29-Oct-10 News -- EU appears near another financial crisis point - 29-Oct-2010 - Generational Dynamics

When the EU bailed out Greece in May (see "11-May-10 News -- Europe's super-nuclear bailout"), it was thought that the country's budget deficit for 2009 was 13.6% of the gross domestic product (GDP). In fact, that was the figure published by Eurostat, the European Union's statistical agency.

The official common story line adoped by the EU and Greek politicians was that Greece would lower this percentage to 8.1% in 2010, and even lower in subsequent years, and would avoid default. No one with a shred of honesty actually believed this nonsense, but we're talking about politicians, so dishonesty is the norm anyway.

Eurostat did a thorough audit of Greece's finances, and was scheduled to publish a report on Friday, October 22, updating the 13.6% figure to a completely accurate figure. But on October 22, Eurostat announced that it would have to delay the report until mid-November, according to Dow Jones.

It's assumed that there are political reasons for this postponement, since it came amid rumors that the new 2009 deficit figure would be 15.5% of GDP, sharply higher than Eurostat's previous 13.6% figure.

And now, on Wednesday, the NY Times quoted sources saying that the 2010 defit will be 8.9% of GDP, rather than 8.1%.

Lowering the budget deficit from 15.5% to 8.9%, if that can be accomplished at all, would be a significant feat, and a measure of how severe the austerity measures were that have been put into place since the bailout.

Nonetheless, this news caused Greek ten-year bond prices to fall, and yields (interest rates) to rise to 10.3% from 9.3%, figures that are around the crisis levels that led to bailout in the first place. However, Greece is relatively immune from crisis for a year or two, since they can borrow money from the EU at a little more than 5%.

You know, people think that lying politicians are cute and amusing, but do no real harm. But this little story shows how much damage they do. Any widows and orphans who invested in Greek bonds, believing the politicians who said that Greece would avoid default, are going to lose a lot of money.

Unfortunately, all of these situations are like going to the dentist. Nursing your aching tooth just makes things worse, so you might as well go to the dentist and get it over with. The same is true of accepting the reality of what Greece is going through. By continuing to lie, the politicians are only making what's coming worse.

Portugal's austerity talks collapse, bring PIIGS countries into question

Not just Greece but all the PIIGS countries (Portugal, Ireland, Italy, Greece, Spain) are all under the microscope.

Greece did institute fairly severe austerity measures, but the politicians in Portugal are refusing to do so. It had been hoped that Portugal could avoid a Greece-style bailout on its own, but austerity talks in Portugal collapsed have collapsed, according to Reuters.

Budget talks had been proceeding between the governing Socialist party and the main opposition Social Democrats (PSD) party, but no further talks are planned after the collapse on Wednesday.

There is still a budget vote to be taken, and if the budget is not passed by November 3, then Portugal will be in a crisis and forced to seek international aid.

Portuguese bond yields are still well below those of Greece, but they've been increasing and reached 3.28%.

The dire financial situations in Greece and Portugal have had a domino effect on Irish bonds, according to the Irish Times. Irish bond yields spiked to 6.68% on Wednesday and 7.2% on Thursday, as investors once again begin to lose faith in the entire euro currency experiment.

Germany and France demand changes to the Lisbon agreement

The spectacle of eurozone countries with collapsing finances has caused leaders of France and Germany to demand punitive measures for some countries. They want to create a permanent system for handling financial crises like Greece's debt collapse, according to Reuters, so that nothing like that will ever, ever, ever happen again. This will require changing the Lisbon treaty, which is currently the highest law allowing a central government for the European Union.

Long-time readers of this web site will recall that because of deep-seated historical differences in Europe, the European constitution would never be ratified. That turned out to be true, but I also believed that its weaker replacement, the Lisbon treaty, would never be ratified either. So I was quite surprised when it was ratified, although it was done by a process of extortion very similar in spirit to the way that the health care bill was passed in the U.S. Congress.

It's highly doubtful that a similar process of extortion will work again, so European leaders are looking for ways to change the Lisbon treaty without requiring all 27 EU nations to ratify the changes. The above Reuters article describes various scenarios that the EU lawyers are considering so that they can change the Lisbon Treaty without anyone actually having to vote on the changes.

Germany is particularly adament about wanting to punish member states that flout budget rules, since Germany has the best economy in the EU, and since the German population was absolutely furious at being forced to bail out Greece last spring, as they were the biggest contributors to the bailout.

