macroeconomics professor – from the internet that makes sense
I asked an old Macroeconomics professor of mine to comment on the current state of the economy, and clear things up for me, since most articles I have read have either a strong liberal or conservative spin to them. This is his beautifully crafted reply. Warning, economic terms incoming… you can google things that you don’t understand if you haven’t taken a Macroeconomics class.
Without further ado:
Right now we are experiencing a negative demand shock. We can tell that AD has shifted to the left because economic growth has declined as has the inflation rate. In fact for awhile, GDP growth and inflation were negative. This was the first time since the Great Depression that we experienced deflation. This has been one bad negative demand shock.
The government has two general responses available: monetary policy and fiscal policy. The Federal Reserve tried expansionary fiscal policy on a scale it has never tried before. It purchased over a trillion dollars worth of assets (US GDP is about 14 trillion), with the hope that as it replaced less liquid assets with liquid cash, it would most importantly prevent a liquidity crisis among financial institutions, and then encourage lending since the financial institutions would be flush with cash. The increased lending would in turn increase AD and bring the economy out of the recession.
The Fed was able to stabilize the financial markets, but it was not able to encourage lending. Because the financial institutions were fearful that borrowers would not be able to repay, and because potential borrowers already had large debt burdens, very little lending and borrowing took place. The Fed continued to expand the monetary base, but once interest rates on treasuries reached near zero, the Fed was powerless to do any more.
This meant that it was up to fiscal policy. The federal government did pass an approximately $0.7 trillion stimulus bill, but state and local government spending shrank by an even greater amount. So, the net overall effect of fiscal policy was contractionary, making the recession worse.
The reason why state governments contracted spending was because 49 of them are required to (approximately) balance their budgets. Since in a recession tax revenues automatically fall and transfer payments automatically increase, budget deficits tend to increase during recessions. Since these states are required to balance their budgets, they had to cut spending just when it was needed the most. (Vermont is the sole state not required to balance their budget, but obviously too small to make up for the other 49 states!)
In order to use expansionary fiscal policy, governments can lower taxes, increase transfer payments, or increase purchases. Good ways to choose purchases are those that can be spent quickly or those that increase our productive capacity. The quintessential are shovel-ready infrastructure projects. The most effective tax cuts and transfer payments are to those with the highest MPC. Unemployment benefits tend to go to people with high MPC. Tax cuts to the wealthiest tend to have low MPC’s.
This is a particularly political subject. The wealthiest will argue for tax cuts, particularly for the rich. The poorest will argue for unemployment benefits and blue-collar jobs. There are more poor than wealthy (meaning more who would benefit from Democratic proposals than Republican proposals), but the wealthy seem to be better organized.
There are economic reasons for their better organization. Small groups have lower costs of organization than large groups. Small groups have an easier time divvying up the benefits than do large groups. So, many political decisions tend to favor small groups, even when the benefits to the large groups are bigger.
Right now the politics has taken a further step. Like I said earlier, budget deficits tend to increase in recessions. It good times, a large deficit crowds out private investment, but these are not good times. (We can see that private investment is not being crowded out since the interest rates are so low.) So, Republicans see this as an opportunity to shrink the size of government and are arguing that we need spending cuts, but we need to stimulate the economy so there cannot be tax increases, even on the richest 2.5%. However, their argument is not consistent. Either tax cuts or spending increases would help the economy, but either would also increase the deficit. However, the Republicans are advocating the worst combination of trying to stimulate the economy and balance the budget, since tax cuts to the rich help the economy the least. (In fact, the tax cuts were proposed as temporary in 2001, and now politicians are fighting over whether they should expire. Also, taxes have been cut even further under Obama, primarily through the FICA tax cut. So, even with Obama’s proposed end to the temporary tax cut on the wealthiest 2.5%, overall taxes would still decline under Obama, at least since he took office. The Republicans’ argument is very tenuous.)
But the Republicans also want Obama to fail. Mitch McConnell said as much. A strategy of the Republicans seems to be not just keep taxes low for the rich, but to keep the economy down so that Obama is not re-elected. I personally would say that our democracy is not functioning as we would expect. Even some Republicans have commented that their party is no longer functioning properly. For example, Obama proposed a health care plan (rising Medicare and Medicaid costs are the biggest source of of future deficit spending) that was similar to one advocated by the Republican Mitt Romney when he was Governor of Massachusetts. But Republicans fought Obama. Obama has proposed more spending cuts than tax increases, but Republicans still fight it. Unemployment rate are about double what they normally are, and Republicans are fighting to keep the highest tax bracket go from 35% to 39%, even though tax rates are the lowest they’ve been since the early 60′s (I believe since Kennedy lowered them).
It’s not clear what a debt default could cause. We have never defaulted on our debt. We have a stellar repayment record and have the best credit in the world. We pay the lowest interest rates of anyone in the world because of our stellar repayment history. Right now, the interest rate on 3-month treasuries is 0.0507% (that is not 5%, but less than one tenth of a percent). The rate on 2-year treasuries is 0.371%. Those are extremely low rates. That also means that since the inflation rate is higher than the nominal interest rate, in real terms lenders are paying the government to borrow money. Such a deal!
The low interest rates also suggest that the markets do not think that the government will default. If they did, then they would insist on a much higher rate.
We might be tempted to look at other countries for clues to what would happen if the US defaulted, or to whether a large debt is a problem. However, the US is in a unique position. The US has the best credit record in history, and the US borrows in dollars. Many other countries that have defaulted, such as Russia, Mexico and Argentina, had borrowed in dollars, not their own currency, and that meant that when their currency devalued, it became more and more difficult to repay the dollars. Those countries would sell reserves in order to keep up the value of their currency, but currency traders soon would realize that the countries might soon run out of reserves, and therefore they would speculate the currency would soon collapse. This speculation would hasten the collapse, and the collapse would make it nearly impossible to pay back their dollar-denominated debts. This is not a problem for the US.
So, I think that the problems now are political. Because states require balanced budgets, they are enacting contractionary fiscal policy when we need expansionary. Because Republicans want Obama to fail, they are fighting his attempt to help the economy. I do, however, think that they will not go so far as to allow a default. So, I think that we will limp along at high unemployment rates, but not go into a crisis like Argentina has before.
Seth Klarman – Baller – We haven’t learned from 2008
In these annual-letter excerpts, from VII, investing legend Seth Klarman explains why he believes no long-term lesson have been learned from 2008, defends short-selling, and describes the two key elements to investment success.
