A New Article by Paul Davidson...
IS ECONOMICS A SCIENCE? SHOULD ECONOMICS BE RIGOROUS?
BY PAUL DAVIDSON, Editor, Journal of Post Keynesian Economics
Many mainstream economists (e.g., Lucas, Cochrane) claim that the characteristics of a “science” require rigor, consistency, and mathematics. So if economics is to be a science it must display these characteristics. Paul Samuelson has added the claim that economists must accept the ergodic axiom in their models in their pursuit of economics as a science on par with physics, astronomy, and chemistry. Efficient market theory possesses all these characteristics. So how is it possible that efficient market theorists did not foresee the financial crisis that started in 2008?
Whether they declare themselves Monetarists, Rational Expectation theorists, Neoclassical Synthesis [Old] Keynesians or New Keynesians, the backbone of their mainstream theories is the efficient market analysis where the future can be known. For “Old” and “New” Keynesians the only thing that prevents efficient markets operating in the short run is the presumption of fixity in nominal wages and prices. [Thus, these “Keynesians” urge government action only because, as John Williamson is always telling me, they are too impatient to wait for the long run.]
To stimulate discussion, I wish to address two aspects of these mainstream economists universal beliefs. The first involves a discussion of the difference between a nonergodic stochastic process and an ergodic stochastic process for “knowing” the future. The second and related aspect involves the use of the deductive axiomatic logical analysis and mathematics by mainstream economists to glorify efficient market theory and the Arrow-Debreu-Walrasian general equilibrium or dynamic general equilibrium as the only way to do real world economics.
For example, to “prove” markets are efficient and the use of the Ricardian equivalence theorem to show that fiscal stimulus policies are useless– at least in the long run– requires the presumption that the economic system is “ergodic”.
Efficient market theory, Arrow-Debreu models, Ricardian equivalence, etc. requires the households, business enterprises, and politicians to possess a significant correct and accurate message of things that are going to happen in the future if they are to make efficient (optimal) decisions today.
Why? Because time is a device that prevents everything from happening at once. Thus decisions made today usually require significant time to elapse before the payoff of the decision occurs. This is true not only for decisions involving investment projects by entrepreneurs, but also for most consumer decisions, such as the purchase of an auto or an ipad, or even a decision as to what restaurant to go to get a good meal for dinner. [How many of us have sometimes been disappointed in the meal we ordered at the restaurant?]
The message of efficient markets, Arrow-Debreu, Ricardian equivalence, etc. is inapplicable to the world of experience because in the real world, households do not have any significantly reliable information about the future, and neither do budgetary policy makers, nor entrepreneurs. The erroneous message based on the assumption of people having significantly reliable knowledge about the future is the result of accepting bad axioms as the basis for mainstream theory. It is not the fault of using the deductive method, rigor, and mathematicsper se. So do not blame the messenger for the message!
THE ERGODIC AXIOM
First, let us take up the ergodic- nonergodic stochastic process distinction. Paul Samuelson [1969] has written that if economists hope to move economics from “the realm of history” into “the realm of science” they must impose the “ergodic hypothesis” on their theory[1]. In other words Nobel Prize Winner Paul Samuelson has made the ergodic axiom thesine qua non for the scientific method in economics. Lucas and Sargent [1981] have also claimed the principle behind the ergodic axiom is the only scientific method of doing economics.
Following Samuelson’s lead, most economists (e.g., Cochrane, Stiglitz, Mankiw, M. Friedman, Scholes, etc) and economic textbook writers either implicitly or explicitly have assumed that observable economic events are generated by an ergodic stochastic process.
But not Keynes! Keynes [1936, p. 16] suggested the way to understand why classical economic theory (e,g., efficient market theory) is not relevant to the world of experience, when he noted that old economic thinkers were “like Euclidean geometers in a non Euclidean world who discover that apparent parallel line collide, rebuke these lines for not keeping straight. Yet, in truth there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics”. Keynes developed a theory that is more general than classical and mainstream economic theory because it is based on fewer restrictive fundamental axioms[2]. The fewer the number of underlying axioms, the more general the theory. The most important classical axiom Keynes eliminated in his general theory[3] is the ergodic axiom.