In particular, what Germany wants is to change the Lisbon treaty to have a member state's EU voting rights suspended if they did not meet the budget requirements, according to Spiegel.

This is actually a breathtaking proposal. Imagine if the United States denied voting rights in the Senate to Senators from California and Illinois because of their desperate budget situations.

It seems pretty clear that if such a change to the Lisbon treaty were somehow engineered, it would infuriate Greece, Portugal, and the other PIIGS countries, as well as Britain and France, who are also in violation of the EU's budget rules.

This proposal is being discussed this week at an EU summit. If it somehow survives the summit, it's going to lead to a very bloody political battle.

Jeremy Grantham outlines Washington's financial fantasy

Of course, lying and extortion are not unique to Brussels. There's plenty of it in Washington and on Wall Street as well, where many people are claiming that the world will be saved by "QE2," a new proposed Federal Reserve quantitative easing program of hundreds of billions of dollars.

Jeremy Grantham's October newsletter (PDF) provides an excellent explanation why the program will not work. Here is the summary from the newsletter:

"1) Long-term data suggests that higher debt levels are not correlated with higher GDP growth rates.

2) Therefore, lowering rates to encourage more debt is useless at the second derivative level.

3) Lower rates, however, certainly do encourage speculation in markets and produce higher-priced and therefore less rewarding investments, which tilt markets toward the speculative end. Sustained higher prices mislead consumers and budgets alike.

4) Our new Presidential Cycle data also shows no measurable economic benefi ts in Year 3, yet point to a striking market and speculative stock effect. This effect goes back to FDR, and is felt all around the world.

5) It seems certain that the Fed is aware that low rates and moral hazard encourage higher asset prices and increased speculation, and that higher asset prices have a benefi cial short-term impact on the economy, mainly through the wealth effect. It is also probable that the Fed knows that the other direct effects of monetary policy on the economy are negligible.

6) It seems certain that the Fed uses this type of stimulus to help the recovery from even mild recessions, which might be healthier in the long-term for the economy to accept.

7) The Fed, both now and under Greenspan, expressed no concern with the later stages of investment bubbles. This sets up a much-increased probability of bubbles forming and breaking, always dangerous events. Even as much of the rest of the world expresses concern with asset bubbles, Bernanke expresses none. (Yellen to the rescue?)

8) The economic stimulus of higher asset prices, mild in the case of stocks and intense in the case of houses, is in any case all given back with interest as bubbles break and even overcorrect, causing intense fi nancial and economic pain.

9) Persistently over-stimulated asset prices seduce states, municipalities, endowments, and pension funds into assuming unrealistic return assumptions, which can and have caused fi nancial crises as asset prices revert back to replacement cost or below.

10) Artifi cially high asset prices also encourage misallocation of resources, as epitomized in the dotcom and fi ber optic cable booms of 1999, and the overbuilding of houses from 2005 through 2007.

11) Housing is much more dangerous to mess with than stocks, as houses are more broadly owned, more easily borrowed against, and seen as a more stable asset. Consequently, the wealth effect is greater.

12) More importantly, house prices, unlike equities, have a direct effect on the economy by stimulating overbuilding. By 2007, overbuilding employed about 1 million additional, mostly lightly skilled, people, not counting the associated stimulus from housingrelated purchases.

13) This increment of employment probably masked a structural increase in unemployment between 2002 and 2007, which was likely caused by global trade developments. With the housing bust, construction fell below normal and revealed this large increment in structural unemployment. Since these particular jobs may not come back, even in 10 years, this problem may call for retraining or special incentives.

14) Housing busts also help to partly freeze the movement of labor; people are reluctant to move if they have negative house equity. The lesson here is: Do not mess with housing!

15) Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the fi nancial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefi ts are reduced. It is likely that there is no net benefi t to artifi cially low rates.

16) Quantitative easing is likely to turn out to be an even more desperate maneuver than the typical low rate policy. Importantly, by increasing infl ation fears, this easing has sent the dollar down and commodity prices up.

17) Weakening the dollar and being seen as certain to do that increases the chances of currency friction, which could spiral out of control.

18) In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment."

In other words, the only effect of "QE2" will be to push the stock market up into even higher bubble territory, and one day that bubble will burst.

From the point of view of Generational Dynamics, a major financial crisis is overdue. It may be triggered by a some kind of collapse in Europe or some kind of collapse on Wall Street ... or a collapse somewhere else, leading to a domino effect. It's impossible to predict what will trigger it, but the fact that it's coming is absolutely certain.

