Friday 22 July 2011

Errors in Media Reporting on the Greek Bail-out Crisis

A very brief post from Limassol, Cyprus. The errors or misleading statements in the media this past week on the Greek debt crisis are simply astounding. Here are only a few examples: 

The Sun: Grecian Earner: The deal was hammered out at a nine-hour session - and comes 14 months after Greece, which is more than £300billion in debt, was given its first £100billion cash injection.

Ø  This is wrong, or misleading: Greece has only received approximately EUR 50 billion of the first bail-out package of EUR 110 billion. This is UKP 44 bln out of UKP 96.9 bln. The full “£100billion” hasn’t been disbursed.

The New York Times, After a Deal, Only More Challenges, 21 July 2011: It includes 109 billion euros ($157 billion) in aid to Greece.

Ø  This is not aid to Greece, it is a mix of new sovereign loans or private sector loan roll-overs. This ignores the whole question: can Greece repay its old and new loans?

The BBC: EU austerity drive country by country, 20 July 2011: But the Greek government has not delivered on a major element of the rescue plan - large-scale privatisation. The goal is to raise 50bn euros from sales of state assets by 2015.

Ø  This is a true statement, but fundamentally a wrong one. The government passed the EUR 50 billion privatisation package in June 2011, about three weeks ago. Of course the package hasn’t been implemented yet.

Nicole Itano in a Bloomberg video Legal Disputes Complicate Greek State Asset Sales, June 28: “There isn’t even a land registry to help sort out the mess.”

Ø  Actually, there is a land registry: you can view it here.  The problem is that there are ownership disputes on some parcels of land, mainly a result of historical factors, tradition and the backlog in the Greek legal system. The other problem is that the registry does not cover all areas, as not everyone has declared their property. Most individual property is already in the land registry.

There are others too numerous to mention. There are also numerous errors regarding the interest rates offered by the private sector: they are higher than the EUR 3.5% offered by the EFSF.

You can view the Eurozone press statement here. Check also the IIF press release. There is precious little by way of detail. I’m still running the numbers – some are very unclear – and hope to post an update over the weekend.

(c) Philip Ammerman, 2011
Navigator Consulting Group Ltd.  

Thursday 21 July 2011

Waiting for the Next Eurozone Summit (Haven't we Seen this Film Before?)

There is little substantial progress to report since my last blog post on the Greek debt crisis (The Greek Debt Crisis and International Contagion: July 13, 2011). But there is much to report by way of commentary.

I was most interested by an article published by Larry Summers, the former US Treasury Secretary, on Reuters on Sunday, 17 July, in which he states:

"It is to be hoped that European officials can engineer a decisive change in direction but if not, the world can no longer afford the deference that the IMF and non-European G20 officials have shown toward European policy makers over the last 15 months"

In this article, Summers offers three realties which must be recognised if there is a chance of success at resolving the crisis:

a. The maintenance of systemic confidence of essential in a financial crisis. Given the rise in Spanish and Italian bond rates in the past week, it’s becoming clear that system confidence is failing.

b. No country can be expected to generate huge primary surpluses for long periods to the benefit of foreign creditors. It is ironic that the European Union and IMF have apparently so quickly forgotten the lessons of German reparations after the First World War.

c. Whether a country is solvent depends on only on domestic policies but on the broader economic context. This has been a consistent observation I’ve been making: see for instance my post of November 28, 2010: Watching the Decline:

The micro- and macro-economic environment against which Greece is making its reforms appears to be almost ignored. We are working in an environment characterised by three major trends:

•  The long-term trend of declining international competitiveness, both within Greece, but also within the EU. In this environment, Asian producers are increasingly winning market and value share, and climbing the innovation ladder. Greek and wider European producers, in contrast, rely excessively on protected markets or subsidy schemes, most of which nurture sunset industries such as agriculture or cotton textiles, while penalising (through regressive tax systems) future industries.

•  The fact that we are not fighting against the deflation of one bubble, but two. The first bubble is the high sovereign debt issues which characterised most countries in the past 10 years, and which are regrettably set to continue into the future. The second bubble is the fact that nearly every sector in Greece (and Europe) is characterised by massive overcapacity, at a very time when public and private sector consumption must fall to balance excessive debt. Much of this overcapacity is value-destroying (based on sunset or protected industries) rather than value-creating, or is based on the import of Asian products (textiles & garments, electronics).

