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By Detlev Schlichter, on 15 November 11
“The unlimited resources” of the European Central Bank (ECB) is quickly becoming the new magic mantra in political commentary and financial market analysis, now that the bigger euro-dominos are beginning to wobble and everybody realizes that nobody has the firepower to bailout Italy, or to ‘recapitalize’ (i.e. bailout again) all the banks that lent to the country. So the chorus that demands that the printing press finally be put to good use is getting louder by the day.
Robert Peston, the BBC economics expert, last week claimed that the solution now lies with the ECB, and he spoke confidently of the ECB’s ‘unlimited resources’. Yesterday Vince Cable demanded ‘unlimited powers’ for the central bank. He also shamelessly regurgitated the well-worn politician’s excuse for Europe’s problems, namely that these countries are under ‘speculative attack’. The advocates of large-scale ECB intervention now include many pundits and commentators plus a sizable group of financial market economists and strategists whom decency obliges me to leave nameless. “It is important to keep the ECB engaged,” as one economist put it, “as only the ECB has unlimited resources”.
Such proclamations immediately invoke Albert Einstein’s famous dictum: “Only two things are infinite, the universe and human stupidity, and I am not sure about the universe”.
Everything is going according to script.
None of what is going on surprises me. It is perfectly in line with what I predicted in my book. However, I am ready to admit that I am a bit baffled by the quick willingness by so many people to embrace what is ultimately a sure road to complete economic destruction. In Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown I explain why systems of elastic money are always suboptimal, unstable and ultimately unsustainable. A monetary system like ours must, over time, accumulate dislocations and imbalances that will finally become so big that their liquidation through market forces is deemed politically unacceptable. Then, out of desperation, an unwinnable war against economic reality will be fought by means of the printing press. Ever more money will be created ever faster in a futile attempt to outrun the market’s urge to liquidate.
In chapter ten of my book, I describe the two final stages of a paper money system as Monetization of Debt and Inflationary Meltdown. We are now firmly in the Monetization of Debt phase. This process will accelerate in coming months and quarters. Not only in the Eurozone but also in the United States and in the UK. All of these central banks will continue to expand their balance sheets aggressively and use their ability to print money without limit to support banks, governments, and a wide range of asset classes.
Bernanke (Fed) and Draghi (ECB) pointed out in their respective press conferences recently that monetary policy is not a panacea for all economic ills. It doesn’t matter. Policy has no other tools left to postpone the inevitable or to make the status quo appear sustainable again. By the way, it is entirely immaterial what Bernanke or Draghi think and say. Their press conferences keep our dear Street and City economists busy. But these gentlemen are quickly becoming mere extras in a bigger political game, in which desperation rules, and in which they will simply perform their roles of fiat money producers.
When do we enter the final stage of inflationary meltdown? Difficult to say. It all depends on when the public loses faith in a form of paper money that is being printed in ever more bizarre quantities only to keep states and banks alive and to project some resemblance of normalcy to the masses.
I do not disagree with the mainstream economists on whether paper money central banks can create essentially unlimited amounts of money. Of course, they can. That is precisely why gold and silver as monetary assets were replaced with entirely flexible state money under central bank control in the first place. And I do not disagree that we will soon see more debt monetization by the ECB and other central banks around the world.
What is sheer lunacy, however, is to advocate such a policy as a solution, or part of a solution, to our problems. This is where I draw the line. It is simply beyond me how people who call themselves economic experts and who must have at least a basic understanding of monetary theory and some knowledge of economic history can seriously advocate debt monetization as a sensible policy tool.
Dr Strangelove – Or how I learned to love the printing press.
I suspect that many of them, at least the financial market economists, are talking their own book. Not in the sense that they personally invest in Greek or Italian sovereign debt. I know of no private individual who is this careless with his or her own hard-earned savings. Investing in these bond markets is now predominantly an institutional affair. Banks, insurance companies and pension funds own these securities (which means your own savings or retirement funds are probably at risk through the channels of professional money management). I don’t even want to imply that these institutions tell their economists to advocate debt monetization via the printing press so that they get bailed out – although I wouldn’t put it past them either. They don’t have to. I rather suspect that now that the fiat money model is approaching its endgame many economists, just like other people who built their careers in the financial markets of the past thirty years of cheap credit and ever-growing balance sheets, feel the ground move under their feet as established business models, career plans and the cherished benefits of sitting so close to the ceaseless fountain of easy money are all coming unglued. Our financial market economists now cling to anything that promises to buy them time and some stability, even if logic tells them that what they are advocating is exactly the opposite of what should be done. They are not unlike the gambler who knows he should quit but, out of sheer desperation, is rolling the dice one more time.
Of course, there are always those who are imbued in Keynesian economics and other sorts of interventionist myth to such a degree that they honestly think that there is no problem that cannot be fixed with government stimulus. If the medication hasn’t worked, just keep increasing the dose. Paul Krugman (Nobel laureate) and Christina Romer come to mind. But I don’t quite believe that all economists are in this camp.
But whatever their reasons and motivations, it is quite clear that all these economists are now mouthpieces for the establishment. They are all defenders of the status quo, or of what has passed for the status quo for the past thirty years. Government bonds should again be considered ‘risk-free’ assets, and banks should again be considered ‘too big to fail’ and ‘too important to fail’, so that risk premiums come back in and the symbiotic and clubby relationship between states and banks that a fiat money system fosters and that has been so mutually beneficial to the political class and the banks, can finally be restored. It is a sad spectacle to see people who call themselves economists and often even free-market economists come up with ever more extreme recommendations of how we can fund Big Government.
To the broader public and the economy as a whole, the collapse of this system would be painful first but ultimately hugely advantageous. It would allow a renaissance of real capitalism rather than the continuation of this system of monetary interventionism that has allowed the state to assume control over such vast resources and the financial sector to enjoy uninterrupted fiat-money-fuelled growth for decades.
