Dr. Doom Sees More Doom

Nouriel Roubini, a professor from NYU most famous for predicting the housing collapse, sees more disaster ahead. Writing in the Financial Times, Roubini, nicknamed Dr. Doom for predicting disaster in the housing market when everyone else was riding high, spells out the problem facing Europe, and thus the rest of the world.

Italy is too-big-to-fail, but also too-big-to bail. Even if it restructured its debt (2.58 trillion USD), it would still suffer from “a large current account deficit, lack of external competitiveness and a worsening plunge in gross domestic product and economic activity.” To resolve those problems Italy may “need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone.”

Until recently the argument was being made that Italy and Spain, unlike the clearly insolvent Greece, were illiquid but solvent given austerity and reforms. But once a country that is illiquid loses its market credibility, it takes time – usually a year or so – to restore such credibility with appropriate policy actions. Therefore unless there is a lender of last resort that can buy the sovereign debt while credibility is not yet restored, an illiquid but solvent sovereign may turn out insolvent. In this scenario sceptical investors will push the sovereign spreads to a level where it either loses access to the markets or where the debt dynamic becomes unsustainable.

Roubini continues:

So Italy and other illiquid, but solvent, sovereigns need a “big bazooka” to prevent the self-fulfilling bad equilibrium of a run on the public debt. The trouble is, however, that there is no credible lender of last resort in the eurozone.

He explains that Eurobonds are out of the question due to German politics – they’ve bailed out enough people, they say (rightly) – and the ECB is prevented from doing so: “as unlimited support of these countries would be obviously illegal and against the treaty no-bailout clause.” Roubini also dismisses other discussed options as ineffective or unrealistic.

The austerity necessary to pay down the debt and save the credit ratings, he argues, will make the recession worse: “Raising taxes, cutting spending and getting rid of inefficient labour and capital during structural reforms have a negative effect on disposable income, jobs, aggregate demand and supply. ”

Even a restructuring of the debt – that will cause significant damage and losses to creditors in Italy and abroad – will not restore growth and competitiveness. That requires a real depreciation that cannot occur via a weaker euro given German and ECB policies.

If you cannot devalue, grow, or deflate to a real depreciation, you must abandon the Euro. The eurozone could survive Greece or Portugal doing so, but not Italy (or Spain). That would effectively break-up the eurozone. That “slow-motion train wreck is now increasingly likely.”

Only if the ECB became an unlimited lender of last resort and cut policy rates to zero, combined with a fall in the value of the euro to parity with the dollar, plus a fiscal stimulus in Germany and the eurozone core while the periphery implements austerity, could we perhaps stop the upcoming disaster.

There are even odds that this will happen. Berlusconi has resigned as prime minister, but that will only calm the markets for so long. The structural problem of their debt remains. As does the threat of the collapse of the euro. They will continue regardless of who hosts the next bunga bunga party.

Why The Euro Will Fail

Not so in the case of the euro. The euro zone is a hybrid: a single currency with 17 national fiscal and economic policies. It has no common treasury, no tax-raising powers, no joint bonds and no central bank acting as lender of last resort. In good times, this did not matter. But in the worst financial crisis in decades, the flaws are glaring. Even Mr Berlusconi cruelly described the euro as “a strange currency that has convinced nobody”.

Countries cannot quit the euro without extreme economic pain, but nor is it easy to fix. Vetoes may be needed to maintain democratic consent, even if they make for poor crisis management. A blockage in one country endangers all. The markets are testing the ambiguities to destruction. Vague promises to “do whatever it takes” to save the euro are not enough. Will the ECB deploy its full resources to stop the crisis? How much intrusion into national policies are Greece and Italy ready to accept? How far is Germany willing to extend its credit? Will the euro zone’s states hang together or hang separately?

These are big questions, affecting the nature of the state, sovereignty and democracy. Mr Papandreou may have messed up his tactics, but he was right on one point. The changes needed to save the euro are so profound in nature that, sooner or later, they must have the explicit consent of the people—or they will fail.

Source.

The Cost of Dependency

Rioters have clashed with protesters in Athens where thousands of people are rallying outside parliament to condemn new cuts.

Scores of masked youths attacked a group from a communist-backed trade union with stones and petrol bombs, and police fired tear gas.

