Finance Matters

Archive for January 30th, 2010

The Super Bowl — it’s about football and parties and a city rallying together over a unified desire to beat that other city that’s gone football mad.

But, really, it’s about business and the NFL is a big one — one willing to look ridiculous to protect its brand.

The league is claiming that it owns the phrase “Who Dat?’”

NFL spokesman Brian Mcarthy: “If ‘who dat’ is used in a manner to refer to Saints football, then the Saints own the rights.”

Someone knows how to take the fun out of things! The league is sending cease and desist letters to local businesses selling homegrown “who dat”-related items, several of which, according to The Wall Street Journal, are complying because they are the size of a kick off tee and the NFL is a left tackle. 

Some will argue that if the NFL did not protect its “brand” in situations like this it would be in a tough position in important infringement cases when the opposing side would point out the instances in which the NFL just turned a blind eye.

But the league does have the option of making the statement, sending letters to the larger infringers and then moving along. 

We are fairly certain there has been unauthorized “who dat?” Saints t-shirts in New Orleans for a while now. It’s always when your team hits the big time that the big time player becomes interested.

The Wall Street Journal has a full report, complete with other New Orleans lingo not to be missed. The dat-filled headline: Who Dat Owns ‘Who Dat’? Dat’s Us, Sez da NFL

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• Tough Hits But No Clear Winner In Supreme Court NFL Antitrust Case
• Gameday! The NFL Hopes To Tackle The Supreme Court
• War Story: It’s Easier To Cross-Examine A Priest Than A Legendary Football Coach

These two charts tell you pretty much all you need to know about the state of the US economy.  They also, unfortunately, provide some clues as to how this movie will end.

First, from John Mauldin, the state of the U.S. government’s finances.  The red line is spending.  The blue line is tax revenue.

Can you imagine if that was your household?

Second, from Ned Davis, the state of our country’s debts, as measured by debt as a percentage of GDP.  The little peak to the left was the debt mountain we accumulated during the Great Depression, which took a decade to work off.  The, um, bigger peak to the right, is the one we’ve accumulated now.

So how will this movie end?

Well, in the near-term, we can try to borrow more to fill the hole between the red line and the blue line in the chart on the top.  That will postpone the ending and give us a chance to kickstart the economy again. 

Of course, every dollar we borrow will also drop down to the chart at the bottom, making the mountain even taller (unless private-market debt shrinks by an offsetting amount–this chart includes both government and private debt).

If we’re lucky, in the intermediate term, the economy will start growing more rapidly (blue line turns up) and the government will be able to ease off on spending (red line turns down), making it so we can borrow less every year.  If that happy trend continues, we’ll eventually only have to deal with the nasty looking chart at the bottom: The debt mountain.

As to that…  The accumulation of the debt mountain is what has fueled the impressive GDP growth we’ve enjoyed for the past 30 years.  It’s fun borrowing more money, because when you borrow more money, you can spend more money, which is fun!

Of course, in the end, when you’ve borrowed as much as you can, you have to start paying some of the money back (or, at the very least, borrow less each year than you used to).  And to pay the money back, you have to start spending less.

So, again, how do you think this movie will end?

If we’re lucky, it will end gradually, in a long, boring couple of decades in which we gradually get our discipline and competitiveness back and bring our finances under control.

And if we’re not lucky?

Well, then, the movie will have a more exciting ending.

See Also: We Are So Screwed

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See Also:

• We Are So Screwed
• We Have Seen The Amazing Future Of Apple’s iPad And This Is It
• McKinsey: You Won’t Believe How Much Pain We’re Still In For

Jeff Jarvis reports from Davos…

First, the news: Google told me today that they would consider giving more transparency about revenue splits in Adsense.

At a private meeting with a dozen and a half media people at Davos with CEO Eric Schmidt, President of sales Nikesh Arora, search boss Marissa Mayer, YouTube founder Chad Hurley, and counsel/”chief diplomat” (Schmidt’s joke) David Drummond in a Davos apartment dolled up with lava lamps, the execs discussed China, the company’s push into display, critics from France to News Corp., Android and its phone strategy, and news.