What good do these economists expect to come out of ECB debt monetization? Do they really believe that once the ECB has committed itself to buying hundreds of billions worth of Italian government bonds in order to manipulate the yield on these bonds – against market forces – down to what the political class deems sustainable, let’s say 5 percent, that then Italian politicians will reform public finances in the country, that they will quickly bring down deficits and the debt load to sustainable levels, at which point Italy can borrow from the market again, the ECB can safely sell its bonds and reduce its balance sheet, and everybody lives happily ever after? Does anybody seriously suggest that this scenario is likely, probable or even possible?
Fact is that none of these governments can be trusted to bring their finances under control as long as they have access to cheap credit, i.e. to funds at ‘sustainable’ interest rates. Germany forced through the Stability and Growth Pact at the start of EMU (does anybody remember Theo Waigel?) that should have limited debt-to–GDP ratios to 60 percent, only to violate it herself. Germany’s ratio is now officially at 83 percent. The government is already on the hook for another €211 billion under its EFSF commitments, which are now all but guaranteed to come due as the bailout fund is supposed to cover first losses on bonds in order to maximize its ‘firepower’, meaning Germany is already set for more than 90 percent of debt to GDP. And that is supposed to be Europe’s “stability anchor.”
All rules and guidelines that were designed to guarantee the fiscal and monetary stability of EMU and were implemented at its start have by now been broken – without exception. Do you think that this will change once the politicians have obtained the unlimited support of the printing press?
“Quantitative easing” in Japan, the United States, and the United Kingdom goes hand in hand with growing debt, not debt reduction. Providing a lender-of-last-resort and easy money and cheap credit to governments does not lead to deleveraging but to the opposite.
Only default and cutting off a government from additional borrowing will reform the government. That is why I say: Embrace default!
The Future
When the ECB has implemented its backstop for Italian government bonds, it will end up buying vast amounts of these securities at above market prices. Draining equal amounts of liquidity from somewhere else in the system in order to minimize the inflationary impact will be illusionary. Inflation will creep higher. Concerns about sovereign solvency are, of course, not restricted to Italy. These concerns plus rising inflation will put upward pressure on the yields of other bond markets, in particular Spanish and French bonds. The ECB will have to expand its support program in order to stabilize these bond markets as well. Why should unlimited ECB support be limited to Italy? What is good in the case of Italy must be equally good for Spain and France!
The notion that the ECB could ever change course now and tighten policy in order to fight rising inflation pressure will appear increasingly fantastical. Market participants and the wider public that uses the euro will simply not believe it. Inflation expectations will rise rapidly. Money will become a hot potato. When money demand falls, inflation will shoot up quickly, which would require the central bank to establish markedly positive real interest rates in order to restore confidence in paper money. But this would mean allowing several governments that are now reliant on cheap central bank funding to go bankrupt. This will not be allowed to happen which will undermine confidence in paper money further. We will have reached the Inflationary Meltdown phase.
All complete paper money systems in history were established to fund the state. Our system is no exception, as becomes increasingly clear. All paper money systems in history failed. Ours will be no exception either. Our system is the most ambitious. We had a global system of unrestricted fiat money production for forty years. The endgame is fast approaching.
I increasingly feel like an observer who predicts that a war is likely and even inevitable, and who is fearful of the consequences as both sides have a massive nuclear arsenal at their disposal. And everyday in the papers and in the research pamphlets of ‘experts’ what I encounter is not concern, calls for moderation and thoughtful inaction but the shouts of war-mongering chicken hawks: “Press the button! Press the button!”
Let’s quote Albert Einstein once more. “Insanity: doing the same thing over and over again and expecting different results”. On that definition, the advocates of unlimited ECB support can safely be called insane.
In the meantime, the debasement of paper money continues.
This article was previously published at Paper Money Collapse.
By Alasdair Macleod, on 12 November 11
In the last two weeks the headlines have switched from Greece to Italy. Financial and economic commentators who dismissed Greece as a small cog in the Euroland machine are now seriously alarmed and see no solution to Europe’s sovereign debt crisis other than the short-term expedient of getting the European Central Bank to print lots of money. They castigate Germany’s sound money approach, ignoring the fact that it has been central to Germany’s economic success, preferring to commend the loose-money economics of the unsuccessful “PIIGS” (Portugal, Ireland, Italy, Greece and Spain). And when listening to them, just remember that none of them foresaw this crisis, when it was obvious to Austrian economists in the early days of the banking crisis.
Keynesian and monetarists believed that the problems surfacing in the PIIGS would be resolved by economic growth, which would follow so long as governments maintained their deficit spending. As events are now proving, this analysis was flawed, which is why Keynesians are now confused. They should open their minds and absorb Austrian economic theory to gain a proper understanding of human actions and how people are affected by money and credit.
The first thing they will learn is that the economic benefits of credit expansion are a myth. All it does, by a process of capital redistribution – from savers to those who are first in line to receive the new money – is distort the economy and restrict its long-term potential. By lowering interest rates and diverting private sector resources from genuine production to government spending, the economy becomes less efficient and malinvestments occur. The mistake has been to only consider the visible benefits, such as short-term job creation, while ignoring the destructive effects of deficit financing.
The distortions created by easy money and deficit spending will naturally try to reverse themselves as surely as night follows day. The recession that follows the temporary boom is the way an economy cures itself from unsound money and government intervention. This is hard for interventionist governments to accept because it strikes at the heart of their existence. And while printing money and credit is always popular with an electorate that does not understand what is happening to their money, reversing the process is readily noticed and immensely unpopular.
This brings us back to Euroland’s problems. The creation of the euro twelve years ago allowed banks to expand credit massively in the mistaken belief that sovereign risk had been eliminated. The result was that spendthrift governments availed themselves of cheap credit. Eurozone governments, particularly the PIIGS but also France and Belgium, have squandered huge sums to prevent the unwinding of malinvestments and other economic distortions, preferring to perpetuate existing malinvestments. The only solution is for them to let the unwinding happen, which is what the financial markets (for which read reality) are now forcing them to do.
