The Hole In The Wall

Our old friend George Soros (See post 004 – Short Selling), the Hungarian investor / currency speculator of Black Wednesday notoriety, has appeared in Newsweek and given his frank assessment of the current financial situation. To say he paints the outlook as a bit bleak is to understate it spectacularly:

"The euro must survive because the alternative – a break-up – would cause a meltdown that Europe, the world, can't afford. I'm not here to cheer you up. The situation is about as serious and difficult as I've known in my career. We are facing now a general retrenchment in the developed world. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system. We need to move from the Age of Reason to the Age of Fallibility in order to have a proper understanding of the problems."

George Soros - probably won´t be doing the Edinburgh Fringe anytime soon.

He wasn´t the only one articulating concern. Christine Lagarde, the French, 6ft tall, silver-haired Director of the International Monetary Fund has also been upping the ante of late, warning us that unless we throw more good money after bad "we could easily slide into a 1930s moment. A moment where trust and cooperation break down and countries turn inward. A moment, ultimately, leading to a downward spiral that could engulf the entire world."

She´s joined the ranks of Sarkozy, Merkel and Van Rompuy, all of whom have adopted this infuriating tendency of implying the continent is going to be plunged into a violent and bloody war which can only be avoided if  a) the UK agrees to a new financial transaction tax, b) the combined peoples of the EU agree to a retirement age of 89, c) we continue to prop up failed financial entities with taxpayer money. I really am starting to get a little annoyed with the bellicose rhetoric that is increasingly becoming par for the course. There´s not a shred of evidence to show that a sovereign default by any EU nation would result in war.

"My fist... Cameron´s face" chortles the pint-sized Sarkozy, showing off.

It’s hard to believe now, but there once existed a time when you could listen to an entire news bulletin and not hear the IMF mentioned once.  In fact whole weeks could lazily roll by without a single growth forecast being revised down or an inflation projection being revised up.  Occasionally on the breakfast news you´d hear of some corrupt and crumbling Latin American or African regime, in the throes of hyper-inflation, that was looking for IMF help, but it was a minor concern and completely forgotten about by the time you´d finished your cornflakes. But then came sub-prime, then Lehman, and suddenly Dominique Strauss-Kahn was in my front room more than I was.

Given the organization’s high profile, and with its fingers in pies in Ireland, Greece, Portugal, Ukraine, Hungary, Serbia… in total some 70 nations, I thought it an opportune moment for us to have a closer look at where it came from, what its role is and how it’s funded. Let´s begin at the beginning:

In 1944, representatives from the 45 Allied nations convened in the New Hampshire town of Bretton Woods, US of A, with the objective of preparing a framework for international economic cooperation which would be implemented once peace had been restored to the planet post WWII. The impetus for this new synergistic and open approach to global trade, exchange rates and cross border payments was a desire to avoid a repetition of the 1930’s “Great Depression” the cause of which was allotted to countries raising trade barriers, devaluing their currencies in an export war and in some cases even prohibiting their citizens from holding foreign currency.

The IMF´s own website states that “The International Monetary Fund (IMF) is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.” Now I don´t know to what extent the IMF feels it is achieving those lofty objectives of financial stability, sustained growth and high employment, but a quick glance at the Spanish press would suggest to me it really wants to be awarding itself an “E” in this year’s annual self-assessment.

The website goes on to explain ;  “One of the IMF's most important jobs is to conduct an annual "checkup" of the economy of almost all the IMF's member countries. These checkups help uncover issues in a country's economy that other member countries may be unaware of. Sharing accurate, objective information avoids nasty surprises in international trade and monetary exchange. The IMF's reputation and success depends on this open sharing of information. “

Christine Lagarde and her twin sister. Christine parts her hair on the left. 

I'm not a fan of the IMF but to be fair to it, it can do all the scrutinizing and account checking that it likes, but it doesn't have the jurisdiction to implement economic policy within a sovereign nation’s borders. It can make recommendations but if its advice goes largely unheeded it can hardly be held responsible for the ensuing chaos.

