Category: Uncategorized

The Day When the ECB Gave Up

And so it begins:

The European Central Bank will plough €1.1 trillion into the eurozone economy in a last-ditch attempt to breath [sic] life into the European economy. At its monthly governing council on Thursday (January 22), the bank’s governing council agreed to start buying up to €60bn of government bonds from March in an unprecedented quantitative easing programme.

How is this supposed to happen? Private spending would accelerate if interest rates went down, but that will happen if and only if the interest rate on treasury bonds falls as a result of this new ECB spending program. That, in turn, can only happen if demand for treasury bonds increased enough to overcome the risk premium associated with euro-zone member states.

However, the risk premium was supposed to go away with the bond purchase program that the ECB announced last summer. Back then the bank pledged an open-ended purchase program for treasury bonds issued by troubled euro-zone countries: everyone and anyone who owned a treasury bond issued by, say, Greece would be guaranteed to get his money back by selling it to the ECB. This guarantee, then, would bring down interest rates and stimulate private-sector activity.

But this did not happen. The bond buy-back program may have had a marginally visible effect on interest rates, but it certainly was not enough to encourage any sustained upswing in private-sector activity.

When that did not work the ECB pushed bank-lending interest rates through the floor by lowering the rate on overnight bank deposits to -0.2 percent. That had no effect whatsoever on private-sector activity. So after having opened two liquidity flood gates on the European economy, without coming even close to achieving desired results, the ECB has now decided to open the third flood gate.

Well, if you try the same thing enough times over and over again, then eventually it might actually work…

Back to the EU Observer story:

The programme is open-ended, and will run until September 2016 at the earliest. Speaking at a press conference following the governing council meeting, ECB president Mario Draghi said that the bond-buying programme would remain in place “until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2%” … The Frankfurt-based bank hopes to boost inflation and drive down the value of the euro against other major currencies in a bid to make the bloc’s exports more attractive.

This is a tried-and-failed strategy. Every time a country depreciates or devalues its currency to boost exports, the main result is an increase in profits among large, dominant and already-established manufacturing businesses. Those profits, in turn, are free of charge for the businesses: all they have to do is keep manufacturing the very same products, without investments toward improved competition.

If this currency-based exports rebate is maintained long enough, the result will be a decay in productivity in exporting businesses. They have no profit-based reason to make new investments – quite the contrary. Any investments toward enhanced competitiveness will divert funds from the free-cash profits.

But what will the businesses use their cash for? Financial investments. This in turn will flood the domestic economy with even more liquidity than was already injected into it by the central bank’s aggressive monetary policy. More and more money will chase fewer and fewer profitable investments. In the meantime, little to nothing is going to happen in the real sector; the only moving part will be credit-driven consumption of durable goods like cars, and private real estate. But that will require a rapid build-up of private-sector debt, which in turn is a recipe for – yet another – future financial crisis.

Overall, as I have explained before, this QE program will notch the euro yet another inch or two toward its grave. And just to make sure there is enough certainty about where the euro is heading, the other day the the EU Observer reported that Greece may be allowed to exit its tough austerity program – without having solved its underlying macroeconomic problems:

A legal opinion by the EU top court and comments by the EU economics commissioner about the end of the bailout troika have come just days before elections in Greece, where troika-imposed austerity is a central issue. … EU economics commissioner Pierre Moscovici on Monday (19 January) … said the “troika should be replaced with a more democratically legitimate and more accountable structure based around European institutions with enhanced parliamentary control”. Moscovici added that the troika “was useful and necessary” at the height of the crisis, “but now I think we need another step.” His comments come just a week after a legal opinion by the general advocate of the European Court of Justice said that the European Central Bank should not oversee reforms of countries it helps via Outright Monetary Transactions, a bond-buying scheme coupled with structural reforms modelled on what the troika has done in bailed-out countries.

In other words, the ECB can no longer come with cash in one hand and demands for austerity in the other. It has to choose either. Since the ECB has chosen to come with money, this means an end to austerity demands.

In reality this is a carte blanche to euro-zone governments in, e.g., Greece to get back to the old days of spending. The ECB promises to buy its treasury bonds, the austerity protesters in, e.g., Syriza have in the public opinion won the argument over austerity, and the ECB is desperate to see some kind of life sign in the European economy. This is a perfect storm for a massive increase in government spending.

This is, of course, exactly the wrong recipe for the European economy. Nevertheless, this is how the game is set up. More government spending, more money printing – until the euro is in so bad shape that it collapses into junk status and goes the same way the Reichsmark did in Weimar Germany.

The cold, hard, bottom line here is that government spending, bankrolled with monetary printing presses, does not create productive economic activity. All it does is dig the economy further into the same hole into which it has been slowly sinking for the past six years.