What we are seeing, the markets unwinding economic distortions from the past, is a necessary process and therefore beneficial, a point which goes completely unrecognised. If only governments had the sense to understand this, it is not too late to plan wisely for regenerated economies and a sounder Europe. Unfortunately, the gut reaction of the political class and its advisors is to continue as before at all costs, deferring this necessary adjustment and increasing its eventual severity.
There is no joy for the informed spectator in seeing continuing economic destruction. However harsh it may be in the short-term, the EU elite needs to start paying attention to Austrian School remedies to Europe’s financial woes – and fast.
This article was previously published at GoldMoney.com
By Alasdair Macleod, on 6 November 11
The basic market problem is there is too much sovereign borrowing for the money available, which would normally drive interest rates sharply higher. Some countries have got round this by printing money while pretending they are issuing bonds. A few countries are unable to do this, because they lack their own printable currencies. And that is the root of the problem faced by the weaker eurozone members.
This problem for some of them has become so acute that they cannot now fund their deficits. What is less obvious is that these highly-indebted states also have to roll over existing debt as it matures. Traditionally this debt has been absorbed on a replacement-basis in the markets, but that only works as long as the markets are fundamentally confident, which they are no longer: the inability of the political classes to resolve their difficulties has seen to that. Therefore, as bonds mature, investors and banks are unlikely to re-invest, preferring cash. Even if the weaker states are able to fund redemptions, from an expanded European Financial Stability Facility (EFSF) for example, this will be used to reduce euro-denominated bank credit and improve capital ratios.
This need not be a bad outcome, because the economic effect is to simply transfer the funding of sovereign debt to the EFSF. The question is who is going to fund the EFSF, which with its gearing is a risky proposition? There are only two possibilities: the ECB (which should not be assumed at this stage) and those with trade surpluses to recycle, particularly China. And since she is the only major source of this potential funding in the running, she is in a position of enormous negotiating power.
Looking at the proposition from China’s viewpoint is instructive. She is being asked to bail out profligate nations, who have run out of credit and whose citizens enjoy a far higher standard of living than their own. It amounts to a position of power ahead of her economic development. Furthermore, China’s economists were brought up with the Marxist dictum, that capitalism ultimately destroys itself, so they are being invited to merely delay something that is inevitable. Will they fund the EFSF? Beyond perhaps a token amount, it seems unlikely. But will they stand back and let Europe sink? That would be a missed opportunity to wield her enormous power, and we need to give this thought some historical context.
The one thing the Chinese have learned is that they cannot guarantee their own security through military means alone, they also require economic strength. This was the reason old-style communism failed. It has taken them only thirty years to acquire that strength. To consolidate it, they now seek to eliminate their dependency on the US dollar. Therefore, the price Euroland will have to pay for funding is that either the Chinese are given some control over the euro, perhaps by having permanent representation at the ECB, and/or there must be a material advancement for the yuan in trade settlements. And it is unlikely loans will go through the EFSF, because China will want to set her own terms.
This describes the strength of her position. It remains to be seen how China uses this longed-for escape route from dollar domination, and how she plays a winning hand. Initially, she may wisely play for time, letting the Euroland situation deteriorate further, to get the terms she requires.
This article was previously published at GoldMoney.com.
By Nick Ottens, on 1 November 11
Eurozone leaders ordered their banks to raise additional capital last week to prepare for a partial Greek default. The continent’s banking industry didn’t yet receive a direct financial injection but will be allowed to appeal to national governments and the European bailout fund for assistance.
A recapitalization of Europe’s financial industry was championed by the International Monetary Fund and the United States as well as countries whose banks are excessively exposed to Greek debt, notably France. It is why President Nicolas Sarkozy liked to enable banks to tap into the European Financial Stability Facility that was set up last year to help countries, not companies, in financial distress so his fiscal challenges wouldn’t be aggravated. German Chancellor Angela Merkel insisted that banks raise capital from their own governments before raiding the bailout fund.
It’s a better plan, but one that will provide only temporary relief to Europe’s sovereign debt crises before making it worse.
Europe’s leaders agree that Greek debt levels have reached unsustainable heights. Its public debt is now worth 50 percent more than its entire economy and is projected to growth further in the coming years as Athens struggles to rein in spending substantially. Greek debt will be “restructured,” which means that roughly half won’t be paid back. European banks that have loaned to Greece could be in trouble. Even if they aren’t, other banks and investors might worry that they are, causing the market to tank. “Recapitalization” is designed to prevent that from happening.
In the short term, it could, but several weeks later markets would likely start wondering whether pumping billions of euros into a financial system that’s bloated with debt is really an intelligent strategy.
Western banks have been hesitant to loan money, to each other and to businesses, since the 2008 financial panic when the investment bank Lehman Brothers collapsed. American and European central banks lowered interest rates in response, allowing banks to borrow cheaply in the absence of private sector confidence.
The European Central Bank has been more prudent than its American counterpart, the Federal Reserve, and didn’t buy sovereign bonds, from Italy and Spain, until this summer. The Fed, by contrast, has been financing American deficit spending by printing trillions of dollars for more than two years. Both have supported banks in the expectation that they would continue to extend business loans and mortgages.
They haven’t really—not enough to stir an economic recovery, anyway, because they realize that the market is still full of dislocations and excesses.
If there weren’t central banks or if they hadn’t intervened, those dislocations and excesses, build up in an era of “cheap money” when financial institutions knew that they were “too big to fail,” would have been cleared out in 2008 when Lehman collapsed and threatened to sink half of Wall Street with it. Prices that did not reflect real demand, especially in housing, where government policy had encouraged people without sufficient income to apply for mortgages, would have deflated—considerably.
