Category Archives: Economics

What Happens if Greece Defaults?

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Our entire economy, for better or worse, depends upon an active banking sector. Should that sector freeze up, then the entire economy begins to freeze up as well. People are still having a hard time getting money together for a down payment on a home, now that lending requirements are significantly tightened up. My friends in real estate can sell homes, but they can’t get loans approved like they used to: that’s a banking issue.

Now, say Greece defaults later today, just to get it over with. (Greek debt is now CCC and costs more to insure than *Pakistani* debt. Yikes.) OK, first, how do they default? If it’s a soft default, then only European banks take most of the hit, as such a default won’t trigger insurance payouts. On a hard default, US banks are left holding the bag, because US banks are the ones insuring Greek debt. European banks finance it, US banks insure it.

So let’s say the default is bad and hard: the Greek PM resigns and the new guy from the “We’re Not Gonna Take It” party says everyone can take a flying leap into a lake of their choice, they’re all going back to drachmas and autarky. As the financial advisors from North Korea land in Athens, European banks now have to face a drastic reduction in their balance sheets. They will need an infusion of emergency cash to shore up their positions or they’ll be insolvent. Both the cash infusion and the insolvency will be bad things, but the cash infusion allows more room for maneuver, so that’ll happen… until the governments run out of cash. If it’s not there, they’ll have to turn to the ECB, and the ECB itself lacks solid-enough assets to provide a general bailout. That means banks go insolvent and the money-creating ability of banks heads south. That’s deflation, and the economy follows along, with five-cent apples for sale to people that don’t have a dime.

Over here in the USA, debt insurers face a host of claims… not all will be able to pay out 100% of those claims, so they’ll have to get that cash infusion or default. Sure, we got lots of cash in the USA, but we’re already at a discount rate barely above zero. The discount rate has to be that low to avoid hyperinflation: any higher relative to the money supply, and the prices march inexorably upward across the board. With a massive increase in the money supply to bail out a banking system a second time, we cross that discount rate:money supply limit and enter a hyperinflationary environment.

Now maybe we’re lucky enough to withstand the stress of a Greek default. Then we get a Portuguese default, an Irish one, and… oh no, a Spanish one. There’s an analogy to this situation in the game “Buck Buck.” A YouTube video shows what happens to a system that faces repeated stresses… it eventually collapses. While those are kids playing in that video, Bill Cosby tells the story of how his bunch of friends back in the day always won the game of Buck Buck because they had a ringer in one Fat Albert. Fat Albert could crush any competing Buck Buck squad, with ease. Even if Greece is a feather, Portugal feels like a fly landed on us, and Ireland is a leaf, Spain is the Fat Albert of the potential defaulters in our financial game of Buck Buck.

This is why I’m reading Der Spiegel’s reporting on the Euro Crisis religiously.

On Crisis

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Reinhart and Rogoff are looking at historical evidence of defaults and make a strong case about what prerequisites will allow for a crisis to precipitate. Right now, Greece, Spain, Portugal, and Ireland are in the most precipitous situation and stand ready to create a replay of the crisis that followed in the wake of German default in the late 20s.

Is this a stretch? I don’t think so.

Zimbabwe, Argentina, and others went bust either singly or as part of a regional financial crisis. We’re looking today at a global situation, with much more going on in more countries than in any other crisis since 1927-1933. Look at Spain’s recent election results: the Socialists that advocated austerity were swept aside in favor of populist parties. Greece isn’t likely to accept a surrender of fiscal independence to a band of German bankers, so look for a political trump there of any possible economic solution involving staying in the Euro with austerity. Italy’s and Belgium’s debt outlooks have both been lowered, and Italy is one of the G7/G8 nations: they’re a whale to the minnow of Greece.

The outcome of a crisis is never certain: one only knows that a crisis will precipitate an outcome that is in many ways significantly different from the set of conditions that existed prior to the crisis. While hindsight is also clearer than what people see at the time events are happening, it’s also insulting to those that experienced the events. By that, I mean we need to take a look at how people react in the midst of a crisis and what causes them to realize what will happen down the road. What danger signs do people consider? What events do they consider significant?

In Nazi Germany at the time of WW2, roughly half the Jews there had fled, while roughly half remained. While there were likely many Jews that could not afford to travel, there were those who could afford to do so that felt things would be all right in the long run. For those who fled, different things acted as triggers to their decision to depart. As the events became more obvious, escape became more difficult to accomplish, but remained possible. From a man who wrote “Mein Kampf” leading a coalition government to the Reichstag fire to the Enabling Act to Kristallnacht to the Nuremberg Laws to Rhineland occupation to Anschluss to Sudetenland to the Danzig crisis, events mounted in seriousness and yet war and its consequences still came as a surprise to many observers. Such will happen again in the current crisis.

