Greecing the Skids to Economic Calamity

Right From the Start

Tuesday’s Oregonian carried a headline stating “Stocks slip as Germany cools hope for a debt deal.” This is a variation on alternating headlines involving Greece’s debt problem. The alternative headline trumpets “Progress on resolving Greek debt crises.”

Those two variations have been bouncing around for several months, each causing a dramatic rise in the stock market followed by an even more dramatic plunge. They have been repeated so many times that you would think that the “genuinely smart guys” on Wall Street would recognize a “boy calling wolf” one too many times. But if there were genuinely smart people on Wall Street they would have told the federal government to “buzz off” when Congress required banks to loan money to people who could not or would not repay it. If there were “genuinely smart people” on Wall Street instead of just greedy ones, they would not have compounded the problem by creating complex derivatives for packages containing these questionable loans and then leveraged them as “investment grade” shares.

But then we all know how that turned out and how the politicians – both parties and President Barack Obama – benefited enormously from tens of millions of dollars in the form of campaign contributions. And we all are painfully aware of the trillions of dollars lost in investments, including pension plans and individual retirement accounts – and that doesn’t include similar amounts in lost equity as a result of the housing crash.

But all of that begs the question as to what is really going on with Greece and the other troubled economies in Europe. And more importantly how both the problem and the proposed solutions parallel and portend economic catastrophe in the United States.

Greece, Spain and Italy are all in an economic crisis because they have created a system of recurring governmental social spending that exceeds the revenues that they can raise on a recurring basis. As a result, they have borrowed – not for capital expenditures – but for recurring expenses. And not just once, but for decades. Does this sound familiar?

Every financial advisor – with the exception of those advising Mr. Obama and the Congress – will tell you that if you are borrowing money on a recurring basis to pay recurring expenses, you are headed for disaster. There are legitimate arguments that borrowing to meet recurring expenses in a rapidly growing economy is justifiable. That however, assumes that 1) you are in a rapidly growing economy, and 2) the pace of borrowing remains at a nearly constant rate when compared to the economic growth – the best measure being a percentage of Gross Domestic Product (GDP).

And now back to Greece. As previously noted, Greece has been, for decades, borrowing to pay recurring expenses attendant to social welfare programs. Greece’s economy, which had been growing at an anemic rate prior to 2008, has been shrinking ever since – and yet their borrowing not only continues but increases. It increases because the expectation of social welfare spending increases annually, the cost of servicing the debt that Greece has incurred increases annually and the revenues that Greece can extract in the form of taxes declines.

Without more borrowing, Greece cannot service its existing debt. Without more borrowing, Greece will default. Let’s not gloss over this. Without more borrowing Greece will default on its existing debt. But, by borrowing, Greece makes a debt load that it cannot currently service even greater. And so what are the solutions being discussed by all the “really smart people” on Wall Street and the European capitols?

Well, they want the existing bondholders – banks and other private institutions – to take a “haircut.” That means some portion of the existing debt is written off as uncollectable. That allows Greece to create additional new debt to replace the existing debt that it couldn’t service. Private investors suffer while government continues spending in excess of its ability to pay. Does that sound familiar?

Spending by the Greek government will be curtailed to a degree but wholesale reform of its social welfare spending remains relatively untouched. The net result will be that Greece will not balance its budget in the foreseeable future and it will continue to slide into default albeit at a slower rate. Does that sound familiar?

Understanding that, one wonders why all of the “genuinely smart people” on Wall Street and the European financial capitals prefer to extend the problem into the future where it will grow much larger and be more draconian in its failure rather than allow the default currently or – more importantly – attack the problem at its root cause.

Even in the United States the “big compromise” reached by Congress and Mr. Obama, did not significantly address our own economic problems. We are, and will continue, to spend more – primarily on social welfare programs – more than we take in. The $4 Trillion debt reduction ballyhooed by the press and politicians was not a debt reduction at all, but rather an estimate that our national debt would grow slower over the next ten years than was previously projected. Even with the $4 Trillion debt reduction, our national debt is expected to grow to over $22 Trillion over the next ten years.

And while there is a greater chance that America’s economy can grow at a rate that mitigates the effect of the increase in national debt, there are absolutely no plans, including Mr. Obama’s Stimulus II, that will rationally lead to that kind of growth.

Until political leaders – in Greece, in Europe, in the United States – are prepared to acknowledge that you cannot spend your way out of a debt problem; that you must address the systemic problem of welfare spending in excess of revenues; that government cannot solve all problems and certainly cannot support all, let alone a majority (57%) of it population, the countries of Europe and  even the United States will continue on a slide to default.

Wake up, this is not that complex. Even a community organizer should be able to recognize the problem.