Markets shocked by FT Orderly Default Story11 Jul 2011(*) Analysis of the orderly vs disorderly default debate Citing unnamed senior officials, the Financial Times has claimed, on the front page of today's paper, that the EU are planning to allow Greece to default in a managed way without leaving the Eurozone, putting the country's debt on what they call a "sustainable footing". A few days ago the FT's chief economist, Martin Wolf, described a Greek debt to GDP ratio of about 80% as sustainable. With Greek debt now running at 140% of GDP, an 80% footing would inflict large losses on Greek bondholders in the first developed world sovereign default since Germany in WW2. Although this default scenario is already fully priced into the Greek government bond market, some people still hope that market prices simply reflect panic and default can ultimately be avoided. I should say that I am long Greek bonds at current levels, and I believe Greece can avoid default if the politicians can get their act together. If, however, Greece is allowed to default on a substantial proportion of its debt in a non-disorderly non-suicidal way, it seems highly likely that other failing European states will eventually follow its example. Indeed Greece's favourable natural resources, asset portfolio, and grotesquely inefficient and immoral government make it, in my opinion, one of the easiest failing state to reform. Taking a long term perspective, I think Portugal, for example, faces a much greater challenges. So, according to the FT, it seems that European politicians can't stand the temperature in the kitchen any longer, they have exhausted themselves in the sweltering suffocating heat tirelessly and bravely fighting the fire with economic reforms, and now they intend to reduce the temperature by opening the door, letting the heat escape into the corridors. This is what we call the "orderly default" option, now the danger is that the fire spreads to the rest of the building. The amputate or cure alternative is to keep the kitchen doors sealed, allowing the kitchen to either burn out completely, or to be saved by the brave economic reform fire fighters. This is what we call the "disorderly default" option, by sealing the escape exits it forces the people in the kitchen to choose between life and death (collapse of Greek banks, exit Euro). Orderly default is humane but contagious, disorderly default is inhumane but uncontagious. Orderly default leaves Greek bond holders with the current market value, disorderly default forces them to take an all or nothing gamble on successful reforms. Orderly default has short term positives and long term negatives, disorderly default has short term negatives and long term positives. Orderly default is the choice of pacifists, disorderly default is the choice of warriors. If you believe the FT's article you had better dump European assets like there is no tomorrow, and especially Italian bonds (debt to GDP of 120%), this is the political capitulation to the fires of hell that marks the beginning of the end of the world. Only Greek bonds are correctly priced, because default is already priced in; everything else could catch fire. But can you really trust the FT? Who is the article written by? Peter Spiegel. This guy is an ideologist, and the FT is an ideological newspaper, and the FT's political and economic prophesies are so appalling that the paper is typically a reverse indicator. What is the FT's ideology? The FT used to be a great paper, but it has gotten caught on the wrong side of history and that has provoked a terrible intellectual regression. Now it's full of populist pacifistic liberal laissez-faire relativism complete with bizarre articles about the Big Society. Even though their biggest economic commentators are German, they are so obsessed with Anglo-Saxon ideology they used to talk down Germany's economic prospects every day. I have seen this so many times on the trading floor, it's like life evolves into a new perspective because our old viewpoint was flawed, and those who can't bring themselves to let go of what they used to feel become perfect reverse indicators. People suddenly go from hero to zero, because they can't evolve. An alternative article in today's Wall Street Journal quotes Charles Dallara, a baking industry big wig, saying "selective temporary default" by Greece need not be as dire as widely though. Such a move has nothing to do with putting Greece on a sustainable footing, the idea is to placate German politicians with a headline gesture and a slightly reduced bailout package, whilst simultaneously doing as little damage to the Eurozone's reputation as possible. The EU may well go this route, it's the slavish path which tries to be all things to all men in some kind of politically correct short term timeframe, but which does nothing to solve the problem, indeed it has only negative consequences at the longer term time perspective (because a vital line connected to a vital moral principle is crossed on shaky grounds and for insignificant gains). Why are European politicians failing to resolve this crisis? The problem, of course, is that they grasp various sides of the debate using emotion. In this chaotic cacophony of competing opinions they can find no vision beyond some sort of impossibly far off and politically impossible dream of total federalism (that they naively hope would instantly transform the policymaking of failing states by diluting local democracy with technocratic intelligence), so they are lost at sea, they are caught like rabbits in headlights, they can't find the cure for a self inflicted disease which is going pandemic and could kill half of Europe. A philosopher has to detach from all this emotional chaos and dig deep into the crisis at its most fundamental level. In fact, he goes beyond even the various psychological paradoxical perspectives, beyond the superficial pains and pleasures of orderly and disorderly default, and traces the argument right back to the very purpose of human