Tuesday, July 07, 2015

Greece's New Trojan Horse, And What It Means To America


The Greeks, faced with what amounted to an ultimatum from the EU rejected further austerity measures and decided yesterday not to accept the EU's proposal by a whopping 61%. It's not hard to see why.

Greece's debt now exceeds 177% of their GDP.They owe massive amounts to their bondholders and other creditors, whom already took a huge haircut for the last bailout. In order to pay the next payment due on what they already owe, they needed yet another bailout and what Greek's left wing PM Alexis Tsipras called 'debt relief.' That essentially means they want EU nations like Germany to pay off part of Greece's debt.

In response,the EU, led by German Chancellor Angela Merkel offered a take or leave it proposal that would have given Greece enough money to pay off the IMF, which will then give them the money to pay the European Central Bank, and so on and so on. But the EU also demanded severe austerity measures to do it, including spending cuts, reforms to Greece's expansive pension and social welfare system and 'labor reform', which means more cuts in civil service jobs. That's what the EU wanted in exchange for yet another 240 billion euro ($262.7 billion) bailout.

To add an additional bit of arm twisting,the European Central Bank (ECB)took the step of cutting of all cash to Greece's banks, which are dependent on it since they were connected to the system. The banks are now closed, with ATM deposits limited to 60 euros (about $66) per day if you can find an ATM that still dispenses cash. Greeks are reverting to barter to purchase food and ordinary household supplies, and Greek banks are forecast to run out of money totally sometime this week.

What's really going on is sheer politics. Greece's debt is never going to be paid off, ever. And the EU knows it. What they're really after is damage control, AKA a modicum of control over Greek fiscal policy to limit the fallout.

The EU is in something of a bind. If they cut Greece some slack, other countries with major debt problems like Portugal, Spain and Italy who received bail outs but are making their payments and coping with austerity are very likely to reconsider making their own payments. After all, if Greece can get away with this, why not them? And there's also the factor of someone like Merkel having to face angry German taxpayers if Greece slides away from its obligation and they have to pick up the slack once more.

By the same token, if Greece is forced out of the Eurozone, it sets a precedent for others to do the same thing and have the whole over-leveraged structure topple over.

So the result of this Sunday's referendum means there's going to be one of two outcomes.

Either the EU will cave in and make a better offer, which is exactly the argument PM Alexis Tsipras used to urge Greeks to vote no. Or the EU will decide it's had enough of Greece, and Greece exits the euro.

From Greece's point of view, either way works, really.Again, here's why, in a nutshell..


Whatever happens, Greece is in for some pain, but I think they'd probably be better off simply dropping the Euro, which is exactly what I wrote in 2012.

Dumping the euro and adopting the Greek drachma, which would of course devalue naturally would have several salutary effects once the initial chaos subsided. Greece would no longer be locked into a fixed exchange rate, which would make its exports more affordable and undoubtedly create a boom in tourism, one of Greece's chief industries. Plus, let's face it, no one is going to lend the Greeks money or buy their debt for some time to come at anything like decent rates, so they might be better off just wiping the slate clean with a bankruptcy and starting fresh.

Not only that, but if the Greeks are smart, they will institute their own form of austerity reforms. The costs of government is nearly half of Greece's GDP right now (49.3%). A great deal of money could be saved simply be revaluing civil service salaries and pensions in drachmas instead of euros at a government set exchange rate that could be far less than the actual market rate.

There's an interesting lesson to be learned here, with an example from the other side of the Mediterranean.

In 2004, Israel was faced with a similar financial debacle, made even worse by the high cost of Israel's defense needs. At that time, Greece actually had a higher per capita GDP than Israel did and was arguably in much better financial shape overall.

Over the last ten years, the story has changed considerably.Greece's per capita GDP has actually shrunk in terms of 2004 dollars, while Israel's has grown by a whopping 50%. Unemployment in Greece more than tripled, from 8.4% in 2002 to 26.5% in 2014, while unemployment in Israel dropped by more than half from 12.8% in 2002 to 5% in 2015.

In 2004, both countries had a similar proportion of their GDP needed to service their debts, around 94%. Since then, however, Greece's has shot up to 177.2%, while Israel's fell to 68.8% and dropping in the same period of time. Israel's current credit rating is A+ with S&P, with no credit rating company rating them below A. Investors are flocking to invest in Israel, and the country's economy is projected to grow this year by over 3%.

Greece's credit is rated by all credit rating companies at CCC- by Standard and Poors, the lowest possible rating, with no credit rating higher than CCC. Foreign investment is negligible, and the economy is actually shrinking.

So what happened? It's simple, really.

Between 2002-2007, Greece borrowed lavishly on its EU credit card and used the money to increase government size and expenditures (at one point, it seemed like almost everybody worked for the government). They 'invested' in building projects fronted by the well connected and bought votes in the form of more social welfare "benefits" for the public they couldn't afford, like those famous pensions from the age of 57. Meanwhile, raising taxes and producing red tape to try and match expenditures with income and add more revenue made Greece a poor place to invest and do business in. Greece was rated 84th in the world in the most recent Economic Freedom of the World Index. Greece, to put it bluntly, is a prime example of why the EU is eventually going to come apart at the seams.

Without access to rich Uncle IMF or the ECB, Israel solved its situation by doing exactly the opposite Greece did, with self-imposed austerity programs, privatization, cutting government red tape to encourage Israeli entrepreneurs and cuts in government spending.Many of these reforms were carried out under the present Prime Minister, Benyamin Netanyahu when he was Israel's finance minister. Essentially, these reforms got Israel out of its financial mess by weaning Israelis away from the quasi-socialist system that created the mess in the first place.

So how is what's going on in Greece relevant to America? As a warning.

The United States isn't in Greece's position, at least not yet. But we're traveling on the same road...just give us time. Right now, our debt to GDP ratio is 101% and increasing. Growth is stagnant, inspite of thefairy tales being spun in Washington. Moreover, we also have a metastasizing government, and billions in unfunded social welfare mandates and pension obligations...and to the aggravate the situation, the Obama Administration no longer enforces our borders and is allowing millions of people to come here and stay illegally to add to those unfunded, budget busting social welfare mandates. As Europe has discovered, the majority of these migrants will be tax dollar recipients rather than tax paying contributors.

Like Greece, we also have a government that likewise strangles entrepreneurship with high taxation, arcane and costly regulations, red tape and diktats.

And the reckoning could be closer than we think. What if foreigners stop buying our debt, or demand a higher interest rates because our debt lowers our credit rating again? Suppose China or the Arabs decide they need a few billion to spend at home or that America simply isn't the investment they thought it was and engage in a massive sell off? What if a major American bank goes under because a Chinese or EU bank whose paper they hold had a major stake in Greece or derivatives based on those securities? Given what's been going on lately with the Chinese stock market, that's hardly an unlikely scenario.

Even if nothing like this happens, one thing is certain. It's only a matter of time until we run out of running room and other people's money. We're not too big to fail, and if we continue on this road, we will eventually get into Greek territory.And there's no one to bail America out, at any price.

The old saying from Homer's Odyssey is 'Beware of Greeks bearing gifts.' In this case,the warning we ought to take from Greece is no Trojan Horse, but a gift we shouldn't refuse.

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