Greece a Canary in the Deficit Mine

So, who gets to play Lehmans in this comedic repeat…?

Isn’t Greece marvellous?

Paying income tax, or any kind of tax it would seem, has been entirely optional. Which should have powered its economy like 1960s’ Hong Kong.

But public spending, however, accounts for 40% of GDP. So who financed that spending if so few people paid?

Last year, only 15,000 of Greece’s 11-million population declared an income above €100,000. The government only got round to making shop receipts mandatory this week. Tax evasion is thought to cost the Greek purse €15 billion per year ($20.5bn). The untaxed “shadow economy” accounts for some 25% of annual output.

“The Greek issue is a Eurozone issue,” wrote Athen’s finance minister in a letter to the Financial Times this week. Which is true, and not just with regard to taxation – and not just with regard to the 16-state currency zone.

Yes, untaxed business accounts for one Euro in five generated in Spain, Portugal and Italy, or so reckons one Austrian economist. But this is nothing next to the gap between income and spending now looming for pretty much the entire Western world.

Greece, in short, is but Northern Rock in this farce. The first bank to collapse – and thus the first to get rescued – it now looks a mere footnote to the historic crisis which followed. Neither the cause nor a “domino”, the Rock was more than a warning. It announced the crisis was on.

The scramble for tin hats began…

On Weds 12 Sept. 2007, Northern Rock– the biggest employer in Newcastle-Upon-Tyne…sponsor of the city’s football team…and the fastest-growing of the UK’s fast-growing mortgage banks – ran a banner advertisement across the front-page of the national press.

It offered 6.30% interest on new deposits, then more than 250 basis points above the average return offered by High Street savings accounts. Clearly, the bank needed cash in a hurry! And come Thursday it had to arrange an emergency loan from the Bank of England. By 9am Friday, queues were forming at its branches across the country, and Northern Rock’s stock promptly dumped 20%.

On the following Monday, the government effectively rescued the bank’s savers, guaranteeing their deposits in full. And from then until Feb. 2008, when it finally came, nationalization was only a matter of time.

The Rock’s demise wasn’t the first sign of trouble. August ‘07 saw inter-bank interest rates jumped to a near-nine-year high. Both Bear Stearns and BNP Paribas had already closed certain mortgage-investment funds to withdrawals. A handful of smart-arses pointed to the 40-to-1 leverage at leviathan banks such as Lehmans.

Fast forward to early 2010, and the US and UK are running record peacetime public-purse deficits. Dubai last month suspended (and then restructured) repayments on a chunk of its debts. The cost of insuring government bonds against default has risen sharply for more than a month.

So…who gets to play Lehmans in this comedic repeat?

For all London’s dithering and dawdling, saving the Rock was never in doubt. No politics or ideology stood in the way. But making German savers pay the wages of Greek civil servants is another thing altogether. Either the Greeks take a wage cut, or somebody stumps up, or the central bank simply prints money, or Greece will default on its debts as bond-buyers vanish.

Writ large across the developed world’s spending, we’ll thus need the Martians to help…or perhaps we’ll ask God for a loan…if the ever-greater cradle-to-grave promises made after WWII aren’t wound back before they come due. Alternatively, we could just keep printing more money.

After all, it worked to stem the crisis in banking.

“A sovereign debt crisis in the West is coming sooner or later though it is probably not right now,” says Christopher Wood in his closely-followed Greed & Fear analysis for CLSA.

“This is why the recent correction in gold is an opportunity to buy more bullion and more gold mining shares” – a defense, says Wood, against the “almost inevitable Western currency debasement which will be the consequence of the increasingly untenable welfare states and related social security systems.”

It wouldn’t be the first time a sense of impending doom sparked a fresh move worldwide into physical gold. And until the next crisis in debt is resolved, it might not be the last either.

Adrian Ash

February 16, 2010

The Daily Reckoning