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Two problems are upon us at once: short-term stimulus that is unaffordable over the long run and runaway entitlements that must be reined in. But restoring fiscal sanity will be bad for the economy and financial markets. What Treasury official or politician would want the cash spigot turned off before a recovery is certain? Recipients of government handouts – a large percentage of the population – would grumble at the termination of policies that offer them outsized benefits. So prepare for a chorus of “but not yet.” One already sees this in editorials and commentaries, such as the ones saying it’s time to close down bankrupt Fannie Mae and Freddie Mac, but not yet, because doing so would harm the still-weak housing market. There will never be a good time to end housing support programs, reverse quantitative easing policies, end fiscal stimulus, or reduce massive budget deficits – because doing so will restrict growth and depress share prices. Nor will there be a good time to cut entitlement programs or to solve Social Security or Medicare underfunding. All will agree the stimulus cannot go on forever, that excessive entitlements must be reined in, “but not yet.
The financial collapse of 2008 highlighted our national predicament. The sudden decline in consumer activity that followed the plunges in the housing and stock markets represented a reasonable – indeed a desirable – response to overindebtedness. Yet the federal government saw this well-advised retrenchment as cataclysmic, because the national economy had grown dependent on our living beyond our means. The imagination of our financial leaders remains so shallow that their response to a crisis caused by overleverage and excess has been to recreate, as nearly as possible, the conditions that fomented it, as if the events of 2008 were a rogue wave of financial woe that can never recur. It is only in Fantasyland that the solution to vastly excessive debt is more debt and the answer to overconsumption is less saving and more spending. Worse still, we have yet to see a serious assessment by policymakers of the causes of the 2008 financial market and economic collapses so that we might take action to ward off a repeat performance. The government’s knee-jerk response to contraction was to prop up economic activity by any and every means possible; the hole in consumer activity had to be materially repaired on the government tab. While Treasury Secretary Timothy Geithner ingenuously professes a belief that the U.S. will never lose its AAA rating, Moody’s recently warned that, absent a change, a downgrading could be just around the comer. Or, in the words of David Letterman, “I heard the U.S. debt may now lose its triple-A rating. And I said to myself, well who cares what the auto club thinks.”
Most of us learned about the Great Depression from our parents or grandparents who developed a “Depressionmentality,” by which for decades people shunned leverage, embraced thrift, and thought twice before quitting their secure jobs to join risky ventures. By bailing out the economy rather than allowing the pain of the economic and market collapses to be felt, the government has endowed our generation with a “really-bad-couple-of-weeks-mentality”: no lasting lessons are learned; the government endlessly intervenes in the economy, and, ironically, the first thing to strongly rebound from the 2008 collapse isn’t jobs or economic activity but speculation.
Benjamin Graham’s margin-of-safety concept – to invest at a sufficient discount so that even bad luck or the vicissitudes of the business cycle won’t derail an investment – is applicable to the economy as a whole. Bridges intended for ten-ton trucks are overbuilt by engineers to hold vehicles of 30 tons. Responsible investors assume their best judgments will sometimes go awry and insist on bargain purchases that allow room for error. Likewise, an economy built with no margin of safety will eventually implode. Governments that run huge deficits, promise entitlements that will be next-to impossible to deliver, and depend on the beneficence of foreigners to stay afloat inevitably must collapse – perhaps not imminently but eventually, as Greece and Ireland have recently discovered.
It is clear, both in the financial markets and in government policy, that no long-term lessons have been drawn from the events of 2008. A friend recently posited that adversity is valuable not for what it teaches but for what it reveals. The current episode of financial adversity reveals some unpleasant truths about the character and will of our country and its leaders, and offers an unpleasant picture of the future that awaits, unless we quickly find a way to change course.
The Demonization of Short-Seller
While we rarely sell securities short – both because of the degree of execution difficulty and theoretically unlimited risk compared to limited potential return – we do believe that short-selling serves a vitally important function. Markets, of course, fluctuate; driven by human emotion, greed, and fear, they can reach significantly overvalued levels. This is bad, both because it can induce some who cannot afford losses to speculate, and because it can lead to an improper allocation of society’s resources. The recent housing bubble illustrates the problem: excessive home prices led to excessive home building, eventually resulting in a price collapse, large loan losses, and great personal hardship. In addition, the decline that follows periods of market overvaluation is bad for the broader economy, for confidence, and for rational decision making; it also frequently triggers government intervention in markets, with all of its inevitable distorting effects. Just as value buyers can dampen downside volatility, short-sellers can dampen the upside excesses. They don’t actually change the eventual outcomes, just help us get there sooner. This makes short-sellers unpopular, as the uninformed masses enjoy high and rising securities prices for the short-term profits they produce, without understanding the societal costs of the future reversal. The less you understand valuation, the more that overvaluation seems like a free lunch – which of course it isn’t.
From our experience, much long-oriented analysis is simplistic, highly optimistic, and sloppy. Short-sellers, by going against the long-term tide of economic growth and the short-term swells of public opinion and margins calls, are forced to be crackerjack analysts. Their work product is usually top-notch and needs to be. Short-sellers shouldn’t be reviled or banned; most should be celebrated and encouraged. They are the policemen of the financial markets, identifying frauds and cautioning against bubbles. In effect, they protect the unsophisticated from predatory schemes that regulators and enforcement agencies don’t seem able to prevent.
Moreover, the short-seller who is fundamentally wrong, who mistakenly sells short an undervalued security, will lose money and, if the pattern continues, will eventually go broke. Short-sellers, like long-only buyers, need to be right more than they are wrong; when they are right, their actions are socially beneficial, not harmful. The only exception to this point, the only danger short-sellers pose to society, is when, in the equivalent of yelling “fire” in a crowded theatre, they spread false rumors that prevent a company that needs regular financing (such as brokerage firms) from being funded. Then, their predictions become self-fulfilling prophecies, enabling them to profit, whether or not they were fundamentally correct; they may actually be able to change the outcome. Yet, even in this situation, one may wonder whether any company – or highly leveraged government, for that matter – should employ a funding model that depends on perpetual access to the capital markets, which are notoriously fickle, volatile, subject to the influence of malicious gossip, and short-term oriented. In any event, mechanisms such as the uptick rule and rules against market manipulation already exist to prevent such misbehavior by short-sellers.
A Framework for Investment Success
Two elements are vital in designing an investment approach for long-term success. First, answer the question, ”what’s your edge?” In highly competitive financial markets, with thousands of very smart, hardworking participants, what will enable you to reliably outperform the field? Your toolkit is critically important: truly long-term capital; a flexible approach that enables you to move opportunistically across a broad array of markets, securities, and asset classes; deep industry knowledge; strong sourcing relationships; and a solid grounding in value investing principles.
