Greece’s near default and rescue by the European Union has brought one reality starkly into relief: in an age of fiscal and monetary stimulus, it isn’t only banks that can give debt investors sleepless nights. Greece is no more “risk-free” than was Lehman Brothers, and indeed Britain is no more “risk free” than Merrill Lynch. The implications of this for the global economy are disturbing, but not all negative.
The principal implication is that the differentials in borrowing costs between countries, which had been suppressed since US monetary inflationism began in 1995, are about to reappear. This is not entirely a bad thing. Excessively low bond yields had led investors to chase higher returns through pushing out to less and less creditworthy countries.
In a few cases, such as Vietnam, this jump-started economic growth and put the country on the road to prosperity at rate faster than could have been achieved in a more balanced economic system.
In more cases however, such as Greece, but also including notably Argentina, Kazakhstan and Russia, it allowed incompetent and unpleasant regimes to get away with plundering their middle classes and redistributing the wealth to themselves for much longer than should have been possible. Thus an increase in country risk differentials is generally to be welcomed.
The country risk differentials that are now bound to reappear will however be different from those that governed in the middle 1990s. Many Asian countries, which in the period after the Asian crisis of 1997 paid premiums to borrow because of their poverty or high capital needs, will find money readily available this time around. South Korea, which should never have got into trouble even then, will find its ability to borrow little affected by the new tightening, as it has not engaged in major “fiscal stimulus” nor run an excessively accommodating monetary policy.
At a lower income level, there is also no reason why Indonesia should find its access to capital significantly affected. It has substantially reformed both its economy and its political system since the crash of 1998 and in the 2009 crisis pursued well thought out, conservative policies. The risk of investment in Indonesia is still significant, because of the corruption remaining in the country, but it remains an attractive diversification for investors seeking higher long term growth in emerging markets without putting all their eggs in breakable BRIC baskets.
One emerging market which should continue to prosper generally but may find life difficult for a while is Vietnam. Vietnam is generally economically well run, but ran a colossal balance of payments deficit in 2007-08 as its exchange rate was pushed up by a tsunami of foreign investment, both in hard assets and from “hot money.” It will thus suffer short-term as the flow of risk-seeking capital lessens and risk premiums widen. However the progress Vietnam has made and its undoubted cost advantages, together with its healthy level of domestic capital formation, should allow it to continue to prosper in the long run, albeit with a higher (and healthier) domestic proportion of capital in its growing industries.
The principal losers from tightening credit markets will be the rich countries that have deliberately put themselves on a path to bankruptcy, even if delayed bankruptcy, under the impression that this would in some magical way lessen the impact of the 2008-09 recession. The more artificial “stimulus” they indulged in, the greater the economic price they will have to pay. Countries like Britain, the United States and Japan that were like Greece already grossly over-indulging their public sectors before 2007 will be in the greatest danger. Naturally, the effect will be different, because all three countries have independent currencies. Their chance of default – at least in the short term– is less than Greece’s but their likelihood of prolonged and debilitating recession is equally high.
The likely increase of risk premiums for wealthy countries that have unbalanced their fiscal positions will not simply be reflected in higher borrowing costs for their governments. That would be poetic justice, and would affect few inhabitants of those countries, except in the very long term as debts piled up. However as well as their governments, the costs of borrowing will rise for private businesses based in those countries, and their availability of finance will diminish. We have already seen this effect in Japan as the foolish Aso and Hatoyama governments reversed the sound policies of Junichiro Koizumi and pointed the Japanese public sector towards more unsustainable “stimulus.” Unlike in other countries, the huge budget deficits in Japan have caused a collapse in domestic prices, genuine deflation, so real government long-term bond rates, including the reduction in prices, have increased by more than 4% since the autumn of 2008. Japan has moved from being one of the world’s finest credits and soundest economies, because of its citizens’ hard work, excellent education and savings habits, to an oversized Greece, with a debt position that has become unsustainable and a private sector that is being starved of finance.
As I wrote here last week, the damage from “stimulus” has also begun to appear in the United States, where the excessive issuance of Treasury bonds and government guaranteed housing bonds has made bankers put their feet up on the desk, collect the large leveraged returns for risk-free and brain-free investment in those securities, and abandon the small business sector to an unpleasant fate.
In a world of higher funding cost differentials, the fortunes of the BRIC countries will diverge. China, although engaging in “stimulus,” did so from the basis of a very sound fiscal position and with low foreign debt. It is thus in no immediate danger of government default. It is currently struggling with a real estate bubble that is in the process of bursting, and it has the problem of a banking system much of whose assets are bad. However China’s leadership has an unexpectedly good grasp of even the more complex areas of economics – as evidenced by its decision this week to raise reserve requirements in its banking system to cool its real estate bubble. This is in contrast to Ben Bernanke’s “trial balloon” this week of abolishing minimum reserves altogether – he appears to have missed the point that fractional reserve banking is unsustainable, bound to crash in ruin and hyper-inflation, if you make the denominator of the fraction zero and money creation thereby infinite.
India on the other hand is largely a curried version of Greece, highly corrupt and with a public sector devoted almost entirely to rent seeking. The Indian electorate’s foolish decision last May to re-elect the Congress party, creators of this ghastly system, will reap its reward in the relatively short run, as India’s consolidated fiscal deficit of 12% of GDP and relatively low savings rate collapses the economy once again into a financial crisis similar to those that limited it to the “Hindu rate of growth” for forty years from independence. Needless to say, the splendid Indian private sector, which had finally allowed 1.2 billion people to see the possibility of better living standards, will be the worst sufferers from this disaster.
Russia and Brazil are less interesting. Russia will do fine while commodities prices are high, but the inevitable growth slowdown that increasing risk premiums will produce will destabilize Russia’s economic position, probably producing another default like that of 1998. Brazil, which a decade ago would have been a major sufferer from an increase in global spreads, has greatly improved its position. Its exceptionally sound monetary policy has kept real interest rates high, prevented excessive domestic consumption, government or private, and built the country’s domestic savings base. At this point, Brazil could probably do with a change in government, to ensure that property rights are not eroded and public spending remains under control, so that the bonanza from high commodity prices is not wasted.
As for the Eurozone, most directly affected by Greece’s problems, its likely fate is no worse than elsewhere, since a number of its members, notably the soundly run Germany, did not engage in “stimulus”, indeed denouncing it as the “crass Keynesianism” that it was. Its fate from here on depends on how effectively it forces Greece to behave itself, sharply downsize its corrupt and bloated public sector, collect taxes from its citizens and right its fiscal ship.
If EU discipline reminds older Greeks of the Nazi occupation, with thuggish all-powerful sadists with monocles and black leather uniforms forcing the locals to clean up all the corruption rackets that they have enjoyed for decades, all will be well. In that case, news of the horrors afflicting Athens would spread to Portugal, Spain, Italy and Ireland, forcing them towards unpleasant reform on their own for fear of the same scourge arriving in their own countries.
If on the other hand the bailout resembles most EU operations, with polyglot socialist bureaucrats drafting 1,000-page reports, while deceiving themselves as to the theft that is going on under their very noses, then the Eurozone is in real trouble. In the latter case, in spite of the common sense exhibited by Germans and Scandinavians alike, the EU will dissolve into an orgy of rent-seeking, probably collapsing completely when the much larger Spain, Italy and Britain demand access to the bailout gravy train. (Britain would presumably be refused, thus causing both economic collapse and a tsunami of anti-EU sentiment, forcing the country to leave the EU and seek its fortune elsewhere; out of evil can come good!)
The Greek crisis appears to have pushed us into a new world. On the whole, this is a good thing.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)