FedUpUSA

Archive for July 17th, 2011

For decades, the U.S. government has had a AAA rating.  On the scales used by the big three credit rating agencies, that is the highest credit rating that a government can get.  Moody’s scale actually uses lettering that is a little different from the other two big agencies (“Aaa” instead of  “AAA”), but you get the point. Right now, the U.S. government is closer than ever to losing its AAA rating.  The threat of a rating downgrade is going to continue to grow regardless of how the political theater that we are watching unfold in Washington D.C. plays out.   The truth is that the federal government has accumulated a debt that is so vast that it will never be paid back.  In fact, we are rapidly approaching the point when this debt will no longer be serviceable.  If the credit rating of the U.S. government is not slashed right now, it will be soon enough.  In fact, the truth is that the U.S. government is such a financial mess that it should have been done long ago.  But whenever the United States does lose its AAA rating, we could potentially see financial hell unleashed because it will also mean that there will almost certainly be a wave of credit rating downgrades from coast to coast.

As I have written about previously, government debt becomes more painful the higher that interest rates go.  When the big credit agencies downgrade the credit rating of a government, that is a signal to investors that they should ask for higher interest rates on debt issued by that government.

This does not always play out in practice (just look at Japan), but nations such as Greece, Portugal and Ireland sure are going through financial hell right now as they deal with reduced credit ratings and soaring interest rates.

Right now, the U.S. government is able to borrow gigantic quantities of money at ridiculously low interest rates. This is the primary reason why the debt disaster predicted by so many in the past has not arrived yet.

If the credit rating of the U.S. government is downgraded, it could finally get investors all over the world to realize that the game is over and that they should be demanding much higher returns on debt issued by the U.S. government.  The truth, as U.S. Representative Ron Paul put it recently, is that the U.S. government is already “insolvent” and at some point we are all going to have to face reality….

“Ultimately, the fundamentals show this country is bankrupt.”

So whether or not it happens right now, the truth is that at some point the credit rating of the U.S. government is going to go down and interest rates are going to go up.

Unfortunately, it appears that this might happen sooner rather than later.

Earlier this week, Moody’s Investors Service publicly announced that it would be reviewing our Aaa bond rating for a possible downgrade.

On Thursday, S&P actually went so far as to announce that there is a “50 percent chance” that it will downgrade the credit rating of the U.S. government within the next three months.

S&P has been warning of trouble for some time now.  Back on April 18th, Standard & Poor’s altered its outlook on U.S. government debt from “stable” to “negative” and warned that a downgrade was likely at some point soon if nothing changed.

If the credit rating of the U.S. government gets slashed and if that results in higher interest costs on the national debt, that is going to make it much harder to balance the budget.

The U.S. government will take in somewhere around 2.2 or 2.3 trillion dollars this year.  It will spend somewhere in the neighborhood of 3.5 or 3.6 trillion dollars this year.

Included in that spending is about 400 billion dollars that goes for interest on the national debt.

As I explained in a previous article, if our interest costs double or triple it is going to make it basically impossible to balance the budget under our current system.

If interest rates on U.S. government debt were to rise to moderate levels, we could soon be easily paying a trillion dollars a year just in interest on the national debt.

If interest rates on U.S. government debt were to rise to the levels that Greece, Portugal and Ireland are now facing, it would be beyond catastrophic.

But a reduced credit rating and higher interest rates would not just hurt the finances of the U.S. government.

Any financial institution that is linked to the U.S. government in any way would also probably be downgraded.

This fact was noted in the announcement put out by Moody’s this week….

In conjunction with this action, Moody’s has placed on review for possible downgrade the Aaa ratings of financial institutions directly linked to the government: Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks.

We have also placed on review for possible downgrade securities either guaranteed by, backed by collateral securities issued by, or otherwise directly linked to the government or the affected financial institutions.

Just think of the financial carnage that would cause.

Also, check out what one Bloomberg article had to say about the potential cascading effects of a credit rating downgrade for the U.S. government….

At least 7,000 top-rated municipal credits would have their ratings cut if the U.S. government loses its Aaa grade, Moody’s Investors Service said.

An “automatic” downgrade affecting $130 billion in municipal debt directly linked to the U.S. would occur if the federal level is reduced, Moody’s said yesterday in a report. Additionally, top-rated securities with no direct links to the national government will be reviewed for similar action.