The ECB has given up. They are not even trying to play defense anymore.

This is the beginning of the end of the euro.

Euro-QE Would Be Big Mistake

How much time does the euro have left? That question was put on its edge last week when the Swiss National Bank decided it was no longer going to anchor the Swiss franc to the iceberg-bound euro ship. It was a wise decision for a number of reasons, the most compelling one being that the euro faces insurmountable challenges in the years ahead.

In fact, the Swiss decision was de facto a death spell for Europe’s currency union. More specifically, I noted that the euro

survived the Greek depression of 2012 by a razor-thin margin. Now it faces three very serious threats to its own survival. The first is the upcoming Greek elections, where anti-austerity, anti-euro, pro-Hugo Chavez Syriza looks like winners. Should they emerge victorious they could very well initiate a Greek exit from the currency union. The euro would survive that, and the German government has a contingency plan in place to stabilize the euro. But then there is the Greek government debt… Syriza has openly declared that they want “debt forgiveness” for governments throughout Europe. If the drachma is reintroduced, it will very likely plummet vs. the euro, making it exceptionally difficult for Syriza to repay its loans to the EU and the ECB. A default is within the realm of the probable; remember the Greek “debt write down” three years ago.

If all the problems for the euro were tied to Greece, the currency would indeed have a future. But there are so many other challenges ahead for the common currency that nothing short of a miracle – or unprecedented political manipulation – can keep it alive through the next three years.

The biggest short-term problem – Greece aside – is the pending announcement by the ECB of its own Quantitative Easing program. Reuters reports:

The European Central Bank will announce a 600 billion euro sovereign bond buying program this week, money market traders polled by Reuters say, but they also believe this will not be enough to bring inflation up to target. In the past two months traders have consistently predicted that the ECB would undertake quantitative easing, considered the bank’s final weapon against deflation. Eighteen of 20 in Monday’s poll said the bank would announce QE on Thursday.

This highly anticipated European QE program must be viewed in its proper macroeconomic context. It is going to be very different from the American QE program. For starters, the balance between liquidity supply and liquidity demand was very different in the U.S. economy than it is in the euro zone today. After its initial plunge into the Great Recession the American economy slowly but relentlessly worked its way back to growth again. Since climbing back to growth in 2010 the U.S. GDP has grown at a rate slightly above two percent per year. This is not something to throw a party over, but it has allowed the economy to absorb much of the liquidity that the Federal Reserve has pumped into the economy.

By being able to absorb liquidity, the U.S. economy has avoided getting caught in the liquidity trap. Growth rates have been good enough to motivate businesses to increase investment-driven credit demand; households have gotten back to buying homes and automobiles (car and truck sales in 2014 were almost as good as in pre-recession 2006).

The European economy does not absorb liquidity. It is stagnant, and has been so for three years now. The ECB has pushed its bank deposit rate to -0.2 percent, in other words it is punishing banks for not lending enough money to its customers. Despite this ample supply of credit there are no signs of a recovery in the euro zone, with GDP growth having reached the one-percent rate once in three years.

In other words, the positive outlook on the future that motivates American entrepreneurs and households to absorb liquidity through credit is notably absent in the European economy. When the ECB now evidently plans to pump even more liquidity out in the economy, it appears to not understand how significant this difference is between the euro zone and the United States.

Or, to be fair, with all its highly educated economists onboard, the ECB most certainly understands what role liquidity demand plays in an economy. Its pending decision to launch a QE program appears instead to be based in open ignorance of the lack of liquidity demand.

Which leads us to ask why they would ignore it.

The answer to this question is in the declared purpose of the QE program. If it is aimed at buying treasury bonds, then the QE program clearly is not designed to re-ignite the economy, an argument otherwise used. If QE is supposed to monetize government deficits, then its purpose is really to secure the continued existence of the European welfare state. If that is the purpose, then the only safe prediction is that there will be no end to QE before the welfare state ends.

That, in turn, means the ECB would be stuck monetizing deficits for the rest of the life of the euro. Which, under such circumstances, would be a relatively short period of time…

More on this on Thursday, when the ECB is expected to announce its QE program. Stay tuned.

Europeans Are Still Unemployed

The production of macroeconomic data from the European Union for the last two quarters of 2014 is a bit slow. The main source, Eurostat, took until last week to release GDP data for the third quarter, though that was under ESA 2010 standards. We are still waiting for the “modernized” versions to be released.

According to the “older” series, which I reported on last week, economic stagnation continues to hold Europe in an unforgiving chokehold. A look at unemployment statistics – which is updated faster than national accounts data – confirms this picture:


Regardless of what configuration Europe is given – the EU as a whole or the euro zone – its unemployment rate is not where it should be. Before the Great Recession, U.S. unemployment was almost half of what it was in Europe; after a brief period of declining jobless rates, Europe experienced a long period of unrelenting increase. In fact, as Figure 1 shows, European unemployment has been creeping upward for five years, from mid-2008 to mid-2013.

