Bloating treasuries, shrinking banks

The 2011 economic indicators that matter are now out. We only need to rely on the three crucial ones: the total debt or credit, the Case-Shiller house index and the labour force participating ratio (LFPR).

The most important indicator of the three, of course, is total credit. This indicator can be examined from several perspectives: its annual growth as well as that of its individual components, and lastly its ratio to GDP by debt component.

On the left is the first chart, depicting the total credit growth which is still flagging. It's still susceptible to falling into negative territory given that throughout 2011, the breakout from credit contraction lacked momentum, all the while hovering around the 1% mark.

Let's see which debt sector was driving the flaccid debt growth in 2011. For this, the sectoral growth is shown in the left chart. This time we can see two contradicting trends, one of growth and the other of decline and ambivalence.

The growth part involves only two sectors, government and non-financial businesses. Without the growth in government borrowings, the situation would have been much worse with all the other sectors showing worsening declines instead. Contrary to the Republicans' claim, it's Obama's deficits that have been holding up the economy. But not for long.

As for the decliners, to wit, the financials and GSEs (Fannie Mae, Freddie Mac, and Ginnie Mae), they are still shrinking although the pace has slowed down. The US and also the whole world's financial sectors are shrivelling as banks, in a process known as deleveraging, are ridding themselves of debts on the liability side of their balance sheet, which in turn means that they need to cut down on their loan books on the asset side. This whittling down of the financial sector will continue until the total credit has reached a point that can be sustained by the economy. This undoubtedly is a long process as the US total credit which stood at 386% of GDP as at first quarter 2009, only decreased to 353% by the end of 2011. Even if the GSE debts are excluded to eliminate double counting, that still leaves a high 304%. If we look at the chart above of more than 130 years of US debt history, a level of 150%-200% would have been a sustainable number over the long-term. That means current US debt load would need to be shaved by at least one third.

As banks dwindle in size, the credit or money supply will likewise contract putting more pressure on prices of equities, commodities and real estate. It is a truism that banking thrives on continuing loan growth. As loans grow, asset prices riding on the back of loans, rise as well to the benefit of both borrowers and bankers. Unfortunately, when the process reverses, bank failure is the natural outcome. During the 1930s Great Depression, a similar situation prevailed to the extent that nobody wanted to work in banking.

Now the next chart shows which debt sector will dominate the rest. Throughout the current recession, the annual federal deficit has exceeded $1 trillion four years in a row. It's very obvious that government debt which has just overtaken all other debts will keep on growing. With Fannie Mae's and Freddie Mac's losses now totalling $183 billion, the GSE debt will in time fall in the lap of the government making the government debt much more higher. Although from 2012-13 onwards, the deficit is projected to progressively decrease, don't bet on this happening. Any sitting president has no control on the economy. It's the economy, or more specifically, the bond market that decides how much the deficit will be.

Even the Republican presidential contenders who are pressing for a balanced budget would surely change their stripes once they are in office. When Roosevelt campaigned for president in 1932, he criticised Hoover for deficit spending. Ditto for Obama. But once they became president, they broke all budget records because if they hadn't, the bond market would see to it that they be impeached. Undeterred, Roosevelt reattempted budget balancing at the beginning of his second term. The economy soon relapsed into a recession worse than that of 1929, forcing him to backtrack. In a depression, you don't meddle with King Bond; just let it grow.

In February 1993, James Carville, Bill Clinton's political advisor, presciently remarked, "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." Then, the bond vigilantes sold off bonds upon hearing that Clinton would embark on deficit spending. Clinton was only saved by the massive borrowings undertaken by the financial sector and the households that allowed him to balance his budget. Now it's not the bond vigilantes but King Bond itself that decides who'd stay in power.

Although lately, economic trends have been pointing towards a recovery, we should treat this as merely blips in a secular downtrend. We've been through this false hope many times. Even in the 1930s depression, there were seven such instances that subsequently left many in a worse state of despair.