But the nightmare would not end there.  The truth is that the credit ratings of large numbers of state and local governments from coast to coast would likely be reviewed and downgraded as well.  Right now, many state and local governments are scratching and clawing in a desperate attempt to survive financially, and a significant rise in interest costs would be enough to wipe many of them out.

The ripple effects of a U.S. government credit downgrade would be endless.

A lot of people argue that if the federal government ran a balanced budget from now on none of this would matter.

Unfortunately, that is not true.

At this point, a very high percentage of U.S. government debt is short-term debt.  That means that gigantic amounts of debt must be “rolled over” each year in addition to any new debt that we take on.  So even if interest rates rise significantly on just the existing debt that we have it is going to be a total nightmare.

And make no mistake, whether it happens now or later a collapse of U.S. government finances is coming.

David Murrin, the chief investment officer at Emergent Asset Management, recently told CNBC the following….

“It’s inevitable that the U.S. will default—it’s essentially an empire which is overextended and in decline—and that its financial system will go with it”

Right now it is being projected that the U.S. national debt will hit 344% of GDP by the year 2050 if we continue on our current course.  We are on a runaway train that is heading straight for a brick wall.

Europe is also a complete financial wreck.  The sovereign debt crisis over in the EU continues to grow worse by the day and there is no end in sight.

If the U.S. collapses, Europe is not strong enough to save it.  If Europe collapses, the U.S. is not strong enough to save it.

We really are entering an unprecedented time in world history.   We are on the verge of the first truly global financial disaster.

It is going to be interesting to see which major currency crashes and burns first.  Some think that it will be the euro.  Others think that it will be the dollar.

In any event, the reality is that the current global financial system is not sustainable.  The folks that are in charge can try to keep things together for as long as possible, but at some point the dominoes are going to start to fall and the house of cards is going to crash.

We have entered a time when there is going to be financial crisis after financial crisis.  Even if the EU and the U.S. government can somehow fix things for the moment, more problems are going to be just around the corner.

The world has become incredibly unstable and the entire globe is going to be shaken.  Most people cannot even conceive of the kind of financial hell that is coming our way as a nation.

Yes, it can be a bit sad to think about what is happening, but it is much better to be armed with the truth than to be totally clueless and totally unprepared.

The Economic Collapse

The lies are flying fast and furious this weekend (and all last week for that matter) related to the “debt ceiling” and partisan wrangling has reached a fever pitch, with some representatives now claiming that the Republicans are “racist” for refusing to raise it.

Let’s look at the facts, and deal with them – because we really have no other choice here.  I apologize in advance for the length of this post, but there’s simply no way to make it shorter.

I’m going to start with some indisputable history.  We’ll begin with this chart, because it tells us exactly what the outcome of each quarter of economic activity has been since 1953.  It draws on two official data sources – The Fed’s Z1 and The BEA’s GDP series:

I’ve presented this chart many times before, but it is important to understand what it shows you.  This is simply a mathematical ratio of the number of dollars of GDP created and the number of dollars of new debt created anywhere in the economy.  It does not distinguish as to where the credit is created, just that it is, nor does it distinguish as to how the GDP is created (e.g. is it consumption, net investment, etc)  If, for each dollar of GDP expansion there was one dollar of debt expansion, then the ratio is “0″.  If there are two dollars of debt expansion for each dollar of GDP expansion, the ratio is “-1″.  And if there are two dollars of GDP expansion for each dollar of debt expansion, the ratio is “1″.

Therefore, for any quarter in which this ratio is positive, debt is being used predominantly for expansion of output, and is productive.  The more-positive, the more productive.  For any quarter in which the ratio is negative debt is being used for either speculation or consumption and is destructive.

The problem is this: Since 1980 there has not been one three month period in which GDP expanded faster than new debt did.

Read that again: There has not been one quarter in which actual economic expansion occurred, on net, funded by improvements in actual economic output since 1980.  Not one time, even with the introduction of the personal computer, the introduction of the Internet, and with the so-called “great productivity” improvements that we have been sold as “facts” by the so-called mainstream media.

We have literally put the nation’s forward “progress” on the credit card in each and every three month period since 1980!

This is the root of the problem we now face and there is nothing we can do about history; it is fact.  We can only change the future.

