Is Greece a Real Financial Crisis? Inflationism and Terminal Debt
So far, the financial markets have decided that Greece is not a real crisis. That's because markets are focused on peripheral issues: will Greece leave the euro (maybe) and will there be political or bond market contagion in other euro zone members (probably)?
Is Greece a Real Financial Crisis? Inflationism and Terminal Debt
So far, the financial markets have decided that Greece is not a real crisis. That's because markets are focused on peripheral issues: will Greece leave the euro (maybe) and will there be political or bond market contagion in other euro zone members (probably)?
The real issue is excess debt. In fact, we call it terminal debt. Since the first bailout by the EU in 2010, Greece's debt load is up nearly 50% while the GDP required to service this debt is down nearly 30%. There is no way this debt can be carried. Even the IMF, one of Greece's main creditors, has stated that the debt must be cut substantially. The EU refuses to accept this fact because default requires them to recapitalize the public institutions that hold that debt. Recapitalization means member countries must incur more debt by issuing more sovereign bonds. This debt will surely have to be purchased by the ECB which will, itself, have to be recapitalized...a circle-jerk if there ever was one.
Greece is not alone...there is never just one cockroach
Meanwhile, Puerto Rico has emerged as "America's Greece". In Puerto Rico today, more than 40 percent of the population is living in poverty, the unemployment rate is over 12 percent, and the economy of the small island nation has continually been in recession since 2006. Nonetheless, Puerto Rico has continued to pile up even more debt to the point where it is simply not sustainable. Almost all of the 73 billion dollar debt is owed to U.S. financial institutions. Another example of terminal debt made possible by what Doug Noland calls central bank inflationism.
The recent crash of China's equity markets is a further example of central bank inflationism. Attempting to halt a real estate crash, the central bank has led the world in credit expansion, resulting in an equity bubble which has collapsed nearly 30% in three weeks and seems to be resisting extraordinary government and central bank efforts to prevent a complete 1929-style melt-down.
As Noland notes, the global leveraged speculating community has placed decent sized bets in Greece, China and Puerto Rico, driven to these fringe 'opportunities' by zero interest rates, aggressive QE and perceived central bank market backstops. Current developments are a possible catalyst for self-reinforcing globalized de-risking/de-leveraging (meaning lower financial asset prices), exactly what gold needs to move higher.
The US has been without QE for nine months now and the credit system is beginning to show the effects. Credit growth already slowed sharply during Q1 (to 2.8% annualized from 4.9%). Not surprisingly, the uptrend in financial markets has also stalled. Robust credit growth is absolutely essential to take care of debt rollovers and fund the levitation in financial assets.
Rampant Inflationism
The real issue is that central banks around the globe have adopted policies of extreme inflationism...printing more money to buy more debt and maintaining ridiculously low interest rates. The evidence of inflation is in asset markets, not in consumer prices as your government measures them. These inflationary policies have not helped to achieve sustainable growth in economies already overburdened by debt. At the same time, inflationism has significantly increased risks in the financial system by mispricing financial assets. Extraordinary complacency, rapidly increasing debt levels, overvalued stocks and bonds and slowing economic growth have together created enormous vulnerability in the world financial system.
Everything looks somewhere between ok and good as long as asset markets remain inflated. But as Noland points out, enormous amounts of leverage continue to accumulate throughout the securities markets. Borrowings to finance M&A, stock buybacks, and leveraged speculation in bonds and stocks are the prevailing (unrecognized) sources of credit fuelling the markets. This type of credit is inherently susceptible to reversals in asset prices.
Greece, Puerto Rico and China are signs that inflationism is failing and terminal debt is approaching. There will come a point when markets realize that central bank policymakers do not have things under control. Then, watch gold perform.
See Doug Noland source material at: http://creditbubblebulletin.blogspot.ca/2015/07/my-weekly-commentary-triad.html