The IMF is funded by its member nations which pay quotas based on their wealth. The richer a country is, the bigger share it pays, and the more it pays, the more voting rights it is awarded. As you might expect, the US is the largest contributor and as such has over 16% of the votes. However this system led to same strange anomalies recently. For example, Spain and Italy were (and still are) getting hammered in the sovereign bond markets, paying 5, 6, 7% yields on their debt, and yet they were then paying their quota to the IMF, who in turn lent the money to Greece, who paid just 3.3% interest back to the IMF. It was nonsense; borrowing money at 6% to lend it at half that rate. Italy was tapped for its 12.6 billion dollar contribution and the way things are carrying on there, it could effectively be contributing to its own bail-out fund.

Another charge levelled at the IMF is that much of the work it does is cloaked in secrecy. It will insist on certain policies being implemented in states that it has agreed to support, but neglects to inform what or who guides its decision making process . There’s no public debate. It demands transparency from its member states and yet completely lacks transparency itself.

But by far the most damning criticism of the IMF is that it frequently makes a bad situation worse. Despite the humanitarian and charitable feel to its propaganda, it often stands accused of destroying nations by demanding the ruthless implementation of crippling austerity measures in return for access to emergency finance. It is far more concerned with its loan repayments than it is with education, sanitation, health – services which it often insists are slashed as part of an assistance agreement. It suffocates any hope of growth by demanding budgets are cut, public sector workers are fired and taxes are hiked up. It squeezes the economy to such an extent that far from attracting new investment, existing business flees, thus creating even higher unemployment and further socio-economic distress.

Sir Merv King - Don't worry, be happy.

However, my favourite quote yesterday came from Sir Mervyn King, Governor of the Bank of England. He wasn´t having any of this “Lights out In Europe”, “The Planet on the Brink” clap-trap. He calmly said “There´s no reason to despair, all crises come to an end…” and then I like to imagine he made himself a pot of tea and settled down with a Bill Bryson book by the fireplace. And on that reassuring note, I´m off to enjoy my lunch and look forward to the last installment Of Downton Abbey this evening. Enjoy the rest of your day!

P.S. I´ve left a few links today for anyone who wants to read a bit more about the IMF. I´ve no doubt at all that we´ll be coming back to this organization again and again over the coming months and years, it really is worth reading up on how it operates. The interview with Nobel-laureate economist Joseph Stiglitz is interesting, although the bright blue page background should carry a health warning.

http://www.thirdworldtraveler.com/IMF_WB/HospMakesYouSick_IMF.html

http://www.thedailybeast.com/newsweek/2011/07/10/amar-bhide-and-edmund-phelps-on-what-s-wrong-with-the-imf.html

A very Good Morning to you, I do hope that you enjoyed your weekend. As part of the continued austerity measures I´m introducing at home, I spent yesterday evening cutting the kids´ hair with a pair of clippers borrowed from a neighbour. Looking out the window at them now, the three of them silhouetted in the back seat of the car waiting to be taxied down to the school bus stop, they resemble a row of toilet brushes about to embark on a day out – I´m going to have to work on my hair styling skills, perhaps there is a YouTube video aimed at the hopelessly inept home barber.

"Cheerio small people! Work hard!"

At 9am, today’s blog entry had the working title “Central Banks and their role in the global economy” – it was going to be hard-hitting stuff, just the sort of thing to kick off the week in our quest for financial enlightenment. But an hour and half and 800 words later, I still hadn´t even broached the subject of central banks. So now, having employed some cunning editing skills, rearranged paragraphs here and there, ruthlessly deleted some portions and spent another hour biting my lip and writing new bits, I´ve produced today´s post, which whilst it doesn´t deal with the role of central banks in the global economy, is still quite interesting, I hope. Let me begin…

2012 marks the 20th anniversary of one of the darkest days in UK economic history. Aside from making George Soros an awful lot of money, it also made him a household name as “the man that broke the Bank of England”, when the UK Treasury spent 27 billion pounds attempting to prop up sterling. I am of course, talking about Black Wednesday.

