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The bad news
out of Europe continues unabated, including debt and ratings downgrades,
sliding economic growth, and exploding red ink.
It is becoming apparent that many of the countries of Europe have
borrowed so much money from the banks of the other countries in Europe, that almost
none of it can or will ever be paid back -- not with the ever falling economic
growth in these countries, which will worsen as austerity measures are imposed. In other words, even though the buyers of the
bonds of these countries don't yet realize it, the fact is that most of these bonds will never be fully redeemed. In other words they are toxic junk;
the loans will never be repaid, at least not for anything like their nominal and originally stated value.
Most
alarming of all is the enormous amount
of money that the US and UK have
borrowed from banks in various countries around the world. (See the beautifully illustrative graphs at
the link provided both here and below,
courtesy of the BBC. Scroll down to see
them.)
Why is this extreme
and growing US indebtedness particularly alarming? Because buyers for US Treasury bonds are
steadily disappearing, and those who own them, like the Chinese central bank,
are trying to sell what they have.
So who is now
the major buyer of US Treasury bonds? Answer:
The U.S. Federal reserve, which simply
creates the money out of thin air, with computer keystrokes, and uses this "funnymoney'
to buy our nation's bonds. But for how
long can such an Alice-in-wonderland process continue?
Much of the
hope in Europe rests upon carefully crafted bailouts which in turn rest,
precariously, upon assumed rates of
economic recovery and growth in order for loans to be repaid, and everything
related . . to work out. However, without
those assumed and anticipated rates
of growth, such plans will fall apart, and more rescue funds -- or outright
defaults -- are in store for us.
The Specific Situations of Some of Europe's
Basket Cases (Recommendation to the
reader: Except for the "Concluding Paragraphs" at the end of it,
skim this section on first reading)
Ireland is an instructive case
because it entered its difficulties earlier, and it has already received a
bailout, and implemented the austerity measures that were meant to balance the
equation.
Unfortunately,
the plan is now in tatters with the recent revelation that the Irish economy is
slumping more than expected under the twin weights of reduced lending and
imposed austerity. From the Irish Times: "Ireland's debt rating
under threat as economy contracts."
Rating agency Fitch tonight warned it may
downgrade Ireland and five other euro zone countries in the absence of a
comprehensive solution to the region's debt crisis which it concluded may now
be "technically and politically beyond reach."
Furthermore,
the agency placed the ratings of Belgium, Spain, Slovenia, Italy, Ireland and
Cyprus in credit watch "negative," which means a downgrade is probably within
three months.
This move
comes on the back of unexpectedly poor economic data for Ireland, which showed that
its economy weakened considerably in the third quarter, shrinking at the
fastest rate in more than two years.
GNP is a
better measure than GDP in this case because GNP removes repatriated corporate
profits that have left the shores. Many
companies use Ireland as a tax haven, so the monies that cycle briefly into and
then right back out of the Irish system really should not be counted towards
their economic progress. With economic
contraction, the Irish fiscal deficits will once again breach agreed-upon
levels, and repaying debts also becomes that much harder. It is a negative spiral that can be quite
destructive and difficult to stop.
The bottom
line here, which should surprise no one, is that austerity shrinks an economy
and that economic shrinkage and crushing debt loads are incompatible.
Ireland's
debt yields (i.e. the interest rates that its bonds pay) are instructive. While it is true that Ireland's debt yields
are down quite a lot from their maximum levels (which were over 23% for 2-year bonds
and 15.5% for their 9-year bonds), the
current yields of 7.9% and 8.6%, respectively, are utterly unsustainable for an economy that is shrinking! Therefore
it is only a matter of time before those high rates crush the finances of the
Irish government.
Do you know
why the generally agreed-upon limit for persistent government deficits is 3%? It's
because that's the basic rate of GDP growth that history has shown to be
sustainable. As long as deficits are
growing at the same rate as the economy, then the debt-to-GDP ratio stays
constant and everybody is happy. If (or when, I should say) the economy grows more slowly than the rate of interest that is
demanded from a government, it is a mathematical certainty that either the
deficits will swell or austerity
and/or tax hikes must be imposed. There
is no other way to balance the books.
On this
basis, Ireland has major financial problems problem and its economic outlook is
grim.
