dysfunctional
[dɪsˈfʌŋkʃən
əl]
adj
1. (Medicine)
Med
(of an organ or part) not functioning normally
2. (especially of a
family) characterized by a breakdown of normal or beneficial relationships
between members of the group
European
leaders launched the euro project in the last century as an experiment to see
whether political hope could become economic reality. What they have done is
create one of the most dysfunctional economic systems in history. And the
distortions inherent in that system are now playing out in an increasingly
dysfunctional social order. Today we look at some rather disturbing recent
events and wonder about the actual costs of that experiment. What type of
"therapy" will be needed to treat the dysfunctional family that Europe has
become? And maybe I'll throw in a "fun" item to finish with, so let's get
started.
Michael
Lewis has documented quite tellingly in
Boomerang
the dysfunctional country that is Greece – how citizens avoid taxes, how
over 600 categories of workers can retire at the age of 50 with full pensions,
and how fraud and corruption are endemic. Other stories have surfaced about how
few doctors report more than 10,000 euros of income and how few professionals pay
their property taxes.
Recently,
when the current Greek government committed to actually collect some taxes in
order to get more loans, a bureaucrat decided that a great way to collect
property taxes would be to include them in people's electricity bills, a move
that caused an uproar. Lawsuits followed, as the national power company tried
to cut off electricity for nonpayment. In a country where it can take a decade
for a legal matter to get on a court docket, a court rather quickly took up the
case and ruled it illegal for the power company to cut off service for
non-payment. This ruling led to a massive financial loss by the power company
as people simply stopped paying their electric bills.
The
government had to step in with a rather large chunk of cash to keep the power
on. As of May 1, the power company announced, it would no longer collect
property taxes. The natural gas company threatened to cut off supplies to the
electric utility for nonpayment, and emergency meetings are being held to
"…
avert the collapse of the natural gas and electricity system."
The
credit system in Greece is in a shambles, and there has been an open bank run
this year. Reports that hospitals cannot get necessary life-saving medicines abound,
as there is no more credit to be had from most manufacturers. Unemployment is
at 22%, and youth unemployment is over 50%. "A collapse in the country's
economy has
forced many Greeks to turn to black market barter economies
and has left millions financially devastated, with no hope of finding an income
stream for the foreseeable future." (
infowars.com)
The
last election resulted in no possibility of a governing coalition, and new
elections are scheduled for next weekend (June 17) – except that the
employees who run the elections are threatening to strike if they are not given
more pay. The head of the government workers union said Thursday that the union
will hold a two-day strike on June 16-17. He also said municipal employees will
refuse to do any election-related work until then. We will now see whether the
courts will declare such a strike illegal and whether the members will honor a
court decision. (
http://www.washingtonpost.com/business/greek-municipal-workers-call-electoral-strike-threatening-to-derail-crucial-june-17-vote/2012/06/07/gJQAlhOjLV_story.html)
Greece
was already in enough turmoil, with no clear winner emerging in the last polls
that were taken this week. (Note: It is against Greek law to publish the
results of a poll less than two weeks before an election.) And then there was
the "debate."
I assume that by now you have
seen the video of the televised debate among representatives of the seven Greek
parties. In a bit of poor planning, the very nationalistic Golden Dawn party
head, a rather solid-looking young body builder, was seated next to the
Communist Party leader, who is a lady. A few insults were exchanged, some water
was thrown in the face of a rather pleasant-looking young lady (a
representative of a leftist party) across the table from the Golden Dawn guy, there
was a slap on his arm with a folder by the Communist Party leader; and then they
were on their feet and Mr. Golden Dawn was repeatedly slapping and then punching
Ms. Communist Party.
If for some reason you have not viewed
this short but exciting clip, here is a link:
http://www.rt.com/news/greek-politician-slaps-rival-278/
. Or you can Google "golden dawn greek slap" and get a link to a report in your
language of choice. If you choose the German version from
Der Spiegel, you can hear the word
neo-Nazi repeated several times by the German reporter.
This
exchange provokes a few thoughts. First, incidents of violence and vigilantism in
Greece are rising, along with the lawful public demonstrations. Whatever veneer
of civility that was left was ripped away by the boorish behavior of the Golden
Dawn representative.
