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The Daily Reckoning | Friday, May 20, 2011
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The Likelihood of Default A Glimpse into the Future of the Sovereign Debt Crisis
Reporting from Laguna Beach, California...
Eric Fry
The canary in the coal mine is choking...
Greek stocks tumbled to new 14-year lows this morning, as Greek bond yields rocketed to new all-time highs.
The panic in Athens is no surprise, as we explained in yesterday's Daily Reckoning. The Greeks are bankrupt.
The Greeks have been bankrupt for a while, of course, but investors were slow to believe it. Or rather, investors were quick to believe that last year's €110 billion bailout from the European Union and the IMF would be sufficient to prevent the Greeks from defaulting.
But with each passing day, that bailout package is looking increasingly insufficient. You can't make a silk purse out of a sow's ear, as the saying goes. And the finances of the Greek government are emitting a distinctly porcine aroma. They are a mess, plain and simple.
To continue our metaphor, bailouts from the EU and IMF cannot remediate the pigpen; they merely spritz a little perfume on the pig.
The only legitimate solutions to the Greek debt crisis will require both painful adjustments in Greece and punishing losses for bondholders. That's called default.
After default, the borrower walks away stigmatized, the lender limps away chastened. Both sides walk away with less than they had at the outset of their relationship. Both sides suffer. But, importantly, default clears the way for new growth. Because default recognizes all losses, while simultaneously pricing assets to real-world values, new investors can enter the fray to initiate a new cycle of investment and (hopefully) capital formation.
To be clear, your editor does not think Greeks are pigs. Greeks are Greeks. Americans are pigs. The distress we are witnessing in Greece is merely the prelude to the distress that could arrive on our shores. 
The AAA American balance sheet is not so different from the junk-rated Greek balance sheet. The biggest difference between these two sovereign credits is that the former can print as many dollars as it wishes, the latter cannot print any euros whatsoever. A printing press greatly facilitates debt repayment. The Greeks should get one.
But since the Greeks can't print euros, and are incapable of raising taxes significantly or cutting spending significantly, a default seems the likeliest outcome. A Greek default would not be the end of the world, but it might be the end of something...like the Welfare State "business model."
Greece is not the only bankrupt European nation; it is not the only country that promises too much to its citizenry, while receiving too little in terms of tax receipts. In fact, Greece has lots of company...from Portugal to Ireland to Spain to - dare we say - America.
To borrow and distort a famous phrase from Milton Friedman, "We are all bankrupt socialists now."
Thus, the birthplace of the Western World may well become the graveyard of the Western Welfare State. But this funeral procession will take some time. In fact, it might even feel as pleasant as a Fourth of July parade...for a while. Many doomed bonds will rally...for a while, many infirm currencies will increase in value...for a while, while many "safe haven" assets like gold and silver will fall...for a while.
But these delusional, counter-trend-episodes will not last.
Recent trading action during the month of May illustrates the point. During the last several months, as the US dollar's value was steadily declining, commodities and "hard asset" currencies produced sizeable returns. The Reuters/Jefferies CRB Index of Commodity Prices advanced more than 30% during the 12 months ending April 30 of this year. Gold and crude oil advanced similar amounts, as many of the grains jumped more than 50% and silver rocketed more than 100%.
But during the month of May, the greenback has staged its first meaningful advance in months, which has triggered corrections in most of the commodity markets. The greenback's advance - a mere 3.6% for May-to-date - would not been that meaningful, except for the fact that it has been falling for months on end.
So the dollar's rally provides a handy excuse to dump commodities...for a while. The dollar may continue to rally for a while longer, perhaps several more weeks. In which case the precious metals and other commodities might continue floundering for several more weeks.
But gold and silver remain a strong "Buy," mostly because the Welfare State's finances remain a strong "Sell." External Advertisement
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Get this special offer today!The Daily Reckoning Presents Storm Warning! Part II
An Interview with Addison Wiggin by Chris Martenson"Your predictions have become soundly validated, yet that means the dire outcome you feared is arriving," Chris Martenson remarked in a recent Q&A with Addison Wiggin. "What's it like for you to be at this time in history?"
Addison answered that question - along with many others - in yesterday's edition of The Daily Reckoning. Today's edition features additional insights from Addison in the second and final installment of his Q&A with Chris Martenson.
Addison Wiggin: When you look at monetary history - or even the history of empires as we did in Empire of Debt - every 50, 60, 70 years there's a major shift in the reserve currency of the world, in the dominant financial structure of the world, and we're coming up on that now...
So I've been suggesting for a long time, and I still think it's true, that whatever's going to happen next, it's not going to happen without even a higher degree of uncertainty than what we've seen over the last couple years. And the little skirmishes that we have going on in the Middle East and the two "hot wars" that we're involved with in Iraq and Afghanistan, I think they're just precursors to something bigger, which will accompany a shift from the US as the dominant financial player in the world to something else, which will likely be some kind of sharing of financial structures with China, and possibly India.