life. Out of this deep ethical perspective, he can adopt the moral / religious / psychological viewpoint from which a course of action can be easily imagined or deduced. So here, to illustrate the nature of philosophy, is a debate between Socrates and Martin Wolf: Socrates: Mr Wolf are you sure that Greek debt must be reduced to 80% for it to be sustainable? How do you really know the Greeks can't cope with, for example, 200%? Wolf: I am a data junkie who has checked the numbers a thousand times, and that's just the way it works out. You have to face facts, its all hopeless if we don't get Greece to a sustainable debt level, this crisis is endless as long as people are too stubborn to face up to this basic fact. Socrates: Let's imagine the Greek government now paying back their 80% debt. Now let's make the Greek government more "wise", as the Greeks improve the quality of their policymaking wouldn't they find that debt becoming less of burden? Wolf: I suppose so. Socrates: So the sustainable level of debt is actually a function of their wisdom. You can't cling onto a number like 80%, it all depends on how wise they are. Wolf: I suppose so. Socrates: Isn't wisdom, in fact, the overriding factor? Look, if a country is very wise it can become the richest country in the world even without any natural resources (like Japan in the 1980s). At the same time, if a country is very unwise it will be a total mess even if it sits on gigantic oil reserves. Don't you see, in the long run, wisdom is everything? Wolf: I suppose so. Socrates: So the factor your models don't include, namely wisdom, is the most important factor of them all. In the long run the only factor that actually matters is the one you omit from your models. Wold: You can't expect to Greeks to become more wise, it's a democracy, they do as they please. Socrates: Have you heard the old idea that the whole purpose of human life is the evolution of wisdom? Even democracy must evolve. Wolf: I believe in compassion not evolution. Socrates: Compassion for the weak, or compassion for the evil? Wolf: For the weak of course. Socrates: So couldn't we say that if the Greeks were very worthy, but they were faced with unreasonable unjust demands from a much bigger unworthy neighbour, then a compassionate third power would try to protect the Greeks? Notice that a crowd of evil can overcome a solitary sage no matter how worthy he may be, so if good is to triumph over evil in this world, we must fight like dogs for justice. We must love the good, making others who are good our friends and helping them, and we must hate the bad, making those who are bad our enemies and resisting them. Wolf: Yes. Socrates: But if a small evil power tries to inflict unreasonable injustices on a bigger more worthy power, then it is the duty of every good person to resist the smaller evil power? Wolf: Yes. Socrates: And if the whole purpose of human life is the evolution of wisdom, then stupidity is the very definition evil? Wolf: I suppose so. Socrates: So if we can't help the Greeks become more wise with our words of wisdom, shouldn't we allow God to work his magic by inflicting challenge upon them? If you don't interfere, the Greeks have to stand on their own two feet, and they are forced to become more wise, to evolve as God intended. If, on the other hand, you interfere by helping them escape their challenges you defy God and perpetuate evil. Wolf: Look there is no point in getting religious, the Greeks can't possibly survive a 200% debt to GDP. Socrates: Even if we suppose that Greek life is sacred and must be saved regardless of the wisdom of Greek people, how do you know they can't survive 200%? Wolf: I have calculated 80%, and my margin of error can't be that big. Socrates: But we have already ascertained that your calculation doesn't take into account wisdom, the most important variable in the whole equation. Your spreadsheets just reflect some of the short term possibilities, but in the long term they mean absolutely nothing. Look at the USA today, it's debt is rising like there is no tomorrow, if you run the numbers it's bankrupt. If, however, the politicians get their act together they have an infinity of reforms to choose between. So it's not about numbers, it's about wisdom. People are still buying US debt because they are confident that the American people are smart enough to fix themselves. Wolf: I suppose so, but 200% is absurd. Socrates: But if you don't have a model that even includes wisdom, how can you predict anything with any certainty at all? Isn't claiming to know anything, when you don't have the right model, the true absurdity? Wolf: Well 200% just feels absurd. Socrates: Is that because the higher the debt the more it hurts to repay it? Wolf: Yes, I think 200% would involve tremendous suffering. Socrates: So the less the debt the nicer it feels. Why don't you go for 10% then? Wolf: It's obvious that people can pay 80%, because in the textbooks it says that 80% is a healthy level of debt for a country and need not entail too much hardship. Socrates: What about for individuals or companies, don't banks lend much larger multiples of income? Also, if you fail to repay your debts they repossess your house or other assets, they don't let you walk away unless you are penniless. Does that have any lessons for Greece? Look too, if you add the total private sector debts of society they are often a much larger multiple of GDP. So the problem of government debt isn't one of size, but rather the collective unwillingness to take responsibility for collective decisions? Wolf: I heard the Ancient Greeks believed that problems in individuals can be analysed by thinking about society, and problems in society by thinking about individuals, but we certainly don't think that way in the modern world. According to the textbooks 80% is a fair level for a state. Socrates: If the Greeks didn't want to pay back even 80% would that be unfair? Wolf: Yes, I feel that would be immoral. If they really refused to face up to even an 