More signs of desperation out of Europe. Der Spiegel reports:
The European Central Bank wants to spur lending by banks in Southern Europe, but conventional methods have shown little success so far. On Thursday, ECB officials will consider monetary weapons that were previously considered taboo.
The only way to get the European economy going again is to cut taxes, phase out the welfare state and build economic freedom from the ground. But that is about the last thing the clowns in Brussels and Frankfurt want to hear, because in their world, shrinking government – like eating children – is wrong.
Der Spiegel again:
From Mario Drahgi’s perspective, the euro zone has already been split for some time. When the head of the powerful European Central Bank looks at the credit markets within the currency union, he sees two worlds. In one of those worlds, the one in which Germany primarily resides, companies and consumers are able to get credit more cheaply and easily than ever before. In the other, mainly Southern European world, it is extremely difficult for small and medium-sized businesses to get affordable loans. Fears are too high among banks that the debtors will default.
Now, please pay attention to this. We have been told for more than four years now that the current crisis was caused by banks engaging in irresponsible lending. We have been told that it was their credit losses that somehow brought the global economy into a recession and hurled parts of Europe into a depression.
You’d think that with this in mind, with a depression that has wiped out tens of millions of jobs and sent youth unemployment above 20 percent in 20 countries, the last thing that the European Central Bank would wish for is another round of reckless lending.
Well, in a world governed by common sense that would certainly be true. But today’s Europe is not governed by common sense. It is governed by uncommon senselessness. Der Spiegel again:
For Draghi and many of his colleagues on the ECB Governing Council, this dichotomy is a nightmare. They want to do everything in their power to make sure that companies in the debt-plagued countries also have access to affordable loans — and thus can bring new growth to the ailing economies. The ECB has already gone to great lengths to achieve this objective. It has provided the banks with virtually unlimited high credit and drastically lowered the collateral required from the institutions. The central bank has also brought down interest rates to historical lows. Since early November, financial institutions have been able to borrow from the ECB at a rate of 0.25 percent interest. By comparison, the rate was more than 4 percent in 2008.
Private businesses in Greece, Spain, Portugal and the other worst-hit countries are considerably smarter than the big wigs who run the ECB. They are not lending, because they know that in an economy like the Greek one, where GDP has been shrinking for five years in a row, or the Portuguese where GDP is as big today as it was ten years ago, there simply is no market for new investments and business expansion. If anything, business still need to downsize. Which, as Der Spiegel reports, they are still doing:
The only problem is that all those low interest rates have so far barely been put to use. Lending to companies in the euro zone is still in decline. In October, banks granted 2.1 percent less credit to companies and households than in the same period last year.
Apparently willing to ignore elementary banking theory, Mr. Draghi and the Central Bankers are searching for new policy measures. According to Der Spiegel, their search is taking them to the most obscure closets in the ECB attic:
In other words, they want banks to pump more liquidity into the euro-zone economy. Let’s remember that this is an economy that has been flooded with liquidity over the past few years. One liquidity flood gate is the M1 money supply, which is growing at a speed that is about four times as high as the rate of growth in euro-zone GDP. Another is the bond bailout program where the ECB has pledged to buy any amount of government bonds, for any euro-zone welfare state deemed in trouble.
Now they want to send even more liquidity into an already over-liquified euro-zone economy. But what has not worked yet will not work better now just because it is tried a third time. Instead, this will lead to excess amounts of liquidity floating around in the banking system, which history tells us is a great beginning of a great speculation disaster.
But as Der Spiegel explains, this is not all that the ECB has in mind:
The ECB already lent a helping hand to banks with long-term, cheap loans at the end of 2011 and during early 2012, lending financial institutions a total of €1 trillion for the exceptionally long period of three years — a step it has so far only taken one time. Central bank head Draghi spoke at the time of using “Big Bertha,” a reference to a World War I-era howitzer, to battle the crisis. … [The] ECB is still thinking about a new form of long-term credit. Only this time, the loans would only have a term of one year and they are also supposed to have a specific purpose affixed to them. Banks would only be able to obtain the cheap money if they obliged themselves to pass that money on to companies.
And why would banks want to do that when they are already sitting on more idle cash than they have use for?
But wait – there is more:
The ultimate means the ECB has for keeping market interest rates low is to purchase large quantities of bonds from investors. Other central banks including the Fed in the United States, the Bank of England and the Japanese central bank are already using this instrument more or less successfully. The idea behind “quantitative easing” is that a central bank purchases government or company bonds on the market and, by doing so, drives down prices — e.g. interest rates.In contrast to the ECB’s previous bond buying, the new program would not be aimed at easing financing for individual countries.
Somehow the boneheads at the ECB seem to believe that all the euro zone lacks is access to credit. You’d think they would take into account the fact that there is absolutely no growth in any macroeconomically relevant sector of the economy. You’d think that when consumer spending is standing still; when corporate investment is standing still; when unemployment is still slowly trending upward; you’d think they would get the picture. But no. Somehow Mr. Draghi and the Central Bankers got to where they are now in their careers while harboring the delusion that a shrinking or stagnant economy will get started again if more people go into more debt.
I somehow suspect that this is the result of an over-consumption of Austrian economic theory, but I will leave that topic for a later discussion. What matters here and now is that the ECB’s tentative plans to open yet more liquidity floodgates is a big sign of the political desperation that is spreading through the government hallways of Europe.
Desperate people do desperate things. When the desperate people are politicians with a lot of power, the consequences of their desperate actions can be devastating. It remains to be seen what more destruction Europe’s leaders can bring to their continent than they already have (please wait patiently to early 2014 and you will be able to get a full picture of Europe’s disaster in my new book “Industrial Poverty”) but given what the ECB is now contemplating, we have to assume that anything is possible and nothing is impossible.
