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One Minus Three Is Always A Negative Number

There is basic math that politicians tend to habitually ignore.  As most people who manage their household finance know, budgetary math is actually quite simple.  If you spend more than you take in, you incur a debt.  If one day there is promise that you’ll earn more than you spend, then that future surplus can go to repay your debt.  If that promise does not really exist, you will surely default.  If, in default, there is collateral that the lender can grab through foreclosure and the collateral is enough to repay the debt, the lender can come out ok but the borrower not so much. 

I’ve been a lender and debt investor for 30 years.  During that time I’ve witnessed some interesting distortions in governmental borrowing as well as private sector.  Leading into the 2008 financial crisis the private sector indebtedness was very high, and importantly much of it was unhinged from the safety net of the Fed’s printing press as it ran through investment banks that had no access to the Fed window.  The leverage was unsustainable inasmuch as repayment relied upon continually increasing asset values and was unsupportable by income with which the debt could be serviced or repaid.  When that leverage began to unwind the liquidity squeeze was shocking and painful, and life threatening to the global financial system.

Today, the Modern Greek tragedy is a recurring headline.  It is a very instructive example of how ignoring basic math can lead to pain and suffering all around, and that deficits and debts do in fact matter.  For a very long time Greece has been living larger than their economic means would have facilitated.  This “economic miracle” was facilitated both by lenders, who were enticed by the prospect of being paid higher interest rates and thus boosting their net income, stock prices, and executive bonuses beyond the levels that they otherwise would have enjoyed, as well as by borrower’s governmental representatives whose lust for power was easily met by accepting borrowed money to temporarily boost their constituents’ lifestyles.  One can legitimately point here to both borrower and lender when ascribing blame.  One of the primary lessons I’ve learned in finance is that if loanable funds are available then borrowers will borrow.  I’m certain that their borrower’s standing as a sovereign nation comforted the Greek lenders, figuring that these types of borrowers never default.  However, what these lenders missed is that you cannot foreclose on a sovereign nation, at least without an army and a willingness to occupy.

The Greeks will never repay their sovereign debt.  They will not even be able to generate a budgetary surplus in even one year with which they can begin to pay interest on their debt, let alone repay principal.  The math doesn’t work.  And since one minus three is always a negative number, their debt levels will continue to increase as they will need to borrow more to just pay the interest on their existing debt.  Greece is a small nation and thus their problems alone cannot shake the foundation of the global financial system.  The real problem is that too many nations find themselves in the same spot as Greece, yet their problems are not yet being discussed in polite company.  Even the mighty U.S., broadly considered the global safe haven for capital investment, finds itself in a roughly analogous situation, with the exception that it has its own currency and a central bank that can do things to put off its day of reckoning for some time.

In these situations there are only two resolutions possible.  Either the lenders will have to write off the debt and take a loss, or the governments and central bankers of the world will have to accelerate the debasement of all currencies such that the nominal debts become less meaningful.  No one wants to take a write off, neither politicians who would rather push the problem off on their successors nor bankers who want to retain their jobs and be paid bonuses.  Thus, credit will most likely continue to be extended to Greece and other hopelessly indebted borrowers, and the only resolution will be the latter – the continued debasing of currencies.  Investors, facing the prospect of ultra low rates of return caused by the necessary easy money policies, will have to perform miracles to avoid losing significant amounts of purchasing power in the coming years as these debts are reconciled.

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