Up until 16^th September 1992 I´d always assumed that governments, whilst perhaps not pursuing the exact same policies I would have favoured as a bright-eyed 21 year old (beer available on prescription, a 3 day working week, a free terrestrial channel dedicated to 24 hour topless darts) at least had some idea of the difference between their arse and their elbow when it came to running an economy. Black Wednesday made me realise that quite often that´s just not the case.

Major´s government actively implemented a policy of promoting fully-clothed male darts.

With your permission I´ll  try and set the scene: In 1990 new chancellor John Major signed the UK up to the European Exchange Rate Mechanism (The ERM), a sort of stepping stone to the euro. The golden rule for members of the ERM was that the respective governments had to maintain their currency within 6% of the other member currencies, thus ensuring monetary stability amongst the group. In principle it was a capital idea.

Except the UK really didn´t pick the best time to get into the game. The pound entered the ERM at a rate of 1GBP – 2.95Dm which when you consider that the UK was trying to deal with inflation three times that of Germany´s, a huge property bubble, and a current account and fiscal deficit – the writing was really on the wall from the word go.

It wasn´t long before foreign exchange (ForEx, FX) speculators picked up on the anomaly and concluded that the pound was significantly overvalued. The markets began to bet on a sterling devaluation and they did this by shorting the pound.

Shorting (short selling) is the practice of selling something you don´t own, then purchasing it more cheaply than you sold it for once the price has dropped in order to cover the trade.

As an example, let´s say you´re in the market for a 10Kg sack of potatoes, and you´re prepared to pay 50 cents a kilo. I´ve heard the market is about to be flooded with cheap tubers from Eastern Europe so I agree to sell you 10Kg of spuds for 5 euros. With the deal agreed I pop next door to my neighbour and borrow 10kg of spuds from her and promise her I´ll replace them next week. Then I drop them off round at yours and collect payment. Sure enough by Wednesday truckloads of potatoes are turning up in Spain and of course, due to the market forces of supply and demand, I can purchase potatoes to replace the ones I borrowed from my neighbour at 25 cents a kilo, thereby making myself a tidy little profit. That is the essence of short selling, and it goes on all the time across all the markets.

Potatoes - As cheap as chips.

This is what was happening on the currency markets in the run-up to Black Wednesday. Speculators were short selling sterling, effectively selling currency they didn´t own, then as the pound tanked, they´d purchase the currency cheaper than the sale price, and bank the difference. “But which fools were buying this overvalued  currency?” you cry -  The British government were, in an effort to keep sterling in the ERM.

A few years after Black Wednesday I watched an interview with Ken Clarke (the Conservative, brown-suede-shoe-wearing Lord Chief Justice – but Home Secretary back in 1992) and I was just left agog. It was a while back, so I paraphrase, but this is how he summed it up:

“Michael Heseltine (Pres. Board of Trade), Douglas Hurd (Foreign Secretary), John Major (PM) and I were in Admiralty House and we knew things weren’t going particularly well. John suggested raising interest rates from 10 to 12% which we did but it really didn´t make a jot of difference. Norman (Lamont – Chancellor) arrived, visibly flustered and said it was his opinion that the rise from 10% – 12% had done absolutely nothing to reassure markets and that the game was up, we really had to exit the ERM. John disagreed, and raised the interest rate a further 3% from 12% to 15%. But you know, we didn´t have a television, or direct access to live information. It occurred to me how absurd it was that we were the people charged with making the most important decisions regarding the economy of our country and yet we were probably the least well-informed people to be making those decisions. Michael rummaged around in a desk drawer and found an old wireless and Douglas procured some batteries from somewhere and we tuned into the BBC to see what was going on… yes, it was all a bit surreal”