The original idea with modern government was to provide protection for life, liberty and property. Later on, partly thanks to social conservatives, the first seeds of the welfare state were planted. Among the earliest entitlement programs were public education, retirement benefits and poverty relief. From the Preussan income-security model under Bismarck the radical left got their ideas for the first cornerstones of the modern welfare state.
Over the course of the latter half of the 20th century, governments in the industrialized world ran amok with their welfare states. As I explain in my forthcoming book “Industrial Poverty” (due out early 2014) this has now led to a situation where government is causing a new form of poverty under a depressing regime of perennial economic stagnation.
This long-term change of the role of government calls for intense debate, carefully executed research and just in general a lot of scrutiny of what government is doing to our societies, our economies – and the entire Western Civilization.
Part of that scrutiny lies in the hands of those who monitor the financial health of government. Independent credit rating institutions, such as Standard & Poor, Moody’s and Fitch, are at the forefront of this business. Their job is to inform its clients and, indirectly, the general public of how well – or how poorly – government is managing its finances.
This may seem to be a business totally unrelated to the broader change of the role of government I just discussed. However, the relation is much closer than most people think: the bigger and more economically burdensome a government becomes, the more likely it is to be a bad steward of taxpayers’ money.
On top of that, as we have seen over the past couple of years it is dramatically important that we have credit rating institutions that can tell us when a government is reaching the end of its credit line. We know from the partial Greek debt default that governments do indeed default on their debt, and that lending to them is no longer a risk-free affair. The reason for this is, again, that government has sprawled in all possible – and impossible – directions, with piles of spending commitments that it could never afford.
By constantly monitoring the finances of our governments, these credit rating institutions keep the elected officials of our modern welfare states on their toes. Our politicians should take their ratings seriously and do their best to avoid being downgraded.
Instead there have been initiatives, primarily in Europe, to discredit or legislatively intimidate the credit rating industry. This new and rather ugly trend in politics has its origin in the fact that several welfare states have lost their stellar AAA rating in recent years. Politicians who are used to being able to do essentially what the heck they want, suddenly find themselves facing an industry they have a very hard time dealing with. Like an elephant in a china shop, they continue to behave as if they were above all checks and balances. Euractiv.com reports:
The “Big Three” agencies that rate European Union government debt could be fined after failing to fix poor practices from the past, the sector’s regulator said on Monday (2 December). Credit ratings are a key part of the financial system, helping investors assess the likelihood that they will recoup their money. But the financial crisis led to unease that the market is relying to heavily upon them.
Nonsense. This was the first time governments got knocked by these rating institutions. Thin-skinned politicians who take themselves far too seriously could not live with the criticism. Instead they went after their critics. Euractiv again:
The European Securities and Markets Authority (ESMA) published results of an investigation into how Moody’s, Standard & Poor’s and Fitch compiled ratings on sovereign bonds between February and October this year. ESMA is the EU agency responsible for authorising and supervising rating agencies in EU countries, some of which have objected strongly to their ratings by agencies.
Let’s note that the regulator of credit rating here is the same entity whose credit will then be rated. Imagine if we individuals could determine how Equifax, TransUnion etc rate our credit…
Sovereign ratings became politically charged at the height of the euro zone crisis when S&P infuriated Greece in 2011 by cutting the rating of its debt while the country’s EU bailout was being renegotiated. This led to the third of three EU laws to regulate rating agencies in as many years. From next month, the agencies can only release changes to sovereign ratings according to a pre-set calendar to improve transparency.
There is nothing wrong with how S&P handled the Greek situation. The bailout did not solve the crisis; it did nothing to alter the course of the crisis and only served the purpose of prolonging an already unsustainable situation. To use that as a reason for regulatory changes to the ratings industry is to go after the kid who points our that the emperor has no clothes.
“ESMA’s investigation revealed shortcomings in the sovereign ratings process which could pose risks to the quality, independence and integrity of the ratings and of the rating process,” ESMA Chairman Steven Maijoor told reporters. “They should speed up their processes and make sure they get their house in order.”
What shortcomings? More than likely, this is bureaucrat-speak for changes to what these rating institutions can and cannot say, with the explicit purpose to make sure government can continue to borrow money without risking credit downgrades. This would correlate well with some of the Basel III regulations that the world’s welfare states have imposed on the financial industry.
The latest news on the U.S. fiscal crisis is that President Obama is changing is mind on negotiations with Congressional Republicans. The man who would rather negotiate without preconditions with Iran’s Islamist thug regime than democratically elected American legislators has been pushed to the negotiation table by the looming threat of October 17. That is the date when, according to the Obama administration, the U.S. Treasury runs out of money and will default on its debt. Therefore, in order to avoid having to do the unconstitutional, namely to not make debt payments, Obama chooses to sit down with the only people on the face of the planet that he would never negotiate with.
In theory, if the president had ordered the Treasury not to make debt payments he could have been impeached. We will not know for a long time what has been going on behind the scenes in DC over the past couple of weeks, but it is noteworthy that the president suddenly decided that it was better to show a glimpse of leadership on the federal budget situation. It is an open question what the outcome will be, but at least there are talks and different views are being vetted, allowed to clash and then pave the way to an informed compromise. It may not be the best compromise in terms of fiscal policy, but the very fact that there is a vigorous debate in Washington, DC – and that the sides involved can take such harsh stances that the federal government shuts down for a while – is ultimately a sign that the American constitutional republic is in fact working.
As I explained recently, while the Europeans may be laughing at the American “bickering” and government shutdown, their own fiscal house is far from in good order. While there is a hot political fight over how to get the U.S. debt under control, the Europeans seem to have given up entirely on that front. Consider these numbers from Eurostat, reporting changes in debt-to-GDP ratio from first quarter of 2011 to first quarter of 2013:
Source: Eurostat; seasonally adjusted numbers.