* * *

AdSense: At the DLD conference in Munich Monday, Burda CEO Paul-Bernhard Kallen, on a panel with Drummond, said publishers wanted transparency and their “fair share.” I asked him, a fair share of what — AdSense? Kallen said yes. And that put a fence around this debate. Drummond went on to emphasize that publishers do not deserve a share of a search for a camera that doesn’t involve their content. He also said transparency could be discussed.

At today’s briefing, Arora said that the company was considering more transparency. I confirmed with Google’s people that this was new. I suspect that they’re not going to promise the possibility and not deliver something.

I’m happy about this because, with China, this seems to strike off my two biggest complaints — both in What Would Google Do? — about Google: its prior lack of support of free speech in China and its hypocrisy on transparency and ad rates.

* * *

China: “We made a decision that was consistent with our values,” Schmidt said. “We’re not going to operate differently in China as opposed to the rest of the world,” said Drummond.

When is Google going to do something? “It should happen soon,” Drummond said.

Was Google’s original stance on China — making it an exception to its own rules — a mistake? “We said consistently we would evaluate the position,” said Schmidt, “and people didn’t believe us.”

On the attacks, Schmidt said the company had a moral need to “make sure our systems are safe from attack anywhere.”

They wouldn’t discuss any details about any discussions with China. One editor asked whether Google was upset that other companies — especially those that also suffered attacks — have not come forward to openly support Google. I went farther and said that Microsoft had thrown Google under the bus and backed up over it. Schmidt repeatedly said that he manages Google, not other companies. “We speak for ourselves.”

Drummond said the problem of censorship is not in China alone. Hurley said YouTube is blocked in China, Turkey, and Iran “because of freedom of speech.”

“I believe this is an evergreen story for Google and other online companies,” Schmidt said. “As the world goes online, every country is going to have a discussion about what’s appropriate and what’s not. And a lot of these organizations [that is, governments] have not really thought through what they’re doing. We have a strong view about transparency.” [It's about to get a little stronger, it seems.]

Though Schmidt joked about Drummond as Google’s diplomat and apologized for mixing metaphors, he emphasized that Google is not a country, does not set laws, and does not have a police force — or diplomats This is a government-to-government issue, he said.

* * *

Google’s reputation: I asked whether it was lonely at the top, getting grief from France to Germany to News Corp to China. Is it because Google is so big? Is it because it is putting itself on the ledge? Is it a PR problem? Schmidt said no.

“Google is fundamentally disruptive because of our innovation,” Schmidt said. “Google, because of our architecture, does things at a larger scale than others can. We are in the information space, which everyone has an opinion on. … You asked me how does it feel from a Google perspective? It feels as if we’re in the right place.” These aren’t crises, Schmidt said. He treated them as a factor in doing business. “It’s constant. It’s because it’s information that maters.”

* * *

Innovation: Schmidt later talked about the difficulty we all know companies such as this can have: growing big and killing innovation. He talked about the canonical Silicon Valley story: a company starts, it innovates, it grows to middle age, it grows bored, it is sold to another company. Schmidt et al are clearly aware of that threat. Apple, he said, has “proven the model of innovation at scale.”

* * *

Phones: Will they have a tablet? “You might want to tell me what the difference is between a large phone and a tablet,” Schmidt said.

How will they make money on phones? “Not to worry,” Schmidt said. “We do not charge for Android because we can make money in other contexts.”

The strategy, he said, is to establish volume for application development to follow. “The phone is defined by the apps,” he said.

Schmidt took my Nexus One and demonstrated Google Sky. Mayer said the guy in charge of mobile uses Google Goggles to take pictures of wine labels and search on them so he can sound smart: “It tastes of apricot blossoms.” Mayer told Schmidt about Layar (a very neat augmented reality program I wrote about here earlier); he didn’t even know about it yet.

* * *

The economy: “The recession is very much behind us,” Schmidt said. “We see growth and successful businesses I think pretty much everywhere in the world.””

* * *

Display ads: Schmidt said the company is “trying to apply the science of Google to the display space. Display is likely to be our next really big business globally.”

