In his magisterial 1936 work, ‘A World in Debt‘, Freeman Tilden treated the business of contracting a loan with a heavy serving of well-deserved irony, describing how the debtor gradually mutates from a man thankful, at the instant of receiving the funds, for having found such a wise philanthropist as is his lender to one soon becoming a little anxious that the time for renewal is fast approaching. From there, he turns to the comfort of self-justification, undertaking a little mental debt-to-equity conversion in persuading himself that his soon-to-be disappointed creditor was, after all, in the way of a partner in their joint undertaking and so consciously accepted a share of the associated risks.
Next he adopts an air of righteous indignation at the idea that he really must redeem his obligation on the due date, before rapidly giving into a growing fury in contemplation of how this wicked usurer has duped him into contracting for something he cannot hope to fulfil, as so many poor fools before him have similarly been entrapped by this veritable shark.
Likewise, our author quotes the 19th century utilitarian, Jeremy Bentham, to much the same effect.
‘Those who have the resolution to sacrifice the present to the future are natural objects of envy’ for those who have done the converse, our sage declared, like children still with a cake are for those who have already scoffed theirs. ‘While the money is hoped for… he who lends it is a friend and benefactor: by the time the money is spent and the evil hour of reckoning is come, the benefactor is found to… have put on the tyrant and the oppressor.’
Here we should realise the pointlessness of trying to decide whether the Greeks or the Germans are at fault in the present impasse and press on toward the crux of the matter. As Tilden rightly argued about the consequences of a bust:-
‘It follows that any scheme looking towards the avoidance of panics and depressions must deal with this cause [viz., debt] and any plan that does not do so is not only idle, but may be a dangerous adventure.’
‘Hence, the way to deal with a collapse of exchange is not to pretend that “prosperity” is merely in a temporary eclipse, to return again if everybody will act optimistically; but frankly to acknowledge that conditions were unsound, and to permit the natural impulses of trade to rectify them. This prescribes a bitter medicine, which people do not like and politicians cannot collect upon, but quack remedies merely put off the final reckoning.’
Are you listening, Mario?
‘The natural remedies, if the credit-sickness be far advanced, will always include a redistribution of wealth: the further it is postponed, the more violent it will be. Every collapse of credit expansion is a bankruptcy and the magnitude… will be proportional to the magnitude of the debt debauch. In bankruptcies, creditors must suffer.’
The problem with our modern world is that the ‘quack remedies’ we most routinely favour are ones which involve adding another layer of ‘debt debauch’ on top of the still uncleared detritus of the previous one. If you doubt this, I must ask what else, pray, do you think is entailed by QE in all its many variants if not the attempt to find new, biddable debtors to take the place of the grumbling, undischarged old ones?
Even if you are loth to accept this line of reasoning, you surely must concede that a ‘putting-off of the reckoning’ comes with many disadvantageous features and several self-aggravating tendencies and that this should be obvious enough to anyone with sufficient intellectual honesty to consult the record of the past few years – if not decades – objectively.
Firstly, it encourages a wasting forbearance of dead or dying enterprises in a kind of lunatic refusal to recognise that the associated costs are well and truly sunk and that the only valid criterion for continued investment is the judgement that the undertaking will be viable from today, not whether we can thereby avoid booking the losses incurred by it yesterday. Such ‘zombification’ retards, if not prevents, the necessary reallocation of men, machinery, and financial means toward more profitable (and hence more socially beneficial) employment. By propping up the diseased trunks of the past, it prevents light and nutrients from reaching the thrusting saplings of tomorrow. Creative destruction is out and destructive continuation is in to the detriment of all.
Worse, yet, the feeble, ‘stimulus’-dependent manifestation of growth which does then occur leads to that dreadful, anti-Hippocratic impatience to which all our electoral cycle overlords are prone. Bad policy thus leads to more bad policy – whether by way of simple reinforcement of ineffective treatment or by jejune ‘innovation’. As more and more market signals become scrambled, as larger and larger swathes of the economy are turned over either to run-‘em-for-cash basket cases or to newly malinvested Bubble 2.0 entrants upon the stage, the space for genuine entrepreneurship becomes progressively restricted. Growth therefore slows, cycle after cycle, until men in authority – who really should know better – start to mutter rehashed 1930s pessimism about ‘secular stagnation’.
Compounding all this, of course, is the awful truth that practitioners of mainstream economics are in thrall to age-old underconsumptionist fallacies and so require – nay, demand – that no debt must ever be paid down in aggregate (or, as they like to put it, in order to give the idea a thin sheen of respectability, the total of outstanding credit must never fall). Thus, with each successive cycle, new strata of debt are laid down upon the barely eroded bedrock of stale, older ones. Thus it is that the burden of servicing such a growing mountain of claims – an orogenesis of obligation, we might say – can only ever go up. In turn, this results in the officially-imposed interest rate cycle becoming more and more truncated, with each peak lying below the preceding one and with each trough being pushed to – and lately through – the zero bound so that the income drain imposed by that tower of debt does not become too onerous or the old problems re-emerge with renewed venom.
As official rates trend downward, the private sector usually seeks to go one better. Knowing that the debt principal holds little place in the popular imagination but that the monthly payment is the true determining factor in the bargain, lenders start to push out maturities and/or forego the requirement that loans should be smoothly amortized. Not only does this allow the already-indebted both to refinance and then to add to the sums they owe, but it helps entice new cohorts of previously unwelcome borrowers to live beyond their means as well. A fifty-year mortgage or an eight-year car loan? Step this way, sir, we’ll see what we can do.
Soon so much income has been alienated – much of it for such entirely unproductive purposes that little extra earning potential has been acquired in the process – that what we call the intertemporal imbalances again become insupportable. In the current jargon, so much spending has been ‘brought forward’ to prop up today’s faltering system that ever more desperate measures are required to find new expenditures to accelerate and new prodigals to accelerate them when arrives that tomorrow whose fruits we have ‘brought forward’ and the orchard is seen to have been long since stripped bare of its bounty.
On top of this, the eradication of any appreciable opportunity cost in keeping money for its own sake in preference to owning one of the many recognisable claims on greater future money payments (loans, bonds, etc.) leads to a dilution of the principal source of demand for money, the one only transiently expressed in respect of its imminent use as the medium of exchange. This not only confuses the indicators by which we try to balance today’s thrift with tomorrow’s hopes of improved output, but it begins to poison the monetary manipulators’ own wells, to boot.
Accordingly, if money is seen as conferring no great disadvantage should one hold it in place of an ultra-low yielding bond, then the disingenuous assertion first made by Chairman Bernanke that QE is not inflationary because it comprises nothing more than an ‘asset swap’, starts to become all too true.
The central authority, desirous of creating just such an inflation out of a predominant fear of the effect of flat or falling prices on all those whom it has been ceaselessly exhorting to continue to overborrow, easily generates base or ‘outside’ money on which new loans could theoretically be pyramided. But, alas, the commercial banks passively book a good part of these reserves as the primary balance sheet counterparts to the largely inactive settlement deposits of the sellers of the bonds earlier ‘swapped’ for them. Thus, excess reserves do not induce the creation of many additional earning assets – and hence of ‘inside’ money deposits – on top of the original influx.
Moreover, where those same depositors do start to feel their trouser pockets heating up, they typically start to play pass-the-parcel with one another by engaging in a bidding war for bulk credits or listed equities on the financial market, inflating their values and further reducing yields below their optimum levels. What they do not do is rush out and make loans to small businessmen so that these latter earnest souls can improve their capital stock or expand their workforce, no matter what M. Sarkozy may have blustered in 2008 about wanting to ‘…put down the foundations of a capitalism of the entrepreneur and not of the speculator’ as a response to the ongoing financial apoplexy.
With barely a nod to the operation of the much vaunted ‘transmission channels’ so beloved of academia, real-side monetary ‘velocity’ is therefore seen to decline and before too long, the central bank is casting about again for new, more ‘unorthodox’ ways to engineer a perceived surfeit of money and hence to promote a more rapid transactional circulation of the stuff. The vicious circle takes another turn as it does: rates decline further across the curve and yet both borrowing and real-side activity are again only modestly excited.
Before long, men in authority – who really should know better – start to mutter freshly cooked forms of idiocy, claiming that the ‘natural’ rate of interest has fallen to a negative value – a state of affairs in which they must imagine that all of us intemperate, impatient, indulgent mortals have somehow switched en masse to a rare preference for the delayed, rather than the instant, gratification of our wants. Even worse, they find no paradox in supposing that the inexhaustible Horn of Plenty, without which no such unmitigated satiation can have been brought about, must have made its wondrous appearance in a period of mass unemployment and so, presumably, also one of mass want.