Over the past two years, 23 out of the EU’s 27 member states (not counting rookie member Croatia) have increased their debt-to-GDP ratio. Portugal is worst: in the first quarter of 2011 their government debt was 95.1 percent of the Portuguese GDP; in the first quarter of 2013 it was 127.2 percent of GDP, an increase by 32.1 percentage points in two short years.
For the EU-27 as a whole, debt has increased from 80.2 percent to 85.9 percent. This is partly due to the fact that almost all of Europe’s economies are standing still, but the main reason is of course that the variables that drive spending in Europe’s welfare states are still in place. Much of government spending in a welfare state is on autopilot, driven by eligibility variables in entitlement programs. In Denmark, e.g., conventional wisdom among economists is that the legislature can directly affect about three percent of the annual government budget – the rest is governed primarily by welfare-state entitlement programs.
Needless to say, there is a connection between a GDP that stands still and a welfare state that has to dole out more money through its entitlement systems. But this only reinforces the point that Europe has a big debt problem: if structural spending systems run away with the government budget, you don’t sit around with your arms crossed. You dismantle those spending systems.
If you don’t, you will keep on borrowing. Which, again, is precisely what the welfare states in Europe do. Of the 27 EU states, 25 increased their debt in euros – only Hungary and Greece had a nominally smaller debt in Q1 of ’13 than in Q1 of ’11 – and the decline in the Greek debt was entirely due to the partial default almost two years ago. In terms of growth, their debt is back on an out-of-control path.
In total, the 27 EU states have borrowed another 1.1 trillion euros over the past two years. Five countries now have a debt that exceeds 100 percent of their GDP: Greece, Italy, Portugal, Ireland and Belgium. This is compared to two countries, Greece and Italy, two years ago. France is heading in that direction, with a ratio that has increased from 84 percent in 2011 to 92 percent today.
These are all bad numbers. But what is worse is that there is no debate in Europe about how to stop this debt growth. The austerity policies put in place by the EU, the ECB and the IMF have been embraced as fiscal policy gospel by Europe’s political leaders. Since austerity has been in place for four years now in some countries, and since the outcome has been utterly disappointing, it is high time for Europe to reconsider its current path.
For that to happen, though, you need an open and honest debate. America has an open and honest debate. Europe does not.
Guess who will prevail in the end…
I recently expressed my deep concerns regarding the unstable political situation in Greece, concluding that the government’s attempt to ban or otherwise neutralize the neo-Nazi Golden Dawn party is a very risky game. while morally the right thing to do, and politically probably necessary, the potential for a violent backlash is very high. One reason is that many Golden Dawn supporters appear to be supporting the party because they want Greece out of either the currency union or both the EU and the euro.
Their motive is not hard to understand: it has now been five years since Greece entered the economic crisis, and at least four of those years have to the average Greek been dominated by EU-imposed austerity. In package after package, the EU, the ECB and the IMF have dictated bone-crushing spending cuts and prosperity-destroying tax hikes. Since Greece is a welfare state, government is deeply involved in almost every aspect of people’s lives. When it goes on an austerity rampage the effects are by necessity both far-reaching and painful for Greek families.
Today, Greece stands with one foot in the EU and one foot in social and economic chaos. Political extremism is growing, both in the form of terrorizing socialist political violence and growing political intimidation from Golden Dawn. At the same time, unforgiving austerity policies, aimed at stabilizing government debt, have been a complete and utter failure, Greece’s government budget is suffering from chronic deficits, partly because one quarter of the tax base, a.k.a., GDP, has vanished during the austerity years, and partly because a much larger portion of the Greek population depends on the welfare state now than was the case before the crisis.
The question is what the EU-ECB-IMF troika is going to do next. Before we seek an answer to that, let’s take a look at the Greek debt trajectory. This figure shows the Greek government’s debt as percentage of GDP per quarter since 2008:
The debt ratio rises steadily through 2011, then drops dramatically at the beginning of 2012. That is the point when the Greek government, aggressively “encouraged” by the Troika, wrote down its own debt.
When the write-down – effectively a partial default – was executed the Greek government owed 170 euros for every 100 euros of Greek GDP. That ratio was considered entirely unsustainable at the time, especially since the quarter-to-quarter increase in the ratio was at 3.3 percent. But the problem for the EU-ECB-IMF Troika is that the rise in the Greek debt ratio has not changed since the partial default – at least not for the better. Through the first quarter of this year the debt-to-GDP ratio has grown by 4.1 percent per quarter, putting the ratio at 160.3 for the first quarter of 2013.
Before the end of this year Greece will probably have a debt ratio that exceeds what it was at the partial-default point. Here are two scenarios:
The blue line represents a scenario where the Greek debt ratio continues to grow as it has during 2012 and 2013 thus far. The red line extends with a growth trajectory based on the ratio growth rate from 2010 and 2011, namely 3.3 percent per quarter.
As we can see, the difference is negligible. And even if we disregard the exceptionally high debt ratio growth from the first quarter of 2012 (9.3 percent) we still end up with a post-default debt ratio growth of 2.5 percent per quarter. In other words, it is only a matter of time before Greece is back in the same situation as it was in 2011, only this time with an even more tense political situation, an even higher level of economic despair among the people and a youth unemployment rate at a completely destructive 60 percent.
So, back to the question: what is the Troika going to do next? Part of the answer lies in Angela Merkel’s decisive victory in last week’s German elections. Merkel wants to save Greece, keep the currency union intact and put a smiley face on every EU citizen. As far as she is concerned, the Troika should continue to help Greece.
