|
Greece is still in chaos. Italy is now on the closest radar screen as they come to grips with spiking Italian bond yields. So, the financial chaos has spread from Greece to Italy, with Italy having the potential to become a much larger problem. This problem is not some mysterious viral agent, but quite simply TOO much debt. When debt reaches a certain level there are only two solutions and neither one of them is very tasty medicine.
As countries start to realize they are in deep trouble, and contemplate strategies to climb out of their predicament, power hungry politicians look to grab power. This can often lead to even more chaos and lack of confidence as the clock ticks towards an unavoidable eventual default. I will repeat a mantra I have been pounding the table about. This problem of extreme debt burdens has been a process that has been building for decades. The recession of 2008 just happened to expose the inordinate amount of debt risk as revenues fell because of the economic slowdown. It is tough to correct a generational problem quickly, especially with the cure of implemented Keynesian economic policies. Those policies at best, just push the problem farther out and at worst, exacerbate the debt problem.
As Europe is imploding, monies are flowing into the US Dollar and US Treasury Bonds. There are two reasons for this. 1. Investors or traders avoid the riskiest currencies and assets at the moment, which means sell Euros/Stocks and buy Dollars. 2. This perceived flight to safety is possible because we are still the world's reserve currency. The U.S. Dollar Index has been particularly volatile lately as headlines pour out of Greece and Italy. Today, Wednesday Nov. 9th, the US Dollar Index is at approximately 77.67. A little more on this later, but the medicine for excess debt is not more debt. Germany is painfully aware of this and I am not sure how long the German Chancellor will be able to convince the German people that they should continually bail out their less fortunate neighbors. Her only hope is attempting to convince the people that the cheaper Euro allows their exports to thrive more than the Deutsche Mark would if they left the Euro and went back to printing their own currency. That would be a VERY tough sell given the current environment.
As Italy now takes center stage, it is important to remember that Italy will be a much tougher debt hole to cover up than Greece. Italy is larger and a bigger percentage of total Euro GDP. I shudder to think about the potential fallout if Italy has to default. Also, it is good to rehash the default scenarios. When it gets terrible enough a country has two options to default. The first is an arranged haircut on the debt they owe and start over. The second, (and most popular) is an effort to print their way to prosperity and pay back debt with cheaper dollars hoping the economy will recover and raise revenue. This inevitably leads to an inflationary collapse and eventual default. This debt virus is not going to magically cure itself any time soon. Hopefully, we will be much more tolerant of some austerity measures than our European neighbors. We have to not only be willing to cut back on spending but we have to be even more willing to take the economic pain that comes with it. I would much rather take medicine that tastes bad than be left with a potentially devastating disease.
Written by Daniel Petrey, CFO, MBA
|
