Coming To America: The Greek Sovereign Debt Crisis
Yesterday we presented our views on why Europe's decision to tip over the first of the bailout dominoes will be inherently a catastrophic one in the long term, and will ultimately transfer the peripheral liquidity risk into funding, and ultimately, solvency (and once again, liquidity) risk to the very core. Today, Niall Ferguson joins in, in this latest Op-Ed in the Financial Times. "It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate." In other words, Marc Faber 1, CNBC talking heads, 0... as usual.
Ferguson lists the current dead ends presented before the EU:
There is of course a distinctive feature to the eurozone crisis.
Because of the way the European Monetary Union was designed, there is
in fact no mechanism for a bail-out of the Greek government by the
European Union, other member states or the European Central Bank
(articles 123 and 125 of the Lisbon treaty). True, Article 122
may be invoked by the European Council to assist a member state that is
“seriously threatened with severe difficulties caused by natural
disasters or exceptional occurrences beyond its control”, but at this
point nobody wants to pretend that Greece’s yawning deficit was an act
of God. Nor is there a way for Greece to devalue its currency, as it
would have done in the pre-EMU days of the drachma. There is not even a
mechanism for Greece to leave the eurozone.
The options are no surprise to anyone who has followed this drama as it has unfolded over the past two months, starting with the Dubai implosion in late November (whose CDS, incidentally, is almost back to all time wides). It is certainly no surprise to anyone who, like us, has been concerned about the sovereign implosion almost a year ago.
That leaves just three possibilities: one of the most excruciating
fiscal squeezes in modern European history – reducing the deficit from
13 per cent to 3 per cent of gross domestic product within just three
years; outright default on all or part of the Greek government’s debt;
or (most likely, as signalled by German officials on Wednesday) some kind of bail-out led by Berlin.
Because none of these options is very appealing, and because any
decision about Greece will have implications for Portugal, Spain and
possibly others, it may take much horse-trading before one can be
To be sure, Keynesianism is starting to unravel. The greatest failed experiment in economic history could only have been propped up for so long, courtesy of its core beneficiaries: the very oligarchs and financiers who transferred wealth over the ages from the working class to the "financially creative" product class (i.e., those that "packaged" and managed risk...look where they got us, but don't look how much they got paid for it).
What we in the western world are about to learn is that there is no
such thing as a Keynesian free lunch. Deficits did not “save” us half
so much as monetary policy – zero interest rates plus quantitative
easing – did. First, the impact of government spending (the hallowed
“multiplier”) has been much less than the proponents of stimulus hoped.
Second, there is a good deal of “leakage” from open economies in a
globalised world. Last, crucially, explosions of public debt incur
bills that fall due much sooner than we expect
For the world’s
biggest economy, the US, the day of reckoning still seems reassuringly
remote. The worse things get in the eurozone, the more the US dollar
rallies as nervous investors park their cash in the “safe haven” of
American government debt. This effect may persist for some months, just
as the dollar and Treasuries rallied in the depths of the banking panic
in late 2008.
Yet even a casual look at the fiscal position of
the federal government (not to mention the states) makes a nonsense of
the phrase “safe haven”. US government debt is a safe haven the way
Pearl Harbor was a safe haven in 1941.
Even according to the
White House’s new budget projections, the gross federal debt in public
hands will exceed 100 per cent of GDP in just two years’ time. This
year, like last year, the federal deficit will be around 10 per cent of
GDP. The long-run projections of the Congressional Budget Office
suggest that the US will never again run a balanced budget. That’s
This is where shades or Reinhart and Rogoff emerge.
Explosions of public debt hurt economies in the following way, as
numerous empirical studies have shown. By raising fears of default
and/or currency depreciation ahead of actual inflation, they push up
real interest rates. Higher real rates, in turn, act as drag on growth,
especially when the private sector is also heavily indebted – as is the
case in most western economies, not least the US.
As we approach the proverbial endgame, the biggest supporter and enactor of flawed Keynesian policy, the Fed, is fast running out of bullets. Simply without the consumer becoming once again intimiately involved with the lie, the game can not continue.
Although the US household savings rate has risen since the Great
Recession began, it has not risen enough to absorb a trillion dollars
of net Treasury issuance a year. Only two things have thus far stood
between the US and higher bond yields: purchases of Treasuries (and
mortgage-backed securities, which many sellers essentially swapped for
Treasuries) by the Federal Reserve and reserve accumulation by the
Chinese monetary authorities.
But now the Fed is phasing out such
purchases and is expected to wind up quantitative easing. Meanwhile,
the Chinese have sharply reduced their purchases of Treasuries from
around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an
estimated 5 per cent last year. Small wonder Morgan Stanley assumes
that 10-year yields will rise from around 3.5 per cent to 5.5 per cent
this year. On a gross federal debt fast approaching $1,500bn, that
implies up to $300bn of extra interest payments – and you get up there
pretty quickly with the average maturity of the debt now below 50
The conclusion, knowing all too well that our political and financial leaders will do everything in their power, even sacrifice the population, to prevent the collapse of the system, can only be a rhetorical one.
The Obama administration’s new budget blithely assumes real GDP growth
of 3.6 per cent over the next five years, with inflation averaging 1.4
per cent. But with rising real rates, growth might well be lower. Under
those circumstances, interest payments could soar as a share of federal
revenue – from a tenth to a fifth to a quarter.
Last week Moody’s Investors Service warned that the triple A credit
rating of the US should not be taken for granted. That warning recalls
Larry Summers’ killer question (posed before he returned to
government): “How long can the world’s biggest borrower remain the
world’s biggest power?”
On reflection, it is appropriate that the
fiscal crisis of the west has begun in Greece, the birthplace of
western civilization. Soon it will cross the channel to Britain. But
the key question is when that crisis will reach the last bastion of
western power, on the other side of the Atlantic.
America no longer has the luxury of expecting that shoving its head in the sand long enough will fix everything. Indeed, we now live in a world where whole developed countries are being bailed out. A mere 3 years ago this would have sounded ludicrous and deranged, and now it causes a flurry of buying excitement in the stock market. Unfortunately, a repeat of the days of September 2008 is fast approaching, only this time absent Marsians coming to bail out the world, we are on our own.