Monthly Archives: November 2010

Ireland gets its bailout. You ain’t seen nothing yet!

So Ireland finally got its bailout. I discuss the true cost of the bailout here and how this is only a temporary solution here.

Focus has now shifted to Portugal and Spain. Ireland is a country with just 4.5 million people, whereas Portugal has 11.3 million and Spain has 46.0 million. People are now guessing at how big their bailout will be if they are needed.

According to The Telegraph:

Analysts estimate that a Portuguese bail-out might require less than euro 50 billion, less than the sum lent to Greece or Ireland. But rescuing Spain from crisis would require a much bigger sum.

Cornelia Meyer, CEO & Chairman, MRL Corporation, told CNBC Monday:

She predicted that a Spanish bailout would likely cost up to 500 billion euros; but there is no “real mechanism” to deal with it, Meyer added.

While a bailout of Portugal would likely be small, a bailout of Spain would be five times greater than that of Ireland.

One thing analysts are forgetting is that the PIIGS also includes Italy. If Italy, with it 60.4 million people, needs a bailout, it could eclipse Spain’s total. Nobody is talking about bailout for Italy, but nobody was talking about bailouts for Spain and Portugal just months ago. If Spain and Portugal take bailouts, focus will then shift to Italy.

If all five PIIGS need bailouts, we are talking about well over a trillion Euros. Good thing money grows on trees.

If this story sounds familiar, it should. It is eerily similar to the US banking crisis in 2008. First Bear Stearns went bankrupt. An isolated case. Then Lehman Brothers. OK, a second special situation. Next was AIG. Then Citigroup, Wells Fargo, Bank of America, and the rest suddenly needed help from the government. BofA, Wells Fargo, etc. may not have been in real trouble when the whole thing started. Instead, it was an old fashion bank run where depositors/investors get their money back because they don’t trust the banks and banking system. Now we are seeing the same thing in Europe. Ireland didn’t need a bailout… until last week when depositors withdrew billions of dollars from Irish banks. Today, Spain, Portugal, and Italy may not be in trouble, but if people start thinking they are “at risk,” they’ll withdraw their funds and it will become a self-fulfilling prophecy.

And all the bailouts in the world won’t end this madness until these countries get their fiscal and monetary houses in order. Until then, the sovereign debt crisis will spread from one country to another.

Ireland gets its bailout. Now who will bail out the rest of the world?

So Ireland got its bailout. Marketwatch reports:

After weeks of insisting that it didn’t need a bailout, the Irish government said late Sunday that it will start formal negotiations with the European Union and the International Monetary Fund over a financial rescue package.

The United Kingdom and Sweden have also indicated that they are ready to consider loans.

Earlier in the day, Irish Finance Minister Brian Lenihan had declined to specify a total figure for the bailout except to say that it would be less than 100 billion euros ($136.7 billion).

The Irish government will put forward a strategy to provide details of €6 billion of fiscal consolidation in 2011 in order to cut the country’s deficit to 3% of gross domestic product by 2014. An overall consolidation of €15 billion is expected to be achieved over the four years to 2014. Irish Prime Minister Brian Cowen detailed in a press conference that spending cuts of €10 billion and tax increases of €5 billion are expected to make up the total amount.

Additionally:

Ireland’s banks will be pruned down, merged or sold as part of a massive EU-IMF bailout taking shape, the government said Monday as a shellshocked nation came to grips with its failure to protect and revive its banks under its own powers.

But the story is far from over.

First:

A “multi-notch downgrade” of Ireland’s Aa2 rating is now the “most likely” outcome of a review of the nation’s sovereign-credit rating, Moody’s Investors Service said Monday in its weekly credit outlook. Such a downgrade would leave Ireland’s rating within the investment-grade category, the agency said. Ireland on Sunday applied for a European Union-International Monetary Fund aid package that is expected to be used to make direct capital injections into the nation’s banks. While the move is positive for the standalone credit quality of the banks, it will shift the burden of support to the Irish government, underline bank-contingent liabilities on the government balance sheet and increase the sovereign’s debt burden, the agency said, “a credit negative for Ireland and, consequently, the credit quality of bank deposits and debt that the sovereign explicitly and implicitly supports.”

