Tuesday, 16 February 2010

Pigs and other disasters

John Mangun
Outside the Box

Here I go again, talking about subjects that you need to know about but which are ignored in the local press and media. It is a thankless job and nobody really cares, but somebody has to do it.

“Pigs” stands for Portugal, Ireland/Italy, Greece and Spain. The farm-animal pig has a bad reputation, probably undeserved, for being lazy, sloppy, messy, eating everything it can while producing very little. The European Pigs have the same reputation and they most certainly deserve it.

The euro zone and the euro currency were created back in the good old days of economic prosperity as a way to compete with the United States and, to a lesser extent, China. The Europeans figured that if they formed one economic union larger than the US, they could export and import much more effectively. But in order to form this union they had to have a single currency along with complete free trade across their borders.

The free-trade idea would not have worked if there were multiple currencies with different exchange rates. The problem with this union is sort of like inviting all of your “economically disadvantaged” relatives to live with you. The richer nations such as Germany and France had to help the poorer nations. It worked sort of well as long as the rich are still making enough money to support the poor.

Meanwhile, countries like Greece (just like poor relatives) believed that they could do whatever they wanted to economically because there was always the rich relative nations standing by to help them out and give them a few bucks whenever they need it. And if you have ever been feeding a live-in relative while they have been visiting the 5/6 man too often, you will understand the current situation.

In 2009, Greece owed an amount equal to 108 percent of gross domestic product, and its budget deficit is about 12 percent of its GDP. Euro zone rules say a country cannot have a budget deficit-to-GDP ratio of more than 3 percent, but poorer relatives do not always follow the rules. Plus, you know how hard it is to kick people out of your house once they move in.

Now, Greece cannot pay creditors and it is running to France and Germany for a bailout. Problem is that the German people are not happy with having to put a few billion of their own money for Greece. The problem with Greece is that it does not do very much economically. It manufactures very little for the world markets and consumes much more than it produces. Oh, and its birth-rate growth is about 1.3 percent, so there are a lot of old Greeks in comparison to the total population that produce nothing.

So now, the rich Europeans do not want to pay the bills that Greece has piled up, but Greece is still a part of the euro. The easy answer might be to just kick Greece out, but then, that might mean kicking Italy, with a debt-to-GDP of 115 percent, and Portugal out, too. That would sort of make the euro zone a silly joke and the debt problems of these countries would still not be solved. For example, US banks are owed well over $100 billion and if they lose, that could create a major problem in the US banking system. The debt exposure of the European banks is even greater.

Either way, the currency-trader sharks smell blood in the water and they are circling right now, taking big chunks out of the value of the euro. If the euro system fails, they will come after all of these smaller currencies one by one and we will see a larger global financial disaster. If Germany and France do not bail out Greece, all the weak euro currencies will fall in order and you will see a general collapse of confidence in paper money unseen since post-World War I.

Last week also almost saw the financial apocalypse in the US. A relatively small $16-billion Treasury auction nearly failed. The US must borrow large amounts on a regular basis or it will default on its loans.

By fail, I mean that it appeared that no one wanted to loan money to the US at a low interest rate. The US cannot afford to have interest rates go higher, or that economy will go from serious-but-stable into the ICU and “critical” condition.

The interest rate the US government had to pay was 4.72 percent, instead of an expected 4.687 percent. That is not good. But here is where the “failure” part comes in. Foreign and what is called “indirect” (meaning non-US government entities) participation in the auction was only 28 percent, instead of the average of 41 percent. Something is very wrong when the US government, supposedly the safest debt on the planet, has problems getting others to buy it.

It would be sort of like this. The Philippine government wants to borrow money and the only institutions that are willing to loan to it are the Social Security System, Government Service Insurance System and Pag-IBIG. When the last person on earth that will loan you money is your spouse, you are in deep financial trouble.

Watch the situation in Greece carefully because the ramifications are global and very serious. Two scenarios are unfolding and they are both worst-case. One is that the euro zone bails out Greece and then Italy, Spain, Portugal and on and on. The only way the euro zone can do this is by printing euros, which will lead to very high inflation.

The other choice is to effectively break up the euro, which leaves these other countries to the financial wolves and that will send a shockwave through the financial markets that will make 1997 and 2009 seem tame.

You need to keep your money right here at home in pesos and in Philippine banks and in Philippine companies through the local stock market. Anyone who believes that this current global financial situation is not critical and serious probably also thought that typhoon Ondoy was going to be a rainshower.

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