Even now, 20 years later, I´m still gob-smacked at the level of incompetence. What makes it worse is that instead of losing billions, had the government maintained its dollar currency reserves it could have actually turned a profit. Of course with the benefit of 20/20 hindsight, we can see that ejection from the ERM was exactly what the UK needed. The 15% devaluation in sterling kick-started exports, cut inflation, but most importantly I think, it ultimately led to the UK seriously questioning the wisdom of a single currency that lacked complete fiscal union. It´s easy to criticize Gordon Brown, and great fun too, (although selling the UK´s gold reserves at car boot sale prices remains unforgiveable), but he did ensure that the UK remained in control of its base rate and that the Bank of England maintained control over monetary policy, and in that respect, Britain is still master of its own destiny.

Gordon Brown - texture like sun.

PS. I tried in vain to locate footage of the Ken Clarke interview, however I did find this four and half minute Andrew Marr clip which pretty much tells the same story.

www.youtube.com/watch

A few years ago, I was startled, yes startled, at just how quickly grocery prices were rising in the supermarket. In the space of a few months in 2007 a one litre tetrabrik of full fat milk rocketed from around 50 cents a litre up to about 75 cents a litre. That´s a 50% increase. As a familia numerosa we have an awful lot of small people milling about in our house and because of that we get through a tremendous amount of milk; two and half to three litres a day. They need the calcium to build strong little bones and grow nice healthy teeth you see.

As the price of milk went up, so it followed that every other product that has milk as a constituent ingredient also rose. We get through a pack of 8 yogurts every day, a lot of cheese gets eaten, I´m partial to a square or two of chocolate now and again; so it didn´t take long for us to feel the pinch. The price hikes weren’t just limited to dairy products. Poultry, meats, vegetables - just about any product that was derived from farming and agriculture seemed to be rising in price at a phenomenal rate.

In an attempt to halt the spiraling cost of the weekly shop I started making regular forays into the Lidl supermarket close to where I work. What can I say? It was the most thoroughly miserable shopping experience of my life. I´ve often thought about contacting the Lidl head office in Neckarsulm, Germany to see if they´d be interested in publishing a guide I´ve prepared for the uninitiated Lidl shopper, it’s full of handy tips:

• If arriving at Lidl by car, try and secure a parking spot well away from the groups of straggly-haired winos that set up camp on our premises each morning. Failure to do so may result in unextinguished cigarette butts burning away on your car bonnet and empty beer cans placed under your tyres. It will also necessitate at least one heated exchange to explain that you don´t have any cigarettes and that you need the euro in your trouser pocket to get a trolley.
• As part of the Lidl shopping experience it is customary that all our patrons, before entering the store, have lucky heather shoved up their nostrils. They will also be invited to buy a newspaper they´ve never heard of that is mysteriously kept in a sealed transparent plastic bag by the vendor.
• Upon entering the store, avoid eye contact at all costs with our highly trained, black ops, security personnel. A nod or a smile in their direction will immediately identify you to them as a serial shoplifter and you will be subject to a cavity search on departure.
• In order to prolong your enjoyment of Lidl, our staff are trained to close checkouts as soon as there are more than 5 shoppers in the store at any one time. We pride ourselves on queue length and aim to make a 2 minute stop for a packet of biscuits take up the best part of your afternoon.  
• Why not try Fortuna Bread? – exclusive to Lidl. When he´s not “out back”, our chain-smoking baker with the nicotine stained fingers bakes fresh bread, on site, with his unique carcinogenic dough. Mmmmm.
• Finished shopping? Let a gaggle of unstable and potentially violent strangers escort you back to your car with your purchases. Your peculiar team of little helpers will load your groceries, return your trolley for you and even relieve you of all that annoying spare change rattling about in your pocket.

The express "10 items or less" checkout in Lidl.

