Please, click here to read this article in pdf format: january-15-2009

The waters are getting murkier. The problems associated with the 2009 transfer of private sector losses to the public sector are becoming more and more visible at faster speeds. Personally, I had hoped that the debate on the solvency of some Euro zone members like Greece, as well as China’s role in global capital flows would only arise at the end of 2010. However, it looks like history has other plans for us.

Yesterday, Greece announced a program aiming to drive its fiscal deficit to approx. 3% of GDP over 3 years (from current 13%).  Like any other politicians, Greek politicians chose what they think is the path of least resistance: Higher taxes. The plan of course considers a restructuring of the public sector, with consolidation as well as privatization. But at the end of the day, all hopes are on the ability of the government to increase revenues. Very sad…Perhaps today more than ever, it is relevant to remember what Adam Smith had to say on similar circumstances (in his greatest work, “The Wealth of Nations”, Book V, Chapter II), more than 200 years ago, in a world where globalization was negligible in today’s terms:

“The proprietor of stock is necessarily a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business, or enjoy his fortune more at his ease (…) A tax which tended to drive away stock from any particular country, would so far tend to dry up every source of revenue, both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour, would necessarily be more or less diminished by its removal (…) High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be drawn from more moderate taxes…”
If Mr. Smith could clearly “get it” in the eighteenth century, how can the European political class of today fail to see it even more clear, for a country that is under a monetary union?

For the time being, all Greece did was to buy time, and I believe that the European Central Bank shares this view. As we anticipated on January 7th (“Don’t forget Greece” www.sibileau.com/martin/2010/01/07 ): “…If the European Central Bank validates this situation, both spreads should converge to a lower level. If it doesn’t, they should converge to a higher level. The contagion is undoubtedly a fact, and under any scenario, this situation will continue to weight heavily on the Euro…”
As you can see from the chart below (source: Bloomberg), where we show the spread between the 5-yr credit default swaps of Greece (sovereign, in orange) and that of the National Bank of Greece (in white), it seems that the convergence is actually going to take place a higher level. This is not good, but at least, it is not surprising either…

Martin Sibileau