It remains to be seen if 2013 actually was the peak, and if 2014 represents the beginning of a long-term decline. There is no underlying trend in GDP or any of its individual components to hint of a real recovery. Here, the European economy stands in stark contrast to the U.S. economy, where unemployment has been falling, albeit slowly, since 2010.

All is not dark as night in Europe, though. Some countries have seen a drastic decline in unemployment since the peak. Measured from the first quarter of 2013 through the third quarter of 2014, the unemployment rates in…

Hungary fell by more than a third;

Lithuania declined by almost one third;

Estonia, Poland and Portugal have plummeted by about one quarter;

Bulgaria, Czech Republic and the U.K. are down by just over one fifth.

Despite these reductions, rates are still disturbingly high in many countries. Here are the EU member states with an unemployment rate higher than the U.S. rate of 6.2 percent:

Unemployment, EU States, Q3 2014
Greece 25.6 Slovenia 9.3
Spain 23.7 Lithuania 9.1
Cyprus 16.1 Belgium 8.7
Croatia 15.7 Poland 8.2
Portugal 13.3 Estonia 7.5
Slovakia 12.9 Finland 7.5
Italy 11.8 Hungary 7.4
Ireland 11.3 Sweden 7.2
Bulgaria 10.8 Denmark 6.5
Latvia 10.6 Romania 6.5
France 9.9 Netherlands 6.4

While it is good to see that “only” a quarter of all Greeks were unemployed in Q3 2014, as opposed to 28 percent a year ago, it should also be noted that unemployment was lower in 2012 when their economy was plunging like the Titanic after she hit the iceberg. In Q3 2012 the Greek unemployment rate was 25 percent exactly.

Spain, with Europe’s second-highest unemployment rate, saw its peak in early 2013 at 26.9 percent. They are now back where they were in 2012, but the decline is very, very slow.

Cyprus is actually still in the phase where unemployment is increasing. It is unclear if the same is true for Croatia, where unemployment has been fluctuating between 14 and 18 percent – averaging 16.6 – over the past three years. What is clear, though, is that there is no downward trend in the Croatian unemployment rate.

Fifth on the list is Portugal, where unemployment topped at 17.8 percent in Q1 2013 and has been moving down very slowly since then. To their credit, the Portuguese have seen a slow improvement in GDP growth, from an annual, inflation-adjusted rate of -1.4 percent in Q2 2013 to one percent in Q3 2014. Greece and Spain have seen similar improvements:

2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3
Greece -4.2% -2.6% -3.1% -0.4% 0.4% 1.9%
Spain -1.5% -0.5% -0.1% 0.7% 1.3% 1.7%

The Spanish improvement is predominantly driven by exports. The same is ostensibly true for Greece and Portugal as well, in which case the case for a lasting improvement is basically non-existent. A more detailed examination of national accounts data will give us a more detailed picture (stay tuned).

The small decline in Europe’s notoriously high unemployment reported above is far too weak, far to little to indicate anything beyond a temporary easing of the social and economic pressure that comes with large segments of the labor force being unemployed for years.

Swiss Predict Euro Demise

This week the Swiss central bank did the right thing and let go of the Swiss franc’s peg to the euro. The result was a massive appreciation of the franc, primarily vs. the euro. Though the move was not entirely unexpected, there have been a lot of speculations as to why the Swiss did it now.

The answer is not very complicated. The Swiss have grown increasingly uncomfortable with the fixed exchange rate vs. the euro, especially since the ECB:

a) pledged to buy every single treasury bond from every single euro-zone country; and

b) started pumping money out in the hot air to “stimulate spending” in the perennially stagnant euro zone.

International investors, rightly interpreting these reckless measures as the ECB playing desperate defense against the tides of macroeconomics, have taken refuge in the Swiss financial markets. To defend the peg against the euro, the Swiss National Bank (SNB) has been forced to print unhealthy amounts of new money.

There finally came a point where the SNB gave up on defending the peg. When they did they effectively acknowledged that major global financial investors have called it right: the future of the euro is limited.

More on the actual threats to the euro in a moment. First, let us take a look at a couple of interesting factoids that help explain what the SNB did this week.

In order to defend a fixed exchange rate, a central bank must constantly buy and sell its own currency on the international currency market. In this case the Swiss franc was in higher demand than the euro, which forced the SNB to sell large amounts of Swiss francs on the currency market. To do so, they had to print large amounts of money, far more than is needed to keep the Swiss economy fully liquid. Figure 1 below illustrates the excess increase in Swiss money supply over the past few years; first, though, let us note that current-price GDP has been growing virtually on par in Switzerland and the euro zone:

  • Average current-price GDP growth in the euro zone, from 2008 through 2013, was 1.2 percent;
  • Average current-price GDP growth in Switzerland, from 2008 through 2013, was 1.9 percent.