•  The fact that the primacy of the state as a means of development is still followed avidly in Europe, and particularly in Greece. This is despite the fact that state spending in Greece has crowded out and distorted (through corruption, regulation and subsidies), private sector investment, and created much of the overcapacity mentioned. Until the dead hand of the state relinquishes its rigor mortis grip, we cannot expect serious economic development, i.e. development based on commercial viability rather than government subsidies, protectionism or crony capitalism.

I also strongly believe that, for quite some time now, we have been treating the symptoms, not the root causes of the crisis. Refer to my blog post of May 10, 2010: Europe has bought short-term stability at the expense of long-term survival. My conclusions here are that:

In May 2010, the governments of the Eurozone in conjunction with the IMF and the European Central Bank announced a new financial stabilisation package. While this enables short-term financial stability, it risks the long-term equilibrium between public and private spending in the Eurozone and, by extension, North America. It masks the true liabilities in sovereign debt, and removes an important part of the external financial discipline for national expenditure.

The root cause of the problem—that national governments are spending too much, and are relying either on quantitative easing or financial sector borrowing—has not been addressed.

As a result, neither the United States, nor many European countries are taking the meaningful steps to cut public sector expenditure, or at least allocate it to those sectors capable of producing employment and economic value.

The medium-term impacts of this decision will be to:

• Increase inflation as central banks resort to printing more money and expand their balance sheets radically;

• Place the basic credit policies of the ECB and the Fed under question;

• Increase the sense of moral hazard in the financial sector, as both banks and economies (or sovereign debt) became “too big to fail”;

• Increase the trend in public sector expenditure and unfunded liabilities, leading to a vicious cycle of higher taxation and unproductive spending, at a time when demographic changes were leading to an inexorable change in the basic social and economic fabric of most countries;

• Increase the total national debt (public + corporate + household) of most European countries as well as the United States;

• Cause business investment to increasingly be channeled to offshore or lower-tax locations;

• Increase the political power of Germany and, by extension 2-3 other Eurozone countries at the expense of the entire European Union. Rarely has decision-making in Europe been dominated so extensively by Germany, and the previous occasions when this occurred were not happy times.

I believe that with this current decision, the Eurozone has bought time and stability, without a real commitment to fundamental public sector reform. The root causes of the problem are firmly in place, and accelerate as demographics change and Asian economies become more competitive. An alternative solution should be found, before the potential scale of the cost of dealing with these root causes becomes prohibitive.

The Eurozone did indeed buy time and stability in May 2010—just until the Irish bail out in November 2010. At that point, the crash of the dominos began which has not yet finished.

Absent drastic policy measures in the near future, there will be two main impacts of this summer crisis:

a. There is a strong chance that Greece will be unable to make its debt payments in July and August absent a second bail-out. Greece faces sovereign debt repayments of approximately EUR 15 billion to the end of August, of which approximately EUR 10 bln in capital and EUR 5 bln is interest. It is unlikely that the country will be able to finance these payments. Absent new emergency funding, a Greek default will create a firestorm; further European vacillation may lead to the same result.

b. Pressure will continue to increase on highly-indebted countries, including Ireland, Portugal, Spain, Italy and possibly Belgium. The first signs of contagion will hit France.

A technical default by the United States will accelerate this process, into areas we cannot begin to imagine.

I have low hopes for this next summit. It’s clear that on the one hand, a plan is not ready. On the other hand, any real plan will probably have to be approved by national parliaments, creating further uncertainty. Together with the uncertain progress of the US debt negotiations, I’m counting on a long hot summer, and in the case of Greece, a continuation of instability well into the fall and 2012 (don’t forget elections must be held by 2013 at the latest). There is also a 30-40% chance of a catastrophic outcome in the next 45 days.

© Philip Ammerman, 2011
Navigator Consulting Group

Sunday 17 July 2011

The Great Greek Taxi Strike

One of my many friends from the Athens taxi driving community picked me up at 16:20 from Geraka this afternoon for my ride to the airport. The cab reeked of cigarettes and Derti FM was wailing some song of misery. This driver was from Glyka Nera, just across Marathonos Avenue, so we spoke as neighbours.

