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Thread: weekend commentary - lessons that the US could learn from Greece

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    Default weekend commentary - lessons that the US could learn from Greece

    (snip)"A Path-Dependent World

    Path dependence explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant. In essence, history matters.

    With regard to the future, the choices we make determine the paths we will take. As I have been writing for a long time, we have made a series of bad choices, often the easy choices, all over the developed world. We are now entering an era in which our choices are being limited by the nature of the markets. Not only are we in a path-dependent world, but the number of paths from which we may choose are becoming fewer with each passing year.

    Our economic future is more and more a product of the political choices we make, and those are increasingly difficult. We have no good choices. We are left with choosing the best of bad options. Some countries, like Greece, are now down to choices that are either dire or disastrous. There is no "easy" button.

    Let's look at how Greece came to its current rather dismal predicament. And we will look at why it may be even worse than many pundits think.

    First, we need to go back to the creation of the euro. Most of the Mediterranean countries that are now in trouble were allowed into the union with an exchange rate that overvalued their currencies relative to the northern countries, but especially to Germany. That meant that Greek consumers could buy products and services that previously may have been out of their reach. Plus, with government debt at low rates, the Greek government could borrow more to finance deficit spending, without the threat of higher interest rates. And Greece began to increase its debt with abandon.

    Additionally, as it now turns out, Greece basically lied about its finances in order to gain admission to the union. It never complied with the fiscal discipline that was required for entrance.

    With the high exchange rate, however, came the consequence of higher labor costs relative to, above all, Germany. While reviewing some economic facts about Greece, I came across the factoid that Greek workers had the second highest level of actual hours worked. But even with that, Greece was running a trade deficit that is currently 12.7% of its GDP.

    And with the onset of the current recession, their fiscal deficit went from bad to worse. Their total debt is now €254 billion, and they need to finance another €64 billion this year, €30 billion of it in the next few months.

    Bottom line, without some help or a bailout, they simply will not be able to borrow that money. And since a lot of that money is for "rollover" debt, that means a potential for default if they cannot borrow it.

    European leaders said today that Greece will not be allowed to fail, hinting of a bailout. But there are a lot of "buts" and conditions.

    Between Dire and Disastrous

    While German Chancellor Merkel has indicated a willingness to help, the German finance minister and other politicians are suggesting German cooperation will either not be forthcoming or only be there at a very high price; and the price is a severe round of "austerity measures," otherwise known as budget cuts. Greece is being told that it must cut its budget to an 8.7% deficit this year and down to 3% within three years.

    For my American readers, let's put that into perspective. That is the equivalent of a $560-billion-dollar US budget cut this year and another such cut next year. That would mean huge cuts in entitlements, Social Security, defense, education, wages, subsidies, and on and on. And repealing the Bush tax cuts? That would just be for starters. No "let's freeze the budget" and try and grow our way out of it, as we effectively did in the '90s, or gradually cutting the budget a few hundred billion a year while raising taxes. That combination of tax increases and budget cuts would guarantee a US recession. Unemployment, already high, would climb higher.

    And yet, that is what the Greek government is being asked to do as the price for a bailout.

    A few facts about Greece. Some 30% of its economy is underground, meaning it is not taxed. In a country of 10 million people, only 6 (!!!!) people filed tax returns showing in excess of €1 million in income. Yet over 50% of GDP is government spending, and Greece has one of the highest public employee levels as a percentage of population in Europe. And its unions are very powerful. Nearly all of them have gone on strike over this proposal.

    A National Suicide Pact

    Now, here is where it actually gets worse. If Greece bites the bullet and makes the budget cuts, that means that nominal GDP will decline by (at least) 4-5% over the next 3 years. And tax revenues will also decline, even with tax increases, meaning that it will take even further cuts, over and above the ones contemplated to get to that magic 3% fiscal deficit to GDP that is required by the Maastricht Treaty. Anyone care to vote for depression?

    And add into the equation that borrowing another €100 billion (at a minimum) over the next few years, while in the midst of that recession, will only add to the already huge debt and interest costs. It all amounts to what my friend Marshall Auerback calls a "national suicide pact."

    Normally, a country in such a situation would allow its currency to devalue, which would make its relative labor costs go down. But Greece is in a currency union, and can't devalue. Or it would restructure its debt (think Brady bonds) to try and resolve the problem.

    The dire predicament is the one where Greece cuts its budgets and more or less willingly enters into a rather long and deep recession/depression. The disastrous predicament is where they do not make the cuts and are allowed to default. That means the government is plunged into a situation where it has to cut the entire deficit to what it can get in the form of taxes and fees, immediately. As in right now. And defaulting on the interest on the current bonds wouldn't be enough, although it would help.