This is a notable difference, but not nearly enough to explain why the SNB has been printing money much more fiercely than the ECB. Figure 1 illustrates the money growth parity in Switzerland and in the euro zone – defined as M1 growth rate less current-price GDP growth:

Euro CHF

In other words, when we subtract current-price GDP growth from M1 money supply growth, we find that the Swiss M1 growth parity has far exceeded the euro parity since 2008. Since current-price GDP growth represents growth in transactions demand for money – i.e., money to keep the economy monetized and liquid – any growth in money supply beyond current-price GDP is a sign of either of two phenomena: irresponsible funding of government debt, or a desperate attempt at keeping currency speculators and financial investors at bay.

The euro-zone’s excess M1 growth is the result of the former; the Swiss parity is the result  of the latter.

During 2014 the SNB has cut down on money printing – annualized M1 growth rates per month have been less than four percent – and thereby signaled that it would, sooner or later, give up on its exchange-rate peg vs. the euro.

That has now happened. Speculators are free to rake in their currency-appreciation gains, but more importantly: investors have established their concerns about the future of the euro. Which brings us back to the limited life span of that currency. Once launched as the new gold standard of the world, the euro has fallen from the skies, badly wounded by reckless money printing.

It survived the Greek depression of 2012 by a razor-thin margin. Now it faces three very serious threats to its own survival. The first is the upcoming Greek elections, where anti-austerity, anti-euro, pro-Hugo Chavez Syriza looks like winners. Should they emerge victorious they could very well initiate a Greek exit from the currency union. The euro would survive that, and the German government has a contingency plan in place to stabilize the euro. But then there is the Greek government debt… Syriza has openly declared that they want “debt forgiveness” for governments throughout Europe. If the drachma is reintroduced, it will very likely plummet vs. the euro, making it exceptionally difficult for Syriza to repay its loans to the EU and the ECB. A default is within the realm of the probable; remember the Greek “debt write down” three years ago.

If Greece can get away from its debt vs. the EU and the ECB by exiting the euro, it sets a precedent for other heavily indebted countries on the southern rim of the currency area. That creates a standing threat of further destabilization of the euro – and weakens the reliability of the currency.

The second reason why the euro has a limited future lies in the ECB’s intentions to launch a formal Quantitative Easing program. De facto already in place with the treasury purchase guarantee, this formalization would involve the ECB directly in funding the issuance of new government debt (the current pledge is “only” about buying existing debt). This effectively removes any incentives that national governments have in place to keep any tabs on their borrowing.

The Stability and Growth Pact formally enforces a deficit cap of three percent of GDP, but that pact has already hit an iceberg it can’t recover from. The Pact, namely, bans euro zone countries from bailing out each other – something the Germans violated years ago by helping the EU and the ECB to bail out Spain, Greece and Portugal – and it also prevents the ECB from, yes, Quantitative Easing.

With two of the three pillars of the Pact already destroyed, what reasons do euro-zone governments have to abide by the third pillar, especially if the ECB is going to bankroll all the debt  those governments may want to issue?

The third reason for a limited euro future is the French 2017 presidential election. If Marine Le Pen wins, she will pull France out of the currency union. With the second largest economy exiting there is no longer a reason for anyone else to stay in.

Switzerland once again serves as a safe haven for global investors. But the end of QE here in the United States, together with our slow but steady recovery, allows the dollar to shoulder some of that burden. The more the euro shakes and rattles, the stronger the dollar will become.

It is basically a done deal that the euro will end. All we can hope for is that it will be a peaceful exit under stable, predictable circumstances.

Europe’s Long Economic Decline

Earlier this week I explained how Europe has, institutionally, set itself up for a long-term decline in growth. The Stability and Growth Pact should take a lot of blame for this, as it comes with a built-in bias in favor of contractionary fiscal policy. But it is not just any type of contractionary policy that is favored by the Stability and Growth Pact: it is contractionary policy aimed at balancing the government budget – regardless of all other policy goals.

To be clear, there are two types of contractionary fiscal policy:

  • So called “statist austerity” aims at balancing the government budget with the explicit or implicit purpose to keep government spending programs as intact as possible under tighter economic conditions;
  • So called “free market austerity” where the goal is to shrink government spending with the explicit purpose of permanently reducing the size of government.

