Friday, May 07, 2010

Debt and Delusion Part 2

UPDATE: It appears that the EU members have woken up to the gravity of the situation and are treating the situation as an emergency. Here is a report from The Irish Times possible measures to monetize the debt[Link]. The risk is very high and if they "underwhelm" the market doing too little, they will be force to do a lot more but the damage may be so severe by then, it will not help. Monetizing debt is a bad solution but probably the only solution that will bring about confidence. They have to overcome their aversion to this, get it done to buy some time then put in regulation, rules and processes to ensure better fiscal discipline among its members. That was what the Americans did - if there is a fire, save lives first then talk about fire safety regulations later....

Debt and delusion part 1 here[Link].

In March 2010 I wrote about an interesting book by Peter Warburton about how the high debt levels in the economic system which will lead to something no less than a slow collapse and complete change of the existing financial system.

In 2004, Greece was hailed as an economic miracle when it was picked to host the Olympic Games. It was the comeback kid, the epitome of higher living standards brought about by membership to the EU. Today Greece threatens to fall apart under the austerity measures imposed on it by the IMF and other EU members. But it not just Greece that is problematic but a number of countries in the Eurozone known as PIIGS (Portugal, Italy, Ireland, Greece, Spain) that threaten the global economy with a new contagion.

In recent days we are seeing market turmoil similar to those that occurred during the subprime crisis. Fears of troubles in Europe spreading has caused a massive flight from risk as investors flee from equities and commodities to the 'safety' of the US dollar and US treasuries. This type of fear has a way of dissipating quickly resulting in large market rebounds and recovery. However, you have to fear that exceptions can occur such as during the Asian crisis when the financial crisis turned into riots and collapse of govts - some of which was brought about by speculators who created a self-fulfilling prophecy brought by spreading fear and panic throughout the crisis. We are in an extremely dangerous situation because the recovery is fragile and if it is derailed, we will be in for a long haul if we get into a double dip recession. The debt problem in Europe is extremely serious because the sovereign debt that has been downgraded is held by banks throughout Europe. Credit is freezing up and there is little time left. The policy options are very limited for Europe. If you read Peter Warburton's book, there is only one way out. I'll talk about this later. The capital markets have been completely destabilised in the past week. If Europe acts too late, the consequence will be dire. Perhaps before last month, there was some hope that the global economic recovery can lift Europe out of its sovereign debt mess. However, speculators have destroyed this hope in the past week. The falling Euro and globals stocks, brought about in part by speculators can bring a recession by undermining investor confidence. Either the Europeans can't get it done right and the EU falls apart or the make the only right move. If they get it wrong, it will perhaps be a blunder that exceeds the decision to let Lehman collapse.

What do the Europeans need to do? .....Here is a good article on where they are now and what the options are:[Link]

This is taken from a transcript from of a press conference in March 2009 given by ECB's Trichet[Link]:


"Question: Mr Trichet, two questions, please, one is: Could you again elaborate a bit more on your or the ECB’s problems with zero interest rate policy; the arguments which would prevent the ECB from lowering the main refinancing rate to zero.

And secondly, another question on the non-standard measures: If you cannot tell us what measures the Council would prefer at the moment, could you at least give us a sort of time frame for when a decision on this might take place. Or do you think you have unlimited time to decide when to pursue those non-standard measures, because time is a bit short at the moment, is it not?


Trichet: On your first question, time is short and that is why we are taking important decisions. We have taken important decisions in the past few months and we have taken important decisions today with commitments that go beyond the end of the year. As regards your second question on non-standard measures, as I said we are in discussions. I am not ruling anything out. We are not pre-committed to anything. When the time comes, you will know what we have decided. And I shall give you regular updates at our press briefings, but I do not pre-commit to any particular time. In any case, we have proved that we have been able to take decisions at any time when necessary including in exceptional unforeseen circumstances. And, as I have repeatedly said today, uncertainty is the mark of the time. With regard to why we think that zero interest rates would be very inconvenient, I will not elaborate any further. It is clearly an assessment that we have made."