But because investing is, in many ways, a zero-sum activity in which your returns above the market indices are derived from the mistakes, overreactions or inattention of others as much as from your own clever insights, there is a second element in designing a sound investment approach: you must consider the competitive landscape and the behavior of other market participants. As in football, you are well-advised to take advantage of what your opponents give you: if they are defending the run, passing is probably your best option, even if you have a star running back. If scores of other investors are rigidly committed to fast-growing technology stocks, your brilliant tech analyst may not be able to help you outperform. If your competitors are not paying attention to, or indeed are dumping, Greek equities or U.S. housing debt, these asset classes may be worth your attention, regardless of the currently poor fundamentals that are driving others’ decisions. Where to best apply your focus and skills depends partially on where others are applying theirs.
When observing your competitors, your focus should be on their approach and process, not their results. Short-term performance envy causes many of the shortcomings that lock most investors into a perpetual cycle of underachievement. You should watch your competitors not out of jealousy, but out of respect, and focus your efforts not on replicating others’ portfolios, but on looking for opportunities where they are not.
Much of the investment business is centered around asset-gathering activities. In a field dominated by a short-term, relative performance orientation, significant underperformance is disastrous for retention of assets, while mediocre performance is not. Thus, because protracted periods of underperformance can threaten one’s business, most investment firms aim for assured, trend-following mediocrity while shunning the potential achievement of strong outperformance. The only way for investors to significantly outperform is to periodically stand far apart from the crowd, something few are willing or able to do.
In addition, most traditional investors are limited by a variety of constraints: narrow skill-sets, legal restrictions contained in investment prospectuses or partnership agreements, or psychological inhibitions. High-grade bond funds can only purchase investment-grade bonds; when a bond falls below BBB, they are typically forced to sell (or think that they should), regardless of price. When a mortgage security is downgraded because it will not return par to its holders, a large swath of potential purchasers will not even consider buying it, and many must purge it. When a company omits a cash dividend, some equity funds are obliged to sell that stock. And, of course, when a stock is deleted from an index, it must immediately be dumped by many. Sometimes, a drop in a stock’s price is reason enough for some holders to sell. Such behavior often creates supply-demand imbalances where bargains can be found. The dimly lit comers and crevasses existing outside of mainstream mandates may contain opportunity. Given that time is often an investor’s scarcest resource, filling one’s in-box with the most compelling potential opportunities that others are forced to or choose to sell (or are constrained from buying) makes great sense.
Price is perhaps the single most important criterion in sound investment decision making. Every security or asset is a “buy” at one price, a “hold” at a higher price, and a “sell” at some still higher price. Yet most investors in all asset classes love simplicity, rosy outlooks, and the prospect of smooth sailing. They prefer what is performing well to what has recently lagged, often regardless of price. They prefer full buildings and trophy properties to fixer-uppers that need to be filled, even though empty or unloved buildings may be the far more compelling, and even safer, investments. Because investors are not usually penalized for adhering to conventional practices, doing so is the less professionally risky strategy, even though it virtually guarantees against superior performance.
Finally, most investors feel compelled to be fully invested at all times – principally because evaluation of their performance is both frequent and relative. For them, it is almost as if investing were merely a game and no client’s hardearned money was at risk. To require full investment all the time is to remove an important tool from investors’ toolkits: the ability to wait patiently for compelling opportunities that may arise in the future. Moreover, an investor who is too worried about missing out on the upside of a potential investment may be exposing himself to substantial downside risk precisely when valuation is extended. A thoughtful investment approach focuses at least as much on risk as on return. But in the moment-by-moment frenzy of the markets, all the pressure is on generating returns, risk be damned.
What drives long-term investment success? In the Internet era, everyone has a voluminous amount of information but not everyone knows how to use it. A well-considered investment process – thoughtful, intellectually honest, teamoriented, and single-mindedly focused on making good investment decisions at every turn – can make all of the difference. Investors with short time horizons are oblivious to kernels of information that may influence investment outcomes years from now. Everyone can ask questions, but not everyone can identify the right questions to ask. Everyone searches for opportunity, but most look only where the searching is straightforward even if undeniably highly competitive.
In the markets of late 2008, everything was for sale as investors were caught in a contagion of selling due to panic, margin calls, and investor redemptions. Even while modeling very conservative scenarios, many securities could have been purchased at extremely attractive prices – if one had capital with which to buy them and the stamina to hold them in the face of falling prices. By late 2010, froth had returned to the markets, as investors with short-term relative performance orientations sought to keep up with the herd. Exuberant buying had replaced frenzied selling, as investors purchased securities offering limited returns even on far rosier economic assumptionss.
Most investors take comfort from calm, steadily rising markets; roiling markets can drive investor panic. But these conventional reactions are inverted. When all feels calm and prices surge, the markets may feel safe; but, in fact, they are dangerous because few investors are focusing on risk. When one feels in the pit of one’s stomach the fear that accompanies plunging market prices, risk-taking becomes considerably less risky, because risk is often priced into an asset’s lower market valuation. Investment success requires standing apart from the frenzy – the short-term, relative performance game played by most investors.
Investment success also requires remembering that securities prices are not blips on a Bloomberg terminal but are fractional interests in – or claims on – companies. Business fundamentals, not price quotations, convey useful information. With so many market participants fixated on short-term investment performance, successful investing requires a focus not on how one is doing, but on corporate balance sheets and income and cash flow statements.
Government interventions are a wild card for even the most disciplined investors. On one hand, the U.S. government has regularly intervened in markets for decades, especially by lowering interest rates at the first sign of bad economic news, which has the effect of artificially inflating securities prices. Today, monetary easing and fiscal stimulus augment consumer demand, increasing risks not only regarding the integrity and sustainability of securities prices but also those surrounding the sustainability of business results. It is hard for investors to get their bearings when they cannot readily distinguish durable business performance from ephemeral results. Endless manipulation of government statistics adds to the challenge of determining the sustainability – and therefore the proper valuation – of business performance. As securities prices are propped up and interest rates are manipulated sharply lower (thereby justifying those higher prices in the minds of many), prudent investors must demand a wide margin of safety. This is especially so because financial excesses contain the seeds of their own destruction. Market exuberance leads to business exuberance – production of more goods and services than demand ultimately justifies. Of course, when market and economic excesses are finally corrected, there is a tendency to over-shoot, creating low-risk opportunities for value investors who have remained patient and disciplined.
Yet another long-term risk confronts investors: the government’s fiscal and monetary experiments may go awry, resulting in runaway inflation or currency collapse. Bottom-up value investors would not wish to bet the ranch on a macroeconomic view, but neither would they be wise to ignore the macroeconomy altogether. Disaster hedging – always an important tool for investors – takes on heightened significance in today’s unprecedentedly challenging environment. Yet, as this insight is not unique to us, the cost of insurance is high. There are no easy ways to navigate these turbulent waters. But because the greatest risks are of currency debasement and runaway inflation, protection against a currency collapse – such as exposure to gold – and against much higher interest rates seem like necessary hedges to maintain
Cullen Roche = Baller Status $$
I would argue that looking at a govt’s balance sheet is misleading. You need to judge a govt’s effectiveness by the prosperity of its citizenry. Govt doesn’t exist for its own benefit. It is not a profit generating entity. So it shouldn’t be run like one.