To see the true pattern, we can refer to a chart tracking the 10-year treasury yield since 1900 that The Economist has just published. The bond yield has only recently touched the 2% mark, repeating the pattern last seen in the 1930s depression. Then, the yield was down in the dumps for more than 10 years. Self-proclaimed pundits have been advising bondholders to exit bonds in the expectation that a recovering economy would push yield higher and thus bring down bond prices. Don't worry, Bernanke will see to it that the yield would remain depressed until at least 2020.

Would humongous government debt lead to  the downfall of any government? Actually, no. The strength of any modern government depends on the level of the country's new technology acquisition, and it's not just any technology but technology that meets the Kondratieff Wave criteria of capacity and communication. Because of this, the East Asian countries aren't likely to dislodge the US from its preeminent position, not now and never in the future.

However the Fourth and the Fifth Kondratieff Waves are stuffed with technologies that empower the small at the expense of the big. This is the root cause that will precipitate the decline of the US as a superpower. The symptoms of downfall that afflicted past empires will unfold for the US in the coming years. We will witness how hard-pressed the US will be to contain its debt load as the technologies that are in ascendant now and in the future will instead favour the breaking up of large nations.

In the bondage of bonds

Will interest rates go up or down? This is the $64 million dollar question. Supposedly, interest rates will remain in the low single digits because of central banks' quantitative easing (QE). The economy is expected to pick up as everybody will start to borrow to take advantage of the low rates. Is reality unfolding according to script, that is, the Investment Clock script (see left picture, one of many investment clock images widely available on the web)? Let's dissect recent events to uncover the truth behind the general trend.

The investment clock provides us with a  pattern that explains a complete boom-to-bust-to-boom economic cycle. However, as with most man-made patterns, we cannot take it at face value as the original author(s) might not have correctly observed the events over several economic boom-to-bust cycles. You not only need a very keen sense of observation but also a prolonged observation to ensure that your pattern can stand the test of time. As we now possess the hindsight benefit of recent developments in the global economy, we can test the investment clock pattern in this light.

So where are we now on the clock face? It seems that we have passed 5 o'clock. The succeeding events are supposed to move according to the following script:
  6 o'clock - Falling real estate values? Check. Still going downhill.
  7 o'clock - Falling interest rates? Check. Bernanke and co. have buried them for good.
  8 o'clock - Rising share prices? Check. The Dow has recently touched 13,000.
  9 o'clock - Rising commodity prices? Check. Oil is back to above $100 per barrel.
  10 o'clock - Rising overseas reserves? Hmmm. The East Asians and the Germans have always been accumulating but have slowed down lately. As for the US, it cannot have forex reserves, otherwise the whole world will collapse.
  11 o'clock - Easier money? Oops, we shouldn't be here. Quick, back up to 5 o'clock.

Something has gone badly wrong. We've jumped the gun. Money is still tight. Even though it's cheap, the banks are not lending. They are worried not about the return on their money but the return of their money. They know that borrowers, be they businesses or households, are not going to earn enough income to pay back their loans. Simply put, Bernanke's cheap money is ineffective.

What should be the next move? Should we hang on to the Fed's cheap interest rate while waiting for the depression to clear itself out? Actually, there's nothing that we can do. The Fed itself has fallen into the trap that it helped set up. It cannot move. Neither can everybody else. The debt deflation is not going out with a whimper. To appease the debt monster, the Fed continues to feed it, storing trouble for its future handler.

Now, the investment clock's error is that it's meant for an inflation-induced recession whereas we're in a deflation-induced depression. The former is a short acute pain while the latter is a long-lasting chronic one. So to grasp the latter, you should view it as consisting of many repeating cycles of 2 o'clock to 6 o'clock, with short occasional breaks to the 7 o'clock and 9 o'clock range. Every time it breaks out, it comes back with a vengeance. The process iterates until the debt has been reduced to a level sustainable by the economy. Politicians and policymakers can only delay, not prevent, this natural sizing down of the debt monster.

In an inflation-induced recession, demand or consumption is ever present. Only the supply or capacity is tight. This results in prices rising across the board. You need to bring demand down through high interest rates so that it is in balance with supply. Once demand has fallen, interest rates will follow suit. Prices of shares and commodities will then rise as everybody will get back to their old spending ways.