    Why not just let Greece go under? Part of the argument has to do with moral hazard. If Germany bails out Greece, Ireland, which is actually making such cuts to its budget, can legitimately ask, "Why not us?" And will Portugal be next? And Spain is too big for even Germany to bail out. At almost 20% unemployment, Spain has severe problems. Its banks are in bad shape, with large amounts of overvalued real estate on their books (sound familiar?) and a government fiscal deficit of almost 10%. While Spanish authorities say they can work this out, deficits will remain high.

    The fear is one of contagion. Some argue that Greece is only 2.7% of European GDP. But Bear Stearns held less than 2% of US banking assets, and look what happened."(snip)

    (snip)""Yet they are damned if they don't, and damned if they do. 'A Greek bail-out increases the risk of EMU break-up, because monetary union can only work if everybody sticks to the rules,' Mr Felsenheimer said."

    There is talk among some in Europe of a more centralized control of some countries that do not stay within guidelines, which means that Greece might be asked to give up some of its sovereign freedoms in exchange for bailout funds. French President Sarkozy emphatically stated that no member of the EU would be allowed to default. But he did not bring a checkbook to the press conference. Selling this to a variety of national parliaments will not be easy, when they have their own problems.

    And Merkel has problems on the home front. There are reports she is putting the brakes on a bailout, as she is getting pushback from her constituency. The Frankfurter Allgemeine Zeitung warned the chancellor yesterday that offering Greece any kind of bailout would be a betrayal of the trust of the Germans who so reluctantly traded in their marks for the euro. "If the no-bailout clause of the Maastricht Treaty is going to be abandoned, then the last anchor of a stable euro will be destroyed," warned the front-page editorial in the conservative newspaper. "Chancellor Merkel has to be hard now so that the euro doesn't become soft."

    Ultimately, this is a political decision for the Greek people. They have roughly four options. They can accept the austerity measures and sink into a depression for a few years. This would mean the total amount of debt would go up rather significantly, putting a very large crimp on future budgets. Debt is a constraint on growth. Debt-to-GDP is already over 100%. A recent paper by Reinhart and Rogoff (authors of the book This Time It's Different) shows that when government debt-to-GDP goes over 90%, it reduces future potential GDP by over 1%. That locks in a slow-growth, high-unemployment future in an economy already saddled with government spending at 50% of GDP, which is by definition a drag on GDP growth.

    The second option is that they can simply default and go into a depression for more than a few years. This would have the advantage of reducing the debt burden, depending on what terms the government settled on. Would bond holders get 50 cents on the euro? 25 cents? Stay tuned. But it would also most assuredly mean they would not be able to get new debt for some time to come, forcing, as noted above, severe cuts in government spending. From one perspective, it has the potential advantage of reducing government's share of the economy, which is a long-term good but a short-term nightmare. But it also keeps Greece in the euro zone, which does have advantages. However, it does little to deal with the labor-cost differentials.

    The third option is that they could vote to leave the European Union. While this is unthinkable to most Europeans, it is an option that may appeal to some Greeks. They could create their own currency and effectively devalue their debt. It would make their labor and exports cheaper. They would still be shut out of debt markets for some time. Any savings left in Greece would be devalued overnight. Those on pensions would find their buying power cut by a great deal. It is likely that inflation would become an issue. And it would be a full-employment act for legions of attorneys.

    Most people scoff at this notion, but money is flying out of Greek banks into non-Greek ones, and to my way of thinking that is a suggestion that some Greeks think secession might be a possibility. It is also causing severe stress at Greek banks.

    The final option is to promise to make the budget cuts, get some form of guarantee on their bonds, and borrow enough to make it another year - but not actually cut as much as promised; just make some cuts and then promise more next year if you will just bail us out some more. That just kicks the problem down the road for another year or two, until European voters (mostly German) get tired of taking on Greek debt.

    The market is not going to let Greece continue to borrow without showing some serious efforts at cutting their deficit, and probably not even then without some external guarantees. The history of Greek debt is not a good one. They have been in default 105 years out of the last 200."(snip)

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    Default Re: weekend commentary - lessons that the US could learn from Greece

    this is what happens when 'bankrupt' gov'ts are unable to obtain bailout funds and investors are reluctant to loan them any more money ...


