A
Dysfunctional Nation
By John Mauldin | June 9,
2012
A Dysfunctional Nation
One Minute to Midnight?
The Triumph of Hope
A Quadrillion Here, A Quadrillion There
New York, Chicago, Italy, and Singapore
One Minute to Midnight?
The Triumph of Hope
A Quadrillion Here, A Quadrillion There
New York, Chicago, Italy, and Singapore
dysfunctional
[dɪsˈfʌŋkʃənəl]
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.
A Dysfunctional Nation
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:
One Minute to Midnight?
"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."
The Triumph of Hope
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.
A Quadrillion Here, A Quadrillion There
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.
New York, Chicago, Italy, and Singapore
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
John@FrontlineThoughts.com
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