THE BEAR'S LAIR After Greece, a new world
By Martin Hutchinson
Greece's near default and rescue by the European Union has brought one reality
starkly into relief: in an age of fiscal and monetary stimulus: it isn't only
banks that can give debt investors sleepless nights. Greece is no more
"risk-free" than was Lehman Brothers, and indeed Britain is no more "risk free"
than Merrill Lynch. The implications of this for the global economy are
disturbing, but not all negative.
The principal implication is that the differentials in borrowing costs between
countries, which had been suppressed since US monetary inflationism began in
1995, are about to reappear. This is not entirely a bad thing. Excessively low
bond yields had led
investors to chase higher returns through pushing out to less and less
creditworthy countries.
In a few cases, such as Vietnam, this jump-started economic growth and put the
country on the road to prosperity at rate faster than could have been achieved
in a more balanced economic system.
In more cases, however, such as Greece, but also including notably Argentina,
Kazakhstan and Russia, it allowed incompetent and unpleasant regimes to get
away with plundering their middle classes and redistributing the wealth to
themselves for much longer than should have been possible. Thus an increase in
country risk differentials is generally to be welcomed.
The country risk differentials that are now bound to reappear will however be
different from those that governed in the middle 1990s. Many Asian countries,
which in the period after the Asian crisis of 1997 paid premiums to borrow
because of their poverty or high capital needs, will find money readily
available this time around. South Korea, which should never have got into
trouble even then, will find its ability to borrow little affected by the new
tightening, as it has not engaged in major "fiscal stimulus" nor run an
excessively accommodating monetary policy.
At a lower income level, there is also no reason why Indonesia should find its
access to capital significantly affected. It has substantially reformed both
its economy and its political system since the crash of 1998 and in the 2009
crisis pursued well thought out, conservative policies. The risk of investment
in Indonesia is still significant because of the corruption remaining in the
country, but it remains an attractive diversification for investors seeking
higher long term growth in emerging markets without putting all their eggs in
breakable BRIC (Brazil, Russia, India and China) baskets.
One emerging market that should continue to prosper generally but may find life
difficult for a while is Vietnam. The country is generally economically well
run, but it had a colossal balance of payments deficit in 2007-08 as its
exchange rate was pushed up by a wave of foreign investment, both in hard
assets and "hot money". It will thus suffer short-term as the flow of
risk-seeking capital lessens and risk premiums widen. However, the progress
Vietnam has made and its undoubted cost advantages, together with its healthy
level of domestic capital formation, should allow it to continue to prosper in
the long run, albeit with a higher (and healthier) domestic proportion of
capital in its growing industries.
The principle losers from tightening credit markets will be the rich countries
that have deliberately put themselves on a path to bankruptcy, even if delayed
bankruptcy, under the impression that this would in some magical way lessen the
impact of the 2008-09 recession.
The more artificial "stimulus" they indulged in, the greater the economic price
they will have to pay. Countries like Britain, the United States and Japan that
were like Greece already grossly over-indulging their public sectors before
2007 will be in the greatest danger. Naturally, the effect will be different,
because all three countries have independent currencies. Their chance of
default - at least in the short term - is less than Greece's but their
likelihood of prolonged and debilitating recession is equally high.
The likely increase of risk premiums for wealthy countries that have unbalanced
their fiscal positions will not simply be reflected in higher borrowing costs
for their governments. That would be poetic justice, and would affect few
inhabitants of those countries, except in the very long term as debts piled up.
However, as well as their governments, the costs of borrowing will rise for
private businesses based in those countries, and their availability of finance
will diminish.
We have already seen this effect in Japan as the foolish Taro Aso and Yukio
Hatoyama governments reversed the sound policies of Junichiro Koizumi and
pointed the Japanese public sector towards more unsustainable "stimulus".
Unlike in other countries, the huge budget deficits in Japan have caused a
collapse in domestic prices, genuine deflation, so real government long-term
bond rates, including the reduction in prices, have increased by more than 4%
since the autumn of 2008.