The great subject of the day is the taxi strike which, barring any last-minute compromises, will start tomorrow. Travellers to Athens, and indeed all Greece, should be prepared for at least two days of transport problems. The strike may turn nasty, as the drivers are debating whether to close access to airports and ports in an effort to get their views across.

The issue the drivers are protesting is the “liberalisation” of the taxi driving profession. Ostensibly a great priority for the Troika, this liberalisation means that in principle, anyone who applies will be granted a license for a taxi, subject to certain conditions.

One such condition, which has not been fully understood, is the fact that there will still be a cap on the total number of licenses provided, based on a ratio of taxis per 1,000 inhabitants. This limit was originally set at 2.5 licenses / ‘000, but we understand it may be increased to 4 / ‘000 in Athens and Thessaloniki. According to other versions, including the statement attributed to the new Minister of Transport, there will be no cap at all.

Assuming there is a cap, it is impossible to understand what is actually being liberalised. There are 4 million residents in the greater Athens area: assuming a ratio of 2.5 taxis per 1,000 residents, then there should be no more than 10,000 taxis working in the greater Athens area. There are currently 13,500 taxis at work, which explains why fare revenue per driver is so low.

Quantitative caps aside, the impact on the actual market is apparently profound, if we believe the taxi drivers. There are reports of hundreds of applications being submitted for licenses, with a low application fee set by the Ministry. How this can be true if the “quota” has been exceeded is unknown. Nonetheless, it is a major reason for the taxi strike tomorrow.

The drivers are up in arms for two additional reasons: First of all, most drivers had purchased their licenses, typically from another driver, for between EUR 100,000 – 200,000 (values according to the past 10 years). Traditionally, the value of the licenses was intended as a form of pension payment or, in corporate terms, goodwill. However, this also reflected the time when it was actually possible to make a respectable living by driving a taxi. By granting “free” licenses, this value has been eliminated.

Yet the fact that many drivers have taken a loan to pay for this “license value” makes things far, far worse. Similar to the US borrowers who’s homes are now worth less than their mortgages, a good number of drivers are underwater. Unlike the US borrowers, however, the Greek lending standards require real collateralisation: many drivers have pledged their houses. A good many people stand to be destroyed as a consequence.

The second reason is that business has fallen dramatically. With fuel rates at a historic high and a recession now in its third year, most drivers report an average net income of EUR 40-50/day after all driving expenses (car loan, fuel, maintenance, etc.) are taken into account. Most drivers work 12 hour shifts, 6 days a week. To put this level of effort for a gross income (before taxes) of EUR 1,040-1,300 EUR/month is debilitating.

Unfortunately, this is yet another area where the implementation of structural reform is mistake in its scope and abysmal in its execution. In the grand scheme of things, liberalising the taxi trade is an absolute non-issue compared with the other pressing issues affecting Greece. It won’t result in lower rates, since taxi tariffs are fixed (as they are in all other European countries). It also won’t result in higher demand, since there is no shortage of taxis offering their services in the market, and since there are already more taxis available than is reasonable, compared to other European cities.

To claim, therefore, that this liberalisation will somehow lead to greater economic activity or consumer benefit is wrong. With all the major issues affecting the country, one would have hoped that the Troika, in its infinite wisdom and economic competence, would be encouraging the government to spend its limited political capital on the main priorities, not on the non-essential ones. This is apparently not the case.

It’s regrettably less surprising that the government has not been able to successfully communicate what the liberalisation means to the drivers, or to implement it rationally. PASOK has consistently made a hash of this, but in this case it maintains a strong tradition of failure which it proudly shares with New Democracy.

Less than 1 month ago, former Minister of Transport Dimitris Reppas had reached agreement with the drivers’ union on reform, based on 2.5 licenses per 1000 inhabitants. The drivers had accepted this. Now, one cabinet reshuffle later, the new Transport Minister Yiannis Ragousis has proposed changes without any apparent consultation, in which the principle of capping licenses per population has apparently been dropped.

In addition, no part of the proposed “reform” addresses the issue of the lost license value. My advice to the taxi drivers is to seek legal counsel on whether the liberalisation constitutes a “force majeur” or not. If so, they should take mass action to stop their loan payments on licenses. It’s only when the banks start screaming that the government or the Troika will actually understand what the drivers are talking about.

