Tuesday, March 6, 2012

The next two weeks are going to be interesting . . .

. . . because Europe's economic pigeons may be about to come home to roost. If the authorities in the Eurozone, both political and financial, can navigate their way between the fiscal rocks and monetary-policy shoals surrounding them, they may buy a bit more time to solve that continent's almost intractable situation. If they can't, then it's "Katie, bar the door!" - for all of us. Consider the following points:

1. Greece has said it requires the holders of 75% of its outstanding privately-held sovereign debt to 'sign on' to the latest bailout deal, which involves those holders taking a 'haircut' of at least 57% on their investments (which is more likely to end up at around 70%, when all is said and done). However, only 20% have accepted the deal so far. Greece is threatening to enforce participation through new legislation: but it seems that not all outstanding bonds were issued subject to Greek law. At least some (perhaps enough to derail Greece's plans) were issued subject to the laws of other nations, in order to sell them to investors there. If Greece tries to 'railroad' those bondholders under Greek law, it's going to have an international legal fight on its hands. The deadline for all parties to reach agreement is March 8th: and if they don't, the latest bailout deal may fall apart. If that happens, Greece will undoubtedly default on (i.e. be unable to meet) its next payment on its bonds, a sum of about 14.5 billion Euros, which is due on March 20th.

2. Markets around the world are already falling sharply in anticipation that Greece may not be able to make its scheduled payment, and will therefore go into default. That will threaten the status of a minimum of one trillion Euros of debt - bonds issued by Greece and other weak Eurozone economies such as Italy, Spain, Portugal and Ireland. The total amount of debt at risk may actually be several times larger, given the number of off-balance-sheet transactions that have taken place in those nations (particularly among second-tier regional and third-tier local governments). Nobody knows for sure.

3. If Greece defaults, the 'debt pyramid' built up by the world's major central banks will be exposed for the financial 'house of cards' that it is. In the past 3½ years, central banks in the USA, Britain, Japan and the Eurozone have created no less than $8.8 trillion in 'new money'. That's money created out of nowhere, backed by no assets - it's merely a string of numbers on a computer screen. This has been at the root of the so-called 'quantitative easing' programs of the central banks, but has also created growing instability in the world's money supply. Never in the history of the world have we seen money supply growth of this magnitude. No-one really knows to what it may lead - but I can't believe it will end well.

4. That enormous amount of newly created money has been used to prop up the national finances of some of the world's largest - and weakest - economies. In the case of the USA, our national debt has skyrocketed during the past four years. As a result, the interest payments this country will owe on its public debt are estimated at over $5 trillion during the next decade alone - and that's without repaying a single cent of the principal! As CNN points out:

Over the decade, more than 14% of all revenue the government is projected to collect will be sucked up by interest payments.

That's a lot of money that can't be used on the country's other priorities.

Indeed, between 2013 and 2022, estimated interest costs will be:

  • higher than Medicaid spending;
  • equal to half of Social Security spending;
  • close to what is spent on all of defense.

And here's the thing -- the estimated interest costs assume a fairly steady and moderate increase in rates over the decade.

. . .

If it turns out that rates rise one percentage point higher than CBO projects, that could add roughly $1 trillion to interest costs over the decade.

There's more at the link.

If Greece defaults, and other weak Eurozone economies follow it into the economic desert, look for those interest rates to rise very sharply indeed. That'll make the CBO's projections effectively meaningless. For example, the interest rate may double or triple compared to what the CBO projects. That is entirely possible - it's already happened to Greece, and currently threatens Italy and Spain - and it may develop with frightening speed, in a matter of weeks rather than months (again, that's what happened in Europe). If it happens, that means not $5 trillion, but perhaps as much as $10 trillion out of our economy over the next decade - $1 trillion every year - before we've spent a single cent on any other government programs. It may be even more than that. If that happens, ladies and gentlemen, kiss your entitlement programs goodbye - overnight. There'll be no way to pay for them.

5. David Stockman, former White House budget director under President Reagan, recently answered a series of questions about the economy that are directly relevant to this issue. Here's an excerpt.

Q: What will 10-year Treasurys yield in a year or five years?

A: I have no guess, but I do know where it is now (a yield of about 2 percent) is totally artificial. It's the result of massive purchases by not only the Fed but all of the other central banks of the world.

Q: What's wrong with that?

A: It doesn't come out of savings. It's made up money. It's printing press money. When the Fed buys $5 billion worth of bonds this morning, which it's doing periodically, it simply deposits $5 billion in the bank accounts of the eight dealers they buy the bonds from.

Q: And what are the consequences of that?

A: The consequences are horrendous. If you could make the world rich by having all the central banks print unlimited money, then we have been making a mistake for the last several thousand years of human history.

Q: How does it end?

A: At some point confidence is lost, and people don't want to own the (Treasury) paper. I mean why in the world, when the inflation rate has been 2.5 percent for the last 15 years, would you want to own a five-year note today at 80 basis points (0.8 percent)?