Alright, perhaps I´m being a bit harsh. This was a Lidl store located on the outskirts of an industrial estate in Madrid, next to an INEM office. I´ve subsequently visited Lidl supermarkets in Sweden and closer to home in Guadalajara and they´re really not so bad at all. It was unfortunate that I picked what I truly hope is their least appealing store for my first Lidl experience.

I must sound like one of those supermarket snobs. I´m really not you know. I hadn´t spent my life consciously avoiding Lidl, I´d just never had one near home and as a consequence shopping there had never even occurred to me. What´s more I´m in a fairly serious relationship with Alcampo; I have their store card which I think constitutes "commitment", and I spend about 700€ a month there (300€ of which is in their petrol station) but I wouldn´t say I´m entirely monogamous. I’m still young and I do fool around a bit with Mercadona, and as long as no-one gets hurt I don’t see it as a problem.  

I do know people that will only shop in El Corte Ingles. Not because it is convenient or cheap, but because it isn´t cheap. I know, I know. I can't comprehend it either. It really is bizarre. There´s evidently an entire demographic out there that´s operating at completely the opposite end of the grocery shopping spectrum to me. I´d love to follow these people around on their weekly shop; “That´s a bit pricey love, pop that in the trolley.” And just in case any of you doubt the existence of people that actually want to pay more for something than they need to, consider the case of an obscure continental lager, the brewing rights to which Whitbread purchased from the Artois Brewery in the late seventies. Stella Artois back then was a virtually unheard of regional Belgian beer and it really wasn´t selling in the UK. Whitbread called in the ad agencies, the PR firms, the marketing guys and those think tanks that study the science of shopping patterns. Instead of looking at ways to cut costs and produce their lager more competitively, they did the exact opposite. They put the price up, launched a huge television ad campaign and sold it as “Reassuringly Expensive”. Sales exploded, Stella Artois spent the next two decades as the UK´s best-selling lager.

To get back to the point of today´s post, I started to investigate what was causing such acute increases in food prices. I was already aware that the price of oil was marching upward. We do 4 or 5000km a month in our car, plus our hot water and heating runs on gasoil B, so we´re very much at the sharp end of oil price fluctuations. But what I couldn´t fathom out was why a hike in the oil price should have such a detrimental effect on the price of farm produce. I could accept it cost a few euros extra to transport goods to the supermarket and eventually that cost has to be passed on to the consumer, but surely transport costs constituted just a fraction of the overall cost of production.

I wasn´t the only one watching prices with dismay. FACUA, the Spanish consumers association was also monitoring the situation. In fact they became so concerned when milk prices rose 12.5% in just 4 weeks that they asked the Comisión Nacional de Competencia to investigate the possible existence of a price-fixing cartel.

Daisy - she resented accusations of price-fixing.

I began to take a bit of an interest in how food is produced and how cattle are raised. I could say that crop husbandry became a passion, but i won´t, because it didn´t. My prior knowledge of agricultural techniques was limited to what I´d learnt in primary school as a nine year old and really all I could recall were some foggy details about crop rotation and strip farming in the middle ages. It was genuinely an eye-opener to discover just how many petrochemicals are involved in 21^st century farming.

I´d (wrongly) assumed that the gas and oil costs associated with agriculture were mainly due to trundling farm machinery about; tractors, harvesters, grain trucks. But no, that only constitutes about 30% of the total. By far the largest proportion of energy goes into manufacturing fertilisers which are derived from combining nitrogen with the hydrogen in natural gas to produce ammonia. Even more petrochemicals are employed in the manufacture of pesticides and herbicides. Finally there are the energy costs associated with milling, grinding, packaging and ultimately transportation. With all that in mind we can start to see why it costs so much to grow crops during an oil spike, and why the cost of cereal fed livestock is also hugely affected.

Have a good weekend!