Default and deflation however, along with potentially huge losses in personal savings, are politically unacceptable. So instead of failing, the institutions that created the crisis are now on life support while the housing market in many Western countries, and construction with it, is stuck. Homeowners aren’t willing to lower their expectations while buyers aren’t able to purchase at the prices they charge.
Recapitalizing banks after they bought worthless Greek bonds when they should have known better isn’t just wrong; it’s not going to work. If writeoffs are also expected for Portugal and maybe Italy and Spain, investors will realize that no matter how big the EFSF is made to be, the solvent countries in the north of Europe can’t afford to compensate them for their losses indefinitely. If the ECB also turns on the printing presses (which it doesn’t want to), that will be the clarion call for investors to get out. Interest rates on peripheral bonds will skyrocket.
The political willingness to reform structurally rather than cut several billions of euros in annual spending is virtually nil in Greece and Italy. These states are already bankrupt and waiting for Germany to pull the plug. It is king in the land of the blind (or broke actually) but doesn’t have the cash on hand to bail out half of Europe. Some countries just won’t change until they’ve hit bottom. The sooner the better, for the longer banks have to wait for the inevitable, the longer they’ll avoid investing in enterprises and loaning to other banks — they don’t know which will survive the reckoning and which won’t. Recapitalization would thus make the problem worse by providing a false sense of security that cannot last.
This article is based on one previously published at Atlantic Sentinel
By Alasdair Macleod, on 31 October 11
Angela Merkel told the German Bundestag last Wednesday that in the absence of a deal on the eurozone debt crisis, “Nobody should take for granted another fifty years of peace and prosperity in Europe: if the euro fails, Europe fails”.
This perhaps encapsulates Germany’s fears, born out of experience, and it would be wrong to dismiss her statement, as many commentators have, as mere rhetoric. The whole concept of the European Coal and Steel Community, the original forerunner of the European Union, was to tie Germany and her neighbours together in a trade and political union to prevent future wars between them.
The EU has delivered peace and prosperity for Germany. It is reasonable to conclude, as Merkel does, that the destruction of the euro will reverse the political process. Post-war European politics has been largely based on these two premises. But there is a deeper point to Merkel’s statement, which has been forgotten in our modern world of fiat currencies: in history the greatest threats to peace and social stability have usually been associated with currency debasement. And here, Germany’s unhappy experience has become rooted in its people’s psyche.
Germany’s spending in the build-up and early years of the First World War was financed purely by monetary inflation, and even by 1917, 85% of the cost was paid for by new paper money. This came about as a result of the economic advice at the time, principally from Georg Knapp, who believed that money is a government product and should be free of other constraints. For the Kaiser, it was like having a modern Keynesian economist advising a government today that it has a right to finance itself through monetary inflation. It was therefore hardly surprising that an ambitious Kaiser, having been shown how to finance the expansion of Germany by attacking its neighbours, actually did so.
The social consequences of printing money are entirely supported by economic theory of the Austrian School of economists and the lessons of history. It boils down to a simple fact: any electorate can be patriotically roused for war, so long as it doesn’t have to pay for it. And that is the lie behind monetary inflation. If you print money to finance a war instead of raising taxes, for a time, no one notices the cost.
Germany has been through this lesson twice in the last century, so her people instinctively understand the chaos that results. It is the rest of Europe, with the exception perhaps of Austria, which has forgotten it. So let us state it loud and clear: sound money is the best guarantee of peace, while fiat money is a precondition for chaos.
So Angela Merkel is right, but the pressure from other euroland and G20 states will be difficult to resist. They have placed their trust in an expanded bailout fund to be supported partly by the EU’s Asian trading partners, which if it gets off the ground will do so at the expense of the dollar. The trouble will come if the European Central Bank is also expected to fund it, which so far is assumed by many but not discussed. Any major injection of ECB money into the fund will be extremely controversial in Germany, and therefore should not be taken as read.
By Detlev Schlichter, on 28 October 11
As you know, my expectations were low to begin with. I did not expect the EU summit on the debt crisis to provide a solution. There is no solution. The situation is beyond repair and the crisis will continue to unravel.
What struck me most when reading the first responses to the EU summit was this: most of what you get from the mainstream media pundits or from the financial economists on Wall Street or in the City of London not only misses the relevant points, it usually gets things completely the wrong way round. What these analysts suggest is good policy and needs to be done is almost always bad policy and should be avoided under any circumstances.
Let’s go through the salient points:
1. Write-down of Greek debt to 50%
“Private sector involvement,” aptly abbreviated PIS, is one of those dreadful, perverted phrases that conceal more than they explain. The private sector here means of course the banks that were stupid enough to give billions of euros to Greek politicians.
We all know what happens under capitalism to lenders who give money to borrowers who end up being unable to pay: they lose their money. That is how it should be. That’ll teach them and hopefully make them more prudent lenders in the future. Alas, this is Europe, so there is no capitalism, and you can negotiate your losses with the political class and agree on the ‘appropriate’ haircut. In July, a 20 percent write-off was agreed, now this was upped to 50. Either number is entirely arbitrary.
The positively Orwellian phrase “private sector involvement” makes it sound as if these poor banks were just innocent bystanders – and respectable members of the private sector for that matter – who got dragged into this unfortunate business at no fault of their own.
For how much should the ‘private’ sector be ‘involved’? Well, I would say for exactly as much as it chose to involve itself in the first place by voluntarily lending money to the Greek government. I mean, have the risk managers and credit analysts at the likes of Credit Agricole and Societe Generale ever been to Athens and inspected the bottomless pit in which their loans were dumped? Or have they from the start assumed that the German taxpayer or the ECB would cover their losses?
