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Thoughts from the Frontline

The Good, the Bad, and the Greek (Risks)

February 6, 2013

“The euro will not survive the first major European recession.” – Milton Friedman, 1999

“It seems to me that Europe, especially with the addition of more countries, is becoming ever-more susceptible to any asymmetric shock. Sooner or later, when the global economy hits a real bump, Europe’s internal contradictions will tear it apart.” – Milton Friedman, 1999

“… there will be asymmetric shocks hitting the different countries. That will mean that the only adjustment mechanism they have to meet that with is fiscal and unemployment: pressure on wages, pressure on prices.” – Milton Friedman, 1998

“Barry Eichengreen (1990b), in a detailed analysis of the potential lessons for EMU from the U.S. experience, concluded that monetary integration would limit fiscal independence. He argued that the extent of fiscal transfers in the European Union would have to significantly exceed the extent of fiscal transfers in the United States to be successful, as regional shocks were likely to be significantly greater in EMU countries than in the states of the United States.” – From a lengthy (and exhausting) paper at the Econ Journal Watch, analyzing the writing of scores of US economists about the euro from 1989-2002. The paper was humorously titled “It Can’t Happen, It’s a Bad Idea, It Won’t Last: U.S. Economists on the EMU and the Euro, 1989-2002.”

Greece was (and is) the first real test of the euro. Until the Greek crisis, there was no real need for any eurozone country to actually write a check for any other member. Ireland obligingly shouldered the responsibility for its own bad bank debts, paying off mostly German, French, and British bankers. But Greece required someone else to take the losses and write the checks to bail the country out. The European Central Bank had to agree to allow the Bank of Greece to create euros to bail out its banks (with the fig leaf that somehow Greece will pay them back). As the Greek economy collapsed in the aftermath of the recent crisis, it became evident even to European bankers and regulators that Greece could not pay its debt. Money began to flee Greek banks.

Greece is a small country with large implications. Last week we began to explore what I learned from my recent trip to Greece. In this week’s letter we will finish those observations and in particular look at some of the comments from my meetings with over 40 people: owners of small businesses and large ones, billionaires, taxi drivers, politicians, central bankers, investors, ex-patriots, wives, and mothers. I believe we can arrive at some small understanding of the problems Greece faces. Then we will consider the broader consequences for Europe.

Save the Dates: May 1-3

But first, I take great pleasure in announcing the speaker line-up for my 10th annual Strategic Investment Conference, May 1-3. Here they are, in alphabetical order: Kyle Bass, Mohamed El-Erian, Niall Ferguson and his wife, Ayaan Hirsi Ali, Lacy Hunt, Charles and Louis Gave, Jeff Gundlach, Anatole Kaletsky, David Rosenberg, Nouriel Roubini, and Gary Shilling. We are finalizing a few other well-known names as well. Seriously, where…

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James Wingo

Feb. 14, 2013, 7:29 a.m.

I agree completely with the comments of Nick Jacobs.  I decided to comment after just now reading the Zerohedge headline that “Greek Youth Unemployment Tops 60%”.  When you say that the costs to leave the Euro would greatly exceed the benefits, I shake my head, for two reasons:

1.  This ignores the likely future event risk of staying in the Euro, namely the very high likelihood of a Greek default.  After all, has the Greek situation fundamentally improved?  No, it hasn’t.  So if there’s going to be a default anyway, then what we’re talking about is how bad things will get before it all crashes.  It sort of reminds me of the Soviet Union.  In its last stages their economic model couldn’t even put food in the grocery stores.  But did they ever consider a change?  No, it was forced on them.  So- default now or default later at a higher cost.

2.  The human and finacial costs of staying in the Euro will accrue forever.  The costs of leaving are a one-off.  The former will greatly exceed the latter, because they continue to rise.
  For instance, as I recall, in 2008, before the Greek economy fell apart, you and other financial writers were making the same argument, that it would cost more to leave the Euro than stay.  But what has happened since then is that Greece has incurred just about the same amount of costs just to stay in as it would have cost to leave.

Since 2008, the Greek economy has steadily deteriorated and there have been no fundamental changes in the competitiveness of the Greek system.  Events have shown that it is foolish to tie the Greek currency and structure to that of Germany.  It’s not disputable.  Apples and oranges.  The human cost of ignoring this truth has been immense.  It’s no joke.  When you say that Greece should stay, think of the human cost of their staying- of their having stayed.  It’s a travesty.

Alain V Fontaine

Feb. 13, 2013, 7:08 p.m.

I just read the “How not to run a pension” installment of Feb. 13. My personal opinion is that we will soon start to see and hear “publicity” from our governments “encouraging” the older baby boomers to get voluntarily euthanized a la “Soylent Green”... Think about it, that would reduce the average life expectancy if enough people participate and would therefore reduce the pension plans and other social services (medicare, social security, etc.) liabilities…

Feb. 13, 2013, 1:33 p.m.