A 48-hour general strike is under way in protest at austerity measures aimed at reducing Greece’s crippling debt.

The Socialist-dominated parliament is expected to give final approval to a new austerity bill on Thursday.

The commentator in the video adds that “no modern European country has ever been asked to cut so much so quickly,” but no modern nation so lavishly spoiled itself with money it didn’t have, and then lied about it for years. Essentially the Greeks are asking the Germans to continue to work hard to pay their bills.

There is a Keynesian argument to be made against austerity: it will lead to a contraction that will further the deficit problem. Not all economists believe that, but let us for the sake of argument say that it’s true. Are these protestors really arguing this, or are they fighting like hell to keep their (unearned) entitlements? If there were to be a Keynesian stimulus now, would these same protestors accept spending cuts in the future? When the Socialist Party is the party of fiscal responsibility, you know a nation is in trouble.

The austerity measures will almost certainly be passed to satisfy foreign lending demands. Even with such measures, the Greeks have proven themselves catastrophic to their bond holders.

Private holders of Greek debt may need to accept losses of up to 60 percent on their investments if Greece’s debt mountain is to be made more sustainable in the long-term, a downbeat analysis by the EU and IMF showed on Friday.

Euro zone finance ministers threw Greece a lifeline on Friday by agreeing to approve an 8 billion euro loan tranche that Athens needs next month to pay its bills.

But the European Commission, European Central Bank and International Monetary Fund — the so-called troika — issued a gloomy report on Greece’s ability to pay its debts.

Among three scenarios it examined, the only one that would reduce Greece’s debt pile to 110 percent of GDP — a level still regarded as high — was one in which private bond holders agreed to a 60 percent haircut.

The bond holders are required to sacrifice, but not the Greeks – who collectively act like spoiled teenagers demanding to borrow the car without having first done the dishes.

Let the Greeks default and leave the Eurozone to return to the drachma. Their bondholders will take their losses. The drachma will be allowed to depreciate relative to the Euro which will spur the Greek economy. They’ll be unable to borrow foreign money, and so will be forced into austerity. If they try to print their way out, only the Greeks will be hurt, not all of Europe. They will have to live as responsible adults, not spoiled teenagers. (The difference is that adults pay for their lunches. Teenagers believe they are free.) The rest of the Eurozone can worry about their balance sheets and the health of Spain and Italy – “too big to bail, too big to fail.” The Euro would be strengthened and its interest rates lowered. It would also be more respected as a currency and a stronger rival to the USD as the world’s reserve currency.

“Even after he got fat, he just ate and ate.”

There is no need to buy Michael Lewis’ latest book, Boomerang – it is all available free online – but there is a reason to read it: you’ll know that it is selfishness and shortsightedness that devour us. We are genetically programmed to live in a world of scarcity, but when given low-hanging fruit we devour it, no matter how rotten it may be. We eschew delayed gratification, and thrive by living in the moment without regard to the future.

Boomerang is a collection of five long (and hilarious) articles of Lewis’ “financial-disaster tourism,” originally published in Vanity Fair. All are linked below for those who don’t mind reading 40 pages on their computers. I’ll expound on two of the articles here.

The Icelanders were tired of fishing, and so became investment bankers – some with only a few days’ worth of training – and sank their nation.

The Irish, like Americans, mocked those who said their real estate was a bubble. The government of Ireland eventually confessed to losses of 34 billion euros, which is the equivalent of the U.S. losing $3.4 trillion!

The Greeks were perhaps the most ridiculous of the lot: $1.2 trillion of debt, or a quarter-million dollars for every working Greek. This was not due to a subprime crisis, but to perennial lying by the government about how much it was spending, and reckless disregard by politicians who showered more and more benefits on people who were increasingly less productive.

The retirement age for Greek jobs classified as “arduous” is as early as 55 for men and 50 for women. As this is also the moment when the state begins to shovel out generous pensions, more than 600 Greek professions somehow managed to get themselves classified as arduous: hairdressers, radio announcers, waiters, musicians, and on and on and on.

The Germans made the mistake of trusting everyone else, including the Irish and the Americans. Lewis writes specifically about California and San Jose, but one fears he could easily have written about many similar states and municipalities. But California – with its natural riches so skillfully squandered – is a great pick.