Of course, a haircut of 50 percent, as now agreed in Brussels, is better than the ridiculous 20 percent, or so, ‘agreed’ in July. But looking at Greece’s dire financial situation the haircut should be at least 60 percent, or maybe 90, or 100. As I said here and here, there is no reason for the Greek citizens of this and future generations to suffer endlessly because of the corruption of their past governments and the stupidity of their bankers. Embrace default! Just stop paying, go bankrupt, shrink your government, role up your sleeves and start from scratch. After a complete and proper default the state will not get loans easily again, which coincidentally is an additional bonus of a complete government default, it keeps your future politicians honest. That would be the free-market solution. But again we are in Europe.
An even bigger haircut, one decided not by political horse-trading but by the market and Greece’s true ability to pay, would be more helpful for the Greeks and would conveniently discipline the bankers. Why is it not considered? Well, the politicians don’t like it because it would shut much of the government bond market down and make it difficult or impossible for them to keep running deficits of their own, and also because the banks have skilfully booby-trapped the entire financial system with explosive CDS (credit default swaps) that get triggered if the “private sector involvement” gets too big. The bankers resemble increasingly financial terrorists: If you don’t bail us out we blow the whole place up!
Bottom-line: A haircut of 50 percent is better than 20 but it is still too little for Greece, and the whole idea that the ‘private’ sector negotiates losses with the politicians doesn’t bode well for the future.
2. Fiscal coordination.
Nothing specific was agreed at the summit but this is where we are going, and the mainstream economists are cheering for it.
For years now we have heard this in endless macroeconomic research pamphlets and newspaper editorials: There can be no monetary union without a fiscal union. This is, of course, utter nonsense. Complete rubbish. And it doesn’t get any more right by repeating it at nauseam.
The money of capitalism, of the free market and global trade, has always been gold (or silver, but I will refer to gold here). A gold standard is the oldest and best currency union imaginable, and I would argue, the only one workable. Under a gold standard various countries and their governments use the same currency, gold. There is no central bank and no printing press. Governments have to make do with the income they generate from taxing their local population. In such a system, the state has to live, just like any other entity in society, within its means. Apparently, this is a truly fantastical notion for today’s politicians and mainstream economists. Under a gold standard, the state may also borrow from the market but it is clear to the lenders that they assume full risk of default. There is no lender of last resort. This is a powerful constraint on government largesse.
The Greek crisis was a good test to see how closely the European fiat money union could resemble the workings of a proper gold standard. In theory at least, and as intended by the original designs for EMU, there should have been no bailout and the whole mess should have been a local affair between the Greek government and its lenders, just as it would be under a gold standard.
All this nonsense about the falling apart of the euro was, of course, needless scaremongering, albeit politically motivated. When a government defaults under a gold standard, there is no reason why any other government should give up gold as a currency. Had the no-bailout provision been adhered to, there would equally have been no reason why a Greek default should have affected the acceptance and the usability of the euro in any of the other countries, nor for the Greeks themselves. A currency union does not require a fiscal union. Quod erat demonstrandum.
But EMU is no gold standard, and it already failed its first test of whether it could even be a currency union of some discipline. The gold standard was abandoned globally precisely so that governments would not have to live within their means. The euro is political paper money, fiat money, and issued to allow persistent fiscal irresponsibility, as is any other paper currency. Central banks have always been created to fund the state and the banks. The ECB is no different.
This is the global picture in 2011: After 40 years of complete paper money, public debt around the world has reached such momentous dimensions that the major central banks are now increasingly funding the state directly. This is what is happening in the U.S., the UK and increasingly the eurozone, and it is either accepted with suspicious equanimity or enthusiastically supported by bank economists and the inflationistas in the mainstream media. The trend is the same pretty much everywhere. It is only that within the eurozone it is less clear which government has first call on the printing press. In other paper money economies this can be done more straightforwardly.
To assume that some form of institutional framework for fiscal coordination will discipline the European governments and reduce the desire for ongoing central bank debt monetization is at least naïve, if not outright stupid. All governments in Europe are fiscally irresponsible, even the German one. In the run-up to EMU Germany imposed the Maastricht criteria on her European partners. Anyone remember the 60 percent debt to GDP limit? Laughable. Today Germany is at 83 percent and rising, which may look relatively prudent if compared to Belgium or Greece, but if Germany has to pay up on its already agreed upon commitments under the European Financial Stability Fund, she will go above 90 percent in one giant leap, roughly where Ireland was when her creditors said ‘no mas’! Germany may have the lowest unemployment rate in twenty years and, last year, had the highest GDP growth in twenty years, but she is still running deficits, accumulating debt every year, just like anybody else in Europe.
On a long enough time line, everywhere is Greece!
Bottom-line: We will see a plethora of treaty changes, top-level EU summits and other pointless boondoggles. All to no avail. To assume that governments will not collectively resort to the printing press and that they will instead discipline one another when all of them are long-standing, habitual and incorrigible fiscal offenders, is beyond ridiculous! If you believe it, call me, I may have something I want to sell you!
3. ‘Unlimited firepower’ courtesy of the central bank
I guess you might argue that it could have been worse. Merkel could have given in to demands by Sarkozy to use the ECB straight away to leverage the €440 billion bailout fund. Seems like she didn’t, and Sarkozy will have to go, hat in hand, to the Chinese and see if they have some change to spare. However, this is not a long-term solution and once Italy and Spain are in trouble, the bailout fund will be depleted.
One of the most shocking aspects of this crisis is how acceptable it has become for the mainstream economists and the pundits in the media to point towards the ‘unlimited resources’ of the ECB. True, a fiat money central bank can print unlimited amounts of paper and electronic money to bailout everybody, the government, the banks, the pension funds, etc. It is just that such a policy used to be advocated only by suicidal cranks, as it is a sure recipe for complete currency annihilation. Today, established and supposedly highly regarded economists point out the importance of ‘keeping the ECB engaged’ because only the ECB has the ‘unlimited’ resources to underwrite the boundless fiscal profligacy of modern democratic governments and their vote-buying political elites, and to underwrite the gargantuan debt pile.