As always, your posts are informative and fascinating.  Thank you for your insights.
Best wishes to your daughter, Melissa.

jack goldman

Feb. 13, 2013, 8:56 a.m.

Simple math. 1980, interest rates 18%, $3,000 a month cost $200,000. 2013, interest rates 1%, $3,000 a month costs $3,600,000. In other words a pension is 18 times more valuable in 2013 then it was in 1980. Wages have not dropped to reflect the rising value of pensions. A $100,000 a year pension, at $8,000 a year would cost in the neighborhood of $8,000,000. The public pension people are laughing all the way to the bank.

Simple solution, raise taxes on pension benefits to recycle the money or cut all pensions by 50%. They are not under funded pensions, they are over promised pensions. My wife earns $90,000 a year but her employer only gives her $1,600 a year for her 401k as the MAXIMUM benefit she can draw. In other words we have to save it up. She will get $48,000 in 30 years to live on for the rest of her life. This crime has to stop. The public employees are raping the tax payer and nobody cares. It has to stop. Either bankruptcy or benefit cuts or taxes must change. The inequity is too great. Many of these government employees are married to each other and are world travelers living like millionaires because they are millionaires, on the public dole. It has to stop.

Barry Pither

Feb. 7, 2013, 9:03 a.m.

“And to its credit, Greece may be that rarity in Europe, a government that actually hits it budget targets. They are close to a “primary surplus” (a surplus if you ignore debt service), which is the first step in recovering access to the bond market. With increased tax collections, major new austerity measures may be avoided.”

Bit of Creative accounting, don’t you think?

Roger Ellman

Feb. 7, 2013, 1:29 a.m.

A very informative and accurate summary. Good boots-on-the ground pulse-taking.

You wrote: “And because the government is such a large sector of the economy, everyone has someone in the family or a friend’s family who is part of the problem” - this is he most difficult barrier to changes towards reducing huge public sector costs without any tangible result of benefit to the country as a whole. Perhaps (as also referenced in your article) more important is the barrier this presents to removing the unbearable (I was in business in Greece for 9 years) interference with running a business and to fluidity of daily life, functioning at all for that matter, in Greece,these bloated entities have created.

Greece more than anything may only be able to manage a dramatic change to its tax system for example, a flat rate tax. Modest rate at that. ONly by making it not worthile cheating taxes will taxes for the most part be paid, in the near future, in Greece. This would also provide a stimulus to business creation because of simplicity (fewer would be frightened by the immense and ever-changing complexity and random rules of Greek taxation) and clarity.

Nick Jacobs

Feb. 6, 2013, 6:59 p.m.

John, you’ve spent 2 weeks in Europe, and wrote:

“I think the world is better off with a united and strong Europe, and the fledgling eurozone is part of that process. In any case, I am not the one who has to write checks to bail out the various and sundry countries; but among those who do write them – the citizens of the eurozone – the sentiment is distinctly pro-euro, and they seemed to be prepared to pay the costs.”

I have lived for 20 years in continental Europe and I can tell you that that is hogwash. The POLITICIANS of Europe are willing to spend their taxpayers’ money to held the Eurozone together, yes. But the CITIZENS are most certainly not. Ordinary people in most countries in Western Europe see the Eurozone for what it is, a scheme for the aggrandizement of politicians.

Exactly why is “the world” better off with a “strong and united” Europe? People in most countries just want to be left alone to get on with their lives. They don’t want their governments to meddle in other countries’ affairs; they want their governments to maintain services, including an honest legal system, in their own countries.

The institutions of the EU are not directly accountable (in any meaningful way) to the citizens. There are direct elections to the European parliament, but the parliament has very limited powers. Most power in the EU resides with the European Commission and to the Council of the EU, both of whose members are appointed by other politicians. Perhaps this is why voter participation in elections to the European Parliament is low, and most ordinary people take little notice of it.

The most successful country in Europe (lowest unemployment, for example) is Switzerland - which is not in the EU.

Barry Pither

Feb. 6, 2013, 9:03 a.m.

Actually the “Leftist” government which continued the nepotist tradition in Greece in the seventies was the conservative New Democracy party. PASOK, aka the Socialists, was first elected in 1981. Heavy handed bureaucracy and favors for friends and relatives has ALWAYS been the Greek way. I doubt there will be any radical move to Scandinavian transparency standards in my lifetime.

Mark Johnson 52145

Feb. 6, 2013, 8:24 a.m.

I do not understand how the Greek economy went from a competitive index of over 130 down to 100 in just a couple of years.  I don’t recall reading of a general reduction of wages on that scale.