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.
This article was previously published at DetlevSchlichter.com.
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.
This article was previously published at GoldMoney.com.
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.
This article was previously published at Paper Money Collapse.
“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.
This article was previously published at Paper Money Collapse.
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.
This article was previously published at GoldMoney.com.
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.
This article was previously published at Paper Money Collapse.
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.
This article was previously published at GoldMoney.com.
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.
European countries offer a variety of pension schemes. For our purposes here, I want to draw attention to the variety of public participation rates in the total pensioned assets among EU member states. Consider the following chart, courtesy of Lans Bovenberg and Caspar van Ewijk:
The UK stands out as the country that has, far and away, the highest portion of its pensioned assets in private plans. Some of the usual suspects, like Greece and Italy, round out the bottom of the list with almost all of their pensions in public hands.
Private pensions have many advantages over their public counterparts. These advantages are notable now more than ever. They help diversify risks for investors. With public pensions proving to be less safe than in the past, this is a welcome benefit. Private schemes don’t leave investors exposed to the credit risk of their own governments. Private schemes deepen the capital markets, and allow for better allocation of funds than public (and government debt-centric) pensions. In sum, private pensions promote financial stability.
But there is one advantage that hasn’t been getting much press. Countries with large private pensions make some unfortunate policy choices a little less difficult.
The sovereign debt crisis illustrates the need for European governments to scale back on their expenditures. Lacking an easy way to enhance their revenues, cutting back on services is the only way to stay solvent. Greece is the most evident case of this problem, but it exists in all EU countries to some extent. Voters don’t generally get excited by the prospect of reducing public services. Or more correctly, they don’t get excited by this prospect in a positive way.
Several governments are to the point where significant fiscal reform is now necessary in the quite immediate future to stave off a worse fate. The problem that past reform inaction now breeds is that there are few areas of the public sector that can generate cuts large enough to meaningfully scale back the respective budgets.
Public pensions comprise large swaths of the public budgets of all European states. Large cuts to pensions are not welcome, but they are one of the few areas where significant and timely cost savings can be made. Countries that have made changes to their public pensions in the past have seen much resistance. Violent riots erupted in Greece, and even France had its share of unfortunate reprisals.
This is largely to be expected. With few private alternatives, citizens of these states are left with an almost exclusive reliance on their public pension plans. It could have been a mistake for these people to believe that their public pensions would pay out their full benefits, but that is largely beside the point now. For a 50 year old Frenchman facing a future of pension cuts, there are now few prospects to augment his retirement income.
It should come as no surprise that citizens are hesitant to accept cuts to their pensions. Even those that accept that cuts must be made aren’t thrilled by the cuts having to be made in a way that directly affects them.
Some countries, like the UK, should take notice of these developments and be optimistic. With the public pension scheme proportionately the smallest in Europe, it may face considerably less backlash in reforming than we have seen in other countries.
Of course, the British might look to the recent student protests over tuition and fee increases for university as the opening act for the reaction to the cuts to come. Yet, significant differences exist. Students privately fund only a very small portion of the total cost of their university studies. Going from a situation where one pays a small portion of the total cost to a larger portion is a significant increase in the total cost that they must bear. Any increase in private university fees shifts a comparatively large burden of payment onto students’ pocketbooks.
As a thought experiment, imagine the student riots if the same education cuts occurred. Except instead of the current proportion of public and private expenses for University, imagine that only 25% of costs were publicly provided for, with the remaining 75% privately funded. Could anyone seriously imagine the riots being anywhere near the same magnitude if this funding balance was in place to begin with?
Rioting pensioners in Greece are no different than the students in Britain. They are both part of an entitlement system that promises to pay for large portions of expenses. One should not expect to see the same backlash when a system is changed that isn’t publicly funded to the same extent, such as the public pension scheme in Britain.
People don’t object to paying their own way. They do object to being lied to, or having promises reneged on. The public pension scheme in Britain provides one advantage to reform that its European neighbours don’t have.
“We think we have an agreement, but we are not sure what it is.”
- Negotiator at the Euro zone “crisis summit” last week, as reported in The Economist.
“You don’t have to be paranoid to be terrified.” – Ditto.
If a ballistics expert were so poor at his job that his artillery routinely fired missiles into the sea or, worse still, at his own men, he would soon be removed from office. He might perhaps be purged more dramatically, pour encourager les autres. No such logic would seem to apply, however, in either politics or economics in the west, where discredited practitioners of failed theories are allowed to pontificate and spend into absurdity. We cannot say with certainty what was spooking European investors prior to last week’s make-or-break summit (the 14th such “crisis summit” in 21 months), but it seems plausible to argue that they were concerned about an unsustainable build-up of credit, credit risk and leverage. Happily, those concerns have now been put to rest, because the euro zone’s leaders have pledged more credit, more credit risk, and more leverage. To put it another way, Messrs Sarkozy and Merkel have bought more time, albeit time paid for with yet more borrowed money. A three ring circus of blind, incontinent clowns would have more class.
