Understanding the Universal Language of Insolvency

The Dow Jones Industrial Average is climbing again this morning, as we put the finishing touches on today’s edition of The Daily Reckoning. The Blue Chip index is up more than 100 points to 12,727 – its highest level in two months.

Today’s advance continues what has become a rally of more than 500 points since the Greek government agreed to “accept” more bailouts from the European Union and the IMF. To infer from the stock market, therefore, the Greek crisis has passed. Problem solved.

Testifying against this rosy conclusion are at least two intriguing news items. The first is that Moody’s banished Portugal into the dungeon of “junk credits” earlier this week. Greece, which has been inhabiting this dungeon for several weeks already, may be content to have a new cellmate. But European bond investors are less enthralled.

Don’t pity the Greeks and the Portuguese. They will find a way to amuse themselves in the midst of their financial incarceration. Though they speak different native languages, they understand the universal language very well – the global dialect of insolvency. In fact, they understand this dialect much better than their creditors.

“Bankruptcy” may look like πτώχευση in Greek and bancarrota in Portuguese. But the Greeks and the Portuguese both understand that sovereign bankruptcy in Europe means great, big handouts from their neighbors. It means “promise a bunch of stuff, but do almost nothing until the money runs out.” After that, bankruptcy will mean what it always means: the borrowers will stiff the lenders and life will move on.

The Greeks and the Portuguese will emerge from their dungeon, free from the shackles of debt and austerity, with pocketfuls of drachma and escudos.

How do we know that the story will play out this way? Well, we don’t, but it always does. And one reason we think the bankrupt nations will continue begging money until they ultimately declare bankruptcy is that the Greeks are already at it again.

“Barely a day after a multibillion-dollar bailout from the IMF,” Investors’ Business Daily reports, “Greece’s prime minister has his hand out again for yet another loan, this one from Europe. Has his mendicant state become the Oliver Twist of nations?”

Yes, is the obvious answer. But why not beg when the begging is so easy? Papandreou is asking the European Union to lend Greece another $173 billion, on top of the $156 billion bailout the EU and IMF have already approved, and partially dispensed.

“Successive rescues, guarantees and bailouts have put the grand total spent so far at $394 billion,” Investors’ Business Daily relates. “But Europe seems oblivious to reality as it scrambles to find more money… The London Telegraph points out that the second bailout sought by Greece is likely to last only until 2014 and will leave an even bigger debt after that. Someone will have to pay.

“So maybe the roots of the problem – unfunded mandates and a bloated public sector – ought to be targeted as much as Greece’s parlous fiscal picture,” the IBD continues. “The IMF mega-package addresses just one side of the problem – fiscal accounts. What it doesn’t do is address the entire socialist nature of the system that has made a hash of its finances…IMF loans may keep the government afloat, but it’s that very government that’s keeping the private sector from rescuing Greece for real.

“Bailout in hand,” the IBD winds up, “Greece remains a thicket of price-fixing that distorts markets, clientelism that gives some citizens – generally state employees – privileges over others, and massive regulation of the private sector that encourages tax evasion, idleness and finger-pointing… Papandreou’s call for more money after the IMF bailout is a clear signal of a flawed economic model.”

“I think this will ultimately be a case in which the doctors kill the patient,” predicts Johns Hopkins University economist, Steve Hanke.

Maybe so, but we would put our bet on the patients killing the doctors. Or, to return to our metaphor, the inmates killing the wardens. One way or another, the debtor nations of Europe will stick it to their creditors. Not while the bailout funds are still flowing…but probably a few minutes after they stop.

Governments, as a capitalistic investment, are a very bad bet. Since they do not produce, they are genetically predisposed to failing financially. Corporations also go bankrupt, of course, but many succeed…often in spectacular fashion.

Because of these dynamics, genuine capitalists owe it to themselves to invest in capitalistic enterprises, while also trying to shun habitual consumers of capital like governments.

Eric Fry
for The Daily Reckoning