This is not to say that we’re going to see, specifically, Nazism, World War, and a Holocaust. But I do believe we will see more political extremism and populism, increased tensions that will lead to more conflicts, increased opportunities for small nations to wage war as the bigger nations are preoccupied with internal troubles, and increased opportunities for ethnic-based conflict as the peacekeepers turn inward. We’re already witnessing the various Arab states dealing with their outbreaks of democracy in their own ways, and none of them are finished with their internal turmoil.

A huge question mark in my mind is China. It recently had to declare martial law in Inner Mongolia, adding that region to its list of ethnic hotspots. Couple that with increasing unemployment and inflation, and the necessary preconditions exist for a potential violent regime change in China – political infighting within the CPC at the very least and open warlordism with a breakdown of central authority as a real possibility.

Now back to Europe. 45% of Spain’s under-25s are unemployed. Massive anti-government protests have happened across the nation. This is on the level of what took place in Tunisia and elsewhere, this time in Europe. Greece had similar protests, and those are sure to worsen as the economy there worsens. Italy could be next. On the strategic side, the Visegrad nations of Poland, Hungary, Czech Republic, and Slovakia have agreed to form a battlegroup under Polish command. This is significant because they would not feel compelled to do so if both Russian power were not on the ascendant and protection guarantees from NATO were credible. The Visegrad nations are seeking to extend their alliance to Romania and Bulgaria, to formalize a vision of Pilsudski’s to create an “intermarium” alliance between nations that were traditionally in the orbit of either Russia or Germany, or both.

When was the sign that got me thinking along these lines? When Russia invaded Georgia in 2008 and the rich world watched on, impotently.

Wilson’s “The New Freedom”

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The New Freedom was written by Woodrow Wilson in 1912. I am finding it a fascinating read. While I do not agree completely with everything Wilson says, I do find his observations on the vast changes the USA underwent from 1890 to 1910 to make for compelling reading. Much of what he says resonates today. I would say his comments resonate even more so, since there have been nearly 100 years since he wrote for the forces he observed to continue their work.

Economics Joke

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Four economists are taking a shower. One’s a classical, one’s a Keynesian, one’s a monetarist, and one is a Marxist.

The hot water goes out because someone started the dishwasher.

The classical economist stands there for 90 minutes, shivering in the cold water. He does that because he believes that the hot water will eventually come back on and there’s nothing he should do to bring it back sooner.

The Keynesian starts fiddling with both the hot and cold water valves in an attempt to fine-tune the system while using a government-issued emergency hot water supply he had installed in his shower. Unfortunately, the supply only delivers the hot water to certain sectors of the shower and most of it goes down the drain. Darn leakage!

The monetarist doesn’t want to shiver and he doesn’t want to waste water. He just turns off the cold water and enjoys the warmth of a slowly increasing trickle of warm water. This works well until 2008, when the pipes freeze and the velocity of the water goes almost to zero.

The Marxist thinks the other three are total idiots and lashes out by smashing the hot water tank, leaving everyone and everything equally dirty. Showering was an opiate of the masses.

Quote of the Day for Me:

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“Society has the right and the need to safeguard its interests against an injurious assertion of individuality.” – J.A. Hobson

Sorry, Ayn Rand, but Mr. Hobson is right. O, but that we had heeded his advice at the Fed instead of embracing hers! O, but if only Greenspan had been a devotee of Hobson instead of a disciple of Rand! Alas, but that is what a good government should do: protect society from the injurious assertions of individuality.

Right Concept, Wrong Solution

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The GOP has a plan. Gut programs to aid the poor, and divert what’s left of them to their buddies in the big insurance companies. Yes, we need to cut spending, and that does include the big entitlement programs. But we do not solve the problems of America by giving more money from the poor to the rich. The growing income disparity in America – and it’s been growing since the Civil War, when the USA took on perpetual debt to fund that war – is due not to the poor being unable to hack it in the real world. It’s due to the way the government facilitates the plunder of America’s poor to benefit the rich.

I’ve read books from recent years, from the 1960s, from the 1930s, and from 1902 about the subject. All present telling facts – the same litany of facts, with numbers appropriate to their generation – all decrying the way the government assists large corporations and their directors in plundering the poor of the nation. Republican politicians seem to be the most ideologically predisposed to the plundering of the poor, and the article linked above demonstrates a continuance of that trend. Yes, we need fiscal responsibility, but no, it’s not in continuing to send bags of cash from the poor to the rich.

My solution is simple, but revolutionary. Ban all lending of money or property at interest. Ban any practice that amounts to someone earning money from another’s efforts, regardless of what was borrowed to make those efforts. Forgive all debts once the debtor has repaid the principal, and forgive all debts the debtors are unable to pay. Require conscription of personal fortunes in times of war – and we’ll never have another war again if the rich can’t lend money to profit from them. Amend the constitution with Thomas Jefferson’s idea: require the government to repay all debts within 19 years so that those born on the day the debt was taken out will not be involved in paying it off.

