As you know, my expectations were low to begin with. I did not expect the EU summit on the debt crisis to provide a solution. There is no solution. The situation is beyond repair and the crisis will continue to unravel.
What struck me most when reading the first responses to the EU summit was this: most of what you get from the mainstream media pundits or from the financial economists on Wall Street or in the City of London not only misses the relevant points, it usually gets things completely the wrong way round. What these analysts suggest is good policy and needs to be done is almost always bad policy and should be avoided under any circumstances.
Let’s go through the salient points:
1. Write-down of Greek debt to 50%
“Private sector involvement,” aptly abbreviated PIS, is one of those dreadful, perverted phrases that conceal more than they explain. The private sector here means of course the banks that were stupid enough to give billions of euros to Greek politicians.
We all know what happens under capitalism to lenders who give money to borrowers who end up being unable to pay: they lose their money. That is how it should be. That’ll teach them and hopefully make them more prudent lenders in the future. Alas, this is Europe, so there is no capitalism, and you can negotiate your losses with the political class and agree on the ‘appropriate’ haircut. In July, a 20 percent write-off was agreed, now this was upped to 50. Either number is entirely arbitrary.
The positively Orwellian phrase “private sector involvement” makes it sound as if these poor banks were just innocent bystanders – and respectable members of the private sector for that matter – who got dragged into this unfortunate business at no fault of their own.
For how much should the ‘private’ sector be ‘involved’? Well, I would say for exactly as much as it chose to involve itself in the first place by voluntarily lending money to the Greek government. I mean, have the risk managers and credit analysts at the likes of Credit Agricole and Societe Generale ever been to Athens and inspected the bottomless pit in which their loans were dumped? Or have they from the start assumed that the German taxpayer or the ECB would cover their losses?
Of course, a haircut of 50 percent, as now agreed in Brussels, is better than the ridiculous 20 percent, or so, ‘agreed’ in July. But looking at Greece’s dire financial situation the haircut should be at least 60 percent, or maybe 90, or 100. As I said here and here, there is no reason for the Greek citizens of this and future generations to suffer endlessly because of the corruption of their past governments and the stupidity of their bankers. Embrace default! Just stop paying, go bankrupt, shrink your government, role up your sleeves and start from scratch. After a complete and proper default the state will not get loans easily again, which coincidentally is an additional bonus of a complete government default, it keeps your future politicians honest. That would be the free-market solution. But again we are in Europe.
An even bigger haircut, one decided not by political horse-trading but by the market and Greece’s true ability to pay, would be more helpful for the Greeks and would conveniently discipline the bankers. Why is it not considered? Well, the politicians don’t like it because it would shut much of the government bond market down and make it difficult or impossible for them to keep running deficits of their own, and also because the banks have skilfully booby-trapped the entire financial system with explosive CDS (credit default swaps) that get triggered if the “private sector involvement” gets too big. The bankers resemble increasingly financial terrorists: If you don’t bail us out we blow the whole place up!
Bottom-line: A haircut of 50 percent is better than 20 but it is still too little for Greece, and the whole idea that the ‘private’ sector negotiates losses with the politicians doesn’t bode well for the future.
2. Fiscal coordination.
Nothing specific was agreed at the summit but this is where we are going, and the mainstream economists are cheering for it.
For years now we have heard this in endless macroeconomic research pamphlets and newspaper editorials: There can be no monetary union without a fiscal union. This is, of course, utter nonsense. Complete rubbish. And it doesn’t get any more right by repeating it at nauseam.
The money of capitalism, of the free market and global trade, has always been gold (or silver, but I will refer to gold here). A gold standard is the oldest and best currency union imaginable, and I would argue, the only one workable. Under a gold standard various countries and their governments use the same currency, gold. There is no central bank and no printing press. Governments have to make do with the income they generate from taxing their local population. In such a system, the state has to live, just like any other entity in society, within its means. Apparently, this is a truly fantastical notion for today’s politicians and mainstream economists. Under a gold standard, the state may also borrow from the market but it is clear to the lenders that they assume full risk of default. There is no lender of last resort. This is a powerful constraint on government largesse.
The Greek crisis was a good test to see how closely the European fiat money union could resemble the workings of a proper gold standard. In theory at least, and as intended by the original designs for EMU, there should have been no bailout and the whole mess should have been a local affair between the Greek government and its lenders, just as it would be under a gold standard.
