Professor Elam

Tuesday Feb 9 2010

Steve Meyers of Global Perspectives has some thoughts on the market directions for this year. Students have been asking how the Greek debt crisis affects markets. Steve explains that believing the European countries will 'bail out' Greece ignores the basic problem, too much debt. 

Here is the problem, explained in accounting terms. We know the basic equation to be

Assets = Liabilities + Equity or A = L + OE

Remember that a balance sheet is a snapshot in time. Time my friends changes just as soon as the snapshot is taken. In intermediate accounting II we study the right hand side of that equation. The L part does not change, once a person country company takes on debt, the debt is  owed. The A side however is subject to change. Let's consider oh say, the state of Nevada. Nevada depends on tourists coming to town to gamble and spend money. Nevada has bet big time that this will happen, forever. Its A side is a bunch of casinos, would be condo developments and roulette wheels and blackjack tables. The L is the debt against it and OE is what is left over. 

The downturn means that tourists have stopped coming and spending. Condos sit empty, Dubai missed their payment on City Centre. Whoops, so the value of A has gone down. But the value of L, the debt, remains. And so the only thing left to vary is OE, equity plummets. This is why Nevada can lay off all its state employees and still be underwater on its budget, a staggering statistic. This scenario is being repeated in countries that promise never ending welfare, companies and cities that promise defined benefit plans, none of those promises can be kept in an economy in decline, the revenue of property tax, income tax, and just plain income is not there. But the debt is…As a  student observed in class last night, this bail out game has to end somewhere, EU bails Greece, then Britain is in trouble, who bails Britain, CA AZ NV NY in trouble, the US bails them, but wait, who will bail out the US?  This is why fiat currency the world over is now in question. Countries will debase or devalue their currency to make it easier to re pay the debt. And so commodity values, oil, copper, gold silver rise as real stores of value, politicians cannot manufacture oil gold silver.