This ergodic axiom assumes the economic future is already predetermined[4] . The economy is governed by an existing ergodic stochastic process. One merely has to calculate probability distributions regarding future prices and output to draw significant and reliable statistical inferences [information] about the future. Once self-interested decision makers have reliable information about the future, their actions on free markets will optimally allocate resources into those activities that will have the highest possible future returns thereby assuring global prosperity.
In order to draw any statistical (probabilistic risk) inferences regarding any universe, however, one should draw a sample from that universe. Since drawing a sample from the future economic universe is impossible, the ergodic axiom presumes that the economic future is governed by an already existing unchanging ergodic stochastic process. Consequently, a sample drawn from the past is equivalent to a sample drawn from the future. In other words, calculating the probability distribution from past statistical data sample is presumed to be the same as calculating the risks from a sample drawn from the future.[5] This ergodic axiom is an essential foundation for all the complex risk management computer models developed by the “quants” on Wall Street. If the economy is nonergodic, however, thenthese computer models are weapons of math destruction [For deterministic models, the “ordering axiom” plays the same role as the ergodic axiom in stochastic models.]
For a technical explanation of the difference between ergodic and nonergodic stochastic processes the read should read my book, THE KEYNES SOLUTION: THE PATH TO GLOBAL ECONOMIC PROSPERITY [Davidson (2009)] . For our discussion here we merely need note that, in essence, the ergodic axiom imposes the condition that the future is already predetermined by existing parameters (market fundamentals). Consequently the future can be reliably forecasted by analyzing past and current market data to obtain the probability distribution governing future events. In other words, if future events are assumed to be generated by an ergodic stochastic process (to use the language of mathematical statisticians), then the future is predetermined and can be discovered today by the proper statistical probability analysis of past and today's data regarding market "fundamentals”. If the system is nonergodic, calculated past and current probability distributions do not provide any statistically reliable estimates regarding the probability of future events.
New Keynesians such as Stiglitz accept the ergodic axiom as the basis of the economic system but then add additional ad hoc assumptions to try to tame this presumed knowledge of the future approach to better reflect what they believe is reality. Stiglitz, for example, in his asymmetric information theory assumes that some market participants cannot make the proper statistical calculations because they do not perceive the correct information about the future. In other words, Stiglitz imposes the asymmetric information condition that there are some decision makers who act while lacking the correct information about the (presumed to exist today) probability distribution of future events. Consequently these decision makers (speculative fools?) misread the future and thereby mess up the beauty of the efficient market system.
Nobel prize winner Robert Lucas [1981, p. 287] has boasted that the mainstream theory axioms are “artificial, abstract, patently unreal”. Like Nobel Laureate Samuelson, Lucas insists such unreal assumptions are the only scientific method of doing economics. Lucas insists that “Progress in economic thinking means getting better and better abstract, analogue models, not better verbal observations about the real world” [Lucas, 1981, p. 276]. The rationale underlying this argument is that these unrealistic assumptions make the problem more tractable and, with the aid of a computer, the analyst can then predict the future. Never mind that the prediction might be disastrously wrong.
In the introduction to his bookAgainst The Gods , a treatise that deals with the questions of relevance of risk management techniques on Wall Street, Peter L. Bernstein [ 1996, p. 6] writes:
“The story that I have to tell is marked all the way through by a persistent tension between those who assert that the best decisions are based on quantification and numbers, determined by the [statistical] patterns of the past, and those who based their decisions on a more subjective degrees of belief about the uncertain future. This is a controversy that has never been resolved....to what degree should we rely on the patterns of the past to tell us what the future will be like?”
One would hope that the empirical evidence of the collapse of those “masters of the economic universe “ that have dominate Wall Street machinations for the last three decades has at least created doubt regarding the applicability of the ergodic axiom to our economic world. Even Alan Greenspan in testimony before Congress in October 2008 seems to be having second thoughts although he still has not completely changed his tune. Keynes’s ideas and Soros’s reflexivity concept support Bernstein’s latter group.