Arora said that today marketers buy sites when they want to buy audiences. He said Google will “bring measurability to the process of display” and it is “trying to find a way for the industry to bring the entire inventory together.” That is, “most agencies and buyers don’t have the tools to aggregate across publishers.” Schmidt added: “Before the google question was applied to this, you couldn’t have scale.”

Isn’t this just an ad network? Arora said it would be a collection of networks, an exchange that would “allow you to separate the best owners of inventory from the best sellers of inventory.” I don’t understand what that means and will ask.

Aren’t publishers going to see Google as again disintermediating them and hurting their brands? I asked. Google said the platform will bring greater transparency, more inventory, faster, with scale and speed and that publishers who participate will gain more revenue from the inventory they have (and don’t sell). Indeed, I was talking with one newspaper editor before the meeting as he lamented the small size of the percentage that is sold.

* * *

Relations with newspapers: “We depend on high-quality content,” Schmidt said.

Mayer said Google will help publishers make more money. It will create better advertising products for them, improving display. It will provide ads that are more relevant. It will support pay efforts.

She also said Google is working on making news as compelling as possible. “The issue is one of engagement online: if they spent more time online it would be much easier to make money with it,” she said and then added that publishers must “bring the news to users’ digital doorsteps.” Amen. I’ve written often here about the challenges of engagement and the need to think distributed. Those are ripe areas for Google to help news.

* * *

YouTube: Schmidt said he was very pleased with YouTube and that it was making money but he and Hurley wouldn’t get in the slightest bit specific about the definition of making money (profit? cash flow?) let alone numbers. “In the last year, Chad managed to figure out a way to make money using partners and their video content on YouTube,” Schmidt said. Hurley said it took longer than expected to get their because of delays in bringing in Doubleclick. He said they have a sales force selling video in 20 countries. They also recently made a deal with channels 4 and 5 in the UK to distribute content and they’re going to live-stream cricket.

* * *

Pay: Will Lewis of the Telegraph asked “what’s it like being so brutally attacked by News Corp. What side of genius to you think their pay wall idea is?” Of course, Google’s execs didn’t take the bait.

They talked about hybrid business models and said they’d support them and pretty much left it at that.

* * *

Globalization: Schmidt said a majority of Google users are outside the U.S. and he expects that soon most revenue will come from outside the U.S.

* * *

: The Guardian’s Alan Rusbridger on the briefing: Google as a country.

Jeff Jarvis is an associate professor and director at the interactive journalism program at the City University of New York’s new Graduate School of Journalism. He is also the author of What Would Google Do?, and writes the influential blog BuzzMachine, where this post was originally published.

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See Also:

• Google To "Pressure" China Over Censorship
• Eric Schmidt: ‘Tell Me The Difference Between A Large Phone And A Tablet’
• YouTube Turning A Profit? Eric Schmidt "Assumes" It Is

While the first version of Apple’s iPad does not support video calls, future versions might, according to people taking a careful look under the hood of the iPad developer software Apple has released.

“We just confirmed with extremely trusted sources that iPhone OS 3.2 contains rudimentary support for video calling,” Engadget’s Nilay Patel writes. “We’re told that there are hooks to accept and decline a video conference, flip a video feed (which suggests a front-facing camera) and — most importantly — run the video call in either full screen mode or in just a portion of the screen.”

This seems a likely feature for future iPads, once people are used to the idea of holding a computer in their hands. We assume Apple has at least tested iPads with built-in cameras, but may have passed on them for the first version because of design requirements, price, or other reasons.

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“Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that ‘this time is different.’

“That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.”

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

When does a potential crisis become an actual crisis, and how and why does it happen? Why did most everyone believe there were no problems in the US (or Japanese or European or British) economies in 2006? Yet now we are mired in a very difficult situation. “The subprime problem will be contained,” said now controversially confirmed Fed Chairman Bernanke, just months before the implosion and significant Fed intervention. I have just returned from Europe, and the discussion often turned to the potential of a crisis in the Eurozone if Greece defaults. Plus, we take a look at the very positive US GDP numbers released this morning. Are we finally back to the Old Normal? There’s just so much to talk about…

The Statistical Recovery Has Arrived

Before we get into the main discussion point, let me briefly comment on today’s GDP numbers, which came in at an amazingly strong 5.7% growth rate. While that is stronger than I thought it would be (I said 4-5%), there are reasons to be cautious before we sound the “all clear” bell.