The result of this abysmal failure of policy and basic common sense will be the taxi strike that will take place starting tomorrow. With summer temperatures above 38 degrees, and with the tourist season in full swing, Greece is headed for yet another pointless confrontation that solves absolutely nothing.

Barring a last-minute reprieve, I expect Bloomberg, CNN, Reuters and everyone else to publish photos and clips of striking taxi drivers starting tomorrow, with perhaps a few getting clubbed by police. I expect to see tourists stranded or missing their flights or ferry trips, because there aren’t any taxis available. I expect that millions of derogatory comments about “the Greeks” and their inability to “reform” will be written in the blogosphere or in the New York Times as a result.

And thus this pointless game continues. If stupidity were a human art, the past 14 months has elevated our government officials and our Troika bosses to Olympian heights. Tomorrow the sacrifices resume.

© Philip Ammerman, 2011

Saturday 16 July 2011

Does George Papandreou fly with Ryanair?

Prime Minister George Papandreou visited Kos yesterday to meet with local authorities and the deputy minister of Tourism to discuss Greece’s tourism promotion policy in light of the increased arrivals in Kos. According to the prime minister Kos is an example, “[due to] its collective efforts, its communal efforts, we are showing our culture, we link this with development, with jobs, with quality tourism.” (Kathimerini, 16 July 2011).

Την Κω έφερε ως παράδειγμα, «όπου με συλλογική προσπάθεια, με κοινή προσπάθεια, αναδεικνύουμε τον πολιτισμό μας και τον συνδέουμε με την ανάπτυξη, με δουλειές, με τον ποιοτικό τουρισμό».

He probably should have asked Michael O’Leary why arrivals to Kos are booming. Ryanair has started direct flights to Kos, with departures from Baris, Bologna, Brussels, Kaunas, Liverpool, and Olso. It’s one of 17 new Greek routes the airline is launching this year. The airline estimates it will bring over 700,000 passengers to Greece in 2011, resulting in EUR 350 million in national tourism revenue.

I saw the success of this first-hand this week in Kaunas, Lithuania, where I was working with ISM University. Two of the professors in the case study development group I’m advising are flying to Kos next week for vacation on Ryanair from Kaunas, and are ecstatic about it. “The homeland of Hippocrates!” one professor told me, her eyes shining.

Yes, these are quality tourists: highly educated, upwardly mobile professionals. But being a “quality tourist” does not mean one is a stupid tourist, willing to pay EUR 1,500 for a week in Greece, when a week in an equivalent resort in Turkey costs less than half this amount. By offering low-cost flights to an unserved destinations, Ryanair enables tourists to put together their own packages dynamically by selecting the best price offers in different segments. Quite different from relying on tour operators or expensive flight access. 

Reading this article, I had to wonder if our Prime Minister or any other goverment ministers have ever flown with Ryanair before, or whether companies like Ryanair even enter into the political calculus of the antediluvian unionists who still dominate the upper reaches of PASOK. Judging by the previous law on cabotage passed by former Minister of Economics Louka Katselli in 2010, they do not.

I also have to wonder what our esteemed Tourism Ministry is doing about this. If Greece wants to open up new markets, why not grant Ryanair, Easyjet and various other airlines landing rights at Thessaloniki, Actium, Heraklion, Rhodes, Corfu and elsewhere? Why not fund their aircraft and crews to be based in Greece, at least seasonally?

The city of Paphos, for instance, recently negotiated with Ryanair to base 2 aircraft and crews at Paphos Airport, which is now run by Ermes, a private airport operator owned by the Shakolas Group. According to my sources in the hotel sector, the total annual funding request was EUR 400,000, which would have been split between the Municipality and the Paphos Hoteliers’ Association. This is a pittance compared to the money the Greek public sector wastes every day. In Paphos, the net gain from incoming tourist arriving on Ryanair will surpass this amount each month.

There are many other recommendations one could give the prime minister on promoting the Greek tourism product. We could start with Visit Greece, the abysmal website of the Greek National Tourism Organisation (EOT). Why is it that private companies such as The Margi or Costa Navarino manage excellent sites while EOT, with millions in EU funds and tax revenue available, has developed a website which looks like it was designed by a first-year web design student?

