A Paper Crisis

It’s both heartening and unsettling to see one of MarkOnMarket’s key issues come to its initial fruition.  Greek bonds – never the bedrock of stability – have finally been shown to be worth just about nothing.  Interest rates soared passed double digits after S&P belatedly rated the bonds as “junk” which caused a wave of forced selling by funds who aren’t allowed to hold junk bonds.  The truth is, if these funds didn’t know that Greek bonds were junk before S&P told them, then they have no business investing in sovereign debt in the first place.

Yet, it’s important to remember that this is only the “end of the beginning”, and Greece is not really what this is about.  As a first step, it’s part of the erosion of respectability that Southern European debt artificially gained as it was subsumed into the Euro-zone.  In a much broader context, it’s yet one more signal of the passing of the economic torch from West to East.

As the dominoes fall across Southern Europe – and investors must assume they will – we should be cognizant of the implications.  The German-dominated ECB will eventually be forced to shed the fiscally lax “PIGS“, or to successively and continually bail them out.

In fairness, the problem is not with Southern Europe intrinsically, but rather the idea that the entire continent could be united in a single currency despite very different mentalities and cultures regarding money.  What Southern Europe so desperately needs (inflating away their debt) is the one thing that the Germans can’t give them in good conscience.

The most serious and broadest issue poised by the Greece case, however, has only been hinted at on this blog.  As investors get used to the idea that government promises are sometimes quite literally worth only the paper they are written on, a serious threat to the global monetary system arises.  When investors start questioning everything they are bound to find answers that are less than satisfactory: Just how does the West plan to pay back its debt? Or even just keep paying the interest?

This is not of course to say that this threat is bad and that the current system is good.  At the same time we must not be naive about the future.  No matter how inequitable we perceive the current system, it’s possible that the future system will be far worse.

We must then, walk a fine line.  Let us first realize that the current debt levels of the West are completely unsustainable.  And yet – let us not cheer on the end of the ridiculous financial position of what so often appears to be the twilight of Western Civilization.  Whether through debt defaults or massive inflation, the situation will be poor.

There will be a few choices to make along the way.  Choices somewhere between terrible and disastrous.  What starts in Greece will come to many of us as investors slowly (painfully slowly) come to realize that the West is simply not credit worthy.