First, over 60% (3.7%) of the growth came from inventory rebuilding, as opposed to just 0.7% in the third quarter. If you examine the numbers, you find that inventories had dropped below sales, so a buildup was needed. Increasing inventories add to GDP, while, counterintuitively, sales from inventory decrease GDP. Businesses are just adjusting to the New Normal level of sales. I expect further inventory build-up in the next two quarters, although not at this level, and then we level off the latter half of the year.

While rebuilding inventories is a very good thing, that growth will only continue if sales grow. Otherwise inventories will find the level of the New Normal and stop growing. And if you look at consumer spending in the data, you find that it actually declined in the 4th quarter, both annually and from the previous quarter. “Domestic demand” declined from 2.3% in the third quarter to only 1.7% in the fourth quarter. Part of that is clearly the absence of “Cash for Clunkers,” but even so that is not a sign of economic strength.

Second, as my friend David Rosenberg pointed out, imports fell over the 4th quarter. Usually in a heavy inventory-rebuilding cycle, imports rise because a portion of the materials businesses need to build their own products comes from foreign sources. Thus the drop in imports is most unusual. Falling imports, which is a sign of economic retrenching, also increases the statistical GDP number.

Third, I have seen no analysis (yet) on the impact of the stimulus spending, but it was 90% of the growth in the third quarter, or a little less than 2%.

Fourth (and quoting David): “… if you believe the GDP data – remember, there are more revisions to come – then you de facto must be of the view that productivity growth is soaring at over a 6% annual rate. No doubt productivity is rising – just look at the never-ending slate of layoff announcements. But we came off a cycle with no technological advance and no capital deepening, so it is hard to believe that productivity at this time is growing at a pace that is four times the historical norm. Sorry, but we’re not buyers of that view. In the fourth quarter, aggregate private hours worked contracted at a 0.5% annual rate and what we can tell you is that such a decline in labor input has never before, scanning over 50 years of data, coincided with a GDP headline this good.

“Normally, GDP growth is 1.7% when hours worked is this weak, and that is exactly the trend that was depicted this week in the release of the Chicago Fed’s National Activity Index, which was widely ignored. On the flip side, when we have in the past seen GDP growth come in at or near a 5.7% annual rate, what is typical is that hours worked grows at a 3.7% rate. No matter how you slice it, the GDP number today represented not just a rare but an unprecedented event, and as such, we are willing to treat the report with an entire saltshaker – a few grains won’t do.”

Finally, remember that third-quarter GDP was revised downward by over 30%, from 3.5% to just 2.2% only 60 days later. (There is the first release, to be followed by revisions over the next two months.) The first release is based on a lot of estimates, otherwise known as guesswork. The fourth-quarter number is likely to be revised down as well.

Unemployment rose by several hundred thousand jobs in the fourth quarter, and if you look at some surveys, it approached 500,000. That is hardly consistent with a 5.7% growth rate. Further, sales taxes and income-tax receipts are still falling. As I said last year that it would be, this is a Statistical Recovery. When unemployment is rising, it is hard to talk of real recovery. Without the stimulus in the latter half of the year, growth would be much slower.

So should we, as Paul Krugman suggests, spend another trillion in stimulus if it helps growth? No, because, as I have written for a very long time, and will focus on in future weeks, increased deficits and rising debt-to-GDP is a long-term losing proposition. It simply puts off what will be a reckoning that will be even worse, with yet higher debt levels. You cannot borrow your way out of a debt crisis.

This Time Is Different

While I was in Europe, and flying back, I had the great pleasure of reading This Time is Different, by Carmen M. Reinhart and Kenneth Rogoff, on my new Kindle, courtesy of Fred Fern.