Remember in March 2009, things were quite hopeless all over. There were fears that US banks were insolvent, the global economy was in a severe recession. The focus was not on European sovereign debt although it was one of the major issues. At that point in time, the US and Britain decided to take a risky strategy of quatitative easing i.e. printing money and ECB was considering the same move[Link]. Within a month, the capital markets recovered and today we have some sort of economic recovery. Based on the transcript in March 2009, the ECB was considering some 'non-standard' policy moves. However, because the US & UK started easing and capital markets recovered. This recovery masked the European problems until the early part of this year.

Things have come to a crucial juncture when market instability is going to spill over into the real economy. The ECB now has to reconsider these 'non-standard' policy moves e.g. print money to buy govt debt. They have to act this weekend or face further damage to confidence and risk of derailing this fragile economy. Also, because markets are heavily oversold, measures if announced this weekend will have the intended impact. In the absence of inflation and deflationary pressures in many EU countries forced to cut budget deficits....quatitative easing makes sense. It is a bit silly to be forced by further market deterioration to make this move. The wealth wiped out from global markets must amount to several trillions while they only need to buy back hundreds of billions of govt debt from the banks.

Yesterday, the STOXX 50 Index that track stocks of major European companies fell 4.26% in one day. They have fallen 16% in less than a month. So there is no more time left as confidence will completely shattered if nothing is done...any more dithering and the EU will be forced off the edge and when that happens, nothing they do will work.
Quantitative easing is a strategy to forestall the inevitable and buy time. If they don't do it, they will be worse off with a bigger mess to that cannot be fixed for years. However, there is some lingering political stubborn-ness on the part of Germans who feel short-changed that they have to bailout weaker nations[Link]. But the simple fact is German banks are the biggest holders of European sovereign debt and they will be perhaps the most to lose if there is no resolution of the crisis. We have seen what happens next if decision makers delay actions in such situations. History is very clear on this - we saw it during Asian Crisis and the recent subprime crisis - that the markets will force govts to act even more drastically. Govts have to put aside worries of moral hazard and politics to get this done. Looking how the Europeans bickered, dithered and quarrelled just to cough out $110B to bailout the Greeks, optimism that they will do the right and logical thing make have to be put aside. The worst case scenario is they continue to bungle and drag the rest of the world down with them in the coming days.

Warburton's pessimistic view is at the end of day there is no way out but quatitative easing may lead to inflation and ultimate deterioration in living standards ...but right now there is no choice.

13 comments:

Divali said...

Hi Lucky

Just in case u missed Prof. Krugman's May 6 piece:

http://www.nytimes.com/2010/05/07/opinion/07krugman.html

Anonymous said...

But how will all these affect Singapore?

Will things be as per normal, at least on the surface, as per the past 40 over years?

If so it will be good enough.

StatusQuoNotOK said...

Anon 8/5/10 07:35

U said conditions in Singapore since the 1970s are good. I agree.

But it also implied that the past few years were similarly good. Sorry, can't agree lah..

Lucky Tan said...

It is too early to say. If the Europeans don't manage this crisis carefully, we will re-enter recession for sure. Remember many people too on loans and bought condos recently? In the long run our economic fate will be linked to that of our trading partners. If the world goes into a long slump things will not be good for Singaporeans.

It is still not certain we will do a second dip in the coming months. But whatever it is the European problems are a reminder how fragile the global economic system is. We had 3 recessions in 10 years and 2 crisis in 3 years. All this due to the high level of debt in world.

Because of this instability - safety nets are important. It is important for govts to set aside money during the good times so that they can provide something during the bad. In Singapore this is especially important due to the income gap many are barely able to stay afloat during the good times. When the bad times come, many low income Singaporeans are exposed to risks due to no fault of their own. It is important for govt to provide some reliable stabilisers in their life so that things don't fall apart for them and they can have another chance.

We cannot blame the govt for the bad times and recessions. But the missing basic safety net one that ultimately save us in terms of social costs is a responsibility the govt must fulfil.