As the hysterical calls by the inflationistas for a bold ECB policy get ever shriller, Mario Draghi, the new money-printer-in-chief for Europe, has already signalled his support for the ECB’s debt monetization policy, that is, ongoing buying of depressed and ultimately worthless government bonds with the help of the euro-printing press.
Anyone who has any savings stored in the euro-area should be extremely concerned about what is going on here, and in particular about the tone of the debate. When the mainstream speaks of ‘unlimited’ resources of the ECB, they do in fact mean unlimited. The creation of new euro-currency units will be without ANY LIMIT. And the remaining inflation will also be without limit.
Bottom-line: On the face of it, the German position has won: deeper haircuts and no use of the ECB for leveraging the EFSF for now. But where is the money for the larger EFSF going to come from? Italy and Spain will remain under pressure. Nobody has the money to save them or to recapitalize the banks again when the big deficit countries lose access to the market and fail. The ECB is not off the hook. Resorting to the printing press has become a global policy theme for the past three years, and sadly such thinking is now part of the mainstream. The balance sheet of the ECB will not shrink, it will grow. There is no exit strategy. Pressure for further and accelerated monetization of debt, of budget deficits and bank balance sheets will continue and intensify. The endgame will be inflation.
By Sean Corrigan, on 10 October 11
Since the Great Financial Crisis started (in truth, since well before), we have unwaveringly maintained three main tenets in relation to how one should deal with the aftermath of a credit-driven, mass misallocation of resources.
Firstly, we have said that, even if we did accept, arguendo, the trite macroeconomic mumbo-jumbo of over-aggregation, that tired old, maintenance-of-spending-at-any-cost, Keynesian game of trying to compensate for the overstretch of one particular ‘sector’ of the economy by passing ‘the bad, or depreciating, half crown to the other fellow’ is most likely to tangle us in an inextricable knot of surindebtedness if the ‘fellow’ is a governmental body. We say this, since the specious initial advantage of the state’s temporary ability to ignore the imperatives of accounting logic is doomed to be overwhelmed by the legal intractability associated with that same entity’s eventual financial exhaustion. Furthermore, this mere procedural failing is always horribly compounded by the dilution of the sense of direct responsibility which accompanies its involvement in any plight in which the relevant country lands itself.
Secondly, we have stood foursquare behind the idea that all the losses are actually incurred during the heady euphoria of the Boom, that the Bust is nothing more than the overdue recognition of those mistakes, and that to procrastinate thereafter in their acknowledgement is not to avoid the pain, but to exacerbate it in much the same way as a sufferer from a cancer can do himself nothing but harm by trying to delay the awfulness of the therapy which sadly must await him.
Thirdly, it has been our avowed belief that, contrary to the accepted wisdom, there are very few useful macro solutions to such a condition, but only micro ones; that recovery is built one job, one company at a time, from the bottom up.
Therefore, the most beneficial role for Leviathan is not some crazed, Frankenstein process of pulling levers and administering potions in some swivel-eyed, Gene Wilder fashion, but is one of expediting the renegotiation of now-unfulfillable contracts; of impartially overseeing a just transfer of assets from the failed to the well-founded; and of ensuring as few scarce resources as possible—in this time of unexpected penury—are pre-empted by the dead hand of the bureaucracy and, hence, are made available to the putative builders of a new, more prosperous tomorrow.
In all of this, we have been generally cynical of the ability of politicians to deny themselves the chance to carve their effigy on an imaginary Mt Rushmore of interventionists. We have been even more deprecatory of the nomenklatura of would-be Plato’s who advise them, those ’socialists of the chair’ who blindly fill their pink column inches with the ludicrous argument that the only remedy for the failure of government interference is more interference. We have been vehemently opposed to the machinations of central bankers—the ultimate succourers, when not the original seeders, of the Boom—who continue to frame every response in terms of the provision of liquidity to their precious cartel of institutionally parasitic, fractional reserve banks.
Despite this, it has been hard to suppress the faint fluttering of a hope lately freed from its hard chrysalis of doubt by the integrity of some members of the northern European political class and their nominees within the Heart of Darkness of the central bank itself.
Germany—with both tacit and expressed support from among the Dutch, the Finns, the Slovaks, and others—has wrestled itself close enough to doing the right thing—to writing off much of the debt; to making the imprudent private owners and creditors face their responsibilities; and to insisting on guarantees of future good housekeeping from the incontinent debtors—to merit our applause, even if its courage eventually does fail it, or the temptation to take the road to hell along which everyone else is frantically pointing finally does prove too hard to resist.
However, any sense of the victory we entertain in this critical war of ideas—albeit four years late and several trillion dollars short—has to be tempered greatly by the awful truth that two of the major central banks have already succumbed, once more, to their liquidity fetish, while a third is patently ravening for the chance to overcome the present domestic impediments to further action.
One of them, the ECB, is slowly transforming itself into a Fed—over the careers of ex-Bundesbankers perhaps, but nonetheless inexorably so.
Believe, if you will, that all such measures as those announced this week are ‘temporary’—only to be countenanced for the duration of the emergency—and, as our New York friends say, I have a bridge to sell you in Brooklyn.
Yes, it is true that interbank lending has frozen, that the vast apparatus of sovereign finance is creaking alarmingly, and that real money supply growth in the Zone is hovering just above the zero bound. Of these, however, only the third is a potentially justifiable field for central bank intervention in extremis.
The first is a consequence of the long-suppressed mistrust of one another’s balance sheets being expressed by the banks themselves; a fear which could be dispelled overnight if they would each do no more than is required of any public corporation, namely, to produce an honest set of accounts, even if this would be to undertake an exercise in triage—of the merciless sorting of the weak from the strong. To recognise its origin is already to point to where the cure may be found—extended repo operations and expanded bond purchases do not lie along that way.
