“The honor of the nation was at stake.”
June 9, 2011
David R. Kotok
Stefan Ingves, Sweden’s central bank governor, was asked how Sweden found the political resolve to respond to its financial crisis two decades ago. His answer was, “The honor of the nation was at stake.” A simple statement carrying profound meaning.
In the end, the honor of Greece, Portugal, Ireland, and countries around the world is at stake. In the United States, a debt-ceiling stalemate that results in a default would be a breach of American honor. The damage would be irreparable. This is a key takeaway from the GIC meetings in Helsinki and two days of meetings in Paris. Political will must resolve to do what must be done or face failed governance.
The past six days have been full of discussion. The composition included central bankers, financial experts, economists, investors, and GIC colleagues from countries within the European Union and beyond.
Through our spirited debates, one assertion stands: European policy makers are doing their absolute best to contain the debt crisis to Greece. The contagion risk compels the establishment and negotiation of programs that require continued financing and refinancing of new money for Greece. These programs that enable Greece to pay its bills and avoid defaulting on its debt are designed to produce two outcomes.
The first outcome involves the adoption of better budgets, including spending controls, and more stringent taxpayer compliance. It is imperative that Greece alter its negative behaviors of the last decade. Whether the political system in Greece will permit this necessary change remains to be seen.
If the Parliament were to have a no-confidence vote, establish new elections, and elect a governmental body that would repudiate its debt, a huge risk of contagion could occur. Unfortunately, even if the debt crisis is contained, it will be the citizens of Greece – along with their banks, businesses, and national spirit – who will suffer as a result of years of budget profligacy and lack of taxpayer compliance.
The remaining sixteen eurozone member countries now focus on containment. Is it possible to keep this Greek crisis fenced in? Will the programs established be sufficient so that sustainable balances can be reached in Portugal, Ireland, and other member countries? Can containment effectively neutralize pressures on Spain and Italy as well? At this point in time there are no answers, yet the questions do not fade from our thoughts.
The second outcome involves political change. This takes us beyond Greece and into the member countries of the eurozone. Will change ever come? There is also a growing chasm between Northern and Southern European voters. The political clamor coming from the voters in the north says they do not want to pay any more. Evidence of this is clear as you travel around Northern Europe. In the south, the voters declare they no longer want austerity budgets. They have had enough. That is quite a different political clamor. Are these two on a collision course? Again, the answers we seek are nowhere to be found.
We have seen in Ireland the rising private-sector deposit outflows. Until very recently, they persisted at an accelerating pace. However, they seem to have leveled off. Perhaps the new procedures and structure established in Ireland were sufficient enough to infuse confidence back into the banking system so it could remain operational.
In Greece, this is not the case. Negative deposit outflows from the private sector in Greece continue month after month at double-digit rates. Greek businessmen and depositors cannot be blamed for taking their money out of Greek banks and putting it in banks guaranteed by other nations. Impediments have now been put in place to hinder these actions.
In most banks in the eurozone, the depositor must be physically present in order to open an account. This translates into much more effort on the part of the depositor. However, the existence of these hindrances proves the process to have merit. Depositors see that it has become more difficult to move their euros out of Greek banks, so they are more willing to spend the extra time and effort to travel by car or plane to do so. And so, the fear spreads and the internal debate in Europe proceeds.
We come away from this trip to Europe weary from the road, yet very much invigorated by the challenges that lie ahead. Northern Europe is a success story. The central banking aspects of the euro and its durability as a currency increased in our view. We do not foresee the eurozone dismembering or the European Central Bank failing. The ECB is clear in its long-term strategic purpose. Euro skeptics have been in existence in the United States and elsewhere since the Treaty of Maastricht and before 1999, when the euro started to trade in virtual form. Recent history proves the skeptics wrong, and we believe they will continue to be proven wrong in the years to come.
Sovereign states now have the choice to either hunker down or not. Positive evidence exists. In New Jersey, a new governor and his political opponent have made a budget deal – they had to. Approximately half of American states have turned to better behavior in fiscal matters. Others will begin follow suit. In Washington, a fierce battle will end in some improvement. All this is motivated by the honor of the state.
Let us look at failed states. Zimbabwe is the front runner, with Venezuela following close behind. In Argentina, fiscal deterioration continues and poor governance discloses the lack of state honor.
In ancient Greece, 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 and she attempts to recant what the videotape discloses.
Prophecy of mass default may prove correct, but we believe otherwise. In most jurisdictions, the corrective decisions, though tough, are being made, as they must. The honor of the nation is at stake.
David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors Commentary