Depression in Europe?

There seems to be growing optimism in the United States that the economic recovery is picking up steam.  This is all fine and good, but I still believe that the major potential bump in the road for the United States is the economic and financial situation in Europe. (See my post of January 4, http://seekingalpha.com/article/317268-issue-number-1-for-2012-recession-in-europe.)

Now we have the new austerity program passed by the Greek parliament and the unrest in the streets of Greece protesting the austerity program.

But, the new austerity program, at this point, does not end the concern over whether or not this new plan will be sufficient to end the Greek insolvency.

Greece is insolvent.

With the government’s new austerity program, however, Greece will get a new financial bailout.  The question now becomes: will this new bailout program buy Greece enough time to get its ship in shape so that it can work its way out of its insolvency?

Some think not.  For example, Wolfgang Münchau writes in the Financial Times, “My central expectation is that the program will happen.  A period of calm will set in, but after a few months it will become clear the cuts in Greek wages and pensions have worsened the depression…. Before long, another round of haircuts will be beckoning.” (This from the article “Why Greece and Portugal ought to go bankrupt,” http://www.ft.com/intl/cms/s/0/57485f60-540a-11e1-8d12-00144feabdc0.html#axzz1mGnbTALH.) 

There is another problem on the horizon, however, and that is the fact that a new Greek government will be be elected in April.  The expected winner at this time is Antonis Samaras.  The question is, what will this new government do after it assumes power?

Münchau argues: “I cannot see how this (the bailout) is going to work politically.  For a new prime minister who contemplates a full term of four years, the temptation to pull the plug and blame the mess on his predecessors must be big. He will then have four years to rebuild the country from the rubble of a eurozone exit.  It would be politically much riskier for him to stick to a program that he himself says does not work, and which will keep his country in a depression for the length of his mandate—possibly beyond.” 

And this is exactly the dilemma a “turnaround” leader faces…do I struggle along with the things that were left me…or, do I clean house and start with as clean a slate as possible.

I have successfully completed three corporate turnarounds and to me there is no choice.  The nice thing about being brought in to turnaround an organization is that you have a certain time period to blame everything on the previous management and clean house.  If you don’t do the house cleaning right up front, however, you lose most of your leverage to change things.  The decision is not difficult: you start with as clean a slate as possible.  In the case of Greece, then, declare bankruptcy

Greece is insolvent.  “To rebuild itself, Greece needs a functioning economic infrastructure, a modern labor market, and a less tribal political system.”  It also needs less corruption throughout its culture. 

This is not the only set of problems that Greece…and Europe…faces.  New data on the economies of Europe coming out this week are expected to be rather dismal.  The forecasts for the fourth quarter GDP of the eurozone run from a 0.4 percent to a 0.6 percent contraction.  These figures include the fact that even Germany seems to be in a decline.  Industrial production figures for December are also to be released this week and some analysts see a decline in this measure of more than one percent. (http://www.ft.com/intl/cms/s/0/f9558702-53e1-11e1-bacb-00144feabdc0.html#axzz1mGnbTALH) 

There is some feeling that the first quarter of 2012 may find growth in positive numbers, but not by much.  Germany and others may experience some kind of recovery then, but the southern peripheral countries are not expected to start growing again for some time.  And, with unemployment in excess of twenty percent in some of these countries and continued government austerity, 2012 prospects remain quite gloomy. 

The next question, though, is where the pressure will be applied next.  Münchau contends that Portugal is also bankrupt and should follow Greece in declaring bankruptcy.  Will the international investors now turn their attention to Portugal?  I wouldn’t be surprised. 

Countries…businesses…individuals…do not resolve their financial difficulties until they resolve them.  Continued bailouts only tend to postpone a final solution.  They very seldom correct the insolvency that is causing the problem. 

European Defaults: Portugal is Next After Greece

It ain’t over until it’s over…

The yield on the 10-year Portuguese government bond closed above 14.80 percent yesterday, a new record for the euro-era. 

