The macroeconomic challenges facing the world are not looking any prettier after the leak of an official analysis of sovereign debt issues in the European Union and a renewed bearish call on U.S. municipal bonds by star market watcher Meredith Whitney.
A year ago, the International Monetary Fund and the European Union cobbled together a US$161 billion bailout package for Greece on the assumption that the troubled nation—which can’t pay its bills or debts—would be able to rely on capital markets to finance itself in 2012. But that is now seen as highly unlikely, according to an alarming new report by the EU, IMF and European Central Bank obtained by SPIEGEL ONLINE.
Greece’s so-called troika of saviors has concluded that reform measures have come to a screeching halt, which means the nation’s financial needs will not be supported by private sector loans anytime soon and will therefore need a new bailout. And that’s a major new hiccup because European taxpayers are tired of paying for bad bets on the nation’s debt issues made by international bankers and other Greek bondholders. And IMF’s statutes do not allow the institutional lender of last resort to offfer financial aid to nations that are not deemed able to meet payment obligations within 12 months.
If a debt default takes place in Greece—where GDP grew at 0.2% in the first quarter, as unemployment jumped above 16% and investment plunged almost 20%—another global credit freeze could take hold as fallout reaches far and wide. As Business Insider notes, French and German banks hold US$18.8 billion and US$26.3 billion worth of Greek debt respectively, while British banks have US$3.3 billion at stake. In the U.S., the exposure is US$1.8 billion.
Greece, of course, is just one of the EU’s so-called fiscal PIIGS (Portugal, Italy, Ireland, Greece and Spain) in trouble. But don’t spend all your time worrying about events overseas. After all, American debt woes could prove to be a far more serious issue for the global economy. “As serious as the situation in Europe is,” says a commentary by Recovery Partners, a Toronto debt restructuring outfit, “it is merely a diversion from the developing debt crisis in the United States. Ominously, the latest jobs numbers and other statistics show that the US economy might be rolling over again.”
Not only are U.S. jobs numbers weak, real wages are shrinking as well, providing what Recovery Partners calls “scant reason for any optimism that the consumer can support the economy going forward.” And the U.S. debt situation could get much worse because a number of establishment economists, such as Paul Krugman, are now calling for yet more fiscal and monetary stimulus.
“What these folks and their many acolytes do not seem to understand,” Recovery Partners says, “is that there is no shred of data that supports the idea that fiscal and monetary stimulus can produce any type of predictable growth response in the economy at all.” They also, the firm argues, ignore “the corrosive balance sheet effects of large deficits and monetary experiments.”
The bottom line, according to Recovery Partners, is that the market’s probability of seeing a third round of U.S. quantitative easing, or QE3, is rising fast while the calls for fiscal reform hit a political impasse. “Buckle up,” the firm says. “The ride is going to get bumpy again.”
David Kotok, chief investment officer with Florida-based Cumberland Advisors, is worried about Greece, but not too concerned with the U.S. debt situation. As director of the Global Interdependence Center, which promotes free trade, the outspoken U.S. fund manager just returned from meeting with EU economists, bankers and policy makers at a conference on the sovereign debt crisis in Helsinki, Finland. He thinks the EU and the euro will survive, but reports conference attendees had “universal agreement that Greece is now illiquid and insolvent.
With Greece’s sword of Damocles hanging over their heads, Kotok says European policy makers “are doing their absolute best” to contain the crisis. But nothing much can be done unless the people of Greece find the collective will to alter “negative behaviors of the last decade.” And whether “the political system in Greece will permit this necessary change remains to be seen.”
Back home, however, Kotok sees the will to tackle debt developing. About 50% of U.S. state governments, he says in a recent commentary, have started to alter behavior in fiscal matters. “Others,” he adds, “will follow suit. In Washington, a fierce battle will end in some improvement. All this is motivated by the honor of the state.”
As far as Kotok is concerned, Meredith Whitney, one the first Wall Street analysts to predict the 2007 banking crisis, was dead wrong when she predicted U.S. state funding issues would lead to a municipal bond crisis on CBS’s 60 Minutes late last year. She predicted 50 to 100 sizeable defaults, amounting “to hundreds of billions of dollars,” noting it was something to worry about “within the next 12 months.”
That seems unlikely since there has only been about US$700 million in muni bond defaults so far this year. But Whitney is now once again making her Armageddon call, albeit with an extended time frame. The market response has been skeptical.
“In ancient Greece,” Kotok says, “Cassandra was given the gift of prophecy. Her punishment was that no one would believe her. In modern Muni-land, another goddess prophesies default on Squawk Box. She appears without an opponent to argue the other side. For quite some time after the 60 Minutes prophecy, she was believed. Now evidence is to the contrary.”
Simply put, Kotok says Whitney may prove correct, but he thinks otherwise. “In most jurisdictions, the corrective decisions, though tough, are being made, as they must. The honor of the nation is at stake.”