The two forms employ different policy strategies. Statist austerity can include tax increases; the balance between spending cuts and tax hikes is determined primarily by practical and political considerations. These considerations typically supersede economic analysis: the execution of statist austerity typically takes place over a short period of time and upon short notice, such as looming panic among global investors over a government’s believed ineptitude in balancing the budget.

Free market austerity, on the other hand, aims solely at permanently shifting the balance between the private sector and government. This can be achieved if and only if:

a) government spending is permanently reduced; and

b) taxes are reduced proportionately to the reduction in spending.

As a result, the combination of changes in taxes and spending is entirely different than what is required under statist austerity. In terms of outcomes, the effects of free-market austerity on GDP growth are radically different from the effects of statist austerity: under the latter government actually increases its net claim on the economy, while under the former the private sector is given ample opportunity to expand.

By dictating budget-balancing requirements, the Stability and Growth Pact de facto mandates statist austerity in Europe. The logical outcome of this should be a long-term decline in GDP growth. There is lots of economic theory to draw on for this conclusion.


Figure 1

LB Europe 1 15

The growth rate reported in this figure is of the sliding-average kind (without a forecasting side), which shifts focus from periodic observations to trend observations. As the polynomial (third order) trend line indicates, the long-term path is unequivocally downward. In addition, growth peaks get weaker and shorter.

Perhaps the best evidence of the connection between the Stability and Growth Pact and this long-term trend can be found in the downturn after 2010. Annual growth in the fourth quarter of 2010 was 2.2 percent; a year later it was 0.2 percent and by Q4 2012 euro-zone GDP was shrinking by a full percent. It did not return to growth until the latter half of 2013, and then only at tepid rates below half a percent.

In fact, over the past three years – 12 quarters – euro-zone GDP growth has only been above one percent one single quarter. That was in Q1 2014. For Q3 2014 it expanded by a tiny 0.8 percent on an annual basis.

The relation between the institutional structure and the long-term decline in GDP growth is one of the most important reasons why I have come to the conclusion that Europe is stuck in a state of permanent economic stagnation – a state of industrial poverty – which it will not recover from until it reforms away its institutional barriers to a real economic recovery.

Europe Invented Statist Austerity

In December I took a first look at the European Commission’s “Report on Public Finances”, with the intention of returning to this important document later. It has been almost a month, longer than I expected, but here we are.

In my first review of the report I explained that the strict focus by Europe’s political leadership on government finances has led to a systemic error in their fiscal policy priorities:

Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.

This is a kind of prioritization that has guided European fiscal policy for two decades now. Under the Stability and Growth Pact, EU member states in general are forced to adopt a fiscal policy that inherently has a contractionary – austerity – bias. But it is not the kind of austerity that reduces the size of government. It is the kind that tries to shrink a budget deficit in order to keep government finances in good order and save the welfare state from insolvency.

So long as contractionary fiscal policy – austerity – is focused on balancing the budget and saving the welfare state, it won’t reduce the size of government. For that, it takes specifically designed austerity measures. Those measures are indeed possible, even desirable, but they cannot be launched unless government is allowed by its own constitution to prioritize less government over a balanced budget.

Unfortunately, the Stability and Growth Pact does not permit that member states prioritize shrinking government over budget balancing. Instead, the Stability and Growth Pact forces them to always pay attention to deficits and debt, but never worry about running too large surpluses. Part A of the Pact caps government deficits at three percent of GDP and debt at 60 percent of GDP. At the same time, there are no caps on budget surpluses; since a surplus is excess taxation, and since excess taxation drains the private sector for money in favor of a government savings account, this means that governments can drain the private sector for all the money it wants to without violating the European constitution.

Unlike a budget surplus, which is contractionary in nature, a budget deficit is, at least in theory, always stimulative. However, by capping deficits the European constitution restricts the stimulative side of fiscal policy, while at the same time leaving the contractionary end unrestricted.

In addition to the technical aspects of this contractionary bias, there is also the political mindset that is born from a legislative construct of this kind. Lawmakers and elected cabinet members – primarily treasury secretaries – are concerned with avoiding deficits, thus quick to resort to contractionary policy measures, but pay little attention to the need for counter-cyclical policies. Over time, this political mindset becomes “one” with the Stability and Growth Pact to the extent where parliaments do not think twice of passing budgets that impose harsh contractionary measures in order to balance a budget.

Think Europe in 2012. And read chapters 4a and 4b in my book Industrial Poverty to get an idea of how deep roots in Europe’s legislative mindsets that this “gut reaction” bias toward contractionary measures has actually grown.

With its contractionary bias, Europe’s fiscal policy has permanently downshifted growth in Europe. This in turn has perpetuated the budget problems that said contractionary policies were intended to solve. It left the European economy fragile and frail, vulnerable to a tough recession. All it took was the downturn in 2008-09 with its spike in deficits – and once the fiscal-policy gut reaction kicked in, there was nowhere to go for Europe other than into the dungeon of budget-balancing contractionary measures; statist-driven austerity; mass unemployment; and perpetual budget problems.