At the same time, Greece’s self-proclaimed saviors are running out of options. The partial debt default was evidently a disaster that has, at best, bought the Greek government one year of breathable air. No one this side of a lunatic asylum would try another debt default. But austerity has also been utterly ineffective. The Greek economy simply refuses to produce the result that the designers of austerity expected.
What to do? Well, the only workable solution is so radical it will never win even a remotely serious consideration from the Troika – at least not its two European comrades, the EU and the ECB. That solution would involve Greece leaving the EU, reinstating its own national currency, and a dedicated program to reform away the welfare state.
It is almost a given that the EU won’t let any of that happen. But that brings us back to what options the Troika has left.
Well, what options do they have left?
As I have reported recently, the European crisis is still cooking. Despite five years of austerity, deficits have not gone away. They are so persistent, in fact, that the European Central Bank has been forced to create an unlimited bond buyback program for troubled welfare states: whatever amounts of Greek, Italian, Spanish, Portuguese or any other euro-denominated Treasury bond anyone wants to sell, the ECB promises to buy them without the buyer losing any money.
This program is not making the welfare-state debt crisis easier, but worsening it. Its ultimate consequence could be high and persistent inflation; in order to see why, let us begin with acknowledging another consequence, namely that you can now buy 100,000 euros worth of ten-year Greek Treasury bonds, get 10,290 euros in interest over a year and then be guaranteed to get your money back as if you had bought a Swiss Treasury bond at 1.09 percent. Two weeks ago I explained the potential consequences of this bond buyback program:
In short: there will come a point when the international bond market will test the ECB’s cash-for-bonds promise. Just to give an idea of how much money the ECB could be forced to print, here is a list of government debt by the most troubled euro zone countries: Government debt 2012
Italy 1,988 bn
Ireland 192 bn
France 1,833 bn
Spain 884 bn
Portugal 204 bn
TOTAL 5,101 bn
Greece, notably, does not report its government debt to Eurostat. Nevertheless, here alone we are talking about five trillion euros worth of government debt. If the ECB had to execute on its bonds buyback program for only ten percent of that, it would have to rapidly print 500 billion euros. To put this in perspective, according to the latest monetary statistical report from the ECB, M-1 money supply in the euro zone is 5.3 trillion euros. Of this, 884 billion euros is currency in circulation while the rest is overnight deposits. If the ECB had to print money to meet a run on the bonds in the countries listed above, it would find itself having to expand the M-1 money supply by up to ten percent in a very short time window (theoretically over night). This is to be compared to the 7.7 average annual growth rate of M-1 in May, June and July of 2013.
For all you statists out there, this means increasing growth in M-1 money supply from 7.7 percent to 17.7 percent. By comparison, the Federal Reserve has increased the U.S. M-1 money supply by an average of 11.5 percent per year over the past 12 months (measured month past year to month current year). The growth rate has dropped in recent months, though, falling to 9.1 percent in August.
A temporary boost in euro money supply to stave off a run-on-the-Treasury wave of bond sales would hurl the euro boat into very rocky waters for some time, but if the buyback program really works as intended, the relentless cash pumping by the ECB will eventually calm things down. The problem for the ECB – just as for the Federal Reserve – is that it is a lot harder to reduce money supply than to increase it. Basically, once the cash is out there in private hands, people are not voluntarily going to give it back to the government.
That is, if the buyback program works as intended. It is a very risky program, especially if it would be extended to other euro-zone countries as well. France alone has 1.8 trillion euros in debt, and even though they are technically not covered by the bond buyback program at this time, they could be the next link in the euro chain to come under stress. Their ridiculous tax policies of late will guarantee very weak GDP performance in the next couple of years. I would be very surprised, frankly, if the French economy manages to grow, on average, in 2013 and 2014.
With zero GDP growth, or worse, tax revenues will not grow as the French government intended. They are still wrestling with a deficit – their taxpayers simply cannot keep up with the cost of the welfare state – and with the new, socialist-imposed extra tax burden that deficit is going to be even more persistent.
Since president Hollande and his socialst cohorts in the French National Assembly have pledged to end austerity, they have opened the door for more government spending. This obviously adds insult to injury for an economy already under great stress. It is therefore increasingly likely that the ECB will have to extend its bond buyback program to cover frog-issued bonds as well.
Given the size of the French economy, and debt, this would put the buyback program to the test. Not immediately, but eventually. Today France is paying lower interest rates on its national debt than the United States, but the trend is upward. After almost two years of declining interest rate costs, early this year the trend shifted direction. Interest rates have been going up since February of this year, and the ten-year French Treasury bond now pays almost a half a percent more than it did this past spring.
When the Spanish government started having problems with selling its bonds, it had to increase the interest rate from four to six percent in less than a year. That is a 50-percent spike in the yield demanded by investors, and at the time back in 2011 it took both the ECB and the Spanish government by surprise. Let’s hope no one is surprised if France finds itself in a similar situation 12-18 months from now.
If the ECB thus finds itself saddled with the responsibility to – at least in theory – have cash ready for almost seven trillion euros worth of government debt, it will have to abandon its prime goal, namely price stability. While the United States has proven that you can increase money supply five, six even eight times faster than GDP without causing high inflation, this does not mean that there is no inflation threat attached to money printing. However,
- if the freshly printed money goes out to the private sector in the form of reckless lending – as in China – then there is an inflation price to pay (the Chinese are looking at six or more percent inflation this year); or
- if the fresh new cash goes into the hands of entitlement recipients, thus feeding private consumption without a corresponding increase in private productive activity,
then high, persistent inflation is knocking on the door.