Anonymous said...

Mr Lucky

Obviously, Greece is not in perfect health.
However ...
Greece has just about the same level of public debt as ... Singapore.
Greece is, in the world context, insignificant.
Greece just happens to be the weak link in EU.
And Greece is under attack by the same bunch (+/- a few members) as Thailand and Korea during the Asian Crisis.

Same bunch of people I think you are hoping to save the world btw. You know ... USA Gahmen. Buffet's Moody. GS. etc.

Hope you got lucky in the stock market though.
All liquidated?

Anonymous said...

Mr Lucky

Speaking of debt ...
http://amosatlantis.com/man-jumped-at-bedok-mrt-was-suicide-a-result-of-losing-70k-at-casino/

Anonymous said...

Hi Lucky

What is your opinion abt 'hot money' leaving Europe due to PIIGS (Portugal, Ireland, Italy, Greece & Spain) and entering S'pore & Asian countries?

If 'hot money' does enter then perhaps may appear to boom ('hot money effects') initially, later crash causing recession. Lehman Bros did not have immediate effect here in terms of immediate job losses but backlash occurred later.

Lucky Tan said...

anon 11:41,

Hot money cause boom times to feel great and bad times to feel depressing when they pull out. Even heard of hot money coming here to speculate in property. During 2007 easy money meant companies can leverage to the hilt for expansion....that can make a recession disastrous. However, thanks to Bernanke and gang, easy money flowed and the weakest least conservative most highly leveraged players survived e.g. Sands (LVS) ...that is a red flag because when the next recession comes, it is going to be really painful.

Lucky Tan said...

anon 10:15,

That is sad and it is over 70K. I'm staucnhly against the IR because I think the social cost is too high and the IR creates jobs that we don't need. We don't have an overall unemployment problem but a structural unemployment issue coupled with a low wage problem - overall the SIngapore creates so many jobs we need to import foreigners by the hundreds of thousands to fill them.

I think the "responsible gambling" campaign is a flop and should be a "gambling is bad" campaign. Telling people there is something such as "responsible gambling sends the wrong message that it is okay to "gamble".

Divali said...

Hi Lucky

Greek Crisis in cartoon (both cartoonists are past Pulitzer Prize winners):

http://voices.washingtonpost.com/tomtoles/2010/05/coming_ashore.html

http://www.miamiherald.com/2010/05/07/1618860/5910.html

Anonymous said...

by the same argument, if responsible gambling is bad, responsible whoring is bad too.

how do we rid SINs from SIN?

let them be responsible for the hard lessons while we reap from their foolishness?

Anonymous said...

I dunno what to think after reading ur article...

Bailouts have always been the traditional method to forestall recessions..yet the 2008 crisis should force us to ask some hard questions... like is it really okay to use $180 BILLION to bailout AIG, a PRIVATE institution???

With the Keynesian aversion to recession, whatever will happen to moral hazard or creative destruction then? Paul Volcker did the unconventional, causing a sharp recession but time proved him right. The economy rebounded stronger than ever. Perhaps overleveraged entities should be allowed to fail. There's too much moral hazard nowadays...

As food for thought, perhaps governments should change focus to the cleaning-up efforts rather than just the bailouts to prevent recessions...

No Fear said...

I already have no job, what do I have to lose?

My kids are in late teens and in NS.
My wife will soon lose her job too.

I am debt free.. but need money ( $2000) monthly to live, and pay insurance ( lousy product )

despite this, I believe we will not suffer from any impact of what goes on in Europe or USA.
All recessions for Singapore lasted less than 1 year.. including the SARs period..

I still have roti pratha, hokkien mee and air-con with internet.
We talk about the "poor".. but yet we get civic associations going to Cambodia, Acheh, China to donate $$ to help their poor.

Ironic.

we have F1, Casinos, Great Singapore Sale.. IT fairs, property boomz.. insurance growth, corporate earnings UP, CPF up! COE Up!

What recession? What?.. endless doomsday?.. sounds like the Gov.