Second, this fracas will now
dominate the national conversation. Rather than focusing on what they should do
about remaining in the eurozone, accepting or rejecting austerity, and putting
together some sort of coalition that can govern the country, they will be
focused on this event. Nine days before an election in which no party seemed to
have a clear lead or a path to a ruling coalition, the results are now even
more in question. Golden Dawn had some 6% of the Greek vote. Will it maintain
that percentage? If not, where will its votes go? Will this help or hurt the
mainstream conservative or left-of-center parties?
Whether it be families or
nations, such a level of dysfunctionality almost always ends in tears. The
"slap" is just one more telling incident in a country that is on the brink of
self-destruction. It is very possible that the winner of the election will be a
party that wants to reject austerity but believes that the rest of Europe will
give them the money they need to continue to pay their public employees, maintain
services, and keep the government functioning. The reasoning seems to be that
Europe will do that because they need the Greeks to continue to pretend that
they will pay off their national debt to the European governments and ECB.
Why are we still fixated on
Greece? Even though Greece is small, it matters; because if Greece leaves the
euro then the markets will immediately ask, "Who's next?" And while a year ago
everyone thought the answer was Portugal, the market is now looking hard at Spain,
which is on the same path to insolvency that Greece was only a few years ago.
Spanish government leaders are now
beginning to admit they must have help, as it appears they will soon be frozen
out of the bond market, if that has not happened already. As I have written, it
will take a massive commitment of European (read German) money to save Spain, and
it's not a one-time commitment. It is not just 100 billion euros to re-fund
Spain's banks. If Spain gets frozen out of the market, adding another €100
billion in debt will not make things better, when there is a nearly 10% fiscal
deficit, unemployment as bad as Greece's, and an economy that is in freefall.
Europe is going to have to buy
all Spanish debt for years. And not just new debt but all the old debt that is coming
due and must be refinanced. We are talking hundreds of billions of euros. And
if there is a bank run on the order of Greece's? The number just keeps getting bigger.
To think it will be anything like the €46 billion being talked about by the IMF
today is to simply ignore economic reality.
That
money will have to come from somewhere. Either the ECB will have to monetize it
directly (possible but not likely) or a pan-European entity like the ESM will
have to be allowed to become a bank and then apply to the ECB for loans and a capital
infusion in order to then bail out Spanish (and other) banks.
It
is obvious, at least to your humble analyst, that if the eurozone is to survive
several things must happen. First, there must be something created on the order
of a European FDIC. Banking guarantees and regulation must become a European
responsibility, not a country responsibility. How would it have worked if the
rest of the US had decided that New York should bail out its own banks, when
they had their crisis in 2008?
Second,
if the ESM is allowed to become a bank, then what will those guarantees look
like? Because the original agreement of member countries to back a specific and
limited amount of debt will now be increased ten-fold. And that will mean
something in the neighborhood of €4-5 trillion.
How
could they need that much? The answer is, because it will not be just Spain. Can
Italy be far behind, given the unfolding European recession? And the French
banks? France itself, given the new policy direction of its government and its
own massive unfunded liabilities?
Assume it is just €4 trillion, spread
over a few years. Germany will be responsible for at least 25% of that amount,
or about 40% of their GDP. And that assumes that Spain, Greece, Ireland, et al.
will be good for their portions.
Will Germany want to take on
such a massive new debt? The periphery countries already owe the German
Bundesbank over €1 trillion. German debt-to-GDP is already at 80%. German credit
default swaps are rising in cost.
If Germany takes that first
step, it must be prepared to keep marching, because to stop at any point will
mean even more pain, since they will still be responsible for their share of
any debt created after that first step. As they say at the poker table, "In for
a dime, in for a dollar."
Certainly, if they are to take
on such a debt, there must be guarantees of fiscal control by the nations who need
help.
And that means a tighter fiscal
union. When the euro was created, European leaders thought that a common
currency would naturally lead to a fiscal union. Monetary unions without fiscal
union always become dysfunctional.
Or there will have to be direct
monetization of the debt by the ECB, which goes against the policy that Germany
thinks it agreed to.
Either way, it is a very large
change in position for Germany.