And it's probably going to get a lot uglier before we get to anything that resembles peacetime and normalcy.
Chris Martenson: So we have a period of adjustment, somewhere between here and there, we're going to see some sort of a falloff in living standards, I would guess, if we hold the view that the United States and other advanced economies have essentially been living beyond their means. That means that they have to live below their means for a period of time, and that's where you see disruption, volatility. Is that fair?
Addison Wiggin: Yeah, I think that's fair, and I do think a reduction in our expectations of our standard of living is inevitable...People have grown to expect things that even a generation ago just wouldn't even be considered possible. But those credit cards are starting to run out. So I think we can expect a downward revision of expectations...
Chris Martenson: Many people choose to look at that message and say, "Oh, that's unpleasant." But it just happens to be reality to me. With change, there's always crisis, but there's always opportunity, lots of opportunities out there... When I look at the future I say, "Oh, here's what we're going to stop doing; here's what we're going to have to start doing; here's what we'll continue doing." Getting the big sweeps of [these trends] correct, I think, is the best thing to do...
Addison Wiggin: Right, and one of the central tenants of the Agora Financial strategy is that while we identify a lot of the problems that are arising - mass approach to government, mass approach to the auto industry, and other artifacts of the 20th Century - we also identify the resulting opportunities... In a way it's a positive thing that some of these massive, archaic government structures are crumbling and meeting their demise, because that allows for people to become more nimble, and take advantage of opportunities that would otherwise be swallowed up.
Chris Martenson: Oh, I completely agree. I've heard you're working on another documentary set for release later this year. Does any of this tie in, and can you tell us a little about it?
Addison Wiggin: It does. It ties in, absolutely ties in, because as we were making our documentary, I.O.U.S.A., I kept hearing this mantra, "We're going to grow our way out of this," as if there was a one-size- fits-all solution to the fiscal problem... I kept hearing that phrase and it just made me think, "Well who are going to be the people that help us grow our way out of this?" Predominantly, that's entrepreneurs. Most job creation, most new ideas, most innovation comes from entrepreneurs who are willing to take a risk with their own time, with their own money...
So I wanted to look and see what entrepreneurs were thinking and doing in the post-crisis time, 2008 to 2009. And for a case study, I'm using this company called Odyssey Marine that looks for gold at the bottom of the ocean. I like the metaphor of Greg Stam and his crew going out into the ocean, and using very sophisticated technology that they had to develop themselves, looking for gold at the bottom of the ocean in these shipwrecks. They have to have historians and oceanographers and people that understand how tides work and it's a very sophisticated enterprise.
And in 2007 they found $500 million worth of silver and gold coins at the bottom of the ocean off the coast of Gibraltar. They were immediately arrested by the Spanish government, hauled into Gibraltar, and now even to this day in court trying to [keep what they found]... They've been tied up all this time and in all these kinds of political shenanigans. So to me, the story of Odyssey Marine is a good metaphor for the types of challenges that entrepreneurs across the economy have faced since the housing bubble collapsed and everybody has realized that house prices and stocks don't go up forever. There has to be something else moving in the economy in order for prosperity to take place.
Chris Martenson: I've been thinking on this theme in a slightly different direction which is that if you really want to dig out from a bunch of debt and you want to grow your way out, you need something transformative typically. Railroads at one point, steam engines at one point, maybe the Internet at another, but something. And I've just been wondering, where is this technology? I don't see it right now. We're doing incremental improvements. iPhone 4 is awesome, but not that much greater than iPhone 3, etc.
So where everybody is poised and ready and waiting for that transformation to come, I don't know what it is at this stage. It could be in technologies around alternative energy. It could be in transforming our society away from liquid fuels based on petroleum to something else, possibly like you said, a basket of things. But we're not doing it yet. And so the longer we wait, the more concerned I become that what I think you're chronicling in this documentary is really just governments sort of leaning on entrepreneurs saying, "Can we squeeze this rock a little harder?"
Addison Wiggin: Right. One area that is a potential transformative area, we look at the work that Juan Enrique has been doing in turning algae into methane. Juan Enrique is a venture capitalist based out of Boston who helped to put together the financing for decoding of the genome.
And his big idea is that the thing that sort of saved the US economy in the 1990s was the movement from analog into digital. We transformed almost every industry into a digital industry in a very short period of time and it created a lot of jobs. It created a lot of new ways of thinking. It created new areas of innovation and it spurred on an era of enhanced computational abilities, which is now giving us the ability to solve even greater problems at a faster speed. Juan Enrique believes that the next phase that we're going to see is a transformation from digital to life sciences.
