Do The World A Favor And Let Greece Default

It's a movie we have seen before and are likely to see again unless certain things happen. A year or so ago some praised the first Creek bailout and declared an end to the European financial crisis. But there was one thing I could not comprehend back then about this end-all solution. How do you solve someone's inability to pay off his existing debt by piling on more loans without a significant increase in that individual's earnings? While austerity measures can be effective in certain situations this was not, and is not, the case here. Politicians do not solve problems, they just paper over them. They are fully aware of the causes and the solutions but intelligent enough to offer illusionary fixes that guarantee their re-election.

Capitalism is the best and most efficient economic system mankind has ever seen but only if allowed to function based on the principles of free market with minimal government interference. That means risk is rewarded and failure is punished. Not risk distorted and failure not allowed by government interference. Yet this is exactly what has been happening in the U.S, Europe, Asia and elsewhere, and people wonder why the world still can't shake off the consequences of the 2008 financial crisis.

By not letting Greece default the first time around (a nicer way to say it is to let them restructure their debt) the problem was magnified. This is how. Back then the ECB lowered its standards for the quality of collateral it would accept against lending European banks money to keep them afloat, including Greek banks. But since Greek banks could not raise money in the bond market they issued bonds with the Greek Central Bank guarantee and turned these over to the ECB for cash. On top of that billions from the IMF allowed Greece to pay off the interest due and retire its maturing debt. But two things were missing from this solution. First, the hope was that the world economies would recover and together with the austerity measures implemented (or not) then would allow Greece to generate enough revenue to service its debt and find its way back to prosperity. This hope did not pan out and we ended with Greece still in the same situation it was in a year ago but with much more debt added to its books. The second, and more important missing part, is that the bailout did not involve a restructuring of the debt that would have caused private bondholders, including other European banks, to lose portion of their investments therefore putting Greece in a much better situation able to service the now much smaller debt load. This is the distortion part by not allowing failure. So the result is that a year later we have a world economy that at best is not getting worse and a country with more debt and less means.

I am very careful here to advocate a market lead restructuring and not a government forced one. You see one of the main principles of capitalism is that a set of understood laws be allowed to govern private business transactions free of government interference. Otherwise, lenders in the future will be very hesitant to help finance the world economies.

For the Greek bailout to be effective the European governments and the ECB should make it very clear that they would step in to help only after the private bondholders, including European banks, have negotiated a restructuring of the debt. I understand that many of these bondholders are European banks, even the ECB itself. But this would send a very powerful message to the private sector that government is not going to step all over laws that allow for a clear way to determine and price risk. The pain will be severe if this action is taken, banks would have to be recapitalized, standard of living will have to come down for many years but at the end there is going to be a bright prospect for all. The alternative is the same severe pain extended many years out and another visit of the Greek debt a year or two from now. Yes this action may cause a recession in the short run but as long as the restructuring shaves enough off the overall debt, together with the austerity measures, Greece will be just fine albeit with a lower standard of living. After all who says I am entitled to live the high life with my neighbor's wealth? This solution is a bold one that many governments may not be willing to endorse. However, it is the best and most fair for it punishes those who took the risk and lost, both the lenders and the borrowers in this case, while preserving and re-enforcing the foundation of capitalism. So please do us all a favor, make us suffer, take away our luxuries and let's get on with the healing process. Is there a better feeling than the feeling of not having debt? isn't a mind free of worries indeed a luxurious one?.

On a different note I have been watching China very carefully over the past couple of years. My thoughts, for the most part, have not been positive. But two fairly recent events have reconfirmed my belief about China and have given rise to an alternative investment vehicle to the factory of the world. First, news abound in the last few weeks about unrest in several Chinese cities and provinces (to include a car bomb) whereby the state had to deploy thousands of security/military personnel to ensure these demonstrations don't spread or become acute. Simply put the have not (the vast majority of the Chinese) are protesting inflation and the lack of jobs. Second, closely related to this rise in inflation is the skyrocketing wage increase for Chinese labor. Combine that with an appreciating Yuan (perhaps even as a desire to make it an international currency) which will make Chinese imports cheaper but Chinese exports more expensive and you can see why multinationals will be looking for alternatives. One country that comes to mind is Vietnam (more on that in a later post).

Contact information: gnasr59@yahoo.com