All this nonsense about the falling apart of the euro was, of course, needless scaremongering, albeit politically motivated. When a government defaults under a gold standard, there is no reason why any other government should give up gold as a currency. Had the no-bailout provision been adhered to, there would equally have been no reason why a Greek default should have affected the acceptance and the usability of the euro in any of the other countries, nor for the Greeks themselves. A currency union does not require a fiscal union. Quod erat demonstrandum.
But EMU is no gold standard, and it already failed its first test of whether it could even be a currency union of some discipline. The gold standard was abandoned globally precisely so that governments would not have to live within their means. The euro is political paper money, fiat money, and issued to allow persistent fiscal irresponsibility, as is any other paper currency. Central banks have always been created to fund the state and the banks. The ECB is no different.
This is the global picture in 2011: After 40 years of complete paper money, public debt around the world has reached such momentous dimensions that the major central banks are now increasingly funding the state directly. This is what is happening in the U.S., the UK and increasingly the eurozone, and it is either accepted with suspicious equanimity or enthusiastically supported by bank economists and the inflationistas in the mainstream media. The trend is the same pretty much everywhere. It is only that within the eurozone it is less clear which government has first call on the printing press. In other paper money economies this can be done more straightforwardly.
To assume that some form of institutional framework for fiscal coordination will discipline the European governments and reduce the desire for ongoing central bank debt monetization is at least naïve, if not outright stupid. All governments in Europe are fiscally irresponsible, even the German one. In the run-up to EMU Germany imposed the Maastricht criteria on her European partners. Anyone remember the 60 percent debt to GDP limit? Laughable. Today Germany is at 83 percent and rising, which may look relatively prudent if compared to Belgium or Greece, but if Germany has to pay up on its already agreed upon commitments under the European Financial Stability Fund, she will go above 90 percent in one giant leap, roughly where Ireland was when her creditors said ‘no mas’! Germany may have the lowest unemployment rate in twenty years and, last year, had the highest GDP growth in twenty years, but she is still running deficits, accumulating debt every year, just like anybody else in Europe.
On a long enough time line, everywhere is Greece!
Bottom-line: We will see a plethora of treaty changes, top-level EU summits and other pointless boondoggles. All to no avail. To assume that governments will not collectively resort to the printing press and that they will instead discipline one another when all of them are long-standing, habitual and incorrigible fiscal offenders, is beyond ridiculous! If you believe it, call me, I may have something I want to sell you!
3. ‘Unlimited firepower’ courtesy of the central bank
I guess you might argue that it could have been worse. Merkel could have given in to demands by Sarkozy to use the ECB straight away to leverage the €440 billion bailout fund. Seems like she didn’t, and Sarkozy will have to go, hat in hand, to the Chinese and see if they have some change to spare. However, this is not a long-term solution and once Italy and Spain are in trouble, the bailout fund will be depleted.
One of the most shocking aspects of this crisis is how acceptable it has become for the mainstream economists and the pundits in the media to point towards the ‘unlimited resources’ of the ECB. True, a fiat money central bank can print unlimited amounts of paper and electronic money to bailout everybody, the government, the banks, the pension funds, etc. It is just that such a policy used to be advocated only by suicidal cranks, as it is a sure recipe for complete currency annihilation. Today, established and supposedly highly regarded economists point out the importance of ‘keeping the ECB engaged’ because only the ECB has the ‘unlimited’ resources to underwrite the boundless fiscal profligacy of modern democratic governments and their vote-buying political elites, and to underwrite the gargantuan debt pile.
As the hysterical calls by the inflationistas for a bold ECB policy get ever shriller, Mario Draghi, the new money-printer-in-chief for Europe, has already signalled his support for the ECB’s debt monetization policy, that is, ongoing buying of depressed and ultimately worthless government bonds with the help of the euro-printing press.
Anyone who has any savings stored in the euro-area should be extremely concerned about what is going on here, and in particular about the tone of the debate. When the mainstream speaks of ‘unlimited’ resources of the ECB, they do in fact mean unlimited. The creation of new euro-currency units will be without ANY LIMIT. And the remaining inflation will also be without limit.
Bottom-line: On the face of it, the German position has won: deeper haircuts and no use of the ECB for leveraging the EFSF for now. But where is the money for the larger EFSF going to come from? Italy and Spain will remain under pressure. Nobody has the money to save them or to recapitalize the banks again when the big deficit countries lose access to the market and fail. The ECB is not off the hook. Resorting to the printing press has become a global policy theme for the past three years, and sadly such thinking is now part of the mainstream. The balance sheet of the ECB will not shrink, it will grow. There is no exit strategy. Pressure for further and accelerated monetization of debt, of budget deficits and bank balance sheets will continue and intensify. The endgame will be inflation.