And:

Ireland’s Green Party, the junior partner in the coalition government, on Monday said the nation needs to hold a general election in the second half of January, according to Irish state broadcaster RTE. Party Leader John Gormley said he had discussed the issue with Prime Minister Brian Cowen. Gormley said the government needs to produce a credible four-year plan, deliver a 2011 budget and secure funding support from the European Union and the International Monetary Fund. Gormley said people felt misled and betrayed and that the Irish people need political certainty to take them beyond the coming two months, RTE reported.

But Ireland is just the tip of the iceberg. Or maybe Greece was the tip and Ireland is the rest of the above-water portion of the iceberg. But remember, 90 precent of the iceberg lies underwater. Any way:

Any deal between the Irish government and the European Union and International Monetary Fund to resolve Ireland’s financial crisis is ultimately aimed at cutting short the turmoil in sovereign bond markets that policy makers fear could one day price Portugal or even Spain out of global credit markets.

Portugal, which like Ireland is a small economy with a relatively illiquid debt market, is seen as the next country likely to find itself in the sights of bond traders.

Traders and analysts had hoped that a bailout of Ireland would settle credit default fears, but it has done no such thing. Just look at the stock market today which is down about 100 points. Now that Ireland has been bailed out, instead of jumping for joy, traders are turning their attention to Portugal and Spain, wondering not if but how long until they too need bailing out.

And the sovereign debt crisis continues… Just as I predicted months ago.

Irish bailout in perspective. Hello Weimar Republic.

According to this article:

Lenihan said Ireland needed less than euro100 billion ($140 billion) to use as a credit line for its state-backed banks, which are losing deposits and struggling to borrow funds on open markets.

Ireland has been brought to the brink of bankruptcy by its fateful 2008 decision to insure its banks against all losses — a bill that is swelling beyond euro50 billion ($69 billion) and driving Ireland’s deficit into uncharted territory.

To put this in perspective, Ireland has approximately 4.5 million citizens. So Irish banks have already lost about $15,333 per person and Ireland will be receiving a credit line of up to $31,111 per person.

<Sarcasm> Good thing the EU and IMF do not actually have to produce and sell any goods to provide these funds. God bless the power of printing money out of thin air and dropping it from helicopters. If the EU, IMF, and Federal Reserve didn’t have these powers, we’d be seeing a financial crisis the likes of which we have not seen in generation. <End Sarcasm>

We always joke about our government fiddling while Rome burns. But in this case, the government is actually doing something. Too bad it is the wrong something. Instead of throwing water on the fire, they are putting piles of paper money onto the fire. And as we learned from the Weimar Republic, paper money burns just as well as firewood, but is much cheaper.

Tocqueville on value of religion to society and government

“The reign of liberty cannot be established without morality, nor morality without beliefs.”

“Since religion has lost its sway over men’s soul, the most obvious boundary between good and evil has been overthrown; in the realm of morality, everything seems doubtful and uncertain: kings and nations go forward at random and no one can say where the natural limits of despotism and the boundaries of license are to be found.”

“When a nation’s religion is destroyed, doubt takes a grip upon the highest areas of intelligence, partially paralyzing all the others.  Each man gets used to having only confused and vacillating ideas on matters which have the greatest interest for himself and his fellows.  He puts up a poor defense of his opinions or abandons them and, as he despairs of ever resolving by himself the greatest problems presented by human destiny, he beats a cowardly retreat into not thinking at all.”

*Quotes from Tocqueville’s Democracy in America

Classic quotes about Liberty vs. Safety

Montesquieu: No tyranny is more cruel than the one practiced in the shadow of the laws and under color of justice… [Considerations on the Causes of the Greatness of the Romans and their Decline]

Benjamin Franklin: They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety.

Alexander Hamilton: Safety from external danger is the most powerful director of…national conduct. Even the ardent love of liberty will, after a time, give way to its dictates. [Federalist #8]

John Basil Barnhill: “Where the people fear the government you have tyranny. Where the government fears the people you have liberty.” [1914]

McConnell talks about the path to tyranny

One of today’s top headlines:

McConnell: Health Care Reform Leads America On A Path To Tyranny

McConnell’s actual statement:

“By preventing the accumulation of excessive power, the Constitution is designed to reduce the risk of tyranny or abuse at either the Federal or state levels,” McConnell told the audience of conservative legal scholars. “The health care bill would remove an important bulwark of this protection.”

Wouldn’t it be great if somebody wrote a book about this? Maybe he could call this book The Path to Tyranny.

