The Mother of All Bubbles Huge National Debts Could Push Euro Zone into Bankruptcy

AFP

Part 4: 'Panic Is Slowly Taking Hold'


The rescue package is now a done deal, and the Greeks have a clearer idea of what is in store for them. A European nation has hardly ever been expected to make comparable sacrifices in peacetime. In return for the bailout deal announced Sunday, the Greek government will implement further cost-cutting measures, including drastic reductions in salaries and pensions, further tax hikes and a stricter austerity program for all of the country's public budgets.

It won't be long before new unrest and protests erupt among the Greeks, with their penchant for strikes. Metalworkers and candidates for civil service positions took to the streets of Athens last week, and there were further protests over the weekend. "Panic is slowly taking hold in the minds of people," says economics professor Savvas Robolis.

Because the Greeks, despite the massive capital injections from Brussels and Washington, face an extremely uncertain future and the country can expect to see "explosive unemployment," Robolis isn't certain that social protests will remain peaceful in the future.

If not, speculators will quickly pounce on the euro again. They have made enormous profits in recent weeks and months, after betting on Greece's growing difficulties and a constantly weakening euro. Now they are just waiting for the next opportunity.

Reasons to Be Grateful to Hedge Funds

But Scottish hedge fund manager Hugh Hendry, 41, doesn't feel guilty. The Germans should be grateful to him, says Hendry, who launched the Eclectica hedge fund in 2005 and now manages $450 million in assets. "Politicians like to gloss over economic reality, but we confront them with the facts," says Hendry.

According to Hendry, the Greeks lived beyond their means for years, and now they are no longer competitive. He insists that recognizing this early on was beneficial, because without the warning signals from the financial markets, the Greeks would simply have continued muddling along.

Using his computer, Hendry projects the interest-rate curve for two-year Greek government bonds onto a large screen on the wall of his office in London's trendy Notting Hill neighborhood. He is excited by the clarity of the trend, which clearly points upward.

"The causes of a crisis are usually of a fundamental nature, but hedge fund speculation can lead to excessive prices," says Bernd Berg, who wrote a doctoral thesis about the influence of hedge funds on financial crises like the one in Asia in 1997-98. In that crisis, hedge funds had been betting against the Thai baht for months, until they finally reached their goal. The currency's peg to the dollar was eliminated and it quickly lost value, triggering a major shock in the region.

'Germany Can't Save Everyone'

The financial markets have taken note of the probable bailout of Greece by European politicians. "Countries like Ireland and Portugal have very similar problems," says David Owen, chief analyst with the US investment bank Jefferies International. "Germany can't save everyone."

Hedge fund managers are betting that the turbulence in the euro zone will continue to increase. Initial attacks on Portugal and Spain -- and probably Ireland too, before too long -- show how the situation could develop.

In Portugal, anger against speculators is also uniting politicians from all parties. They cannot understand why the country's debt rating was downgraded last week. The economic situation in Portugal, says António de Sousa, the president of the banking association, didn't just suddenly change on Tuesday.

The fact that the rating agencies have downgraded several euro-zone members precisely now, in this precarious situation, has reignited the debate over the quality -- and neutrality -- of the companies. Their negative assessments are aggravating the crisis, which in turn will lead to further downgrades.

Stagnating Economy

In fact, the Portuguese economy has been stagnating for the last 10 years. It grew substantially before that, after the country had joined the EU. In the years since the introduction of the euro, the Portuguese have gotten used to low interest rates and have "lived completely beyond their means," as President Aníbal Cavaco Silva, an economics professor himself who was also prime minister during the boom years, warned last year. "We spend 10 percent of GDP more than we take in, year after year," says Portuguese economist António Perez Metelo.

Private households owe more than 100 percent of their annual income. Because the Portuguese save so little, banks are forced to borrow money abroad. Each of the 10.6 million Portuguese citizens owes foreign banks an average of €18,300 and paid €590 in interest in 2009.

This situation cannot continue -- not in Greece, not in Portugal and not in most other countries. But the euro zone isn't the only place with a debt problem.

The US budget deficit has now reached $1.6 trillion, or 10 percent of GDP. The national debt is now over $12 trillion and is forecast to expand to more than $20 trillion by the end of the decade. At that point, Americans will be paying $900 billion a year in interest alone.

Paying with New Debt

Today, only four areas consume almost all government revenues: defense, social programs, health care and interest on debt. Americans must pay for everything else with new debt.

Fred Bergsten, director of the Peterson Institute, one of the leading economic think tanks in the United States, warns: "If we don't correct the situation in the next five years, our worldwide position will be in jeopardy."

The disastrous financial situation is in large part due, not to the economic stimulus packages and programs to fight the global economic crisis, but to behavior during the years under former President George W. Bush. At the time, Americans became accustomed to consuming far more than they produced.

They consume inexpensive goods from Southeast Asia, and the Chinese and the Japanese are only too willing to accept US Treasury bonds in return. In other words, Asia is giving the United States an almost unlimited credit line. This is the only reason the Americans were able to keep interest rates low for so many years -- the cost of borrowing was being kept artificially low. Many people believed that they could afford to buy real estate. And in the belief that the value of their houses was constantly increasing, Americans consumed even more and got into more and more debt. This illusionary system fell apart when the real estate markets collapsed.

But current President Barack Obama has also contributed substantially to the biggest American budget deficit since World War II. His healthcare reforms alone will cost the government about $900 billion in the coming years. And the military presence in Iraq and Afghanistan will swallow up $160 billion in the coming budget year.

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barryschatz 05/03/2010
1. Government does not expand output
"The economy has to grow, so that the government can collect enough tax revenue and thus reduce its debt. The trick, in other words, will be to save money while at the same time expanding aggregate output." Only private enterprise expands output. Government consumes output. Any money government manages to save (i.e., not consume) will be left in the hands of the private sector to expand output. Woolly assumptions like this one are largely responsible for the Greek tragedy and those which will shortly follow.
BTraven 05/05/2010
2.
Zitat von barryschatz"The economy has to grow, so that the government can collect enough tax revenue and thus reduce its debt. The trick, in other words, will be to save money while at the same time expanding aggregate output." Only private enterprise expands output. Government consumes output. Any money government manages to save (i.e., not consume) will be left in the hands of the private sector to expand output. Woolly assumptions like this one are largely responsible for the Greek tragedy and those which will shortly follow.
But in situations like now where enterprises and people do not want or are not capable of investing and spending money the government must do it for them. Saving money in the recession makes the situation worse.
barryschatz 05/08/2010
3.
Zitat von BTravenBut in situations like now where enterprises and people do not want or are not capable of investing and spending money the government must do it for them. Saving money in the recession makes the situation worse.
So where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
BTraven 05/11/2010
4.
Zitat von barryschatzSo where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
Fortunately, there is no rule which decisively says that a country overindebted therefore the psychological aspect decides whether a state can be regarded as trustworthy or not. In order to calm the markets the 3 percent rule was introduced. It seems, however, that nobody could imagine that such a rule could be an handicap since every violation will be interpreted distrustfully by analysts. And there is not even a paper which scientifically reasoned why we need such a rule. More tomorrow.
BTraven 05/11/2010
5.
Zitat von barryschatzSo where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
Concerning your example – despite the money central banks have printed to keep the economy running there is no inflation yet because ordinary people has not been given the money. The money provided have hardly reached normal consumers. I only know one measures where money was made available directly to customers – it is the car scrappage scheme. The "new money" circulates in the banking sector. As long as bankers do not speculate on raw materials I cannot see how they could cause an inflation.
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