Historians May Write: In Order to Save Greece, it Was Necessary to Destroy the Euro


What a difference a day does not really make. The back-story to the markets – the slow-motion insolvency of the Welfare States – was ignored by rested U.S. investors yesterday. They came back to the floor and bought stocks like it was old times.

Both the S&P 500 and the Dow Jones Industrials finished up over 1.5%. There were two drivers of the feel good vibe. First was New York’s Empire Manufacturing Survey. It concluded that “conditions” were improving.

As far as we can tell, that doesn’t mean anyone actually made and sold more stuff in New York State. But it does mean the state of mind – how people feel about things – appeared to improve. Hooray! It’s nice people feel better about things. But things are still pretty bad anyway.

The bigger story is that Greece hasn’t been abandoned by the rest of Europe…yet. Europe could probably leave Greece behind and preserve the integrity (such as it is) of the euro as a sound currency. But 50 years of harping on about social justice and economic harmony and humane capitalism is going to make it hard for policymakers to leave Greece to its own devices.

This means the debt crisis is consolidating itself into ever fewer and larger entities…the European Union…the U.S. government…and the U.K. government to name a few. In order to save Greece, historians may write, it was necessary to destroy the Euro.

But investors don’t have time machines. In the modern era of central banking, new lines of credit and public assumption of large liabilities – plus more credit creation – has always been the way out of a pinch. Below, we’ll tell you why this makes the inevitable disaster that much worse.

Here in Australia, it looks like the financial crisis is receding. We have our doubts. But according to Gail Kelly and the good people at Westpac, bad debts were down even more than expected in the first quarter. That’s the good news. The bad news is that, “the average cost of funding is going up.”

The strategic weakness of the Australian banking sector – and perhaps the whole economy – is that it’s a capital importer. That’s why even when Aussie banks didn’t have boatloads of U.S. subprime debt; they still faced higher capital costs when the global cost of capital went up. So what?

If Greece goes down or sovereign debt default spreads go up, it’s going to make importing money into Australia more expensive. And that will probably slow credit growth in the economy. Aussie banks will get jealous of their capital and stingier with their lending. Maybe even house prices – contrary to the laws of Australian financial gravity – will fall.

And if you think that’s gloomy, then you won’t want to read what Albert Edwards from Societe Generale has to say about the status quo. Writing earlier this week, Edwards says, “My own view on this is that obviously we should never have got into this wholly avoidable mess in the first place. But having got here, there really is no way out that does not trigger a major market-moving upheaval.

“Ultimately economic prosperity over the past decade has been a sham: a totally unsustainable Ponzi scheme built on a mountain of private sector debt. GDP has simply been brought forward from the future and now it’s payback time. The trouble is that, as the private sector debt unwinds, there is no political appetite to allow GDP to decline to its ‘correct’ level as this would involve a depression. So burgeoning public sector deficits and Quantitative Easing are required to maintain the fig-leaf of continued prosperity.”

This what we meant above about the inevitability of the disaster that approaches. When the government “brings forward” demand for housing via the FHOG or for consumer goods via stimulus, it’s stealing growth from the future in order to maintain current living standards. In our view, this just perpetuates the misallocation of resources that took place in the credit boom and keeps the money in the weak hands (the financial sector) that took so many bad risks in the first place.

A real free market punishes financial failure with bankruptcy or insolvency. By not allowing a recession to take its natural course, monetary and fiscal policy prevent the conditions for the next growth phase. What’s worse, they’re doubling down on the debt-backed model of prosperity and piling up more liabilities on the public sector balance sheet.

That’s the stage we’re at now. And one insignificant survey on manufacturing sentiment in New York State doesn’t change much. And by the way, the more important news yesterday is that demand for U.S. bonds by foreign investors fell by its largest amount ever. Strong dollar?

Foreign holdings of U.S. Treasury securities fell by $53 billion December. China reduced its holdings by $34.2 billion. The end game is beginning in the Chimerica relationship of vendor financing (China buys U.S. bonds to help keep U.S. rates low so Americans can buy what China makes).

What China doesn’t buy, you can get the Fed will have to monetise – unless the Congress and the President suddenly cut American spending. You can see from the chart below that Japan is now a larger holder of long-term U.S. securities than China.

