Greece seems to be getting serious about its fiscal situation…finally. After all this hand-wringing, today we got some details on what it will do to tighten its belt. A few highlights:
- Slight increase in its value-added tax (If your country is ailing, raise taxes, right? Bad idea.)
- 3-yr public sector pay freeze, recruitment frozen (This is like a formal invitation for more protests.)
- Abolition of ‘13th and 14th monthly salary’ for public sector workers, 5% cut in allowances (Same. Protests!)
- No renewals for short-term public sector contracts (Same.)
- Closure of more than 800 out-dated state entities (Same.)
- Pension system: raising retirement age to 67 (from 53), cut state corporation pensions (Same.)
- Privatization: sales of state corporations; sales and leasing of state-owned properties (Same.)
So it boils down to higher taxes, cutting state employee pay and or jobs, and selling state assets. This will not be popular with Greece’s very large public employee contingent. It’s not fun to be a politician in tough times—these aren’t exactly populist moves. And probably the reason why Greek officials held out this long. It’s a shame too because I’m not convinced the IMF/EU bailout was even necessary had they just elected to do this stuff months ago. Another reason politics and economics make strange bedfellows. Nonetheless, Greece’s acceptance sets the stage for formal approval of the rescue package, which appears to be closer to €120bn in size at this point, but even that’s still not confirmed. The entire bailout might end up acting more as a backstop than a true need. Either way, it still appears worries this will spark a global debt contagion are overwrought. Time will tell.
It’s a certainty that Greece is going to have to get leaner from a government perspective—rein in costs and keep fighting unions. That’s just a reality of their situation.
But when it comes to thinking about the future of the European Union and its broader debt woes, and whether or not this becomes a “contagion”, paring back expenses isn’t everything.
Debt for gigantic sovereign nations or groups is a different thing than debt for individuals. We tend to think about them as equals, but that’s wrong. If you have too much credit card or mortgage debt, for example, you probably have to focus on paying it down, get frugal, start eating rice and water for every meal, and so on until you dig yourself out. That’s mostly because folks generally can’t increase their earnings significantly enough year over year to otherwise surmount the issue.
That’s not really as important for big governments. What is more important is the tax base from which they get their revenues to fund operations and service their debt. Because that can shift rather radically from year to year, and is most often where the biggest fluctuations in government fiscal health come from. Don’t get me wrong—I’m no proponent of profligate bureaucratic spending binges. Quite the opposite. But debt is something governments of the world are going to use—that’s the world we live in and it ain’t changing. And that’s always been fine (and still is) if those governments are able to meet their recurring payments.
We just went through a big global recession, so tax receipts have been lower. So, why, after the chaos of the last few days, are European stocks rallying? Probably two big reasons:
- Europe Economic Confidence Improves to Two-Year High
- European Stocks Advance as Estimate-Beating Earnings Outweigh Debt Crisis
Europe’s economic recovery has been weaker and slower than much of the rest of the world, but it’s still recovering. Which means tax receipts will grow, which means they can service their debt and pay their expenses easier. This applies for states like California and other municipalities, too. Economic recovery is the thing to focus on right now—increasing the tax base.
Granted, this is one facet of the issue, but it’s a big one. Others include the ability to tap capital markets and the yield a country must pay to do so ( Greece ’s debt costs have spiked lately). But it’s basically always been true that if you increase taxes on something you get less of it. And if you lower taxes on something you’re likely to get more of it. So, lower taxes on your economy—its people and corporations—and you’re likely to get better economic growth, which actually will get you higher tax receipts in the long run. (Thank you, Mr. Art Laffer!)
With all the public hubbub and scapegoating going on with Goldman Sachs on the Hill, it would be easy to miss this startling piece in today’s Wall Street Journal:
Essentially, investors are buying derivatives to bet municipalities will default. Oh my! Who would do such a nasty thing? Turns out, rational folks:
“These so-called credit default swaps are basically insurance contracts that have long been available to protect holders of corporate bonds against default. They became available a few years ago for municipal debt, allowing investors to short sell—or bet against—countless cities, towns and bridges, and more than a dozen states, including California, Michigan and New York.”
This is called hedging. It’s normal and risk mitigating and a perfectly fine thing to do. With many municipalities and states ailing after—let’s be honest—decades of gross fiscal mismanagement…these folks are actually upset investors want to protect themselves?