In the Looking Glass world of ‘secular stagnation’ and ‘negative real natural rates’ to which all this monetary accommodation has supposedly consigned us, can you guess what the prescription for a restoration of normality must be? Of course! A determined effort to swamp the world with yet more central bank money, to further suppress interest rates, to co-opt more of the decision-making to the central planners, and to annexe more of the economic realm to the fiefdoms of Frankfurt, Washington, and Threadneedle St.! Whatever it takes, don’t you know?
So, with all that said, we come today to yet another major confrontation between lender and borrower in the respective shape of Germany and Greece, one which has foolishly been delayed for more than seven years by the unshakable intransigence of those in power.
This all began with the early crisis vainglory that ‘no strategic bank will fail – and, yes, they are all strategic’. It continued into 2010 when M. Trichet pointed his metaphorical revolver of the refusal to continue with emergency support right at the head of the unfortunate Irish Finance Minister Brian Lenihan – a kind of financial Melian dialogue which the Greeks seem to have well taken to heart, now that such threats are being repeated once more. It rolled on and on with the efforts of the so-called Troika and with the ever-changing, but never truly effective programmes of the ECB itself. It mounted with the widespread abuse of Target2 – something that is, after all, supposed to be a clearing system, not a continent-wide credit wrapper – and with the inordinate strain placed on the balance sheet of the neighbouring SNB.
All the while, the insidious transfer of debt from the private sector to the state (or at least to banks which could not survive absent either explicit or implicit support from that state) has continued, so rendering the necessary resolution between creditor and debtor too diffuse, too indirect, and too legally undefined ever to achieve.
Pity then a Greece which is unfortunate enough to be stuck at Europe’s bottom-right corner instead of at Asia’s top-left, or an Iberian peninsula separated from its neighbours by the Pyrenees to the north rather than by the Atlas mountains to the south, for can we find it at all conceivable to think that they would both not have long ago have seen their debts meaningfully restructured, much of their dead wood cut away, and many of their people set back on the road to prosperity if they had been ‘emerging market’ nations and not satrapies subject to the reality-denying Canutes who run the EU?
For all the hand-wringing about ‘mindless austerity’ on the part of that economic luminary who occupies the Oval Office between golf rounds and for all the wailing conducted over ‘deleveraging’, the sorry truth, of course, is that neither a shrinkage of government outlays nor an overall reduction in debt levels is to be found in even the smallest corner of the globe.
To take one much quoted recent study, this month’s McKinsey report estimates that, since the start of the Crisis in 2007, global debt has risen by some $57 trillion (so, by around $8,000 for every man, woman, and child on the planet) with almost exactly half of the increase in the sub-total attributable to non-financial entities being the fault of those oh-so heartlessly austere governments who have run up an additional tab of a cool $25 trillion in that brief space of time! This means that, in the 6 ½ years of slump and reflation, Leviathan has treated himself to almost $11 billion a day in deficit spending, a sizeable deterioration of almost 2 ½ times the paltry $4.3 billion it was gobbling up during Pharaoh’s preceding seven years of plenty.
It may not be enough to satisfy a Krugman or a Lagarde, but for our taste that represents a dreadfully large quota of capital either frozen in place, shovelled (sometimes literally) into sub-marginal, make-work projects, or simply squandered on recipients of welfare – whether corporate, individual, or among the serried and largely sacrosanct ranks of the place-holding bureaucracy.
Looking instead to the subset represented by the BIS numbers for ‘global liquidity’ – i.e., the loans extended to and securities bought by banks from non-bank borrowers –we see a similar picture. Since Lehman fell, $25 trillion has been added to this particular pile, an increase of one-third from its starting point. Somewhat alarmingly, two-fifths of that increment has its origins in the Asia-Pacific combination of China, Taiwan, Indonesia, India, Korea, Malaysia, the Philippines, and Thailand. Indeed, the last twelve months’ 21.4% increase in cross-border lending to the region has capped off a nearly 80% rise in debt owed by this octet in the period under consideration. To gain some perspective on the magnitude of this, it should be noted that the $10.3 trillion which this involves matches the sums jointly accumulated by governments, households, and non-financial companies in the whole of Europe, the US, Japan, and Latam put together.
A sizeable proportion of that, it almost goes without saying, lies at the door of the Chinese and, coincidentally, the PBoC has been gracious enough this week to reveal its estimate of what it calls Total Social Finance (a hybrid of bank and non-bank credit, together with a smattering of non-bank equity issuance) – an inclusive agglomeration which the likes of Fitch would argue even so does not in any way account for the whole of the web of obligations being woven so densely across the Middle Kingdom.
Nevertheless, the totals we are given are impressive enough. As of the end of last year, the central bank reckons that TSF outstanding came to CNY124 trillion (around $20 trillion). Having pretty much been stable at a ratio of just over 120% of GDP in the prior six years, the massive stimulus programme unleashed in the immediate aftermath of the GFC and never truly attenuated since has seen the credit measure more than triple in absolute size the most recent six, pushing the ratio dangerously skyward to 193% of national income.
This is the legacy whose baneful influence makes up those ‘Three Overlays’ of debt overhang, surplus capacity, and urgent restructuring with which Beijing likes to remind us it has to tussle on the (Silk) road to its ‘new normal’ of slower, more rational growth, and more market-oriented, value-added activity.
So here we have both a major peril and a possible source of hope. The Chinese authorities appear to have recognised that, by following the practices preached by the execrable Western mainstream – albeit on a truly gargantuan, command-economy scale – it has gone beyond the bounds of merely diminishing to reach the Omega point of no return.
So far, as its economy has stuttered and stumbled along, it has resisted the temptation to add just one last, generous coup de whiskey in order to postpone the inevitable hangover (which does not mean it has been entirely abstemious since the new boys took over in 2013). But now not only is growth stuttering, but many prices are falling, too – principally, if not exclusively, those of the raw materials for which it has such a voracious appetite. However beneficial this discount may be to cash-strapped processing firms, it has nevertheless raised the bogey of so-called ‘deflation’ in the counsels of the wise
The question therefore presents itself: will Xi and Li stick to their guns and rely on broader micro-economic and institutional reform to foster a national renaissance – albeit one backed up with a little judicious concrete pouring ‘Along the Way’, i.e., along the route of the new trade routes being constructed to Europe? Or will the pressure to deaden the pain in the interim prove too intense and so unleash both indiscriminate policy easing and possibly an export-boosting devaluation of the yuan?
So far, all the signals are that they will resist the urge, despite a barrage of domestic commentary to the contrary, but a great deal hangs on the fortitude of Xi himself, that one lonely man, perched at the top of the CCP hierarchy – an organisation which itself sits uneasily at the very peak of a true Mount Olympus of debt.
“Central bankers control the price of money and therefore indirectly influence every market in the world. Given this immense power, the ideal central banker would be humble, cautious and deferential to market signals. Instead, modern central bankers are both bold and arrogant in their efforts to bend markets to their will. Top-down central planning, dictating resource allocation and industrial output based on supposedly superior knowledge of needs and wants, is an impulse that has infected political players throughout history. It is both ironic and tragic that Western central banks have embraced central planning with gusto in the early twenty-first century, not long after the Soviet Union and Communist China abandoned it in the late twentieth. The Soviet Union and Communist China engaged in extreme central planning over the world’s two largest countries and one-third of the world’s population for more than one hundred years combined. The result was a conspicuous and dismal failure. Today’s central planners, especially the Federal Reserve, will encounter the same failure in time. The open issues are, when and at what cost to society ?”
- James Rickards, ‘The death of money: the coming collapse of the international monetary system’, 2014. [Book review here]
“Sir, On the face of it stating that increasing the inheritance tax allowance to £1m would abolish the tax for “all except a very small number of very rich families” (April 5) sounds a very reasonable statement for the Institute for Fiscal Studies to make, but is £1m nowadays really what it used to be, bearing in mind that £10,000 was its equivalent 100 years ago ?
“A hypothetical “very rich” person today could have, for example, a house worth £600,000 and investments of £400,000. If living in London or the South East, the house would be relatively modest and the income from the investments, assuming a generous 4 per cent return, would give a gross income of £16,000 a year, significantly less than the average national wage.
“So whence comes the idea that nowadays such relatively modest wealth should be classified as making you “very rich” ? The middle-aged should perhaps wake up to the fact that our currency has been systematically debased, though it may be considered impolite to say so as it challenges the conventional political and economic wisdom. To be very rich today surely should mean you have assets that give you an income significantly higher than the national average wage ?”
– Letter to the editor of the Financial Times from Mr John Read, London NW11, 12 April 2014
“The former coach house in Camberwell, which has housed the local mayor’s car, was put on the market by Southwark council as a “redevelopment opportunity”. At nearly £1,000 per square foot, its sale value is comparable to that of some expensive London homes.”
– ‘London garage sells for £550,000’ by Kate Allen, The Financial Times, 12 April 2014.
“Just Eat, online takeaway service, slumped below its float price for the first time on Tuesday as investors dumped shares in a raft of recently floated web-based companies amid mounting concern about their high valuations..
