prudent investor newsletters: What to Expect from a Greece Moment

The economist must deal with doctrines, and not with men. It is for him to critique errant doctrine; it is not his charge to uncover the personal motives behind heterodoxy. The economist must face his opponents under the fictitious assumption that they are guided by objective considerations alone. It is irrelevant whether the advocate of a false notion acts in good or bad faith; what matters is if the stated notion is true or false. It is the charge of others to reveal corruption and enlighten the public concerning the same Ludwig von Mises, Memoirs p.40

For some, today’s Greece elections serve as the defining ‘Greece moment’ of the Euro crisis. This would seem like a paradise for the advocates of drachmaisation or the return to the local currency, drachma which enables domestic governments to inflate the system.

Yet whether Greece decides to stay within, or departs from the EU, there won’t likely be significant changes in the dominant policies espoused by policymakers in addressing this crisis.

Inflationistas have been drooling for the aggressive use of monetary inflation as the easy way out of the crisis.

The difference would be that of the policy responses by global authorities as consequence of the political choice made by Greeks.

Uncertainty from the resultant political actions will establish the feedback loop between policy responses to the market’s reaction and market’s reaction to policy responses. That’s why policymakers have incessantly talking about erecting firewalls. Spain’s recent bailout has reportedly been predicated against contagion risks[1] from today’s election.

Utopian False Choice

Inflationistas give us a proposition based on a false choice/ false dilemma[2], analyst John Mauldin[3], a populist, gives a good example

Europe is down to two choices. Either allow the eurozone to break up or go for a full fiscal union with central budget controls. The latter option ultimately means eurobonds and a central taxing authority.

If only the world have been that simple where people think alike, move and act alike and economies are mechanized that can be switched on and off or modulated like temperature gauge of an air conditioning unit. Or that people’s actions can be captured in aggregate numbers.

Yet if this is true, then we won’t be having today’s crisis at all.

As the great F.A. Hayek once warned against utopian thinking[4]

it is probably no exaggeration to say that economics developed mainly as the outcome of the investigation and refutation of successive Utopian proposals—if by ‘Utopian’ we mean proposals for the improvement of undesirable effects of the existing system, based upon a complete disregard of those forces which actually enabled it to work.

The false dilemma presented to us fails to take to account the micro conditions of what plagues the EU crisis affected nations.

This vignette of the Greece government, which has been drawn by a Greek public servant and labeled as macaroni, which I earlier posted on my blog[5], has illustrative been of the anatomy of the Europe’s crisis.

The public servant Mr. Panagiotis Karkatsoulis, who works in the Greek Ministry of Administrative Reform and e-Governance and teaches at the National School of Public Administration, has partly been accurate in the dissection of the origins of crisis, particularly, “More than 30 years of scant coordination has resulted in a morass of contradictory rules and a lack of legal clarity” and “the first government of George Papandreou in 2009 had 15 ministers, 9 vice-ministers and 21 adjunct ministers, along with 78 general or special secretaries, 1,200 counselors, 149 directorate generals and 886 directorates — this for a population of just over 11 million, or the same number of people as those living in Cuba. The resulting mesh of interdependencies for decision making has made governing Greece increasingly difficult”.

So Europe’s fundamental problems can be summarized into the following: mishmash of ambiguous, unenforceable and conflicting arbitrary rules and regulations, bloated bureaucracy, unsustainable welfare state, obscure property rights, politically restrained markets through various interventionist policies and high tax rates[6], and a public sector far larger than the private sector, which has been draining away resources from the private sector, as evidenced by Greece’s consumption economy despite relative lower nominal wages or earnings[7] compared to other developed EU nations. As a side note, the perceived or expected cost of labor has been higher in most crisis affected nations in Europe due to stringent labor regulations and bubble policies[8].

In short, Greece’s economy has survived on a parasitical relationship where unproductive sectors have essentially been draining out resources from the depleted hosts.

Devaluation, thus, will not solve the problem of SOLVENCY, PRODUCTIVITY and COMPETITIVENESS as inflation only destroys real savings and extinguishes purchasing power.

Greece’s problem has not been prompted for by rigidity in wages emanating from market forces, but from the rigidity of her incumbent POLITICAL system. Politics simply won’t allow markets to do what the market does best. And obsession to politics is the price paid through a crisis.

As previously discussed, accelerating capital flight has been spawned by the sustained barrage for the siren song of the devaluation elixir as advocated by the political order and their Keynesian protégés, most of whom ironically are residents outside these crisis affected nations.

It’s easy to make recommendations that don’t affect one’s interests or where errant endorsements don’t have a direct personal impact.

The capital flight in the crisis affected EU nations has accounted for as symptoms of savers and creditors who seek refuge out of their nations (again to preserve savings) as well as risks of a banking collapse, while debtors have practically deferred on making payments, possibly in anticipation that their debts would be best paid on a devalued currency.