Unless you've been living under a rock for the past few years – which, with home repossessions in Spain at record levels, may not be quite as absurd as it sounds - you’ve almost certainly heard the term “European Sovereign Debt Crisis” being bandied about. It´s become a mainstay of financial commentator's parlance these days. Whether it's down to laziness or that they´re simply at a loss to explain why the Dow has fallen for the 7^th session on the bounce, they’ll invariably wheel out the old gem “…due to continued uncertainty surrounding the European sovereign debt crisis.”

To be fair, it does sound like it could cause some havoc. If said with sufficient gravitas, a la Robert Peston, (the BBC Business Editor who has a penchant for stressing random vowels, accentuating the end of every sentence, and then spectacularly combining those two speech peculiarities with a hypnotically slow delivery)  it´s an escape route out of almost anything you have trouble explaining. Give it a whirl yourself. Next time you’re in the shopping centre and one of those ING reps leaps out at you from behind a potted plant, armed with an orange clip board and an application form for a savings account, wave them away with furrowed brow and announce “I couldn´t possibly right now, due to continued uncertainty surrounding the European sovereign debt crisis.” And why stop there? Try it out on phone companies, insurance salesmen, telemarketers, annoying family members… ah but I´m starting to digress.

In this post I want to look at what a sovereign debt crisis is and explore how nations get in so much debt in the first place. Nations, just like people, take on debt for all sorts of reasons. To give you a crude example; we have 3 kids and could really do with an extra bedroom. With the housing market utterly stagnant there are basically two options open to us. We could apply for a loan and start building an extension next Monday, or, we could squirrel away a hundred euros every month for the next decade or two, and with any luck, just as the last of our brood are moving out to set up a home on their own and we´re finally in a position to think about down-sizing, we should have saved just about enough to construct that extension we no longer need. In a similar vein, so a government might have a transport infrastructure project that it needs to fund sooner rather than later. Perhaps there may exist an urgent need for additional social housing, new schools, prisons, hospitals… the list goes on. A sharp rise in unemployment can also mean that a government´s source of funding via income tax is affected, what´s more as it finds itself receiving less in tax contributions, so it has to pay out more in unemployment claims, but as long as the rise in unemployment is a temporary blip, a government can borrow to cover the shortfall. To fund itself for any of these reasons a government will issue bonds.

Very, very simply, a government bond is a financial instrument issued by a federal government or sovereign nation. It does this in order to borrow money over a period of months, a few  years or even decades. The government will pay the buyer (bond holder) interest (usually twice a year) and because governments are in a position to raise or cut taxes, bonds are seen as a very safe investment and extremely low risk, especially amongst western developed nations. But I´ll come back to that in a minute. These bonds have a whole host of names but they are all essentially versions of the same things. Depending on maturity dates US Government bonds are referred to as Treasury Bills (T Bills), Treasury Notes or Treasury Bonds (T Bonds). Bonds issued by the UK government are known as Treasury Gilts, whilst the German issue is known as a “Bund”. But to reiterate, to all intents and purposes, whether it be a T Bond, a Treasury Gilt or a German bund they are all tools for monetising government debt – a way for governments to raise money.

So let´s say the UK government was keen to construct a high speed rail link between, oh I don´t know, London and, off the top of my head, let´s say Birmingham, but needed 32 billion quid to finance it. In order to get work started the Government might ask the Treasury to organize an auction of £5 billion worth of 15 year bonds. £5 billion is a fraction of the overall cost but more than enough to get work started and ensure there´s an army of steel toe-capped navvies marauding over the Chilterns. The auction would be advertised in the financial press and through the UK DMO website (Debt Management Office – an executive agency of HM Treasury) and private and instititutional investors would then be able to apply to purchase bonds. Earlier I alluded to the fact that government issued bonds are seen as a good, solid, low risk investment that offer a steady rate of return. Historically G7 countries have carried a Triple A rating which is an indication that a bond purchase from that country is a top drawer, guaranteed investment. AAA bonds are the bread and butter of well-managed pension funds, who spread risk over a variety of financial instruments. Nicolas Sarkozy made a good deal of noise about defending France´s cherished AAA rating, and one could be forgiven for thinking it was his sole raison d’être. He failed. Standard & Poor downgraded French debt a notch last week to Aa+ which cheered me up no end. To get an idea of a bond in action and to make absolutely sure we´ve nailed this T Bond / Bund / Gilt malarkey let us hypothesise.  Let’s imagine that I, being the big ol’ softie that I am, an incurable romantic, decided to purchase for the wife a £200 holding in 3¾ % Treasury Gilt 2021 for her Christmas present last month. (I didn´t, she got a Bosch hand blender. Actually it´s for food but I bet it could really mangle a hand on a high setting.)