80% debt we should sanction them. Socrates: So the 80% debt is the balance of your dislike of pain, and your dislike of immoral people? It's a sort of harmony that blends individual pleasure and duty. Your 80% number is just note in a the symphony, not a truth, just a blend of perspectives. Wolf: I will think about that one. Socrates: Why don't you think about this too: forget all your feelings and imagine, or reason, what is theoretically possible if the Greeks were forced to evolve to greater wisdom by meeting the challenge of solving the problems they have created for themselves. But if philosophy is beyond the intellectual capabilities of the Western elite what is to be done? My nice little dialogue is all in vain, people think it's as pointless as a game of checkers, they insist on plucking the solutions out of their feelings. Unfortunately there is no consistency in their feelings, it is a never ending revolving door of arguments, some of which assume the Greeks can pay, and others which assume they can't. If you listen to the radio you can hear the debate going round and round between different commentators, nobody changes their mind, nothing evolves, it's just the same old ideas expressed in endless different ways. It's the antithesis of a reasoned argument which develops as principles are agreed, it just endless talk talk talk that never rises above ground zero. So instead of talking endlessly, let's agree a single simple principle. Now imagine whether or not Greece could pay if it was run by Chinese technocrats. I think it is intuitively obvious to everyone that in this case Greece could pay, compared with the incredible challenges of growing China at 10% per annum for thirty years running, a Greek debt to GDP ratio of 140% is a walk in the park. So let's begin our discussion with one agreed principle:- Greece could pay if it was run by hard nosed experts who didn't mess about like elected politicans. Now I haven't seen the idea of temporarily suspending democracy and implementing a state of emergency in failing Eurozone states appear in any newspaper, or be mentioned by any politician. Do you understand, economic World War Three is five minutes away but the nuclear option hasn't even been mentioned by anyone in the world, as far as I can tell, except on this blog. I have searched Google and read countless newspapers, but so far I haven't found anyone taking about it except poor little old me. Don't you think that a state of emergency is the only solution when democracy grinds to a halt as it has done in Greece, Italy and Belgium? No don't let your emotions get in the way, think about this carefully. Treat this problem as life threatening, wake up out of that woolly sleep and come at the problem like a historian, a philosopher, or just an engineer. Don't you see that a state of emergency is designed for precisely these kinds of life threatening situations in which the decision making structure is too slow? Churchill didn't run the UK as a democracy during WW2, and this is every bit as much as an existential crisis as WW2. Don't you realise that democracy is not a sacred truth that is more important than economic collapse and human life? Democracy is still functioning to some extent in Spain, but solving Spain's problems requires reversing the devolved regional structure which is politically impossible. So as long as Spain is a democracy it's game over in the long term, Spain's only chance of life is calling a state of emergency to make some reforms. Across the PIGSBI the problems go so deep that a state of emergency is the only solution, especially given the enormously pressing timeframe. So, I keep labouring the point but it's absolutely vital, do you see that: the fact that the European elite can't even bring themselves to mention the words "state of emergency" testifies to their insanity? Can you stop reading and go round and round on that line till it really sinks in please! Look at difference between the European ideologists and the Chinese engineers. This isn't a complex Greek philosophical paradox I am trying to make you understand, it's the only logical course of action. From the very outset of this crisis the solution has been perfectly obvious, but it still isn't even mentioned by anyone in the elite. It's like a tragic comedy of Ancient Greek proportions, the need for less democracy is hammered home by the success of China, on top of that incumbent politicians are hated and gridlock is paralysing the system, yet still no-one in the Western World talks about a state of emergency. It's like our world is dying because it is run by idiots of cosmological proportions. About two or three years ago I started posting comments on the Financial Times website in the hope of instilling some intelligence in the elite, but in all that time no one ever emailed me, and no politician or journalist or academic ever moved their opinion one inch. I am not some ordinary blogger, I really devoted a vast amount of effort to it and emailed the journalists personally. My analysis is head and shoulders above the normal bloggers on their site, in fact my analysis is head and shoulders above their own commentary, I even put all sorts of predictions about the future on the FT site which came true. I tried love, I tried religion, I tried hate, I tried hell, I tore my hair out trying to do something for this world without accomplishing anything. It used to be my life goal to reach the world by writing for the FT, now I have given up and admit I wasted a vast amount of my time. I am not Socrates but by God I tried hard and I think I did a reasonable job. It's not just FT journalists, although they have failed perhaps more than any other group of individuals in modern history, when famous people write articles at the FT I add comments that they must see. I had hoped that one of these people upon seeing my comment on his article would follow up, and end up here on this web site reading words like these, and the world would be saved. Finally I began to understand