A Glimpse into the Future of the Sovereign Debt Crisis
The canary in the coal mine is choking…
Greek stocks tumbled to new 14-year lows this morning, as Greek bond yields rocketed to new all-time highs.
The panic in Athens is no surprise, as we explained in yesterday’s essay “Lessons to be Learned from the Greek Debt Crisis”. The Greeks are bankrupt.
The Greeks have been bankrupt for a while, of course, but investors were slow to believe it. Or rather, investors were quick to believe that last year’s €110 billion bailout from the European Union and the IMF would be sufficient to prevent the Greeks from defaulting.
But with each passing day, that bailout package is looking increasingly insufficient. You can’t make a silk purse out of a sow’s ear, as the saying goes. And the finances of the Greek government are emitting a distinctly porcine aroma. They are a mess, plain and simple.
To continue our metaphor, bailouts from the EU and IMF cannot remediate the pigpen; they merely spritz a little perfume on the pig.
The only legitimate solutions to the Greek debt crisis will require both painful adjustments in Greece and punishing losses for bondholders. That’s called default.
After default, the borrower walks away stigmatized, the lender limps away chastened. Both sides walk away with less than they had at the outset of their relationship. Both sides suffer. But, importantly, default clears the way for new growth. Because default recognizes all losses, while simultaneously pricing assets to real-world values, new investors can enter the fray to initiate a new cycle of investment and (hopefully) capital formation.
To be clear, your editor does not think Greeks are pigs. Greeks are Greeks. Americans are pigs. The distress we are witnessing in Greece is merely the prelude to the distress that could arrive on our shores.
The AAA American balance sheet is not so different from the junk-rated Greek balance sheet. The biggest difference between these two sovereign credits is that the former can print as many dollars as it wishes, the latter cannot print any euros whatsoever. A printing press greatly facilitates debt repayment. The Greeks should get one.
But since the Greeks can’t print euros, and are incapable of raising taxes significantly or cutting spending significantly, a default seems the likeliest outcome. A Greek default would not be the end of the world, but it might be the end of something…like the Welfare State “business model.”
Greece is not the only bankrupt European nation; it is not the only country that promises too much to its citizenry, while receiving too little in terms of tax receipts. In fact, Greece has lots of company…from Portugal to Ireland to Spain to – dare we say – America.
To borrow and distort a famous phrase from Milton Friedman, “We are all bankrupt socialists now.”
Thus, the birthplace of the Western World may well become the graveyard of the Western Welfare State. But this funeral procession will take some time. In fact, it might even feel as pleasant as a Fourth of July parade…for a while. Many doomed bonds will rally…for a while, many infirm currencies will increase in value…for a while, while many “safe haven” assets like gold and silver will fall…for a while.
But these delusional, counter-trend-episodes will not last.
Recent trading action during the month of May illustrates the point. During the last several months, as the US dollar’s value was steadily declining, commodities and “hard asset” currencies produced sizeable returns. The Reuters/Jefferies CRB Index of Commodity Prices advanced more than 30% during the 12 months ending April 30 of this year. Gold and crude oil advanced similar amounts, as many of the grains jumped more than 50% and silver rocketed more than 100%.
But during the month of May, the greenback has staged its first meaningful advance in months, which has triggered corrections in most of the commodity markets. The greenback’s advance – a mere 3.6% for May-to-date – would not been that meaningful, except for the fact that it has been falling for months on end.
So the dollar’s rally provides a handy excuse to dump commodities…for a while. The dollar may continue to rally for a while longer, perhaps several more weeks. In which case the precious metals and other commodities might continue floundering for several more weeks.
But gold and silver remain a strong “Buy,” mostly because the Welfare State’s finances remain a strong “Sell.”