• 3¾ % tells us the coupon rate, the annual fixed interest payment that she will receive twice yearly on her holding. On a 200 quid holding that equates to £7.50 every year paid as £3.75 every 6 months.
• 2021 tells us when the bond matures, so this is a 10 year gilt. In other words over the next decade she will receive £7.50 each year and then in 2021 when the bond reaches maturity she will receive a further payment of £200 which represents my original investment. And then she´ll take me down the Broken Pencil for a beer.

This system has worked pretty well for centuries. Governments in command of tax revenues and interest rates can keep their borrowing under control and run something approaching a balanced budget. (Not necessarily balanced year on year, but with a surplus in good times that can cover a deficit in leaner times, and over the course of an economic cycle, generally balance itself out) I´ll come to the Nixon Shock, the abandonment of the Gold Standard and the move to fiat currency in future posts but for now, in order for us to get an idea of what constitutes a sovereign debt crisis, we'll turn our attention towards Greece.

It´s now widely accepted that Greece never met the entry requirements for acceptance to the Euro. A bit of creative accounting here, a bit of tippex there, “Ooooh did I add an extra 3 zeros to that statement? don´t you worry your confused little head about it, have some more ouzo, I´ll go and dig that tippex out again…” but discrepancies like that were overlooked and then buried in fanfare and celebration as the euro was launched; finally a potential reserve currency to rival the mighty US dollar. Overnight the Greek government went from paying double digit interest rates on the money it borrowed to paying a rate on a par with Germany - the economic powerhouse of Europe. Greece supports a huge welfare state and civil service. One could be forgiven for thinking that tax avoidance is compulsory, it isn´t, but it’s certainly rife. Greece consistently runs a budget deficit. The prestige of being a Eurozone member suddenly launched Greece into a world of cheap finance that it could never have dreamt of obtaining as an independent sovereign nation using the Drachma. Athens lacked both the fiscal discipline and the will to address the trend of running an ever larger deficit. The government, rather than implementing unpopular policies of a far more stringent tax regime on an electorate whose votes it would require for re-election, instead held bigger and bigger bond auctions in order to roll over its spiralling debts ; effectively borrowing from Peter to pay Paul, whilst all the time enjoying the lowest retirement age in the EU and a government job (sometimes two) for life. We´ve all read horror stories of the hapless shopaholic, who maxed out a store card, so took out a credit card to pay the store card, but found themselves crippled by the interest payments so took out another credit card to pay off the previous credit card… Think hapless shopaholic on steroids, think Greece. To give an indication of just how suspect the tax collection system is, it is worth noting that there are more owners of Porshe Cayennes registered in Greece than there are people declaring an income of 50,000€ or more per annum. Quite frankly it’s nuts.

Nuts.

With many institutions having taken huge hits on the whole US sub-prime episode in 2008 (something we´ll look at in the future) investors began to look very closely at just what bonds, equities and collateral they were holding on their books. It didn´t take long for them to conclude that Greek bonds were looking increasingly precarious, and so they systematically began to sell off their holdings, thereby reducing their exposure to any potential default. Of course once the word is out that Greece could be in trouble, investor confidence evaporates. Who in their right mind is going to buy a Greek bond when there exists the very real possibility of a default. As a result yields (interest the Greek government has to pay holders of its bonds) surged. As yields surged, so the Greek government had to pay more and more money to roll over its debt. A temporary spike in yields is not a disaster, but once a country finds that it has to consistently pay more than about 7% on its 10 year bond issues, the debt dynamics change. This morning the Greek Government 10 year benchmark bond opened with a yield of 35.11%, yes 35.11%. Contrast that with the German 10 year benchmark bund which opened this morning with a yield of just 1.82% and it starts to become clear just how much of a hole Greece finds itself in.