They can now program genetic code and come up with new ways of producing things that are synthetic strands of code. And there are amazing things that they can do. Right now, they're experimenting with programming the genetic code of algae to produce methane, harvesting the methane and using that as an alternate energy. It's been advertised widely on Exxon commercials on TV because they dumped a bunch of money in there.
But that's just one example of the kind of transformative things going on. We have a newsletter called Breakthrough Technology Alert, edited by a gentleman named Patrick Cox, who has been around in these transformative fields for many, many years - looking at companies that are coming up with new and interesting ways of solving basic problems of society. From our perspective, that whole area of transformative technology is potentially the greatest source of new companies and entirely new economies if we're going to reinvent ourselves once again, it's likely to come from that area.
And that's where we're looking most deeply for investment ideas. But also the knock-on effect would be that the economy might be able to grow and produce the kind of income that we need to address the other issues. Although I have to say that Patrick takes a much more dire look at what we would call the Welfare State. He thinks it can't sustain itself the way it is and it's likely just to get destroyed in the next wave of transformative evolution, and that's a good thing in his opinion. Let's get rid of that old, archaic way of looking at things and get onto the business of producing new products, new ideas, and innovations that can actually help people.
Chris Martenson: Great! Thanks, Addison.
An Addison Wiggin interview,
for The Daily Reckoning
Joel's Note: As we mentioned in this space yesterday, Addison is busy trying to get a copy of Ron Paul's "Lost Gold Bible" into the hands of responsible citizens across the land. Actually, he's giving them away along with a subscription to his big picture research service, Addison Wiggin's Apogee Advisory. Here's how, for five bucks, you can get your hands on both.
Also, if you want to check out Breakthrough Technology Alert, which Addison mentions above, now's not a bad time to do so. In his newest presentation, which goes offline in ten days, Patrick Cox reveals "the last stock you'll need to own." Interested? Details Here.URGENT NEWS...
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Click here for full details.Bill Bonner Is the US Approaching the End of an Economic Growth Spurt?
Reckoning from Zurich, Switzerland...
Bill Bonner
Raw, uncensored sex...below! Yes, dear reader...read all about it. But don't skip down right away. First, read this about something much less titillating and less serious: money.
As you know, we've been wondering about the exhaustion of the Industrial Revolution innovation...and the bankruptcy of the Social Welfare state as a result.
We take for granted that a healthy economy 'grows.' Our governments depend on it to pay the bills. Our investments depend on it too; we buy investments that we hope will become more valuable as sales and profits grow along with the economy. But what if all of our assumptions about what is 'normal' are wrong? What if the growth spurt we have known for the last 300 years was the exception, not the rule? And what if it were now coming to an end?
We traveled to Switzerland yesterday. What a great town Zurich is! Clean...prosperous...charming. And last night, it seemed like there were more people enjoying the warm May evening than there were townspeople. The sidewalk cafes, restaurants and bars were overflowing. Everyone was outside...strolling...chatting...drinking. The Swiss must have it made.
"Well, yes, it's a great place to live. But not if you live on a salary," a banker explained. "There are so many Germans moving here - because it's a beautiful city...and because people leave you alone here - prices have gone up. An ordinary citizen can hardly afford to live in Zurich anymore. And when I walk down the Bahnhofstrasse I rarely hear our local language spoken. I hear High German, or Russian, or Turkish, or English."
We can confirm that prices are high. Not by DSK standards, but high for us. Our hotel near the train station was not particularly fancy. But our modest room still cost about $700 a night.
Our friend Rolf Dobelli of getAbstract interviewed us. He challenged our 'end of progress' theory.
"It's hardly a theory," we covered our tracks. "It's just an idea. We don't know if we believe it. Or like it. We're just trying it on to see how it fits."
"Yes, but people take ideas seriously. They might have come to the same conclusion in 1979," he said. "They might have thought that the boom years were over then. But as it turned out, there were still huge growth dividends to be paid - principally from electronic communications and the efficiency gains they bring."
"Maybe," we replied. "But most of the above-trend, real growth since 1979 has been in the energy economies, that are still increasing their energy use per person. The mature economies have realized incremental improvements since then, but much of that was phony - driven by increases in debt and government spending. And it's not clear that advances in communications bring real wealth improvements. Think of the television. It's been around for more than half a century. It has probably actually depressed wealth since then. Now, with all those emails to answer...and Facebook and Twitter to keep up with...it could be that they are more of a nuisance than a wealth-producer.