The opposite is the case with a deflation-induced recession. Money is also tight at the deep end of the recession. In this case tight money is not characterised by highly priced money associated with high interest rates but by zero availability no matter how expensive you want to pay for it. In fact, a paradox happens: money is tantalisingly cheap but you can't even touch it. So near yet so far.

Although money seems cheap, its real cost will be high. Recall that money is credit. The unsustainable level of credit is a major symptom of the depression, the root cause being the skewed wealth accumulation. But the first step in getting out of the depression is to wring out credit. In the process, prices of everything including gold, will collapse. This makes money expensive even at zero interest rate because money increases in value relative to other assets. Everybody wants to retain money rather than lend it out. And nobody wants to borrow unless he/she has no intention of repaying.

Of course, technically, taking the debt to GDP ratio as the basis, we can also increase the denominator (GDP) instead of squeezing the numerator (debt) to bring back the ratio to a sustainable level. However, bear in mind that we're in the Fourth Kondratieff Wave. If you refer to the Elliott Wave chart (reproduced on the left) in the The Five Generations of Warfare, the fourth impulse wave (the green line denoted by the letter 'a') moves downwards, as does the fifth wave (green line 'c'). Henceforth, don't expect the GDP to grow significantly. Sure, we have unprecedented power to produce but we don't have the power to consume. Without consuming power, there's no necessity to produce.

The other alternative is to tolerate high inflation. Inflation will enlarge the nominal GDP while the debt remains fixed. The debt to GDP ratio then will decrease to a more sustainable level. But this option is no longer available as the central bankers have trapped the whole world into decades of low interest regime with their QE bazooka. In the last 20 years, only the Bank of Japan (BOJ) had embarked on QE prior to Ben Bernanke's. Now other central banks, such as the Bank of England and the ECB, though in a roundabout manner with its LTRO, have started to follow suit.

Bill Gross of PIMCO has warned us of the danger of extremely low interest rates. Japan is clear evidence why low rates can trap an economy in gridlock. The chart below (taken from The Wall Street Journal website in October 2010) shows that since April 1995, BOJ's overnight call rate has never risen above 1%. The Fed funds rate has similarly been stuck below 1% since December 2008.

It's not that the Fed hasn't been through this before. In 2003 the Fed funds rate even dropped to 1% because of the need to reinvigorate the economy after the 2001 dotcom bust. The low rates drove real estate prices up. Bond prices on the other hand move inversely with movements in interest rates. So as the interest rates gradually increased from 2004 to 2006, the bond holders incurred losses but these were more than made up by profits on the surging real estate prices. Banks also reaped huge profits on the soaring demand for mortgage loans.

A much longer precedent arose in the 1930s when rates remained in the doldrums for more than 10 years. As the Fed funds rates had not yet been introduced then, the annual average for the 3-month Treasuries rates, used as a proxy measure, fell below 1% from 1932 to 1947. That was a similar depressionary situation to that prevailing now. Hence we can expect our low rates to last till 2020.

How did they get out of the low rates in the 1940s? They had the benefit of electricity, the main driver of the Third Kondratieff Wave. Because of WW2, economic growth from electricity, in the form of factory mechanisation and higher female labour participation, was delayed and even spilled over into the early part of the Fourth Kondratieff Wave. The 1950s and 1960s period was the American century, in which euphoric feeling, as currently experienced by China, prevailed. Also much reconstruction work had to carried out to rebuild Europe after the devastation of WW2. Demand was growing to meet the expanding production. So even though the bonds lost value, growth in other areas more than compensated for the bond losses.

It should also be noted that the biggest chunk of the debt during the peak of the 1930s depression was non-financial corporate debt (see left chart from Forbes) which could be easily struck out with corporate bankruptcies. When WW2 came along, the depression was mitigated by the surge in government debt spending. But this debt surge was contained by the exceptional economic growth in the 1950s and 1960s, and inflation in the 1970s, putting a lid on the debt/GDP ratio. However the low inflation from the 1980s onwards has accentuated the rise of the debt/GDP ratio.