“Just Eat stunned commentators last week when it achieved an eye-watering valuation of £1.47 billion, more than 100 times its underlying earnings of £14.1 million..
““They have fallen because the company was overvalued. Just Eat was priced at a premium to Dominos, an established franchise that delivers and makes the pizzas and has revenues of £269 million. Just Eat by comparison is a yellow pages for local takeaways where there is no quality control and no intellectual property and made significantly less revenues of £96.8 million. A quality restaurant does not need to pay 10 per cent commission to Just Eat to drive customers through the door,” Michael Hewson, chief market analyst at CMC Markets said.”
– ‘Investors lose taste for Just Eat as tech stocks slide’ by Ashley Armstrong and Ben Martin,
The Daily Telegraph, 8 April 2014.
Keep interest rates at zero, whilst printing trillions of dollars, pounds and yen out of thin air, and you can make investors do some pretty extraordinary things. Like buying shares in Just Eat, for example. But arguably more egregious was last week’s launch of a €3 billion five-year Eurobond for Greece, at a yield of just 4.95%. UK “investors” accounted for 47% of the deal, Greek domestic “investors” just 7%. Just in case anybody hasn’t been keeping up with current events, Greece, which is rated Caa3 by Moody’s, defaulted two years ago. In the words of the credit managers at Stratton Street Capital,
“The only way for private investors to justify continuing to throw money at Greece is if you believe that the €222 billion the EU has lent to Greece is entirely fictional, and will effectively be converted to 0% perpetual debt, or will be written off, or Greece will default on official debt while leaving private creditors untouched.”
In a characteristically hubris-rich article last week (‘Only the ignorant live in fear of hyperinflation’), Martin Wolf issued one of his tiresomely regular defences of quantitative easing and arguing for the direct state control of money. One respondent on the FT website made the following comments:
“The headline should read, ‘Only the EXPERIENCED fear hyperinflation’. Unlike Martin Wolf’s theorising, the Germans – and others – know only too well from first-hand experience exactly what hyperinflation is and how it can be triggered by a combination of unforeseen circumstances. The reality, not a hypothesis, almost destroyed Germany. The Bank of England and clever economists can say what they like from their ivory towers, but meanwhile down here in the real world, as anyone who has to live on a budget can tell you, every visit to the supermarket is more expensive than it was even a few weeks ago, gas and electricity prices have risen, transport costs have risen, rents have risen while at the same time incomes remain static and the little amounts put aside for a rainy day in the bank are losing value daily. Purchasing power is demonstrably being eroded and yet clever – well paid – people would have us believe that there is no inflation to speak of. It was following theories and forgetting reality that got us into this appalling financial mess in the first place. Somewhere, no doubt, there’s even an excel spreadsheet and a powerpoint presentation with umpteen graphs by economists proving how markets regulate themselves which was very convincing up to the point where the markets departed from the theory and reality took over. I’d rather trust the Germans with their firm grip on reality any day.”
As for what “inflation” means, the question hinges on semantics. As James Turk and John Rubino point out in the context of official US data, the inflation rate is massaged through hedonic quality modelling, substitution, geometric weighting and something called the Homeowners’ equivalent rent. “If new cars have airbags and new computers are faster, statisticians shave a bit from their actual prices to reflect the perception that they offer more for the money than previous versions.. If [the price of ] steak is rising, government statisticians replace it with chicken, on the assumption that this is how consumers operate in the real world.. rising price components are given less relative weight.. homeowners’ equivalent rent replaces what it actually costs to buy a house with an estimate of what homeowners would have to pay to rent their homes – adjusted hedonically for quality improvements.” In short, the official inflation rate – in the US, and elsewhere – can be manipulated to look like whatever the authorities want it to seem.
But people are not so easily fooled. Another angry respondent to Martin Wolf’s article cited the “young buck” earning £30K who wanted to buy a house in Barnet last year. Having saved for 12 months to amass a deposit for a studio flat priced at £140K, he goes into the estate agency and finds that the type of flat he wanted now costs £182K – a 30% price increase in a year. Now he needs to save for another 9 years, just to make up for last year’s gain in property prices.
So inflation is quiescent, other than in the prices of houses, shares, bonds, food, energy and a variety of other financial assets.
The business of rational investment and capital preservation becomes unimaginably difficult when central banks overextend their reach in financial markets and become captive to those same animal spirits. Just as economies and markets are playing a gigantic tug of war between the forces of debt deflation and monetary inflation, they are being pulled in opposite directions as they try desperately to anticipate whether and when central bank monetary stimulus will subside, stop or increase. Central bank ‘forward guidance’ has made the outlook less clear, not more. Doug Noland cites a recent paper by former IMF economist and Reserve Bank of India Governor Raghuram Rajan titled ‘Competitive Monetary Easing: Is It Yesterday Once More ?’ The paper addresses the threat of what looks disturbingly like a modern retread of the trade tariffs and import wars that worsened the 1930s Great Depression – only this time round, as exercised by competitive currency devaluations by the larger trading economies.
Conclusion: The current non-system [a polite term for non-consensual, non-cooperative chaos] in international monetary policy [competitive currency devaluation] is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector. It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. We are being pushed towards competitive monetary easing. If I use terminology reminiscent of the Depression era non-system, it is because I fear that in a world with weak aggregate demand, we may be engaged in a futile competition for a greater share of it. In the process, unlike Depression- era policies, we are also creating financial sector and cross-border risks that exhibit themselves when unconventional policies come to an end. There is no use saying that everyone should have anticipated the consequences. As the former BIS General Manager Andrew Crockett put it, ‘financial intermediaries are better at assessing relative risks at a point in time, than projecting the evolution of risk over the financial cycle.’ A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.
The Fed repeats its 2% inflation target mantra as if it were some kind of holy writ. 2% is an entirely arbitrary figure, subject to state distortion in any event, that merely allows the US government to live beyond its means for a little longer and meanwhile to depreciate the currency and the debt load in real terms. The same problem in essence holds for the UK, the euro zone and Japan. Savers are being boiled alive in the liquid hubris of neo-Keynesian economists explicitly in the service of the State.
Doug Noland again:
“While I don’t expect market volatility is going away anytime soon, I do see an unfolding backdrop conducive to one tough bear market. Everyone got silly bullish in the face of very serious domestic and global issues. Global securities markets are a problematic “crowded trade.” Marc Faber commented that a 2014 crash could be even worse than 1987. To be sure, today’s incredible backdrop with Trillions upon Trillions of hedge funds, ETFs, derivatives and the like make 1987 portfolio insurance look like itsy bitsy little peanuts. So there are at this point rather conspicuous reasons why Financial Stability has always been and must remain a central bank’s number one priority. Just how in the devil was this ever lost on contemporary central bankers?”
Every Monday morning the readers of the UK’s Daily Telegraph are treated to a sermon on the benefits of Keynesian stimulus economics, the dangers of belt-tightening and the unnecessary cruelty of ‘austerity’ imposed on Europe by the evil Hun. To this effect, the newspaper gives a whole page in its ‘Business’ section to Roger Bootle and Ambrose Evans-Pritchard, who explain that growth comes from government deficits and from the central bank printing money, and why can’t those stupid Europeans get it? The reader is left with the impression that, if only the European states could each have their little currencies back and merrily devalue and run some proper deficits again, Greece could be the economic powerhouse it was before the Germans took over.
Ambrose Evans-Pritchard (AEP) increasingly faces the risk of running out of hyperbolic war-analogies sooner than the euro collapses. For months he has been numbing his readership with references to the Second World War or the First World War, or to ‘1930s-style policies’ so that not even the most casual reader on his way to the sports pages can be left in any doubt as to how bad this whole thing in Europe is, and how bad it will get, and importantly, who is responsible. From declining car sales in France to high youth-unemployment in Spain, everything is, according to AEP, the fault of Germany, a ‘foolish’ Germany. Apparently these nations had previously well-managed and dynamic economies but have now sadly fallen under the spell of Angela Merkel’s Thatcherite belief in balancing the books and her particularly Teutonic brand of fiscal sadism.
Blame it on ze Germans
The pending bankruptcy of France’s already semi-nationalized car industry is, of course, not to be blamed on high French taxes, strangling French labour market regulation, increasingly uncompetitive French wages, and grave business errors – French car companies have been falling behind their German rivals for years – but the result of French ‘austerity’, which hasn’t even started yet and will culminate in – quote AEP, and drum roll please! – a ‘shock therapy’ next year of 2 percent. Mind you, France’s state has a 57% share in GDP, and the economy deserves the label socialist more than capitalist. Does France really need more state spending, or even unchanged state spending? Another government stimulus? I bet you could cut the French state by 10 percent instantly, and in a year or two you’d have faster growth, not slower growth!