I am going to be writing about and quoting from this book for several weeks. It is a very important work, as it gives us the first really comprehensive analysis of financial crises. I highlighted more pages than in any book in recent memory (easy to do on the Kindle, and even easier to find the highlights). Rather than offering up theories on how to deal with the current financial crisis, the authors show us what happened in over 250 historical crises in 66 countries. And they offer some very clear ideas on how this current crisis might play out. Sadly, the lesson is not a happy one. There are no good endings once you start down a deleveraging path. As I have been writing for several years, we now are faced with choosing from among several bad choices, some being worse than others. This Time is Different offers up some ideas as to which are the worst choices.

If you are a serious student of economics, you should read this book. If you want to get a sense of the problems we face, the authors conveniently summarize the situation in chapters 13-16, purposefully allowing people to get the main points without drilling into the mountain of details they provide. Get the book at a 45% discount at Amazon.com.

Buy it with the excellent book I am now reading, Wall Street Revalued, and get free shipping.

A Crisis of Confidence

Let’s lead off with a few quotes from This Time is Different, and then I’ll add some comments. Today I’ll focus on the theme of confidence, which runs throughout the entire book.

“But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.”

“If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget.”

And this is key. Read it twice (at least!):

“Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence-especially in cases in which large short-term debts need to be rolled over continuously-is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!-confidence collapses, lenders disappear, and a crisis hits.

“Economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public’s expectation of future events, that makes it so difficult to predict the timing of debt crises. High debt levels lead, in many mathematical economics models, to “multiple equilibria” in which the debt level might be sustained – or might not be. Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble. When debt-fueled asset price explosions seem too good to be true, they probably are. But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”

How confident was the world in October of 2006? I was writing that there would be a recession, a subprime crisis, and a credit crisis in our future. I was on Larry Kudlow’s show with Nouriel Roubini, and Larry and John Rutledge were giving us a hard time about our so-called “doom and gloom.” If there is going to be a recession you should get out of the stock market, was my call. I was a tad early, as the market proceeded to go up another 20% over the next 8 months.

As Reinhart and Rogoff wrote: “Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits.”

Bang is the right word. It is the nature of human beings to assume that the current trend will work out, that things can’t really be that bad. Look at the bond markets only a year and then just a few months before World War I. There was no sign of an impending war. Everyone “knew” that cooler heads would prevail.

We can look back now and see where we made mistakes in the current crisis. We actually believed that this time was different, that we had better financial instruments, smarter regulators, and were so, well, modern. Times were different. We knew how to deal with leverage. Borrowing against your home was a good thing. Housing values would always go up. Etc.

Now, there are bullish voices telling us that things are headed back to normal. Mainstream forecasts for GDP growth this year are quite robust, north of 4% for the year, based on evidence from past recoveries. However, the underlying fundamentals of a banking crisis are far different from those of a typical business-cycle recession, as Reinhart and Rogoff’s work so clearly reveals. It typically takes years to work off excess leverage in a banking crisis, with unemployment often rising for 4 years running. We will look at the evidence in coming weeks.

The point is that complacency almost always ends suddenly. You just don’t slide gradually into a crisis, over years. It happens! All of a sudden there is a trigger event, and it is August of 2008. And the evidence in the book is that things go along fine until there is that crisis of confidence. There is no way to know when it will happen. There is no magic debt level, no magic drop in currencies, no percentage level of fiscal deficits, no single point where we can say “This is it.” It is different in different crises.

One point I found fascinating, and we’ll explore it in later weeks. First, when it comes to the various types of crises with the authors identify, there is very little difference between developed and emerging-market countries, especially as to the fallout. It seems that the developed world has no corner on special wisdom that would allow crises to be avoided, or allow them to be recovered from more quickly. In fact, because of their overconfidence – because they actually feel they have superior systems – developed countries can dig deeper holes for themselves than emerging markets.

Oh, and the Fed should have seen this crisis coming. The authors point to some very clear precursors to debt crises. This bears further review, and we will do so in coming weeks.

