Wednesday, May 26, 2010
My Big Fat Greek Debt
It's funny how things happen! Once upon a time it was thought that the financial crisis would be "contained". It was supposedly a liquidity crisis and the pundits were claiming that by adding liquidity, everything would be fine. It was soon discovered that the crisis had a solvency component to it. This added a dimension to the crisis in that, without restructuring, the insolvency would not go away just by adding liquidity into the system. Liquidity was there to buy us time to restructure. We knew that if we didn't restructure, the liquidity needs would become permanent like for a patient on permanent life support. Yet we did not do much about it! And interest rates are still at close to 0%. But not for much longer says Bernanke. Well, maybe just until after the Greek crisis is over says the market. OK! replies Bernanke.
You can extinguish a fire with water but if the source of the fire is an oil well, it may require more than water. It may require that you cut off the source of energy, the combustible that is keeping that fire alive. Given enough water you may drown the fire but the collateral damage will be a flood. The same is true with this crisis: you may be able to drawn the problem in excess and permanent liquidity but you will have inflation down the road.
So far the liquidity that was poored over the economy was meant to give it room to breath - temporary life support - while it was supposed to recover from its liquidity crisis and then its solvency problems. The problem is that, while liquidity shortages don't last if there are no underlying solvency problems, they tend to be pepetual until solvency issues are dealth with. But who has the political will to deal with those?
No wonder that the economy is not creating jobs and that it is stalled in third gear. The solvency problem of banks has not been addressed. They still carry the toxic waste on their books and are unwilling to lend. In the meantime, the fllod of liquidity keeps a veil on the problem and lax fiscal policies are creating the illusion of growth. But remove government stimulus and we would have no growth. Turn off the money spigot on top of this and the patient would die. Already SMEs which traditionally are responsible for over half of job creation in our economy are suffocating. It seems obvious that the patient would not be able to survive on his own but that we refuse to acknowledge it. Everything will be fine.
Now Greece. It's the same story. Yet this time it's obvious. The problem is structural in nature. It is not a liquidity crisis. The economy is in need of restructuring simply because it has too much debt and because it wants to continue borrowing more. Any bail-out from other European nations is only postponing the day of reckoning; it is good money thrown after bad.
I don't know if the Greeks are in denial or if they are holding out to be saved by the Europeans but anyone with a clear mind is realising that a once in a life time bail-out is possible but it is not credible. If you give in now, Greeks will not have not any incentives to behave optimally and the signal will also have been clear for others. Except that the others are bigger and that the source of the problem won't be extinguished by throwing money at the problem. That is because the amount of money needed is already huge and will grow with each bail-out; and it will soon become unsustainble. The only source of money that will eventually be infinite will be coming from the magical printing press. If we get there, the temptation will be great to use it. Just a little at first. Then a little more ... until it is too late. It's the same with gambling and torture. You start with good intentions but can't get it under control. It's never been done. Why would we be any different than our ancestors?
That day is coming. How do I know? We have already place our first bet and we lost. Now we are placing our second. Just a small second bet on Greece. And then it's over, I promise. You bet!