Greece And Germany: Time To Take The Hit And Move On

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by: Carlos X. Alexandre

The Greek model of debt negotiation appears to be catching on, and before we know it, there will be plenty of haircuts and baldness will be propelled into vogue. I'll fit right in. But haircuts are nothing new, and last year German magazine Spiegel Online provided a long forgotten glimpse into history. Economic historian Albrecht Ritschl stated that "Germany was the biggest debt transgressor of the 20th century."

SPIEGEL ONLINE: The Germany of today is considered the embodiment of stability. How many times has Germany become insolvent in the past?

Ritschl: That depends on how you do the math. During the past century alone, though, at least three times. After the first default during the 1930s, the US gave Germany a "haircut" in 1953, reducing its debt problem to practically nothing. Germany has been in a very good position ever since, even as other Europeans were forced to endure the burdens of World War II and the consequences of the German occupation. Germany even had a period of non-payment in 1990.

Angela Merkel was born in 1954 and does not remember, but she needs to be reminded of the old adage: "People who live in glass houses should not throw stones." As all eyes are still on the Greek debt negotiations, Reuters reported that "Portugal has been discreetly sounding out advisers on options to restructure its debt."

Some of those consulted are understood to have advised Portugal to follow a similar path to Greece's private sector involvement (PSI) plan, to persuade private sector bondholders to take a voluntary haircut on their bonds, if the latter proves successful over the next six weeks. "If there is success with PSI in Greece, then it could open the eyes of some governments," said one sovereign debt adviser involved in such preliminary discussions. "It would show that after all debt reduction is possible and not the end of the world. That could create an interesting precedent."

It's not as if Portugal's strategy is unexpected, and if the PSI deal is ultimately adopted, we should expect every country in the European Union with similar circumstances to seek similar deals. Why wouldn't they?

But according to the Portuguese publication Económico, Portugal's Ministry of Finance denied that the shopping around for debt restructuring ideas is taking place, reducing the news to unfounded rumors. But as we well know, and using the past as a guide, the "bad" news have always been dismissed only to be proven correct in due time, especially when the denials come from government officials. On the flip side, the "good" news as portrayed by the bureaucrats are the ones that have always fallen short of promises.

Late last year, the "Statement by the EC, ECB, and IMF on the Second Review Mission to Portugal" didn't paint a rosy picture going forward, and considering the sources, these projections have a tendency to carry a positive bias.

Growth in 2011 is likely to be somewhat better than foreseen in the program, but the recession in 2012 is now projected to be more pronounced, with GDP expected to contract by 3 percent and risks to the outlook tilted to the downside. From the external side, global headwinds are hampering exports, while, on the internal side, the fiscal consolidation measures in the 2012 budget, tighter credit and financial market conditions, and weaker confidence are dampening domestic demand. Consumer price inflation will remain elevated, reflecting significant indirect tax and tariff increases. The economy is expected to recover, albeit at a gradual pace, in 2013.

With Portugal virtually shut out of the credit markets with 2 year, 5 year and 10 year bonds at 14.5%, 17% and 13% respectively, Portuguese Prime Minister Passos Coelho stated that the country's debt is sustainable, according to Reuters and as of Monday. We'll wait for next week's update.

What is appalling is that everyone talks about austerity as a one way street, and a good example of the side effects can be found in the report by ekathimerini regarding the Greek negotiations and the demand for a minimum wage reduction.

However, cuts to the minimum wage will have a knock-on effect because they will lead to a 1.3-billion drop in tax revenues and a 2.4-billion reduction in social security contributions. This means the government will have to make up for these losses.

In short, they continue to call for what is obvious in their minds without understanding the fallacies of the obvious. Furthermore, and in the midst of all the debt talk, I have not seen a plan that addresses the obviously failed heavy economic dependence on government, and prepares the eurozone for a gradual reduction of the public sector - and gradual it must be -- while stimulating private investment.

An opinion piece written by Stefan Kaiser and published by Spiegel Online, summarized well what common sense is dictating:

Perhaps, the Greece rescuers on both sides of the negotiating table should try being honest for a change. Here's the truth: If the country is to lastingly reduce its mountain of debt and, at some point, be able to borrow money on the capital markets again, then it needs a comprehensive debt haircut. In other words, it needs to go bankrupt.

Should the U.S. ask for a refund with interest since Germany has done so well over the last 50 years? Of course not, but it's time for the eurozone to accept the mistakes, take the losses, and move forward with a credible plan.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.