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Tuesday 28 June 2011

Ten lessons that could be learned from the Sovereign Debt-crisis. Or, how we always prepare for the last crisis to happen again, which it won’t do.

1.  If you start a new supranational currency like the Euro, check the credibility and creditworthiness of your partners.

One of the most obvious things that we learned from the current crisis is: you can’t trust the financial reports, statistics and official statements of countries to be true. These might be subject to political wishful thinking and/or politically-driven, (semi-)fraudulent changes.

It was not in the interest of countries like Greece and Portugal to tell the whole truth on their financial situation. This would have closed the door for these countries to step into the Euro and would have put them further backwards, compared to the north-western European countries. Therefore these countries decided to spice up their financial reports and statistics, in order to get their chance to enter the Euro-zone.

And the funny thing was, that many insiders knew in advance that the reports and statistics of these countries were not correct. However, nobody in power bothered to listen to these people.

If you want to be really certain on the financial situation of a country, you need independent, international auditors that don’t have an interest in spicing up the financial situation of a country. And to prevent these auditors from getting this interest, you should pay them very well and keep an eye on their behaviour outside working hours.

2.  If the strongest countries start with ‘bending the rules’, the weaker countries might start to break them.

A few years ago, when the credit crisis was still a nightmare from ‘a bunch of loonies with a tinfoil hat’, Germany and France broke the demand of the European Stability Pact to let state deficits not exceed the 3% mark.

Instead of being penalized for this, like the rules of the European Stability Pact required, France and Germany told the rest of the Euro bunch ‘to take a hike’. This angered the formerly Dutch Finance Minister Gerrit Zalm (currently CEO of ABN Amro), but it was a lesson learned well for Greece, Ireland, Portugal and the other PIIGS.

And when the credit crisis gained momentum, these countries themselves thought: ‘take a hike’, when the rest of Europe (Germany and France as front-soldiers) was urging them to stick to the rules and to execute the austerity packages that are laid upon them. And did they break the rules!

 
3.  Stress tests and worst case scenario’s are never useful: either they predict nothing, or they scare the sh*t out of everybody.

We have had stress tests for the American financial markets; and nobody believed them, because they sounded like a walk in the park for banks and insurers. This was caused by the fact that all categories that would have disclosed financial misery, were left out of the test.

We have had stress tests for the European financial markets; and nobody believed them, because they also sounded like a walk in the park for banks and insurers. And after the stress test was hardly over, the ‘healthy’ Irish banks collapsed.

We have had even tougher stress tests for the European financial markets; and nobody believed them, because they still sounded like a walk in the park. Because the scary tests were still left out.

The point is, the only correct stress tests are the ones that scare everyone sh*tless, as they disclose the true financial misery. Executing such a stress test could eventually trigger a bankrun, when the bank or insurer is financially in dire straits. And no politician wants financial misery and bankruns with him on the helm. So stress tests will always be of the bleeding heart, useless kinds.


4.  Accept the unwillingness of politicians to do anything unpopular, that will cost them votes on the next elections.

Through time, there have always been little politicians that had the backbone to take the real hard decisions. That is what also characterizes the politicians during this crisis: running away from decisions, when they count.

And when you ask: what are the hard decisions for politicians? Those are the ones that hit and hurt themselves and their own grass roots: the people that count for their reelection.

The result is that crises like these are prolonged and worsened, as it is easier to submit drugs that masks the true disease, instead of administering the real medicine that initially causes much pain, but opens to road to curing from the disease (thank you, Toddo and Kevin, for the inspiration (http://www.minyanville.com)/).

So there might be a QE3 after all, following QE1 and 2. Everybody knows it doesn’t help, but it gives the people the idea that something is happening.

And Greece and Portugal might indeed receive additional financial aid from the EU, at whatever terms and conditions, although it won’t help. And Greek and Portuguese politicians might indeed silently neglect to follow those terms and conditions, as their grass roots can’t handle them, making the point from the financial aid useless from the beginning.

Another example: It is a fact that there are substantial cutbacks in The Netherlands, in order to save €18bln. Especially within the category of people that didn’t vote for the current cabinet. But the decision that would really count, is not taken: getting rid of Mortgage Interest Deduction, although this would immediately save €16 bln per annum. Because that would hit the grass roots of the current cabinet. So that doesn’t happen.