This is what that chart looks like in terms of what we actually had to do to achieve that horrific outcome:

This is the quarterly change in dollars of GDP and debt in the economy in all sectors since 1953.  You will notice that while the best we’ve ever managed to achieve is around $250 billion in net GDP additions, we have added approximately $1,300 billion in debt in one single quarter.  Again, these are historical facts and nothing we can do will change them.  This is where the distortions in our economy have come from, and they have occurred in both Democrat and Republican administrations along with Republican and Democrat Congresses.  President Clinton, for whom many pine, in fact promoted private business Ponzi Finance at a faster rate than he was “helping” on the Federal side.

Ironically, it was George HW Bush (Bush the Elder) who was the last President to make any sort of actual progress in getting those two lines to cross, albeit unsuccessfully.  As for President Obama, the collapse in credit accreation was due to the economic meltdown, but it was short-lived as you can see.  The reason for that is found here:

Federal Debt creation skyrocketed starting in 2008, Bush’s last year.  But it has only accelerated under President Obama.  To those who claim that President Obama has somehow “inherited” Bush’s problems, irrespective of whether you believe that or not he has continued the destructive policies of his predecessor in this regard.

President Bush tried to cover up an economic depression.  We know this to be factually true for the following reason:

The last calendar year of Bush’s Presidency, 2008, he ran government deficits as a percentage of GDP to 10%.  Absent that deficit spending, since GDP is defined as “C + I + G + (x-i)” GDP would have contracted by at least 10%. This is 2nd grade mathematics – specifically, subtraction. Since the cessation of that deficit spending would have a multiplier effect (and economists fight over exactly how much all the time) the actual contraction would have been more than 10%. The 10% line is the barrier behind which economists call an economic contraction “Depression.”

Ergo, we have been in an economic depression for the last three years which government has covered up through massive deficit spending exceeding 10% of GDP.  Again, this is mathematics, and irrespective of whether you wish to believe it or not, these are the mathematical facts.  Again, both Democrats and Republicans are equally responsible.

Unfortunately the news gets worse.  As I pointed out in the spreadsheet on Friday, our government currently spends about 11% of it’s budget on interest.  It cannot, of course, spend more than its budget on interest, nor can it spend anywhere near all of it, since there are functions of government that are essential (even if only to provide lighting to the Capitol building!)  If we continue to expand government at 5% (over the last ten years it has in fact been 7%) annually and interest rates do not go up at all (3% blended, roughly) then at present rates of government debt creation within ten years more than 20% of the budget will be interest payments, in another 10 it will be nearly 40%, and so on.

You can see the problem immediately – for each decade the percentage of interest payments in relationship to the budget doubles.

You might look at that spreadsheet and deduce that we have some time.  You’d be wrong.  We already used up our “reserve” of time by suppressing interest rates via The Fed. This bought us a few years of time, but that bullet has now been spent.

The reason we cannot continue on the present course is that the important factor is the spread between government debt creation and government revenue increase.  But remember, government revenue can only go up as GDP does in a sustainable fashion.  That’s because government by definition gets its money by imposing tax upon production.  If taxes rise faster than GDP does the attempt to raise taxes fails over the intermediate term for the same reason that debt cannot rise faster than GDP (you can think of taxes as simply an interest payment on GDP if you wish; mathematically they’re identical.)

Right now we have about 2% of “reported” GDP growth on an annualized basis.  We are borrowing and spending, however, almost 12% of GDP.  That means the “spread” is about 10%.

In order to actually begin to increase stability in government debt, that spread must be negative!  Making it “less positive” slows the slide in stability, but does not reverse it.

And that’s where the problem comes in that confounds accurate analysis of where the event horizon lays.  Let’s assume we stop deficit spending tomorrow.  GDP contracts by 12% from where it is now immediately and the spread does not change.  That is, government has not improved its fiscal sustainability at all!

It’s worse; in the short run sustainability will get worse because of the aforementioned multiplier effect.  That is, GDP will contract not to -10% but to something more based on that multiplier!  So in the short run, until that works its way through the system, you actually go further into the hole!

Most economists agree that this effect requires somewhere between three and six quarters to stop percolating.  That is, when you stop (or increase) government deficit spending the GDP impact is “absorbed” in somewhere between nine months and a year and a half.  What we do not know, and nobody can give you can accurate number on, is what the “knock-on effect” percentage is going to be.