“In recent weeks, the treasurer received initial information in letters from the banks, but he is probing further to find out who is buying the products and whether the bank is trading in-house for its own profit. The underwriters who have been questioned are J.P. Morgan Chase & Co.; Merrill Lynch and its parent, Bank of America Corp.; Citigroup Inc.; and Barclays PLC. All the banks told California their activity is making it easier for the derivatives to trade without large price moves and that they aren’t driving up the issuers’ borrowing costs.”
This isn’t a far cry from what Goldman Sachs is going through right now on the federal level. I’d respectfully suggest those folks in charge of said states and cities focus on running a tighter ship so they can attract the capital they need rather than whine about the fact there is now better price discovery on their operations. There is nothing wrong with an investor paying to insure their own risk exposure.
PS—how many folks would’ve said that by April 2010 there’d be talk that some of the larger economies in the world are growing so fast they could overheat? That’s today’s world—stronger and more resilient than most could fathom a year ago.
Well, well. Look who’s arrived on the Beltway—the grandfather of investing himself, Mr. Warren Buffett. Suddenly, Mr. Buffett finds himself in the middle of a political maelstrom, as his company went the political route this weekend, seeking a provision to avoid a significant financial hit from the Obama financial overhaul. Essentially, the idea was to exempt existing derivative contracts from the proposed regulations, thereby allowing Berkshire ’s (and other financial institutions) current contracts to remain unfettered by the new laws.
And who can blame him? New derivative regulation as currently outlined would probably hack out a hefty bit of Berkshire ’s business (used for hedging, I might add), or at the very least cause a great deal of headaches for the company.
Who led this initial prodding on Buffett’s behalf? Why none other than Senator Ben Nelson himself—now widely known as the political pariah who traded his allegiance on the healthcare bill for benefits for his home state of Nebraska. But as of late today, looks like that provision has been killed. Sorry, Warren .
All this speaks to the inherent perversity and chaos of what’s going on with the financial overhaul right now. It’s nothing short of ridiculous that a company with a sterling reputation like Berkshire Hathaway, which, again, overwhelmingly uses derivatives to mitigate risk, is being punished by this new bill. And it also shows just how dislocating some of this bill could potentially be if even the (mostly) politically agnostic Buffett feels he must bring his mighty influence to bear.
I’m often on the opposing side of economist Robert Reich’s views, but I found myself unconsciously nodding my head as I read his piece at the Motley Fool today:
By Robert Reich, The Motley Fool
I don’t much care for the way he approaches the subject, but I’m generally with him on the idea of breaking up the giant Financials as opposed to enacting the lumbering, opaque reform about to be debated in the Senate. (Actually, putting derivatives through a clearing house seems fine enough to me, though I do worry some transactions are best done “over-the-counter”, and forcing an all-encompassing clearinghouse might actually choke off some types of useful derivatives…but I digress.)
Ultimately, competition is still the best of all regulators. Poor Teddy Roosevelt is probably spinning in his grave right now at the sight of this financial overhaul—whatever happened to the anti-trust spirit? Read the gory details of the proposed legislation in its current form here.
Think of it this way: It’s potentially even more hazardous to have giant “private” companies like the banks in close cahoots with the government’s lumbering oversight agencies than the outright taking over the means of production. The former is a kind of neo-fascism, the latter is socialism. Both are pretty bad.
Rather, instead of perpetuating what’s tantamount in many ways to an oligopoly in big Financials with huge government oversight, why not focus on increasing competition?
Have a great weekend.
|*The content contained in this article represents only the opinions and viewpoints of theFisher Investments editorial staff.|
I’ve never really been able to understand why folks look to the IMF for economic forecasts. Granted, they have access to information most others don’t, and are an organization designed to monitor the global landscape…but they’re generally no more accurate than anyone else. Personally, I’d rather the OECD projections, but both types are imperfect. That’s ok—global economic estimates are a messy business and precision is elusive no matter how good the agency.
I get a great kick out of these things because they’re revised so darn often, and usually after the market and other investors have figured things out anyway. Like a lot of ratings and forecasting agencies, government bureaus, and think tanks—there’s a tendency to be more reactive than proactive. These folks are seldom ahead of the curve. And so, today we get this:
- IMF Raises 2010 U.S. Growth Estimate to 3.1% From 2.7%, Warns About Debt
- IMF Raises 2010 Latin America Economic-Growth Forecast to 4% From 2.9%
The irony is, as the IMF raises its global economic forecast, in the same breath it warned of a ‘New Phase’ in the Crisis. As investors—what are we supposed to do with this kind of talk? Only a group that’s ultimately not responsible for their predictions can say such things—well, it’s gonna be better but actually it could get worse. An investor could never think this way or they’d be constantly paralyzed.