We could continue with tourism promotion spend. Given that tourism accounts for nearly 20% of Greece’s GDP, why isn’t Greece spending upward of EUR 300 million on international tourism promotion each year? When is the last time the prime minister has seen an advertisement of any kind for Greek tourism? When is the last time he’s seen an advert for Georgia, Turkey or Croatia?

Shall we discuss tax policy? We could inquire why VAT has a maximum rate of 23%, or why a hotel should have to pay 44% of payroll taxes for IKA, if we want this sector to be competitive.

Unfortunately, it’s painfully clear that either the elected leadership of Greece do not understand the tourism sector, or they don't see it as a priority. If they did, they would be spending as much time and attention on tourism (nearly 20% GDP) as they are on green energy (less than 1% GDP) or agriculture (less than 6% GDP).

The Prime Minister should be speaking at tourism industry conferences and visiting major exhibitions like World Travel Market or ITB. There should be a Deputy Prime Minister chairing a Cabinet working group which includes industry professionals and representatives to develop a 10-point plan for tourism which should be implemented before the 2012 season starts. There should be a national goal to raise arrivals from 15 million tourists in 2010 to 20 million in 2015 and 25 million in 2020. There should be a further goal to streamline the hotel licensing procedure to attract investment into integrated resorts and other special products. 

Unfortunately, there is no such group, and there is no such strategy. Piecemeal initiatives, meaningless conferences, and empty speeches are no substitute. Greece has the infrastructure, the tourism product and the tourism professionals needed to reverse the situation. What is lacks is a long-term, realistic tourism development strategy at the public level, and a realistic understanding of how the sector works.

© Philip Ammerman, 2011

Wednesday 13 July 2011

The New York Times and the Papandreou Family

The New York Times ran an article on the Papandreou family today (“Family Differences, Global Issues”), which relies heavily on the perspective of Nikos Papandreou, the brother of the current Prime Minister of Greece, George Papandreou.

It is interesting to note that the word “corruption” is not mentioned a single time in the article. This is arguable one of the greatest legacies of former Prime Minister Andreas Papandreou's rule, and one which George Papandreou, the son of Andreas and Greece's current prime minister, struggles with today.

There is no mention of the Bank of Crete scandal, in which $210 million were embezzled. Some of these millions were, according to the Bank’s Chief Executive, paid directly to Andreas Papandreou. Although the former Prime Minister was acquitted by a special tribunal, there are few people who do not believe he was involved, that senior PASOK figures did not benefit from this, or that the special tribunal properly investigated the affair.

There is no mention of the Siemens bribery scandal, which began during Andreas Papandreou’s term, and according to the report of the Hellenic Parliament (which was supported by PASOK) may have caused the Greek state up to EUR 2 billion in over-priced purchases. Significantly, there is no mention in the article that the Siemens bribery funds allegedly went to PASOK politicians as well as to PASOK as a political party.

There is no mention of the role of Nikos Papandreou, the protagonist in this article, and his rather mysterious role in the negotiations of the Skaramanga Shipyard from Thyssen Krupp to Abu Dhabi Mar in March 2010. Why was Mr. Papandreou involved in this deal when:

a.     He had, and has, no government position. 

b.   The Greek state had no shareholding in Skaramanga at the time. Why was it involved in the negotiating the deal with Abu Dhabi Mar? Was the price paid to--ostensibly--safeguard jobs at Skaramanga worth it? Was this the only motivation?

c.     Why did Prime Minister George Papandreou not only reverse Greek policy not to accept the first batch of four submarines (one of which was defective), but to order two more, at a time when it was clear Greece could not afford the first four, let alone the second second two?

There is no mention of the fact that Mr. Nikos Papandreou’s name has surfaced as well in the failed Astakos Investment, not least as someone doing somersaults:

Κληθείς να σχολιάσει την εμπλοκή του κ. Νίκου Παπανδρέου στην υπόθεση του Αστακού παραπέμπει σε παλαιότερη δήλωση του πρωθυπουργού, ο οποίος είχε πει ότι οι προσωπικές και συγγενικές σχέσεις δεν επηρεάζουν τη λήψη αποφάσεων. Ωστόσο, ο κ. Παμπούκης καλύπτει απόλυτα τον αδελφό του πρωθυπουργού, καθώς όπως λέει «ο κ. Νίκος Παπανδρέου έχει πει ότι θα έκανε και “κωλοτούμπες” για να φέρει επενδύσεις στην Ελλάδα. Και εγώ λέω ότι πολύ καλά θα έκανε, διότι η χώρα τις χρειάζεται περισσότερο από ποτέ».

