From a small northwestern observatory…

Observations on Greece, the Euro, and the implications for real estate finance —

First, there is extraordinary confusion over the causes of the Euro crisis, and thus confusion over the effects, particularly here in the U.S.  A few observations, to set the stage:

1.  Europe is in a massive demographic decline.  “Native” Europeans have a birth rate which does not support the population, and as such their “native populations are getting older and smaller.  Up to a point, this has positive effects on the economy, because small children cost money and a population actually gets more productive as the “bubble” in its age demographic approaches middle age (middle-agers are more productive than young folks or old folks).  The REAL problem begins when that bubble starts approaching retirement, and there aren’t any younger cohorts to replace them.  This is part and parcel of what happened in Japan not to long ago, and the reason why the Japanese economy seems to be in permanent doldrums.

2.  As an aside, I focus entirely on Europe’s “native” population.  Unlike the U.S., Europe has a terrible problem integrating immigrants into its productive society.  That’s a topic for others to expound on.

3.  The Euro was formed in a very different way from the dollar.  When the U.S. dollar was adopted as a currency, the Federal government took on all of the state’s “operational” debts (the “Alexander Hamilton Solution”) which resulted from the American Revolution, and the states were prohibited from running operational deficits going forward.  States can issue debt to pay for capital items (highways, schools) but not for operational items.  Hence, a state can’t borrow money to pay interest on money it already borrowed.  The Hamilton Solution means that the U.S. has a highly integrated economy, unlike Europe’s, which is more artificially integrated.  (One might argue that the U.S. also benefits from a common language.  Anyone who has ever traveled from Seattle to New Orleans may debate this issue.)

4.  Soooo…… if the U.S. borrows money to cover its operational deficit, it can “print” money to cover those debts.  (OK — a bit of advanced Econ for ya’ll — “print” is an analogy.  Technically, the Fed expands or contracts bank credit to increase or decrease the money supply.  “Print” is just a handy shorthand for the more complex methods.)  On the other hand, Greece can’t “print” Euros — they all come from European central banks.

One might notice that the debt/GDP ratios in Greece and the other troubled countries are no where NEAR where we’d historically see countries in dire straights (Given the dampening influence of the World Bank, IMF, the G-20, and such, we really don’t see hyper-inflation any more in emerging markets like we did a generation ago.)  The big problem is that Greece can’t “inflate” itself out of debt by printing Euros.  If they could, the banks would gladly loan them money so as to “kick the can” down the road a bit.  If Greece had a growing, productive economy, then they could grow their way out of debt, but no-one buys into THAT fairy tale, either.

If, on the other hand, they withdraw from the Euro zone, they’ll be able to print all the Drachmas they want, albeit at terrible inflation rates.  If the Greek citizenry thinks that current austerity plans are potentially painful, they should re-read some history of the German Weimar Republic (you know — that period in history when the Germans were so distraught, they elected Adolf Hitler because he promised to “fix things”.)

What does this have to do with real estate?  At the core, the Greek problem (and by extension, the entire Euro problem) is a BANKING issue, not a debt/GDP problem.  Admittedly, some countries within the Euro zone borrowed money that they had not idea how they would pay back.  That’s a structural failure dating from the creation of the Euro, and it’s highly doubtful, particularly at this stage in Europe’s economy, that the Eurozone nations would be willing to accept such a level of fiscal unity and central governance.  (Not to mention the European Union countries which are NOT members of the Eurozone — such as the UK).

Currently, in the U.S., we just came out of a banking-induced housing bubble.  We’re currently IN a banking-induced housing depression.  In the worst-hit states (for example, Florida and Nevada), the lending market, particularly for retirement or second homes, has nearly stopped.  The Greek problem is, at its heart, a banking problem, since European sovereign debt relies much more heavily on commercial banks than in the US.  Relatedly, banking is global today (Note how many HSBC Bank offices are scattered through the US?)  At the back-office level, banking is almost completely global, with liquidity flowing across oceans as rapidly as phone calls and e-mails.  (Recall:  central bankers don’t “print” money anymore, they just fine-tune liquidity.)

With that in mind, an already damaged US banking system, with credit severely curtailed to one of the most important sectors of the economy, will be increasingly damaged if and as the Greek/Euro crisis continues to escalate.  On the other hand, if the Greek citizenry recognizes that austerity under the Euro is preferable to ultra-austerity under the Drachma, then a huge sigh of relief will permeate the world’s banking customers.