Greeks Bearing Gifts

On Monday, the government of Greece offered a “gift” to the markets of 8 billion euros worth of bonds at a rather high 6.25%. The demand was for 25 billion euros, so this offering was rather robust. Today, those same Greek bonds closed on 6.5%, more than offsetting the first year’s coupon. Greek bond yields are up more than 150 basis points in the last month!

Why such a one-week turnaround? Ambrose Evans Pritchard offers up this thought: “Marc Ostwald, from Monument Securities, said the botched bond issue of €8bn (£6.9bn) of Greek debt earlier this week has made matters worse. Many of the investors were ‘hot money’ funds that bought on rumors that China was emerging as a buyer, offering them a chance for quick profit. When the China story was denied by Beijing and Athens, these funds rushed for the exit.”

Greece is running a budget deficit of 12.5%. Under the Maastricht Treaty, they are supposed to keep it at 3%. Their GDP was $374 billion in 2008 (about €240 billion). If they can cut their budget deficit to 10% this year, that means they will need to go into the bond market for another €25 billion or so. But they already have a problem with rising debt. Look at the following graph on the debt of various countries.

When Russia defaulted on its debt and sent the world into crisis in 1998, they had total debt of only €51 billion. Greece now has €254 billion and added another €8 billion this week, and needs to add another €24 billion (or so) later this year. That’s a debt-to-GDP ratio of over 100%, well above the limit of the treaty, which is 60%.

Greece benefitted from being in the Eurozone by getting very low interest rates, up until recently. Being in the Eurozone made investors confident. Now that confidence is eroding daily. And this week’s market action says rates will go higher, without some fiscal discipline. To help my US readers put this in perspective, let’s assume that Greece was the size of the US. To get back to Maastricht Treaty levels, they would need to cut the deficit by 4% of GDP for the next few years. If the US did that, it would mean an equivalent budget cut of $500 billion dollars. Per year. For three years running.

That would guarantee a very deep recession. Just a 10% suggested pay cut has Greek government unions already planning strikes. Nevertheless, the government of Greece recognizes that it simply cannot continue to run such huge deficits. They have developed a plan that aims to narrow the shortfall from 12.7% of output, more than four times the EU limit, to 8.7% this year. That reduction will be achieved even though the economy will contract 0.3%, the plan says. The deficit will shrink to 5.6% next year and 2.8% in 2012.

The market is saying they don’t believe that will happen. For one thing, if the Greek economy goes into recession, the amount collected in taxes will fall, meaning the shortfall will increase. Second, it is not clear that Greek voters will approve such a plan at their next elections. Riots and demonstrations are a popular pastime.

Both French and German ministers made it clear that there would be no bailout of Greece. But here’s the problem. If they ignore the noncompliance, there is no meaning to the treaty. The euro will be called into question. And the other countries with serious fiscal problems will ask why they should cut back if Greece does not. If Greece does not choose deep cutbacks and recession, the markets will keep demanding hikes in interest rates, and eventually Greece will have problems meeting just its interest payments.

Can this go on for some time? The analysis of debt crises in history says yes, but there comes a time when confidence breaks. My friends from GaveKal had this thought:

“What is the next step? Having lived through the Mexican, Thai, Korean and Argentine crises, it is hard not to distinguish a common pattern. In our view, this means that investors need to confront the fact that we are at an important crossroads for Greece, best symbolized by a simple question: ‘If you were a Greek saver with all of your income in a Greek bank, given what is happening to the debt of your sovereign, would you feel comfortable keeping all of your life savings in your savings institution? Or would you start thinking about opening an account in a foreign bank and/or redeeming your currency in cash?’ The answer to this question will likely direct the next phase of the crisis. If we start to see bank runs in Greece, then investors will have to accept that the crisis has run out of control and that we are facing a far more bearish investment environment. However, if the Greek population does not panic and does not liquefy/transfer its savings, then European policy-makers may still have a chance to find a political solution to this growing problem.

