Thursday, July 21, 2011

Balancing Act - Beggars can't be Choosers

Introduction : Maximum Debt Levels in the USA

The financial world continues to be in what we could label a situation of 'Red Alert'. In the US Republicans and Democrats try to avoid that the US will become one big Minnesota (although politicians in that state did finally reach an agreement concerning the new budget) with Obama's challenge now being to ensure that maximum acceptable debt levels will be increased on the one hand, and - an even tougher challenge - making sure that these maximum levels will remain maximum levels for quite some time to come. In other words: start working toward a reduction of debt levels. And of course: the second part of the challenge is the more complicated one.

LT Chart of US Debt Ceiling - Looks like Credit Card Debt of a Shopping Addict!

With rating agencies considering to reduce the credit rating of the global leader from AAA to a far lower level, the US is already struggling. But when taking the value of the US Dollar as a refereeing judge it looks as if financial markets are still more or less OK with what is going on.

Reason probably being that the US understands that it does at the moment need the support of those with the big pockets, read: China and sovereign wealth funds in the Middle East. If you increase debt levels to new record levels, you better gain support from those who have the fullest pockets. Obama's talks with the Dalai Lama made it clear that the US president understands this simple business concept.

PIGS in Europe

But what about Europe? Nervousness remains in Europe, with a totally different approach so it seems. Greece, Portugal, Ireland and to a lesser extent Spain, Italy and maybe even Belgium are countries with external debt to GDP ratios that are troublesome or even disastrous (Greece). This is not just bad news for the Euro, but it should also be bad news for those who invested in these international securities. These countries were never of the same credit quality as German or Dutch or Swiss government bonds. It is the same old situation: lower rating or higher risk (and with ratings often not as good as they should be, this is not the same!) translates into higher interest rates. Those who go after these rates should know that sometimes this 'excess interest rate return' won't happen because of default.

In the old days with those countries having separate currencies, these defaults did not happen directly but indirectly. Instead of a default the Ministries of Finance would simply print more of the local currency, with the latter depreciating. But: in Eurozone we are now talking about a situation in which the local currency is international currency as well. Result: the borrowing countries cannot simply do that. And that means that they have but one choice: restructure the economy and/or go into default.

If we take Greece as the leading example (it is indeed also the show case that does get most international attention, because the catastrophe is worst there), then it becomes clear that we see on the one hand a lame restructuring effort with Greece expecting that international lenders will in the end take the bulk of suffering. The international financial community in Europe (ministers of Finance, ECB, Central Banks, Financial Sector) and abroad (IMF) seems to forget what the Americans understand perfectly well: in the end it is best to involve the have's when trying to find solutions for the have not's.

Financial Ruins are no Tourist Attractions: So don't talk and watch, but do something

Balancing and How to accept the New Reality

China did already indicate that - as part of their international diversification policy for the reserve position - they will not necessarily let the Euro fail (if only for the sake of creating a better international power balance that isn't too dependent on the US Dollar!) but so far European leaders and IMF (with the exception of Germany beggars themselves, with struggling economies) have chosen to go for a DIY strategy. United we stand together: but without money.

Well, in that case the only way out is either loans that are almost perpetual with very low interest rates (and therefore effectively pose a subsidy to the weak financial countries!) or a restructuring that includes a default with lenders not getting everything back. Some Ministers of Finance (including the one here in the Netherlands) try to score points nationally by talking tough language, but of course they do realize that a tougher stand implies that it is their own lenders who will take a substantial part of the loss. And those lenders are - yep - the same banks that were to a large extent saved or even bought by Western governments during the Global Financial Crisis.

The bottom-line remains: Beggars can't be choosers. There was and is no credit shortage. It is just that flows went from Europe and the US into Emerging Countries and Gold and Switzerland (the latter two as example of flight into safe havens due to the onging nervousness, with the latter also caused by the imbalance that western leaders are now cultivating).

But still: we can listen for hours to TV, read opinion articles for hours and the only thing we do not hear is the story above. The beggars want to continue their belief that the world hasn't change, only to realize far to late that it did!

Beggars can't be Choosers: Looks as if this time the biggest Beggars will be best off!

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