What does a Grecian earn? The march of folly.

It is the ninth year of inconclusive battle on the plains of Troy, where the Greeks are beseiging the city of King Priam. The gods are intimately involved with the belligerents as a result of jealousies generated ten years earlier when Paris, Prince of Troy, offended Hera and Athena by giving the golden apple as the award of beauty to Aphrodite, goddess of love. Not playing fair (as the Olympians, molded by men, were not disposed to), she had promised him, if he gave her the prize, the most beautiful woman in the world as his bride. This led as everyone knows, to Paris’s abduction of Helen, wife of Menelaus, King of Sparta, and the forming of a federation under his brother, the Greek overlord, to enforce her return.

War followed when Troy refused………………………..

Heavy with wine, the Trojans sleep. Sinon creeps from the hall and opens the trap door of the Horse to release Odysseus and his companions…… They sped through the city to open the remaining gates while Sinon signals to the ships with a flaming torch. In ferocious triumph when the forces are joined, the Greeks fall upon the sleeping foe, slaughtering right and left, burning houses, looting treasure, raping the women. Greeks die too as the Trojans wield their swords, but the advantage has been gained by the invaders.

The episode of the Wooden Horse exemplifies the pursuit of policy contrary to self-interest. The Trojans, having resisted for so long, celebrate the retreat of their foe and glory in the gift of The Horse celebrating to excess. Barbara Tuchman, ‘The March of Folly – From Troy to Vietnam’, 1984.

Gary D Cohn, president of Goldman Sachs, went to Athens to pitch complex products to defer debt. Such deals let Greece continue deficit spending, like a consumer with a second mortgage. Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning.

The New York Times 13/2/2010.

It’s amazing really that on average a derivatives trader earns more than a wheat farmer. I guess that’s where the expression ‘Man does not live by bread alone’ came from.

In conversation with Maximus (an Ecinya confidant), who has been both a wheat farmer and CEO of several derivatives departments, on 13/5/2010.

"We have a simple thesis" said Eisman: "There is going to be a calamity and whenever there is a calamity, Merrill [Lynch] is there." When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman’s logic: the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in the neighbourhood. Merrill Lynch was the little fat kid assigned to the least pleasant roles, just happy to be part of things. He assumed Merrill had taken its assigned place at the end of the chain [and was ripe for shorting].

Michael Lewis, ‘The Big Short: Inside the Doomsday Machine’, 2010 (page175)

What is it with you wogs? You always want to pay in cash.

Daryl Kerrigan, the family patriarch, talking to his neighbour, Costas Kilias, as each are facing resumption of their properties along with others in the street that has become a community. From the film ‘The Castle’ starring Michael Katon with Anne Tenney as his loving wife.

It’s a slow day in a dusty little Australian town. The sun is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit. On this particular day, a rich tourist from down south, driving through town, stops at the local motel and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night in. He gives him keys to a few rooms and as soon as the man walks upstairs, the owner grabs the $100 bill and runs next door to pay his debt to the butcher. The butcher takes the $100 and runs down the street to repay his debt to the pig farmer. The pig farmer takes the $100 and heads off to pay his bill at the supplier of feed and fuel. The guy at the Farmer’s Co-op takes the $100 and runs to pay his drinks bill at the local pub. The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him ‘services’ on credit. The hooker rushes to the motel and pays off her room bill to the motel owner with the $100. The motel proprietor then places the $100 back on the counter so the rich traveller will not suspect anything. At that moment the traveller comes down the stairs, picks up the $100 bill, states that the rooms are not satisfactory, pockets the money, and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.

Supplied last week by Prince Geoffrey (an Ecinya confidant) discovering how a fiat money system works in a closed economy.

When the discussion turned to taxes, Reagan’s fist came down squarely on the table. "I don’t want to hear any more talk about taxes" he insisted. "The problem is deficit spending!" It is difficult to politely correct the President of the United States when he has blatantly contradicted himself. The $800 billion worth of deficits were the result of spending he didn’t want to cut.

David A Stockman, ‘The Triumph of politics: Why the Reagan revolution failed’, 1986.

Quotes above: The Core Messages (note old journalistic adage – ‘90% of the message is in the head-note’)

Troy: Enduring fable of government folly
Goldman Sachs: Bad advice to Greece worsens the situation significantly.
Derivatives traders: Overpaid and counter, or unproductive actions, often tantamount to fraud.
Fat boy: Merrills not ethical or smart, now taken over by Bank of America, an icon becomes a victim of its own folly.
Daryl Kerrigan: There is a cultural aspect to the cash economy.
Country town: How a fiat money system works in a closed economy.
Reagan: The source of America’s current calamities, a very poor fiscal President, often cited as an example of good fiscal policy.

