Alan Kohler:

The Greek bailout is merely an exercise in wishful thinking — that, first, 95% of bondholders will accept it and second that Greece’s economy will return to growth sometime next year.

But it should get everyone past the March 20 bond rollover and perhaps even slow down the capital flight from Greece, and buy the authorities some time to deal with Portugal, and then Ireland and then …

But it needs to be remembered that this is, and always has been, primarily a banking problem and that the world remains in the grip of sustained bank deleveraging, similar to what kept Japan in depression for more than 10 years in the 90s and beyond.

And the bottom line is this:

Increasing bank leverage produced the boom of 2002-2007; decreasing bank leverage is doing the opposite, and still has years to run.

You have been warned…

Not likely…

The real issue for the finance ministers is to try to fit the ever-deteriorating Greek numbers within two self-imposed conditions. One is that the restructuring of Greece’s debt should reduce its burden down to “about 120% of GDP” by 2020. The other is that that the contribution of governments to the second package should be €130 billion (including some funds left over from the first €110 billion bail-out) after the “voluntary” losses being negotiated with Greece’s private creditors*. Both are somewhat artificial figures. The debt ratio of 120% was chosen because it is the level of Italy’s debt; the contribution of €130 billion was decided in October, so cannot be changed for fear of giving the impression that Greece is a “bottomless pit”.

But as matters stand at the start of the meeting, the package would leave Greece with a debt burden of 129% of GDP – too high for many of the creditors. Tonight’s homework for the ministers will be to fill the remaining fiscal hole: by convincing the ECB to forego profits on the bonds it bought at a discount (it has more or less agreed to do so) and perhaps by reducing the interest rate that Greece is charged by its creditors…

But even if a deal is agreed tonight, big questions remain. How long will it be before Greece must come back for still more money? And if it must be kept permanently under threat of default, what is the chance of restoring the confidence needed to help Greece recover? For now, the ministers seem ready to play for time, in the hope that Italy and Spain can be stabilised. They will no doubt express confidence that the Greek problem has been settled once and for all. But sooner or later, they will be back for more crisis talks.

You’ve gotta worry about an article that opens with “In the good old days…”

Rest assured, it only gets worse from there, with the author commending the wealthiest (and luckiest) generation in history, the Baby Boomers, for their sacrifices and hard work, whilst chastising Gen Y for having unrealistic expectations.

No mention of sky-high property prices which have been driven up by skewed tax policies and Baby Boomers “wealth accumulation”, let alone the monumental welfare burden being dumped on future generations to care for the Boomers in retirement!

Now it is certainly the case that once in the euro, exiting it is not a path any government would willingly contemplate. Without the second bailout of €130bn, Greece would not have had the money to redeem the €14bn of bonds which fall due on 20 March. The resulting default would mark the start of a process of national bankruptcy which in the first order would mean state pensions, wages, contracts and medical bills not being paid. From there, the insolvency would multiply outwards into the already deeply impaired private sector, where many businesses would find it impossible to stay afloat.

To exit the euro would further savage the private savings market, much of which would be wiped out by devaluation and cascading bankruptcy. An immediate, and violent economic contraction would occur, followed in short order by a likely inflationary tsunami.

The first wave of the inflation would come from devaluation, the second from compensating wage demands, and the third from a central bank forced to monetise the still yawning budget deficit.

It is no surprise, then, that Greece’s technocrats, backed by a substantial majority of its existing politicians, have turned their back on such a course.

But is it really any worse than the one chosen? Repeated rounds of austerity are proving self defeating, which makes it virtually certain that Greece will eventually have to come back for more. What are Europe’s paymasters to demand then?

Can there ever have been a country in such good shape as ours that’s as miserable as Australia is?

… The only thing that makes sense as a single cause of Australia’s misery is excessive debt.

Australia’s household debt as a percentage of disposable income has been stuck at 150 per cent – the highest in the world – for about five years. Twenty years ago it was 50 per cent. In other countries it has come down, albeit painfully. Interest paid as a percentage of income has doubled in 20 years.