Every now and then, there comes a politician that dares to take the real hard decisions. Sometimes, they grow into legends (Margaret Thatcher, Winston Churchill and Franklin D. Roosevelt), but often they are almost forgotten (Dwight Eisenhower). Most politicians, however, prefer mediocrity and clientelism as their main survival strategy.
5. Don’t underestimate the pigheadedness of politicians in retrying solutions that didn’t work before.

This is a natural result of bullet 5. Retrying something that didn’t work the first, second or third time, is much safer than making the really hard decisions. Therefore Greece will probably get its money and the US will probably get their QE3.

6.  Accept that the power of the financial markets to wear countries down is much larger than their financial staying power.

If something has been proved over the last years, it is the truth of this statement. It didn’t matter how much money the ECB, IMF and the countries of the Euro-zone threw in during the sovereign bond crisis. The financial markets could wear them out anyway.

In my opinion, this does not happen intentionally (except for maybe a limited number of cases), but just because the market smells the weak points in government statements and gets scared to death.

And when the billions of dollars and euros are flying around like leafs in the fall, you know the financial market will win again.
7. Economists are like frogs in a wheelbarrow: jumpin’ to all sides. And there is always a side that fits you.

Unlike mathematics and fysics, economics is not an exact science, but a series of theories, definitions and ‘best practices’, often based on mass-psychology. And masses do what you think they do, until they don’t!

In economics, there is no fundamental truth. Everybody that states otherwise, is a believer of his own truths (that includes the writer of this, by the way) and just as wrong as the other believers that he abolishes.

That is the fundamental weakness of the profession. There is always an economic theory that supports your approach of a crisis, whatever that approach is. This makes listening to economic pundits suitable for reflection of thoughts, but unsuitable for funding your decisions upon. Therefore it are politicians that take decisions and not economic professors.

8. Large crowds can be wrong: don’t put your blind trust in their wisdom.

Especially among populists, there is a religious belief in the ‘vox populi’: the voice of the people. They exaggerate the wisdom of crowds and think the larger the crowd is, the wiser its decisions will be. History has enough shocking examples of the falseness of this opinion.

Also in the sovereign crisis, the vox populi cannot always be trusted:
·   The Greeks in general don’t want to pay more taxes and work longer, even if it could save their country.
·   The people in other European countries want to kick Greece and the other PIIGS out of the Euro, even if this is virtually impossible and would cost them much more money eventually.
·   Many people want to abolish the EU and the Euro, although these brought them enormous wealth and prosperity.
·   Most crowds go for the easy solutions that won’t solve anything, rather than looking at things from different point-of-views.
·   Crowds believe the stories of populist reactionaries that in the past everything was ‘so much better, when all foreigners were still living in their own country’. Whenever that time has ever been?!

Of course, there are many times that the crowds are right. I won’t deny this. But it is the wisdom of good politicians, that decides when to follow the crowds in their opinions and when not. Therefore the need for politicians with a backbone is today greater than ever.
9.  The market does not make people and companies smarter and more honest
Some economic and financial pundits think that the market makes companies and people smarter and more honest. And think that the market will punish all bad / dishonest behaviour. They also think that every kind of government intervention is bad.

The market, so is their statement, will catch people and companies that don’t play by the rules and it will punish them. These people should ask:
·    Was is the market that disclosed the practices of Bernie Madoff?
·    Was it the market that caught the representatives of Enron?
·    Was it the market that shed a light on the dishonest bankers?
·    Was it the market that caught the countries that were not telling the truth in their annual reports, statements and statistics?

If you answered one or more questions with ‘no’, than you understand that supranational governmental supervision will always be necessary.  It is not the football match that keeps football teams fair and square: it is the referee. And that is a lesson that should always remembered.

10. Forget the last nine lessons; the next crisis will be totally different.

The most important lesson to learn from this credit crisis, is that the next crisis is almost impossible to predict. People will go on making mistakes and big mistakes will inevitably lead to new crises.

The main reason for this is, that people took counter-measures against every circumstance that caused the last crisis and then start to think that all circumstances causing crises are wiped off from the face of the earth. Hence: eternal economic growth is finally on its way.

And yes, people are thinking that in every secular bull market.

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