Dr Strangelove: or how I stopped worrying and love the debt

Major T.J. “King” Kong: “The contents of your survival kit is... one pair of nylons, five condoms, one .45 caliber pistol with two magazines, $200 in gold coins, 2 packs of chewing gum, one miniature bible and combination Russian phrase book... OOOOOWEEE, a feller could have a pretty good time in Vegas with all that!

To many investors there is a new doomsday machine, the European sovereign debt crisis, and they can be forgiven if they are mistaking European politicians for the cast of Stanley Kubrick’s famous black comedy, President Merkin Muffley, Premier Dmitri Kissoff, Group Captain Lionel Mandrake and General “Buck” Turgidson among others.

Unlike the doomsday machine though, this crisis can be stopped if decisive action in taken.  The one lesson of past financial crises is that authorities must get ahead of events and stop them by applying massive force.  Mexico in 1994 is perhaps the best example of that.

Unfortunately, the EU has done the opposite, partly out of pride (no, this is not Latin America, and no, we don’t need the IMF) and partly out of inexperience.  While the initial tab was put at €30 billion, it is now in the trillions.

As I have argued in this blog, there is no way for Greece to pay off or even service its public debt, and as a result, there is little incentive for it to make drastic adjustments; the Greeks, and other countries in the same situation, have to understand that they need to sacrifice as much for their own benefit as for that of their creditors.  This presupposes that the debt be significantly reduced both via “haircuts” and large scale privatizations.

Whether Greece remains a full member of the EU or not is not easy to answer.  In either case, it would need to make profound structural changes, as did Chile in the 1980s, otherwise, it would continue to stagnate (if it stayed in the EU) or would expose itself to exploding inflation (if it exited).  My view is that if Greece exited the EU it would probably not come back; as much as sticking to the euro would represent a headwind, being a member of the EU would maintain pressure on Greece to practice good economic management.  All things considered, it is probably best for it to stay in the EU.

The heavy lifting is really about Italy, and to a much lesser degree, Spain.  Quite simply, there is no EU without Italy. Germany and the rest of Northern Europe should know it and act in consequence.  Likewise, Italy should realize that not making the kind of adjustments that are necessary will sink the euro, and they will sink with it.

So for all of you in Berlin, Paris, Rome, Brussels and elsewhere in Europe, here is, one more time, Major T.J. Kong:

“Well, boys, I reckon this is it - nuclear combat toe to toe with the Roosskies. Now look, boys, I ain't much of a hand at makin' speeches, but I got a pretty fair idea that something doggone important is goin' on back there. And I got a fair idea the kinda personal emotions that some of you fellas may be thinkin'. Heck, I reckon you wouldn't even be human bein's if you didn't have some pretty strong personal feelin's about nuclear combat. I want you to remember one thing, the folks back home is a-countin' on you and by golly, we ain't about to let 'em down. I tell you something else, if this thing turns out to be half as important as I figure it just might be, I'd say that you're all in line for some important promotions and personal citations when this thing's over with. That goes for ever' last one of you regardless of your race, color or your creed. Now let's get this thing on the hump - we got some flyin' to do.”