that the Western "elite" have deliberately closed their eyes to the light to sell newspapers or maintain power etc. I realised that these people are completely and utterly spiritually bankrupt. I realised that evil is not something you see on the psychological surface, it's a sort of energy that is buried below that level and controls the psychology of the individual. So this evil inside them turns them into robots perfectly in tune with the herd, which allows them to control the people like the "wild beast trainer" in Book 6 of Plato's Republic. Slowly I realised the absolutely horrifying truth is that the elite are pure poison, pure evil, and their karmic fate is so terrible that I describe them as the evil walking dead - the zombies. So the zombies running Europe are completely incapable of intelligent analysis, they are demons that live on the wild beast buried in humanity, they feed it, they nurture it, they love it, they enjoy it's love, and their demonic love affair has it's endpoint in the death of humanity. So reporters write articles which push ideas that would destroy the people, politicians play games with sovereign default. It's the slippery slope to hell, and for those who learn to see the truth of our sinfulness, society is absolutely terrifying, indeed the evil is so endemic it has almost brought us to our existential endpoint. Can anything be done? Perhaps you think we could be saved if somebody could get the zombies to repeat to themselves like an incantation "If Greek & Co don't reform all the little people who vote for me are going to start starving to death, and one day they are going to get so hungry they are going to eat me." If that shocking realization could be sunk into their tiny self-centred minds, they would stop worrying about debt levels and concentrate on implementing growth models. If the zombies realized that Greece can never be put on a sustainable footing until it is reformed, which we should have guessed ten years ago given Greece's modern history, then in their fight for self preservation they would suspend Greek democracy and put Lee Kuan Yew in charge of Greece. In an instant the Greece-Germany 10 year yields spread would go from +15% to negative. If Lee Kuan Yew ran Greece he could eat a debt to GDP ratio of 140% for breakfast. This example would have a transformative impact on European public opinion, and allow the move to more technocratic federalism. This would, of course, be God's choice. Those of us who study philosophy know that wisdom is the goal of human life, and the fruit of wisdom is reform, and the mechanism of reform is challenge, and this crisis is part of God's marvellous symphony. If, on the other hand, you leave Greece like it is, run by mindless poisonous zombies, you could cancel all their debt and ten years later they would back at the cliff edge again. Then the True Germans, and True Fins, and True Dutch would rise up in indignant fury, and eat their politicians. The euro would die, and the PIGSBI would explode, and the untrue Italians, untrue Greeks, and untrue Spanish would rise up in hungry fury, and eat their politicians. Then there would be a war between Northern Europe and Southern Europe and the incompetent South would be annihilated. But it doesn't have to work that way, how much pain we take depends on how stubborn we are. But then after thinking about all this for a very long time you realise why the "state of emergency" option is never mentioned. The terrifying truth is that the elite are demons, and the beast, the devil, or whatever you want to call the corrupting force, doesn't want Greece to reform, he doesn't want this crisis to end. The beast has another plan of course! You see he doesn't just control the elite, he controls everyone. We have played this game before a countless times, it's called elite failure and popular revolution and vicious tyranny. Like 1930s Germany, the system fails, the liberals fiddle while the city burns, then the mob takes over and the devils got a flush hand. That's what you suddenly realise from reading Plato, that's why democracy is the last but one system of government, that's why Plato describes tyranny following democracy. Protogras was the liberal fiddler, Thrasymachus was the violent revolutionary who claimed the liberals can't smell. In Book 6 of The Republic Socrates said: Living in a word of madness and falsehood and depravity, is it any wonder philosophers become vicious cranks? Forgive them, if truth ever led the way they would be gentle and friendly again. I am not vicious, I feel like I have been shot with millions of arrows. I used to pray "Oh God help me save the world", then "is it too late?", now I am simply exhausted. In Plato's Republic Socrates says: I don't think Thrasymachus (the anarcho-capitalist) can be saved this time, but we shall leave this written work so that those who aren't going to make it can be saved in another incantation. But that's an incredible period of time you are talking about says Glaucon. Oh it's nothing to the Gods says Socrates. Well you helped me Socrates, but I guess you had bigger plans than that. So I am supposed to end with a EURUSD call, but if I said buy you would become complacent. I once believed in Western civilization being saved by the Germans and Italians coming together, I had some funny vision of an ECB official suspending democracy in Italy or Greece and saving Europe. I still want to believe that, but even if an Italian bureaucrat was converted to the light and started a debate in the press about a state of emergency, it's now so late in the day that I don't know if he could win that debate in time. If default is Europe's fate, surly it won't happen till next year, doesn't the world burn in the year of the Dragon? Or perhaps not, don't forget that some big things have happened in September and October in the year of the Rabbit. Anyway, 2012 isn't going to be just another year of Dragon, like 2000, 1988, 1940, 1927, and 1916, what is going on right now is truly staggering. |