Sunday, 28 August 2011

12:17 – Irene nailed the North Carolina and Virginia coastal areas pretty badly, but we saw no effects in Winston-Salem other than a stiff breeze and a bit of rain. This storm had the potential to make landfall as a Category 3 or even 4, so most of those in the affected areas are probably feeling pretty lucky that it was “only” a Category 1. Of course, that’s small consolation to those who were killed or injured by this storm, or suffered severe property damage.

I’m still working on the biology kits (and book). We made up subassemblies yesterday for another 18 chemistry kits, which means I need to start getting orders ready for more components. While I’m doing those orders, I’ll add the stuff I need to prototype the biology kit and produce maybe a dozen of them.

I periodically get emails and a few comments about how the Euro crisis is not really serious. Those messages invariably comment on the size of the US debt relative to Euro nation debts. Now, it’s true that the US is highly indebted, but what really counts is how much each country has to pay on that debt. Assuming that Greece, Italy, and the US all had to refinance all of their existing debt tomorrow at the current bond yields, here are some rough numbers with interest payments as a percentage of GDP.

US – interest payments of about $200 billion a year on outstanding debt of about $15 trillion, with GDP around $15 trillion = 1.33% of GDP

Italy – interest payments of about $200 billion a year on outstanding debt of about $3 trillion, with GDP around $2 trillion = 10% of GDP

Greece – interest payments of about $200 billion a year on outstanding debt of about $488 billion, with GDP around $305 billion = 66% of GDP

I’m making some assumptions here that render these percentages meaningless, because the market would not continue to lend money to any of these countries if they attempted to refinance their entire debts at one time. For Italy, I’m assuming yields of about 6.7%. They’re currently right at 5% on 10-year debt, but that’s with the ECB buying Italian bonds like crazy. They can’t do that much longer, and when they stop doing it the yields on Italian bonds will skyrocket. On Greek debt, I’m using the current 2-year yields, which are north of 40%, because few people are crazy enough to lend money to Greece on a 2-year basis, let alone for 10 years. And, of course, these countries don’t need to refinance all of their debt overnight. But Italy and Greece do need to refinance a huge chunk of their current debt over the next few months, and these yields are reasonable in that scenario. In fact, I’d expect to see yields north of 10% if not 15% on Italian debt when the big chunks come due for refinancing, and yields considerably over 50% for Greece. That won’t actually happen, of course, because both Greece and Italy will default first.

Making matters worse, while the US can print as many dollars as it needs to avoid default, that option is not open to Greece or Italy. There are two potential directions this could go. First, Greece and Italy could abandon the euro and return to the drachma and lira, respectively. If that happens, their local currencies will be devalued hugely literally overnight. They won’t be able to buy enough euros to honor their debts, and they will default. Conversely, Germany and the other northern tier countries may abandon the euro and return to their local currencies. If that happens, the countries that remain in the Eurozone will see the value of the euro plummet relative to the northern tier currencies as well as the pound and dollar. The new ECB can print as many euros as it needs to, and it will need a lot to pay off all those debts. Someone who holds a euro-denominated bond for a billion euros will in fact be paid that billion euros. The problem is, those billion euros will be worth probably at most a tenth of what they’re worth now relative to the dollar or pound or Swiss franc. The remaining Eurozone countries become dirt-poor overnight, while the northern tier countries benefit by paying off their euro-denominated debt in euros that are nearly worthless. Of course, the holders of that debt suffer badly, as will holders of any euro-denominated debt. Northern-tier countries see their exports plummet, but those high levels of exports to other EU countries were never anything other than illusory anyway. There’s no point in sending goods to countries that aren’t going to pay for them.

All of this makes me wonder when our politicians are going to wake up to the fact that J. M. Keynes was completely wrong. If they had any sense, they’d be reading F. A. Hayek, who had it completely right all along. Of course, being politicians, by definition they have no sense. And, to a politician, Keynes’ advice to governments to intervene constantly and heavily in markets is much more appealing than Hayek’s advice to keep their damned hands off the markets.

3 Comments and discussion on "Sunday, 28 August 2011"

  1. Chuck Waggoner says:

    I agree with the last paragraph, but in all the rest of it, I cannot agree. Keynes’ fictions have become a religion, just like the Jesus fiction is now a whopping big religion, followed blindly and aggressively by people who have never even researched the matter.

    But I have heard and read enough from the Germans in positions to make things happen, that the fact is, industry is quite happy with the Euro. It has solved a lot of problems for Germany–and also quite a few for their bosom buddies over in France. It has essentially fixed exchange rates so buying and selling across the whole of the EU no longer has any exchange rate downside.

    Most importantly, the world has accepted the Euro,–so much so that, in many cases, it is now preferred over the Yen, Pound-Sterling, Brazilian Real, and others.

    You will not find Germany pulling out of the Euro unless it collapses entirely. Trade is of the utmost importance to Germany. It took them over 50 years work to achieve the Euro, and introducing a new currency would quickly undermine all that work. In my experience, the German nature is totally opposed to quickly switching tactics, as if it were an American football or basketball game. For whatever reason, Americans just do not have the ability to understand that cultural difference.

    Germany and the north countries have the wherewithal to rescue the South–and THEY WILL DO IT, as long as Germany wants it done. Industry is in control in Germany, and as one German academic said not long ago: the people are highly organized, incredibly industrious and well educated (and they are rich compared to Americans); but their nature is that they want somebody (a boss) to tell them where to show up and what needs to be done. In the final analysis, the Germans will do what the captains of industry say. And they are not saying, ‘ditch the Euro.’

    The biggest problem in Euroland at the moment, is that Germany’s will, will be done. Whole countries’ prosperity depends on them. Regardless of whether those southern nations have been profligate or not, there is a big risk that they will come to hate Germany, as European countries did leading up to WWII. It will be interesting to see how Germany handles that.

  2. Robert Bruce Thompson says:

    Chuck, as Buffy once observed, your logic does not resemble Earth logic.

    Of course many German manufacturers have loved the Euro, although that love affair is fast disappearing as they finally recognize the hidden costs. Other countries coming to hate Germany? Surely you jest. They already hate Germany. They’ve hated Germany and Germans since 1870, and they’ve never stopped. Germans rich compared to Americans? Pull the other one. On average, Germans have a noticeably lower standard of living than Americans, and that’s ignoring the former East, whose richest sections are poorer than the poorest in former West Germany. Germans have a noticeably lower GDP per capita than the US, much higher taxes, and much higher government spending. The only argument that the facts support is that the average German is richer than the poorest Americans. We have a much greater spread of income distribution here, thank goodness.

    Germany and the norther tier do *not* have the wherewithal to rescue the southern tier, even on a one-time basis, let alone an ongoing basis. Even now, German banks are teetering on the edge of insolvency. Attempting to bailout even Greece may put them over the edge, and attempting the same for Spain or Italy, let alone Spain *and* Italy would beggar Germany. And then there are Belgium *and* France to consider.

    But we’ve both said all of this before. As I said, there’s no point in arguing. Events will prove one of us wrong sooner rather than later. If you really believe what you say, why don’t put your money where your mouth is and convert all your assets into Greek bonds? At >40% yields on two-year bonds, you’d make a killing, assuming you’re right. So how much do you have invested in Greek bonds?

  3. Dave B. says:

    Given the difference between the yields on German debt, and Greek and Italian debt, it’s obvious to me the markets don’t believe Germany will keep bailing out the financially troubled European countries. The markets are very rarely wrong.

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