The decline of great powers
is caused by simple economic over extension
Paul Michael Kennedy
British historian, and author of “The Rise and Fall of the Great Powers”
...In the last few days, bond markets have decided that the deflationary adjustments – cutting wages and prices — needed in large parts of the eurozone are not politically feasible. The deflationary spiral that will come with fiscal cuts causes political turmoil and reduces revenues – that in turn makes it ever harder to service debt; see Greece this week. Eurozone countries running large budget deficits with substantial outstanding public debt are finding they are cut off from credit markets as a result. This is a solvency issue, not a liquidity issue.
...Greece clearly must end up restructuring its debt. The IMF program makes that obvious – how can Greece make a total of 19% of GDP in cuts, only to end with 149% of GDP in debt, and a perpetual bill to pay German, French, and other foreign holders roughly 10% of income each year just to cover interest?
This is a political disaster for all concerned and should be cleaned up now rather than left to ferment. The markets, with their high interest rates on Greek debt, show they believe this is the outcome. The market prices in about a 29% chance that Greece’s default within one year, and 35% over two years (assuming a 40% recovery rate on Greek bonds after default and restructuring).
When national debts have once been accumulated to a certain degree
[there has never been] a single instance
of their having been fairly and completely paid
The liberation of the public revenue...
has always been brought about by bankruptcy
Adam Smith
Moral philosopher and Father of Modern Economics
Portugal should restructure preemptively – they have a large budget deficit and current account deficit, and will have similar problems cutting the budget deficit. When the government takes fiscal austerity measures, unemployment will rise further, the economy will slow, so revenues will fall, and that will mean they make too little progress bringing in their deficit.
Spain is in a very difficult position. It is unlikely they can avoid restructuring for the same reasons as Portugal and Greece, but they are starting from a position with less public debt outstanding (if the numbers are correct). However, Spanish banks own a great deal of Portuguese debt, so if Portugal restructures it poses a major additional burden on Spain.
Italy and Ireland are clearly in trouble also, depending on exactly how expectations for eurozone growth are revised downwards.
...Without the traditional investors available, who is going to finance Spain, Ireland, Italy, and Portugal’s ongoing large budget deficits?
And this is the next problem. This week the EU commission released its forecasts for budget deficits in 2010 and 2011. Those were a depressing set of numbers. ...Greece, Portugal, Spain are all in the same range – large budget deficits and little improvement on the horizon. These are unrealistic plans given the lack of buyers for their bonds. Careful study of the details will only exacerbate concerns about fiscal solvency.
...the core problem is that the euro zone as currently designed is a failure. It has proven wrong to blend so many disparate nations into one currency, and then manage the currency according to relatively hawkish German preferences.
The euro zone in its current form needs to be wound down, most likely being reduced to a core of countries that are sufficiently similar – and without the presumption that others will soon be admitted.
...there needs to be an orderly plan for debt restructuring across the euro zone.
...But do not think that Greece can restructure its debts without having broader repercussions. All the weaker eurozone countries must proceed together on this front or there will be chaos.
...There is no real leadership in the EU, combined with complete unwillingness to admit the fundamental error of the euro zone itself. The Germans are happy to let other nations suffer for their past mistakes, so they will do nothing until there is a more complete crisis.
There is an element in the readjustment of our financial system
more important than currency
more important than gold
and that is the confidence of the people
Franklin Delano Roosevelt
Replaced Herbert Hoover as US President in 1932
after government intervention failed to mitigate The Great Depression
...bond markets have closed for the periphery. This can only mean bond yields keep rising, there are runs on the banks in many nations, and then eventual economic collapse. This, unfortunately, is the path of least resistance for all parties.
Peter Boone and Simon Johnson
The Baseline Scenario, May 7, 2010
Ponzi finance units must increase its outstanding debt
in order to meet its financial obligations
A transition occurs over the course of an expansion
as increasingly risky positions are validated by the booming economy
that renders the built in margins of error superfluous
encouraging adoption of riskier positions
Eventually, either financing costs rise
or income comes in below expectations
leading to defaults on payment commitments
Hyman Minsky
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