it is time to take another trip to Greece, where nothing has changed for the better. Just over two weeks ago I reported that Greece was on the verge of an uncontrolled bankruptcy. That bankruptcy scenario is as real today as it was then, and its consequences would be just as terrifying. The Greek government has been in frantic talks with the EU, the ECB, the IMF and treasury secretaries of other euro-zone countries to avoid an otherwise imminent bankruptcy. Unfortunately, those talks are running into stumbling blocks, but even if they result in a solution for now, that solution is only going to exacerbate existing problems. The debt reduction plan that is supposed to take the Greek debt down to 120 percent of GDP by 2020 or 2022 demands more destructive austerity policies, the same policies that have already done so much damage to the country’s economic, political and social stability.

And that is, again, if the parties involved can agree on their long-term plan for Greece. Of more immediate concern is the acute situation where Greece needs tens of billions of euros just to continue to pay its immediate expenses. The Economic Times reports (thanks to Greece Crisis for tip):

Eurozone finance ministers and the IMF are still far from a deal on releasing rescue funds to Greece because of disagreement over Greece’s debt pile, a source close to failed overnight talks told AFP on Wednesday, contradicting France. “We are really not close to an agreement,” the source who declined to be named said after eurozone ministers and the IMF failed in talks in Brussels which went into the early hours of Wednesday morning.

The immediate problem is that the Greek government runs out of cash before Christmas. It has nowhere else to go for money than to the EU-ECB-IMF troika. They have conditionally agreed to lend another 31.5 billion euros – the problem is that the conditions must be palatable to all parties involved. As The Economic Times explains, that has not yet happened:

The talks, lasting 11 hours, were unable to agree on releasing the latest instalment of rescue funding needed to save Greece from bankruptcy and which are tied to approved new austerity measures, because of the related issue of managing the huge Greek debt mountain. The source told AFP that the talks, attended by the director general of the International Monetary Fund, Christine Lagarde, and the president of the European Central Bank, Mario Draghi, were stuck on the issue of how to ensure that Greek debt is sustainable in the medium term.

Most of the resistance to an immediate deal comes from the IMF:

The IMF was insisting that measures be agreed to ensure that the ratio of Greek debt to output be reduced to 120 percent by 2020 from an expected figure of 190 percent, the source said. Currently, the IMF “is refusing to sign an agreement which it considers to be unrealistic,” the source said.

Euractiv has more details, including information on how the troika wants Greece to reach its debt reduction goal:

“To bring the debt ratio down further, one needs to take recourse to measures that would entail capital losses or budgetary implications for euro area member states,” the document [from the latest meeting] says. “Capital losses do not appear to be politically feasible and would jeopardise, at least in a number of member states, the political and public support for providing financial assistance.”

Capital losses means, simply, that lenders forgive some of the loans they have given Greece. This has been tried before, with the only outcome being an even worse credit rating for the troubled country.

And now for the most contentious point. Euractiv again:

[Eurogroup chairman Jean Claude] Juncker said at a meeting a week ago that he wanted to extend the target date to reduce Greek debt by two years to 2022, but [IMF president Christine] Lagarde insists the 2020 goal should stand. The view of the IMF, which has played a role in both Greek bailouts so far, is critical since it provides international legitimacy and credibility for the efforts the eurozone is making. If the IMF were to withdraw its support for the bailout programmes, it could have a deeply damaging market impact.

That’s putting it nicely. If the IMF pulls out, there will no longer be any U.S. sourced funds available. That would leave the EU and the ECB to fund the entire Greek crisis on their own, which in all likelihood would bring about a bankruptcy or at least a massive debt default (which is almost the same thing as a bankruptcy). That, in turn, would probably force the other euro zone countries to expel Greece from the currency union.

A forced exit, as opposed to a voluntary one, would send shock waves through what is left of the Greek economy. It is an entirely open question whether or not the Greek parliamentary democracy could survive such a shock.

All this, again, depends on whether or not the debt talks would break down and the IMF walk away from the deal. According to the Economic Times and Euractiv, that possibility is not insignificant. At the same time, the Financial Times has a somewhat more optimistic view (no-cost subscription required):

Officials said the IMF, which has clashed publicly with the eurogroup recently over providing financing for Greece, continued to resist prematurely giving its assent to a package that did not fill the financing gap. But it did not insist on a rigid target of reducing Greek debt to 120 per cent of GDP by 2020 – a point that recently sparked a public spat between Christine Lagarde, the IMF’s managing director, and Mr Juncker. The IMF argued more generally that the debt burden needed to be on a sustainable medium-term path, officials present said. … Ms Lagarde left the meeting saying that while the gap had closed, “we are not there yet”. “It is progress but we have to do a bit more,” she said.

The fundamental problem remains, though: the troika, as well as the euro zone member states, are all still pushing for the same old policy measures in order to bring down the Greek debt. That means higher taxes and less government spending, with increasingly harmful across-the-board slashes to entitlement programs. As implied by the Financial Times, when these measures have been put to work over the past few years they have only resulted in a reinforced recession – which in turn has moved the debt reduction goal post:

Greece’s debt burden has ballooned since the last bailout deal in March because the country’s recession has been deeper than expected and because privatisation plans have failed to get off the ground. Greek debt is now expected to peak at 190 per cent of GDP by 2014. Furthermore, an agreement last week to extend Greece’s bailout by two years, giving Athens more time to hit austerity targets, requires an additional €15bn in financing that will further add to the country’s debt pile.

Even if the debt talks result in the release of the emergency funds of 31.5 billion euros, the Greek disaster is going to continue to unfold. Furthermore, under the best circumstances the debt talks will only result in more austerity, be it over a shorter or longer period of time, and that in turn will only mean further depression of the economy. No upturn in sight, in other words.