[Chuck Reed, the mayor of San Jose, has] a problem so big that it overwhelmes ordinary politics: the city owes so much more money than it can afford topay to its employees that ic ould cut its debts in half and still wie up broke. ‘I did a clculation of cost per prublic emploee,’ he says, as we settle in. ‘We’re not as bad as Greece, I don’t think.’

We are not as bad as Greece. Some consolation.
We are still bad, and certainly worse off than we were before, both fiscally and morally. The fiscal reality is well known. Well, the specifics may not be well known – how broke we are exactly – but the average American knows we are broke. That’s a start. The moral bankruptcy is not spoken of nearly enough. Living outside one’s means or living off of unearned income corrupts us morally. Work does not just make us better off, it makes up better.

In Greece, flawed character – corruption, tax evasion, bribery, etc. – is the name of the game. Voters demand more and more services of the state, while working and paying less. The result is an utter disrespect of the civic virtues of citizenship and of their fellow citizens themselves.

The Greek state was not just corrupt but also corrupting. Once you saw how it worked you could understand a phenomenon which otherwise made no sense at all: the difficulty Greek people have saying a kind word about one another. Individual Greeks are delightful: funny, warm, smart, and good company. I left two dozen interviews saying to myself, “What great people!” They do not share the sentiment about one another: the hardest thing to do in Greece is to get one Greek to compliment another behind his back. No success of any kind is regarded without suspicion. Everyone is pretty sure everyone is cheating on his taxes, or bribing politicians, or taking bribes, or lying about the value of his real estate. And this total absence of faith in one another is self-reinforcing. The epidemic of lying and cheating and stealing makes any sort of civic life impossible; the collapse of civic life only encourages more lying, cheating, and stealing. Lacking faith in one another, they fall back on themselves and their families.

Such attitudes exist in our own society as well, though fortunately to a much smaller extent. Some areas excel in this Athenian arena though. Take Vallejo, CA.

Back in 2008, unable to come to terms with its many creditors, Vallejo declared bankruptcy. Eighty percent of the city’s budget—and the lion’s share of the claims that had thrown it into bankruptcy—were wrapped up in the pay and benefits of public-safety workers. Relations between the police and the firefighters, on the one hand, and the citizens, on the other, were at historic lows. The public-safety workers thought that the city was out to screw them on their contracts; the citizenry thought that the public-safety workers were using fear as a tool to extort money from them. The local joke was that “P.D.” stands for “Pay or Die.”

Thus a society begins to unravel.

The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans.

Why exactly do we have such high personal indebtedness? It’s not due to the current recession; our indebtedness predates it. But rather it is due to our desire to keep up with the Joneses. It is due to our materialism. I have a right to the iPhone. I have a right to those designer jeans. Everyone has a right to everything that is new and good and desirable. Walmart reintroducing lay-away might not be a bad indicator when all is said and done. It may mark a return to more personal responsibility, which may translate into more public responsibility. We need more delayed gratification and savings, during good times and bad.
Either buy the book or read the articles online, but either way, read Boomerang.

Berlusconi and Germany’s Nightmare Scenario

As I wrote two days ago, Beslusconi is an embarrassment to Italy. Fareed Zakaria writes that he is also a nightmare for Germany, and by default (pun completely intended), the rest of the Eurozone.

A few weeks ago, we got a glimpse of Germany’s nightmare scenario: Markets began focusing on Italy and its debt became expensive. The European Central Bank intervened, buying Italian bonds, which lowered rates at which Rome could borrow. As soon as the situation stabilized, Italy’s prime minister, Silvio Berlusconi, began watering down his commitments to enact economic reforms.

With such leadership, the future looks bleak for Europe.

Europe needs a crisis agenda to get out of its bind, but beyond that it needs a growth agenda, which involves radical reform. The fact is that Western economies — with high wages, generous middle-class and political subsidies, and complex regulations and taxes — have become sclerotic. Now they face pressures from three fronts: demography (an aging population), technology (which has allowed companies to do much more with fewer people) and globalization (which has allowed manufacturing and services to locate across the world). If Europe — and, for that matter, the United States — cannot adjust to this new landscape, it might escape this storm only to enter another.