The second handicap is the legacy of long years of populist vote-buying whereby venal politicians have far too liberally dispensed a morally corrupting patronage, not by having to undertake the invidious task of clearly identifying the winning net recipients of tax monies from the losing net payers standing beside them at the hustings, but by recourse to the seemingly painless expedient of borrowing funds which are never intended to be repaid and which are, in great part, the result of inflationary credit creation on the part of the same central and commercial banks who are now so threatened by the fall of all these democratic Bourbons. Again, to make this diagnosis is to indicate what form the remedy must take and to show that the prostitution of the central bank, so as to maintain the status quo ante, will prove futile, if not fatal, to the patient
As for the Bank of England—well, yes again, real money supply has been running at a negative rate in the UK for some good few months past, dragging activity lower as it has. Yet a very good part of this real contraction is because the Bank has also managed to ignite a nasty rise in prices in violation of its rather open-ended mandate to moderate these over a self-determined and highly elastic ‘medium-term’.
As we have said before, the fact that the UK still manages to run a near-record trade deficit amid a severe recession and during an ostensible private sector credit crunch, despite a 25% drop in sterling’s real effective exchange rate such as to take it to a level only matched during the IMF crisis of the mid-70s Labour administration, is testimony both to the fact that the overall squeeze is not so intense as it seems and to the failure of all this macro-meddling to restore a semblance of competitiveness to a hollowed-out nation.
Where the leakage occurs, of course, is in the realm of the state where, for all the gnashing of teeth and tearing of hair about the ‘austerity’ programme, spending continues to rise, with the change in the state component of expenditures in Q2 outstripping that of households for the fifth quarter out of the last six. Total state outlays are still making new record highs, both outright and as a proportion of non-state GDP—that latter ratio now bumping up against the 60% mark, no less.
So it is all very well for Mervyn King to bleat about facing the most severe financial crisis since the 1930s, or to casually dismiss the cries of the thrifty that their livelihoods are being crushed in the vice of rising prices and falling returns to capital, but it is he and his predecessors, together with the political masters they serve, who have led us into these straits, by dint of their unshrinking embrace of a perverted orthodoxy of inflationary entitlement—of the entitlement of welfare recipients to their doles, of office-seekers to their votes, and of inveterate financial gamblers to their place at the tables of the state-sponsored, state-regulated, and state-underwritten casino.
Mr. King’s response to all this? Why, again to make it easy for the state to spend more and difficult for many of the most vulnerable elements of the nation to spend as much. Bravo, indeed!
So, while Chairman Bernanke can, for now, only threaten to increase the disruption he causes to the market’s pricing signals and to its ability to allocate resources optimally over time, his peers are already at work doing much the same mischief.
Caught up with the demands of their real dual mandate—that of keeping the ruling class happy while looking after the interests of their cabal of big bankers—few of them will stop to listen to what businessmen are telling them, though the message is being broadcast in the most clarion of tones.
Take the most recent Duke University/CFO Magazine quarterly survey of senior US executives as a case in point.
Asked to list external concerns in order of importance, the perennial question of sufficient demand for the firm’s products came top, but a clear second place was secured by the category ‘Federal Government agenda/policies’ – aka, REGIME UNCERTAINTY!
As for internal worries, the ability to maintain margins was top, the cost of health care, second, and the ability to forecast, third—over to you, Mssrs Bernanke and Obama, once more, for creating and fostering such extreme REGIME and MARKET UNCERTAINTY!
And the result of all this? Exactly what we showed in graphical form and briefly discussed in our last edition:-
A third of CFOs say they will not deploy excess cash this year, because they want to retain it should credit markets tighten. Twenty-nine percent say they are hoarding cash due to economic uncertainty, and 31% say they don’t have any excess cash to spend.
More worrying still for all those executives and traders who keep telling us that while business in the Old World may be slow, Asia will keep firing away and so save their bacon, the separate respondents from that particular region also manifested an uncharacteristically subdued tenor. We quote as follows:-
Optimism about the regional economy in Asia (not counting China) fell, with optimists and pessimists now evenly balanced. Last quarter, optimists outnumbered pessimists by two to one. In China, 69 percent of firms have grown more pessimistic about the economic outlook.
The top internal concern among Asian CFOs is difficulty in planning due to extreme uncertainty, working capital management and employee morale. The top external concerns in Asia are global financial instability, intense pricing pressure and weak consumer demand. Chinese CFOs also worry about government policies.
QED
But, carry on regardless! The present approach has been so successful that while one in ten Americans with a full-time job lost it in the slump, barely one in six of those unfortunates has found similar work since, leaving the total at 2000 levels and its fraction of the population at 1975 and 1983 recessionary depths, despite the intervening incorporation of women into the workforce. As for manufacturing—supposedly doing well on the cheapest dollar of the modern era—almost one quarter of the hours worked here were lost from the local maximum of 2006, of which, again, less than a sixth have since been replaced, leaving total hours fully a third below the stationary average of 1984-2001, and still stuck where they were in St. Roosevelt’s bleak 1940s!
Meanwhile, the 3mma of US NAPM new orders has dipped below the 50 watershed for the first time since the crisis, an event which has historically signalled a further deterioration over the succeeding six months in 70% of cases, and an ill omen we must interpret in light of the fact that the magnitude of the last few months’ fall in this component has only been exceeded three times in the past century—in 1974/5, 1980, and in 2009 itself.
Even in Germany, 2009-10’s impressive growth in factory orders has begun to peter out to the point that there has been little further sustained growth so far this year. Meanwhile, at the other end of the world, a PMI of Korean orders languishes at a 2-year low, while exports of capital goods from Taiwan have not been this weak since early 2010.
It may be too much to say that the wheels are coming off the recovery, but they are certainly beginning to wobble.
By Tim Lucas, on 27 September 11
I came across this excellent report by Boone and Johnson from the Peterson Institute for International Economics on the mechanics of how the Eurozone sovereign debt crisis built up (hat-tip James Aitken of Aitken Advisors).