Never did Europe’s leaders think twice of trying to actually release its member states from the shackles of the Stability and Growth Pact. Never did they think twice of permitting a widespread downward adjustment of the size of government.

The Commission’s “Report on Public Finances” cements this statist approach to contractionary fiscal policy. It has an entire section that suggests further collaboration and coordination among EU member states on the fiscal policy front. So long as the Stability and Growth Pact remains in place, such coordination would be a thoroughly bad idea. All that such coordination would accomplish is to cement statist austerity as the prevailing “fiscal policy wisdom” ruling the economy that feeds 500 million people.

I will return in more detail to this report. In the meantime, do take a minute and read my paper Fiscal Policy and Budget Balancing: The European Experience. It is part of a five-paper series of discussion papers on the ups and downs of a balanced-budget amendment to the United States constitution.

Another Greek Debt Default?

Three years have passed since Greece simply nullified part of its debt. In the last quarter of 2011 the Greek government owed its creditors 356 billion euros; in the first quarter of 2012 that debt had been reduced to 281 billion euros, a reduction of 75 billion euros, or 21 percent. The banks that owned Greek treasury bonds were strong-armed by the EU and the ECB into accepting the debt write-down; ironically, that only added insult to injury as banks in, e.g., Cyprus started having serious problems as a result of precisely that same write-down.

As some of you may recall, a bit over a year after the Greek government unilaterally decided to keep some of the property lenders had allowed them to use – in other words wrote down their own debt – banks in Cyprus began having problems. Having invested heavily in Greek treasury bonds they had to take a disproportionately impactful loss on their lending to Athens. As a direct result the EU-ECB-IMF troika began twisting another arm: that of the Cypriot government. They wanted the government in Nicosia to order the banks in Cyprus to replenish their balance sheets with – yes – money confiscated from their customers.

That little episode of assault on private property is also known as the Cyprus Bank Heist.

Both these events, which exemplify reckless disrespect for private property and business contracts, make Bernie Madoff look like a Sunday school prankster. Unlike Madoff, government is established to protect life, liberty and property. But in both Greece and Cyprus government has voided property rights simply because it is the most convenient way at the time for government to fund its operations.

In other words, to protect the welfare state at any cost.

There were many of us who thought that Europe’s governments had learned a lesson from the massive protests against both the Greek debt write-down and the Cyprus Bank Heist. Sadly, that is not the case. Benjamin Fox, one of the best writers at EU Observer, has the story:

With fewer than three weeks to go until elections which seem ever more likely to see the left-wing Syriza party form the next Greek government, the debt debate has returned to the centre of European politics. Syriza’s promises to call an end to the Brussels-mandated budgetary austerity policies … are not new … But what is potentially groundbreaking is Syriza’s proposal to convene a European Debt Conference, modelled on the London Agreement on German External Debts in 1953 which wrote off around 60 percent of West Germany’s debts following the Second World War

Apparently, Syriza does not think twice about the actual consequences of their proposal. If it was carried out, it would have the same kind of effects on Europe’s banks as the last debt write-down. While there are no immediately reliable sources on how much of the Greek government debt is owned by financial corporations, we can get an indirect image from other euro-zone countries in a similar situation. In Spain, e.g., banks owned 54.3 percent of all government debt in 2013; in Italy the share was 55.6 percent while 41.2 percent of the French government were in the hands of financial corporations.

Adding up actual debt for these three countries, both total and the share owned by banks, gives us a financial-corporation share of almost exactly 50 percent. Using this number as a proxy for Greece, we can assume that banks own 160 billion of 320 billion euros worth of Greek government debt.

A Greek debt write-down according to the Syriza proposal would, if it cut evenly across the total debt, force banks to lose 86 billion euros. And this is under the assumption that, unlike the last write-down, banks are treated on the same footing as everyone else. Back then banks had to assume a bigger shock than other creditors.

The 2012 write-down was worth a total of 75 billion euros.

Has Syriza even taken into account that families, saving up for retirement, own treasury bonds? In Italy they own as much as ten percent of all government debt, a share that would equal 32 billion euros in Greece. But even if that number is five percent – 16bn euros – and you ask them to give up 60 percent of it, the impact on remaining private wealth in Greece would be devastating.

To make matters worse, Syriza does not confine their confiscatory dreams to their own tentative jurisdiction. Benjamin Fox explains that Syriza hopes that a write-down in Greece…

would lead to a huge write-down of government debt for … other southern European countries. The idea was initially mooted by Syriza leader Alexis Tsipras in 2012 when the left-wing coalition finished second in the last Greek elections. Roundly dismissed as fantasy for almost all the two years since then, the proposal is at the heart of the party’s campaign manifesto and Syriza insists it won’t back down if it wins the election.

