The Big Fat Greek Bailout

Did anyone think the Greeks wouldn't get a bailout? Of course, not. We are living in the Age of the Bailout, a period inaugurated on September 15, 2008, with the Lehman Brothers crack up, and which will stretch on until Europe and America have completely destroyed their currencies. In the AotB, no government will allow a financial institution with over 50 billion in assets under management to fail; industries that are politically well connected and/or possessing sentimental appeal are also part of the club. And the laws of the AotB apply to sovereign entities, too: the IMF-World Bank, the Fed, the EU, the U.S. government et al. have only just begun with a series of bailouts of governments and American states. England, California, Ireland -- they'll all get bailed. It's only a matter of time.

Both the Financial Times and Wall Street Journal have front page stories on how the market for Greek bonds has rallied on word of the 45 billion settlement, and the spread between Greek debt and the always reliable German "Bund" has closed. But this is mostly meaningless. Markets often rally on news that governments are "doing something" ... only to fall back to reality. The day after Nixon ended Bretton Woods and introduced price controls (August 16, 1971), the Dow Jones achieved its largest single-day gain to date. It didn't last. 

Furthermore, what happened in the soverign debt market over the past 24 hours isn't particularly impressive. As Tyler Durden notes, "even after bailout #4, 10 year spreads are just wider than where they were when this latest risk-flaring episode commenced, and are now in the 6.6% range, a spread to bunds of about 350 bps." And the spread is still much worse than it was a year ago (a helpful chart is here); this indicates to me that even in the height of post-bailout Euphoria, no one thinks anything has been solved.

And nothing has been solved because Greece isn't ever going to actually pay off its debts, because Greece can't pay off its debts. 

Argentina burned through a series of useless bailouts at the turn of the century -- and in the denouement experienced something close to hyperinflation. In 2001, Buenos Aires had a public debt running at 62 percent of GDP; Athens's debt ratio is twice that, up over 120 percent. And its economy is probably less competitive. 

And this is just the tip of the iceberg for the aging, highly leveraged, highly pensioned "Anglosphere." Ambrose Evans-Pritchard reports that this reality is even dawning on central bankers, as the Bank of International Settlements report makes clear:     

Official debt figures in the West are "very misleading" since they fail to take in account the contingent liabilities and pension debts that have mushroomed over recent years. "Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody's guess," said the report. The BIS [Bank for International Settlements] lamented the lack of any systematic data on the scale of unfunded IOUs that care-free politicians have handed out like confetti.

The usual guess for Washington is that it has 70 trillion in unfunded liabilities; the big welfare states like California and New York have their own massively underfunded pensions. But then, America is the Big Daddy of the world financial system and thus will probably be last on the list to have to face the humiliating choice between default or massive inflation. (And at that point, there might not be anyone willing to bail out Uncle Sam, or the AotB might have passed.)

Evans-Pritchard senses that after Greece, the UK will be next to blow up: 

Perhaps the most shocking detail in the BIS paper is that the UK's debt will rise to 300pc of GDP by 2040 under this moderate fiscal squeeze even if it is accompanied by a freeze on age-related spending. Britain -- unlike Greece -- can no longer rely on soft measures to cut the structural deficit, such as increasing the share of women in the work force. Such low-hanging fruit has mostly been picked already. [...]

If countries do not retrench quickly, they will create a market fear of "monetization" that becomes self-fulfilling. "Monetary policy may ultimately become impotent to control inflation, regardless of the fighting credentials of the central bank" it said.

Some states may be tempted to carry out a creeping default by stoking inflation. "The payoff to do this rises the bigger the debt, the longer its average maturity, the bigger the fraction held by foreigners." The BIS said the danger that any government would consciously take this path is "not insignificant" in the longer run.

Of course, a brutal fiscal purge in every major country at once itself poses a danger. The result would be to crush recovery and tip the world economy back into crisis, making deficits worse again. Countries are damned if they do, and damned if they don't.