European Debt: Another Brief History

Standard and Poor’s are at it again.  For the last several months, they’ve been running around the world acting like everybody’s international told-ya-so auntie.  A couple of days ago, they landed in (or on) Italy.  The next thing you know, they’re having a five-star lunch on the Via Veneto and downgrading Italy’s debt rating to extra crispy.  What this basically means is Europe’s third largest economy now has less borrowing power than Slovakia, the agrarian little sister of the Czech Republic.  I’m sure Berlusconi shook himself out of his afternoon nap, give it a WTF and asked somebody (a la Barack Obama) “Who do these people think they are?”  The simple answer is S&P are the canary in the mineshaft and right now they’re gasping for air: pay attention!

Like it or not, the Post World War II European Slumber Party is over.  It was a great time, everybody had fun, but now it’s time to wake up, smell the espresso and go back to work.

In fact, the party’s been over for 20 years.  The alarm clock should have gone off in 1989, when the two different Germanys took turns dancing on the Berlin Wall.  At that time, after more than a decade of relative austerity, the prevailing wisdom was “Wunderbar!  Let’s spend the Peace Dividend.”  So instead of putting a couple of drachmas, liras, pesos or what-have-you aside for the eventual rainy day, Europeans actually started overspending again.  In their zeal to continue creating a second Mediterranean Eden of overlapping social programs, nobody bothered to remember the Peace Dividend was an illusion.  There was no significant amount of extra money available to Europe from cuts in defence spending simply because they’d never paid full price in the first place.  American taxpayers had been footing the bill for European defence ever since the days of Stalin.  Ironically, as Americans forgot about the Cold War and closed up shop on the Iron Curtain, Europeans had even less discretionary cash because they had to start buying their own tanks and helicopters again.  Nor was that the only dividend the Europeans were spending.

From the mid 50s until the Oil Embargo of 1973, there had been an economic miracle in Europe.  Called Wirtschaftswunder in Germany and Trente Glorieuses in France, the western continent from the Brandenburg Gate to the Bay of Biscay was doing business.  Believe it or not, during that time period, Greece’s average annual economic growth rate was 7% and Spain and Italy weren’t far behind.  Western Europe was awash with cash.  Once again, however, nobody bothered to stash a few coins in the cookie jar just in case one day the Saudis might start demanding full price for their oil.  But that’s not the real problem.

With mountains of money and American muscle to keep it safe, the Europeans could indulge every socialist fantasy their intelligentsia had ever imagined — from Karl Marx to Charles Fourier.  Social problems were bottomless pits, education and unemployment were subsidized career choices, government departments were bloated with employees, and wages and benefits everywhere went through the roof.  Money was no object and the Europeans threw it around like rice at a wedding.  This was all fine until King Faisal and his friends decided to cut off the goo that lubricated the wheels of European industry.  As oil prices shot up, European industry began to shrink.  This constricted the tax base and put an even greater strain on the social safety net.  In essence, OPEC outlawed miracles.  Unfortunately, the Europeans didn’t see the writing on the wall — or they chose to ignore it.  When revenues were no longer sufficient to cover their obligations, rather than halt some of their more ostentatious social projects, European governments turned to the banks.  To cover the shortfall they borrowed billions against future revenues.  By 1989 this vicious circle was spinning out of control.  That’s why the illusionary Peace Dividend looked so attractive.

Today, after three generations of entitlement programs, any mention of austerity is met with protests and riots.  The party might be over in Europe, but nobody’s leaving just yet.

So, as they say at the accounting firm of Dewey, Cheatem and Howe, “What’s the bottom line?”  It’s very simple.  If nothing changes, there is no way Greece can ever meet its financial obligations.  They either have to completely revamp their economic structure — or default.  There’s no third option.  Likewise, Portugal and Spain must either drastically curtail their social spending or face the same problem.  The IMF recently said that this is a very volatile time, and if everybody isn’t super careful, European debt could slide the entire world into recession.  That’s like saying Chris Rock and Russell Peters are a couple of funny guys and if you’re not careful you could end up laughing.  Recession is the given right now; the only questions are how deep and how long.  Guys like Berlusconi need to tear themselves away from politicking for a couple of minutes, listen to what the money boys like Standard and Poor’s have to say, and act accordingly.  If they do, the recession will be short, sharp and painful.

If they don’t, it’s going to be long, hard and ruinous.