"It's like anything else. You get the big gains in the beginning. You invent a bow and arrow, for example. You hunt more effectively. Then, you can improve it. But there are only so many improvements you can make. After the bow and arrow, humans waited a long time - with little or no progress - until the firearm was invented. And note that guns, like every other major forward move in human history, were effectively a way of using more energy. You sent a projectile further, faster by drawing on condensed energy sources. Broadly, energy is wealth. The more you use, the richer you are."
"But what about conservation measures...efficiency gains? Most European nations have stabilized or even reduced their use of energy in recent years."
"That's my point. You get big productivity and wealth gains from the first increments of oil-based energy. Then, you eventually reach a point of diminishing returns, where gains are few. You become more efficient. You become better at using it. But your 'growth' levels off too.
"We're seeing a reflection of this in population figures. Fertility rates are high in the emerging economies - where energy use is increasing rapidly. They are low in countries where energy use is topping out. In Germany and Japan - probably among the world's most efficient energy users - there has been zero population growth for the last 10 years. And now, the population in Japan is actually falling. The Japanese economy is collapsing too. It's gone nowhere for 20 years, and now - in the first quarter of this year - it's shrinking at a 3.7% rate.
"As countries use more energy their birth rates decline. I'm not sure there is a cause and effect link, but that's what happens. It is as if people knew, subconsciously, that they are reaching the limits of their new, oil-fired habitat. The latest population estimates show world population still rising...but at a slower and slower rate...until growth comes to an end in about 2050 with about 9 million people on the planet. Most likely, that is about when gains from additional energy inputs level off too." Meanwhile, the news yesterday brought nothing special. US stocks rose a bit. Oil remained below $100 - still three times what it was 5 years ago. Gold fell to $1,492.
The Fed pumps in more and more money. Stocks float. But key parts of the US economy are made of lead. Housing and unemployment, mainly. The New York Times tells us today that debt-burdened college graduates are having a much harder time finding suitable work. And when they do find a job, the starting salary will be an average of 10% lower than it was 5 years ago - not including inflation.
Even when new jobs are created, they're rarely the 'middle class' jobs that can support the housing market. So more than 1 out of every 4 homeowners is underwater...with more sinking every day.
Curiously, many of these drowning homeowners are actually helping to support the consumer economy. More than 4 million of them aren't making regular mortgage payments. The typical foreclosed mortgage hasn't been serviced in more than 17 months. That leaves millions of people in houses they aren't paying for...giving them more money to spend.
And back to our thoughts...
"Poor fellow," we said. "He's really got himself in a jamb this time."
Elizabeth was less sympathetic.
"It makes me feel bad. What is wrong with him?"
We might have been talking about Arnold Schwarzenegger. Or about Dominique Strauss-Kahn. Or about Silvio Berlusconi. Or maybe even about Newt Gingrich. But the person in question was neither a former governor of California nor a present IMF director.
He was an old friend.
Whatever the ailment, it seems to be contagious. And, in men over 60, it is more common than inflammation of the prostate.
You'd think the fires of spring would be burning less brightly. But maybe that's the trouble...
"I can't imagine why he did it," Elizabeth continued. He had everything going for him. A beautiful, young wife. Beautiful children. He wasn't exactly as famous as DSK (as the French call Dominique Strauss-Kahn) or the Austrian Oak...or as rich...but he has been very successful. And he's handsome and exceptionally smart.
"But maybe that's what happens to older men. They become desperate to prove that they've still got what it takes. They want to defy time and show they're not getting older. They seem to lose their judgment...go off the deep end."
As to DSK, we're still suspicious. It seems almost unbelievable that the man actually tried to rape the woman in question. At first, we suspected a set-up...now we suspect a mix-up. But what do we know? We weren't there.
More commonly, a middle-aged man gets himself in trouble not by attempting sex with an unwilling partner...but by achieving it with one who is all too ready to go along.
That was our old friend's problem. Then, when his wife found out...she kicked him out.
"I guess what depresses me is just to realize that people are so disloyal, shallow and fundamentally unromantic," Elizabeth continued.
Maybe she expects too much. We're not saints. We're not even very good beasts. Geese are more faithful. Dogs are more loyal. Swallows are more sentimental.
What a disappointment the human race has been! Even the best of us are always falling short. We set low standards for ourselves...and then miss them by a mile. Our friends feel sorry for us. Our enemies gloat. Our families are humiliated, angry and hurt.
We want a perfect wedding, but the best man falls down drunk. We hope for a perfect marriage, but then, the parlor maid lifts her skirt. We buy stocks and bonds - and then the whole capital structure falls apart.
Our leaders start silly wars. Our economic policies are trillion-dollar frauds. Our public philosophers are clowns and counterfeits.
But heck, everyone makes mistakes. Even God himself makes an error from time to time. After all, He made man in His own image! That must have been the screw-up of all time.
Regards,
Bill Bonner
for The Daily Reckoning
Saturday, 21 May 2011
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