Yes, this means defaulting on the US debt and that we’ll never be able to borrow money again (supposedly). That seems to me to be a good thing, going forward. We need a new way of living in which we do not permit the exploitation of the poor. That is the true path to fiscal responsibility for the nation as a whole. I’m ready to ride a bike 6 miles to work when gasoline is unavailable to us – and that might not be so bad, either. It’s not the easiest world, but it’s a brighter future than one in which debt looms over us all and the rich continue to oppress the poor.

Think about it.

Usury: A Scriptural, Ethical and Economic View

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Mr. Elliott wrote this title in 1902 and complained of how any interest rate, large or small, presented a gradual shift of wealth from the poor to the owners of the banks. A simple, insidious process of concentrating the wealth of a nation into fewer and fewer hands. It’s no wonder that so many people have spoken out against the crime of usury, defining it as any interest charged, as a means of oppression of the poor.

Reading in light of today (2011), I cannot help but underscore most of Mr. Elliott’s points. Even if one discounts the divine nature of Christian and Jewish religious figures, one cannot deny their innate compassion for the plight of the poor: it is in harmony with many other leading intellectual and religious movements that value compassion. By allowing usury, we have sealed our fate. Even if we have no direct debts ourselves, we pay the debts of others through the prices they charge on their goods and services, set at such a level so as to clear a profit after paying interest on their debts. No one person can truly be debt free without society itself being debt free.

The book is free as an eBook from Project Gutenberg and Amazon’s Kindle Store.

The Cost of a Free Market

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If the Bureau of Labor Statistics reports that unemployment has decreased, but there is no corresponding report of an increase in the total jobs available in the economy, which of the following conditions is necessarily true?

a. current equilibrium is at full-employment output
b. the Federal Reserve is selling bonds in open-market operations
c. the money supply is expanding
d. net capital inflows are increasing
e. the number of discouraged workers is increasing

The correct answer is e. Sadly, this AP Macroeconomics question comes directly from recent data that show precisely what the question indicates. Where are the jobs?

Free-market boosters like to point out that companies can make jobs where labor is cheap. The jobs help the local economy and then, when the economy has been helped out and the wages rise, those same corporations go somewhere else to find cheaper labor. They’ll say this is a win-win situation.

Except when those corporations pack up and leave, the people left without the jobs face massive structural unemployment. Nobody is demanding their skills, so they have to make their way as best they can. Kind of like Detroit.

And that’s the new model for America: a city that’s seen better days, but now it has trouble scraping enough money together to fix the potholes. In their search for profits, the corporations built up with the idea of serving up a portion of the American Dream to one and all kept the profits and moved their jobs elsewhere.

The Wealth Gap Widens

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A recent article on the BBC discusses the global concentration of wealth and how it is increasingly separating the wealthy of the world from the poor. And make no mistake: if a flirtation with a dread disease would wipe out your income and savings at a stroke, you are poor. You are not rich unless you could still make millions while dead.

Which probably explains the exuberance with which today’s crop of super-rich individuals work at looting the world. They do not yet have that stable, old money revenue stream. They are dependent on work. One heart attack, and their cash flow goes to zero. They take jobs at major banks, run spreadsheets constantly, and innovate ways of fleecing the world in order to line their pockets.

So what happens when the rich are too rich and the poor are too poor? The article concludes that the rich either have to spread the wealth or crack down harder. If they choose the latter course, they invite the day when, as the Lakota described it, the world will roll to and fro like a tired, angry old dog, trying to shake off the fleas sucking its blood.

So what do you want to do when you grow up? My recommendation: be virtuous. Live with dignity and bear up under hardships. You’ll keep your soul and you’ll need that for when capitalism is no more.

Should We Have Let the Banks Fail?

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Interesting article about Iceland, which let its banks fail instead of bailing them out. Creditors for the banks had to take their losses and the taxpayers didn’t have to foot the bill. Iceland’s government took a hit and their economy went way down, but they’re apparently on their way back up.

Ireland, on the other hand, has a government that, like the US, wants its taxpayers to pay for the banks’ criminal, stupid, and/or reckless behavior. Iceland’s public debt, while high, is still manageable. Ireland has taken on debt that is 12 times – 1200% for those who like big percentages – of its GDP. This is known in economic circles as “unmanageable.”

While the USA has a big enough GDP to absorb the calamities of 2007-2008, will it be able to manage things if there is another banking crisis? It might happen… Click that last link for a paper on how the underlying fundamentals of the banking system remain reckless, stupid, and, yes, criminal.