Now with real estate prices going downhill since April 2006, and commodities vacillating in an unclear direction, Bernanke's suppressing of interest rates has pushed bond prices up. Their yields have fallen so low that any slight uptick in yields can result in substantial falls in prices. For example, take the 10-year T-bonds. Its current yield is around 2%. If its yield goes up by 1%, the bond price will fall by 8.5%. And if it rises to 6%, the fall in value would reach almost 30%.

The Fed has become addicted to lowering the yield that Bernanke has hinted that he might buy the 30-year Treasuries, which currently has a yield of slightly over 3%. To fund the buying he'd be issuing short-term repos (repurchase contracts) to the banks. This has no impact at all on the money supply, only the long-term bond yield may go down. By doing this, he'd be tightening the grip that the bond market has on the economy. He can no longer countenance any rise in interest rates unless he wants to wreck the bond holders who are sitting on a large pile of bonds. The T-bonds alone now amount to $10.5 trillion, of which $5 trillion are held by foreigners and $1.65 trillion by US financial institutions.

We can look at Japan's total credit market (left chart from The Economist) to see how its government bonds have transformed into a godzilla. The legend at the top is incorrect. The bottom band is financial, followed by government, non-financial businesses and finally, topmost is households. Seeing how big the government debt has grown, it's not surprising that Japan is suffering from revolving door leadership; the bond is the de facto leader, the shogun behind the premiership. Japan has no other option. Push up inflation and the bond holders will scream while the financial system will be crippled. Stay status quo and the godzilla keeps getting bigger as other asset prices continue deflating.

Let's see how the US total debt market is stacking up. The left chart from The Economist also has the same erroneous legend as the Japanese chart. The chart which plots up to the first quarter 2011 still shows households (top band) as the biggest debtor. However the latest report from the Fed as of end 2011 indicates that the government debt has dethroned household debt from the top spot. And the government debt will be getting relatively much bigger as other debts will shrivel through debt write-offs. The trouble with government debt is that it can't be cancelled through bankruptcies or debt restructuring. As this debt progressively balloons, the effective future president of the US will be President Bond. Like Japan's, the nominal presidents will be lucky to last even one term.

How do we get out of this quagmire? Only strong economic growth would do as the debt has grown too large to be rooted out by inflation alone. Probably equities may rise in the Fifith Kondratieff Wave. But we know the Fifth Kondratieff Wave will be weaker than the Fourth which in turn is weaker than the Third. If the US can't get out of this hellhole, then the whole world will face an utterly bleak future.

Bee-urocratic lessons for the EU

The EU is a region with weird contradictions. While austerity measures are being imposed on the hapless EU southerners, late last year the overpaid EU eurocrats threatened to strike over a pay dispute, a proverbial case of the eurocrats fiddling while the EU burns. It seems that not only the EU political leaders but also its 40,000 eurocrats are out of touch with the hardships faced by the southern EU states.

This classic failure of communication is a common phenomenon between EU leaders and its eurocrats, on the one hand, and the EU populace, on the other. No, the communication here refers not to the virtual communication which itself has been carried far to extremes, drowning the important in a sea of insignificance. Instead, the real communication failure is the breakdown in thought process, or more precisely, the neuronal communication.

Our brain neurons communicate with other neurons both for learning new patterns and for quickly retrieving existing patterns. The former is handled by our prefrontal cortex, while the latter is delegated to other parts of the brain's grey matter. We can see the process at work by observing how swarm animals, such as ants, bees, starlings, termites, locusts and schooling fish communicate. The essay that explains how these animals do so appeared in the National Geographic, July 2007. Its author, Peter Miller, has followed it up in interesting detail with his book, The Smart Swarm.

Unlike human brains, swarm animals' brains lack the ability to learn new patterns but they have an astounding ability to retrieve ingrained patterns that have ensured their survivability over thousands, if not, millions of years. We can take the ants as an example of how swarm animals use their simple brains to tackle complex tasks. Ants communicate through pheromones, that is, the chemicals that they secrete through the tips of their abdomens. There's not just one type of pheromone, but at least more than ten, each used to signal a different purpose.

