Tuesday, September 13, 2011

Europe -- A Case Study in Why Government Is Not The Answer

So, where are we now in fixing the Greek debt crisis. Greek government debt maturing in March of 2012 is trading in the open market at 55 cents on the dollar, according to today's Wall Street Journal. The yield on two year Greek debt is now 75 percent, on 10 year paper 20 percent. So, the default has really already occurred. The fiscal deficit for Greece through the first eight months of the year is 22 percent higher than last year. Meanwhile, real GDP is likely to drop 10 percent this year as compared to a fall of 5 percent last year. So, where does it end? -- where it should have ended two years ago when Greek sovereign debt was a lot lower and European banks were in far, far better shape.

This impending disaster is a direct result of government policy. Merkel and Sarkozy in cahoots with the ECB (European Central Bank) have served up the myth that somehow they could avert a Greek default through politics. We now see the results of their efforts -- economic disaster for Greece and the weakening of the entire European financial structure. So much for bailouts.

Think of how regulation is faring. Why would European banks be in trouble if they are marking their positions to market, as liberal politicians claim regulators will force them to do. Actually, liberal politicians are forcing these banks to mis-mark their positions so as to foster the illusion that they are in good shape. Yesterday, these European banks shed between four and ten percent of their value in a single trading session and most are down more than sixty percent in value value this year. Way to go regulators!! If you have properly marked your bond positions, then why not just sell them? That shouldn't change your net worth at all since you have already marked them to market. But, no. The regulators know best. Now, they are forcing the banks to publicly lie about the value of their holdings. Wow! Isn't that great. Good to see the regulators doing their job.

But, meanwhile, the markets are not fooled by the regulators and the politicians. The markets are showing the way and the way is down for European sovereign debt and down for the European banking system. Had the market simply been permitted to work its will two years ago and let Greece default, we would have only minor problems today with the Euro and with European banking. But, no, politicians and central bankers had to take center stage, repeating the same mistakes that American policy makers made in the fall of 2008. These folks never learn.

Take a lesson from the Asian Crisis of 1997, which was first and foremost a debt crisis. What happened? Fortunately, the IMF was unable to be a backstop or a bailout source for that crisis. So what happened? The crisis ended naturally by 1998 and by 2000 Asia was back and roaring ahead. Why didn't Asia stagnate like the US did after 2008 and Europe is now? Because no one bailed them out. Three cheers for "no policy." "No policy" works.

What doesn't work is government policy. It doesn't work in the US and we are watching government policy turn a minor crisis in European sovereign debt into a major conflagration. When will we learn?