However, Monsieur Hollande is eager to live up to his socialist promises, all the egalité he was voted for, and does not shrink the state but instead raises taxes further, lowers the pension age and raises minimum wages, none of this a demand from Rosa Klebb in Berlin, as far as I know, but AEP doesn’t quibble over such detail. It is all ‘austerity’ to him and ‘austerity’ is always imposed by Germany, and to make really sure that you get that this is a bad idea, and a bad idea coming from Germany, he now calls it the ‘contractionary holocaust’.
Nice touch. There is no place for subtlety, I guess.
Bootle does not stoop quite so low but his pieces are equally filled with the Keynesian myth that there is no economic problem that cannot be solved by more debt and easy money and the occasional devaluation. The fallacy here is the standard Keynesian one: there is no limit to debt, the market doesn’t matter, people can be fooled forever.
The real issue
The reality is different: the markets are slowly waking up to the fact that the social-democratic welfare-state that dominated the West since the First World War is going bust. Everywhere. Faster in some places (Greece, the UK), more slowly in others (Germany), but the direction and the endpoint are the same. This is not a specifically European problem, or even one that is particularly linked to the single currency project; it is pretty much a global phenomenon, and it will shape politics for years to come. It is naïve, dangerous and even irresponsible to dress this up as a design-fault of the euro and thus imply that the problem would be smaller or more easily manageable, or even non-existent, if countries could only issue their own currencies, print money, keep running deficits and devalue to their hearts’ content. The false impression that is being conveyed by Bootle and AEP is that Spain, Greece, Portugal and Italy could somehow simply turn back the clock and, in the more open, more competitive world of the 21st century still run the cosy big state, high inflation, frequent debasement policies of the 1970s.
Bootle and AEP represent the naïve Keynesianism that still believes deficits just pop up in recessions as a ‘natural corrective’ – in fact, AEP exactly describes it that way. The truth is, countries like Greece have been running big deficits in good times and now run bigger deficits in bad times, and they are far from being alone in this. Since the introduction of unconstrained fiat money, most states see no need to balance the books but operate blissfully under the assumption that they can keep accumulating debt forever. Since Greece joined the euro and thereby benefitted from lower borrowing costs, the country’s average wage bill went up 60%, compared to 15% in Germany over the same period. Present Greek structures are simply unsustainable. An economy that has been stifled for decades by the persistent political rent-seeking of its powerful, connected and self-serving interest groups, by an overgrown public sector and uncompetitive wages, simply will not be reinvigorated by yet more debt. And in any case, the bond market has now had enough and won’t fund the Greek state any more anyway. Letting deficits rise, as AEP suggests, is no longer even an option. Not now in Greece, and soon elsewhere. Austerity is, increasingly, not a policy choice but an unavoidable necessity.
So what about devaluation? — It is a bad idea. It must mean inflation, the confiscation of wealth from savers – and savers are the backbone of any functioning economy, even though Bootle and AEP apparently believe it is the state and the central bank that make the economy tick – it must lead to persistent capital flight and hinder the build-up of a productive capital stock. And once you have accumulated a certain level of debt, devaluing the currency could undermine confidence completely and end in hyperinflation, default and total economic destruction.
No country has ever become prosperous by having a soft currency and devaluing repeatedly, yet many have become poor. A hundred years ago, Argentina was among the 8 richest nations in the world and has since managed to decline from first world status to third world status through persistent currency debasement. Since the end of Bretton Woods, Britain has consistently debased its currency, more rapidly than Germany or even the United States, a policy that has undoubtedly contributed to the country’s de-industrialization over this period, its high debt-load, low savings rate and its dependence on cheap money that lasts to this day.
True and lasting prosperity – as opposed to make-believe bubble wealth – has the same sources everywhere and at all times: true savings, proper capital accumulation, and as a result, rising labour productivity. Hard money is the best foundation for these powerful drivers of wealth creation to do their work.
Default instead of devaluation
It is not my goal to defend the policy of the German government or of Chancellor Merkel here. The present policy is wrong in many ways and will fail. But the reasons and my conclusions are different from those advanced by AEP and Bootle. Merkel is desperately trying to pretend that these governments are not bankrupt, that the debt will be repaid, and in so doing she throws good money – that of the German taxpayer – after bad. Most of the governments in Europe, plus the US, the UK and Japan, are unlikely to ever repay their debt, and the big risk is that, once the 40-year fiat money boom that facilitated this bizarre debt extravaganza has ended for good, and the illusion of living forever beyond your means has evaporated, a lot of that debt will have to be restructured, which means it will be defaulted on. That is not the end of the world, albeit the end of the type of government largesse that has defined politics in the West for generations, and it will be the end of the modern welfare state, and herald an era of proper austerity, imposed by the reality of the market and not the Germans. The question is only if policymakers will desperately try and postpone the inevitable and in the process also destroy their fiat monies.
In the case of Greece and Portugal and other countries, default should simply be allowed to occur, a proper default, not the type of managed default that Greece went through and that left the country with more debt as a result of more official aid – all in the vain attempt to pretend the country is somehow still solvent and creditworthy. Whether any issuer is solvent or not, is not decided by a bunch of Eurocrats in Brussels but by the market. The market is not lending to Greece, ergo Greece is bankrupt. Period. It would be better for everybody to admit it.
Germany is far from healthy. It, too, is travelling on the road to fiscal Armageddon, just at a slower speed. Merkel’s policy of bailing out her ‘European partners’ – a policy for which she gets little credit from AEP, Bootle and the rest of Europe – will only hasten that process.
Proper defaults on government debt would also teach bond investors a lesson, namely that they should not engage in the socially destructive practice of channelling scarce savings through the government bond market into the hands of politicians and bureaucrats with the aim of obtaining a ‘safe’ income stream out of the state’s future tax receipts (i.e. stolen goods) but to instead invest savings in capitalist enterprise and thus fund the creation and maintenance of a productive, wealth-enhancing capital stock. Losing their money in allegedly ‘safe’ government bonds is, quite frankly, what they deserve.
In defence of a common currency
None of this means that defaulting nations should be forced to leave the single currency. There is, in most cases, simply no need for leaving, and staying in a widely shared common currency does indeed have many benefits.
The idea that numerous countries – even countries with very diverse economic characteristics – should share the same money is entirely sensible and highly recommendable. Money is a medium of exchange that helps people interact on markets and cooperate via trade, and this cooperation does not stop at political borders. Money is valuable because it connects people via trade, and the more people money can connect (the more widely accepted and widely used any form of money is), the more valuable it is, and the more beneficial its services are to society overall. Yes, the best money would be universal money, global money, such as a global gold standard. It is nonsense to have money tied to the nation state. This type of thinking is a relic of the 19th century when the myth could still be maintained that a ‘national economy’ – somehow magically congruous with the political nation state – existed, and that the national government should manipulate the national money according to national objectives. That is the type of thinking that Bootle and AEP epitomize. Although, already by the late 19th century, this myth of the national economy was dying, as the Classical Gold Standard began to provide a stable global monetary framework that allowed peaceful cooperation across borders by vastly different states, and heralded a period of unprecedented globalization, harmonious economic relations and relative economic stability.
Every form of money is more valuable the wider its use. Currency competition is deceptively appealing to many free marketeers, and as an advocate of pure capitalism, I would never stop anybody from introducing a new form of money. But the economic good ‘money’ conveys enormous network benefits. Because of its very nature as a facilitator of trade, there will always be an extremely powerful tendency for the trading public to adopt a uniform medium of exchange, that is, for everybody to adopt the same money.
There is a persistent fallacy out there, and Bootle and AVP are among its numerous victims: the fallacy is that countries can do better economically by cleverly manipulating their own domestic monies. This is erroneous on a very fundamental level. Any easing of financial conditions through extra money creation, through an extra bit of inflation or a bit of devaluation, can never bestow lasting benefits. Such manipulations of money can only ever result in short-lived growth blips, at the most, and these growth blips always come at the price of severe economic costs in the medium to long run. Monetary manipulation is never a free lunch. It is always damaging in the final analysis.
Being part of a currency-union means the end of national monetary policy, and that is, on principle, to be welcome. The main problem with monetary policy today is that there is such a thing as monetary policy. Money should be hard, inflexible, apolitical and universally accepted to best deliver whatever services money can deliver to society. The problem with the euro is not that it encapsulates so many diverse countries but that it is not hard, not inflexible, and not apolitical. The euro is a paper currency, and like any state fiat money it is a political tool, constantly manipulated to achieve certain ends, and over which ends to pursue there is, quite naturally, almost constant conflict.
If only the euro was golden!