“What could a political solution be? The answer here is simple: there is none. So if Europe wants to save Greece from hitting the wall towards which it is now heading, the European commission, the ECB and/or other institutions (IMF?) will have to bend the rules massively. In turn, this will likely lead to a further collapse in the euro. But for us, an important question is whether it could also lead to a serious political backlash. Indeed, at this stage, elected politicians are likely pondering how much appetite there is amongst their electorate for yet another bailout, and for further expansions in government debt levels. The fact that the intervention would occur on behalf of a foreign country probably makes it all the more unpalatable (it’s one thing to save your domestic banking system … but why save Greece?).”

If Greece is bailed out, Portugal and Ireland will ask “Why not us?” And Spain? Italy? If Greece is allowed to flaunt the rules, what does that say about the future of the euro? Will Germany and France insist on compliance or be willing to kick Greece out?

A few months ago, the markets assumed that not only Greece but Portugal, Italy, Spain, and Ireland would have a few years to get their houses in order. This week, the markets shortened their time horizon for Greece.

Even so, we get this quote, which may end up ranking alongside Fisher’s quote in 1929, that the stock market was at a permanently high plateau, or Bernanke’s quote that “The subprime debt problem will be contained.”

“There is no bailout problem,” Monetary Affairs Commissioner Joaquin Almunia said today at the World Economic Forum’s annual meeting in Davos, Switzerland. “Greece will not default. In the euro area, default does not exist.”

The evidence in This Time is Different is that default risk does in fact exist. You cannot keep borrowing past your income, whether as a family or a government, and not eventually go bankrupt.

Are we at an inflection point? Too early to say. It all depends on the willingness of the Greek people to endure what will not be a fun next few years, for the privilege of staying in the Eurozone. And on whether the bond market believes that this time is different and the Greeks will actually get their fiscal house in order.

Oh by the way, did I mention that the history of Greece is not exactly pristine in terms of default? In fact, they have been in default in one way or another for 105 out of the past 200 years. Aristotle, can you spare a dime?

And one last thought. The US is running massive deficits. If we do not get them under control, we will one day, and perhaps quite soon, face our own “Greek moment.” Look at the graph below, and weep.

Obama offering to freeze spending by 17% in US discretionary-spending programs, after he ran them up over 20% in just one year, is laughable. Greece is an object lesson for the world, as Japan soon will be. You cannot cure too much debt with more debt.

Biotech, Conversations, and More

Two quick commercial notes. I mentioned a few weeks ago that I was going to start a stock-buying program for the first time in 15 years (I normally invest in managers and funds rather than specific stocks). I published an Outside the Box last week that talked about why I think biotech stocks could be at the beginning of a decade-long run, and why I wanted to participate directly. You can read that Outside the Box by clicking on this link.

Second, I offer a subscription service called Conversations with John Mauldin, where I hold conversations with people who I think have something important for us to understand. It has been very well received. We provide both audio and a transcript. I just posted my latest Conversations, in which I interviewed two gentlemen who are CEOs of companies that I think are at the very bleeding edge of the biotech revolution. Subscribers have already gotten that posting. Over the year, in addition to the usual economic Conversations we have, I will be interviewing other industry leaders who will be changing the world of medicine in the coming decade. You can subscribe at https://www.johnmauldin.com/newsletters2.html.

In addition, George Friedman and Niall Ferguson and I are exchanging emails on a time to get together for another of the series where George and I talk about geopolitics. I guarantee a lively and fascinating Conversation.

It is good to be back from Europe. While it was fun, it was mostly long days and a lot of planes, trains, and automobiles. I arrived home to find baby bottles and other baby paraphenalia around the house. Tiffani and Ryan are starting to come back to work at the house with me, and of course my granddaughter Lively will be here most days with them, along with a nanny so Mom can actually work. It has been a long time since I had a baby around. As I went to bed, I realized that I was going to get to watch this grandchild grow up on an almost daily basis. It was with a sigh of contentment that I went to sleep.

And then today, they came and brought her. She has grown so much in just the week I was gone! Once again, I get to experience the miracle of kids growing up. Only this time I don’t have to change the diapers. Life is good.

Your believing my grandkids will have a better future analyst,

John Mauldin
John@FrontLineThoughts.com

Copyright 2010 John Mauldin. All Rights Reserved

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• Just Biding Our Time Before The Crash In 2011
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