China Retreats from Treasury Morass

Source: U.S. Department of the Treasury

The long-term trade on this is to get the heck out of U.S. assets. Whether “risk assets” like commodity currencies or commodities are the ultimate refuge is yet to be seen. But oil, gold, and resource stocks are certainly getting a big today on greenback weakness.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. Great article, thanks.

    i think greece will eventually falter regardless, but the euro will still become the reserve currency of choice due to a lack of an alternative. its gonna be fun getting there though!

  2. Call me Neanderthal ,but why cant bankrupt countries sell what assets that they do own. These assets are probably not making a return on investment because they are so badly managed. It would then up to the new owners to turn a profit and it would be up to governments to do whatever governments do . JONESY

  3. What I can foresee is STAGFLATION is going to happen in United Kingdom and rest of PIIGS countries in Europe.

    Provided if China is successful in converting itself from an exporting country into one which relies on internal consumption/market, by then internal consumption will account for more than 50 percent of China’s GDP.

    People says China is exporting cheap products around the world which help to counteract inflation or “Exporting Deflation” to be exact term, however it becomes exporting inflation in the next 20 years and beyond.

    Most western countries are service sectors oriented and produce nothing or rely on import of foods/supplies from abroad, which means there will be imports driven inflation coupled with economic recession is STAGFLATION in United Kingdom & PIIGS. Especially if Yuan stays strong China could pass on its bubble to foreign trading partners.

  4. China is keeping the Yuan devalued to keep their exports cheap so overseas countries continue to buy…

    February 18, 2010
  5. Ah what a difference a day makes, seems like that USD slide only lasted the metaphorical 24hrs of my prediction. I’m on more solid ground thinking those “foreigners” investing in the US are just returning USD leverage. AUD down and am selectively trading the other side of the book today.

    Sims reporting revenue down 39%. AUD strength only part of the story. Inventory way up (note preceding comment which should have mitigated), receivables way up. NTA only down smalls. Heavily leveraged and invested into the US at the wrong time and in the wrong business. Matching borrowings on an AUD balance sheet to earnings in USD is also watchable in a USD spike that might otherwise provide opportunity. Picking timing on the extend and pretend stocks and weighing the forces that oppose is my recent interest.

  6. I agree George Lee

    Try buying smoked oysters! All brands, even the one that purports to get only the best, — all made in China and imported. You cannot get a smoked oyster grown and made here. I never knew China had so many oysters!!! (tongue in cheek). Needless to say my canapes are sadly lacking these days!!

  7. “Provided if China is successful in converting itself from an exporting country into one which relies on internal consumption/market,”

    George, you can’t rely on internal consumption, in fact it’s not something I would ever describe as “successful”.

    Eventually the wheels of the market slow and the economy becomes inefficient.

  8. “Provided if China is successful in converting itself from an exporting country into one which relies on internal consumption/market,”

    George, you can’t rely on internal consumption, in fact it’s not something I would ever describe as “successful”.

    Eventually the wheels of the market slow and the economy becomes inefficient.

    – have to agree on not relying on china becoming a consumer market, it may well happen but isnt about to do a 180 turn in the coming year. i think thats a more viable theory for the second half of the decade…

  9. Greeks really need to pay their taxes properly and that would help a lot

  10. If Greece defaults there are big losses to be had by German and French Banks, so the German and French governments have to bail out Greece to save their banks. All sounds a little like A.I.G.. Taxpayers just get done over.

  11. Yes but Angela Merkel is yet to sing.

    My gut feel is that Merkel will want to bludgeon Greece into submission if she can. But can she? If she does, what will happen in Greece and some other Eurozone countries? Riots are not in the interests of either debtor or creditor.

    Countries can default but the debt invariably gets rescheduled…with long term inflation on the side of the Greeks. The term “bankrupt country” is a figure of speech rather than an a legal truth.

    As for those swaps agreements. My view is stuff them. A default would be an event that would trigger counterparty insurance payments. I haven’t looked at them but it could be that they are not actually true debts.


    Coffee Addict
    February 18, 2010
  12. Great comment Coffee Addict. Something worth considering is the impact of politicians going against the will of the people. If Germans don’t want to bailout Greece, and the German Govt. does anyway, what is the chance of re-election? Opposing parties would get some decent traction.

