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First with Financial Comment from Arabia

Greek debt only the start of this global tragedy

with 2 comments

It is easy to understand global financial markets rising on news that the Greek budget crisis might be over, albeit greeting Greek’s bearing gifts has a poor historical precedent.

It is also far from certain that the Germans are going to offer the Greeks any gifts in return. Chancellor Angela Merkel knows political suicide when she sees it. But cutting public spending to lower deficits is going to become a global theme this year, and sadly one that will not help economic recovery, at least in the first instance.

Dubai austerity package

Dubai Government departments have just been asked to find another $1 billion in savings this week. So much for maintaining public expenditure to counter a difficult year for local business, but eminently sensible in view of the well-known debt problems of the emirate.

Yet look back at Europe. Last year German auto exports fell by 29 per cent, machinery exports by 24 per cent and chemical exports by 20 per cent. This is a formidable economic slump in what was until last year the world’s biggest exporter.

If, as looks inevitable, we now see public spending cuts in Greece, Spain, Portugal, Italy, Ireland and possibly Belgium, how does that affect demand for German exports? It can hardly be good news can it?

Californian example

Over in America it is the states led by California where the most immediate public spending cuts are necessary. Even in the home of deficit finance there is a limit to public borrowing, and the first weakness is going to come in local bonds.

The real point is that the Great Recession can hardly be declared over. It can at best be half way through and pausing before the second half.

Is it therefore good news when the Greek Government announces 4.8 billion euros in deficit cuts, including pay cuts for civil servants? Sellers of German cars are going to have an even tougher time in Greece.

And yet from a global perspective this has to happen. There has been a great inflation of asset prices driven by excessive debt, and public spending has risen on the back of it, and now we have a great deflation as the worst excesses are corrected.

Investment implications

Will this be a gentle process with no volatility in financial markets? Obviously not, and the bias must be to the downside until the debt problems of the world are solved.

Politicians have two ways to deal with such problems. The hard way is with spending cuts like those announced in Greece or Dubai. The easy way is to inflate debt away as the Federal Reserve and Bank of England are trying to do by printing money.

But none of this is good for economic growth rates or financial markets. A flight to cash, precious metals and commodities will be the result as markets for real estate, equities and bonds tumble.

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Written by Peter Cooper

March 4, 2010 at 8:53 am

2 Responses

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  1. Larry Kudlow just said on his CNBC TV show that the latest US Government estimate for the US Federal Debt in 2020 is $20,000,000,000,000. (That is trillion in case you lost count of the zeroes like I do. Pretty soon they will need to start using scientific notation to write the debt number.) The US GDP is about $14 trillion. Obviously, the actual debt will be larger, because they always make best case assumptions for economic growth, and don’t consider little things like the effect peak oil may begin to have on the economy after about 2016. (Heck, what do self made billionaires like Sir Richard Branson and his paid experts know about oil.)
    When people argue that the economy will recover just like it has from recent recessions, I am skeptical for several reasons. Reflect on a few ideas with me.
    Have developed countries ever had the debt levels that they now have? The end of WW II comes to mind. Yet, in the USA at least, the Government was willing to impose a marginal income tax rate of 90% on the wealthy to help reduce that debt. Can that happen today? Impossible. Why do you think the AIG CDS holders got 100 cents on the dollar from the US taxpayer.
    And after WW II, oil was virtually free and limitless. The Texas Railroad Commission forced producers to limit oil sales until around 1970, so that the oil price wouldn’t go down to pennies per barrel. The USA exported the stuff. Natural gas was often burned off to get rid of it. Not anymore baby. The era of nearly free energy is over. Plus, that darn energy cost pops up in just about everything you try to do. Even with the economy flat, and oil demand down 10%, oil still costs $81 a barrel. That is up 700% in a decade. Think what will happen if the economy does start to grow. More people driving to work will instantly start to use more oil. The price will go up to $100 before you know it.

    And you know what, when things just don’t seem right, they usually aren’t. Look at a graph of the US S&P 500. Does that look like normal economic activity to you, with those two big teeth, and a third one forming? It doesn’t to me. I think the peaks were all based on an increasing level of debt, instead of real growth in economic output.
    It doesn’t take a genius to figure out that you can’t keep increasing debt levels forever. Eventually, something very bad will result. And next time the debt bubble pops, the entire financial system could pop with it. The Fed created a few trillion magic dollars to transfer the loss from the private to the government sector last time the bubble popped. The next time the debt bubble will explode, and tens of trillions will be needed to rescue the reckless. It will be like me trying to buy IBM with my credit card. Sorry, it won’t work. I hope it doesn’t happen when I’m still around, because a meltdown of the financial system won’t be something I want to experience living in the developed world. Everyone doesn’t live on the farm anymore. I doubt that Barton Biggs, in his latest book, is advising his rich friends to buy a remote farm and stockpile food and guns because everything is just fine.
    I will leave a discussion of what $600,000,000,000,000 of derivatives might do to the financial system, if a significant percentage of them are ever somehow triggered, to those of you who understand them. All I know about them is that the world’s richest man, Warren Buffet, called them financial weapons of mass destruction.
    Still think that it isn’t different this time?
    Now I’m off to the live Chile earthquake coverage on the Internet and some red beans and rice. I can live on rice, and luckily, Louisiana grows a lot of rice. Thankfully for Chile, there is no substitute for copper.

    Bill Simpson in Slidell

    March 6, 2010 at 7:17 am

  2. VIX in the US is now at just over $17. Crazy, it’s like it went into a coma and as if there were no worries in the US. With the VIX this low I see a chance of a big rally from here on. Only time VIX gets this low is when the market is bullish or when there is an invisible hand manipulating the market and its movements. Asian markets pretty much gave the green light to the US today. The manipulation these days is pathetic. May as well go bullish and quit trying to fight the bullish trend.

    Andy

    March 5, 2010 at 7:17 pm


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