Some people say that the euro is like a gold standard and that its failure demonstrates the undesirability of a return to gold. This is nonsense. To the contrary, the euro would work better if it operated more like the gold standard and if it was as hard, as inflexible and as non-political as gold. Then, interest rates could not have been kept artificially low back in the early 2000s, for the benefit of Germany and France, a policy that laid the foundation for the real estate and debt bubbles in the EMU-periphery. Then banks could not have ballooned their balance sheets quite as much as they did with the help of the ECB and not have dragged us all into a major banking crisis, and once the banks had self-destructed, they could not have been bailed out with unlimited ECB loans and artificially low and even lower rates so that they might continue in their merry reckless ways. Today’s major imbalances, from over-extended and weak banks to excessive levels of debt, are inconceivable in a hard money system. But even now that these imbalances have been allowed to accumulate, it would still be preferable to go back to hard and inflexible money. Under a hard money system politicians and bureaucrats cannot lie and cheat and pretend, at least not as much as they can today. Hard money has a tendency to expose illusions.
This is not a defence of the EU, which is a wretched project, and increasingly morphs into a meddling, arrogant super-state, an ever more potent threat to our liberty and our prosperity. I am not particularly keen on the fiat-euro either. But still, the idea of many countries sharing the same currency is a good one. No question.
If Bootle and AEP were right that weaker nations should opt for weaker currencies, for the monetary quick-fixes of devaluation and inflation, what would that mean for so-called national currencies? By that logic, shouldn’t Italy not only exit the euro and return to the lira, but instead adopt a number of different local liras? Should Italy’s Mezzogiorno not issue its own super-soft currency and devalue against the hard lira of the north? Why should these two diverse regions be tied together under the same currency? Should Scotland have its own currency and happily devalue versus more prosperous South East England? And wouldn’t Liverpool and Manchester not benefit from their own monies, conveniently manipulated to stimulate and reinvigorate their local economies? The absurdity of the whole idea becomes quickly apparent.
But AEP is quite happy with his little island nation state. The extent to which he hopelessly underestimates the challenges facing his home nation – and by extension, the world – becomes apparent when he assures the reader that he, AEP, too, supports modest austerity, namely the present coalitions’ pathetic and entirely insufficient attempt of trimming spending by ‘1 pc of GDP each year’, ‘thankfully’ (AEP) flanked by generous debt monetization from the Bank of England and constantly checked by the Labour Party’s opportunistic clamouring for more deficit spending. Well, last I checked, the UK was running 8 pc deficits per annum. Next to Japan, Britain is the most highly geared society on the planet (private and public debt combined), and when the markets pull the plug on this island nation, the fallout might make Greece look like a walk in the park.
But then, AEP won’t be able to blame it on the Germans.
In the meantime, the debasement of paper money continues.
The eurozone continues to keep us in suspense in the wake of the French elections, and pending the second Greek election in as many months, the underlying financial deterioration is accelerating. Funds are being withdrawn from banks in troubled countries, rapidly depleting their capital. At the same time collateral held against loans is often over-valued, so write-offs that should have been taken have not. The predictable result is a developing run on both individual banks and whole national banking systems.
It should be noted that there are two reasons depositors are fleeing banks: fear that the bank itself is insolvent, and fear that the relevant government might impose restrictions on the movement of money. Fear of bank insolvency is driving funds out of Spanish banks, while fear of government restrictions is driving funds out of Greek banks. To deal with these problems they must be recognised as distinct and different.
A potential banking crisis, as that faced by Spain, requires two further considerations. The first, of providing liquidity, has been addressed by the European Central Bank through its long-term refinancing operation (LTRO); but this is a stop-gap measure and requires the second consideration to be addressed: the reorganisation and recapitalisation of the banks. And here, the cost for Spain is impossible to meet at a time when she faces a combination of deteriorating government finances and escalating borrowing costs.
Greece’s difficulties are even greater, given that depositors are trying to discount the possibility she may leave the euro entirely and introduce exchange controls to manage a new drachma. The virtually unanimous consensus among Keynesians and monetarists is that such a move is both inevitable and desirable, but public opinion in Greece is increasingly in favour of sticking with the euro. Call it the difference between macro-economic theorising and on-the-ground micro-economic reality. For the fact of the matter is that neoclassical solutions that rely on devaluation as an economic remedy provide only temporary relief at best at greater eventual cost, and exiting the euro is neither a legal nor a practical option.
That is the monetary reality behind the eurozone’s crisis. The solution is not to ease the pressures on governments to address their excessive spending: if anything this pressure needs to be intensified, a point well made in a recent Cobden Centre article by Jesús Huerta de Soto. And the idea that more money should be made available for profligate governments through multi-government sponsored bond issues should be firmly rebutted. The banks, which should be allowed to fold, should be removed from the system in a controlled manner, that is to say that the ECB and the national central banks must devise a solution, perhaps a good bank/bad bank division, to give depositors sufficient confidence to keep their funds in the system.
Unfortunately, the political tide is running strongly against this two-pronged approach, with the developing rebellion against “austerity” from all European politicians, and the Keynesian and monetarist pressures from everyone else to reflate increasing. The chances of the ECB properly ring-fencing funds to deal with the banks and stopping them being used to prop up eurozone governments are becoming more remote by the day.
Should the Greeks have a referendum on whether they want to stay in the euro? Are the upcoming elections such a referendum? Would it be better for the Greeks if they left the euro? – Are you, like me, sick and tired of hearing these questions and then the answers based on the same stale and superficial logic?
Most commentators assume that it was a mistake of ‘the Greeks’ to enter European Monetary Union and that they would do better outside of it. I suspect some undue generalization behind such verdicts. For who do these observers talk about when they say ‘the Greeks’? It seems evident, for example, that to the extent that the Greeks are savers they do not believe that exiting the euro and having again a depreciating local currency is in their interest. In fact, they expect to get hurt by such a move. These savers – the forgotten men and women of the crisis – are already holding their own referendum. They are shipping their savings to Germany, the Netherlands and Finland in an attempt to protect them from confiscation through devaluation and inflation. They want their savings to stay in the eurozone. Such ‘voting’ could be characterized as ‘Germanic’, although I would say it simply serves to show that the interests of those who save are very similar, regardless of which country’s passport they hold.
Savers play an important role in the market economy. Capitalism is based on capital, and capital is generated through saving and not money-printing, contrary to what many economists and central bankers want us to believe. Prosperous societies have always been built on hard money, which encourages saving and the expansion of the capital stock, and in turn increases the productivity of human labour. Greek savers are no different from American savers or German savers, and the role of money, saving and capital is no different in Greece from that in any other country. The laws of economics change as little from one place to another as the laws of physics. And sacrificing the interests of your savers for some short-term boost to growth will have the same adverse long-run effects in Greece as it has anywhere else.
It is often said that Germany can afford to live with a harder currency than her European ‘partners’ because she has a strong industrial base and a high personal savings rate. This confuses cause with effect. Germany has a strong industrial base and a high personal savings rate because she has had a relatively hard currency for so long. The absence (at least in relative terms) of inflation and currency depreciation has encouraged saving, capital accumulation and efficient, competitive corporate management. The de-industrialization of Britain, to take just one example, may have been the result of militant unionism in the 1950s to 1970s, and of the craze for nationalization of industry but the ongoing policy of currency debasement by the Bank of England certainly played its part, too.
We should therefore be very suspicious if we are told that it would be in the interest of ‘the Greeks’ if they adopted a weaker currency. It has never been in the interest of any country to adopt a weak currency.
Politics versus economics
The political urge to superimpose some unifying ‘national interest’ on all citizens runs counter to everything the decentralized spontaneous market order stands for. The whole point of a market economy is that it is based on private property and voluntary, contractual exchange. And voluntary, contractual exchange works so well because two parties frequently have different interests or tastes or preferences. If I sell you one of my old vinyl LPs for $2, it doesn’t mean we agree that this record is worth $2. We disagree. You value the LP more than $2, I value $2 more than the LP; otherwise we wouldn’t trade. By trading we have both improved our position. Extended human cooperation based on private property and free, non-aggressive and voluntary exchange improves the position of everybody participating in such a society. In the market economy, not everybody will be rich and not everybody will necessarily be happy. But for those who prefer a larger supply of things to a smaller supply of things, there is no better way to achieve this than by participating in a private-property economy.
The market economy is precisely so powerful because it is a highly efficient way of human cooperation that does not require ‘common interests’ or ‘single goals’. To the contrary, it thrives on differences and still achieves peaceful cooperation. That is precisely its strength, and that is also what sets it apart from politics. The diversity of human talents, interests and preferences that is simply a fact of life does not have to be suppressed and curtailed to fit into the dumb tribalism of politics, which is always about ‘the Greeks’ need this but ‘the Germans’ want that.
All we need for this cooperation on markets to work is the rule of law and hard money as a medium of exchange and store of value. Other than providing these two things, there is no legitimate role for politics in the economy (and by the way, it can be argued that even money and the rule of law are best provided outside the state but this is a different topic). In that sense, there is indeed a common interest that everybody shares, but not only all ‘Greeks’ but equally ‘the Japanese’ and ‘the Congolese’: That is a common interest in a framework that allows human cooperation on markets, and that framework is simply the protection of property rights (the rule of law) plus hard and apolitical money. The rest you can safely leave to the people – laissez faire!