The ratings agencies need to be more precise in their ratings. If they are going to measure a revenue constrained country like Greece then their normal MO would apply. If they are going to rate a country like the USA, which is not revenue constrained, they should focus on the risk of hyperinflation.
Bubble Trouble – My favorite prescient person – Andy Xie
By ANDY XIE
The current generation of decision makers was raised in a string of bubble economies. This environment has greatly influenced their sense of balance between a bubble economy and growth. Every time a bubble bursts, they can save the economy by creating another bubble, so they have no fear of bubble economies fueled by low interest rates.
A prominent policymaker from the US recently stated that concerns about an Internet bubble reflected a confidence in the regained strength of the American economy. This is a common misconception amongst policymakers. All surveys report a high level of nervousness among the American people. In fact, the Internet bubble has nothing to do with the confidence at large, but merely emphasizes the dire situation the financial system is in.
The continuous chain of bubbles in the last 20 years was due to the fact that policymakers repeatedly used low interest rates to save speculators. Meanwhile, the speculators seem to firmly believe that growth solves all economic woes. As a result, even though the bubble could burst again, leading to an economic downturn, they believe they can solve their economic problems by creating another bubble. Furthermore, politicians serve relatively short terms, so they are inclined to simply delay the problems until their successors take office.
If inflating a new bubble solves the problems caused by an old bubble bursting, then we would be in paradise. Everyone would be extremely rich, and would not have to work. Clearly, no such world exists.
Inflation and bubbles are both monetary phenomena. We could offer all sorts of explanations on the specific causes of a bubble’s formation, but the truth is that without loose monetary policies, a bubble cannot possibly form. Inflation and bubbles compete for money in the market. When inflation is low for some reason, such as the outsourcing over the past 20 years, an excess supply of money will prompt the formation of a bubble. When there is no way to keep inflation rates low in the short run, then the bubble cannot be sustained as its funding gets cut off.
This time, the biggest bubble lies in government bonds, which have been seen as the safest investment, and since the world is still in an economic hole, a lot of money has been going into this type of asset. In my opinion, given that inflation has been on the rise around the world, fear of bond devaluation will eventually take over, specifically in the last quarter of 2012.
-DOUBLE DIPPING
Just as it did last summer, the global economy is now winding down again. With a quarter of American homeowners having negative equity in their houses, the US housing market is taking another nosedive. As there is no immediate hope of recovery, they would be keen to hand their property back to the mortgage banks, and free themselves of debt. As the banks collect more houses, the housing market continues to slide, fearing a liquidation of the banks’ entire housing inventory. The adjustment isn’t all technical – the total US property value is still at 110% of GDP, despite a 30% drop from its peak, compared to previous cycles where it bottomed out far below 100%. In some smaller cities, residential land is down 90% from its peak value, compared to 1% for similar cities in China.
Europe’s sovereign debt crisis has reappeared, a problem that was never fully solved. The money supplied to Greece and other member states by the EU was only enough to resolve their immediate liquidity problems, without addressing their ability to pay off their debts over time. While the only solution is for Greece to default, the EU fears a contagion effect spreading to other countries, and is still waiting for a miracle. This latest crisis won’t be the last.
Japan is in the middle of a severe recession, with the March earthquake and tsunami destroying much of its productivity, and it will take a long time to recover. Hope of a quick turnaround is keeping the yen from devaluing, though this hope will soon vanish. As Japan increases imports for its reconstruction, its trade deficit will continue to worsen, making a sharp devaluation in the yen in the second half likely.
Emerging economies’ tightening of policies to curb inflation has been ineffective for two reasons. Firstly, the Fed still maintains a loose policy, spurring inflation in commodities, which emerging economies have no means to respond to. Secondly, because emerging economies raise their interest rates slower than inflation grows, their real interest is still negative, further fueling inflation. More tightening is necessary, but this would raise market concerns about its impact on economic growth.
It seems the whole world is on a downward spiral, and economic data this summer will likely be very poor and shocking, letting fear take over the financial market again.
-WHO CAN RESCUE THE MARKET?
A month ago, I mentioned the possibility of QE 3, which was criticized by many as impossible. Once the market started dwindling, it seemed possible again. I believe QE 3 is possible only if oil prices drop another 25%. Once oil prices are low enough, the Fed can then introduce another stimulus package.
As in other countries, inflation is eating away any income growth in the US. The Fed still rejects the idea that its policy is ineffective in virtually every aspect, creating bubbles, hindering structural changes, and hampering consumption. It continues to stimulate its currency in hopes of reviving its economy. As the economy continues to worsen, one can only wonder how the Fed will respond this time.
If the Fed takes any action, stock prices will rise, and people will feel better for a short while. The Fed’s stimulus plans will cause oil prices to skyrocket, thus erasing any gains from rising stock prices. So no matter what the Fed does, they’re headed for disaster.
If Europe can solve its debt crisis once and for all, it will regain its confidence. It’s certain that Greece will default, but dragging this out will only affect the financial market. Once a solution is drafted, the losses are calculated for Greece’s bondholders, and the amount of refinancing required from the European banks is confirmed, the financial market will be able to move forward.
The financial market has high expectations for China, with talks every month about China’s inflation reaching its peak, and the country loosening its policy again. Although not impossible, the chances of this happening are slim. China’s inflation is very unstable right now, and experiences speak louder than statistics. In today’s China, the price of goods and services often rises by 10-30%. This illustrates the severity of China’s inflation problem.
China’s economy is approaching a slowdown, which is good news. Its current growth relies too heavily on its housing bubble, and the longer this growth lasts, the more painful the adjustment process will be.
Furthermore, China’s growth bottlenecks are becoming increasingly hard to overcome. For instance, if China decides not to curb inflation and to stimulate growth again instead, then it could face a severe energy shortage. The Fed or Europe might try to support the financial market again, but China won’t.
-ROAD TO THE NEXT CRISIS
The world is approaching another economic crisis, this time centered on government debt. After the 2008 crisis, none of the major economies fully restructured in order to prevent another bubble from forming. Instead, they used stimulus packages to create growth, hoping to grow out of their problems.
The key problem in the developed countries is the high cost of social welfare. Unless they can cut costs greatly in this area, their fiscal deficits will remain high. After WWII, developed countries set up welfare state policies to obtain social peace. As the population ages, the cost of this policy becomes unbearable. At the same time, they have lost their initial competitive advantage over developing countries, making them unable to grow out of their problems. Their short-term solution is to run fiscal deficits to keep the system afloat. This means many other countries will wind up like Greece. The US is particularly in danger. Although it can print money to pay off its debts, the prospect of inflation will eventually drive Treasury investors away. The resultant high bond yield will force the Fed to tighten to avoid hyperinflation.
