Lies My Politico Told Me

We have been hearing for months now, that a Greek default would spell financial Armageddon for the European and global economies. Such statements have rarely been supported by any kind of reasonable argument or evidence. Instead, the mainstream media (MSM) numbly parrots what they have been spoon-fed without any evidence of cognitive activity in the process. So let’s look at the claim.

Examples of the Hype

We did a Google search for some recent examples:

  • First, appropriately, from the Armageddon Times, January 18, 2012: Ack! They Are Actually Going To Let Greece Default!
    • That is why a Greek default (whether orderly or disorderly) is so dangerous.  Investors all over the world would be wondering who is next. Not only have investors been considering this question for a year or two now, the MSM widely discusses it. So what’s the danger?
    • Well, if there is a Greek default all hell will break loose in Europe. Well I suppose this is a definition of Armageddon, but it says nothing else.
    • Banks and investors lend out money because they have confidence that they will be paid back.  When you take that confidence away, the system does not work. Actually, the system works perfectly well. Prospective debtors either rectify their profligate behavior or go broke. The weak players remove themselves and stronger players emerge in whom investors are able to assess risk and confidence levels. Lending continues to the new debtors. Certainly there are dislocations with pain and suffering, but this is simply the adjustment the system itself makes in changing state.
  • The online Digital Journal posted an article on November 2, 2011 titled Greek vote on bailout package precursor to financial Armageddon?
    • They state that when a country defaults on its IOU’s, it loses its ability to borrow more money and in Greece’s case that could be catastrophic. Even more catastrophic is the ripple effect that will be felt around the world if Greece defaults. That’s because world financial markets are inexorably tied to each other in a complex web of interconnected financial instruments. It could have a giant domino effect on world economies. Equally, a Greek default could have very little effect on markets and may already be priced in. Based on the supporting data  they present – none – both scenarios are equally valid – or invalid.
    • They correctly state no one really knows what effect a Greek default will have on world markets. So to claim catastrophic effects is baseless.
  • Jim Rickards speaking to King World News, June 25, 2011 identifies the key issues (our paraphrase in italics):
    • The problem is not Greek debt as much as the derivative trading against the debt and the uncertainty of who holds them. The notional amount of derivatives taken out against Greek debt is considerably larger than the exposure to the debt that they insure against. In other words, there is a large market betting for and against a Greek default without any direct involvement with the debt. The moral and righteous path would be to allow these bettors to take their losses. If Goldman Sachs and JP Morgan go down and need to be restructured, it would be the end of some bankers’ world but not the world of the man on the street.
    • The risk is a Lehman-style global financial market meltdown. We’ve been to the brink once with Lehman. The too-big-to-fail-banks have had 4 years to get their houses in order. If they’ve failed, they deserve to be terminated. Governments have had 4 years to prepare rescue scenarios. If they’ve failed, they deserve to fall. In such a case, rows of bankers and politicians hanging from light posts outside parliament buildings would be warranted.
    • Rickards does a good job of pinpointing the key issue – derivatives. What we don’t have is any assurance that this will not be the endgame – the Armageddon scenario – no matter what our politicos do. Nor do we have any experience that a Greek default will cause the Armageddon scenario or if the scenario is triggered, the final result will be any worse than the collective misery and pain being inflicted on populaces by the actions of the political and wealthy elites today.
  • From Bloomberg, June 16, 2011, Europe’s ‘Lehman Moment’ Looms as Greek Debt Unravels Markets: Euro Credit. Points are:
    • The collapse of Lehman Brothers Holdings Inc. in September 2008 caused credit markets worldwide to freeze as investors fled all but the safest government debt. Comments as per the Rickards entry above.
    • If not, then Armageddon scenarios come into play, which include default and potentially the whole contagion scenario plays out. Well default has been widely discussed by authorities for some time now. We have to interpret the 639% interest on the Greek one-year bond recently posted as that the market has already priced in default. Contagion, which had been causing rising rates throughout the periphery, has subsided recently and will pick up again after Greece defaults. Not the end of the world, we think.
  • The blog-site Economic Collapse, June 16, 2011, posted an article European Armageddon? Greek debt crisis sends shockwaves through currency and equities markets. The author quotes Charles Diebel, head of market strategy at Lloyds Bank Corporate Markets in London as saying “If not, then Armageddon scenarios come into play, which include default and potentially the whole contagion scenario plays out.” As in most articles about Greece on catastrophic collapse and financial Armageddon, the twin bogeymen of default and contagion are cited. Unfortunately no supporting evidence is provided for us to assess the validity of the claims.

