PIIGS on Borrowed Time

The Eurozone is lumbered with a profound disadvantage: Diverse cultures and economic variables that can be isolated to a single country in most political structures are sorely lacking among these EU-zone member nations. If one country is severely out-of-whack economically with its neighbors, the traditional solution imposed by the global marketplace would denigrate the value of that country’s currency relative to the currency of more stable nations. Folks in the offending economy wouldn’t see hard number pay-cuts, but their buying power in the international marketplace would fall as the value of their currency tumbled. In other words, inflation would eat away at this buying-power, but the currencies would float and adjust to the perceived relative economic disparities.

Hard to think of Greece and Germany as sharing the same economy, when those two nations could not be more diverse in terms of culture, productivity, manufacturing and service sophistication, financial capacity and fiscal discipline. But they do. What’s more, all of the EU attempts to “solve the European debt crisis” fly in the face of economic reality. No matter the solution, no matter the degree of fiscal austerity imposed, no matter the purchase of bonds from weaker nations, for most of the PIIGS (particularly, Portugal, Spain and Greece), there is absolutely no possible way for them to pay their accrued national debt or even to get that debt within borrowing parameters that the rest of the world considers prudent.

Oh sure, we can pretend that they are paying their national debt by having them pledge to pay very-low-yield bonds over, say, forty years, but that would be trading bad debt for bad paper. And the only way you would get buyers to take those bonds is if they already were owed piles and piles of debt (principal and interest) and their choice would be to take a huge cut or zero… or take these crappy low-yield promises to pay. These bonds would instantly be worth less than their face value (because of the low yield) even on the day they were issued.

The other more honest approach would be simply to write down substantial portions of this debt – which is the inevitable practical effect of any solution – a reality that is currently untenable, particularly in the cold northern European nations like Germany, Austria, the Netherlands, etc. who are completely fed up with their profligate southern brethren. The lending countries and international banks (including U.S. banks) would feel the pain instantly, and they are trying everything in their power to postpone the inevitable. The impact on the euro of such a write down would be inflation and devaluation of the currency, and Germans fear both these alternatives more than a depression (their legacy attitude from their post-WWI reparation-driven economy). But a de facto write-off of much of the southern bad debt is going to happen sooner or later, and postponing the decision only allows more interest to accrue that also will not be repaid, making the problem that much worse.

Why? Why is it that United States can have soaring deficits – which have impacted our credit rating – but these PIIGS nations cannot? Doesn’t seem remotely fair, even though at some level, we too will have to pay the piper. The answer is growth. Walk around your home and tell me what products you have around that were made in Spain, Portugal or Greece. Some wine? Olive oil? Cheese? What? Take the same look for products made in Germany. Oh, you are looking in your garage, I see. Lucky you. Debt with growth potential, to a point, is a sustainable theory. Debt without growth can kill nations.

Growth is generally measured in (1) comparative productivity ratios (output per worker), and Germany and the United States are among the most productive nations on earth, as well as (2) gross domestic product (GDP) which looks at aggregated output of an entire nation. The relevant ratio, as I have noted in earlier blogs, is then aggregated debt to GDP. This debt/GDP ratio is the telling statistic, and if your debt goes down but your GDP goes down even more, the ratio still reflects a no-win economy. Growth is a function of providing sufficiently high-level skills through an infrastructure and economic delivery system that can monetize those skills or by having massive surplus high-demand natural resources with a system that can place these recourses relatively easily into the global marketplace. Portugal, Spain and Greece have neither.

What’s worse, to have growth where you don’t have stuff like vast oil reserves, you need investment, and from a government perspective, that means (1) a population with greater in-demand skills (education), (2) the ability to access those skills, power and build the requisite manufactures and move goods and services to their appropriate economic destination (infrastructure) and (3) the cutting edge systems to give your economy special values (research and exploration).

Unfortunately, for the PIIGS, austerity measures have not only deleted workers from the work force (thus heavily reducing the number of consumers who can spend money to support their economy), creating a negative ripple effect across the land, but the essentials for future growth – education, infrastructure and research – have been “baby with the bath watered” out of these fragile economies. Thus, the prospect for future growth has been curtailed if not destroyed, and hence the debt/GDP ratios will continue to tank, recessionary numbers will only continue to get worse, and the prospects for managing the European debt crisis, which most certainly impact us in the United States, are only dimming.

But the world, including Wall Street markets, is addicted to mythology. There is a path, believe most, where that European debt crisis can be solved and put behind us to enable a near-term recovery. Americans seem to believe that you can cut taxes for the rich – who don’t need the cuts – spend more on defense and less on education/infrastructure/research and somehow fix the economy with lots of new and well-paying jobs. Both of these beliefs are profoundly misguided, will only exacerbate a problem that will only get worse until global leadership begins to “get real” and understand that growth doesn’t just happen. And without that growth, there are no solutions that can create the sustainable future we believe we deserve.

I’m Peter Dekom, and the degree of “leadership mendacity” that seems to be required all over the planet to win elections is precisely the head-in-the-sand mentality that can sink entire civilizations.