European Economic Reality: It’s Not Sexy

One of these days, the Germans are going to get fed up and quit forking over Euros to every Juan, Liam and Spiros who comes wandering by with a sob story.  Lately, Angie Merkel has been shovelling money off the prosperity truck like it’s Weihnachten; unfortunately, the German taxpayers haven’t been told they’re Santa Claus.  When they find out, there’s going to be hell to pay.  Meanwhile, across the Rhine, Sarkozy is robbing Peter to pay Papandreou by convincing the French private financial sector to bankroll his vision of stability in the European Union.  This isn’t very smart.  Remember, up until recently, Les Trois Grands (Credit Agricole, BNP Paribas and Societe Generale) were all government institutions, so if things start to go bad for the banks it’s going to be the Palais Bourbon who gets to bail them out – on the backs of les taxpayers francais, I might add.  I’m not pointing fingers, but something is rotten in Europe and this time it isn’t in Denmark.

The problem with economics is it’s not sexy.  A bunch of old men sitting around a conference table dividing up the spoils, just doesn’t make headlines the way a good riot does.  Bombs make better copy than balance sheets because, in general, people think economics is dull, complicated and just a little bit icky.  The stereotypical international banker is not somebody you want to spend an isolated weekend in the country with.  The result is most people don’t know how money works.  They believe it’s some magical thing that rich people use to get richer.  Not so!  International billions work the same way as your lunch money.

All economics is based on faith.  Here’s the beer league version.  You don’t have to push a wheelbarrow full of money around because you’ve got a credit card.  It’s a wallet-sized, unsecured short-term loan.  (By the way, despite rumours to the contrary, that’s all it is.)  McDonald’s gives you a Big Mac and fries because they believe the credit card company is going to give them money.  The company, in turn, pays McDonald’s because they believe you’re eventually going to repay the loan.  You get your lunch, McDonald’s get its money and you pay the accumulated bill at the end of the month.  Everybody’s happy.  The whole system is based on everybody’s rock solid faith in your ability to pay.  It’s that simple.

Chopped down to its core, international finance works the same way.  The world monetary system is based on everybody’s faith in the local taxpayers’ ability to pay.  Countries borrow money.  They repay it back over several years from the taxes they collect.  (That’s the only income they have.)  Again, everybody’s happy – as long as the system works.  When it doesn’t, things go bad — real fast.

The situation in Europe these days is several countries have been basically buying too many Big Macs.  They’ve been using their national credit cards promiscuously — way beyond the ability of their citizens to pay.  For example, this current crisis in Greece stems from the fact that they owe nearly half a trillion dollars — with no foreseeable way to pay it back.  The banks have lost faith in the Greeks.  They want their money — yesterday.  This is where things get complicated because — if Greece goes bust — nobody’s going to repossess the Acropolis and call it square.  No, the money disappears: along with several huge banks, the financial structure of Europe and possibly the Euro itself.  The sub-prime mortgage crisis in America will be a surfer’s wave compared to that tsunami.

Enter Merkel and Sarkozy, who have a vested interest in keeping Europe afloat.  They’ve told the banks, “Okay, you don’t have faith in the Greeks anymore, but you still trust us.  We’ll guarantee the loans and we’re backing that up with our taxpayers.”  This is great – problem solved — except for one small flaw.  The EU has already done this twice.  In November, 2010 Ireland went bust (to the tune of 100 billion) and in May, 2011, Portugal did the same (with a 78 billion debt.)  Both times, the EU, led by Merkel and Sarkozy, stepped up and bailed them out with guaranteed loans.  French and German taxpayers woke up this morning on the hook for over 50 billion dollars in other people’s debts.  Not only that, but their banks have guaranteed the same amount again.  And that’s just in the short term.  There’s more to come later.  Trust is not an infinity commodity.  Even the stupidest of the profit-and-loss boys are getting gun shy about throwing more Euros at this mess.  But here’s the real kick in the ribs.  Waiting in the wings is Italy, up to their Armani suits in unsecured loans, and Spain (Europe’s fourth largesteconomy) equally in hock, with a 27% unemployment rate.  Their taxpayers couldn’t pay even if they wanted to.

Bluntly, the ship is about to hit the sand in Europe.  At some point, financial institutions are going to lose faith in even the Germans’ ability to pay.  Long before that happens, the Europeans are going to have to tighten their belts — buckles to the backbone.  The quaint idea that you can eat Big Macs all day on somebody else’s Euro is over.  The Europeans have been out to lunch for a long time, and now the bills are coming due.  They need to become financially responsible first thing tomorrow morning because one of these days the German taxpayers are going to wake up and say, “Was ist los?  I didn’t sign on for this.” And that will be the end of everything.