We thus cannot go to the “wire” before we decide to take this problem on and fix it.  If we do we will blow up for certain.  There is also nobody, myself included, who can give you an accurate read on exactly where the cliff-edge is.  I don’t know, they don’t know, nobody knows.  But what is absolutely certain is that the longer we take to deal with this the higher the probability that we will initiate a downward spiral where government revenues effectively collapse while interest rates skyrocket, making it impossible for the government to cover its debts.  This is what happened in Greece; they danced too close to the line and when they tried to pull back went off the edge instead.

The following facts are in evidence and cannot reasonably be disputed:

1. We do not have ten years to get to the point where government deficits grow slower than GDP does. We may have five years.  It is possible we’re already beyond the event horizon and squandered our chance in 2007. Nobody knows exactly where the cliff-edge is, and anyone who claims they do is lying.  The longer we take to get to sustainability the greater the risk is that we’re too late, and there are no “mulligans” in this game.
2. The mathematics are immutable facts in regard to the sustainability of what we’re doing. There is no arguing with the law of exponents.  Those “economists” who claim otherwise are lying.  If they do not understand the spreadsheet linked here and elsewhere it’s due to willful blindness – the properties of exponential functions are taught in middle school.  There is no complicated math required nor can you change the outcome of exponential functions irrespective of what sort of mathematical model you throw against the wall.
3. Due to the immutable law of exponents the longer we wait to get government debt level growth below that of GDP the worse the economic damage will be. It does not matter if you cut spending or raise taxes; both are immediately subtractive to GDP since taxes must come from either “C” or “I” in the GDP computation and spending comes out of “G”.  This is subtraction, which is typically taught in second grade.  No amount of arm-waving can change these facts.
4. We cannot avoid recognition of the economic depression we entered in 2008. The worst GDP change we recorded in 2008/09 was -4% annualized.  We must, inevitably, absorb at least three times that much damage. “Postponement”, known in the media as “kicking the can”, makes the problem worse.  To illustrate my back-of-envelope computations show that the total damage necessary in 2000 to restore balance was approximately 10% of GDP.  Now it’s at least 20% and may be more.  Not far from that level is catastrophic collapse.
5. Printing money, QEx and whatever else cannot change this outcome. Distorting the interest rates on government debt, which is what QE does, temporarily changes the amount of time you have before everything blows up but for any positive interest rate you blow up anyway. Simple emission of currency (which is what unbacked QE eventually devolves into if you keep at it long enough) destroys the purchasing power of each unit of currency (the dollar) which cannot work either; due to slippage and offshoring of labor this simply destroys your tax base and therefore trashes the government’s coverage ratio (or the ratio of interest payments related to tax revenues.)
6. We must fix the medical system.  If we don’t, nothing else matters. Notice I didn’t say “Medicare” or “Medicaid.”  I said the medical system. I have written extensively on this and cover it in depth in my upcoming book Leverage, which is currently in copy editing and will be out soon (estimated publication date is currently in November.)  The simple fact of the matter is that we can write checks with technology in the medical space we cannot cash, and we’ve tried to cover this up with all sorts of ridiculous and destructive distortions, from EMTALA to providing $1m births “free” to illegal immigrants to cartel-like behavior in diagnostics to barring re-importation of drugs and devices.  It’s simply outrageous that the local Best Buy must post a price on their 46″ TV and honor it for everyone, yet I cannot walk into a doctor’s office or hospital and get a price on having my gallbladder removed which must be honored for everyone.  This sort of behavior is illegal in many other industries (see the Sherman and Clayton Acts specifically) but the medical and insurance industries are, through various devices, exempt.
7. We must fix the tax and trade systems. While we cannot prevent the economic contraction we can try to blunt it’s impact by putting a stop to the incentives to offshore production that are based on near-slave labor, environment arbitrage and tax preference.  These are big issues and must be debated in the open and fixed.  Among the problems with the tax system is that many Americans have literally no skin in the federal tax game.  That must end.  So must the fiction of a “Social Security” and “Medicare” trust fund.  Either cut them loose and turn them into true trustee arrangements (in which case you can opt out and walk away) or stop lying about them and fold the entire mess into the general operating budget.  When it comes to taxes either a flat tax only on people (no corporate income tax) with zero deductions (yes, I said zero!) or The Fair Tax on consumption makes sense.   What doesn’t make sense is what we do now.  Key among the things we must stop doing is allowing deductibility of any interest expense – by anyone.  There’s much more (again, covered in the Ticker over the years and in Leverage.)
8. We must have an actual energy policy. A real one.  This is a tough, tough issue but we must face it.  30 years of blowing Arab Shieks is not an energy policy, but this must be dealt with anyway.  Roughly half of our military expenditure goes, directly and indirectly, to securing energy supplies.  We import about 1.5 billion barrels a year from nations that are deemed “dangerous or unstable” by the US State Department. If $300 billion a year of our military expenditures go toward protection this access, directly and indirectly, then each of those barrels does not cost $100, it costs $300 and our net cost of a barrel including domestic and “friendly” imports (think Canada) is approximately $200!  This is idiotic and must stop. It cannot, however, stop with “greenie” promises and premises – they do not work when analyzed on the basis of thermodynamics.  There are solutions (again, I’ve gone over them extensively in The Ticker and they feature in Leverage as well) but what we cannot do is continue on the path we’re on today.

