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Economic Reality: Nowhere to Run, Nowhere to Hide, Part 1

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Central banks cut interest rates, governments provided cheap money giving only the illusion of recovery and a normal functioning economy. But the year of wishful thinking is over.

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Editor's Note: This is Part 1 of a two-part series. Click here to read Part 2.


A Year of Wishful Thinking


The period from March 2009 was the year of wishful thinking. Central banks cut interest rates and governments opened their checkbooks, providing a flood of cheap money that gave the illusion of recovery and a normal functioning economy. By pouring a lot of water into a bucket with a large hole, the world sustained the impression that the receptacle was almost full. As Norman Cousins, an American political journalist, noted: "Hope is independent of the apparatus of logic."

Governments merely transferred the debt from private sector balance sheets onto public balance sheets. The Global Financial Crisis (GFC) has morphed into a Global Sovereign Crisis (GSC) as sovereign governments now face difficulty in raising money.

Stock markets and asset prices have tumbled. Money markets are exhibiting an anxiety not seen since late 2008/early 2009. The year of wishful thinking has run its course.

Cradle of Debt

If sub-prime was the Patient Zero of the GFC, then Greece, the cradle of Western civilization, was the equivalent of the GSC. As historian Arnold Toynbee observed: "An autopsy of history would show that all great nations commit suicide."

Greece's significance is not its economic size (around 0.5% of global GDP (Gross Domestic Product)) but its significant debts. Profligate public spending, a large public sector, generous welfare systems -- particularly for public servants -- low productivity, an inadequate tax base, rampant corruption, and successive poor governments were responsible for the parlous state of public finances.

Several events focused attention on the problems. Greece needed to borrow around Euro 50 billion in 2010 to refinance maturing debt and fund its budget deficit. There were damaging disclosures that Greece, like many other European countries, had used derivatives to manipulate its debt figures. Greece bungled attempts to mask its increasing difficulties in refinancing maturing debt, including statements about a large purchase by China of its debt which was denied by the supposed buyer.

The revelations focused attention on underlying problems setting off alarm bells. Smelling blood in the water, markets pushed up the cost of Greek debt. The Greek stock market fell sharply by around 30%. Gradually, the ability of the country, as well as Greek banks and companies, to raise money ground to a halt.

Greece was also the "canary in the coal mine", highlighting similar problems in the PIGS (Portugal, Ireland, Greece, and Spain) as well as some Eastern European countries. These countries alone have around Euro 2 trillion of debt outstanding. Larger countries -- the FIBS (France, Italy, Britain, and the States) -- also have similar problems of large public debt, unsustainable budget deficits, and (in most cases) unfavorable current account deficits (both in absolute terms and relative to GDP).

Going Nuclear

Will Durant, an American historian, advised that: "One of the lessons of history is that nothing is often a good thing to do and always a clever thing to say." Initially, European politicians and bureaucrats, who suffer from delusions of adequacy, did nothing, but wouldn't shut up about it. The oft repeated battle cry was "no default, no bailout, no exit." Germany remained especially hostile to any financial bailout. Repeated invocations of the no-bailout clause underlying the eurozone drew attention to the risks of Greece's debt.
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