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You load sixteen tons, what do you get?
May. 27th, 2010 02:44 pmAnd, as the song continues ... "Another day older and deeper in debt".
Bill Gross of Pacific Investment Management Co (PIMCO) reckons that this is the case for Greece.
As one would be tempted to say, you can try telling this to the Germans, but you'd only be talking to the hand.
A commentator this week on a Robert Peston Post (yesmemightaswell) wrote some very perceptive stuff, pointing out that bankers merely "rode the surf of a mighty wave" that saw its origins not just in the Bush madnesses of 2001 (stop the dotcom bubble by creating another bigger bubble) but also in the Asian crisis of 1997. He concludes, perceptively, with the rhetorical question (assuming that Greece and Spain get their act together)
Both writers lead one inevitably to the conclusion that Germany's proposed solution — that Greece and Spain become more like Germany, is no solution at all. Bill Gross says, mildly, that it's hardly any wonder that the private sector is wary of Greek and Spanish bonds, despite the ECB's "guarantees". What he does not say, but which he implies and which any half-way intelligent reader can infer from his final sentence referring to the song that I quote above, is that, if the current solution is no solution, then default, of one form or another, is the only possible consequence.
Gross's numbers are hard to dispute. We don't even need a global recession; The ECB's own numbers are enough. Greece's debt as a percentage of GDP will be more than 130% by 2011. the "Sixteen tons" territory is about 90%-plus. In other words, the Greek population could undergo a Damascene conversion to the German way of life tonight, and it wouldn't make a blind bit of difference (or, to put it another way, if Germany was somehow find itself in Greece's current situation, it would not be able to get itself out of the shit).
(By the by, Great Britain's debt as a percentage of GDP immediately after World War II was 180%. And look at the impact that this debt had on the UK for a decade.)
But all of this is building up straw men to knock them down. It's just further evidence that defaults are going to come. Far more interesting is the implication of those defaults. As I am now going to harp on about with tedious repetetion, I think that the sovereign debt crisis is not the real crisis. The real crisis is a solvency crisis in the banks -- one that started to evidence itself in 2007 and which has not yet ended.
I had a little think about this yesterday. The need for small Swedish bank HQ to raise cash was the spark. Let's have a little thought experiment. The sovereign debt crisis spirals out of control. Banks left, right and centre get into trouble. Governments cannot bail them out. Systemic global financial collapse looks as if it is just around the corner. We need money!
And who has money? Why, the Germans and the Chinese. As Aardvark said, the PRC suddenly has a role to play.
Neither Germany nor China want the global system to collapse.
Now, let's step back to the near-collapse of RBS and AIG. When the company can't pay its debts, but it's "too big to fail", the standard move is to swap debt for equity. The US and UK governments took equity in AIG and RBS respectively, in return for injecting enough capital to keep them going.
As the German banks begin to fail, Germany will have to inject much of the surplus that it accumulated (th parts of it which Greece and Spain don't renege on) into its banking system. Elsewhere, China will be the investor of last resort. The sole, non-war, solution to the problem would appear to be the PRC taking control of much of the eurozone's banking system.
I'll leave it to you to decide whether that is politically feasible.
Back to PIMCO. Bill Gross said that, although for many countries we are in a "sixteen tons" situation, for a few others, including the US, could, theoretically use increased debt levels to spur enough growth to pay debt. However, Gross mentions "strong doubts" about the US using its fiscal deficits in such a wise way.
It's a bit like an addiction -- the bottom has to be reached before you can turn it around, unless there is an "intervention" (to use the US phrase) from friends and family. The US has one fundamental strength not shared by any other country -- it's still an industrial powerhouse and it's still a massive producer of raw materials. The second alone differentiates it from Japan, and makes a "lost decade" of deflation unlikely.
So where does all this lead? Within a few years (possibly months), the sovereign debt crisis, allied to a bad debt crisis, escalates to the stage that banks start to go under. Perhaps governments rescue the first bank, or the second, pretending that it's a liquidity crisis and a credit crisis. But before too long the true nature of the crisis becomes plain -- too many banks are technically bust, killed by debts that are not going to be repaid.