We know from previous climactic bailouts that money, being so debased by our central banks, doesn’t get you very far these days. We have now had a €1 trillion bailout whose benign market impact lasted all of a day. By Friday last week, Italian 10 year bond yields were back up at 6% – the “danger zone” – which does rather make one wonder just what the hell our monetary and political “leaders” think they are achieving with all this thinly disguised but very costly can-kicking. Evolution Securities’ fixed income research team called the bailout plan “a sugar rush” of stimulus. A one-day wonder is neither here nor there; what matters is where Italian government bond yields are in six or 12 months’ time.
The euro zone’s leaders faced at least three specific objectives. Resolution to each would have been and remains necessary but not sufficient to ease the crisis:
- Put Greece out of our misery.
- Recapitalise the banks.
- Do something magical and sexy with the EFSF.
What we actually have is a peculiar fudge even by the standards of eurofudge whereby a Greek default mysteriously doesn’t appear to trigger credit default swap protection, as Alen Mattich of the Wall Street Journal points out. Separately, and not for the first time, banks are being tasked with mutually exclusive objectives: keeping the lending taps open without compromising and indeed actively improving the quality of their balance sheets. This is impossible. The Economist (whose coverage of the summit this week has been excellent) cites Morgan Stanley’s Huw van Steenis, who suggests that European banks might end up pursuing a “crash diet” that results in a shrinking of balance sheets by up to €2 trillion over the next year, which would be a disaster for SMEs and others. And in the meantime, a credit bust that is the natural response to too much inherent leverage and financial engineering is being “solved” by.. leverage and financial engineering. At least the acronym for the Special Purpose Investment Vehicle is a fair reflection of the intellectual bankruptcy being deployed. One summit attendee noted of the bailout plan that “the more zeroes the better”. It is unclear whether he was referring to taxpayers’ further involuntary capital commitments, or to political non-entities.
One cannot really avoid the conclusion first reached by writer Adam Fergusson in his study of the Weimar era collapse and hyperinflation, ‘When Money Dies‘:
What really broke Germany [and which may end up breaking the euro zone] was the constant taking of the soft political option in respect of money.
Talk of hyperinflation will, one trusts, ultimately be both premature and irrelevant, but wishful thinking is no sustainable basis for an investment approach when we have the current crop of political and economic no-talent clowns calling the shots. Last week we hosted our external investment panel, an oversight committee in effect, and one of the panellists pointed out that the anticipation and preparation for acute inflation, like that for financial panic, cannot be finely timed. One minute the system is deemed to be secure. The next minute, pensioners are queuing up outside Northern Rock.
Since we have mentioned the ‘W’ word, we have an obligation to discuss what strategies best preserved the wealth of German investors during that dark period. (“Life was madness, nightmare, desperation, chaos” writes Fergusson. We are not quite there yet – but we also note that sensible financial commentators have already begun to refer to Japan as our Weimar in waiting.) Other, more valuable foreign currencies, for example. In 1923, that meant the US Dollar. This time round, since the Swiss National Bank has lost the plot, we would favour the Canadian and Singapore Dollars. Back then, the answer lay in gold, and we think it does this time, too, as the finest currency protection paper money can buy. One can also consider gold and silver mining companies – John Hathaway of Tocqueville Asset Management has written very nicely about the ‘Golden Mulligan’ being presented to investors who missed the gold bull on the way up. Markets very rarely offer second chances; investors without any form of gold exposure would, we think, be well advised to step on board now. Other forms of real assets will play their part (we note the substantial increase in the cost of British agricultural land). And since sins of omission can also be costly, investors looking for ‘safe havens’ would be well advised to be highly selective in their choice of bonds (if they choose bonds at all), as well as common stocks.
Those who have studied the Weimar experience suggest that the point of no return in the inflationary process did not come about through currency depreciation alone, nor from the growing velocity of money in circulation (as German savers tried desperately to spend their fast- eroding paper wealth), nor from the balance of payments deficit. In fact it came from a devaluation of political principles. Yale Economist Robert Shiller has suggested that one of the reasons for equity investors’ irrational exuberance in the 1990s (it was Shiller, and not Greenspan, who coined the phrase) was the fall of the Berlin Wall – which seemed to conclusively display the superiority of western free market capitalism over the discredited Soviet model. Now the superiority of the western model is so apparent that we have cash-strapped eurocrats looking to raise money from the Communist leaders of a country, most of whose citizens live in abject poverty. This writer is proud to call himself British; he would be disgusted to be regarded as European.
This article was previously published at The Price of Everything.