Greece - Pretty much buggered.

Clearly once yields are over the 10% mark countries find themselves effectively locked out of the markets, they simply cannot afford to pay rates that high. It is the equivalent of you or me trying to buy a house on a credit card at 22.9% APR; a 30 year €200,000 mortgage would cost us an eye-watering €3820 per month. Once a government can no longer raise money on the bond markets it becomes increasingly desperate. It has wage bills to pay, hospitals to run. Simply not paying government employees would result in anarchy, civil war, revolution. So in order to function it will raid public employee pension funds in order to pay the bills, it will look to sell state-owned assets; telephone companies, railways, ports and it will face the fact that it has to introduce massive austerity measures if it wants to avoid defaulting on its obligations. With this in mind it is worth keeping an eye out on ebay for a bargain; you might find the Elgin Marbles or the island of Skyros at an attractive price. It will also talk to the IMF, (International Monetary Fund) to arrange emergency funding (a bail-out) and will talk to holders of its bonds in an effort to restructure its debt. The IMF will arrive and scrutinize the accounts, and insist on various conditions being met before it releases any money. It will expect a firm commitment from the government that it will cut spending, reduce costs, raise (and collect) taxes and then money will be released in tranches based on certain criteria being met. The other option available of course is default. In the case of Greece it could simply refuse to honour its financial obligations. This would certainly mean expulsion from the Eurozone, meaning it would have to reintroduce its own currency. Trade embargoes would be implemented, political sanctions imposed; Greece would find itself in the political wilderness. However, there´s a valid argument that says after an initial period of adjustment, it could be the making of Greece. Free of the shackles of the euro and in control of its own currency, it could manipulate its interest rates, print money, devalue; it could become a competitive tourist destination once again.

Hello, Happy New Year and welcome to my blog! It is a mish-mash of whatever happens to be going through my mind but if it does possess an underlying theme, economics, capital markets and finance are it. For a long time I´ve had a peculiar fascination with how seemingly distant events  – a bit of a skirmish in the Niger Delta for example, can have a huge impact on how much I pay for a litre of milk in my local supermarket.

My aim in this blog is to try and de-mystify what the markets are and how they operate, and of course their effects on us as individuals. We´re living in extremely uncertain times, something which is reflected in the volatility we´re seeing across the board in oil prices, gold, currency exchange and especially government treasury bonds in the European Union.

I´m aware that for many of us the financial pages in the press appear to be a non-sensical cross between sudoko and scrabble, full of jargon, void of clear explanations... which is a great pity because underneath all the industry terminology is information that has a direct impact on almost every aspect of our lives.  From how much we pay for a tank of fuel to what our pension is worth. Property prices, electricity bills, interest rates and unemployment levels. It´s all in there, we just need to coax it out in language we understand.  

Over the course of 2012 we´ll dissect events as they unfold, but at the same time I´ll endeavour to provide some background information. We´ll find out just what quantitive easing is all about. How does a credit default swap work? What was the gold standard? What is the EFSF? Where does the IMF get its money? We´ll gradually build up a glossary of terms and I might even do the odd profile of the main players so we´ll be able to answer questions like: Who the hell is Herman van Rompuy and who has ever voted for him?

The idea is to keep it as simple and light-hearted as possible. I´m no economist but over the years I´ve asked lots of silly questions on lots of forums and occasionally people were patient enough to explain something I didn´t “get”, or took the time to point me in the right direction for some relevant further reading. I’ll attempt to impart some of the information I've gleaned, here…