Amidst all the hoopla, cheering, and insanity of throwing money at currencies thinking it will make them rise, here are a few voices of reason on my radar today.



John Hussman



Greek Debt and Backward Induction



.... The bottom line is that 1) aid from other European nations is the only thing that may prevent the markets from provoking an immediate default through an unwillingness to roll-over existing debt; 2) the aid to Greece is likely to turn out to be a non-recourse subsidy, throwing good money after bad and inducing higher inflationary pressures several years out than are already likely; 3) Greece appears unlikely to remain among euro-zone countries over the long-term; and 4) the backward induction of investors about these concerns may provoke weakened confidence about sovereign debt in the euro-area more generally. ...



Looking at the current state of the world economy, the underlying reality remains little changed: there is more debt outstanding than is capable of being properly serviced. It's certainly possible to issue government debt in order to bail out one borrower or another (and prevent their bondholders from taking a loss). However, this means that for every dollar of bad debt that should have been wiped off the books, the world economy is left with two - the initial dollar of debt that has been bailed out and must continue to be serviced, and an additional dollar of government debt that was issued to execute the bailout.



Notice also that the capital that is used to provide the bailout goes from the hands of savers into the hands of bondholders who made bad investments. We are not only allocating global savings to governments. We are further allocating global savings precisely to those who were the worst stewards of the world's capital. From a productivity standpoint, this is a nightmare. New investment capital, properly allocated, is almost invariably more productive than existing investment, and is undoubtedly more productive than past bad investment. By effectively re-capitalizing bad stewards of capital, at the expense of good investments that could otherwise occur, the policy of bailouts does violence to long-term prospects for growth. Looking out to a future population that will increasingly rely on the productivity of a smaller set of younger workers (and foreign labor) in order to provide for an aging demographic, this is not a luxury that our nation or the world can afford.



Meredith Whitney



With regard to credit issues, some remarks by Meredith Whitney from a Bloomberg hedge fund conference last week are notable (if familiar):



"If you look at what happened last year, I would say a vast majority of the banking sector's profits and capital creation was government induced. In the first quarter, it's highly arguable that certain companies wrote up assets. People lowered their provisions on losses.



"What has kept home prices stable - and make note that politicians and banks are eating their own cooking because they really believe home prices are stable - they're stable because there's been a ton of inventory kept from the market. So if you control the supply, you can control the price without controlling the demand.



"Here's a statistic that I find fascinating. This is just for the top four banks. If you look at nonperforming assets - that's loans that haven't paid over 120 days - the size of that is 1.5 times all of the chargeoffs that banks have incurred since 2005. So you think credit has stabilized, mortgages have stabilized? Non-performs have ballooned so they've more than doubled since the beginning of 2009, and that's just stuff that has to start going on to the market, and interestingly, this quarter you're starting to see housing supply reach the market. That to me triggers another down leg in housing, so to me, I'm steadfast in my belief that there's going to be another double-dip in housing



"There's huge growth in non-performing assets. These are numbers, apples-to-apples, on the four big banks. The issue is when does that stuff that's not paying come to market, and when do banks recognize the chargeoffs? I think you're going to see more of that in the second quarter and the third quarter. Does the supply move in the second quarter and then you report it in the third quarter? The timing may be weighted more to the third quarter. I just don't know. I think you see a huge leg down in asset prices when you see the supply reach the market. So no, it's not factored into valuations. No, it's not factored into bank guidance. And yes, I think it's going to be a big problem for the banks."

Bill Cara

Morning Call [6:23am ET] There has been agreement on a $1 trillion tripartite debt guarantee package (1/3 from the IMF, 58.7% from 16 European countries plus 8% from the European Commission) to replace the soon to mature debts of Greece and presumably the other European nations in the same difficulty. This debt swap, putting the burden on “Other People”, is the European solution to living within fiscal responsibility.



German Chancellor Angela Merkel says this action was necessary to fight a Euro short selling syndicate. "The eurozone's member states showed yesterday that we have a common political will to do everything for the stability of our common currency," she said. "This is a determined and united message to those who think that they can weaken Europe."



I have news for the Chancellor: you are merely building a bigger problem that ultimately will result in a bigger failure.



If these so-called public servants were schooled in economics and not politics they would understand that shifting a debt burden from one group to another does not eliminate the burden. The owners of capital – the ones who hold unencumbered assets – are today asking themselves how long will such insanity last? Fiscally conservative people (the ‘pay-as-you-go crowd’) know that wealth creation, savings, investment based on economic returns, debt reduction and budget surpluses are the only ways to solve the crisis.

Caroline Baum

Greece sneezes and Portugal catches a cold. Portugal coughs and Spain falls ill. Spain runs a fever and Italy comes down with the flu.



Contagion, or contagion theory, is sweeping the euro zone, where Greece’s debt crisis is infecting neighboring countries and threatening to make its way across the Atlantic to U.S. shores.



At least that’s what we’re told on a daily basis. European Central Bank council member Axel Weber warned last week of “grave contagion effects” for countries that have adopted the euro. “Greece Fuels Fears of Contagion in the U.S.,” trumpeted a May 6 Wall Street Journal headline.



I hate to pour cold water on that theory, but healthy countries aren’t susceptible to Greece’s disease. The sick ones, already plagued with high debt levels and bloated state budgets, don’t need a carrier. Capital flight from these countries “is not evidence of contagion,” said economist and author Anna Schwartz.



Of course, Schwartz said that in 1998 following the Asian financial crisis. In “International Financial Crises: Myths and Realities” (the Cato Journal, Vol. 17 No. 3), Schwartz punctured the notion that financial crises spread from the initial source to innocent victims. Nations are vulnerable because of their “home grown economic problems,” she said.



....



There is no question we live in an interconnected world. Subprime mortgage defaults by homeowners in Irvine, California, infected banks in Europe and Asia, thanks to the miracle of securitization.



So yes, European banks that hold Greek debt are vulnerable to losses. The interbank lending market is showing signs of stress. And the austerity measures required in Europe’s peripheral countries may spill over into reduced U.S. exports. That’s not the kind of contagion we keep hearing about.



On the other hand, it would be a mistake to interpret the flight-to-quality into U.S. Treasuries last week as a sign of immunity. The U.S. is already infected with the debt virus. It’s still in its incubation period.

My Friend "BC"

Being Keynesians, the majority of economists primarily only consider aggregate demand/consumption to discern the economy's condition, rarely parsing the relative contributions of the private and public sectors and the sources of growth of consumption, and most always with the assumption that incremental government borrowing and spending will pass through or kick start and sustain private economic activity for the cycle.



But when private debt growth and associated increasing returns to financial capital have been the primary source of growth since the early '80s to early to mid-'70s, increasing government borrowing and spending to make up for the loss of debt growth in the private sector only results in government debt eventually growing faster than exponential vs. incomes, production, and GDP, setting the stage for fiscal insolvency atop private sector debt-deflation.



Add in the demographic drag effects and the structural effects of Peak Oil (and net energy), and private economic growth is impossible; financial markets have yet to price in this reality, although it is apparent that markets' attempts are being thwarted by government and central banks determined to prevent it.



The positive feedback of crash (or mini-crash), bailout, crash, bigger bailout risks a series of sequential hyper-volatility oscillations causing the whole machine to come apart.