Investors Spooked by Greek Reality Check
Liz | 05/07 at 11:48 AM
Last week I had dinner at L’Ami Louis in Paris. This small, old-time favorite is, according to Zagat, especially known for its Bresse chicken and “orgasmic” French fries, and almost impossible to book. With great anticipation we examined the menu, and were astonished to see an appetizer of asparagus priced at 66 Euros – more than $85! Stunned, I asked the waiter how the asparagus was done, expecting to hear that it had been infused with caviar, or possibly contained deposits of platinum; he answered that the fat spears were sprinkled with a bit of lemon juice. We ordered chicken and fries, which were rather ordinary in my view and bizarrely overpriced, and concluded that L’Ami Louis was a perfect example of the emperor’s New Clothes. They will continue playing to sold-out crowds at exorbitant prices until someone calls their bluff.
We have seen this same phenomenon at work in the financial markets of late. Stock prices in the U.S. have had a remarkable run over the past year, correctly anticipating a recovery in the economy and in corporate profits and willfully ignoring looming problems. Market averages soared even as many noted rising state and federal budget deficits, probable tax hikes, higher interest rates and continued unemployment. Given the prevailing euphoria, it took a veritable cascade of bad news to finally provoke the sell-off of the past few days.
And what a sell-off it was! Is it possible, we all want to know, that some knucklehead trader can cause near-panic by mistaking billions for millions on his laptop? Today the authorities will try to put the stopper back in the bottle, will sort through the trades – reversing many at great cost and creating considerable uncertainty – and attempt to bring sanity back to the markets. The damage, though, has been done. Nerves are shaken, and some have begun to question the emperor’s wardrobe.
The deteriorating crisis in Greece brings home just how shabby the outfit is. Investors were spooked over the past couple of weeks in part because Greece is in hock to many European banks, so that a debt default could create a chain reaction like that spawned by the fall of Lehman Brothers. They were also alarmed that Portugal, Spain and even Italy faced similar budget and debt crises. And, yes, these problems are not limited to the Eurozone. The U.S., too, faces rising deficits and debts, and some of our states are at the brink of insolvency.
In my view, the drama playing out in Greece forced investors to face the new reality. The world today is made up of two kinds of countries – the haves and the have-nots. Greece is clearly in the latter category, as are the southern European nations mentioned above as well as England and Ireland. (A new report out today reminds us that Britain’s budget deficit could reach 12% of GDP this year – the highest in the EU and actually above Greece’s 9%.) China is most prominently in the “have” lot, given their huge foreign currency reserves and rapidly growing economy.
Despite their successes, though, even the Chinese have had to unwind the fiscal stimulus programs undertaken during the financial crisis and bring their economic house in order. To fend off a ballooning real-estate bubble, the government has aggressively raised reserve requirements for banks and taken other measures that have caused the Shanghai stock market to fall 16% this year.
What is the U.S. doing to rebalance our books? Nada. Instead of prudently acknowledging that we have been through a one-off period requiring huge government outlays that now need to be brought under control, we continue to create even greater government obligations – most notably through President Obama’s health-care legislation. We don’t even have a plan for future deficit reductions. So far, the harsh duty of retrenchment has fallen on the shoulders of our mayors and governors. Many states are struggling to balance their budgets, leading to some of the same conflicts that have impassioned the demonstrators in Greece.
For sure, it is not easy to cut spending. When Chris Christie in New Jersey asks teachers to take a one-year pay freeze, he gets death threats and an all-out assault by the teachers’ union. When the Tory candidate in the U.K. went public early on in his campaign with the kinds of draconian budget cuts that he thought necessary, voters immediately blanched. Conservative candidate Cameron quickly discovered that as nervous as voters were about deficits, they are even more wedded to their reliance on government programs.
It is a vicious circle. Cutting spending abruptly and heavily can slow an economic recovery. However, providing excess stimulus for too long a period can result in inflation and a collapse in confidence. Voters are not stupid. At the end of the day, they know the budget has to make sense. In the past 48 hours, as the likelihood of David Cameron taking over as U.K. Prime Minister increased, the pound sterling rose in value. Voters may not relish his prescription for the country, but investors understand its urgency.
Growth is the only cure for what ails the world. China will quickly expand out of its minor budget issues, with GDP expected to rise over 10% in the current quarter. Other emerging countries have similar opportunities. For the EU, growth will be limited by the need for various countries to bring their deficits down to permitted levels. The sinking Euro will help exporters like Germany compete, which will provide some wind behind the region.
The U.S. will face a similar balancing act. While today’s employment report in the U.S. is encouraging – the private sector added 231,000 jobs – the unemployment rate still stands at 9.9%, with more than 15 million Americans out of work. I continue to fear that President Obama views government – as opposed to the private sector – as the preferred engine of growth. By encouraging ramped-up regulation – with a new (redundant) Consumer Protection Bureau and with the recent FCC incursion into overseeing the Internet, for instance – and prohibitions on businesses, the administration is creating uncertainty and slowing progress. At the end of the day, the government does not create wealth; the private sector does that. All the government spending programs in the world will not make the United States wealthier. So, as voters and investors evaluate our prospects, they will surely recognize that promising more than we can responsibly deliver is just like, well, the emperor’s new clothes.