Thanks for the article. I recommend Fiat Money Inflation in France by Andrew Dickson White, concerning events in France after 1789. Nothing has changed except that disaster is now threatened on a continental scale.
Oddly another, the post Revolution crash in France was engineered by a Scotsman. Like our crash here in the UK. I thought they were meant to be thrifty – but maybe that’s just with their own money. Devolution NOW!
I love your articles Detlev, always incisive and to the point. I have rarely come across a person with whom I agree on everything. However, with respect to financial issues, I have not so far read a single word you have written that I disagree with.
Reading the mainstream media makes me think I am going mad, particularly since 2007. Reading your material at least confirms to me that it is not me that is insane but rather it is most of our politicians, economists and financial journalists who are in fact either completely and utterly incompetent or deluded, or simply outright insane.
Simon: I used to share you opinion of politicians and mainstream media etc. Call me cynical if you like but their actions must be deliberate. This is the ancient power-grab on a continental scale. They are merely indifferent to the magnitude of the suffering that will follow. To them, crisis equals opportunity.
Hugh Hendry believes that the Euro behaves as the gold standard did in the 1920s… Is the 1920s gold standard somehow different to the gold standard that Detlev has in mind?
Hugh Hendry at LSE AIC 2/5 :
It could….but if it keeps to bail outs on bail outs of bail outs, then very firmly NO!
Jesus Huerta De Soto also holds a similar view , if it stayed to its constitutional mission, but alas……..a politician can only ever say jam today and jam everyday for ever and vote for me and I will give you bigger dollops of jam than the other guy , so money making happens now like any other system.
Hi AIT, I was trying to give the explicitly Keynsian view of savers, implicitly (and probably unconsciously) held by most ‘liberals’. I was being the Devils advocate.
But taking your point ‘savers are not selfish unless the keep their cash under the mattress’…
Isnt this even more true of gold held in a deposit account rather than in an interest yielding loan bank account? (- and thus the subject of fractional reserve amplification of money supply described in Detlev’s book).
But the Devil has plausible and persuasive arguments, and so long as those are the only points of view aired as ‘mainstream’ by the likes of the BBC, your hope of a balanced budget is DOA. Any attempt to cut into departmental budgets will be met with the ‘Washington monument’ defense.**
I agree with your sentiments, but at the moment the classical liberal ideas you espouse seem a lost cause. It is so easy for a progressive to attack your stance as heartless and uncaring, pretty much a sitting duck. Classical liberalism dragged humanity out of the Malthusian trap, and gave us our modern wealth which the state can dispense with flamboyance on victim groups (the sick, unemployed, oppressed etc). It is strange that mainstream progressivism wants to end this affluence and reduce humanity to some sort of green subsistence living again – and that a conservative government should be promoting this.
Washington monument defense
The post democratic apparatus being constructed to save the Euro and avoid war:
So… the gold standard in the 1920s was a failure that led to the unpleasant big governments of the 1930s.
And yet Detlev wants (such) a gold standard.
The Euro would have had some gold qualities had the magic formula not been found to create near unlimited bail out Euros for PIGS.
Hendry apparently blames gold for the 1920s problems because magic does not work with gold based money. He can hear the same 20th century historical echo that Merkel did when she said she felt a bit ‘Hitlery’ (as The Daily Mash had it).
Gold prevents money printing from helping countries become more competitive. Money printing is a win-win from a progressive perspective. It taxes selfish savers, funds big benevolent government and ‘defense’, and helps exports.
In the absence of a widespread classical liberal class consciousness I dont see a simple gold standard having a hope.
IMO It is a tragedy that the insight gained by understanding that there are two classes (the industrious class and the class who live of that work – through money creation or taxation) is alien to the modern mind. Thank goodness for the Mises institute.
International bankers, who had been reluctant to take a 50% ‘haircut’ on their exposure to Greek debt changed their negotiating stance after Frau Merkel pointed out that Goldman Sachs sounded ‘a tad Semitic’……
She then stressed they could take a 50% haircut or have their actual heads completely shaved.