If the ECB starts buying back Treasury bonds en masse, the latter effect could kick in:
1. Troubled governments know that the ECB will guarantee their bonds, thus significantly reducing their incentives to shrink their deficits;
2. The ECB has attached austerity demands to the buyback program, but those demands have proven totally ineffective against government deficits, thus practically voiding those austerity demands of meaning;
3. Persistent, high and socially stressful unemployment has shifted the fiscal balance in troubled welfare states on a permanent basis, with fewer taxpayers and more entitlement takers; in order to maintain political and social stability national politicians will avoid more cuts in the welfare state;
4. As the welfare state’s spending programs remain and more people join them as a result of the economic crisis, government spending will rise while tax revenues are stalled or even decline.
By allowing an increasing share of the population to live on entitlements, Europe’s troubled welfare-state governments will create an imbalance between productive and improductive economic activity strong enough to drive up inflation.
Add to this the imported inflation that inevitably comes in from other countries when the ECB’s new, massive money supply eventually weakens the currency.
The involvement of the ECB in trying to keep Europe’s welfare states afloat is troubling for many reasons. The prospect of the bond buyback program bringing about inflation is not a very healthy one. But for every year that goes by without the EU doing anything to reform away its welfare states, the scenario outline here, which is somewhat speculative today, moves closer and closer to becoming reality.
Just because you have not heard a lot about the European welfare-state debt crisis does not mean the crisis is over. Quite the contrary, it is alive and kicking. This story from the EU Observer is a good update:
The European Central Bank (ECB) is prepared to back its promise to do “whatever it takes” to save the euro by utilising its controversial government bond purchase programme, an ECB executive board member has said. Speaking on Monday (2 September) at a conference organised by the German Institute for Economic Research in Berlin, Benoit Couere, a member of the ECB’s executive board, said the bank’s Outright Monetary Transactions programme remained “necessary from a monetary policy perspective.” “OMTs are not just words: the ECB is fully prepared to use them,” he added.
The practical meaning of this is that the ECB is ready to buy up as much EU member state debt as is needed to continue to give the impression that the debt crisis is either over (haha) or stabilized (yeah right).
The Frankfurt-based bank unveiled its OMT programme in August 2012, with President Mario Draghi saying that the ECB would do “whatever it takes” to prevent countries being forced out of the eurozone by spiralling debt costs. The programme, which allows the ECB to buy up government bonds with maturities of between one and three years, has been widely credited for ending fears about a possible break-up of the eurozone.
Obviously. If you can buy a Spanish treasury bond at seven percent interest and then sell it to the ECB with the same reliability of getting your money back as if you had bought a Swiss government bond at a fraction of that interest rate, then what reason does anyone have to ponder the possibility that the euro zone would break apart? Never mind that this program means that the ECB will have to keep its monetary printing press working overtime, flooding the world with increasingly worthless euros.
The EU Observer again:
It has also calmed the bloc’s sovereign debt markets, pushing down borrowing costs faced by Spain and Italy, regarded as the eurozone’s ‘too big to fail’ economies.
That is only because demand for those bonds increased as a result of the ECB’s guarantee. Higher bond prices by definition mean lower interest rate on those same bonds. The Eurocrats, on the other hand, take this as a sign that they have somehow solved the crisis. All they have done is put a more effective band aid on it.
Then the EU Observer lets us know that the austerity programs put in place by the EU-ECB-IMF troika are also alive and well:
The ECB has also insisted that it will only use the programme if countries keep to tough economic reforms agreed with the eurozone’s permanent bailout fund, the European Stability Mechanism (ESM). For his part, Couere added that the programme would “never be used to indiscriminately push down government bond spreads” which should “continue to reflect the underlying country specific economic fundamentals.”
Nonsense. The very existence of the buy-all-your-bonds program neutralizes the “underlying country … fundamentals”. Bond buyers now know that once a country in crisis reaches a certain “boiling point” in its path from macroeconomic health to a Greek meltdown, the ECB will step in with its cash-for-bonds program. At that point it does not matter what the specific country risk profile looks like.
Interestingly, the ECB boasts about the program to the point where they make big noise of not having had to use it:
“The irony of this success is that it has actually been a pure psychological tool so far. The ECB has not bought any single bond under the OMT programme, yet,” ING chief economist Carsten Brzeski told this website.
Of course not. It was just created. But just wait until the next major euro zone country plunges into the hole. France is a good candidate, with its ridiculous tax hikes. When that happens, the exposure of the bond buyback program will reach entirely new levels.
In short: there will come a point when the international bond market will test the ECB’s cash-for-bonds promise. Just to give an idea of how much money the ECB could be forced to print, here is a list of government debt by the most troubled euro zone countries:
|Government debt 2012|
Greece, notably, does not report its government debt to Eurostat. Nevertheless, here alone we are talking about five trillion euros worth of government debt. If the ECB had to execute on its bonds buyback program for only ten percent of that, it would have to rapidly print 500 billion euros.
To put this in perspective, according to the latest monetary statistical report from the ECB, M-1 money supply in the euro zone is 5.3 trillion euros. Of this, 884 billion euros is currency in circulation while the rest is overnight deposits. If the ECB had to print money to meet a run on the bonds in the countries listed above, it would find itself having to expand the M-1 money supply by up to ten percent in a very short time window (theoretically over night). This is to be compared to the 7.7 average annual growth rate of M-1 in May, June and July of 2013.
A more than doubled growth rate in the M-1 money supply is not a good way to run an already weak currency.
The welfare-state debt crisis in Europe is far from over. It is brimming and brewing under the surface, bursting out occasionally, with the ECB running around as a whack’em’all player trying to beat down the symptoms of the crisis.