The pheromone trail created by this process is used, for example, to tell other ants the best path to take in foraging for food. There could be more than one path but over time the best path, usually the shortest, would have the strongest pheromone trail as ants that go out the shortest route would walk back the same way earlier than the ants using other paths, in the process reinforcing the trail scent with more chemical secretions. The decision to choose the right path thus is a result of the collective effort of many ants. Other types of pheromones are used for alerting the colony to danger, marking territory, or summoning help.

Ants also communicate by antennae touching. In deciding whether the colony should forage for food on any day, scout ants would go out first. The foragers would wait near the entrance for the scouts to return at the right pace. They know it by touching the antennae of the scout ants as well as through the odour of the scout ants. If the scouts' rate of return is too slow or too fast, the foragers would be discouraged from going out. Again, the decision is reached after having inputs from scout ants.

In practically all situations, ants rely a lot on communication. Each individual ant is analogous to a neuron in our brain, possessing the ability to make simple decisions. However when an ant is joined in a chain of many ants, the chain possesses the ability to generate varied patterns. We can take the example of digital storage: a bit can have two states but when strung into an 8-bit byte, the different permutation of data that it can store increases to 2⁸, i.e., 256. Replace the bits with neurons and you can imagine how the brain functions. One neuron by itself doesn't store much but a string of neurons do.

For any living organism with brain, only certain of the whole possible permutations are used so as not to overwhelm the brain. As the organism matures, the unused neuron pathways are pruned and the commonly used ones are reinforced, speeding up neuronal communication. Our exceptional thinking ability among living organisms is because our brain, specifically the prefrontal cortex, can put together a longer string of neurons that is dedicated towards learning, planning and self-control, abilities that the non-humans can hardly attain to.  Of course, whales and elephants have bigger brains than us but their prefrontal cortices as a proportion of their brains are very much less.

The EU leaders and the eurocrats, on the other hand, are analogous to a very small brain, and a very slow one at that, directing a massive body. The leaders are so distant from the whole EU populace to be able to decide what's in its best interest. The neuronal communication line is no longer connected. In nature, if there is a mismatch, one part has to size down in order to restore balance. That's reason enough for the EU to split itself into north and south, if not, its constituent states.

Swarm insects living in nest colonies also split off to form new nests. They leave their nest to establish a new colony once the present colony has outgrown its optimum size. They have no need to keep expanding the size of the present colony since beyond a certain carrying capacity, costs would outweigh benefits. This rule also applies to pack animals, such as wolves. The EU, in fact, has exceeded its optimum size and is ripe for a scale down. Expanding its borders means taking on states with vastly different economic, political and cultural values, adding on more costs with marginal benefits in return.

Although the ants' communication pattern appears resilient, it actually suffers from two serious weaknesses. In rare circumstances, the chemical trail can get washed out, for example, by a downpour, leaving the ants scrambling to form a new trail. Peter Miller recounted such a scene in Panama in 1936 in which a group of army ants had been trapped in a suicidal circular march. Apparently, the ants at the periphery had laid down a circular trail of pheromone that the other ants followed. Because the ants had been circling on the same spot, the pheromone scent had become too strong for them to escape. By the following day, all the ants had died of exhaustion.

Like the ants' suicidal circling, the EU leaders and eurocrats are similarly caught in a vicious circle of austerity measures that eventually will doom the whole of the EU. The surprising thing is that although the economic indicators all over the EU states are pointing towards a negative outlook, the EU leaders are sticking to the austerity tack, believing that the present efforts are not strong enough to yield positive results. More is needed to achieve the desirable outcome. The fault lies in depending too much on the received wisdom that low inflation, savings, current account surplus, and government budget surplus are good. Yes they are good but only in certain circumstances, certainly not at the end of the Kondratieff Wave cycle in which the opposite should prevail.

But how do you escape from this deathly vicious circle? For this, we need a helicopter, or rather, bee view. Ants rely much on information passed on by other ants. Bees, however, in matters crucial to the survival of the whole colony, such as scouting for a new nest site, do not rely solely on information passed on by other scout bees. How they overcome this shortcoming is fascinating to note. Scout bees would normally visit several sites and each would advertise its preference for a site by the vigorousness of its waggle dance. Other scout bees, attracted by the intensity of the dance, would check out the site themselves. Eventually, once most of the scouts are convinced of the site attractiveness, the bee colony will migrate to the new site. Like the bees, the EU leaders must seek their own counsel, putting less reliance on the pernicious advice of economists and central bankers.

