PEP Talk ... Two

Now, where was I? I think my intended short Blog of 17 November started to grow legs once I got into it - and if you have come into this Blog "cold" as it were, PEP stands for People, Economics and Politics!

It started off by saying that you should never judge a person's intelligence by the way they dress and look, and then I was suggesting that our global Economic woes were largely caused by People. We have to a large extent brought this current crisis on ourselves, (but of course are quick to blame everyone and anything else!). I then started down the "Economics" path - busily distancing myself from any specialist knowledge on the subject, but just speculating (oops, that word again!) on what might happen next, in particular in the Eurozone. And it is this Eurozone region, to me anyway, that is currently at the heart of what is likely to happen next.

We all know Greece has a problem. Unless they are prepared to accept tough measures that will undoubtedly impact their lifestyle, they will go bankrupt. Why will anyone want to lend more to a Government that cannot repay its debts because they cannot raise enough money to do so? This is serious enough, but it has other implications too.

For example a similar story might now be emerging in Italy. This is a country that has to re-negotiate approximately Euros 350 billion of debt next year. That is, renegotiate or repay. It cannot do the latter. But if you borrow - you pay interest. As a "sovereign" borrower, previously they might have had to pay 3 or 4% interest annually but the most recent issue of Italian Government 10 year bonds had an interest rate of around 6.8% per annum; expensive - very! If that trend continues, then next year's re-negotiations could be at historic highs making it hard for Italy to even service the interest repayment! The same story is repeated in Spain and Portugal.

But if you are still with me - it gets even worse. Banks who make these loans to Governments have in the past not had to put any capital reserves to one side against this sovereign debt, because Governments always repay!! But Greece has now asked its lenders to take a 50% reduction in the amounts it will repay, which means that Government debt can no longer be considered "risk-free". Therefore, in future banks will probably be asked to provide some capital cover for this type of lending. Maybe it will be 50%, maybe it will be 20%. I don't know the answer, but what it will mean is that banks will have to raise more capital in the market - and how much is available for them to borrow to increase their balance sheets? Already one Italian bank has started the process, others will have to follow and the French and German banks will not be immune at all. The two major French banks are already showing signs of strain.

And I'm not finished yet. With the gloom already in the markets, add to that the fact it is becoming clear in Asia that shipments out of the region to the West particularly, USA and the Eurozone - are sharply down as people spend less in those econmies and you can see that there is going to be a ripple effect into the markets here, in Asia.

As matters stand today, we have problems. And they are not being tackled well. In fact the structure of the Eurozone doesn't help. Too many countries are involved when it comes to making a decision, which renders the process to make decisions neither easy nor quick. And each month's delay in taking action compounds the problem.

 So, we have thought about the People. We have done a little about the Economics - and which is the last part of the piece - the true villains, perhaps? The Politicians. That breed of people who bear a strong resemblance to analysts and rating agencies.

Like analysts because they have short time horizons. The next election is their key target. How to maximise their people-popularity - which by the way is not usually achieved by taking strong measures that affect lifestyles even if their reluctance is likely to shove the country deeper in debt. (Of the "bad" economies in Europe at present perhaps Ireland is the stand out success. They know something has to be done, and they do seem to be doing it).

Like rating agencies because they have a CYA mentality (with apologies to readers of a gentle disposition). 

Thus the dilemma. Most people I speak to believe that the economic reality of all this mess at present can only be resolved by firm and swift action. If letting Greece go is the answer - let them go. If re-designing the Eurozone, even putting it back to the original founding members (with or without Italy?) is the answer - then do it. BUT - the politicians have an eye on their own futures, their jobs, their pensions ... and not losing face by having created, and then having to disband a concept that has grown out of control. So we have "Economic Reality vs Political Expediency". 

Is this a game to win or lose - or will it more likely end up as just another "muddle through" - with compromises all round.

Oh, I almost forgot. If you want China or anyone else like them to help do not think they will do so through Europe directly. They won't. There is no upside for them. But keep an eye on the IMF instead - and there, maybe, you will find an answer.

Comments

[Robert]

This is an Excellent synopsis! CYA exactly!!
More sinisterly - with what is happening in the EU (which your cartoon so admirably demonstrates ie. - the problems will continue to mount up until you get OUR point!) - is this not another attempt to control Europe by Germany, by other means than Military power? Rewatching, as I am, the excellent BBC Great War videos, one is struck by the same (perhaps indelible) blinkered, inflexible mentality that is typical of the psyche! Again stark reality may be looming - this time with serious international consequences!

[zzachary]

Brilliant write up Mr Eldon...not only you a 'good tennis' player...you are a good 'economist' too...