Surplus capital will be needed, and Germany/China are the two countries that can supply it. At that point, politics gets involved. Somehow, China's massive surplus capital position will come into play. Perhaps they could take direct equity in the banks. Or perhaps (more to the Chinese taste?) they could buy the assets seized by the banks after loan defaults. Meanwhile, more political solutions are found to the sovereign debt crises -- inflation, voluntary renegotiation of the details, haircuts is the principle. These "solutions" are never simple. But two outcomes seem inevitable.
1) Only some of the debt will be repaid,
2) the PRC and Germany will end up holding a lot of assets in lieu of supplying capital.
Will the cost of capital go up? Theoretically, with only two real suppliers and an awful lot of demanders, it should. But this is not free-market economics. If the PRC and Germany realize that hiking the cost of capital will kill the sheep rather than shear it, then it makes more sense to keep the cost of capital relatively low. The choice is between, say, 60% of your capital now and nothing thereafter, or 10% of your capital a year for a decade. Your choice. Or, rather the choice of the PRC and/or Germany.
There will be other lenders out there. These two countries are just the two with the biggest surpluses. There are countries that are both lenders and borrowers (i.e.,"yes, we owe you bundles, but Spain owes us bundles"). There are countries with the advantage of an ongoing surplus if the slate was wiped clean (Australia, New Zealand, Canada), while others would be in some trouble if the slate was wiped clean (Norway). And, of course, things are not static. And I haven't even mentioned Brazil, Russia, India, non-Dubai Middle East and Africa.
The near-term appears to me to involve Spain rather than Greece. Greece is in deeper trouble, but is really only a peripheral player in the main game. It's the size of Spain that matters. perhaps not quite big enough to be "too big to fail".
So, that's where I'll be keeping my beady eye.
Just in time to miss the small bank in Slovenia that sets off a financial nuclear holocaust.
_______________
Bill Gross of Pacific Investment Management Co (PIMCO) reckons that this is the case for Greece.
"At the now restrictive yields of LIBOR+ 300-350 basis points being imposed by the EU and the IMF alike, there is no reasonable scenario which would allow Greece to 'grow' its way out" of debt, Gross wrote, adding that "Recession becomes the fait accompli, and the deficit/GDP ratio moves ever higher because of skyrocketing risk premiums and a plunging GDP denominator. In many cases, therefore, it may not be possible for a country to escape a debt crisis by reducing deficits.
As one would be tempted to say, you can try telling this to the Germans, but you'd only be talking to the hand.
A commentator this week on a Robert Peston Post (yesmemightaswell) wrote some very perceptive stuff, pointing out that bankers merely "rode the surf of a mighty wave" that saw its origins not just in the Bush madnesses of 2001 (stop the dotcom bubble by creating another bigger bubble) but also in the Asian crisis of 1997. He concludes, perceptively, with the rhetorical question (assuming that Greece and Spain get their act together)
"But if the Eurozone and China run surpluses, who is going to run the deficits? There are no debtors of last resort left. The result will be a return to competitive devaluation (either through currency or through real wages and prices) and subsequent global slump — the beggar my neighbour policies of the 1930's!
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2010/05/a_european_bank_tax_to_pay_for.html
Both writers lead one inevitably to the conclusion that Germany's proposed solution — that Greece and Spain become more like Germany, is no solution at all. Bill Gross says, mildly, that it's hardly any wonder that the private sector is wary of Greek and Spanish bonds, despite the ECB's "guarantees". What he does not say, but which he implies and which any half-way intelligent reader can infer from his final sentence referring to the song that I quote above, is that, if the current solution is no solution, then default, of one form or another, is the only possible consequence.
Gross's numbers are hard to dispute. We don't even need a global recession; The ECB's own numbers are enough. Greece's debt as a percentage of GDP will be more than 130% by 2011. the "Sixteen tons" territory is about 90%-plus. In other words, the Greek population could undergo a Damascene conversion to the German way of life tonight, and it wouldn't make a blind bit of difference (or, to put it another way, if Germany was somehow find itself in Greece's current situation, it would not be able to get itself out of the shit).
(By the by, Great Britain's debt as a percentage of GDP immediately after World War II was 180%. And look at the impact that this debt had on the UK for a decade.)