After years and years of bone-crushing austerity; after having lost 25 percent of its GDP; with six out of ten young and three out of ten of all workers unemployed; you’d think Greece would be out of its crisis, right? That is, if austerity was the right kind of medicine for their crisis.
That is a pretty big “if”, and it grows bigger for every year. As I have reported repeatedly, austerity is not the right medicine for the European crisis in general, and certainly not the right remedy for Greece. It has now been five years since the crisis broke out, and nowhere in Europe has a government been more devoted to spending cuts and tax hikes than in Greece (with the exception, perhaps, of Sweden in the ’90s). Alas, as the English-speaking Greek news site Ekathimerini reports, the result is a still-uncontrollable budget deficit:
Greece will not be able to return to bond markets next year to help plug an estimated 11-billion-euro financing gap that will start to open up, market sources said this week, contrary to earlier suggestions from the government and its European partners.
Greece has not been able to sell its treasury bonds on the open market for a long time. Its bonds were tossed on the financial junk yard more than a year ago when the country de facto – though not formally – went into bankruptcy. The EU-IMF-ECB troika rescued the Greek government with cash loans and demanded a continuation of austerity. They believed that such measures would reassure the bond market enough to let Greece return as a credible borrower.
The problem is that Greece has not accomplished any of the objectives sought by means of austerity:
- GDP growth forecast, adjusted for inflation, for 2013 and 3014 is -1.2 percent and -0.4 percent, respectively;
- Private consumption is expected to decline by the same numbers;
- From 2009 to 2012, government revenue increased as share of GDP from 38 to 45 percent of GDP, yet during the same time government spending has remained at 54-55 percent of GDP;
- In 2012 the Greek budget deficit was at ten percent of GDP for the third year in a row.
The fact that Greece has not seen a decline in government spending as share of GDP is sometimes taken as an indicator that they have not made any serious efforts at cutting spending. But they have, as data for government consumption shows. Here are the changes in percent, adjusted for inflation, in government consumption from 2010, including forecasts for 2013 and 2014:
There are two reasons why, despite these numbers, government spending does not fall as a share of GDP. The first is plain macroeconomics: even though government spending is the most inefficient way to get anything done in our economy, it is an indisputable fact that government-funded hospitals, schools and other services do produce some services. When we cut those services we also cut the number of people on payroll, the purchases of inputs (think medical instruments for hospitals and food for school cafeterias) and spending on other, related items. These cuts are felt, especially by local economies, where small businesses lose some demand and thus have to shrink their activities.
The second and more important reason is that the other part of government spending, namely financial transactions (welfare, unemployment benefits and similar income-security items), actually increases when the economy is in a decline phase. As people lose their jobs they go from being paid for work to being paid not to work. People who are paid for work, whether private or public employees, spend money in their local communities, pay taxes on their consumption and property, etc. Unemployed people spend a lot less (unless unemployment benefits cover 100 percent of your previous income which I don’t think is the case anywhere in the free world) and typically pay no income taxes on the benefits they receive.
In other words, as unemployment goes up government has to spend more money through its cash entitlement programs. This is one big reason why the Greek government is unable to close its budget deficit. It is also a major reason why there is again, as Ekathimerini reports, rising desperation in Europe over the black hole also known as the Greek government budget:
With pressure mounting on eurozone officials to find a solution to the 4.4-billion-euro shortfall the International Monetary Fund projects will kick in from August 2014, and widen by a further 6.5 billion euros in 2015, more debt relief now seems all but inevitable for Athens. “The troika will not likely be able to avoid new bailout discussions before the end of 2014 in order to plug the gaps, and is very likely to decide on an extension,” said Barclays in a research note. “We do not see how Greece could possibly return to the markets next year, even if recent developments have been very positive.”
Again: the troika has failed in achieving any of the objectives behind its relentless austerity policies.
As if to highlight the desperation mounting over the Greek economy:
European Union officials – who believe the size of the gap next year is somewhat smaller at 3.8 billion euros – see the issuance of short-term bonds as an option to make up the shortfall, alongside utilizing unused funds earmarked for the country’s bank recapitalizations and/or new loans. Bankers, however, say the country will struggle to convince investors to buy its bonds, especially given that further restructurings are not out of the question.
By “restructuring” they mean debt write-downs. Or, in plain English: the borrower unilaterally declares that today he owes his creditors less than he did yesterday.
But the threat of a new debt write-down is not the only problem in the way of utilizing the bank recapitalization funds. Many Greek banks are not in a shape to absorb the loss of recapitalization funds, and the reason has to do with the country’s terrible real-estate market. Behold another article at Ekathimerini:
Government and opposition MPs have reacted to suggestions that the coalition is considering lifting the restrictions on the repossession and auctioning of people’s main residence if they are not able to keep up mortgage repayments. Repossessions have been suspended in Greece since 2008. It is thought that the sale of some 200,000 homes has been prevented so far.
That is 200,000 homes that banks have invested money in – money that they in turn borrowed from someone. While the banks have to pay their loans back, mortgage defaulters are not paying them, and when the banks are prevented from selling the defaulters’ houses they lose big money. The banks, which lost enormous amounts on the government debt write-down, are slowly but steadily bleeding to death. Without recapitalization and without access to its assets on the real estate market they will inevitably go the way Titanic did.
As Ekathimerini explains, there seems to be little understanding of the exceptional consequences of a full-scale bank collapse in Greece:
Deputy Development Minister Thanasis Skordas suggested on Thursday that there could be a partial lifting on the ban from next year … New Democracy MP Sofia Voultepsi said there was no way she would discuss the auctioning of reposed [sic] homes. [Social Democrat party] PASOK deputy Paris Koukoulopous said Parliament would never accept such a measure. Opposition parties also raised concerns about the possibility of such a measure being introduced.