Macroeconomics as politicized economics
Sadly, however, there is a branch of economics that has been all too happy to look at the world through the prism of politics, and this branch is modern macroeconomics with its focus on national account statistics. The macroeconomist, believing that the statistical aggregates he can measure and observe are also the driving forces of the economy, happily subscribes to the political fiction of the ‘national economy’. Such an economy is assumed to be congruous with areas of political jurisdiction, so the macroeconomist can talk to the politician about ‘the Greek economy’, which is, we are to believe, a clearly distinguishable economic entity and neatly ends where the neighbouring countries begin. And he can then ascertain what special needs this specific ‘national economy’ might have; what its unique requirements are; and what would be beneficial for everybody living within the borders of this ‘national economy’. With this dubious intellectual sleight of hand, the spontaneous interaction of all those people with all their different, divergent and often conflicting ideas, preferences and tastes who make up the essentially borderless, increasingly global market economy disappears and is, conveniently for the political mind, replaced with national objectives and clear goals. ‘The Greeks’ need a weaker currency. ‘The Greeks’ need lower interest rates. ‘The Greeks’ need higher inflation. — All of them? — Tribalism as the currency of politics is restored. And – bingo! – the economist has a role as policy adviser.
The mirage of manageable capitalism
If you want to get an idea of how the bureaucratic elite perceives the world, you only have to open the Financial Times. Take last week’s edition of May 23. There is the IMF bureaucracy telling the UK bureaucracy that ‘the Brits’ need lower interest rates and more government spending. Martin Wolf tells us that ‘the Greeks’ can be helped if ‘the Germans’ accept higher inflation. (Hint: Martin Wolf is almost always in favour of easy money and a bit more debt to ‘stimulate’ the economy). Then there is Professor Jeremy Siegel of the Wharton School of the University of Pennsylvania, who tells us that what everybody in the eurozone needs is a proper devaluation of the euro. It is, of course, no coincidence that all this advice from the IMF’s Lagarde to the Wharton School’s Siegel points in the same direction: toward lower interest rates, more money printing and currency devaluation. The debasement of money is the cure-all for economic problems, according to our policy elite.
Of course, the logic of Lagarde, Wolf and Siegel is roughly equivalent to suggesting that you and I would benefit in our little exchange of old records for dollars if the bureaucrats kept debasing the dollars or otherwise intervened to artificially prop up the prices of old vinyl records. Of course, their interventions may occasionally help one party to the trade at the cost of the other, but they cannot improve the mutual benefit that you and I derive from this commercial transaction and that is its true raison d’etre. Most important, however, is that the mere fact that they are intervening at all – and keep intervening – will raise our uncertainty about the value of dollars and the prices of records in the future. The whole idea that their currency manipulations will make our co-operation better or more beneficial is entirely preposterous.
Helping Greece through monetary debasement?
Of course, I am not denying that Greece as a political entity has some specific problems. This is how Professor Siegel in his article on euro devaluation describes the three key problems:
First, the flight of deposits out of fear of euro exit. Second, the unsustainable budget deficit. Third, high Greek labour costs that make Greece uncompetitive, in particular versus Germany.
I think the answers to these problems are straightforward in a market economy. You can only keep your savers if you are committed to hard money. For Greece that means, first and foremost, not leaving the euro. If the budget deficit is too big, which it certainly is, you have to rein in spending. As I have said repeatedly, Greece should not only have defaulted on some of its privately held debt but also on its loans from official lenders. Greece should then not have accepted additional official loans and should now drastically cut public spending. This is hard, for sure, but it is the only cure for a deficit and debt problem. You cannot cure debt with more debt. And if labour costs are too high, they have to be reduced. If wages are too high – and they have risen much faster than in other eurozone countries – wages have to be allowed to fall. For this to happen, the labour market needs to be liberalized.
Staying in the euro, cutting spending and implementing structural reforms in order to make the labour market flexible and operable – that sounds a lot like what the much reviled ‘austerity camp’ prescribes, and I have to admit that it has economic logic more on its side than the ‘stimulus camp’. These prescriptions also have the advantage that they directly address what is wrong rather than try to shift the pain to others, for example to taxpayers in other eurozone countries or to euro-savers throughout the eurozone.
But Professor Siegel does not recommend ‘austerity’. He recommends devaluation for the entire eurozone, one assumes via aggressive money printing from the ECB and foreign exchange intervention. His belief is that this will address the competitiveness problem in particular. But uncompetitive wages in Greece are a relative-price problem, and furthermore a local one, and not a general purchasing power problem. Many Greek wages are too high in relation to what consumers – whether in Greece or outside Greece – are willing to pay for Greek goods and services. By debasing the euro Siegel does not directly impact the relative prices that are out of whack but he would inevitably set off numerous secondary and largely unforeseeable relative price effects throughout the eurozone. The good professor is willing to debase the euro internationally and by doing so disrupt the entire eurozone price structure in order to maintain the illusion among parts of the Greek population that their wages are sustainable.
As do most inflationists and currency-debasers, Professor Siegel only considers the immediate inflationary impact of his policy, the direct impact on the statistical average of euro prices, which he believes to be minor. That may or may not be the case, but the aggressive easing from the ECB that would be required to properly debase the euro would have many other effects, in particular on relative prices and on capital allocation, and this throughout the eurozone. At a minimum it would discourage saving and disrupt the process of deleveraging and bank balance sheet repair. Professor Siegel expressed concern about capital flight from the eurozone periphery (his first point above) but happily risks it for the entire eurozone as his policy would affect savers throughout the single currency area. And what about the deficit problem? Does he really think aggressive easing would provide incentives for fiscal consolidation anywhere in the eurozone?
Currency debasement creates a fleeting illusion of competiveness but would leave the eurozone ultimately with more debt, less saving and less true capital formation, and thus a less well-functioning economy. Professor Siegel himself states the following:
“Historically, overpriced labour markets have been cured, albeit painfully, by currency devaluation – an option which is not open to euro-based economies.”
It was precisely the recognition that this historical option of the quick fix had too many painful side-effects and that it was not really a cure to begin with, that made a currency union so attractive, in particular for countries with a history of currency debasement. By taking the placebo of currency devaluation away from local politicians in places such as Italy and Greece, it was hoped that they would finally address the real structural issues in their economies and stop robbing their savers and thus impairing domestic capital formation. They have not done so during the first 10 years of European Monetary Union as the global credit boom was in full swing and simply allowed them to borrow more. The time for change has finally arrived.
But our most prominent policy advisers seem to have learnt nothing. After we severed the last link to gold, we have had forty years of relentless fiat money debasement and debt accumulation to cover up the rigidities of the modern welfare state. Today, around the world, central banks have reached near zero policy rates and are resorting to employing their own balance sheets to keep the overstretched credit edifice from collapsing. Yet, the chorus of ‘experts’ still thinks that what we need is another devaluation, another round of QE and another rate cut, if at all possible. Their ideology has brought about the present mess. It is time we stop listening to them.
In the meantime, the debasement of paper money continues.
“Europe fights back against austerity” was how The Daily Telegraph headlined its weekend election coverage.
Anti-austerity movements are gathering pace across Europe following political earthquakes in France and Greece. A total of 12 European governments have now been dismissed in three years.
As the European welfare state is officially in its death-throes none of us should be surprised if political strife gets cranked up to eleven. I firmly expect that we will see much more of this in the future. While I can understand the anger of the electorate and sympathize with the sense of desperation and foreboding, I can, however, not consider the electoral choices of the weekend particularly enlightened, and I do not think that they reflect a coherent, let alone intelligent strategy as the Daily Telegraph headline seems to imply. If those who ‘won’ the election deliver on their promises, economic disintegration will only accelerate. What is being offered in terms of ‘solutions’ is a dangerous assortment of economic poisons, more suitable to describe the European disease than provide a recipe for stronger growth.
Recovery through early retirement and infrastructure spending? – C’mon. Nobody can take that seriously.
But it seems that just because this heap of economic stupidity can neatly be swept under the wide tent of ‘anti-austerity’, the commentariat seems somehow willing to believe in the wisdom of the crowds and look for some deeper insights here.
I guess the reason for this is that the economic ideologies that are now being strenuously interpreted into the election results rhyme with the economic prejudices of most commentators. They, too, believe that state bankruptcy is best to be ignored or not to be taken too seriously so that we can spend our way out of this mess. For a long time media pundits have treated us to the perceived wisdom that economic growth can only come from the actions of the government. Only devaluation through euro-exit, inflation through more money printing and more government deficit-spending, preferably by the still credit-worthy Germans and then fiscally-transferred to the maxed-out Greeks, can revive the economy because only this can lift aggregate demand, the magic cure-all of economic problems.