In the three countries mentioned earlier, Italy, Spain and Greece, banks own a total of 2.47 trillion euros worth of debt. A 60-percent write-down of that equals 1.58 trillion euros. Compare that, again, to the total Greek write-down of three years ago of 75 billion euros.

In Italy alone households own 215 billion euros in government debt. Is the socialist cadre leading Syriza ready to rob them of 89 billion euros just to improve their government’s balance sheets? That would be 1,500 euros for every man, woman and child in Italy. Obviously, all of them do not own government debt, but the more concentrated the ownership is the bigger the impact will be on their economic decisions.

This is, for all it is worth, an idea of galaxy-class irresponsibility. If it ever became the law of the land in Europe it would set off a financial earthquake far beyond what the continent experienced in 2009. And I keep repeating this: all of this is under the assumption that banks will not be discriminated against – an assumption that is not likely to survive all the way to a deal of this kind. Europe’s socialists have a tendency to despise banks and consider them unfair, even illegitimate institutions. It is possible that Syriza, at least as far as Greece is concerned, would force banks to eat the entire write-down loss.

But is this really worth all the drama? After all, the Greek election is three weeks out. Benjamin Fox notes that “Syriza is so close to taking power that the proposal deserves to be taken seriously.”

This debt write-down is part of a broader plan that Syriza has put in place for the entire European Union. To work at the EU level the plan would have to be more complex and involve a series of transactions involving the European Central Bank that, frankly, amount to little more than macro-financial accounting trickery. At the end of the day, those who have lent money to Europe’s governments would make losses worth trillions of euros.

As things look today it is not very possible that Syriza would have it their way across the EU. But it is almost certain that they will go ahead and do it in Greece. What the ramifications would be for the Greek economy is difficult to predict at this point – suffice it to say that the storm waves on the financial ocean that is the euro zone will rise again, and rise high, if Syriza wins on January 25.

Monetary Madness in Europe

On Monday, in an analysis of the ECB’s declared intentions to monetize government deficits and the apparent desire to get the wheels going again in the European economy, I wrote that:

Unless the ECB is planning to buy bonds directly from European consumers, there is no direct connection between Draghi’s bond purchases and consumer spending. If he is hoping to depress interest rates even further and thereby stimulate consumption, then he has very little to play with. In most euro-zone countries interest rates are plunging toward zero – credit is practically available for free.

My comment about consumers was a bit tongue-in-cheek; it should be apparent to everyone, I thought, that handing out cash to consumers is not the way to go if you want more growth, more jobs and more prosperity.

Apparently, I had missed out on just how desperate – or economically ignorant – well-educated people can get. Alas, from Der Spiegel:

It sounds at first like a crazy thought experiment: One morning, every resident of the euro zone comes home to find a check in their mailbox worth over €500 euros ($597) and possibly as much as €3,000. A gift, just like that, sent by the European Central Bank (ECB) in Frankfurt. The scenario is less absurd than it may sound. Indeed, many serious academics and financial experts are demanding exactly that. They want ECB chief Mario Draghi to fire up the printing presses and hand out money directly to the people.

This is being done on a daily basis. Tens of millions of working-age Europeans receive cash directly from government through all sorts of cash entitlements. In 2012 the governments of the 28 EU states handed out 2.37 trillion euros in cash benefits to its citizens. That was an increase of 288 billion euros, or 12.1 percent, over 2008.

In Spain the increase was 15.8 percent, while the economy was in complete tailspin. Greek cash entitlement handouts grew by 11.7 percent; during the same time period the Greek economy shrank by one fifth in real terms.

What some thinkers in Europe are now proposing is, for all intents and purposes, the same kind of cash entitlement program, only with a short-cut administration process: instead of governments borrowing the money from the ECB and then handing it out as entitlements, the ECB should simply send the checks directly to people.

It has not worked when done the traditional way; but shame on those who give up on a hopeless idea – maybe if we print just a little bit more money, and send it to just a little bit more people, then all of a sudden the free cash won’t have the same work-discouraging effect it currently has. If we just churn out a bit more newly printed money, we will find that sweet spot when people start spending like mad dogs.


Back to Der Spiegel:

Currently, the inflation rate is barely above zero and fears of a horror deflation scenario of the kind seen during the Great Depression in the United States are haunting the euro zone. … In this desperate situation, an increasing number of economists and finance professionals are promoting the concept of “helicopter money,” tantamount to dispersing cash across the country by way of helicopter. The idea, which even Nobel Prize-winning economist Milton Friedman once found attractive, has triggered ferocious debates between central bank officials in Europe and academics.