Long story short, the situation in Greece is as bad as it has ever been during the current economic crisis. The EU has failed to provide adequate help, the Greek governmetn is on i ts last straw of popular credibility and the banking sector is destined for collapse.
So long as Greece remains in the EU and the euro zone its government will be forced to continue to depress the economy with the same kind of measures that have turned the country into an economic wasteland. So long it continues with its austerity policies, the Greek government is undermining the last few pillars of support among the Greek people for the parliamentary system of government. Last year four in ten voters supported more or less totalitarian parties, which opens a frightening perspective on what may very well happen if the country does not very soon regain its fiscal and monetary freedom.
In two articles I have pointed to the global regulatory cartel that the G20, governments of the world’s 20 largest economies, decided to form in 2008. By stating that they want to leave no institution, no market and no product unregulated they have opened a Pandora’s Box of government control over the economy.
The 2008 G20 summit was concentrated on regulating the global financial industry, but as with any new government power it is a safe bet that it will not stop there. Once the G20 governments have created a global regulatory cartel on financial products and markets they will move on to their next target, which will most likely be pharmaceutical products and other medical technology products.
To get an idea of what this means, let us look a bit more closely at what the G20 governments said about regulating the financial industry. A “fact sheet” on the summit, issued by the White House in 2008, says that the world’s largest economies agreed to:
Strengthening transparency and accountability by enhancing required disclosure on complex financial products; ensuring complete and accurate disclosure by firms of their financial condition; and aligning incentives to avoid excessive risk-taking.
The last part of this regulatory item is the most important one. Governments, the “fact sheet” says, are supposed to give banks and other financial institutions “incentives” to not take “excessive” risks. But risk taking is an inherent part of what the financial industry does. Risk management is the very essence of what financial institutions do.
Think for a moment about what a bank does for a living. They lend people money, borrow the money they lend and make an interest margin that pays for their operations. But in all this they take a risk, namely that the borrower defaults on the loan. The bank still has to pay whoever they borrowed money from, which historically has been us Joe Sixpacks who deposit our savings with the bank.
In order to make more money and spread their risk taking, banks have over the centuries developed new products. They lend to businesses as well as to individual households; they lend to real estate purchase and to private consumption; they have secured loans and unsecured loans; revolving credit and asset-based credit…
And lending to government. As I noted the other day, in the most recent crisis banks have been unable to successfully balance and manage their risk taking, and the reason is their enormous exposure to bad government debt. If it was not for the downgraded debt of assorted European welfare states – debt which exceeded what the banks lost on bad private loans – our international financial system would have been able to absorb and manage the shakes and rattles caused by mortgage and other private loan defaults in 2008-2009.
This is important to keep in mind. It tells us that the real crisis in the financial system – the crisis that governments are using as an excuse to step up regulations – was brought about by those very same governments.
None of this is mentioned in the “fact sheet” from the White House. However, the sheet says a lot of other things, such as that governments should enhance…
sound regulation by ensuring strong oversight of credit rating agencies; prudent risk management; and oversight or regulation of all financial markets, products, and participants as appropriate to their circumstances.
We have already noted that the biggest contributor to the bank crisis is government itself. The same governments that brought about the crisis, either by directly over-indulging in debt or indirectly by helping troubled welfare states prop up their spending with excessive taxes (there is an implicit tax cartel between the European members of the G20), now want to tell the risk management professionals in the financial industry how to do credit rating and “prudently” manage risk.
Government even takes on the role of final arbiter on what financial products the financial industry is allowed to offer!
Imagine what this would look like if it was applied to the pharmaceutical industry.
The “fact sheet” again:
Promoting integrity in financial markets by preventing market manipulation and fraud, helping avoid conflicts of interest, and protecting against use of the financial system to support terrorism, drug trafficking, or other illegal activities.
Look what they tucked in to this one: “helping avoid conflicts of interest”. What does that mean? What kind of conflicts of interest is government supposed to regulate? On a free market there are constant conflicts of interest where businesses compete side by side for the same customers, where customers compete side by side to get the best products available, where entrepreneurs compete for investors to help them expand their businesses.
Whose interests are government regulations supposed to protect here, and whose interests will be shoved to the side? More than likely, the interests favored will be the ones put forward by government itself, disguised – as is often the case with sweeping “interest-based” regulations – as “the common good” or the “general interest of the public”.
There is an ominous undertone to this entire regulatory over-reach that resonates badly when applied to the financial industry but opens an entire cacophony of economic dissonance when extended to other industries.
And then for the cartel manifesto in the “fact sheet”:
Reinforcing international cooperation by making national laws and regulations more consistent and encouraging regulators to enhance their coordination and cooperation across all segments of financial markets. Reforming international financial institutions (IFIs) by modernizing their governance and membership so that emerging market economies and developing countries have greater voice and representation, by working together to better identify vulnerabilities and anticipate stresses, and by acting swiftly to play a key role in crisis response.
“Emerging markets” is a code word for developing countries with a growth spurt and little to no government accountability. What they can contribute to any discussion on advanced finance is a mystery; it is an even bigger mystery why they should be allowed to participate in regulating one of the world’s most important industries.
But the big matzo ball is of course the statement about “Reinforcing international cooperation by making national laws and regulations more consistent and encouraging regulators to enhance their coordination and cooperation across all segments of financial markets.” There you have it spelled out: the world’s 20 largest economies are governed by politicians who, back in 2008, laid the groundwork for a global government regulatory cartel. Once that cartel has turned the financial industry into an extension of a government oversight office it will move on to the next industry on its hit list: the pharmaceutical and medical technology markets.
There are interesting parallels between the financial industry and said med-tech industries. More on that later; for now, try sleep well tonight knowing that the G20 country governments are working hard to regulate-to-death the world’s financial institutions.