Developing countries should stop property bubbles from forming, as they make the ruling class richer, while leaving the workers and entrepreneurs without a penny. Developing countries like China and Vietnam are very competitive with costs, with low wages and the source of their wealth. However, they use the property bubble to redistribute wealth, which undervalues workers and businesses and encourages speculation. As fewer and fewer businesses and workers are willing to produce, inflation becomes rampant. Unless the basic governing philosophy changes the inflation crisis in emerging economies will worsen.
The world is unstable because decision-makers refuse to resolve structural problems, and short-term solutions only offer temporary relief. Once these solutions run out, the world will face another major crisis.
china debt
http://mpettis.com/2011/07/incentives-and-debt/
want to start this newsletter with a story that may be fairly illustrative of one of the problems within the Chinese economy that I worry about. There was anarticle in last Sunday’s edition of the South China Morning Post about a real estate project in Guangdong. (WC Fields’ was supposed to have once called Mae West “a plumber’s idea of Cleopatra”, and for some reason that story popped into my mind when I read the article.)
It says that a real estate developer is attempting to build a replica of a beautiful Austrian village in Guangdong province not too far from Shenzhen:
It is a scenic jewel, a hamlet of hill-hugging chalets, elegant church spires and ancient inns all reflected in the deep still waters of an alpine lake. Hallstatt’s beauty has earned it a listing as a Unesco World Heritage site but some villagers are less happy about a more recent distinction: plans to copy their hamlet in China.
After taking photos and collecting other data on the village while mingling with the tourists, a Chinese firm has started to rebuild much of Hallstatt in Guangdong province, just 60 kilometres away from the Hong Kong border, hoping to attract wealthy mainlanders, “homesick” expatriates in Hong Kong and tourists. The project had drawn a mixed response from residents in the original village.
The article goes on to discuss the anger many of the residents of Hallstatt feel about having their town copied and replicated without permission.
That this sort of building project seems a tad over the top is not why I bring up the article. Those of us who live here are quite used to the many sometimes-bizarre projects aimed at attracting new wealth and signaling status. Of course if it makes the residents of Hallstatt feel any better, I am absolutely certain that the Guangdong replica will not be a perfect copy of Hallstatt. I have no doubt that there will be hundreds of architectural and cultural “improvements” that will ensure that no one confuses the shiny replica with its dowdy original. Excessive restraint typically isn’t one of the sins afflicting real estate developers that cater to the local rich.
What interested me about the article was something else altogether. According to the article, the project is being developed by “Minmetals Land, the real estate development arm of China Minmetals, China’s largest metals trader.”
I’m sure MinMetals is no slouch when it comes to trading metals, but it wouldn’t have occurred to me that a metals trading background would have made anyone particularly good at real estate development, and especially at developing such an undoubtedly classy project. This kind of thing, however, is actually not an anomaly in China. A surprisingly large number of SOEs and other large companies in China have real estate development subsidiaries.
In fact a lot of Chinese SOEs are involved in a very wide variety of business activities, and are especially fond of activities in which cheap capital is the comparative advantage, or in which there is political advantage to be gained. That makes real estate development and “high tech” two of the most popular ancillary businesses.
Does it matter? Perhaps. This type of business diversification is not new and it doesn’t have a very encouraging history. For example the 1960s in the US was a period which saw an explosion in the growth of what were then called “conglomerates”, and as is always the case, there seemed to be a plausible reason for their growth: good managers are good managers, and can generate growth from many types of companies, and their ability to generate growth is magnified by the lower cost of capital associated with substantial diversification.
But after the initial enthusiasm, conglomerates performed awfully, and in the 1970s in the US a consensus developed that large conglomerates involved in very different lines of business tended to be value destroying. The reason often given was that managers who might be successful in one line of business – say coal extraction – might not necessarily be especially good in another line of business – say children’s retailing, or movie production. By forcing senior management to disperse their expertise across a wide range of very different businesses, conglomerates were very good at mismanaging many if not all of the businesses they controlled.
Incentives affect behavior
I am not sure if I am totally satisfied with that explanation, although I am sure there is some truth to it. To me the main reason why conglomerates tend to be weak at creating value has to do with the distorted incentive structures involved in their creation.
In many cases – especially when skeptical investors aren’t monitoring their every move and threatening to punish them when they fail – senior managers had no great incentive to manage shareholder money very carefully. They do, however, have strong incentives to build their assets and to diversify – the former because the larger the company the more important and more highly remunerated the managers, and the latter because highly diversified businesses are more likely to be involved in whatever business is hot today and, because they are diversified and large, are less likely to fail.
In that case, as long as there were no constraints to managers’ ability to raise money and invest in other businesses, managers naturally did just that. The problem is that what is in the best interests of the shareholder – creating economic value to be captured by shareholders – is not necessarily in the interest of managers, who might find it totally rational to overpay for assets and to pile into “hot” markets.
This distorted incentive structure ended up encouraging capital misallocation, and after a few exciting years, the profitability of conglomerates plummeted. Incentive structures, in other words, determine behavior in the aggregate, and if the incentive is to ignore value creation in favor of some other objective, value creation tends not to occur. In fact the opposite occurs. Value tends to be destroyed if those other objectives can be met by deploying capital.
It is hard to imagine that in China today the incentive structure for top managers of SOEs is aligned with that of creating economic value. Like anywhere else, the bigger your company, the more important you tend to be as CEO, the more preciously your bankers and investment bankers will treat you, the more time you will spend with senior political leaders, and the more highly remunerated you, your family and friends tend to be. What’s more, as Beijing tries to consolidate smaller companies into larger ones, the bigger you are the most likely you are to be the head of the surviving company. In that case companies will want to grow.
There is an additional and very important distortion. The most important comparative advantage that large Chinese companies have is access to cheap credit, and so from a P&L point of view the best policy is always to borrow as much as you can and buy or build assets. Even if you overpay or if your projects are actually value destroying, it doesn’t matter too much because artificially low interest rates are the equivalent of debt forgiveness, and after several years of hidden debt forgiveness, even the worst investments start to seem profitable.
Under those circumstances, I would not be confident that every large SOE investment or every move to diversify is likely to create economic value. The fact that nearly every important SOE, and many not-so-important ones too, have real estate development subsidiaries probably has a lot more to do with access to cheap capital and the opportunity to share in the real estate bonanza than with any real ability to add to the underlying wealth of China.
Everything is debt financed
And of course if it is true that SOEs are investing unnecessarily for reasons that have nothing to do with value creation, one consequence is likely to be an increase in debt, as SOEs borrow and invest. I have written a lot about unsustainable increases in debt in China, and on that note let me append below something that I wrote this week for the New York Times.
