INGESTING THE FINANCIAL HEMLOCK

2/10/10

Late last week and early this week, reports that Greece was in serious fiscal trouble, perhaps on the verge of default on its sovereign debt, rattled the markets. Rumors that Greece was not at all unique, that much of the southern tier of the Eurozone (at least Portugal and Spain, in addition to Greece) might be next resulted in what most of the media types and financial experts, never having seen real panic, would call panic.

The permabulls among us at first told us not to worry. Even though French banks hold $75 billion of Greek sovereign debt, German banks hold $43 billion of Greek sovereign debt, and other foreign banks hold, collectively hold another $185 billion of Greek sovereign debt, Greece is, after all, a small country that, in the great scheme of things, doesn’t matter much from a financial perspective.

Now the news has (Surprise!) suddenly changed. The same bulls who told us that Greece was no problem due to its diminutive size now report that the EU, at the behest of Germany, is leading a charge to guarantee Greek sovereign debt.

Hmm…

Greece is inconsequential from a financial standpoint, yet it is imperative that the EU intervene to prevent Greek sovereign default. One can only conclude that it’s now official: Everyone gets a bailout. It doesn’t matter if Greece is quantitatively financially inconsequential. It doesn’t matter that Greek debt in the vaults of the banks of the Old World was purchased by supposedly sophisticated (Ironically, the English word “sophisticated” comes from the Greek word “sophista,” which originally simply meant “instructor” but which eventually came to mean an instructor who, while professing to dispense wisdom and knowledge was instead dispensing specious “logic” and other intellectual tomfoolery, hence the English word “sophistry.”) investors seeking more yield in a money hungry world, people whom are sometimes called “yield pigs.” Greece gets a bailout.

And why not? Everyone else has gotten a bailout. The banker who managed to bring down his venerable institution by stuffing its portfolio with “investments” that he clearly did not understand. The homeowner who bought far too much house for his income. The entitled consumer who “just had to have it” (“It” being the latest gimcrack that represented only the latest attempt to fill the emptiness of his or her life with ephemeral material trappings of happiness and genuine wealth.) despite not having the money to pay for it. All the other governments that got in over their heads due to the inability of their “leaders” to say “no” to an electorate that equates “democracy” with a means to seize the accumulated wealth of other people. The industrial company that badly misread its market and could not say no to the outrageous demands of its workers, union or otherwise. The list goes on and on. Everyone else has gotten a bailout, why not Greece?

And we sit here and wonder why people engage in financial behavior that is ruinous to themselves and their families, to our once great nation, and to the whole world.

Two additional notes:

First, Greece’s budget deficit is expected to amount to 13% of its GDP, thus bringing it to the threshold of financial ruin. Our budget deficit should come to about 11% of GDP this fiscal year. That’s right…only 2% separates us.

Second, one of the reasons Greece is running such an immense budget deficit is that its underground economy is so huge, estimated at about 25% of GDP. People in Greece do a large measure of their business “off the books” to avoid taxation. (This phenomenon is by no means unique to Greece, but seems to be induced by something in the warm waters of the Mediterranean. Spain, Portugal, and Italy all have underground economies that comprise about 20% of their GDPs.) What is the Greek’s government’s response, then, to its fiscal problems? It is raising marginal tax rates on people making more than the princely sum of about $55,000 per year. It is eliminating “loopholes” and special rebates. It is increasing taxes on dividends and on offshore companies doing business in Greece.

Hmm…

Wouldn’t it be logical to conclude that people sensibly opt to do business off the books because tax rates are too high and the tax code too complicated? Wouldn’t it make sense, then, to reduce tax rates and simplify the tax code to the point at which it no longer paid to evade taxation? If tax rates are low enough, and the tax code simple enough, people will no longer have sufficient incentive to go through the often complicated process of evading the tax man and thus will do business that was formerly conducted in the black, or underground, economy in the above ground, if you will, economy, thus exposing that activity to taxation and generating additional revenue for the government. Wouldn’t it thus make sense for the Greek government, and a lot of other governments, to reduce tax rates if it wants to generate more revenue?