Feckless modern pharaohs

The Dow down 97 points yesterday.

And the Greek story nears its conclusion.

The Germans agree to bail out the country... at least for a while.

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And the Greeks agree to act more like Germans... at least while everyone is looking.

But now everybody agrees that the farce has gone on long enough.

Let's recap:

The big banks lent the Greeks money. Then, the bankers paid themselves big bonuses, rewards for having booked so much business.

The Greeks spent it like they stole it which they practically did. They rigged their accounts so as to appear to be better credit risks than they really were.

Then, of course, the Greeks could not repay. Since they gained independence from the Ottoman Turks in 1828, the Greeks never, ever repaid a loan as promised. Instead, they were in default about half the time.

But rather than let Mr Market sort it out as he had every other time, Mr Government Fixer stepped in. He promised to manage the situation so that the careless lenders wouldn't have to take the losses they deserved. How? By lending the borrower more money!

So, the Greeks were given more money and told to straighten up.

And the Greeks made an effort. Rather than spend money as freely as before, they cut back. Thousands of government employees were laid off, budgets trimmed, belts tightened.

This, naturally, led to an economic slump. GDP fell at a 5% rate in the third quarter of last year. In the fourth quarter it was falling even faster, at a 7% annual rate. The New York Times reports:

By many indicators, Greece is devolving into something unprecedented in modern Western experience. A quarter of all Greek companies have gone out of business since 2009, and half of all small businesses in the country say they are unable to meet payroll. The suicide rate increased by 40 percent in the first half of 2011. A barter economy has sprung up, as people try to work around a broken financial system. Nearly half the population under 25 is unemployed. Last September, organizers of a government-sponsored seminar on emigrating to Australia, an event that drew 42 people a year earlier, were overwhelmed when 12,000 people signed up. ...

The situation at the macro level is, if anything, even more transformational. The Chinese have largely taken over Piraeus, Greece's main port, with an eye to make it a conduit for shipping goods into Europe. ...

The latest austerity plan meant to satisfy Greece's creditors and allow for new infusions of financial aid may have averted involuntary default and a global economic downturn but will nonetheless make life for ordinary Greeks even more difficult. The plan reduces the minimum wage by more than 20 percent, mandates thousands of layoffs and reduces some pensions, probably ensuring that strikes and demonstrations will continue to be a feature of the Greek landscape.

As in Argentina ten years ago, the Greek middle class is being hit hard. The upper classes are protected. They own stocks. They have bank accounts in foreign countries. And the lower classes had nothing before the crisis. They haven't lost a penny.

But the middle classes lose jobs, income and benefits.

That is what is happening in America too. Middle class wealth, built up between 1980 and 2007, was largely an illusion. It was money borrowed from the future. Now, it must be paid back.

And there's not much Mr Government Fixer can do about it. The problem is too much debt. Adding more debt doesn't help.

And more thoughts

"But Bill, aren't you being a little simplistic," asks a dear reader. "The idea is not to add debt for its own sake. The idea is just to try to mediate the social consequences of private sector de-leveraging while giving the economy time to get back on its feet. Why won't that work?"

Why won't it work? We repeat the question to give us time to think.

Oh yes... it won't work because it ignores the reason the economy was knocked on its derrire in the first place. If the cause of the setback had been interest rates that were too high or a natural disaster, the strategy might work. Just as an ancient Pharaoh made Bible-fame by saving grain in the fat years and then releasing it when the harvests failed, so might a sage government today draw on its own surpluses to help soften the blow of a bad winter or an earthquake.

But the government has no surpluses. Only deficits. And you can't mitigate the damage of an earthquake by setting off a nuclear explosion. Neither can you solve the problem of too much debt by adding to it.

When an economy has too much debt, there's only one solution. Debt delenda est. Debt must be eliminated. It can be done in the old fashioned way by Mr Market. Or it can be done by Mr Government Fixer.

Mr Market will do it quickly, efficiently and brutally.

Mr Government Fixer will hesitate, equivocate, vacillate, prevaricate and generally fornicate everything up. He will protect the guilty insiders at the expense of the innocent taxpayers and general public. And in the end, he will let the debtor default, too, for he will have no other choice.

We warned you about buying Facebook.

Here, another colleague, Dan Ferris, elaborates:

"Buying the Facebook IPO at its rumoured valuation level would be a big mistake. Buying the other social networking companies at current valuations is also a mistake."

Dan thinks the whole market has been infected by a bullishness.

If you're eating, sleeping, and breathing in lots of news, it's virtually impossible not to get infected. For example, check out the American Association of Individual Investors Sentiment Survey. Every week, they ask investors if they're bullish, neutral, or bearish on stocks for the next six months.

In the most recent survey 43.8% of those surveyed were bullish and just 25.1% were bearish. (The average level of bullishness is 39% and the average bearish reading is 31%, so the latest survey is showing extreme bullishness.)

Dan thinks that investors most of them routinely buy the wrong investments at the wrong time:

"A famous study shows how investors ruin their results by letting the market's ups and downs rule their decisions. Market research firm Dalbar runs an ongoing study comparing stock market returns (the S&P index) with real investors' returns. As of the 20-year period ended December 31, 2010, stocks returned 9.14% per year, on average, but investors earned just 3.27% per year during the period."

"Investors got slighted because they got scared at the bottom and sold, and bought back in only after a rising market fueled their confidence. Plenty of professionals make money following the market's trends, but their methods are highly technical and unemotional. That's the opposite of the hysteria that sinks so many investors. Getting caught up in bullishness gives many investors another reason to fool themselves in thinking they are smarter than they really are."

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