Japan has moved from being one of the world's finest credits and soundest
economies, because of its citizens' hard work, excellent education and savings
habits, to an oversized Greece, with a debt position that has become
unsustainable and a private sector that is being starved of finance.
As I wrote last week, the damage from "stimulus" has also begun to appear in
the United States, where the excessive issuance of Treasury bonds and
government guaranteed housing bonds has made bankers put their feet up on the
desk, collect the large leveraged returns for risk-free and brain-free
investment in those securities, and abandon the small business sector to an
unpleasant fate.
In a world of higher funding cost differentials, the fortunes of the BRIC
countries will diverge. China, although engaging in "stimulus", did so from the
basis of a very sound fiscal position and with low foreign debt. It is thus in
no immediate danger of government default. It is currently struggling with a
real estate bubble that is in the process of bursting, and it has the problem
of a banking system much of whose assets are bad. However, China's leadership
has an unexpectedly good grasp of even the more complex areas of economics - as
evidenced by its decision to raise reserve requirements in its banking system
to cool its real estate bubble.
This is in contrast to Federal Reserve chairman Ben Bernanke's "trial balloon"
of abolishing minimum reserves altogether - he appears to have missed the point
that fractional reserve banking is unsustainable, bound to crash in ruin, and
lead to hyperinflation, if you make the denominator of the fraction zero and
money creation thereby infinite.
India on the other hand is largely a much larger version of Greece - highly
corrupt and with a public sector devoted almost entirely to rent seeking. The
Indian electorate's foolish decision last May to re-elect the Congress party,
creators of this ghastly system, will reap its reward in the relatively short
run. As India's consolidated fiscal deficit of 12% of gross domestic product
and relatively low savings rate collapse the economy once again into a
financial crisis similar to those that limited it to the "Hindu rate of growth"
for 40 years from independence. Needless to say, the splendid Indian private
sector, which had finally allowed 1.2 billion people to see the possibility of
better living standards, will be the worst sufferers from this disaster.
Russia and Brazil are less interesting. Russia will do fine while commodities
prices are high, but the inevitable growth slowdown that increasing risk
premiums will produce will destabilize Russia's economic position, probably
producing another default like that of 1998.
Brazil, which a decade ago would have been a major sufferer from an increase in
global spreads, has greatly improved its position. Its exceptionally sound
monetary policy has kept real interest rates high, prevented excessive domestic
consumption, government or private, and built the country's domestic savings
base. At this point, Brazil could probably do with a change in government, to
ensure that property rights are not eroded and public spending remains under
control, so that the bonanza from high commodity prices is not wasted.
As for the eurozone, most directly affected by Greece's problems, its likely
fate is no worse than elsewhere, since a number of its members, notably the
soundly run Germany, did not engage in "stimulus", indeed denouncing it as the
"crass Keynesianism" that it was. Its fate from here on depends on how
effectively it forces Greece to behave itself, sharply downsize its corrupt and
bloated public sector, collect taxes from its citizens and right its fiscal
ship.
If EU discipline reminds older Greeks of the Nazi occupation, with thuggish
all-powerful sadists with monocles and black leather uniforms forcing the
locals to clean up all the corruption rackets that they have enjoyed for
decades, all will be well. In that case, news of the horrors afflicting Athens
would spread to Portugal, Spain, Italy and Ireland, forcing them towards
unpleasant reform on their own for fear of the same scourge arriving in their
own countries.
If, on the other hand, the bailout resembles most European Union operations,
with polyglot socialist bureaucrats drafting 1,000-page reports while deceiving
themselves as to the theft that is going on under their very noses, then the
eurozone is in real trouble. In the latter case, in spite of the common sense
exhibited by Germans and Scandinavians, the EU will dissolve into an orgy of
rent-seeking, probably collapsing completely when the much larger Spain, Italy
and Britain demand access to the bailout gravy train. (Britain would presumably
be refused, thus causing both economic collapse and a large wave of anti-EU
sentiment, forcing the country to leave the EU and seek its fortune elsewhere;
out of evil can come good!)
The Greek crisis appears to have pushed us into a new world. On the whole, this
is a good thing.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-10 David W Tice & Associates.)
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