If the central banks ever stop buying, or actually begin to reduce their totally bloated, abnormal, freakishly large balance sheets, all of these speculators are going to sell their bonds in a heartbeat.

That's what happened in Greece.

Here's the heart of the matter. The Fed is a patsy. It is a pathetic dependent of the big Wall Street banks, traders and hedge funds. Everything (it does) is designed to keep this rickety structure from unwinding. If you had a (former Fed Chairman) Paul Volcker running the Fed today — utterly fearless and independent and willing to scare the hell out of the market any day of the week — you wouldn't have half, you wouldn't have 95 percent, of the speculative positions today.

Q: You sound as if we're facing a financial crisis like the one that followed the collapse of Lehman Brothers in 2008.

A: Oh, far worse than Lehman. When the real margin call in the great beyond arrives, the carnage will be unimaginable.

More at the link. Bold print is my emphasis. Go read it all. You can't afford not to!

6. The inimitable Charles Hugh Smith asked Zeus Yiamouyiannis to comment on the situation. The resulting article is titled simply, "When Greece Comes Crashing Down, Everything Comes Crashing Down". Here's an excerpt.

This is not just about fairness anymore; it is about the exposure of central, global illusions that affect everyone, not just banks. For the last three plus decades, debt-fueled “growth” has instilled a life sense that everyone gets rich, values always go up, and no one has to pay. If those illusions evaporate than those citizens complicit in this failed fantasy may actually join forces with the realists (those who knew it was a scam all along) to produce unified citizen revolt. Hell hath no fury like the people spurned and lied to, even if many had some responsibility in welcoming and fanning those lies.

The implicit deal was this: We will collude so everyone gets rich going forward. We will collude so no one has to pay if there is any unwinding. (But, hey, it’s a new era, and that’s not going to happen!) Open default breaks the illusion, and austerity breaks up the collusion. This is why default has to be hidden, deferred, restructured. It is not just about chaos around party/counterparty risk (in particular, cascading claims that are not backed by anything). It is not even just about finance. It’s about all the other things that will unwind, culturally, politically, and psychologically, if Greece defaults and sets into motion the necessity of someone actually paying up. In short, recognition of reality has disastrous consequences for the status quo and its control myths.

The infinite growth meme unwinds: The cancerous economic obsession with infinite growth in a finite world is already unwinding, but will hit full force with cascading defaults. It is one thing to have a “slowdown,” and another to have your economic brakes lock up on you and your gears slammed into reverse. About the only thing that seems to be growing currently is the number of people partially employed or permanently unemployed.

. . .

Guaranteed entitlements unwind: So now that the illusion of infinite growth is being exposed, the corresponding ballooning entitlements that enticed the larger public to become complicit in the illusion are becoming unglued. It would take almost a decade of gross national product to pay off the U.S. unfunded liabilities for Social Security, Medicare, and Medicaid, which exceed the staggering sum of 100 trillion dollars.

Retirement and health benefits cannot be paid out of fake prosperity and “notional” (i.e. imaginary) values. They require real services and products and an accepted public medium of exchange. (I will leave off the argument as to what constitutes “real” and “accepted” since even fiat currencies are dubious in this regard.) People will be forced to adjust their expectations and adapt their realities. With public and private pension plans also complicit in derivative scams to fund benefits, it will be no surprise if many pensions simply declare themselves bankrupt in the next decade.

Again, more at the link. This is a must read, I say again, a MUST READ for anyone trying to imagine the overall, worldwide economic consequences of the current financial situation. It's that important. Go read it. NOW.

All this comes to a head during the next two weeks, folks: first on March 8th, which is Greece's deadline to finalize investor participation in the bailout deal, then on March 20th, which is when Greece must make a multi-billion-Euro debt payment. If the bailout deal falls through, and if Greece defaults on that payment . . . things are going to get very interesting, very quickly.


EDITED TO ADD: Karl Denninger weighs in on the subject in his usual right-to-the-point fashion:

Let's assume that Greece fails to get their "PSI" and thus hard-defaults. The correct thing for them to do in this instance is to default all externally-held bonds at minimum (and maybe all of them, external or not.)

Why should Portugal, Ireland or Italy pay if Greece can erect the middle finger?

Oh yeah, we didn't think about that, did we?

. . .

I have held since the beginning of this mess that Greece was going to default -- it was inevitable. I will add that it is inevitable that if The United States does not immediately -- not in five years, not in ten, not in fifteen, but now -- balance its budget and cut the deficit spending to zero we will inevitably default as well.

. . .

We are quickly running out of time in America and Europe appears to be the trigger that will force our hand. This does not surprise me; the only surprise is that we've managed to get away with our obfuscation and lies for as long as we have.

Time's up!

More at the link. Bold and italic print are Mr. Denninger's emphasis. Go read the rest!

1 comment:

SiGraybeard said...

Excellent summary. Linked back from my place.