I will leave the NYT to attempt to decipher this Greek text on their own—it may be instructive.

Somersaults or no, if I had done the interview, I would have asked at least these simple questions: How is it possible that the brother of the Prime Minister, who does not hold government office, and has no apparent qualifications in investment management, represent Greece at this level? Isn't there a conflict of interest? Doesn't the Prime Minister trust his own Ministers Pamboukis and Katselli who were involved in the negotiations? 

There is also no mention of Mr. Antrikos Papandreou, the other brother of Nikos and George, who is founder and head of the Institute for Climate and Energy Security. This organisation not only benefits from contracts from the Greek government, notably the organisation of the Mediterranean Climate Change Initiative, but is apparently lobbying for the creation of a EUR 200 million investment fund for green energy investments.

There is no mention of the fact that Prime Minister Papandreou’s PASOK party is highly indebted, that it has pre-absorbed its government funding until 2016, and that it has over EUR 40 million in bank loans. Together with its implication in known corruption scandals (the Siemens funds), one has to wonder exactly how much negotiating power Greece’s Prime Minister has when he attends these European meetings in Brussels and Berlin.

As Greece tries to clean up the mess inflicted by two generations of venal and corrupt politicians and their allies, this historical perspective would have been valuable, more so than the anodyne comments made by former Minister Louka Katseli. Andreas Papandreou's dark legacy continues to this day, and it is this legacy that his son, who was an active Minister in his father's governments, is called upon to change.  

© Philip Ammerman, 2011

The Greek Debt Crisis and International Contagion

The Eurozone meeting in Brussels this past Monday confirms that the Eurozone leaders are as far apart as ever on reaching a resolution to the Greek debt crisis. Absent real decisions in the next two weeks, it is likely that contagion will spread not only to Italy and other Eurozone economies, but possibly to the United States and Japan as well.

In any turn-around management situation, the first priority is to diagnose the problem. Following this, a turn-around plan is needed which reduces the financial losses and focuses on creating income and profitability. The first plan for Greece, in the winter-spring of 2010, took far too long to agree, and then was flawed in that is maintained a deficit to 2015, but required a return to the markets even with small-scale Treasury borrowing in 2010.  The second plan for Greece, required by the IMF as a condition for lending, has still not materialised. In the meantime, Greece’s economic situation is worsening.

A key factor of a turn-around plan is to sustainably re-negotiate or restructure outstanding debt. There are two elements to this: reducing interest rates, and extending debt maturities. In a drastic situation, the debt is actually partially reduced, or a “haircut” occurs. These two elements, sadly, have not been addressed. The first bail-out package was a carte-blanche roll-over of private sector debt, with a 1:1 redemption rate and a higher interest rate payable by Greece on the EUR 110 billion sovereign loans. This was intended to buy time, but little else. It certainly didn’t buy confidence. The second bail-out has still not been agreed.

Over the past 2 days, judging by press reports, the Eurozone is debating a mix of policies which for the first time may lead to meeting the two conditions of a debt restructuring: interest rate reduction, and maturity extension.

One proposal under consideration is to use the European Financial Stability Fund to allow buybacks of national debt, presumably on the open market. It is not clear what effective discount this would deliver, since steady buying in large volumes would presumably eliminate the discount in time. Furthermore, it’s not clear what happens next: how long does Greece have to pay off the debt which would be held by the EFSF?

A second proposal, made by Mr. Martin Blessing, Chief Executive of Commerzbank, and reported today by the Financial Times, is to implement a 30% haircut on Greek bonds, and exchange the present bonds for new ones with a 3.5% yield and a 30-year maturity.  Again, it’s not clear whether this represents bonds which have already been purchased (or slated for purchase) in the EUR 110 bln bail-out, or if it refers to the remaining outstanding debt. In any case, this condition would be an excellent suggestion if implemented—far better than the French proposal.

The principle of private sector participation in setting the Greek debt crisis has been confirmed in principle by the Eurozone finance ministers, although the ECB remains opposed, and no one is quite sure what this means.