These eight points are ones I’m willing to have a debate on with anyone who cares to – whether in the comment section of The Market Ticker, on Capitol Hill either in private with the staff of legislators or in public via testimony (taking as long for questions as the Reps and Senators involved would like.)

I recognize that the short-term pain involved in addressing these issues will be considerable.  There is no way to avoid that outcome – there wasn’t in 2007 and there wasn’t in 2001.  The economic pain required is significantly worse now than it would have been in 2007, but that doesn’t matter.  We either do it or we go off the cliff – that’s indisputable and is easily proved.  Those who argue otherwise have the burden of proof upon them to show how, given the relentless reality of basic mathematics, they’re going to avoid what is before us.  The “Ryan Plan” originally put forward was bereft of this ability, as have been President Obama’s claims – both relied on utterly unreasonable assumptions for GDP growth in the future along with doing nothing to address the underlying debt ponzi that has been accumulated over the previous 30 years.

I understand fully that partisan political bickering and deadlock are first and foremost how Washington DC scores “points.”  But today we can no longer pretend that we have time, nor that phony-baloney “solutions” will work.  Three years into the alleged “solutions” that were put forward by both Republican and Democrat administrations nothing has been resolved, employment has not come back and deficits have not stabilized.  The claims made over these previous years, in short, have been shown to be false.

These issues, and the debt trajectory for our government and nation, must be addressed now.

Trying to induce inflation to reduce accumulated debt is not a modern invention.  Dr. Carmen Reinhart and Dr. Kenneth Rogoff trace this kind of financial crisis and others back to the Dionysius of Syracuse during the 4^th century.  The debasement of currency also occurred in the Roman empire and Byzantine empire and as usual printing money or devaluing your own currency does not usually lead to beneficial outcomes if we are to use history as any guide.  We need to be upfront about what is going on here and that is the globe is reaching a peak debt situation.  Think of the recent problems we have seen in Iceland, Ireland, and Greece.  Yet these are simply tips of the visible iceberg of financial mania in our current system.  Europe has many issues to contend with especially when looking at Spain, Italy, and Portugal.  Here in the U.S. the Federal Reserve and U.S. Treasury are doing everything they can to ignore the reality of our current situation.  Politicians are unable to make the hard choices and bankers simply want to extract productivity from the working classes.  Our current predicament is not unusual in the books of history but the size and global interconnectedness is.

A history of manias and speculation

Source:  Extraordinary Popular Delusions and the Madness of Crowds; Charles Mackay 1841/1852

Speculation is inherent in most financial panics.  The above picture is from the South Sea Bubble of 1720 where investors speculated in South America.  This was largely concentrated in the United Kingdom but had a parallel event with the Mississippi Bubble that concentrated speculation in France.  Bubbles seem to spread so it is no surprise that Europe was whipped up in frenzy and when the bubble popped, the economies crashed and many were left in financial ruin.  In both cases investments were exaggerated in value and many people got sucked into the desire for a quick buck.  Banks like the Banque Générale Privée were more than happy to allow the speculation to continue.  We can find many parallels in our banking system and how it was central to the U.S. real estate bubble.

Let us rewind and look at the massive viral like expansion of subprime debt for example:

Source:  Inside Mortgage Finance

Read more at My Budget 360

Ok, so I just got done listening to the TOTUS once again pontificate about how moderate changes in the budget can make things work.