There are three problems that
Europe must solve. They have a sovereign debt problem and a resulting banking
debt problem. Both of these are evident and there might be some solution, given
time and money.
But the third problem is the
more difficult one. That is the trade imbalance between Germany and the
peripheral countries and the differing levels of productivity of their workers.
Trade deficits must be brought into line. The usual way to do this is through
currency devaluation by the country with the trade deficit. That is not
possible for the countries in the eurozone. So, the only other way is for the
workers of an uncompetitive country to accept lower wages. Since no one thinks
they are underpaid, that will happen slowly and painfully and mean a protracted
recession or depression.
Which leads to voter frustration
and frayed nerves that spill over into dysfunctional actions. It also leads to
political changes.
Let's hold that thought for a
moment. In the weekend
Financial Times,
my friends Niall Ferguson and Nouriel Roubini have written an op-ed calling for
a European banking authority and tighter fiscal union, if the eurozone is to
survive.
http://www.ft.com/intl/cms/s/0/c49b69d8-b187-11e1-bbf9-00144feabdc0.html#axzz1xHuDXIr4
Let's look at a few paragraphs
from the op-ed, with its leading question:
"Is it one minute to midnight in
Europe?
"We fear that the German
government's policy of doing 'too little too late' risks a repeat of precisely
the crisis of the mid-20th century that European integration was designed to avoid.
"We find it extraordinary that
it should be Germany, of all countries, that is failing to learn from history.
Fixated on the nonthreat of inflation, today's Germans appear to attach more
importance to 1923 (the year of hyperinflation) than to 1933 (the year
democracy died). They would do well to remember how a European banking crisis
two years before 1933 contributed directly to the breakdown of democracy not
just in their own country but right across the European continent….
"But now the public is finally
losing faith and the silent run may spread to smaller insured deposits. Indeed,
if Greece were to leave the eurozone, a deposit freeze would occur and euro
deposits would be converted into new drachmas: so a euro in a Greek bank really
is not equivalent to a euro in a German bank. Greeks have withdrawn more than
€700m from their banks in the past month.
"More worryingly, there was also
a surge in withdrawals from some Spanish banks last month. The government's
bungled bailout of Bankia has only heightened public anxiety. On a recent
visit to Barcelona, one of us was repeatedly asked if it was safe to leave money
in a Spanish bank. This kind of process is potentially explosive….
"Until recently, the German
position has been relentlessly negative on all such proposals. We understand
German concerns about moral hazard. Putting German taxpayers' money on the line
will be hard to justify if meaningful reforms do not materialise on the periphery.
But such reforms are bound to take time. Structural reform of the German labour
market was hardly an overnight success. By contrast, the European banking
crisis is a real hazard that could escalate in days.
"Germans must understand that
bank recapitalisation, European deposit insurance and debt mutualisation are
not optional; they are essential to avoid an irreversible disintegration
of Europe's monetary union. If they are still not convinced, they must understand
that the costs of a eurozone breakup would be astronomically high – for themselves
as much as anyone.
"After all, Germany's prosperity
is in large measure a consequence of monetary union. The euro has given German
exporters a far more competitive exchange rate than the old Deutschmark would
have. And the rest of the eurozone remains the destination for 42 percent of
German exports. Plunging half of that market into a new Depression can hardly
be good for Germany.
"Ultimately, as Angela Merkel,
the German chancellor, herself acknowledged last week, monetary union always
implied further integration into a fiscal and political union. But before
Europe gets anywhere near taking this historical step, it must first of all
show it has learnt the lessons of the past. The EU was created to avoid
repeating the disasters of the 1930s. It is time Europe's leaders – and
especially Germany's – understood how perilously close they are to doing
just that."
When
the Eurozone was created it was the triumph of hope over the reality of
political and economic discord. Somehow, countries that had different
languages, customs and national characteristics; that had fought each other for
centuries; and that all had different views of themselves in relation to the
rest of their fellow Europeans, were supposed to come together into a fiscal
union, because they now shopped with the same money.
Rather than simply creating a
free-trade zone and allowing for a common understanding and economic integration
to develop over time, the European leaders wanted to jump-start the process. And
they had numerous critics. Many of the best and brightest in the economics
world pointed out the problems.