    (snip)"Greece Outlaws Cash Transactions Above 1500 Euros, Unveils New Taxes

    In an attempt to rein in the shadow economy and collect more tax revenue, Greece outlaws cash transactions greater than 1500 Euros. Please consider Greek Finance Minister unveils tax reform, wage policy.

    "From 1. Jan. 2011, every transaction above 1,500 euros between natural persons and businesses, or between businesses, will not be considered legal if it is done in cash. Transactions will have to be done through debit or credit cards"

    "There's tax relief for incomes up to 40,000 (euros)"

    "Taxable income based on the new scales will include capital gains from the short-term trading of stocks"

    "Deposits in banks outside Greece are exempted from audits of their origin if they are repatriated within six months of the passing of the tax bill and are taxed with a 5 percent rate"

    "Wages of board members in unlisted state companies will fall by 50 percent"

    "The budget bill for allowances and compensations will be cut by 10 percent"
    Buy It Now

    Everyone in Greece will quickly figure out that the time to make major purchases is now. So expect to see sales plunge starting January 1, 2011 as demand for everything priced above 1500 euros shifts forward.

    New 40% Tax Rate

    In addition, attempts to collect more sales taxes (VAT), Greece to levy 40% tax rate on more earners.
    Greece will lower the current 75,000 euro income threshold that is subject to a 40 percent tax rate as part of reforms to urgently boost government revenues, the country's finance minister said on Monday.

    "The 40 percent tax rate will be applied on income levels that are lower than what is the case today, but there will also be intermediate rates that will provide relief for low and middle incomes," Finance Minister George Papaconstantinou told Ta Nea newspaper in an interview.

    He said that as a result of the tax changes, the biggest burden would be felt by a small percentage of tax payers as 95 percent of earners report incomes below 30,000 euros a year.

    Retirement Age, Fuel Taxes Rise

    Please consider Greece raises retirement age and fuel taxes a day ahead of nationwide civil service strike.

    Prime Minister George Papandreou told a cabinet meeting that the reforms “must go ahead now … with greater speed.”

    “Our primary duty now is to save the economy and reduce the debt, aiming to do so through the fairest possible solutions that will protect — as far as that is possible — the weaker and middle classes,” said Papandreou, who is to meet in Paris with French President Nicolas Sarkozy on Wednesday ahead of a European Union summit the following day.

    The new tax bill, Papaconstantinou said, will increase the burden on the rich while easing taxation for those on low incomes. The top income bracket which will be taxed by the maximum 40 percent will be expanded to include incomes of over euro 60,000 a year, from the current euro 75,000 threshold.

    Papaconstantinou said that public consultation over the tax bill continued, and that there could be changes, but that any amendments would be based on the broad principles outlined in the draft.

    He confirmed plans to freeze public sector hirings and wages, while cutting bonuses or stipends by 10 percent, a move he said would trim between euro18 and euro345 euros off monthly salaries. The stipend cut will also apply to those of the prime minister, ministers and other high-ranking ministry officials.

    “We all know that the civil service salary system is one full of injustices, that lacks any central logic and has evolved with successive bonus payments,” Papaconstantinou said. “We are committed to have a unified payment system.”

    He also said all Greeks must collect receipts in order to qualify for the income tax-free amount of euro12,000 — an attempt to crack down on widespread tax evasion, where vendors under-declare their income by not giving receipts. Cash registers will have to be installed everywhere, including kiosks found on practically every Greek street, and food markets."(snip)

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    Default Re: weekend commentary - lessons that the US could learn from Greece

    and by sheer coincidence ...



    (snip)"Trichet to Greece: Drop Dead!

    Obama to California: Uh…

    Yesterday, stocks lost 103 points on the Dow. This looked like a confirmation to us. The stock market appears to have begun its next and final phase…

    AP seemed to think so too:

    “Stock investors see threats from all directions,” said the headline.

    We didn’t bother to read the article. We already know the directions.

    From the north, investors worry about falling consumer demand. Consumers are in a funk – they have more debt, less income, fewer jobs, and less access to credit. The only news on that front we have today is that even jumbo housing loans are going bad…delinquencies are up to 9.6%.

    From the east, investors worry about the continued invasion of cheap consumer goods and cheap services. China’s economy is said to be growing at double-digit rates. How can US firms compete? And what if China is a bubble, as Jim Chanos believes? When it blows up, US stocks will come down too.

    From the south comes the threat of higher interest rates. The poor dopes think the recovery might be for real. If so, inflation will rise and the feds will increase interest rates…possibly cutting off the new boom.