And the underlying cause of this is the high price of land in Australia. It is one of the mostly sparsely populated nations on earth, yet the cost of land is among the highest in the world, crippling the citizens with massive debts and leading to hugely profitable banks.

One can only hope…

Chovanec tells Nouriel Roubini the conflict between driving growth through investment-directed credit, and the resulting inflation problem, is being brought to the fore by looming debt maturities:

“…the thing that’s really intensifying that is the need to roll over debt. No longer are we talking about bad debt as a theoretical possibility, we’re talking about it as a real thing that needs to be dealt with within the system, and it’s eating up the available credit within the system. So, if you want to drive growth, you have to do it through credit expansion, if you expand credit, then you’re creating inflation. And that trade-off has become much more intense than it was a year ago, two years ago.”

There are two ways in which a bank can find itself in trouble. The first and most common is when its assets – the loans it has given to its clients – deteriorate in quality. This happens when the folks who borrowed the money struggle to repay it. They might have lost their job, or the asset they offered as collateral against the loan – say, a house – may have lost value and their own balance sheet is under pressure. If they sell, they can’t repay the whole loan amount. You can see how this process can feed upon itself as distressed sales leads to more falling prices. At a certain stage the banks themselves get into trouble as enough assets are impaired and their capital begins to decline. They must then restrict lending and the problem gets worse again. This is called a credit crunch.

This is what happened in the US. Australia is also in the early stages of such a process with falling house prices, rising unemployment and rising impaired loans at the banks. It’s difficult to judge how far into this we are and whether it can be reversed. The jobs generated by the mining boom offer the hope that it is possible to arrest the decline and instead of a credit crunch we get a stall in housing and a redistribution of capital elsewhere. The primary protection against the process getting out of control is monetary policy, or interest rates, which can be lowered to alleviate the borrower stress at the heart of the problem.

The second way in which a bank can find itself in trouble is on the other side of the balance sheet: the liabilities. This happens when the people lending money to the bank – depositors or investors – get nervous and want a higher interest rate to give the bank their money. In the past this was not much of a problem for Australian banks as they relied upon steady deposits. However, after the millennium, the banks went a bit nuts borrowing less stable money from investors here and abroad and loaned that money largely to punters betting on houses. Now, through a combination of the troubles in Europe, the fact that the process of deteriorating assets is under way, and through their own incompetence in the mishandling of covered bonds, investors want much higher interest rates to lend our banks money. So yes, they need to raise interest rates to extract more money from the other side of the balance sheet to compensate. If they don’t then they’ll not be able to lend money on unprofitable loans and the credit crunch still transpires as the banks limit the supply of credit.

In short, whichever way the banks turn right now, whether they pass on their borrowing costs to mortgagors and put downward pressure on their assets, or they absorb the higher funding costs and stop making unprofitable loans, we edge further into a credit crunch. And indeed, as you can see, the two halves of the balance sheet aren’t at all separate. As risk builds in one then it has a deleterious effect on the other and so another feedback loop threatens.

One of the pillars of the Australian financial system, the independence of the Reserve Bank of Australia to set interest rates, is crumbling. It will soon be apparent to all that if anyone outside the big banks has the power to set interest rates in Australia, it is Treasurer Wayne Swan.

Successive Australian treasurers, including Swan, have endorsed the independence of the Reserve Bank and this new power is not one that the current treasurer desired. And I am not sure that either he or Treasury have fully grasped that the game has changed.

With the benefit of hindsight we should have realised that the ability of the Reserve Bank to be the main determiner of interest rates was weakened when Australian banks in the past two decades — but particularly in the past 10 years — turned their back on using local Australian savers but rather funded their growth by massive overseas borrowing on the wholesale banking market.

At the time, they could obtain funds overseas much more cheaply than local savings and this was a contributor to the large growth in bank profits and the Australian economy. But if we had thought about it, we would have realised that we had greatly lessened our power over Australia’s interest rate destiny.