The
reality is that the euro has never been a real currency. It is still an
experiment. If it is even around in five years, it will be a true currency, as
it will have endured its first real crisis. The peripheral countries used the
low interest rates of the euro to borrow heavily (both privately and publicly)
and got in trouble, and now the true costs of the euro project are being
revealed.
A break-up will cost multiple
trillions of euros. Keeping the eurozone together will cost multiple trillions
of euros. But keeping the eurozone together will also cost countries a
substantial loss of sovereign independence. When voters all over Europe signed
on for the euro project, they did not think they were giving up their national
independence and the right to control their own budgets.
Will Spain or Italy or Germany
be willing to allow a European institution to set their budget priorities and
limits? To set their retirement policies and health care? To tax them
independently? That is what is meant when one talks fiscal integration. Germany
is now a minority on the ECB and is beginning to realize it has lost control.
Will its voters want to give up political control and become a minority in a
"United States of Europe"?
That
is the true problem. When real economic difficulties arise, as in Greece or
Spain, voters tend to get rather touchy. Tensions rise. And the center does not
hold.
George
Soros said this week that Europe has three months to resolve its problems.
Nobel Laureate Joseph Stiglitz said Soros was being optimistic. A decision is
going to have to be made quite soon about Spain, and likely before it becomes
clear whether Greece will stay in or leave the euro. And that makes it
difficult to give Spain aid that is not offered on equal terms to those Greece
got. Monetizing Spanish debt (however you want to do it or whatever you want to
call it) when Spain is running an almost 10% deficit, when it had agreed to a
little over 5% only a few months ago, will not sit well with Greece.
But it now seems that Europe is
unlikely to get the time it needs, absent some rabbit pulled out of its
monetary hat to allow Spain to borrow money at rates that it can afford. The
Endgame approaches. It will be a long summer.
I get asked all the time if the
euro will break up. The honest answer is, we really don't know. I think the
economically rational thing to do in the very long term is for some countries
to figure out how to leave the euro, but that is more a political question than
an economic one. And if you can tell me what politicians and voters will do in
a political crisis and deepening recession, then your crystal ball is less
foggy than mine.
I think it is 50-50. The drive
to hold the euro together will go head to head with national self-interest. Right
now, it depends on whom you ask as to what answer you get. But I do not think
we will be asking the question much longer. Soon enough, we will know.
To be clear, Europe has no good
choices, only a choice among very distressing and expensive options. This will
not be good for them or for the world. I think we are already seeing a global
slowdown, in great part due to Europe. Let us hope they get the answer right,
whatever it is.
Everett
Dirksen was a Republican Senator from Illinois back in the '50s and '60s. He is
credited with saying "A billion here, a billion there, and pretty soon you are
talking about real money." It seems that thorough research does not turn him up
actually saying that line, although researchers do note that one reporter said
he had asked Dirksen about it and received the reply, "Oh, I never said that. A
newspaper fella misquoted me once, and I thought it sounded so good that I
never bothered to deny it."
But
that quote has slipped into the US national memory, and whether or not he said
it, it does make a real point. And that was back in the early '60s, when a
billion dollars was not just a rounding error in the national budget.
Today
we have become rather casual in our use of the word
trillion. "A trillion dollars" slips so easily off the tongue, but
it is too big a number for most of us to even fathom. Estimates of the total
stars in our galaxy run between 100 and 400 billion. A trillion barrels of oil
would fuel the world for over 30 years. One trillion seconds is almost 32,000
years. The mind boggles. Yet today we think almost nothing of adding a trillion
dollars every year to the already bloated US debt! In fact, economists like
Paul Krugman fume that we are not adding more trillions to the debt each year,
as if debt brought no consequences. By this thinking, Greece should not be made
to have to suffer austerity because it has taken on too much debt. Rather, other
nations should be taxed to give Greece the money to go even deeper into debt that
it cannot and most likely will not repay.
So,
I must admit that when I came across this next item, it gave me pause. We turn now
to a report published by Bloomberg and authored by my friend Dr. Gary Shilling,
talking about the massive debt that has been accumulated by Japan. Gary argues
that Japan is reaching a critical point where its debt cannot be financed
except by extreme monetization by its central bank, because turning to world
markets to sell the debt will drive up interest rates to unsustainable levels.