I was asked by the newspaper to identify some of the difficulties facing China with an especial emphasis on the worries that have surged in the past year over the large debt levels run up by local government financing vehicles. My response was that the focus on this kind of debt might be at least partially misplaced.
For the past decade China-focused analysts have been able to describe static economic conditions with some accuracy but have failed generally to understand the underlying growth dynamics. We’ve done a great job, in other words, of describing the landscape through which the train is passing, but because we don’t understand where the train is headed we are constantly shocked when the landscape changes.
It should have been clear for many years that China’s investment-driven growth model was leading to unsustainable increases in debt. As recently as two years ago most analysts were ecstatically – and mistakenly – praising the country’s incredibly strong balance sheet, but when Victor Shih shocked the market last year with his analysis of local government borrowing, the mood began to change. Now the market has become obsessed with municipal debt levels.
But dangerously high levels of municipal debt are only a manifestation of the underlying problem, not the problem itself. Even if the financial authorities intervene, unless they change the economy’s underlying dependence on accelerating investment, it won’t matter. They will simply force the debt problem elsewhere. In all previous cases of countries following similar growth models, the dangerous combination of repressed pricing signals, distorted investment incentives, and excessive reliance on accelerating investment to generate growth has always eventually pushed growth past the point where it is sustainable, leading always to capital misallocation and waste. At this point – which China may have reached a decade ago – debt begins to rise unsustainably.
China’s problem now is that the authorities can continue to get rapid growth only at the expense of ever-riskier increases in debt. Eventually either they will choose sharply to curtail investment, or excessive debt will force them to do so. Either way we should expect many years of growth well below even the most pessimistic current forecasts. But not yet. High, investment-driven growth is likely to continue for at least another two years.
I want to stress this point. Right now everyone is worried about municipal debt levels and wondering if Beijing’s plans to resolve the problem will work or not to clean up the municipalities. But this is the wrong focus. The problem is not whether or not the municipalities will be able to repay. Repayment simply means shifting the debt servicing to another entity, and we should be worrying not about the debt-servicing ability of specific borrowers but rather about the whole system. The problem, as I see it, is that the system has reached the point at which unsustainable increases in debt are necessary to sustain growth.
When is an increase in debt unsustainable?
As I see it there are three things that make increases in debt unsustainable. The first, obviously, is borrowing for consumption. This is what happened in the US and in the peripheral countries of Europe until the 2007-08 crisis, and it is pretty clear that this kind of borrowing cannot go on forever. Why not? Simply because with consumer financing the value of liabilities rises more quickly than the value of assets, and this cannot go on forever unless the borrower has an infinite amount of excess assets.
But it is a testament to how US-centric the whole world is that we cannot seem to separate underlying problems from the US manifestation of that problem. Since the US spent much of the past decade experiencing an unsustainable increase in debt to finance consumption, most of the market assumes that this is the only way it can happen. Since we aren’t seeing consumer financing in China, then there cannot be an unsustainable debt rise in China.
But consumer financing isn’t the only way it can happen. The second way we can experience an unsustainable increase in debt is when borrowing is used to fund investment that is misallocated or wasted. Whenever the value of liabilities rises more quickly than the value of assets, the increase in debt is by definition unsustainable unless, of course, the borrower has an unlimited amount of excess assets. This is a little more complicated to explain, but the process is just as definitive.
Assume, for example, that a local mayor borrows $100 dollars to build a subway system. The subway creates economic value, directly because businesses can grow more quickly thanks to lower transportation costs, and indirectly because consumers can spend more of the time and they have money left over,
If the economic value of the subway exceeds $100 dollars, the mayor can service the loan by taxing (directly or indirectly) the increased economic value. In that case net assets rise because there is more than enough to repay the cost of the investment.
If the economic value created is less than $100, however, the loan cannot be fully serviced without forcing someone – usually the taxpayer – to step in a make up the difference. This is what we mean by an unsustainable increase in debt – it will result either in a default or in a rescue.
We need to be careful about how we define the loan servicing cost. What matters is not the interest rate actually paid, but rather the theoretically “correct” interest rate. Why? Because that is the true servicing cost to the economy as a whole. Imagine if the US government passed a law saying that the interest rate on all of its debt is now set at 0%. Would it have any trouble servicing its debt? Of course not. So why not do it if it solves the debt servicing problem? Because artificially lowering the interest rate is simply a way of transferring the borrowing cost to the lenders. It does not reduce the true cost, it simply turns it into something else.
So if we want to know what the debt-servicing cost in China really is, it doesn’t help to look at the financial statements of the borrowers to determine whether revenues exceed the interest expense, even if you trust the financial statements. You would have conceptually to raise the interest rate for local and municipal governments, SOEs, real estate developers, etc. substantially – probably by at least 5 or 6 full percentage points or more – to eliminate the impact of artificially suppressing the rates. It is only then that you can calculate the true debt-servicing cost
Forget about consumer financing
The third kind of unsustainable debt increase is caused by a sudden explosion in contingent liabilities. When balance sheets are structured in risky or mismatched ways, an unexpected change in circumstances can cause a sharp change in the relationship between the values of assets and liabilities, and so result in a net surge in indebtedness.
There are many examples of this kind of mismatch. Financing companies that lend against assets, including copper or land, run the risk of a surge in net indebtedness when asset prices fall. Banks that borrow short and lend long are mismatched, and can see assets fall relative to liabilities when interest rates surge. The PBoC has a huge currency mismatch on its balance sheet. Because it borrows in RMB and lends in foreign currency, mostly dollars, as the value of the RMB rises against the dollar, its net indebtedness automatically rises too.
Mismatched balance sheets are not always a problem. When the surge in contingent liabilities occurs under “good” conditions, it can actually be stabilizing for the economy because there will usually be a corresponding reduction in net liabilities when things are going badly. For example central banks usually like their currency mismatches because they only lose money when their economies are doing very well and there is pressure for their currency to appreciate. When their economies are doing badly, of course, the pressure is for depreciation and they actually make a profit on their mismatch just when they need it.
They are hedged in that case. To be hedged means to make money when things are otherwise going badly for you and to lose money when things are otherwise going well. It is only when the balance sheet is what I called “inverted” in my book that you have a problem.
Take copper financing by lenders in China. This is an example of an inverted balance sheet. As the biggest consumer of copper, China largely sets global copper prices. If China is growing quickly, this tends to push up the price of copper, and lenders who are secured by copper see the value of their loans increase – they become more secure. The lenders of course are delighted. They are probably making good money because China is growing, and on top of it their loans are becoming more secure than ever.