But all of this is building up straw men to knock them down. It's just further evidence that defaults are going to come. Far more interesting is the implication of those defaults. As I am now going to harp on about with tedious repetetion, I think that the sovereign debt crisis is not the real crisis. The real crisis is a solvency crisis in the banks -- one that started to evidence itself in 2007 and which has not yet ended.
I had a little think about this yesterday. The need for small Swedish bank HQ to raise cash was the spark. Let's have a little thought experiment. The sovereign debt crisis spirals out of control. Banks left, right and centre get into trouble. Governments cannot bail them out. Systemic global financial collapse looks as if it is just around the corner. We need money!
And who has money? Why, the Germans and the Chinese. As Aardvark said, the PRC suddenly has a role to play.
Neither Germany nor China want the global system to collapse.
Now, let's step back to the near-collapse of RBS and AIG. When the company can't pay its debts, but it's "too big to fail", the standard move is to swap debt for equity. The US and UK governments took equity in AIG and RBS respectively, in return for injecting enough capital to keep them going.
As the German banks begin to fail, Germany will have to inject much of the surplus that it accumulated (th parts of it which Greece and Spain don't renege on) into its banking system. Elsewhere, China will be the investor of last resort. The sole, non-war, solution to the problem would appear to be the PRC taking control of much of the eurozone's banking system.
I'll leave it to you to decide whether that is politically feasible.
Back to PIMCO. Bill Gross said that, although for many countries we are in a "sixteen tons" situation, for a few others, including the US, could, theoretically use increased debt levels to spur enough growth to pay debt. However, Gross mentions "strong doubts" about the US using its fiscal deficits in such a wise way.
It's a bit like an addiction -- the bottom has to be reached before you can turn it around, unless there is an "intervention" (to use the US phrase) from friends and family. The US has one fundamental strength not shared by any other country -- it's still an industrial powerhouse and it's still a massive producer of raw materials. The second alone differentiates it from Japan, and makes a "lost decade" of deflation unlikely.
So where does all this lead? Within a few years (possibly months), the sovereign debt crisis, allied to a bad debt crisis, escalates to the stage that banks start to go under. Perhaps governments rescue the first bank, or the second, pretending that it's a liquidity crisis and a credit crisis. But before too long the true nature of the crisis becomes plain -- too many banks are technically bust, killed by debts that are not going to be repaid.
Surplus capital will be needed, and Germany/China are the two countries that can supply it. At that point, politics gets involved. Somehow, China's massive surplus capital position will come into play. Perhaps they could take direct equity in the banks. Or perhaps (more to the Chinese taste?) they could buy the assets seized by the banks after loan defaults. Meanwhile, more political solutions are found to the sovereign debt crises -- inflation, voluntary renegotiation of the details, haircuts is the principle. These "solutions" are never simple. But two outcomes seem inevitable.
1) Only some of the debt will be repaid,
2) the PRC and Germany will end up holding a lot of assets in lieu of supplying capital.
Will the cost of capital go up? Theoretically, with only two real suppliers and an awful lot of demanders, it should. But this is not free-market economics. If the PRC and Germany realize that hiking the cost of capital will kill the sheep rather than shear it, then it makes more sense to keep the cost of capital relatively low. The choice is between, say, 60% of your capital now and nothing thereafter, or 10% of your capital a year for a decade. Your choice. Or, rather the choice of the PRC and/or Germany.
There will be other lenders out there. These two countries are just the two with the biggest surpluses. There are countries that are both lenders and borrowers (i.e.,"yes, we owe you bundles, but Spain owes us bundles"). There are countries with the advantage of an ongoing surplus if the slate was wiped clean (Australia, New Zealand, Canada), while others would be in some trouble if the slate was wiped clean (Norway). And, of course, things are not static. And I haven't even mentioned Brazil, Russia, India, non-Dubai Middle East and Africa.
The near-term appears to me to involve Spain rather than Greece. Greece is in deeper trouble, but is really only a peripheral player in the main game. It's the size of Spain that matters. perhaps not quite big enough to be "too big to fail".
So, that's where I'll be keeping my beady eye.
Just in time to miss the small bank in Slovenia that sets off a financial nuclear holocaust.
_______________