Political leaders must understand the workings of an economy because the economy inevitably underpins politics. A struggling economy makes for chaotic politics. Economics is too critical an issue to be left to economists, more so when most economists hold fatally erroneous views on money, inflation and deflation. Accentuating these errors is the separation of economics from political and social matters. All these bodies of knowledge must be taught and learned together, compartmentalising them results in tunnel vision economists and politicians, both extremely dangerous because of the influence that they hold on the rest.

That brings us to the second weakness of the ants or all the swarm animals, to wit, their limited learning capacity. As long as the environment remains stable, their communication pattern will stand them in good stead. But when faced with a major ecological upheaval, their brains are not designed to quickly adapt to the changed environment. To overcome this constraint, we need the human brain. Unfortunately, we do not fully avail ourselves of the powerful thinking process at our disposal.

The common fault that most smart people commit, is not in the problem analysis which is very thorough but in the problem solution which is very facile. Their thinking depth should have been in reaching the solution. Actually, they do not have to think much. The failure of most decision makers is in putting too much thought in dreaming up the solution from scratch. Look at the swarm animals, their limited brain capacity does not allow them the luxury of thinking. Everything is based on established patterns which are in-built in their DNA. We can go one better than them, if only we know how. Through our written records and recorded visuals, we actually have access to a cornucopia of patterns, be it in history, economics, ecology, anthropology or any other body of knowledge. We do not need to store them in our DNA.

The proper decision making process then is to choose the right pattern. When we concoct our seemingly novel solution instead of tapping into established patterns, we do not go the full length. Everything in the real world is really a pattern, that is, a sequence of events that unfold in a predetermined manner. For example, our half-baked solution may go from step A to D, whereas the  right one should have stopped at step M. Our brain is not powerful enough to think of all the complete steps without resorting to established patterns.

In tribute to the intelligence of the bees, we will recall two instructive though fictional patterns from the bees, one a recorded visual and the other a written record. The first is the animated film, Bee Movie, which tells the story about a bee that successfully stops the human race from consuming its honey. In so doing, the bee disrupts the balance of nature as the massive stockpile of unconsumed honey leaves most bees unemployed and flowers unpollinated. This triggers a collapse of the food chain which is averted only at the last moment. Realising their mistake, the bees restart their honey production and allow the human race to resume its consumption of honey. Wouldn't the EU austerity measures be a repeat of the bees' mistaken belief in the false virtue of holding back consumption?

The other is the poem, The Grumbling Hive, that appeared in the book, The Fable of the Bees. It was authored by Bernard Mandeville and published in 1714. It shares a common theme with the Bee Movie. The poem is about a corrupt but prosperous hive that suddenly turns virtuous. This results in a rapid loss of prosperity. The moral of the poem is that to have a prosperous society, some vices, such as greed, luxury and depravity, among others, have to be tolerated. In economics, virtue and vice are inseparable. There can be no creditors without debtors, no income without spending, no savings without borrowings, and no current-account, trade and budget surpluses without someone else or some other nations incurring deficits of equivalent amounts. The well-off nations and individuals should always hold this in mind when bearing down on their unfortunate indebted counterparts. Harsh and repressive measures bring only misery to all.

Creditor vs. Debtor

The breakup of the EU is definitely a foregone conclusion. The EU must get rid of its debt mountain first before it can get out of the morass. In zeroing on the highly indebted states, the EU leaders remain blind to the real crisis. They conveniently choose the easy way out by heaping pressure on the struggling states. The chance of those states ever repaying their debts even with tons of bailout money is as good as zero.

One of the rules of management is not to manage things that are beyond your control. If the EU leaders have some sense, they should confront the creditor banks instead of the struggling states. In a crisis of a massive debt overhang, it's the creditors that must bear the heavy burden of debt write-offs. After all, it's not just the debtors that are at fault, the creditors are equally guilty of indiscriminate lending. But the creditors hold the debt assets while the debtors have only debt liabilities. Writing off liabilities is virtually impossible when the asset owners are in no mood to play ball. However it's the asset owners that are actually in a weaker position.