The Euro debt crisis solution explained:
The great Ralph Raico:
You misunderstand. Savers are not selfish and unless they hide their money in the mattress, it will be spent buy banks, being loaned out to finance production not consumption. What you are suggesting is stealing from those who responsibly save (and give the soundest basis for credit generation). Money printing only confers a short term financial advantage of making goods appear cheaper but the day of reckoning via inflation sets them back to a place lower than they started. A balanced budget would prevent Govt spending more than it takes in, but without the threat of debt Govt loses a tool of control over the unwary voter.
Progressives are dishonest regressives and controlled by bankers. Wealth redistribution is for the elite not the average person and was invented for this purpose. A gold standard would force every nation to follow suit, hence it is prudent to have a monetary union to hide the deception. As the main article points out honest money is just that. Anything else is immoral and criminal….but that leaves progressives without work as they cannot provide a good or service that someone else wants.
Gents, even the man who puts his money under the mattress is being very beneficial to his fellow man, as he is increasing your purchasing power if you are spending, as there is less money (his) chasing the available goods and services you are trying to secure!
Scrooge McDuck is in fact very beneficial to all people in the economy .
It is a tragedy of economics that this basic fact has been losts as consumptionist cranks have taken over the study of economics.
Glory the hoarder!
Indeed the use of money results in the reduced hoarding of non-monetary goods. Hoarding would be bad news if it were people hoarding useful things and thus not willing to exchange them. The existence of a medium of exchange allows folks to hoard money instead which, as Toby notes, results in the increased purchasing power of money, allowing others to benefit from increased purchasing power.
One of the many sorry stories from hyperinflationary times in the past was that as money became discredited, food became monetised. Hence, hoarding of this for monetary purposes resulted in starvation despite there being good harvests and plenty to go around.
You misunderstand the great depression. This was not a failure of the gold standard but a failure of a dishonest banking system which was allowed to create massive amounts of credit out of thin air. The failure of the gold standard was an effect and not a cause.
I personally think we should move away from the idea of a gold standard and move straight to a system of gold as money i.e. 100 per cent reserve banking with all money designated in grams/kilograms/tons of gold.
Gents, Churchill as Chancellor put the pound back at its pre war parity thus overvaluing it by some 10% plus, thus plunging the economy into Depression . I do not think this is a controversial fact, but accepted even by the mainstream .
I agree with Simon and Toby.
For me, the gold standard is a red herring and it implies that Gov’t has a responsibility and a right to determine what we should use as money. The only non-arbitrary determination of money is provided by the market. Gov’t has no place in money production. A gold standard is merely the penultimate stage before we arrive at a full fiat currency.
Perhaps read through Simon Rose’s excellent website on savings here. http://www.saveoursavers.co.uk
I was putting the conventional Keynsian viewpoint of savers (and of money printing) forward as devils advocate. Everyone who matters believes in deficit investment spending now. (Although Mervyn King utters an occasional uncomfortable squeak.)
Any attempt to balance budgets will be faced by economic collapse due to huge taxation and/or riots due to benefit cut backs and the Bureaucratic washington monument defense described here:
Toby’s defence of genuine ‘under the mattress’ savers is well put, by saving in a bank at interest one is inflating the money supply. I think I gathered that much from my attempt to understand Detlev’s book. Should Bill Gates give his money to charity, or build it into a bonfire and burn it….?.
I dont understand the great depression at all, was it the money printing before hand, or the massive government intervention during that made it drag on?.
Lord Randolph Churchill, chancellor of the exchequer famously remarked of decimal notation “I never could make out what those damn dots meant.”
His son was little better it seems. But it does show that imposing a gold standard can be very damaging.
Another interesting Euro link:
The private banks will take a cut of 50% but will be compensated for this cut. That’s what MEP Daniel Hannan told me anyways.
The corrupt establishment elite (the Economist magazine and the rest of the usual suspects) are denoucing the German government for not committing more money – they are “starving” the “rescue fund” (read the bailout slush fund) and so on.
The establishment have clearly come to the conclusion that their credit bubble “finance economy” can not survive without endless subsidies (the bailout orgy of 2008 was not enough for them). And they are right – it can not. However, their system will eventually collapse anyway. At least they are consistent – the elite (including the fincial elite – George Soros and so on) support welfare for everyone (health care and every other entitlement program) as well as unlimited credit money subsidies for themselves.
Now if only they could find some galatic federation (or what not) to fund all this unlimited corporate and other welfare……..
However, in the real world, this folly will lead to economic and social breakdown.
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