What is lost on these commentators is that the European mess is nothing but the inevitable result of government-stimulated aggregate demand. Easy money funded the Spanish and Irish real estate booms and bankrupted their banks and by extension their governments. Easy money allowed Greece’s political class to go on a borrowing binge that has now bankrupted the country and lured large parts of the population into zero-productivity, soon-to-be-eliminated public sector jobs.
Do you still want the state to ‘stimulate’ the economy? – Be careful what you wish for.
The real culprit of high youth unemployment in Spain and Italy is not ‘austerity’, which hasn’t even started there, but a bizarrely overregulated and sclerotic labour market in which it is almost impossible for firms of a certain size to fire people. The incentives are thus stacked massively against hiring. Yet, in France one of Hollande’s election promises is not to deregulate the labour market. If I were unemployed in France I would not be counting my chances of getting a job over the next five years.
In France the state runs more than half the economy, yet Hollande promises not to privatize state-run industry. Where is the wisdom in that?
Yet, the statists and socialists are delighted. Paul Krugman, who never saw a debt crisis you could not borrow and spend your way out of, rejoices at such display of economic genius. We are all Keynesians now! Listening to Krugman you would think Greek and French voters were not using the ballot to cling desperately to some remnants of the welfare state but were in fact positively advertising the wisdom of government stimulus and the mystical ‘multiplier’.
Some of the commentators tried to argue that what happened over the weekend was also some kind of anti-establishment vote, a verdict against centralisation and the dominance of the deservedly despised bureaucratic elite in Brussels.
Nice try, but I think that that is rubbish.
This was not an anti-establishment vote at all. It was not a vote for change but a desperate vote for the status quo. Of course, the old elite deserved the sack but they were largely booted out not because people got tired of the old policies but because the leadership now finally admitted that they could no longer deliver on the old promises.
The established parties lost because they could not continue upholding the false promise that had kept them in office for years or decades, the promise to make the “European model” work. They had to admit that the European welfare state was now bankrupt. Kicking the can down the road is increasingly not an option as the end of the road is now in sight.
And the election winners were those who had the chutzpah to maintain that drastic belt-tightening and painful reform were not required but that the people just had to ‘stick it to the man’, who is Angela Merkel and sits in Berlin. The tactic is straightforward. Shoot the messenger!
In France that meant voting for a charisma-free Socialist bureaucrat who will revive France with higher taxes, early retirement and a Hoover dam funded by Eurobonds and the ECB. In Greece, the big winner was an ex-Communist firebrand who admires Hugo Chavez, and who has raged against austerity measures and structural reform.
I guess we now know what the electorate is against. “Say no to cuts!” But what is it for? Over in Ireland, the deputy leader of Sinn Fein, Mary Lou MacDonald, had the answer: “A No vote (to the ‘Austerity Treaty’) in Ireland will strengthen those arguing for jobs and growth.”
Well, who could not love a politician who promises jobs and growth? But the relationship between politics and jobs and growth is a tenuous one. Politicians are not savers who fund the creation of a capital stock through saving, and they are not entrepreneurs who put that capital to productive use. Politicians are people who spend other people’s money. In Ireland the budget deficit runs at 13 percent of GDP per annum, which according to Krugman’s logic must be a fantastic recipe for jobs and growth. Let’s just sit back and watch how that economic miracle is going to unfold.
My guess is that many people in Europe still know, or at least instinctively sense, that the promises of jobs and growth through state spending and money printing are hollow. They know that the state is bust and cannot keep spending money it doesn’t have. The policy options are much more limited than the campaign rhetoric indicates. On trend, fiscal consolidation and structural reform will continue, and Germany’s negotiating position will remain strong.
Yet, on the margin this was an indication that Europe, and in particular France, remain in many areas unreformable, and that the pressure on the ECB to sustain the unsustainable with sizable money injections will, if anything, intensify.
In the meantime, the debasement of paper money continues.
Greece has now defaulted, and other eurozone governments as well as agencies such as the International Monetary Fund, European Central Bank and European Investment Bank have retrospectively inserted themselves as senior creditors, a precedent that should be of great concern and which has profound implications for private sector banks.
Furthermore, when a state defaults it is only a small part of the whole story, because governments today are major participants in their economies. The consequences of a central government default extend to state guarantees for other entities and related businesses: in the case of Greece its default has altered the assumptions behind all non-central government public-sector loans, such as railway bonds. And the private sector not directly dependent on government subsidies or contracts is also affected by the prospect of excessive taxes.
For this reason, the consequence of Greece’s default goes considerably beyond the loans directly involved, and all other eurozone nations are in a similar position. The headline numbers are a fraction of the total involved.
This brings us to a fundamental truth. Government debt is the basis for fiat money systems. This basis is now being questioned. It is the key component of the capital held by banks, as well as cash and deposits at central banks – both of which are also government creations ultimately backed by government debt. Ever since gold was legislated out of the monetary system, confidence has become totally dependent on the validity of government debt.
The insolvent position of a number of eurozone nations invalidates the general assumption that government paper provides a solid foundation for eurozone banks. That the stronger euro-countries can underwrite the weak is now also doubtful. The precedent that has been set by the retrospective interposition by governments and their agencies as senior creditors undermines the value of government debt even further for private-sector banks, who become junior creditors. It is not surprising that they have re-deposited the bulk of the money lent to them by the ECB with the ECB itself. Euros held at the ECB only give refuge from exposure to specific government paper and is the best of a bad choice. Banks outside the region are exercising the option of opting out altogether.
It may seem unnecessary to question the very basis of the European financial system in this way. But this is bound to be debated in boardrooms across the entire banking network, inside and outside the euro area, and banks will react. It is also the underlying reason why the situation remains so precarious regarding Europe’s debt crisis. The way Greece’s default has been handled brings an increased risk of capital flight from the region at the worst possible time. Funding for all eurozone nations has become a lot more difficult. The ECB will come under growing pressure to not only rescue banks, whose balance sheets are imploding, but also to directly bail out governments as well.
Because of the systemic role of government debt, the crisis can be expected to spread rapidly from the insolvent weaker euro-nations to all the others. In short, the mishandling of Greece’s debt problems has made things worse.
Greece was bailed out for the second time in four months. Or did it default? Well, a bit of both, I guess.
All bondholders are equal. But some are more equal than others. If you are the ECB, your Greek bonds were exchanged, par for par, for new Greek bonds, and you can go on pretending that they are worth their principal amount. You won’t have to report a loss for now. But if you are a ‘private’ entity – and that is a rather loosely used term these days as it includes the banking industry which is either now partially owned by the state or to a considerable degree dependent on ongoing support from the lender-of-last-resort – more than half your Greek investment was wiped out. So Greece defaulted. But as you ‘agreed’ to the ‘haircut’ it was in fact a ‘voluntary restructuring’, although you really had no choice.
Bankruptcy is not nice. Everybody loses. The creditors take a hit as they will have to write off most of what they lent. The borrower takes a hit as he will now be cut off from new credit and will have to live of whatever sources of income the creditors could not lay their hands on. Chances are he will not get a penny of new credit for a while. In that respect Greece is not doing badly at all. Although it just defaulted on €107 billon of private credit, Greece immediately gets another €130 billion taken from taxpayers in other countries. And these new loans plus the ones that were agreed at the time of the last bailout were just made cheaper. They now only cost 2 percent per annum after 3.5 before the restructuring.
So on some level it all looks pretty swell for Greece. It defaulted on its ‘private’ lenders and got more money at lower rates from its official lenders. Only problem is, these official lenders have just made clear that they do not like to agree to haircuts, and they are demanding that Greece gets its fiscal house in order…and REPAY!
This seems to be the point that gets everyone so excited, and even angry, including many commentators in the media. There is an almighty whinge-fest going on in the press. A distraught Ambrose Evans-Pritchard in the UK’s Daily Telegraph speaks of ‘ever-escalating EU demands’ that condemn Greece to decades of economic depression and oppression. Is all this austerity forced onto Greece not going too far? Are the spending cuts not pushing the economy deeper into recession and will this not aggravate the debt problem? Would Greece not have been better off staying outside the euro? Should it leave the euro? And what happens to Greek democracy?
I guess we shouldn’t lose sight of the fact that Greece’s economic model is fundamentally unsustainable, whichever way you cut it. Greece has been living beyond its means for a long time, and has managed to do so by flying under air-cover of the EMU project and with the tailwind of cheap credit and easy money. Spending by the Greek state accounts for more than half of registered economic activity, and a third of the workforce is employed by the public sector. ‘Activities’ are being subsumed under the heading of ‘Greek GDP’ that nobody would voluntarily pay for, that are to a large degree wasteful, and that are simply unaffordable under anything but the most bizarrely generous credit conditions, i.e. precisely those that Greece enjoyed from 2001 to 2008. Easy money has been used to paper over grave economic imbalances. Some of what is generously labelled ‘GDP’ should be discontinued – and fast.