Doctor Evil’s solution to the sovereign debt crisis

There are three stories out this morning regarding the sovereign debt crisis in Europe.

First off is Ireland:

Ireland is likely to end up tapping a loan worth “tens of billions” of euros as a result of talks between the government and officials from the European Commission, European Central Bank and the International Monetary Fund, the head of Ireland’s central bank said Thursday.

The talks aren’t about a bailout, but will lead to a loan to Ireland that the government would have to accept, Central Bank of Ireland Governor Patrick Honohan said in an interview, according to Irish state broadcaster RTE.

The yield on the 10-year Irish government bond fell to around 8% this morning from 8.3% Wednesday, strategists said. European equity markets rallied, with the Irish ISEQ stock index gaining 1.4%.

I don’t see how this changes anything. It may stave off immediate default, but Ireland is simply borrowing more money, exactly what got it into this mess in the first place. This simply buys them time to get their house in order, but will they?

Now, over to Spain:

Spain sold 3.654 billion euros ($4.943 billion) in 10- and 30-year bonds, but was forced to pay higher yields than two months ago as worries about fiscal problems on the periphery of the euro zone push up borrowing costs. The Spanish Treasury offered 3 billion to 4 billion euros of 10- and 30-year bonds. The government paid an average yield of 4.615% on the 10-year bond, up from 4.144% at a September auction, Dow Jones Newswires reported. The 30-year bond auction produced an average yield of 5.488% versus 5.077% in September. The 10-year auction produced a bid-to-cover ratio of 1.84, versus 2.32 in September, the report said.

The market is relieved that Spain was able to sell its bonds. Again, great news that Spain was not forced to default, but it doesn’t change Spain’s fiscal situation. In fact, one can argue that by lending to Spain is simply enabling one is enabling their addiction.

And over to Greece:

The Greek government on Thursday submitted to parliament a budget plan that it said would allow to stick to its target of reducing its deficit to 7.4% of gross domestic product in 2011 despite a sharp upward revision to its 2009 and 2010 deficit levels. The European Union statistics agency Eurostat earlier this week upwardly revised Greece’s 2009 deficit by nearly two full percentage points to 15.4% of GDP. The government raised its estimate of the 2010 deficit to 9.4% of GDP. The finance ministry said it would further cut spending and boost revenues to meet the 2011 deficit target, taking measures that include a rise in the lower value-added tax rate to 13% from 11%, a levy on highly-profitable firms, cuts in government operating expenditures and a nominal pension freeze.

Greece was forced to take more austerity measures because the economy did worse than expected. I am not surprised by this because the austerity itself hurts the economy, like a medicine that tastes bad but is required to kill an infection. I expect more such bad news over the following years. Government forecasts of narrowing deficits in Europe’s at-risk countries and here too in the United State rely on solid economic growth over the next three to four years. Yet, this optimistic economic outlook will only reduce their deficits, or so they hope, to about 3 percent of GDP. Why aren’t they trying to eliminate their deficits entirely? Why are they relying on optimistic economic growth rates? Has government never heard of “expect the worst, hope for the best?” Instead, they hope for the best and trap themselves in a corner if that does not occur.

All this reminds me of a scene from Austin Powers. Doctor Evil finally captures his nemesis Austin Powers:

Dr. Evil: Scott, I want you to meet daddy’s nemesis, Austin Powers.

Scott Evil: What? Are you feeding him? Why don’t you just kill him?

Dr. Evil: I have an even better idea. I’m going to place him in an easily escapable situation involving an overly elaborate and exotic death.

Later in the scene:

Dr. Evil: Come, let’s return to dinner. Close the tank.

Scott Evil: Aren’t you going to watch them? They’ll get away!

Dr.Evil: No, we’ll leave them alone and not actually witness them dying, and we’ll just assume it all went to plan.

Scott Evil: I have a gun in my room. Give me five seconds, I’ll come back and blow their brains out.

Dr.Evil: No Scott. You just don’t get it, do you?

These bailouts, loans, and austerity measures in Greece, Spain, Portugal, and Ireland are “an easily escapable situation involving an overly elaborate and exotic death.” Instead of eliminating the deficit immediately, they have convoluted plans to reduce it over a five-year period. Will these plans work? Nobody knows. But that’s okay because “we’ll just assume it all went to plan.”