This is a lie.

Here’s another spreadsheet proving it – if we do not cut this crap out right now, we will become Greece.

I know you don’t want to hear this.  I know full well that there are a lot of people who believe they’re entitled to their benefits, to their Medicare, to their Social Security, to their Welfare and Food Stamps.

I understand.

The math doesn’t care what you claim you’re entitled to, nor what I believe you’re entitled to, nor what Congress wishes to grant you.

Here are the facts:

• Government debt has grown 11% in each year for the last three years, more or less.  This is a fact which you can verify from the Treasury’s “Debt To The Penny” series. Please do so, because I hate having to post the numbers after someone pops up and claims I’m lying.
• GDP growth since 2000 has averaged 4.1%.  I’ll use that number, even though our current GDP rate is under 2%.  This spreadsheet is a lot worse at 2.1%; government interest expense exceeds GDP (or government size) about 10 years faster!
• I am using a blended interest rate of 3% on government debt.  This is consistent with the Treasury’s own current numbers.  It is also very low on a historical basis.  I presume it will not rise, which is likely foolish.  If it rises, the spreadsheet gets a lot worse.
• I am using a government growth rate, all-in, of 5%.  This provides us a doubling time of about 14 years.  This is too conservative since 2000 (government has doubled in size in the decade, which is about 7%) but I am assuming we cannot maintain 7%.

Here’s the deal.  With these assumptions right now interest expense is about 11.3% of government’s total budget.  Within ten years it is 21.3%.  In 10 more it will be 40.52%.  In 10 more, that is 30 years from now it will be 76.98% (!) – in theory.  And in 35 years, it will consume the entire government budget.

Of course in 30 years interest expense will not be 3/4 of the federal budget.  Long before then the market will say “bullcrap!” and blow the entire charade to beyond the orbit of Pluto, much as happened in Greece and Ireland, and which threatens to occur in Italy.

If you believe we can fix this on a path that “stops accumulating the debt” in ten years, remember two things:

1. It’s roughly twice as bad in terms of interest expense as a percentage of the budget in 10 years as it is now, which means that twice as much harm in programs will have to be absorbed then as now, and the damage to GDP will be twice as bad.
2. Cutting the size of government temporarily makes the ratios worse! That is, there’s lots of pain in resolving this problem.

Ten years from now it is entirely possible that we will have gone too far to absorb that pain in attempted resolution.  There’s no precise way to know, but it is reasonable to assume this is the case, given these metrics., and the spreadsheet I have put forward is conservative in its assumptions.

The bottom line is this folks: Debt must never, ever grow faster than GDP does, whether that debt is in a given sector (e.g. government, consumer, financial, etc) or in the nation as a whole.

We therefore must balance the federal budget right now and accept the economic contraction that will come when we do it.  Yes, it will be bad – very bad – in the short term for the economy to do this.  But it’s worse now than it would have been in 2007 when I started The Market Ticker and the longer we wait the worse it will get, no matter what else we do.

Go ahead and download the spreadsheet and play with the assumptions.  The fact is simple as I pointed out before, and it applies to government as well as the general economy. For any growth rate in debt that exceeds that of GDP which has any positive rate of interest, you will eventually go bankrupt.

We argue only when, not if; this outcome is a consequence of indisputable mathematical facts.

Spreadsheet link: https://spreadsheets.google.com/spreadsheet/ccc?key=toI80r-WEj1hmDCfEZDotmw#gid=0

Steen Jakobsen, chief economist for Saxo Bank in Copenhagen, pinged me with a personal thought regarding Europe:

“I am just back from Italy and Russia and what really strikes me is how  people have given up, and I mean totally given up. To my mind we are  entering extremely difficult time where balancing EU, US debt and social  tension makes for a black Swan event.”

On his blog, Steen writes: Time is Running Out for Europe

Europe is close to losing a generation of youth in Spain, Ireland, Portugal and Italy, with between 20 and 45 per cent youth unemployment. To avoid losing this generation, European politicians and the ECB need to come up with a radically new game plan.

First, we need to stop pretending we can dance around the word “default” Let me help: if your income is less than your expenses and you can’t borrow money, you are done, finito, insolvent and in default.