Of course this changes if the Chinese economy were suddenly to slow, especially if it slows sharply. In that case the lenders would probably see their revenues decline at the same time as the value of the collateral supporting their loans declines. If their borrowers are then forced to liquidate the collateral in order to repay the loans (which is likely to happen if the economy slows sharply), the liquidation value could easily be less than the value of the loans. In that case China would see an unsustainable rise in its debt – and notice this always happens at exactly the wrong time.
It is important to remember this when thinking about financing risks in China. We often hear analysts argue that because China has little consumer financing and because mortgage margins are high, they don’t have a debt problem. This argument is about as useless as the claim that because China has large reserves it is unlikely to have a financial problem. The limited consumer and mortgage financing in China means that china will not have a US-style financing problem, and the large amount of reserves means that China won’t have a Korean-style financing problem, but no one has ever seriously argued that those are the kinds of risks China faces. What matters is the level of debt, whether or not its growth is sustainable, and the kinds of contingent structures that are embedded. I would argue that all three measures are worrying.
Bye bye commodities commodity long-only who buy to hold are going to experience a > 50% drawdown (from current levels) on their industrial metals, crude oil and agricultural positions sometimes in the next 12-18 months.” The catalyst: China.
Industrial commodity bulls may be advised to steer clear of the latest quarterly commodities update by Global Tactical Asset Allocation’s Damien Cleusix whose conclusion is that “Most commodities remain deeply overvalued.” Specifically, “As with other assets it does not really matter in the short-term (as long as the trend is positive) but it is paramount for longer-term projections. We have little doubts that commodity long-only who buy to hold are going to experience a > 50% drawdown (from current levels) on their industrial metals, crude oil and agricultural positions sometimes in the next 12-18 months.” The catalyst: China. “Demand has been artificially boosted by China strategic reserve building, infrastructure intensive fiscal stimulus, booming demand from the rest of emerging economies and, as the trend persisted, by trend followers and money managers new attraction to the sector (you know it is not correlated so you should buy them to diversify your portfolio… sorry it WAS not correlated…). The introduction of physically-based ETFs is not helping in this matter as it represents a big short-term increase in marginal demand especially when the Fed was still busy implementing QE2.” Agree or not, the cases for both the up and downside are compelling and well researched, with lots of supporting facts. Much more in the full presentation.
http://www.zerohedge.com/article/global-tactical-asset-allocation-q3-update-commodities
sustainability of global bailouts
sure. everyone in my opinion is pretty much undercapitalized (everyone meaning public sector)
and banks…
how long can public entities continue to print themselves into impossible to cover deficits to the point that people start withdrawling from banks and exporting their wealth?
lol.. and then where do you put your wealth when this is happening all over the place? that’s the question..
i dunno… i’m just thinking about how … why is this situation unsustainable just because it is impossible? perhaps governments can continue to perpetually make fiscally unsound decisions…. without consequences?
north korea has been screwing its inhabitants for decades… just sayin’
The Greek Scam goes for another year!
The Big Fat Greek Gravy Train: A special investigation into the EU-funded culture of greed, tax evasion and scandalous waste
Last updated at 9:09 AM on 25th June 2011
Even on a stiflingly hot summer’s day, the Athens underground is a pleasure. It is air-conditioned, with plasma screens to entertain passengers relaxing in cool, cavernous departure halls – and the trains even run on time.
There is another bonus for users of this state-of-the-art rapid transport system: it is, in effect, free for the five million people of the Greek capital.
With no barriers to prevent free entry or exit to this impressive tube network, the good citizens of Athens are instead asked to ‘validate’ their tickets at honesty machines before boarding. Few bother.
Cracking up: The Euro is at risk of collapse because of the Greek financial crisis
This is not surprising: fiddling on a Herculean scale — from the owner of the smallest shop to the most powerful figures in business and politics — has become as much a part of Greek life as ouzo and olives.
Indeed, as well as not paying for their metro tickets, the people of Greece barely paid a penny of the underground’s £1.5 billion cost — a ‘sweetener’ from Brussels (and, therefore, the UK taxpayer) to help the country put on an impressive 2004 Olympics free of the city’s notorious traffic jams.
The transport perks are not confined to the customers. Incredibly, the average salary on Greece’s railways is £60,000, which includes cleaners and track workers – treble the earnings of the average private sector employee here.
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The overground rail network is as big a racket as the EU-funded underground. While its annual income is only £80 million from ticket sales, the wage bill is more than £500m a year — prompting one Greek politician to famously remark that it would be cheaper to put all the commuters into private taxis.
‘We have a railroad company which is bankrupt beyond comprehension,’ says Stefans Manos, a former Greek finance minister. ‘And yet, there isn’t a single private company in Greece with that kind of average pay.’
Significantly, since entering Europe as part of an ill-fated dream by politicians of creating a European super-state, the wage bill of the Greek public sector has doubled in a decade. At the same time, perks and fiddles reminiscent of Britain in the union-controlled 1970s have flourished.
Greek farce: Living it up in swanky harbour-side restaurants
Ridiculously, Greek pastry chefs, radio announcers, hairdressers and masseurs in steam baths are among more than 600 professions allowed to retire at 50 (with a state pension of 95 per cent of their last working year’s earnings) — on account of the ‘arduous and perilous’ nature of their work.
This week, it was reported that every family in Britain could face a £14,000 bill to pay for Greece’s self-inflicted financial crisis. Such fears were denied yesterday after Brussels voted a massive new £100bn rescue package which, it insisted, would not need a contribution from Britain.
After running battles with riot police, who used tear gas to disperse protesters, thousands are still camped out in the square ahead of a vote by Greek politicians next week on whether to accept Europe-imposed austerity measures.
Even if this is true — and many British MPs have their doubts — we will still have to stump up £1billion to the bailout through the International Monetary Fund.
In return for this loan, European leaders want the Greeks’ free-spending ways to end immediately if the country is to be prevented from ‘infecting’ the world’s financial system. Naturally, the Greek people are not happy about this.
In Constitution Square this week, opposite the parliament, I witnessed thousands gathering to campaign against government cuts designed to save the country from bankruptcy.
After running battles with riot police, who used tear gas to disperse protesters, thousands are still camped out in the square ahead of a vote by Greek politicians next week on whether to accept Europe-imposed austerity measures.
Yet these protesters should direct their anger closer to home — to those Greeks who have for many years done their damndest to deny their country the dues they owe it.
Clash: Protesters continue to riot in Athens
Take a short trip on the metro to the city’s cooler northern suburbs, and you will find an enclave of staggering opulence.
Here, in the suburb of Kifissia, amid clean, tree-lined streets full of designer boutiques and car showrooms selling luxury marques such as Porsche and Ferrari, live some of the richest men and women in the world.
With its streets paved with marble, and dotted with charming parks and cafes, this suburb is home to shipping tycoons such as Spiros Latsis, a billionaire and friend of Prince Charles, as well as countless other wealthy industrialists and politicians.
