Having trouble meeting loan repayments?

Wouldn't be awesome if you could print money? 
Say you're struggling a bit on your home loan repayments, or perhaps that stumble in the market last week pushed you into Margin Call territory, you simply head into your home office and fire up your laser printer. I would have suggested using an inkjet but then if any of your 'money' got wet it would be worthless again.


Of course most of you would think that this is a ridiculous idea, but this is essentially what the US and to a certain extent the UK have been doing. Except, they are taking it to an even lazier easier extreme, why print millions and millions of notes when you can print out a couple of treasury bonds (T-bills, T-notes etc).

The end result of this is that their debt is reduced, or rather the real cost of the debt is reduced, by making their currency worth less they also make the debt less. For the most part it would seem that reducing the worth of your currency isn't the best thing to do. Essentially this is inflating your way out of debt. So the question is:

Can you inflate your way out of debt?
Unfortunately for us this is not possible on an individual basis, inflation eats away at the individual like an insidious parasite that you are never quite aware of. That 3% pay rise is essentially a pay cut if there is 4% inflation. But the US Dollar is in a unique position in the global markets as the defacto standard  against which all other currencies and a great deal of commodities are compared. So perhaps there is a chance that the US can print there way out of trouble. Although the general consensus is that this isn't really going to work but that is a discussion for a different time, the main discussion point for this post is what can Greece and the rest of the PIIGSs in the Euro Zone do and what can the financial powers that be, France and Germany do to recover the Euro?


Why Greece faces a Heraclesean* Challenge?
*Why not Herculean I hear you say? Well the nerd in me has to point out that Hercules is the Roman name for the Greek God Heracles.
The problem that faces Greece is that they don't even have the option of attempting to inflate their way to fiscal freedom. They do not control the Euro printing press (Indeed the rest of the Eurozone countries don't really either, there is a camel sitting at the control panel). So what are their options for repaying the debt, which will require 12% of their GDP to service? That is $1 in every $8 goes to paying their interest bill, not even repaying the debt. Basically they have to reduce there public service (one of the largest in the world), increase their taxes and sell some assets. They will also have to increase the retirement age (currently among the lowest in Europe). All of these options are immensely unpopular amongst the people which is what is causing the widespread rioting.

Why Germany and France are getting a raw deal!
Think of Germany and France as the sensible siblings in Europe, they went to school, they studied hard and now they have a steady, well paying job and are doing fairly well for themselves. Their pigish siblings on the hand have squandered their youth on sex and drugs and live life pay cheque to pay cheque, relying on their sensible siblings to bail them out.

The main problem facing Germany and France is the inherent weakness in the EU. When times are good, everything is great, when times are bad the EU has no power to extract punitive retribution from the member countries.

Think of it this way, if NSWs for example had to borrow a large amount of money from the Federal government. The Federal government would be able to compel payment in the form of adjusting GST revenue flows or introducing a new tax or levy on New South Welshman. The EU has limited power in the regard and it affects how the EU can react to the financial problems facing it's member countries.

One thing is sure, we have not seen the end of the economic stability problems within Europe and we have not seen the end of their effects on the rest of the world markets.

Does the Reserve Bank need a reality cheque?

So continuing on from last post on the the PPoD I saw an article today discussing the Reserve Banks recent rate rise and their take on the PPoD. This is perhaps most succinctly expressed with a quote from Tuesday's rates announcement.

"To date, there has been very little contagion outside Europe" Glenn Stevens

It is almost as though the market itself heard these words and decided to prove him wrong. Just two days later the DOW plummeted and over the course of the ensuing 4 days the global markets lost around 10%. Of course this is ridiculous, the reality is of course that there is a lack of understanding of the wider impacts of global debt servicing problems across the board.

Or rather it is not that there is a lack of understanding, it is that there is a distinct lack of the ability for existing forecasting and modelling to handle such discontinuities as a Greek default on debt, or an unpronounceable volcano grounded all  aircraft in Europe, or the Federal Reserves printing press breaking and throwing their currency devaluation plans into disarray (more on this in a future post).

The problem really arises from the fact that it is nigh on impossible to firstly predict events, such as a volcano or an accidental order to sell ten times as many shares as planned and secondly to predict the markets reaction to these events. The initial prediction can for the most part be covered by the traditional assumptions of randomness and probably bludgeoned into submission with some Monte Carlo simulation, the real difficulty comes with assessing the impacts of the initial event.

So, what is the Reserve bank to do? It would seem to be that they would be better off being over cautious in the current climate than over zealous. This will probably mean that we have seen the last rate rise for a while indeed, we may be at an inflection point, where we are not climbing out of the original recipe GFC but falling into the grasp of the second "Zinger" financial crisis which will be spurred on by the collapse of countries under high debt loads. They may have stumbled through the last crisis only to succumb to a second wave of market doubt and volatility.

Why the Stock Market doesn't like Souvlaki

The PIIGs Pentagon of Debt

This image (from the New York Times which I found in a thread on forums.overclockers.com.au) is what I loving refer to as the PIIGS' (Portugal, Italy, Ireland, Greece and Spain) Pentagon of Debt or PPoD.

The PPoD sums up the debt fears that are weighing down the stock and lending markets across the world. Now, like most Australians I used to think, who cares that the Greeks are having little trouble paying off a few loans. Well, basically the financial woes of Greece are small compared to the wider PIIGS debt levels and this pales into insignificance when you consider that the US debt is currently at around $12.5 trillion dollars, that is ten times that of Italy and approaching the value of their GDP.

So why do we need to care?

Well, basically the cost of borrowing money is going up. This obviously hits us quite close to home (literally) as it forces the banks to increase the spread between the Reserve Bank rate and the actual home loan rate that you are receiving. So, while the general public focus is on the Reserve Bank rates here in Australia, there should also be more consideration of the increasing loan costs by the Average Joe. The problem is that there is no easily accessible or understandable figure. There is the US Prime Rate and the London Inter Bank Offered Rate (LIBOR) which are the  rates that the banks used on a day to day basis to lend money to each other. But it is hard to draw a useful affect of the day to day changes of these rates against the long term cost of borrowing money from your local branch.

There is also the effect that this has on Australian and International business, it becomes harder and harder to fund new ventures and to generate new value when the cost of borrowing money goes up, this has the flow on effect of decreasing the productivity and ultimately the profitability of businesses, this means their stock is worth less and this leads to the widespread drops that you see in the global stock markets.

Also, in the end the markets value stability and while the Greek Parliament has passed the Austerity Bill we still don't have a clear picture of how the other PIIGS will perform. Or for that matter the US.

So, hang on to your seats folks, because I fear we are in for a bumpy ride.