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The Survivability of Sovereign Default

October 05, 2011 | About:
The Daily Reckoning

The Daily Reckoning

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“Adjusting for slippage.”

That’s how Greek Finance Minister, Evangelos Venizelos, characterized his nation’s downwardly revised budget deficit forecast. The deficit that was supposed to total a hefty 7.6% of GDP for the 2011-12 fiscal year will now total an even heftier 8.5%, at least until the next adjustment for slippage.

To be fair, the Greek government is not alone in “adjusting for slippage.” Many governments’ deficits around the world have been adjusting upwards because economic growth has been adjusting downwards. Not surprisingly, stock markets around the world have been slipping on the adjustments.

Numerous factors are to blame for bringing global growth to its knees. But the sovereign debt crisis in Europe is certainly high on the list. This unfolding crisis does not merely pose a clear and present danger to Europe’s most heavily indebted nations, or to Europe’s most heavily exposed banks, the crisis also threatens to destroy the euro itself.

“The euro is Confederate money. It is the emission of a confederation of states,” scoffs Jim Grant, editor of Grant’s Interest Rate Observer, in a recent Barron’s interview. “The centrifugal forces in Europe are strengthening, and they are beyond the capacity of governments to deal with. The euro will break up.”

Whether Grant is right or wrong about the euro’s fate, the mere fact that the euro faces possible extinction is enough to cast a pall over many parts of the global economy.

Will Greece default? Will Portugal follow? And what about Spain and Italy? Can the euro experiment survive multiple sovereign defaults? Can it survive even one default? These are the questions that promote widespread uncertainty in Europe, widespread anxiety in global financial markets and widespread paralysis in the global economy.

The leaders of the EU believe they can restore order to the chaos by doing all the things that never work:

  • Throw money at lost causes
  • Force a struggling nation to raise taxes into the teeth of a deep recession
  • Impede the process of bankruptcy, liquidation and recapitalization
These tactics won’t work; they will merely forestall the inevitable. If the EU wishes to save the euro, it must lose Greece. And even then, it may be too late to save the euro. But that may not be such a bad thing. Switzerland and Norway seem to be doing okay, even without the euro. In other words, the growing financial distress in Europe “may be fatal, but it’s not serious,” as our friend, Doug Casey, would say.

“Greece is a lost cause,” The Financial Times declared yesterday. “No amount of fiddling, massaging or austerity is going to get the country to meet its fiscal targets…Athens is in a vicious spiral that poses a grave threat to the eurozone. It is time for policymakers to get their priorities right. The task now is not to save Greece, but to save the eurozone.”

Maybe so, or perhaps the task now is for the policymakers to stop making new policies and to get out of the saving business altogether. Let capitalism do its dirty work. Successful capitalism relies on busts as well as booms.

“Capitalism is not just about success — that’s the easy part,” Jim Grant states in his Barron’s interview. “It’s also about failure — recognizing it, dealing with it, liquidating it, properly pricing it… To the extent we allow markets to clear, we’ll be on our way.”

Defaults and bankruptcies are a staple of economies that flourish over the long-term. The destructive portion of “creative destruction” plays a vital, therapeutic role. But the leaders of the eurozone clearly have no appetite for the slightest taste of creative destruction. Instead, creative denial is the order of the day.

Sovereign defaults and financial sector bankruptcies aren’t part of the script; they’re not part of “happily ever after.” You won’t find them in nursery rhymes, not even in German nursery rhymes. Defaults and bankruptcies may be slightly better than “what little boys are made of,” but they are not even close to “sugar and spice and everything nice,” which appears to be the approximate objective of the EU leadership.

But here’s the problem: Folks who spend a lot more money than they earn are not supposed to live happily ever after, at least not right away, and neither are the folks who loaned all the money to the folks who spent it. That storyline doesn’t seem right. It feels contrived.

Usually, the folks who spend a lot more money than they earn live happily in the here-and-now…until the borrowed money runs out. After that, not so happily. The next chapter in the story is called, “Bankruptcy.”

The EU leadership is trying to rip that chapter from the book.

Bad idea.

A Great Correction is underway, as Bill Bonner continuously reminds us all. And the Great Correction will do its work, no matter how many bailout schemes, loan guarantees or “stability facilities” the policymakers place in its path.

Eric Fry

for The Daily Reckoning

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