Disclaimer. After nearly 40 years managing money for some of the largest life offices and investment managers in the world, I think I have something to offer. These days I'm retired, and I can't by law give you advice. While I do make mistakes, I try hard to do my analysis thoroughly, and to make sure my data are correct (old habits die hard!) Also, don't ask me why I called it "Volewica". It's too late, now.

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Friday, July 15, 2011

Getting out from under

An interesting interview with Jim O'Neill of Goldman Sachs London about the Greek debt crisis, made before the Greek Parliamentary vote.  Longish but worth listening to.  (For those who don't know, his accent is midland English, though the 'f' instead of 'th' is an individual quirk, one my dad had too.  Of course, maybe he's just lived in London a long time: the f/th alternation is something the Cockneys do too.)

Greek 10 year bond yield
The problem is that raising taxes and reducing expenditure merely deepen the economic downturn which in turn reduces tax revenue and increases government expenditure all over again.  This dynamic has already happened in Greece which is why we're having this second package, and in a smaller way is happening in the US, where employment growth is puny because state, local and federal government employment has fallen by nearly a million since the GFC as states and municipalities try to balance their budgets.   At the same time, the doubts about creditworthiness lead to interest rates on government debt rising (as shown in the chart on the left, from Bloomberg.)   Refinancing old debt at higher interest rates causes the deficit to balloon even further, thus increasing doubts, which causes even higher rates and further tax increases ....  The doom loop continues until there is a circuit breaker.  So far the pollies on either side of the Atlantic haven't produced any suggestion of a circuit breaker, as O'Neill points out.  A circuit breaker would be O'Neill's suggestion of a central Euro lending authority, for the portion of government debt below 60% of GDP.  Or it might be a refinancing of short-dated debt liabilities with longer-dated instruments at lower yields, a la Brady bonds plan from the late 1980s, with the banks "taking a haircut".  The ECB (European Central Bank) is against this, but frankly, the ECB hasn't covered itself with glory over the last few years, and it may be time to tell them to go take a jump.

If the crisis spreads to the other PIIGS (Portugal, Ireland, Italy, Greece, Spain) it could be both bad and good.  Bad initially, because markets will not like it at all, but good later because it might be enough to get the pollies to engineer a solution.  We shall see.  Getting out from under will take more than pious protestations.

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