It is now extremely urgent that a resolution is reached, and it has to be reached in the next 2-3 weeks in order to calm the “bond vigilantes” and the wider debt markets. With contagion knocking on Italy’s door, and with the US embroiled in its own debt negotiations, the international climate is rapidly deteriorating.  Ireland and Portugal have been downgraded to junk by at least one rating agency (each). China’s growth is showing worrying signs of slowing: high inflation is observed alongside slowing imports. International sentiment is likely to worsen in the months to come.

A decision has to be made soon. Waiting until September, as German Finance Minister Schauble suggested, is the height of irresponsibility. 
Although news headlines have been dominated by the economic contagion affecting Greece, Ireland and Portugal, research by Navigator Consulting Group indicates that the public debt situation in major economies, including the United States, Japan, Italy, Belgium and France, is rapidly approaching the danger zone. This is exacerbated by the fact that in many countries, including the United States, the national debt has not been fully consolidated.

In the United States, for example, the debt:GDP ratio is already 98% at the Federal level. However, if state budget and local (municipal) deficits are added, as well as the sub-prime securities and mortgage-backed securities held by the Federal Reserve, then the true level rises to approximately 112% expected 2011 GDP (market values).

Federal Debt*
$ trillion
US Federal Debt
FY 2011 Deficit Forecast
Additional Debt: Federal, State & Local Systems
$ trillion
Federal Reserve: Mortgage-Backed Securities
Federal Reserve: Maiden Lane
US State Deficits, FY 2010
US Federal Deficit, FY 2011
Total Additional Debt
Total plus Federal Debt
2011 GDP Growth Rate Estimate
2011 GDP
* March 2011
Sources: US Congressional Budget Office; Bloomberg; US Federal Reserve; US Treasury

Of course, the US debt situation is not entirely similar to Greece for the following reasons:

a. It is not exactly clear what share of the Fed’s mortgage-backed securities are toxic or non-peforming, and what the actual market value of these securities are. In our opinion, the Fed’s practise of “investing” in these securities was as distortionary as the Greek government’s practise of guaranteeing the debt of state organisations such as the Hellenic Railways Organisation: it should be avoided if possible. (The same principle applies to the $ 5 trillion in mortgage guarantees issued by Fannie Mae and Freddie Mac: the government has in principle agreed to wind down these positions, but it is difficult to see how this will occur).

b.     A large part of the US debt is due to Federal government borrowings on the Social Security trust fund. In essence, one part of the government is borrowing from the other. Nevertheless, under standard debt consolidation rules, this has to be counted as debt (and does, in fact, count towards the current debate in raising the debt ceiling). Given the strength of demographic change in the United States, counting social security debt as central government debt is probable necessary.

c.     The United States dollar remains a global reserve currency; the US Federal debt remains a global safe haven in times of risk. It remains to be seen how much longer this situation will apply.

Each of these caveats about the United States, however, are overshadowed by the unfunded pension liabilities at the Federal, State and Municipal levels, as well as future costs of the Iraq and Afghan Wars. Together with declining competitiveness, a persistent trade deficit, demographic change and political gridlock in Washington, the future outlook is bleak.

By 2015, we estimate that the public debt in many leading OECD economies, including France, the United States, Spain, Belgium and Italy risk being in a range between 100-130% of GDP unless further, immediate structural adjustment measures are taken. The Debt:GDP ratio of Japan may exceed 220%.

The impact of higher public debt will have an immediate impact on a range of issues, including higher inflation, higher interest rates, and a crowding out of credit for private sector investments.

The situation is so fluid as to change daily. Italy has come under renewed fire this week, for perhaps the first time since the sovereign debt crisis began. The United States has a self-imposed deadline of early August before it reaches its debt ceiling and a technical default. Japan has been largely spared international difficulties, in no small part due to the fact that nearly all its debt is funded from national sources. But between demographic change, Chinese and Asian competition, the tsunami and a range of other factors, it is difficult to see a sustainable exit strategy in the next few years.

As a final note, my corporate and personal policy since late 2009 has been to diversify risk and take every step possible to protect assets. There is little in the economic forecasts of the next 2-3 years which has changed my opinion since then. I encourage everyone to take a very hard look at their financial situation, and see what the worse case scenario could be. It may be closer than we think.

© Philip Ammerman, 2011