PIGS and the Smell of Bacon

Bacon, Bacon, Bacon…

The bacon reference has been claimed. Marius Gustavson has written a brilliant article on the sovereign debt crisis facing the world. From The Market Oracle:

Smells Like Bacon

“The Greek debt crisis has led many observers to believe a eurozone-wide contagion is in the making, including all of the PIGS – Portugal, Italy, Greece and Spain – and it could spread to the north-western periphery as well. As Ian Bremmer and Nouriel Roubini recently commented in the Wall Street Journal:

“The current crisis in Greece is only the worst example inside the EU. The PIGS … all boast public debt above or headed for 100% of GDP. Though the PIGS acronym was apparently coined by British bankers, Britain, Ireland and Iceland also smell distinctly of bacon.”

Debt distressed nations being called PIGS, countries smelling of bacon, and dubious political spending referred to as pork. What’s next? Maybe Bernanke will bypass money dumping helicopters and grow wings himself – pigs might fly.

The U.S. budget deficit certainly is soaring. It “widened to a record in February as the government boosted spending to help revive the economy.” How spending money that had to be borrowed from someone else can stimulate is a mystery. It just moves money around. How it indebts future generations is not a mystery:

“The figures show the deficit this year will likely surpass the record $1.4 trillion in the fiscal year that ended in September.” The light at the end of the Keynesian tunnel is a runaway steam train loaded with debt obligations.

Wall Street still only sees the light. It has marked its best 12 month performance since the rebound from the Great Depression.

Who done it?

The latest European blame game has begun. After believing the Keynesian free lunch would provide for a cushy future, it seems Europe’s politicians are descending into an even deeper state of denial and delusion. Marius Gustavson at The Market Oracle continues:

“So far the two PIGS most afflicted by the European debt crisis, Greece and Spain, blame mysterious foreign conspirators, rather than home-grown macroeconomic mismanagement.

“Greek Prime Minister George Papandreou expressed the view that the crisis is “an attack on the euro zone by certain other interests, political or financial,” whereas the Spanish government has, reportedly, ordered an investigation into the alleged “collusion” between American investors and the media to hurt the Spanish economy.”

Considering those evil financial institutions hold vast amounts of government debt, as well as facilitate bond markets, the Greeks and Spaniards might want to keep their mouths shut.

Biting the hand that feeds you is a bad idea. This is no less true if that hand is attached to something as unscrupulous as a bank. In fact, it holds even more true.

Amusingly, those unscrupulous banks find themselves in the same fix as Shylock did. If they hold countries accountable for their excesses by requiring higher bond yields, then the bank’s capital base weakens. If they continue to buy bonds, they expose themselves to sovereign risk.

And yes, losing a pound of flesh does compare to losing capital. The real difference is that Shylock could walk away from the debt. Although, with million dollar bonuses, I suppose bankers could walk away quite comfortably. That’s where derivatives like Credit Default Swaps come in. We’ll leave that for another day.

Me, Myself and the Lenders

Sadly, it seems the delusions of politicians have filtered down to the citizens. They now also feel some sort of entitlement to being lent money.

The vast benefits promised by governments and provided by debt markets seemed endless. When it turns out they aren’t, trouble brews. Greece is just the beginning.

“The importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood,” said El-Erian, co-chief investment officer at Pacific Investment Management Co, known as PIMCO.

If Greece is where the world is headed (metaphorically speaking) then things could get interesting.

Bloomberg reports that “Greece’s unions will shut down hospitals, airports and schools today in the country’s second general strike this year to protest Prime Minister George Papandreou’s latest round of budget cuts to curb the European Union’s biggest deficit.”

The Economist, far more insightfully, reports that “Militant pensioners unexpectedly broke through a police cordon blocking the road to Mr Papandreou’s office as he was announcing the new measures.”

Please take a moment to picture that.

Militant pensioners… And it’s not like they have nothing better to do. It’s just that they want to claim what they can while they still can. Marko Papic of Stratfor has forecasted that interest will amount to 6% of GDP for the Greeks by next year. That is past the point of no return, according to Professor Altman, who developed a popular model used to calculate corporate defaults.

His reasoning is that Greece faces structural problems, which are difficult to turn around, even in the long run. Based on this, any bailout will be like a bandaid for a cancer patient. Nobody but two year olds and stock brokers would be comforted. That does leave room for a short term rally. Caveat emptor. Please don’t confuse that with Carpe diem.

One clever solution did pop up in the press. According to two German senior ministers, it would be a good idea for Greece to sell a few of its islands to pay off debt. No kidding, zose German politicians are getting power hungry again.

Meanwhile, the Italians are being themselves as well. “For Greece, the problem is completely over,” said Romano Prodi, a former Italian prime minister. The reason this is newsworthy is that a predictor of the Argentinean debt crisis, Charles Calomiris, has stated that Italy is the next Greece in terms of debt problems – because of political corruption.

Be-ratings Agencies

Those ratings agencies are still at it. Having been beaten and humiliated by the public and the government, they are getting their own back.

The ratings agency Fitch warns of sovereign debt downgrades for the UK if plans for austerity are not outlined. If they are outlined, Fitch will realise the severity of the problem and decide to downgrade anyway.

Karma in action.

So, when will the crisis hit? When does the sovereign debt bubble burst?

After staring into a crystal ball for several moments, the answer strikes as being obvious. The sovereign debt crisis begins when people get rational again. It’s that simple.