Our governmental leaders may not be evil like Dr. Evil, but they certainly are as naive in assuming their plans will work. And they think we are too naive to notice their plans’ inadequacies.

Chinese bubble about to burst?

The Chinese market fell sharply today, the second time in three sessions, as China tries to slow down its economy:

Chinese stocks suffered sharp declines Tuesday, with property developers tumbling on further tightening measures that target the sector, while coal and metal shares fell on concerns about price curbs.

Chinese property stocks fell sharply after Beijing on Monday announced new limits on the ability of foreigners to buy residential or commercial property.

Chinese refining, coal and metal stocks stumbled after the China Securities Journal, citing unnamed sources, reported that the country might unveil a set of measures in the near term to control rising prices.

China is in the midst of a huge bubble, quite possibly the largest bubble ever anywhere. There have been numerous reports of entire cities built in China that now sit empty. See here, here, and here for example. There are reportedly 64 million empty apartments in China.

China is now in the process of deflating its bubble. It hopes to prick the bubble without suffering an economic collapse. But this is unlikely to occur. Despite all the building and growth, China is still a poor country. The vast majority live in poverty and the middle class is much poorer than the American middle class. Despite its relatively lack of wealth and, correspondingly, capital, China has spent hundreds of billions on wasteful projects that now sit idle. [How much money was spent building 64 million apartments that now sit idle?] The US housing bubble pales in comparison, yet the US economy is three times the size and is better able to survive such waste.

When the Chinese bubble bursts, it will take down much of the world with it. With Ireland, Greece, Portugal, and Spain already on edge and the US suffering from a weak economy, huge deficits, and growing debt, the world economy can hardly afford another burst bubble at this point. But what are the options? Prolonging the bubble only makes the pain worse when it does burst. Better to take our medicine now and return to reality as soon as possible.

EU falling apart as Ireland refuses its money and Austria refuses to help Greece.

Marketwatch reports:

Irish officials resisted intensifying calls for the nation to accept a bailout as euro-zone finance ministers prepared to meet Tuesday, insisting the government is capable of fulfilling its debt obligations until the middle of next year.

But that misses the point, economists said. The debate centers on worries about the state of the nation’s troubled banks rather than Dublin’s sovereign-debt obligations for the near term.

European officials are reportedly cranking up pressure on Ireland to accept a bailout in an effort to keep Dublin’s fiscal woes from driving up borrowing costs in Spain, Portugal and other so-called peripheral countries in the euro zone.

Meanwhile, the cost of insuring Irish debt against default rose after declining from record levels Friday and Monday. The spread on five-year Irish credit default swaps widened to 515 basis points Tuesday morning from 497 points on Monday, according to data provider Markit.

The Portuguese CDS spread widened 12 basis points to 425, while the Spanish CDS spread widened to 255 basis points from 250 and the Greek spread widened to 900 basis points from 853.

The EU is basically begging Ireland to take its money. Ireland says it doesn’t need it, at least not now. But the EU is not really trying to help Ireland here. It is trying to show the world that it stands behind the EU nations. The EU is trying to help Spain, Portugal, and Greece by lending to Ireland. But why should Ireland hurt its reputation for those countries?

This “selfishness” is spreading across Europe:

According to Dow Jones (via ForexLive) Austria has decided to withhold its contribution to the Greek bailout, citing failure to make progress on finances.

This is obviously a pretty big problem, since that will spur others to wonder why they’re still contributing to the bailout fund.

So, debtors are refusing to borrow from the EU and creditors are refusing to support the debtors. The European Union is not looking very unified right now.

Anybody who studied basic economics learned that cartels cannot survive forever. From wikipedia:

Game theory suggests that cartels are inherently unstable, as the behaviour of members of a cartel is an example of a prisoner’s dilemma. Each member of a cartel would be able to make more profit by breaking the agreement (producing a greater quantity or selling at a lower price than that agreed) than it could make by abiding by it. However, if all members break the agreement, all will be worse off.

The incentive to cheat explains why cartels are generally difficult to sustain in the long run. Empirical studies of 20th century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years. However, one private cartel operated peacefully for 134 years before disbanding.[7] There is a danger that once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed.

We are now seeing the EU cartel fall apart. While it is unlikely the EU will disappear entirely, it appears to losing power as individual countries restore their economic sovereignty.

The Balance of Power in the Roman Republic, the US Constitution, and Today