One of the reasons they are so rich is that rather than paying millions in tax to the Greek state, as they rightfully should, many of these residents are living entirely tax-free.
Along street after street of opulent mansions and villas, surrounded by high walls and with their own pools, most of the millionaires living here are, officially, virtually paupers.
How so? Simple: they are allowed to state their own earnings for tax purposes, figures which are rarely challenged. And rich Greeks take full advantage.
Astonishingly, only 5,000 people in a country of 12 million admit to earning more than £90,000 a year — a salary that would not be enough to buy a garden shed in Kifissia.
Yet studies have shown that more than 60,000 Greek homes each have investments worth more than £1m, let alone unknown quantities in overseas banks, prompting one economist to describe Greece as a ‘poor country full of rich people’.
Running battles: The riots are threatening to destabilise the Euro
Manipulating a corrupt tax system, many of the residents simply say that they earn below the basic tax threshold of around £10,000 a year, even though they own boats, second homes on Greek islands and properties overseas.
And, should the taxman rumble this common ruse, it can be dealt with using a ‘fakelaki’ — an envelope stuffed with cash. There is even a semi-official rate for bribes: passing a false tax return requires a payment of up to 10,000 euros (the average Greek family is reckoned to pay out £2,000 a year in fakelaki.)
Even more incredibly, Greek shipping magnates — the king of kings among the wealthy of Kifissia — are automatically exempt from tax, supposedly on account of the great benefits they bring the country.
Yet the shipyards are empty; once employing 15,000, they now have less than 500 to service the once-mighty Greek shipping lines which, like the rest of the country, are in terminal decline.
With Greek President George Papandreou calling for a crackdown on these tax dodgers — who are believed to cost the economy as much as £40bn a year — he is now resorting to bizarre means to identify the cheats. After issuing warnings last year, government officials say he is set to deploy helicopter snoopers, along with scrutiny of Google Earth satellite pictures, to show who has a swimming pool in the northern suburbs — an indicator, officials say, of the owner’s wealth.
Officially, just over 300 Kifissia residents admitted to having a pool. The true figure is believed to be 20,000. There is even a boom in sales of tarpaulins to cover pools and make them invisible to the aerial tax inspectors.
‘The most popular and effective measure used by owners is to camouflage their pool with a khaki military mesh to make it look like natural undergrowth,’ says Vasilis Logothetis, director of a major swimming pool construction company. ‘That way, neither helicopters nor Google Earth can spot them.’
But faced with the threat of a crackdown, money is now pouring out of the country into overseas tax havens such as Liechtenstein, the Bahamas and Cyprus.
Parliament: It could be all over for Greece, which is effectively bust from relying on EU cash from richer northern European countries
‘Other popular alternatives include setting up offshore companies in Cyprus or the British Virgin Islands, or the purchase of real estate abroad,’ says one doctor, who declares an income of less than £90,000 yet earns five times that amount.
There has also been a boom in London property purchases by Athens-based Greeks in an attempt to hide their true worth from their domestic tax authorities.
‘These anti-tax evasion measures by the government force us to resort to even more detailed tax evasion ploys,’ admits Petros Iliopoulos, a civil engineer.
Hotlines have been set up offering rewards for people who inform on tax dodgers. Last month, to show the government is serious, it named and shamed 68 high-earning doctors found guilty of tax evasion.
Hotlines have been set up offering rewards for people who inform on tax dodgers. Last month, to show the government is serious, it named and shamed 68 high-earning doctors found guilty of tax evasion.
‘We will spare no effort to collect what is due to the state,’ said Evangelos Venizelos, the new Greek finance minister of the socialist ruling party. ‘We promise to draft and apply a new and honest tax system, one that has been needed for decades, so that taxes are duly paid by those who should pay.’
Yet, already, it is too late. Greece is effectively bust — relying on EU cash from richer northern European countries, but this has been the case ever since the country finally joined the euro in 2001.
Two years earlier, the country was barred from entering because it did not meet the financial criteria.
No matter: the Greeks simply cooked the books. Two years later, having falsely claimed to have met standards relating to manufacturing and industrial production and low inflation, the Greeks were allowed in.
Funds poured into the country from across Europe and the Greeks started spending like there was no tomorrow.
Money flowed into all areas of public life. As a result, for example, the Greek school system is now an over-staffed shambles, employing four times more teachers per pupil than Finland, the country with the highest-rated education system in Europe. ‘But we still have to pay for tutors for our two children,’ says Helena, an Athens mother. ‘The teachers are hopeless — they seem to spend their time off sick.’
Although Brussels has now agreed to provide the next stage of its debt payment programme to safeguard the count ry’s immediate economic future, the Greek media still carries ominous warnings that the military may be forced to step in should the country’s foray into Europe end in ignominy, bankruptcy and rising violence.
For now, the crisis has simply been delayed. With European taxpayers facing the prospect of saving Greece from bankruptcy for the second year in a row, some say even the £100bn on offer will pay off only the interest on the country’s debts — meaning it will be broke again within two years.
Meanwhile, there are doom-laden warnings that the collapse of the Greek economy could be the catalyst for another global recession.
Perhaps if the Greeks themselves had shown more willingness to tighten their belts and pay taxes due to the state, voters across Europe might not now be feeling such anger towards them.
But having strolled the streets of Kifissia, and watched the Greek hordes stream past the honesty boxes on the underground, it does not take a degree in European economics to know when somebody is taking advantage — at our expense.
China conducts emergency liquidity experiments as crisis erupts
China Conducts Emergency Reverse Repos To Calm Money Market Liquidity, Fails, As 2 Week SHIBOR Hits 8.6%
Submitted by Tyler Durden on 06/20/2011 23:24 -0400
Yesterday, when we pointed out the surge in the overnight SHIBOR, many were quick to dismiss this dramatic contraction in liquidity, because it happened to be a replica of a comparable such move before the Lunar New Year which did not end result in an end of the world type event. And while many ignored this very disturbing interbank lending lock up sign, there was someone who did not: the PBoC. According to Market News, “The People’s Bank of China has conducted reserve bond repurchase agreements with at least one bank in a bid to ease liquidity conditions, local media reports said Tuesday. The National Business Daily cited an interbank market trader as saying the central bank injected at least CNY50 billion into the China Construction Bank on Monday via a 14-day reverse repo at 7.5%.” Which incidentally is how it should be done: want to get emergency funding from your central bank? Sure. But it will cost you a whopping 7.5%. Now the question of whether CNY50 billion is enough (and in related news, the USDCNY parity just dropped to a fresh all time record low of 6.4690) is a different matter altogether: we expect to get today’s updated SHIBOR fixing any second, and have a feeling more reverse repos will have to be injected before this is over.
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