    And from the west what do they have to fear? Well, there’s that business in Europe. You know, Greece and all. The PIIGS – Portugal, Italy, Ireland, Greece and Spain… Europe’s peripheral countries are in trouble. Lenders fret that they might be forced to default on their debt. So, they want higher interest rates. This, of course, just makes state finances worse…pushing the PIIGS closer to default.

    The PIIGS owe $2 trillion, which might need to be restructured. Yes, dear reader, the sovereign debt problem is a big one – much bigger than Bear Stearns, Lehman Bros. and AIG. But the biggest porker of all – the USA – has fives times as much sovereign debt as all the PIIGS put together.

    It won’t take investors long to figure out that there isn’t a whole lot of difference between Greece’s finances and those of the US. Each has about the same amount of debt and the same size deficit, relative to GDP. The big difference is that the US ultimately controls the currency in which its debt is calibrated. Greece does not. Neither does California.

    Both California and Greece borrow long-term at about the same rate…around 6%. Lenders know that when their backs are to the wall, both governments will have only two choices, not three. They can cut spending. Or, they can default. What they can’t do is wiggle out of their obligations by inflating their currencies.

    Jean Claude Trichet has already made that clear:

    “…belonging to the euro area, you…have an easy means of financing your current account deficit. You share a currency that is credible, so that you have a quality of financing that corresponds to that of a credible currency.”

    He went on to say that Greece contributes only about 3% to the total output of the euro-zone. If push comes to shove, Greece will be pushed out rather than allowed to weaken the euro.

    Then, Mr. Trichet made an odious comparison. California is a much bigger part of the US economy than Greece is of the euro economy. In fact, it is more than four times as large. Will the US come to California’s aid? Mr. Trichet didn’t say.

    It is possible, of course, that Mr. Obama will say to the Golden State what Gerald Ford said to the Big Apple. In 1975, New York City’s back was to the wall. It appealed to Washington for help. “Ford to City: Drop Dead,” was the famous headline in the New York Daily News, reporting the president’s response.

    New Yorkers were incensed. Later, they realized that by vowing to veto a bailout President Ford had done them a great favor; he forced New York to clean up its act. The city went on to its greatest years. Likewise, the feds would be doing all of us a favor by letting failure fail with dignity.

    Will Obama help California mend its ways? Or will he turn it into a zombie state?"(snip)

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    Default Re: weekend commentary - lessons that the US could learn from Greece

    and here's an interesting precedent ...



    (snip)"The council of EU finance ministers said Athens must comply with austerity demands by March 16 or lose control over its own tax and spend policies altogether. It if fails to do so, the EU will itself impose cuts under the draconian Article 126.9 of the Lisbon Treaty in what would amount to economic suzerainty.

    While the symbolic move to suspend Greece of its voting rights at one meeting makes no practical difference, it marks a constitutional watershed and represents a crushing loss of sovereignty.

    "We certainly won't let them off the hook," said Austria's finance minister, Josef Proll, echoing views shared by colleagues in Northern Europe. Some German officials have called for Greece to be denied a vote in all EU matter until it emerges from "receivership".

    The EU has still refused to reveal details of how it might help Greece raise €30bn (£26bn) from global debt markets by the end of June. Investors are unsure whether this is part of Kabuki play of "constructive ambiguity" to pressure Greece and keep markets guessing, or reflects the deep reluctance by Germany to be drawn deeper in an EU fiscal union. Greek bonds sold off as ten-year yields jumped to 6.42pc, but the euro rallied to $1.3765 against the dollar as broader issues resurfaced in currency markets.

    Jean-Claude Juncker, head of the Eurogroup, hinted that ministers have already agreed on a support mechanism, should it be necessary. It will most likely involve by bilateral aid by eurozone states. He said proposals for an IMF bailout - backed by Britain - were "absurd" and would shatter the credibility of monetary union.

    Many Germans disagree, including Otmar Issing, once the backbone of the European Central Bank. He said an EU rescue for Greece would be fatal, arguing that unflinching rigour is the only way to hold monetary union together without political union.

    Tuesday's EU verdict amounted to a thumbs down on Greece's earlier austerity efforts, viewed as too reliant on one-off measures and too light on spending cuts. Greece must reduce its deficit from 12.7pc of GDP to 3pc in three years. Greek customs officials expressed their anger by kicking off a three-day strike, the first of many stoppages set to culminate in a general strike next week. "(snip)


    Under this precedent, if California or Michigan or other cash flow bankrupt US states apply for a Washington based bailout financed by federal taxpayers, would California or Michigan lose their voting rights in the US house and senate until they are able to emerge from 'receivership' by repaying the bailout money ?

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