Thursday, May 20, 2010

How To Turn a Big Problem into a Huge Problem

The European bailout will not work. It simply doubles down on a bad bet. Greece is broke. They should restructure their debt with their creditors (in other words, take bankruptcy and start over). That probably is the direction that Spain, Italy, Portugal and the UK will be forced to take at some later date. There is not any real way to avoid it.

Contrary to popular opinion, the bailouts in the US in the Fall of 2008 exacerbated the woes of the financial sector. Had we simply restructured Fannie and Freddie and AIG, the worst would have been over by early 2009 and we could have embarked on recovery without the debt and bad asset overhang. Of course, Obama's policies likely would have retarded any recovery, but we would have gotten much of the financial service debt problems out of the way. Now, they are still there and Fed has a bloated balance sheet that it has no idea how to reduce. Meanwhile, Bernanke and Obama are urging the ECB to take the same disastrous route that the US took.

Does anyone seriously think that US is doing okay? Does this recovery look like anything we have seen since World War II? The combination of erratic and foolish policies in the Fall of 2008 and Obama's growth killing initiatives have put the US in stagnation mode. Now they want to do the same for Europe.

Much of Europe needs to take bankruptcy, including very likely France and Germany. Yes, they are in terrible shape because of their commercial banking systems, especially France. All of Europe needs to dismantle the welfare system.

The welfare system is numerically impossible to fund. It seemed to work for a long time because of the accident of demography. As countries grew younger, then it seemed to work. Same with health care. But as populations age, it just won't work. The numbers don't add up. Health care costs arise mostly in the elderly population. Retirement costs are exclusively in the elderly population. The elderly population is the fastest growing part of the population. Who is left to support this group? The answer: a dwindling number of folks, many of whom work in the public sector where the work ethic and output is suspicious to say the least. Someone has to produce real output to support all of this.

Germany and France are just whistling dixie through the graveyard. Merkel and Sarcozy are becoming psychotic and paranoic. They see evil speculators in every corner If only, they think to themselves, people would see how wonderful the Euro is and how wonderful our way of life is, they would support the Euro.

But, investors aren't interested in supporting anyone's way of life. They are interested in a return on investment. Buying European sovereign debt is a fool's game and will end up in massive losses. You cannot fool markets forever.

Merkel and Sarcozy will get overwhelmed by an electorate that sees clearly what Merkel and Sarcozy cannot see -- Greece is going to go bankrupt regardless of European policies. There is no way out. The only impact of Merkel and Sarcozy it to take Germany and France down too. The citizens of Germany are right.

Greece is spending money it doesn't have. It will continue to do that after the so-called austerity program is put in place. What then? By then the German bund will begin to look like a house of cards. That is where this is headed. The best thing the US can do is avoid ownership of any European sovereign debt. Of course, Bernanke and Obama are planning to enlarge swap lines, which, in effect commits the Federal Reserve to ownership of European sovereign debt by the bucketloads. Any dollar/euro swap is by definition a swap of the government debt of the US for government debt of the Eurozone.

So, after Germany and France collapse, we will be next.

Had they simply let Greece restructure that would have put some French and German banks in a pickle. The German and French banks that failed could be nationalized and then everyone could move on and economic recovery could take place in Europe. Not now. Europe will now join the US in the economic quagmire.