The report helpfully runs through the various policy options that the Eurozone leaders have, and runs through the likely consequences of default – interesting reading given the growing probability of some portion of this option being taken with respect to Greece at least. The writer at least believes that default and ‘an end to the moral hazard regime’ has now become the most likely option.
Cobden centre readers will enjoy the description of how it was the ECB’s repurchase operations that entrenched moral hazard throughout the Eurozone through the treatment of all sovereign paper as collateral from banks equally regardless of its creditworthiness.
There is also an up-to-date summary of the current net claims of all countries against each other, all guaranteed and monitored through the ECB, imbalances that are still building. Germany as of July was the largest creditor to the scheme at over Eur335bn. In gamblers’ parlance Germany’s decision over whether to throw good money after bad will determine the route the crisis will take next.
By Steven Baker MP, on 14 April 11
Let us establish some principles first. Central banks do indeed pose a risk to economic stability but not because their monetary policy is constantly too tight but because is it systematically too loose. Inflexible commodity money – such as gold and silver – has everywhere been replaced with state-issued fully flexible paper money under the control of central banks for one reason and one reason only: so that the supply of money can be constantly expanded in accordance with politically defined goals (such as a certain growth rate, a certain inflation rate, a certain unemployment rate….and constantly expanding bank balance sheets). Today’s consensus believes the following: When inflation is low and thus not an imminent threat, the central bank should ‘support’ economic growth via low interest rates and a moderate expansion of the money supply.
Wrong.
This is precisely the dangerous fallacy that made the dramatic events of the past four years ultimately inevitable. Yet, nobody seems willing to learn the lesson.
Constant expansion of the money supply and the persistent lowering of interest rates below the levels that would be justified by available savings – the raison d’etre of paper money and central banking – lead to misallocations of capital. Always. This – and not higher consumer price inflation – is the most immediate negative effect of monetary expansion. Today’s consensus is, sadly, still obsessed with CPI inflation (CPI= consumer price index). As long as monetary expansion doesn’t lead instantly to a higher grocery bill, the mainstream considers it a welcome boost to growth and practically a free lunch. This is a gross misconception, and this misconception is in essence still behind most of the commentary on monetary policy today. And it was again on display in the debate about the ECB’s recent move.
You can read Detlev’s superb article in full here but beware: he believes “that a collapse of the paper money system is practically inevitable”…
By Prof Philipp Bagus, on 19 January 11
January 14th 2011 is the day on which the Greek government ultimately would have failed. Only extreme interventions by the ECB, breaking former promises, are holding the Greek government afloat. On January 14th, Fitch downgraded Greece from BBB- to BB, a rating considered junk status. Fitch was the last of the big three rating agencies after S&P and Moody’s that had rated Greece above junk.
The ratings are essential for governments because of the collateral rules of the European Central Bank (ECB). When governments spend more than they receive as tax revenue, they issue government bonds. These government bonds are bought by the banking system because banks can use government bonds as collateral for new loans from the ECB. This mechanism is explained in detail in my book The Tragedy of the Euro. The ECB does not accept just any kind of security or government bond as collateral for its valuable loans. The ECB wants some quality, and requires a minimum rating by one of the three rating agencies for these securities.
During the financial crisis the ECB had lowered the required minimum rating for its open market operations from A- to BBB- in order to help out banks because the rating of securities, especially mortgage backed securities, were falling. The reduction was supposed to be an exception and was to expire at the end of 2010.
The uncertainty of Greece’s rating triggered the sovereign debt crisis in 2010. Due to budgetary problems, Greece was in danger of losing the minimum A- rating. What would happen in 2011 when the minimum rating would be raised back to A- and Greece’s rating would not meet this requirement?
The market started to have doubts about Greece’s being able to repay its debts. And it was feared that the ECB would stop financing the Greek deficit indirectly. If the ECB would stop accepting Greek bonds as collateral for loans, no one would buy Greek bonds. The government would have to default on its obligations.
In January 2010 Jean-Claude Trichet, ECB president, still maintained a hard money rhetoric: “We will not change our collateral framework for the sake of any particular country. Our collateral framework applies to all countries concerned.”
Market participants interpreted this statement as a pledge that the ECB would not extend the exceptional reduction of the required minimum rating to BBB- just to save the Greek government. Along the same line, chief economist of the ECB, Jürgen Stark, stated in January that markets were wrong in believing that other member states would bail Greece out.
As Greek problems intensified in March 2010, Trichet, in contrast to his January statement, announced that emergency collateral rules would be extended through 2011. Greek bonds regained the potential to serve as collateral.
Yet, the Greek situation was worse than central bankers had expected. Markets started to believe that Greece would even fail to meet the BBB- rating in 2011, an expectation that finally became reality on January 14th with the downgrade by Fitch. They continued to sell Greek bonds.
In May 2010 at the height of the debt crisis, the independence of the ECB began evaporating when it announced it would drop all rating requirements for Greek government bonds. The ECB would accept Greek bonds as collateral no matter what. Only by this measure does the ECB continue to accept junk rated Greek bonds as collateral.
By contradicting its previous approach and becoming an executor of politics, the ECB lost its credibility. The ECB presented itself more and more as the inflationary machine—in service of high politics—that had been intended by French and other Latin politicians.
From the beginning, the Euro has been a political project. In order to save the project, the ECB disregarded its mandate of price stability and changed its collateral rules to accommodate the bailout of Greece. Far from being a copy of the Bundesbank that during its history repeatedly dismissed inflationary wishes of politicians, the ECB proved to be an instrument of politicians toward a centralization of power in Europe.
In 2011 we are at a decisive moment regarding the future of the European Union. Either the EU takes a leap forward toward a strong centralized European state, or we will move towards more freedom as competition is fostered. The ECB has shown on which side it stands.
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