To even suggest that such an economic model would be manageable if Greece, a country with about three quarters of the population of metropolitan Los Angeles but with less than half of L.A.’s GDP, only had its own paper currency and could inflate and devalue to its heart’s content, is economically illiterate. No country ever prospered by running budget deficits funded by the printing press or by creating domestic inflation. Devaluing your currency may give your exporters a shot in the arm – for about five minutes. But it scares your domestic savers away for years to come and severely diminishes your ability to keep or attract capital, the backbone of any sustainable economic model. To even try and attempt to ‘inflate away’ a debt load worth 160 percent of a generously calculated GDP would cause economic damage of gigantic proportion. One must have swallowed the Keynesian mythology of deficit-spending whole to believe that the country could borrow and print itself out of this mess. A proper default on its existing debt and rebuilding from a lower base – but with a hard currency – are the better options.
The economic commentators in the media seem to only ever see the superficial and short-lived benefits of devaluation. They forget that nobody wants to hold a currency specifically issued for the purpose of debasing it, and that includes the locals. Greek savers are pouring money into gold and London real estate and German banks not only out of understandable concern over the health of Greek banks but also out of fear of devaluation which always means robbing the savers. Leaving the euro now would be complete disaster for Greece, in my view. And even had Greece never entered monetary union and kept its currency, its economic model would have equally been on the way out by now. In any case, adopting an inflationary currency does not make running budget deficits and a bloated state apparatus harmless or even sustainable. It only means the country would add the dislocations from monetary debasement to those it already incurs from a bloated public sector and government directed resource use. (This is not to say that the euro is or will be a hard currency. It is a soft currency and will go the way of all paper currencies. But the frequent suggestions for Greece to exit the euro are obviously founded on the premise that an even weaker currency would be good for the Greeks. This is wrong.)
That printing your own paper money provides your domestic economic policy with extra degrees of freedom is a dangerous fallacy. It is precisely this fallacy that is at the core of this entire global mess. It seemed to work for a while but even that was largely an illusion. There are no free lunches, and the bill for decades of habitual monetary debasement is being presented now. Everywhere, not just in Greece. Once the overall debt load reaches a certain level and the private market loses faith in the possibility of this debt ever being repaid, the game is up. It is now up for Greece, and it will be soon up for others.
There is no alternative to shrinking the Greek state drastically. It may not be nice for the Greeks to get told so by the Eurocracy – who run equally unsustainable models in their respective home countries, even if they have not been found out by markets yet – but that can change quickly. I guess it would have been better for Greece to default properly, that is fully and on all bonds, rather than only on 53% of what the ‘private’ sector held. That would have meant a lower debt load going forward but also no access to new money, and I think this would have been an less politically charged way of shrinking the Greek state than having the cuts superimposed on the electorate by other countries’ politicians. But maybe not. In any case, I consider it more likely that the present measures are not far-reaching enough.
That the coming shrinkage of the Greek state – and it will happen, one way or another – will cause hardship to many ordinary Greeks, nobody can deny. But what are the realistic alternatives and who is to blame? I see no alternatives and as to the blame, this falls squarely on the modern social democratic welfare state, a model that is now collapsing everywhere around us under the weight of its own economic absurdity. Large sections of Western society have for decades been lulled into accepting as a fact of modern life that the state would always look after them, that politicians could offer them secure employment, high and rising living standards, secure pensions and top-notch yet affordable health-care – all delivered by an ever-expanding state bureaucracy funded through rising taxes on productive activity, cheap money from the fiat money central banks and ever more debt. The final bill was supposed to be deferred forever. This irresponsible political theatre is coming to an end. Greece is just the first domino to fall.
And what does it mean for democracy? – This is a well-meaning question but do those who ask it imply that tough measures would be more acceptable if they came from local politicians, or do they imply that the Greeks could vote themselves a less harsh reality?
“The landslide has started. It is too late for the pebbles to vote”, as a character in the TV series Babylon 5 says.
Whatever happened last week is unlikely to be the end of the Greek crisis but, more importantly, far from the end of the global financial crisis either. Greece is not the only country with an unsustainable economic model obtained under the fair-weather conditions of the 1971-2007 Great Fiat Money Expansion. Modern habits of governance seem to be founded on the illusion that states qua states have unlimited credit lines and could never go broke. Fact is that the debt trajectories of all major countries are pointing in the same direction. Sooner or later, everywhere is Greece.
And if printing lots of money is not a solution for Greece it will not be one for the others. This week the ECB will conduct another round of QE, although it calls it LTRO – long term refinance operation. The ECB will give hundreds of billions of new money to the European banks. When describing these operations, many economists and journalists are naively (or astutely?) sticking to labels such as ‘liquidity provision’ or ‘stimulus’, which sound harmless and are thus misleading. ‘Liquidity injection’ sounds like the ECB was doing nothing more sinister than adding a bit of grease to the economic machinery. And ‘stimulus’ makes it appear as if the ECB was only applying a gentle kick to the backside of Europe’s economic mule.
Nothing of the like is going on here. In fact the ECB is providing funding to the overextended banks that they could never obtain from savers in the private market, so that the banks, rather than shrink and consolidate, can provide more cheap money to the various debt-addicted European states, to keep yields on their debt at artificially low levels and to allow them to maintain the appearance of solvency. LTRO/QE is a policy of price fixing, market manipulation and all-out make-believe – let us all pretend this entire charade is funded voluntarily by a free market.
This is not about stimulus or liquidity, this is about maintaining a system a tad longer than has run out of private savings, private trust and private credit, and that is – despite being officially brain-dead – now on the life-support of never-ending LTRO injections. There is no exit strategy here. This will have to go on – forever.
In the meantime, the debasement of paper money continues.
Last Monday night, before the US markets opened after President’s Day, bailout terms for Greece were announced. The detail is secondary to assessing whether or not it will work, or whether only a little time has been bought. Theoretically the deal can work, but it is extremely unlikely that it will. Almost everyone knows or suspects this, but the survival of the European political system is at stake, and this systemic priority is more important than hard economic reality.
The sceptics are right for the wrong reasons. Few analysts correctly define the problem and how it might best be resolved, because they only understand intervention. Some insist that Greece should leave the euro and allow a new drachma to float lower, so that the cost of Greek labour becomes competitive. The fallacies in this argument are numerous and obvious; suffice it to say that a new drachma backed by nothing more than misplaced hope would immediately collapse, ensuring complete chaos, while euro-denominated debts would remain unpaid.
Others say that GDP is falling at whatever-rate-per-cent and that cutting government spending will make it fall even faster: by postponing economic growth, Greece’s ability to pay down the debt will be severely limited. This confused argument ignores the economic burden of excessive government and consequently the benefits of cutting it to the bone.
The idea that government has resources not raised from its citizens is a Santa Claus fable, elevated to the dignity of an economic doctrine and endorsed by all those expecting a personal benefit. A government can only spend what it takes from its citizens, and the more a government spends the greater the burden it imposes upon them. Therefore, if the creditor-imposed unwinding of government spending results in the net transfer of resources (net, that is, of debt repayments) back to the private sector it will have a chance of success. However, all those citizens banking on hand-outs from the government will need persuading that it is for the best.
This is a difficult task, and given decades of interventionism no one is equipped to argue a cohesive case for reversing government expansion. It has been successfully done before, most notably by Britain after the Napoleonic Wars. The difference then was that public opinion was not entrenched in a benefits mentality.
Unwinding economic distortions, the result of the public sector’s intrusion into and imposition upon the productive economy, will be a very difficult political task. At the end of the day a prosperous private sector is Greece’s only hope, and it requires sound money to support capital investment, radical cuts in the public sector, and the lowest taxes possible consistent with sound government finance. The instincts of the interventionists are to do the exact opposite.
The chances of the powers-that-be getting it right are frankly, very slim. It can only be done by giving up all pretentions that intervention has economic benefits, and convincingly arguing the case in front of a sceptical public which is now minded to rebel against all authority.
Unfortunately, the Greek crisis is far from resolved, and will most probably worsen.
I was glad to see Cobden Partners’ Gordon Kerr on Bloomberg yesterday, explaining why the Greek bailout will fail:
As I wrote elsewhere, the western world may be in a second crisis of state socialism, a crisis of the welfare state. It appears that politicians’ excess spending pledges over what they could raise in taxation have been covered indirectly by chronic credit expansion since the end of Bretton Woods. As Hayek, Mises, Huerta de Soto and others have explained, that was bound to lead to a banking crisis.
If this thesis is essentially correct, it may be that Greece is simply in the vanguard of a pattern which we should expect elsewhere. That implies a need for everyone who cares about peace and prosperity to think fundamentally and without fear or favour about our plight. That’s why I am proud to be associated with both the Cobden Centre and Cobden Partners.