We only need to recall Jean Paul Getty's quote on the relative strength between borrowers and their bankers, "If you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem.", to remind ourselves as to who really should hold the upper hand in the debt negotiations between the opposing parties.

But the debtors don't know how to play their hands. They should've entered the negotiations in concert, all the PIIGS countries banding together. Only then can they force the bankers' hands. Note that with just a 30 percent write-off of the banks' debts, the bank owners would lose all their equity holdings. In time, practically all the eurozone banks will become wards of state. With the current economic conditions in the eurozone, debt write-offs of more than 50 percent are almost certain. There's no way that the eurozone banks with total loan exposure of $30 trillion could survive without nationalisation. To put it in perspective, the EU's GDP is only $12.6 trillion. This colossal hole is the thing that EU leaders are trying to prevent from an implosion that would wreak havoc on the German, French and British banks and, by implication, the three biggest economies in the EU.

Instead of calling the banks' bluff, the debtors are being picked off one by one by the banks. Next in the target sight after Greece is Portugal. To make matters worse, both Greece and Italy have picked former professors as their political leaders. Cocooned in the academic world, professors go by the book, never once willing to put up with unconventional approaches. At negotiations, they can easily play into the hands of the bankers. Lucas Papademos naively believes that failure to obtain bailout money would lead to chaos. Actually it's the austerity measures imposed by the bailout terms that would see Greece descend into anarchy.

Now how the PIIGS should have strategised? Before going to the negotiating table the PIIGS must countenance all the available means of countering the banks so that their negotiating position is stronger than that of the banks. Dumping the euro in favour of their former national currencies, bank holiday, capital controls and trade protectionism are in. Only then can they have the negotiating flexibility to arm-twist the banks. Instead the PIIGS are ludicrously sticking with the status quo, very much weakening their negotiating position. The EU project anyway is an anachronism in a world that's moving towards fracturing of states and societies.

These are desperate times. We are in the midst of the Grand Depression, that is, the 1930s Great Depression scaled up multifold. What the PIIGS are suffering from now is an extreme shortage of currency or liquidity. The only way out is a huge dollop of spending money which could only come about if they are in control of their own currencies. Only then can they export their way out of economic depression. Of course, they can no longer maintain the same lifestyle as in the past but at least they could get their jobs back instead of rioting in the streets. Initially, things would be very expensive but prices would soon stabilise after the initial spurt as the whole world is now suffering from excess capacity coupled with insufficient demand. For example, Iceland which has seen its krona value dropping by about 50 percent since 2008 no longer endures high inflation (see left chart from The Washington Post).

What if all other states also embark on money printing to depreciate their currencies? Don't worry, money printing without public spending won't cheapen the currency. Just ask Ben Bernanke and Mervyn King about their recent experiences. Apparently they still can't figure out why things don't turn out as predicted. Even if the other governments unleash their public spending and drive up inflation, that's well and good. That'll transfer the wealth from the creditors to the debtors and that's what we need to redress the extreme imbalance between creditors and debtors.

But all these can only happen if the PIIGS realise that they have a strong bargaining hand. The debt fight is theirs to lose. For the sake of the whole world, they'd better use their trump card.

It's only a game

Some take the game seriously, too serious, in fact, that their zealousness is preventing others from joining in the fun. If it were a typical game, it wouldn't have mattered. But this is a life-and-death game, you lose, you're dead. As for the winners, they'd soon find out that as the others are increasingly pushed out, the game is about to end. The end means the end for all, the winners included.

The game is, of course, the wealth accumulation game. To keep the game going, the winners, if they are sensible enough, should throw some of their winnings to the losers so that the game can keep on going for the benefit of all while waiting for the successor game (the Fifth Kondratieff Wave) to be ushered in.

In a philosophical break from this rigorous pursuit of wealth, we should sit back and reflect on the wise words of the following people, some deceased, some still winning and one fictional:

If only the winners could see the lighter side of the game, their views of the losers probably wouldn't be so harsh. After all, they could be winners only because the greater others have been losers.