That is another lesson from Greece; the longer you avoid facing the truth, the more you solve debt with debt, the deeper the hole you are digging as your new beginning necessitates a larger and large initial trauma.

Politicians tend to underestimate their voters ability to deal with a crisis. If the population at large knows it’s coming, they can and will deal with it. Many of today’s generation of politicians forget that their grandparents lived through two wars, the depression and several stock market crashes only to create the most robust growth era in modern history.

Yes, there will be some contagion and some short-term high volatility if Greece goes the default rout, but as they say in the world of sports: no pain, no gain.

In fact, a crisis 2.0 could be what is needed to create both the economic and political platform that will solve Europe’s problems: namely, a fiscal union. Do not misunderstand me – I am agnostic on the EU’s existential question, but the EU was created as a political institution, not an economic one. Europe is a house without a financial foundation: no ministry of finance.

The time has come for some major decisions if the great European experiment is to survive. The Euro Zone needs a Ministry of Finance, one that should probably issue Euro Bonds from EFSF/ESM.

The idea that one day the voters of Europe will rise up and embrace the EU idea is fading fast. The rising social tension in all of Europe shows us that – similar to my impatience with the Danish national football team – time is running out. Let’s for once hear some straight talk from the EU and the ECB and let’s put an end to the extend-and-pretend nonsense and attempts to pull the wool over the public’s eyes. Otherwise, Europe will continue to score own goals. That’s a pity, as a new start – even if painful at first – could set up decades of sustainable growth as more transparency and less leverage would bring more stable financial markets.

Nanny State or a Breakup?

Steen says ” I am agnostic on the EU’s existential question, but the EU was created  as a political institution, not an economic one. Europe is a house  without a financial foundation: no ministry of finance.”

That is precisely the problem. Unfortunately, the only solutions I see are as follows:

1. Breakup of the Eurozone
2. Creation of the European Nanny State

I have written about the “Nanny State” several times.

Support Rises for “European Nanny State”

…Is Germany unfit for the Euro or is the Euro unfit for the PIIGS? Isn’t that the real question?

Such  discussions are the consequences of a currency union with a one size  fits all interest rate policy combined with widely varying fiscal  policies, pension structures, union benefits, and other problems.

Arguably, the Euro experiment was never meant to work in the first place, at least for such a complicated heterogeneous mix.

Trichet Calls for Creation of European “Nanny-State” and Fiscal “Nanny-Zone”

Rather than admit the innumerable mistakes has has made, ECB president Jean-Claude Trichet has continually upped the ante on taxpayers with increasingly risky measures such as loading up the ECB with junk bonds from Greece and Ireland in clear violation of the Maastricht Treaty.

Today, in the wake of still more failures of the bond market to follow his wishes, Trichet openly calls for a bold new initiative, one that would effectively transform the Euro-Zone, into a fiscal Nanny-Zone as well. ….

My friend “HB” commented

This  is what the fools that rule  the Eurocracy want – a huge centralized  nanny state in which taxes are  ‘harmonized’ and citizens can no longer  choose between low and high tax  nations.

It is the absolutely worst thing that could possibly happen. It would be better for the euro-area to break up.

Trichet was one of the architects of the Maastricht Treaty, and he has violated that treaty at will ever since.

Now he wants to completely trash the treaty, effectively transforming the Euro-Zone into a nanny-zone “Eurocracy”.

When will Germany finally step up to the plate and tell Jean-Claude Trichet in no unmistakable terms where to shove it?

Right Place to Crash the Plane

The quote of the week can be found in the Yahoo!News article Rising euro pressure could force Merkel U-turn

“At the moment we are just trying to win time in the hope of preventing contagion to other weak countries,” said one senior lawmaker from a party in Merkel’s conservative coalition.

“The truth is that for Greece, what we are really looking for is the right place to crash the plane. It should not be over a city, but in the countryside if possible.”

Deutsche Bank chief economist Thomas Mayer wrote this month that if political leaders did not offer bold new solutions, the outcome could be determined by grass-roots events — a rebellion by Greek or German lawmakers, or a Greek bank run.

“Given the recent momentum in the political debate, we would give such an outcome over the coming 6-12 months the highest probability,” he wrote.

We all realize the plane is going to crash. The debate now is when, where, and how big the crater.

Mike  “Mish”  Shedlock
Global Economic Analysis