“The markets are pricing in a Portuguese default with 10-year bonds trading at about 50 percent of par, a deeply distressed level in the eyes of many investors.” (http://www.ft.com/intl/cms/s/0/49916f7a-468a-11e1-89a8-00144feabdc0.html#axzz1kTbnc8Yy)

“Friday the 13^th may be an unlucky omen for Portugal.  On that day, almost two weeks ago, Standard & Poor’s became the last rating agency to downgrade Lisbon to junk, marking the moment for many investors when default looked inevitable for Portugal as well as Greece.” 

For more on this see my post on blogspot “Credit Downgrades and Europe” for January 16, 2012. (http://maseportfolio.blogspot.com/).

The downward spiral in defaults will continue as long as Europe fails to honestly face its problems. (See my post on blogspot for January 25, 2012 titled “How Long Will Europe Continue to Lie to Itself”: http://maseportfolio.blogspot.com/.)  

In the past, analysts, including myself, tried to explain what officials in Europe were doing by casually remarking that their actions amounted to “kicking the can down the road.”  Basically, the actions of the European officials were an effort to postpone dealing with the real issues, hoping that by delaying what was needed to be done the situation would eventually correct itself.

Now, it seems that the days of “kicking the can down the road” are reaching a climax. 

European officials hope to reach a deal on the Greek debt situation by the end of this month.  The current write down seems to be somewhere around 50 percent of face value, but there still remain issues to be decided like whether or not the European Central Bank will have to write down the Greek debt it has on its books. 

Bond markets have responded to this reality by dumping Portuguese debt.  Note that the yield on the ten-year government bond was about 10.40 percent (compared with 14.80 percent yesterday) around the middle of November, a time when it still seemed that maybe the European Union might be able to pull things together and avoid a Greek default. 

As the officials of Europe finally seriously travelled down the path to restructure Greed debt, the price of Portuguese debt started to weaken.  The price declines accelerated, as the possibility of a Greek write-down became more of a reality.  Today, the yield on the 10-year bond was around 15.00 percent.

I know that governmental officials hate to give in on these write-downs because they hate to concede to the “bond markets” and “speculators”. 

It is hard for governmental officials to admit that maybe the “bond markets” and the “speculators” might be right. 

It is a very difficult lesson for governmental officials to accept the fact that they cannot continue to cater to their constituencies with jobs and other benefits ad infinitum.  Over the longer-run, either taxes have to be raised or money has to be printed because the bond markets will not continue to underwrite debt that will be repaid, both principal and interest, by the issuance of more debt.

The economist Hy Minsky referred to this kind of debt financing as a “Ponzi” scheme.

 “Ponzi” schemes come to an end and the end cannot just be blamed on the “bond markets’ and the “speculators”.  In fact, the governments just line the pockets of the “bond markets” and the “speculators” by extending their uncontrolled spending until the collapse of the market becomes a “sure thing.” 

So the charade continues and Portugal seems to be next. 

Who will follow Portugal?  Spain…or Italy…who knows?

Yet, this is not the only concern that many of these officials are facing.  The austerity programs enacted by governments throughout Europe are not setting well with the people.  There is “discontent” and “upheaval” arising in many countries.

“The only consistent messages seem to be that leaders around the world are failing to deliver on their citizens’ expectations and that Facebook, Twitter, and other social media tools allow crowds to coalesce at will to let them know it.  That is not a comforting picture for the 40 heads of state  or leaders of governments who are attending the World Economic Forum (in Davos, Switzerland)…”  (http://www.nytimes.com/2012/01/26/world/europe/across-the-world-leaders-brace-for-discontent-and-upheaval.html?_r=1&scp=1&sq=across%20the%20world,%20leaders%20brace%20for%20discontent%20and%20upheaval&st=cse)

The situation is quite uncomfortable.  But this is what happens when you fail to deal with a problem…when you continually try to “kick the can down the road.”  The situation does not go away and the delay in dealing with the situation often turns out messier than if the situation had been dealt with earlier. 

The only way for the officials to resolve a condition like this is to get in front of it.  I don’t see anyone around in a position to do this.  The only real possibility is Merkel but the resentment that already exists against Germany makes it that much more difficult for her to achieve what is needed. 

If no leader arises then the defaults will continue…and the austerity will grow…as will the “discontent” and the “upheaval.” 

“Europe risks being handicapped if it doesn’t deal decisively with this challenge to democracy.”  Thought provoking way to end the New York Times article.