Even as we write we get this Wall Street Journal headline: Greek Finance Minister: No Loan Deal Means Absolute Catastrophe (subscription required).

A Rational Refutation of the Hype

To be able to make a credible claim that a result will be catastrophic, one must necessarily be able to scope out the dimension of the problem, determine and quantify the pertinent factors and measure the total impact against some scale of past events judged to be catastrophic. A more important option should be considered, however.

Suppose there is a binary choice such that one branch leads to the catastrophic state and the other leads to some other state, presumably the natural extension of the present if the choices leading to catastrophe are not made or the circumstances leading to it are averted. Then it would be equally important to evaluate the non-catastrophic state in a manner that its properties could be quantitatively compared to the catastrophic state to inform authorities as to which is the preferred path.

In the case of Greece the catastrophic state of default and contagion, which is the Armageddon scenario everyone is panicking about, has not yet been reached and may possibly be averted. We already know such things as economic performance in Greece has plummeted, youth unemployment is greater than 50%, there are anecdotal stories of children being put up for adoption because their parents can’t provide for them and a plethora of similar stories of personal hardship and suffering. In short, Greece is in a depression. This is the cost to date of avoiding default. What will be the total cost in the future of such an avoidance compared to a future in which Greece immediately defaults? Of course, this is the impact on the citizens of Greece. The impact on European investors is a separate problem.

The point is we have no study that has even begun to present a rational assessment of the validity of a claim of catastrophe. We do have, however, a rich historical record of states that have defaulted and recovered to become solid investment environments.

The seminal work on this subject is the book This Time Is Different: Eight Centuries of Financial Folly, by Reinhart and Rogoff. For example, we find in Table 6.6, the total number of defaults and debt reschedulings of selected countries since 1800:

  • France – 8
  • Germany – 8
  • Greece – 5
  • Italy – 1
  • Portugal – 6
  • Spain – 13

So there is a terrible irony in the fact that other than Spain, France and Germany in the last 200 years have defaulted more than any other of the so-called PIIGS, especially Greece. Yet it is France and Germany in particular that have been absolutely viscous in their treatment of Greece.

The point we wished to make however is that defaults and currency union breakups are common, the world and global economies of the time as well as the affected countries survived and have gone on to prosper. Armageddon not!

Another study on the topic is one titled: A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solution. The paper’s summary states:

Many economists expect catastrophic consequences if any country exits the euro. However, during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit.

The paper confirms that catastrophic thinking is the current conventional wisdom on default and a euro breakup. The authors review the more recent history of currency union breakups and examine the cases of the Austro-Hungarian Empire in 1919, India and Pakistan in 1947, Pakistan and Bangladesh in 1971, the USSR’s ruble zone in 1992-95 and Czechoslovakia in 1992-93. They go on to suggest ways of ending the current European currency union that would not be catastrophic.

Let Lying Liars Lie

The case for financial Armageddon or catastrophe is unproven. The case for sovereign default and currency union breakup leading to prosperity is supported by numerous examples over the last hundred or so years. Anyone who chooses to perpetuate the hysteria is either ignorant (most of the media and some economists) or working from hidden agendas of disinformation and lies (politicos and some economists). We have had enough of bankers and politicos running around screaming the sky is falling. So far the sky looks OK but if it should fall, we somehow think that the people of Greece, Spain, the 46 million Americans on food stamps, and others in their situation will hardly notice.

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