Also capital controls[9] from the elevated risk of a potential exit has likely been seen as a consequential threat.

All these, including tax increases, negative interest rates, price controls, inflationism and various regulatory proscriptions, are financial repression measures undertaken by desperate governments and endorsed by their institutional apologists who seek to persecute and expropriate assets of their private sector constituents in order to sustain the privileges of the political elite.

Add to these the rising incidence of protectionism[10] which mostly emanated from developed nations, particularly the EU.

So Keynesian (and Fisherian) snake oil prescriptions has essentially backfired or produced a series of unintended consequences. Aside from capital flight, falling tax receipts (including Italy[11]) and a breakdown of trade has been intensifying the crisis[12].

Also fiscal and political union naively extends the problem of the tenuous parasitical relationship. Eventually new hosts or EU’s creditor nations as Germany, Finland, Netherland and the others will also get drained by such unproductive and unsustainable redistributive relationships.

Fund manager John Hussman makes a great analogy of mainstream’s foolish ideas which he analogizes as the “WarrenBonds”[13],

This is like 9 broke guys walking up to Warren Buffett and proposing that they all get together so each of them can issue "Warrenbonds." About 90% of the group would agree on the wisdom of that idea, and Warren would be criticized as a "holdout" to the success of the plan. You'd have 9 guys issuing press releases on their "general agreement" about the concept, and in his weaker moments, Buffett might even offer to "study" the proposal. But Buffett would never agree unless he could impose spending austerity and nearly complete authority over the budgets of those 9 guys. None of them would be willing to give up that much sovereignty, so the idea would never get off the ground. Without major steps toward fiscal union involving a substantial loss of national sovereignty, the same is true for Eurobonds.

Even if 9 broke guys accedes to give up on their sovereignty, for as long as the structural system of parasitical relationship remains, even Warren Buffett will see his resources dwindle and will go bankrupt.

In short, all sorts of proposed and implemented bailout mechanisms—banking union, Eurobonds, EU regional deposit guarantee schemes, European Stability Mechanism and or the European Financial Stability Fund (“EFSF”), Securities Markets Programme (SMP), Long Term Refinancing Operations (LTRO) and Target2—are essentially transfers of resources from productive to unproductive nations, which ensures capital consumption and the eventual demise of the Union.

Of course what exponents of inflationism via devaluation don’t see or refuses to see are that there are other practical market based options such as outright default or restructuring and ‘shock liberalization’[14] as coined by University of Chicago Professor John Cochrane, viz., liberalize economy, allow banks to fail, reduce government spending (by cutting down the bureaucracy and repealing unnecessary regulations), reduce tax rates and sell state assets or privatization.

Whatever the outcome of today’s election, the crisis will continue to linger and will most likely fester for as long as solvency, productivity and competitiveness issues will not addressed by giving the private sector a bigger hand.

Exploring the Greece Moment

A Greece vote to stay within the EU will likely have concerted efforts by the European Central Bank (ECB) to reflate the system backed by some superficial ‘austerity’ policies. This will be another attempt to delay the day of reckoning.

This will likely another incite short term upswing for the markets but eventually will wear off, as with all the rest.

In short, boom bust cycles until the grand finale: defaults either by massive inflation (which likely brings the end of the euro experiment) or by outright default (disunion may or may not happen).

A Greece vote out of the EU to may spell interim trouble for the global markets, but this would likely prompt central banks to collaborate by massively inflating the system. So volatility can swing fiercely from downside to upside and vice versa, depending on how large these actions will be.

I would make another guess. Under the conditions where global central banks steps on the proverbial pedal to the metal, the RISK ON RISK OFF environment will probably transition to a stagflationary environment[15] (slow economic growth, high unemployment but also high consumer price inflation).

Again this will be conditional or mainly dependent on the scale or degree of actions which is something cannot be foreseen. I have to admit I don’t have telephatic powers that would allow me to read the minds of central bankers.

Yet under a stagflationary setting, market’s attention may likely be focused on commodities as inflation hedges.

And that’s where I’d be.

[1] Bloomberg.com Euro Bloc Faces Greek Vote Giving First Spanish Test, June 11, 2012

[2] Wikipedia.org False dilemma

[3] Mauldin John MAULDIN: The 'Bang!' Moment Is Here Businessinsider.com, June 16, 2012

[4] Hayek Friedrich von Four History And Politics The Trend Of Economic Thinking p.15 libertarianismo.org

[5] See Chart of the Day: Greece’s ‘Macaroni’ Bureaucracy, June 15, 2012

[6] Wikipedia.org Tax rates of Europe

[7] Eurostat Wages and labour costs European Commission

[8] See Germany’s Competitive Advantage over Spain: Freer Labor Markets May 25, 2012

[9] See The Coming Age of Capital Controls? June 13, 2012

[10] See More Wall of Worry: Rising Accounts of Protectionism June 15, 2012