How to Get Trapped by Sovereign Debt
01/11/11 Paris, France –
It’s a new decade. Time for a new thought. A new idea. A new theme.
When did we have our last new idea? Was it in this century? We can’t remember.
Fortunately, in the world of money the fewer ideas you have the better. Ideas are usually wrong. They are like mutations. Most are sterile. Dead ends.
Most ideas are dead ends too. Because they are necessarily stupid. At any given time, both in past, present, and future, there are an infinite number of things going on. An idea is merely a way of understanding a little bit of them. You try to capture a part of what is going on…an important part, you hope, in a single metaphor. And you hope others will say: “Oh, that’s what’s going on!”
But in order to put it into a containable, bounded thought…you have to ignore everything else. All the things that don’t quite fit…all the things that make no sense…all the extraneous facts and circumstances. In fact, you have to ignore almost everything that is going on in order to focus on one idea that makes sense to you.
Every idea is like a jealous mistress; she insists that you look only at her. As a result, you miss more than you see…
But that doesn’t stop us from having a good time with an idea from time to time. And we’ve got one today.
We’ll introduce it in a moment…
First, let’s take a look at the news. We begin by noticing that the English seem to have a better idea of what is going on in America than the Americans themselves. The London “Telegraph” reports:
The US is drifting from a financial crisis to a deeper and more insidious social crisis. Self-congratulation by the US authorities that they have this time avoided a repeat of the 1930s is premature.
There is a telling detail in the US retail chain store data for December. Stephen Lewis from Monument Securities points out that luxury outlets saw an 8.1pc rise from a year ago, but discount stores catering to America’s poorer half rose just 1.2pc.
Tiffany’s, Nordstrom, and Saks Fifth Avenue are booming. Sales of Cadillac cars have jumped 35pc, while Porsche’s US sales are up 29pc.
Cartier and Louis Vuitton have helped boost the luxury goods stock index by almost 50pc since October. Yet Best Buy, Target, and Walmart have languished.
Such is the blighted fruit of Federal Reserve policy. The Fed no longer even denies that the purpose of its latest blast of bond purchases, or QE2, is to drive up Wall Street, perhaps because it has so signally failed to achieve its other purpose of driving down borrowing costs.
Yet surely Ben Bernanke’s ‘trickle down’ strategy risks corroding America’s ethic of solidarity long before it does much to help America’s poor.
The retail data can be quirky but it fits in with everything else we know. The numbers of people on food stamps have reached 43.2m, an all time-high of 14pc of the population. Recipients receive debit cards – not stamps – currently worth about $140 a month under President Obama’s stimulus package.
The US Conference of Mayors said visits to soup kitchens are up 24pc this year. There are 643,000 people needing shelter each night.
Jobs data released on Friday was again shocking. The only the reason that headline unemployment fell to 9.4pc was that so many people dropped out of the system altogether.
The actual number of jobs contracted by 260,000 to 153,690,000. The “labour participation rate” for working-age men over 20 dropped to 73.6pc, the lowest since the data series began in 1948. My guess is that this figure exceeds the average for the Great Depression (minus the cruelest year of 1932).
The long-term unemployed (more than six months) have reached 42pc of the total, twice the peak of the early 1990s. Nothing like this has been seen since World War Two.
The Great Correction continues, in other words.
In the markets… The Dow fell 37 points yesterday. The price of gold rose $5. Nothing very important. The news this morning is dominated by Europe’s debt woes. Portugal is the latest nation to suffer an attack by the bond vigilantes. Investors insist on 7% interest to fund Portugal’s budget deficits. That’s less than the 10% they want in exchange for lending to Greece, but it’s 4% more than Germany pays.
Most importantly, it’s too much. Here’s the problem with national debt. When you have too much of it, you’re trapped. You can try austerity. You can try refinancing. You can try to “grow your way out.” But at a certain level of debt, it’s too late. You’re already off the cliff. All you can do is fall.
This is what happened to the Germans after WWI. The reparations demanded by France and Britain were so high that the Germans couldn’t pay. And when they tried to pay, the outflow of capital so weakened their economy that they were even less able to pay.
And imagine a bailout. The Chinese have come to rescue Portugal…and behind the Chinese stands the European bailout fund. But these friendly lenders are a menace. At the end of the operation, you’re in worse shape than you were before.
But maybe the bailouts give you time to “work your way out?” Possibly. But it depends on the circumstances. Greece, for example, owes an amount equal to 130% of GDP. All that debt has to be rolled over…often several times…before it could possibly be paid. Lenders want 10% interest to cover them against the risk of default. If all the debt carried a 10% coupon, it would take 13% of GDP to pay the interest alone. And if Greece could collect taxes at the same rate as in the US, it would take nearly 100% of all tax receipts just to keep up with the interest payments.
Obviously, that wouldn’t work. Greece is working its way INTO more debt, not out of it. The only way out is default, or “restructuring,” to sugar coat the pill.
And now the vigilantes have come ashore on the Iberian Peninsula. They are rampaging through Portugal. How long will it be before they cross the border into Spain? And then, into France?