    Likewise, Greek citizens who think that they should not have to pay extra taxes are not likely to vote for a Govt. who has just taxed the bajingos out of them. More traction for the opposing parties.

    This partly links in to the discussion about Democracy in the other DRA article. Democratic nations tend to hamstring themselves when the people want short-term happy-time policies, but the country needs longer term hard-line solutions.

  13. Is it possible that this is China’s response to USA selling 6 Billion dollars of weapons to Taiwan???

  14. Unbelievable isn’t it. Today you would buy stocks and the kiwi. It may be a day traders paradise but I’m taking the gains and pulling my head in because the bureaucrats run the show and they will catch up some time.

  15. Definitely a slow motion train-wreck for the US. Some recovery, with Wal-Mart losing ground for the first time! Playing funny-buggers with the Europeans isn’t going to make life any tidier either. Let’s hope that high-tech military is as capable as it’s made out to be, because it’s going to be used soon.

    However the fall in China’s treasury holdings is maybe less of a signal than it seems, in that it was only in 2008 that China surpassed Japan in treasury holdings, plus its fall in holdings occurred mainly due to maturation of previous big purchases. Maybe they’re buying less to apply pressure on the US to raise interest rates? If so, it’s still more a defensive move at this point in time.

  16. Dan, the US Okinawa base story is significant too. Not sure if Toyota sees themselves as victim but cynicism perpetuates after a point. The Japanese/Chinese j/v in Afghanistan is still lurking. Obama is coming to Australia ….. Past time for both Rudd and Abbott to consult the people and get a mandate before they do their all the way with LBJ blindside trick on us. I personally have had enough of their dominoe theries and global Caliphate theories and just about every other cheap penny lane tune they tweet.

    From wikipedia,

    Proposed solutions

    As recently as 2003 the U.S. was considering moving most of the 20,000 Marines on Okinawa to new bases that would be established in Australia; increasing the presence of U.S. troops in Singapore and Malaysia; and seeking agreements to base Navy ships in Vietnamese waters and ground troops in the Philippines. Under plans on the table, all but about 5,000 Marines would move, possibly to Australia.

    The Americans seem to count heavily on Vietnamese animosity / fear of China. I’m not sure what the Vietnamese now think after what the Americans did with the dong (the proof that floating against the USD is bad for your health), the Jetstar thing there too is interesting. American ships in Vietnamese waters and around that territorial dispute with China and the Phillipines would be trouble with a capital T for the kids of all Australians. The thing recently however is that the Chinese and Iranians have gained systems that can sink the damned things cheaply while standing off at great distance and that they are thus becoming less relevant.

  17. Good analysis Ross. Certainly, in order for there to be any military confrontation that is not initiated by the US, there has to be a more even balance in the weapons scenario. It’s coming to that fairly quickly on some fronts, but even so, war with anybody is not ever _really_ going to be in the interests of Russia’s or China’s population. It might well be in the interests of third parties who stand to gain from the spoils and who have other agendas such as population culling and resource hogging.

    To a degree, the US is creating its own monsters (eg: North Korea, possibly sea pirates and other phenomena) to justify a presence in this or that ocean. The surface ships are for show. The real destructive power comes from the seabed, and as yet is impossible to prevent.

    Incidentally does anyone know how a seismologist can distinguish between a regular earthquake and a nuclear explosion on the sea floor? Not that it’s ever happened or anything, but surely there’s a difference?

  18. Japans flagship company is suddenly finding that’s it once iron clad competative advantage (saftey and quality)being questioned seriously. Does anyone else smell a rat??

    Now if this were high school and i was getting bullied my first course of action would be to find a target i could pick on hoping this would somehow restore my self esteem.

    Would not be surprised to see perishable Aussie exports rotting on Japanese wharfs fairly soon.

  19. Maybe Phil, but just as likely they are outsourcing their parts manufacturing and maybe even some of their design work and this has resulted in failure of quality control systems. To my understanding, Japanese cars are different from, say VW which is capable of doing everything in-house from breaks, to engine, chassis, drive train and trim. The advantage is cost saving but disadvantage is that while most aspects of a car may be excellent, a bad apple will ruin the lot – or at least it shows when engines don’t match car sizes etc.

    Right now is probably the best time to buy a Toyota – you can bet they will be selling good stuff at heavy discount.


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