In addition to the fact that proponents of this ludicrous idea won’t learn from existing examples, there is also the tiny little nagging thing called the Stability and Growth Pact – Europe’s constitutional debt and deficit control mechanism. The Pact consists of three parts:

1. Government debt cannot exceed 60 percent of GDP and government deficit cannot exceed three percent of GDP;

2. Member states cannot bail out each other in times of deep deficits; and

3. The ECB is banned from monetizing debt and deficits.

For a long time, member states have almost made a habit out of breaking the first rule. In recent years that has led to intervention from the EU, the ECB and the IMF, also known as the Troika, which has imposed serious austerity programs on those countries. The effect has, at best, been temporary and minor.

Germany broke the second rule when it participated in a bailout of Greece, and the ECB has been stretching the third rule time and time again by its participation in member-state bailouts. If this cash entitlement program goes into effect, it will drive a dagger through the heart of the last, remaining piece of the Stability and Growth Pact.

Der Spiegel is not too concerned with the consequences of the Pact falling apart. Instead, their article centers in on the fight against deflation, a battle that the ECB is not winning:

Draghi and his fellow central bank leaders have exhausted all traditional means for combatting deflation. The failure of these efforts can be easily explained. Thus far, central banks have primarily provided funding to financial institutions. The ECB provided banks with loans at low interest rates or purchased risky securities from them in the hope that they would in turn issue more loans to companies and consumers. The problem is that many households and firms are so far in debt already that they are eschewing any new credit, meaning the money isn’t ultimately making its way to the real economy as hoped.

And the bright minds at the ECB headquarters in Frankfurt did not realize this before they bing lending to banks? Of course they did. They just refused to see the causality between a recession, high household debt and the inability of said households to afford more debt.

Somehow they must have thought that if only you print money fast enough, credit scores won’t matter.

Anyway. Back to the helicopter cash idea and its prominent backers in the highly sophisticated world of advanced economic thinking:

In response to this development, Sylvain Broyer, the chief European economist for French investment bank Natixis, says, “It would make much more sense to take the money the ECB wants to deploy in the fight against deflation and distribute it directly to the people.” Draghi has calculated expenditures of a trillion euros for his emergency program, funds that would be sufficient to provide each euro zone citizen with a gift of around €3,000. Daniel Stelter, founder of the Berlin-based think tank Beyond the Obvious and a former corporate consultant at Boston Consulting, has even called for giving €5,000 to €10,000 to each citizen.

If this is such a good idea, why stop there? Why not crank it up to 50,000 euros? A hundred grand? What is keeping them back?

As an addition to the magnanimous disregard for basic economic theory that is fueling the monetary helicopter:

Many academics have based their calculations on experiences in the United States, where the government has in the past provided cash gifts to taxpayers in the form of rebates in order to shore up the economy.

It is one thing to let people keep more of what they have already earned. It is an entirely different thing to give them what they have not earned. When people get a tax refund they have already been productive, they have already participated in the production of total output in the economy. When people are given a handout they have not earned, they do not participate in that same production process, partially or entirely.

Cash handouts discourage workforce participation. It does not matter if it is a one-time event or a permanent entitlement program: the effect is the same, differing only in how long it lasts. When people reduce their workforce participation they increase their demand for other entitlements as well. That effect is small for temporary cash handouts, but consider what will happen in low-income families if, as a pundit quoted above suggested, the ECB gave away 5,000 or 10,000 euros per resident. A family of four would suddenly have 20-40,000 in extra cash.

How likely is it that both parents in that family will continue to work for the next year, when they just got more cash than one of them earns in a year (after tax)?

More cash in consumer hands and less workforce participation is a recipe for rising prices. Which, one should note, is just the intention behind this program. European economists and politicians are paralyzed with fear over the imminent threat of deflation. They will do whatever it takes to get inflation up to the two percent where the ECB would like it to be.

The problem is that if they succeed in causing inflation, it is going to be a rapid spike, i.e., an upward adjustment of prices very early in the spending cycle that the ECB would stimulate with its cash entitlement program. Retailers and manufacturers, squeezed by seven years of economic stagnation, will be quick to raise prices when they see a reason to do so. The price jump will eat up a large share of the consumption stimulus that helicopter proponents expect. As a result, the effect on jobs will be modest, if even visible.

Because of the inflation bump there will not be any lasting effect of this stimulus. It will be a blip on the GDP radar. The risk, however, is that the higher prices linger, thus putting pressure on money wages across Europe. It probably would not be a serious issue, but it would most likely eradicate any remaining stimulative effects of the helicopter entitlement program.

In other words, it is hard to find reliable transmission mechanisms to take the European economy from where it is today to a recovery simply by doing a one-time cash carpet bombing of the economy.