Rationality isn’t a terribly difficult thing to get a grasp on. But irrationality is a pain in the neck for an economic forecaster. How long it can last cannot be explained, as it is by nature irrational. So you see the quagmire.

For now, my claim is to be telepathetic, not telepathic, of Mr Market’s intentions.

Tightwire to Nowhere

Regarding forecasts on economic growth, talk has again turned to the letters V U W. V being the rapid recovery that often follows recessions, U being a longer period of anaemic growth, and W being a double dip recession. Nouriel Roubini and his team at RGE have indicated they see an increased risk of the W scenario developing.

That is stating the obvious. Government has gone from being a major player in the economy to being the major player in the economy. If its institutions stuff up, the ability of the free market to correct the mistakes is now severely hampered. The problem is that governments inevitably stuff up.

They can’t even manage their own balance sheet, despite having the power of the law to play with. Now they claim to be gallantly walking a tightwire between inflation and deflation.

The managing director of the International Monetary Fund, Dominic Strauss-Kahn, explained this supposed balancing act policy makers face in their use of fiscal and monetary stimulus:

“If we exit too late … it’s a waste of resources, it’s bad policy, it’s increasing public debt, we should avoid this … But if you exit too early, then the risks are much bigger.”

Michael Pomerleano sees it very differently. Rather than bothering with a balancing act, take a look at where the economy is headed:

“Nationalisation of private debt injects considerable inefficiency into the economic system, inhibiting Schumpeter’s process of Creative Destruction that is essential in a market economy and needed to maintain the private sector.”

But what of the audience watching the spectacle? A V shaped recovery isn’t much different to a U or W if the jobs situation remains awful. One quickly gets the impression they just want to see someone plunge to their death instead of prancing around for applause.

For the “history repeats itself” buffs:

“As historical research conducted by University of Maryland economist Carmen Reinhart and Harvard University economist Kenneth Rogoff shows, financial crises are usually followed by government-debt crises. This starts as private debt is shifted onto the balance sheet of the government, through bailouts and purchases of toxic debt. The government-debt problem is then made worse as the economic downturn leads to an increase in expenditures in the form of unemployment benefits and stimulus spending, coupled with a decrease in tax revenues.”

Here in Australia, the economic outlook could not be more ominous for history fans. According to The Age, the profit outlook for SMEs is the best it has been for 2.5 years.

“Optimism among small and medium size firms about future profits is at its highest level since before the global financial crisis, a survey finds.”

“… before the GFC” are the key words. Just like in 2007, the future is based on optimism. When that turns out to be a load of rubbish, the games will begin again.

Capital Crunch

Enthusiasts of the Austrian School of Economics have mixed feelings for legendary economist Adam Smith. Nevertheless, we don’t like to think of him rolling over in his grave. He must have done so when it was decided that the 20 pound note would bear his face.

You see, Adam Smith was an investor and firm believer in Scottish Free banking. The idea that government should hold a monopoly over issuing currency would not be agreeable to him. Putting his face on a Bank of England note is like having Tony Abbott on abortion ads.

Strangely enough, the UK still has 10 note issuing Banks. People don’t seem interested in the reason. They have bigger things to worry about – like what their government has in store for “its” banks. The Telegraph reports:

“Jonathan Pierce, from Credit Suisse, believes UK banks will have to reduce the size of their balance sheets by as much as £530bn over the next three to four years to meet new regulations.

“According to his analysis, British banks need to issue £420bn-£750bn of long-term wholesale funds. “We don’t think this is plausible and hence we expect balance sheet footings to fall by 6pc-18pc to compensate,” he said.”

In a world that relies on credit to turn, somebody has to get burned if bank balance sheets really do contract that much.

House Prices Uncovered

Based on feedback, it seems property comments are fair game for the Markets and Money. So here goes.

That reputable institution, the Reserve Bank of Australia, has not informed us that house prices could rise. It has warned us that house prices could rise. Hmm, so that’s a bad thing now.

It doesn’t have to be. In a free market, an increase in house prices is a signal to builders to build more houses. Once they do, prices normalise again, as supply balances demand.

The idea that house prices can steadily rise relative to incomes is flawed. Why would one generation want to pay more as a percent of their income on housing than another?

More importantly, why would builders not build more homes as prices rise?

The answer is zoning laws, town planning and all regulations remotely similar. Yes, it’s the government again.

If you examine where house prices rise (and then plummet) the most and compare those areas to where prices remain stable relative to income, you will find a remarkable correlation to the intensity of planning and zoning laws.

This was best illustrated in the US. Areas that had the most planning experienced the biggest booms and busts because supply couldn’t adjust to demand. Areas with low planning had little problem and simply built more as demand increased. They haven’t experienced the same subsequent bust either.

Have a great weekend.

Nickolai Hubble.
Markets and Money Week in Review

Nick Hubble
Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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3 Comments on "PIGS and the Smell of Bacon"

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it’s a fallacy to assume that markets are “rational”, and that Mr. Market is always right. how do speculators clean up otherwise ? one can argue that when housing prices rise, builders build more houses to supply apparent market demand. but if people chose not to buy or can’t afford to buy, then prices drop. and builders who forgot to hedge their bets over the ever present downside risk, lose their shirts along with their investors…(check Von Mises business cycle theory, as oppose to his credit cycle theory) [ooooh! la la ]. who gives a crap about the jobs numbers.… Read more »

One major correction: PIGS = Portugal IRELAND Greece Spain. Not Italy.
In the same area of the other mediterranean countries, yes, but officially still not a Pig!


Why not Italy?

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