I am working on a third installment about the G20 governments’ solemn vow to not leave any business, any product or any market unregulated. While that one is progressing, it is time to yet again say:
Never bark at the big dog. The big dog is always right.
Today Ambrose Evans-Pritchard of the Daily Telegraph has this to say about Europe’s troubled banks and even more troubled welfare-state governments:
Anybody with serious banking exposure to any EMU state on the front line of Europe’s macro-economic crisis now knows what to expect. The deal reached by EMU finance ministers on the use of the bail-out fund (ESM) to recapitalise distressed banks makes clear who will in fact suffer the real losses: first shareholders, then bondholders and then deposit holders above €100,000. They stand to lose almost everything, as we saw with Laiki in Cyprus.
See I told you so. I have said all along that this will spread, and not just to other European countries. This is going to become a big problem for the banks in any country that adopts the Cyprus Bank Heist confiscation scheme. It is very likely going to change the very way that banks provide services for wealthy customers.
But there is more to this. I have also pointed out on numerous occasions that the banks are liable for losing customers’ money on wild-brained real estate speculation, but I have also explained that if there had not been a welfare-state crisis at the same time, the banks would have prevailed without requiring bailouts and restructuring help. With Evans-Pritchard, this point is now slowly beginning to make its way out in the public:
Officials from the European Central Bank and the European Commission warned during the Cyprus crisis that it would be dangerous to set such a precedent, fearing contagion. The Portuguese were openly alarmed. So has that risk of contagion since dissipated? One should have thought quite the opposite, given the yield spike in Portugal, Spain, Italy et al since the Bernanke Fed dropped its taper bomb this week.
He is right. Nothing has changed in terms of the depressed economic activity in Europe’s more troubled welfare states. Then we get to the marriage-made-in-hell kind of relationship between banks and governments in Europe, and a reminder of how the decision to raid bank customers’ accounts fits into the picture:
The states that are already in trouble will have to carry most of the burden of recapitalising banks, pushing them over the edge into actual insolvency. They will have to come up with the money needed to raise capital ratios to 4.5pc of assets. Then come the private haircuts, which of course risk devastation for the host country, and the collapse of investor confidence.
There is one more angle to this. Europe’s banks bought massive amounts of government bonds during the decade leading up to the current crisis. While in 2009 EU governments committed 700 billion euros for bank recapitalization and restructuring programs, in that same year, according to Eurostat, financial institutions owned more than one trillion euros worth of treasury bonds issued by Ireland, Spain, Italy and Portugal.
These are, as we know, some of the most troubled welfare states in Europe – frankly, some of the most troubled in the world. And we are not even counting Greece here. In theory, therefore, if banks had refrained from buying any bonds from troubled welfare states they would not be in such a bad need of tax money to bail them out. Or, better yet: if the welfare states would have bought back the bonds they sold to the banks, the banks would have been solidly recapitalized and could have reinvested their money in bonds from more reliable countries.
Again: without the welfare state, Europe and its banks would have been in far better shape than they are now. As for America, the welfare state stands right in the middle of a fork in the road. Either we try to save it and follow Europe into the dungeon of industrial poverty; or we structurally reform away the welfare state, restore economic freedom and resume our pursuit of endless prosperity.
Never bark at the big dog.
I have been saying this for 18 months now: the current economic crisis is not a bank crisis – it is a welfare state crisis. The bank bailouts that so many have blamed for the large deficits in Europe are often smaller than the banks’ holdings of government bonds. The losses the banks took on, e.g., real estate speculation were moderate enough for them to handle, if the treasury bonds they also held had remained solid, reliable low-risk anchors in their portfolios.
Then the welfare states were downgraded, one by one. Even the United Kingdom had to take a credit downgrade. Greece, Spain, Portugal, Italy… they all sank toward junk status. Since they in many cases had invested a lot more in treasury bonds than what they needed in bailout, the bailouts did not do much to stabilize their portfolios. Since the banks were already over-exposed to risk they had to restrict their investments in treasury bonds.
This is where the European Central Bank (ECB) stepped in and promised an endless stream of euros in a buyback guarantee for all troubled euro-zone treasury bonds. Whoever wanted to sell it was basically going to be able to send their bonds to the ECB and get a check in the mail the next day. As a result the European bond market stabilized and the notoriously over-spending welfare states could merrily get back to printing treasury bonds.
Not a thing has been done about the underlying problem: the welfare state and its perpetual spending excesses.
Now the chickens are coming home to roost. City AM reports:
Outspoken Bank of England official Andrew Haldane warned yesterday that the bursting of a bond bubble is the biggest threat to the world’s financial stability. Haldane, the Bank’s executive director of financial stability, told the Treasury Select Committee that central banks’ massive asset-buying programmes have created significant risks.
In other words:
“If I were to single out what for me would be the biggest risk to global financial stability right now, it would be a disorderly reversion in government bond yields globally,” Haldane told the MPs. “We’ve intentionally blown the biggest government bond bubble in history. We need to be vigilant to the consequences of that bubble deflating more quickly than we might otherwise have wanted.”
Even more problematic is that an orderly way out of this would require an end to endless borrowing. That end is nowhere near in sight. The only thing that has changed so far is that the on-the-brink nations in southern Europe are not suffering from economically lethal interest rates. That, however, is entirely due to the ECB stepping in with its printing presses and bond buyback program.
But, as City AM notes, it is not just the deeply troubled countries that have seen interest rates rise:
The yield on 10-year UK gilts was 1.65 per cent on 1 May, yet has risen to 2.14 per cent. Specifically, it is feared that the US Federal Reserve could be set to taper its latest bout of QE.
It will be interesting to see how far this will go.