Vladimir Putin triggers topless protest and speculation about face bruises

Russian Prime Minister Vladimir Putin triggered speculation on Wednesday in a visit to Kiev Ukraine. He was wearing heavy makeup, but it wasn't enough to hide the dark bruises beneath his eyes. Putin's spokesman said that the appearance was simply caused by tiredness, according to the Kyiv Post.

While he was in Kiev, negotiating a treaty to keep Russian ships in the Black Sea port of Sevastopol, he was met by topless women from a feminist group demanding that Putin not interfere in Ukraine's business.

Additional links

The Soviet Union fought a "Vietnam-style" war in Afghanistan in the 1980s, and was finally driven out by the Taliban mujahadeen. But now Russia and Nato are developing a closer relationship, and this may cause Russia to be drawn back in to the Afghanistan war, in support of Nato coalition troops. Guardian

Despite many reforms that have been implemented by the government over the past few months, including a crackdown on tax evasion and on graft in the public sector, Greece is still perceived as the most corrupt state in the 27-member European Union, according to the corruption index published by Transparency International. Kathimerini

Foreign aid to Haiti that followed January's earthquake has itself been something of a disaster for Haiti, as it failed to create any permanent jobs or industries, and has robbed the government of legitimacy. Reuters

Recent news reports that Iran has been supplying "bags of money" to President Hamid Karzi of Afghanistan have raised the ire of opposition leaders in Iran, who are demanding an explanation. Eurasia Review

The border separating Yemen from Saudi Arabia is extremely porous, and is posing a security threat to Saudi Arabia. Al-Qaeda on the Arabian Peninsula (AQAP) is headquartered in Yemen, and has successfully targeted the Saudi leadership through terrorists crossing the border. Also, rebel groups in northwest Yemen, possibly being funded by Iran, fought with the Saudi army after crossing the border. Saudi Arabia is being to take the border more seriously, to combat drug smuggling and to prevent hundreds of thousands of migrants from crossing. NY Times

India�s Prime Minister Manmohan Singh said he will ask the central bank to learn more about Islamic finance from Malaysia, which has the world�s biggest market for Shariah-compliant debt. Experts are recommending that Indian banks experiment with Islamic finance in order to attract more capital. Bloomberg

Russia is facing a potential demographic catastrophe unique in the world for a relatively developed country. The birth rate is falling, as it is in many western countries, but what makes Russia different is that the death rate is soaring. Experts are puzzled by the cause. Eurasia Net

Just as mysteriously as China started its recent embargo on exporting rare earth minerals, China abruptly and mysteriously ended the embargo on Thursday. The decision came a day and a half after Secretary of State Hillary Rodham Clinton announced plans to visit China on Saturday. NY Times

Will Facebook kill people during a flu pandemic? That's the fear of U.S. government officials, who fear that social media sites will spread dangerous rumors. "We were terrified about what was going to happen with the flu pandemic and social media," says one official. Social media is a place where a lot of rumors can start about what causes flu. We had an untested, never-tried-before vaccine that we developed. One wrong thing on Facebook or Twitter and a whole bunch of people in this country--especially children and pregnant women, that's who this disease targeted--could die." Fierce Government IT

Paul the Octopus, who correctly predicted the outcome of eight World Cup soccer matches this year, has died. Devastated Germans will build a memorial to him. Spiegel

Generational Dynamics Web Log for 29-Oct-2010
29-Oct-10 News -- EU appears near another financial crisis point

Greece revises its budget deficit sharply upward

Portugal's austerity talks collapse, bring PIIGS countries into question

Germany and France demand changes to the Lisbon agreement

Jeremy Grantham outlines Washington's financial fantasy

Vladimir Putin triggers topless protest and speculation about face bruises

Additional links

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Generational Dynamics Web Log for 29-Oct-2010 29-Oct-10 News -- EU appears near another financial crisis point

Greece revises its budget deficit sharply upward

Portugal's austerity talks collapse, bring PIIGS countries into question

Germany and France demand changes to the Lisbon agreement

Jeremy Grantham outlines Washington's financial fantasy

Vladimir Putin triggers topless protest and speculation about face bruises

Additional links

Web Log Pages

Generational Dynamics Web Log for 29-Oct-2010
29-Oct-10 News -- EU appears near another financial crisis point