GREECE IN PERSPECTIVE

Greece accounts for about 0.5% of global GDP, Australia 1.2%, the PIIGS (Portugal, Ireland, Italy, Greece and Spain combined) account for about 5.8%. China accounts for 12.8% and the United States of America 21%. It must seem bewildering to many that Greece could account for the unfolding calamity that occupies most of our TV space, air-waves, daily newspapers and the hyperbole of our Prime Minister and his Treasurer. As an addendum to the ‘Global Financial Crisis’ politicians in Armani suits can proclaim their brilliance and embark on bold adventures, all of which, if they fail, you get to pay for.

Beware of Greeks bearing gifts – the enduring legacy of the Trojan Horse.

LET’S KEEP IT SIMPLE

Greece has a simple economic system. Very few people work for a taxable wage; very few people pay taxes, and the biggest earners (remember Aristotle Onassis) pay low taxes relative to their income and have assets abroad, generally hidden. The people in the cities are mainly involved in tourism, construction, or work for the government. Apparently, around 25-30% work for the government. Because welfare is high and taxes are low the government has, in effect, borrowed heavily to meet their payroll and welfare commitments. All systems can survive a great deal of folly while conditions are favourable.

As the government ran out of money they decided not to tell the voters nor the European Commission. Rather they borrowed more money in the hope that things would get better before they got worse. Many of you may remember that old Irish sage, Murphy, who said: "If it can go wrong, it will." But our editor has met very few people who are aware of the old Scottish sage, McPherson, who said: "That Murphy, bless him, is an incorrigible optimist."

But when things get difficult, you call in a financial engineer and try to buy some time. His fees are seldom cheap. So Goldman Sachs turns up and creates a derivative that takes the large debts off the Greek balance sheet and they comply with their European fiscal obligations. Then people realise that all is not well and the Greek government has to seek a hand-out from others who are encouraged to look favourably on the proposals because their citizens savings are now at risk. Will a bail-out increase or reduce the chances of recovery?

The Trojan Horse is alive and well.

However, the now awakened populace revolt. They plunder, burn cars and buildings, and even kill some fellow citizens that are in the same boat as themselves. This could be fairly described as counter-productive behaviour. Living in a paradise, a fool’s paradise suddenly is revealed.

TOWARDS THE SOLUTION

When the global financial crisis was well advanced and we were trying to work out how it might unfold, in 2008 we purchased the Churchill speeches from World War II to determine how a real fiscal crisis unfolded, rather than the exaggerated cacophony we were hearing from people who didn’t know it was in the making anyway, such as the Bush administration, Mr Greenspan, Mr Bernanke, and the IMF, to name a few.

We then revisited Bill Bonners’ book ‘Empire of Debt’ (2007) and played the Churchill tapes over and over whilst driving in the car. Thus we were able to see ‘the beginning of the end’ in our March 2009 ‘Bounce’ paper and then later stated in our 2010 Overview Paper that the recovery would be complex. Messrs Bonner and Wiggin said: "Clearly, the central bank of Zimbabwee has overdone it. But if the central bank of the USA has overdone it few seem aware of it. The secret is to give people more money, but not so much more that they realize all they’re getting is pieces of paper. Paper money may be a fraud, but it still represents purchasing power. When more units of it appear, people assume they have more purchasing power. And when they spend more, the merchants think there is more demand & increase production. Pretty soon there is a boom."

We added our own foot-note in January 2009 as we developed our thesis: "Fiscal stimulus should work based on historical precedent and barring a serious war, but some of it will be well & truly wasted."

We also added another Ecinya note at the same time to our working reference document, which said: "History never precisely repeats, but it certainly rhymes" (Mark Twain). The last bubble/ crash was the tech/telco crash when the S&P went from 1527 to 776 & made a final bottom in March 2003 at 800, just as the first shot was fired in Iraq. The recovery/ boom to 2007 then started and was sustained by the housing credit bubble led by Bubbles Greenspan. Top to bottom in 2000-03 was 751 trading days (2.6 years including weekends). Using that last crash as a template takes us through to about September 2010. My guess is that this quicker crash will be followed by a quicker recovery in the USA than last time, and also in Australia if commodities recover (though past dizzy heights will not re-occur). This crash began at SP1565. REMEMBER THIS IS A ‘MADE IN AMERICA’ (GLOBAL) RECESSION.

When called to the Greek rescue, Goldmans Sach’s should have said: ‘Look, I suggest you fess up and we can underwrite some bonds for you at a reasonable price and interest rate. If you wait for the walls to tumble, it will be much more expensive later on, perhaps even terminal.’

THE SOLUTION

The solution is America. If it can get its house in order, the world will follow. Perhaps an early option would be taking the world’s top 50 derivatives traders to Christmas Island and then selling the island to the International Monetary Fund. But that is a story for another day. Derivatives are now the synthetic tail wagging the real dog, and the dog is visiting the veterinary surgeon on a daily basis. Hedges properly used can be constructive. Improper use is very destructive. Beware of Trojan Horses. Beware of Greeks, or bankers, bearing gifts. Exercise caution.