I have made similar arguments, but that is a topic for another letter. Today, I
want to quote just one paragraph. (
http://www.bloomberg.com/news/2012-06-07/strong-yen-won-t-survive-japan-s-fiscal-cliff.html)
"As Japan's government debt of
1,085 trillion yen matures over time, it will be subject to any higher
refinancing rates. The average maturity of Japanese government debt is six
years and 11 months. Yet 17 percent of that debt matures this year, 52 percent
in the next five years and 76 percent in the next decade. Markets anticipate,
so Japanese bonds throughout the spectrum will probably plummet in price and
leap in yield at the first sign of a current-account deficit, maybe even
before."
One thousand trillion yen. 32,000,000
years' worth of seconds. Yes, I know a yen has a few extra zeros in relation to
the dollar, but we are talking about one quadrillion yen.
Are we really ready for the word
quadrillion to enter the lexicon in
what is supposed to be the developed world? In the case of Japan, we are apparently
there. A hundred years ago, a deficit of US$1 billion would have been
unthinkable. We actually had balanced budgets for most of our first 200 years,
except during wars and economic crashes. And now we talk trillions, albeit in
the wake of inflation that has made the word
trillion less than it was 100 years ago. Will our grandchildren in
the latter half of this century talk quadrillions? Or quintillions? Is that even
thinkable? Let's just hope the word
quadrillion
doesn't come into common parlance any time soon.
I leave for New York Monday
afternoon, arriving in time to have dinner with Art Cashin, Barry Ritholtz,
Barry Habib, Rich Yamarone, and a few other friends, before I spend the following
day speaking at a few private events with my partners from Altegris. I am back in
Dallas Wednesday and home till the middle of next week, when I make a quick
trip to Chicago for the Morningstar National Investment Conference, again with
Altegris.
Then Friday evening I leave for
Tuscany (with a night in Madrid) for two weeks. I will be writing from there
and catching up on my reading, but a vacation for me is staying in the same
place for two weeks. I will have some friends in, as well as some family, with
a few side trips here and there, but I'm hoping to relax some.
I expect to be writing this
letter as usual from Tuscany, although right now Ed Easterling and I are
talking about revisiting some work we did in 2002 on secular bull and bear
markets. We both believe we are still in a secular bear, but the question now
is, when will it end? The original work was published in this letter and in
Bull's Eye Investing and is the core of that
book.
Wiley recently released an edited,
smaller version of the book, called
The Little
Book of Bull's Eye Investing, which updates the main points. Given that the
single most important thing for an equity investor is to know what long-term
secular cycle we are in, the material is most topical. (And if you are asking
what a secular cycle is, then you REALLY need to read the book). I like the way
the book turned out. You can order a copy at
http://www.amazon.com/Little
Book.
I think it will take us at least
two weeks to cover the topic, but it is important and will help us all think about
something besides Europe, even if I am sitting right there in the middle of it.
On a personal note, many of you
know that I quit drinking alcohol about ten months ago, for health reasons. It
has helped. One of the side benefits, I thought, was that I could expand my
diet somewhat, since I was no longer consuming all those calories in wine and
scotch. I added bread and desserts and a lot of red meat. Then this week I got the
results of my latest blood tests. It seems I now have a cholesterol problem.
Nothing that changing my diet can't fix, but I have to admit, I was enjoying
indulging myself and not really gaining any weight. Oh well. A little
moderation is good for the soul, or so they tell me.
Oh, and we're getting really
close to the launch of
Mauldin Economics, with a brand-new website and an investment
newsletter that will turn some heads. Stay tuned!
It really is time to hit the
send button. The sun is coming up and I need to get some sleep. (I
procrastinated much too long tonight.) My grandson (Henry's son) has a birthday
this weekend, so the family will gather on Sunday for brunch and a party. It will
be good times. But I see chicken, not steak, on my menu. Have a great week.
Your needing to eat more fish analyst,
John Mauldin
John@FrontlineThoughts.com
Copyright 2012 John Mauldin. All Rights Reserved.
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