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Samuelson, Lucas and others adopted the ergodic axiom because they want economics to be in the same class as the “hard sciences” such as physics or astronomy. For example the science of astronomy is based on the presumption of an ergodic stochastic process that governs the movement of all the heavenly bodies from the moment of the “Big Bang” to the day the universe ends. Accordingly probability analysis using past measurements of the movements of heavenly bodies permit astronomers to predict future solar eclipses within a few seconds of when they actually occur. Nothing Congress, the President of the United States, the United Nations, or environmentalists can do will alter the predetermined dates and time for future eclipses. For example, Congress cannot pass a law outlawing solar eclipses in order to provide more sunshine and thereby enhance crop production. In an ergodic world, all future events are already predetermined and beyond change by human action today. The future movement of the heavenly bodies can be known by anyone who has measured past movements and projected these movements into the future. There are no speculative fools, who suffering from asymmetric information, think Mars is going to crash into the earth.
George Soros has explained why the efficient market theory is not applicable to real world financial markets with a slightly different terminology than Keynes but conceptually in the same way. Soros (2008) wrote: “we must abandon the prevailing [efficient market] theory of market. behavior. ” Soros states that there is a direct connection “between market prices and the underlying realty [that] I [Soros] call reflexivity” .
What is this reflexivity? In a letter to the Editor published in the March 15-21, 1997 issue of The Economist Soros objects to Paul Samuelson insistence on requiring the ergodic axiom to make economics a science. Soros argues the ergodic hypothesis does not permit “the reflexive interaction between participants’ thinking and the actual state of affairs” that characterizes real world financial markets. In other words, the way people think about the market today can affect and alter the future path the market takes; the future is not predetermined. Soros’s concept of reflexivity, therefore, is the equivalent of Keynes’s rejection of the ergodic axiom[6]. Reflexivity means peoples thoughts and actions create the future, while mainstream economists presume the future has already been predetermined and can be discovered by analyzing today’s market fundamentals.
NON EUCLIDEAN ECONOMIC THEORY
In creating a “NonEuclidean” economic theory to explain why these unemployment “collisions” occur in the world of experience, Keynes uses the logical deductive method but he had to deny (“throw over”) the relevance of several classical axioms for understanding the real world. The classical ergodic axiom which assumes that the future is known and can be calculated as the statistical shadow of the past was one of the most important classical assertions that Keynes rejected.
Keynes's general theory is a deductive method of analysis. Keynes’s concept of uncertainty about the economic future requires the economic system to be generated by a nonergodic stochastic process. At the time of his writingThe General Theory, Keynes did not know of the ergodic stochastic theory that was being developed by the Moscow School of Probability in the 1930s. Nevertheless in his criticism of Tinbergen's [econometric] method, Keynes [1939] wrote[7] that Tinbergen's method is not valid for any economic forecasting because economic data “are not homogeneous” over time. Non homogeneity is a sufficient condition for nonergodicity.
Taleb’s Black Swan concept attempts to explain market crashes as an event lying in the far off tail of an ergodic probability distribution. It should be noted that Knight’s vision of uncertainty and Taleb’s Black Swan concept are both based on the ergodic presumption for the economy. Taleb’s Black Swan is an already predetermined outcome but the Black Swan event is so far out in the tail of the ergodic probability distribution that its occurrence is so rare that it is never likely to be observed– except in the long run when we will all be dead. Similarly Knight’s applied his uncertainty concept to an event that is “in a high degree unique”[8] and hence so far out in the distribution as to be observed perhaps only once in several lifetimes.
For Keynes, as well as for Soros, the belief that intelligent people “know” that they cannot know the future is an essential element in understanding the operation of our economic world. For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know, however, that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment today in order to remain liquid maybe the most judicious decision possible.
Our modern capitalist society has attempted to create an arrangement that will provide people with some control over their uncertain economic destinies. In capitalist economies the use of money and legally binding money contracts to organize production, sales and purchases of goods and services permits individuals to have some control over their future cash inflows and outflows and therefore some control of their monetary economic future. It also provides other parties (business firms) to engage in money sales contracts with the legal promise of current and future cash inflows sufficient to meet the business firms’ costs of production and generate a profit.
Households and business entrepreneurs willingly enter into money contracts because each party thinks it is in their best self interest to fulfill the terms of the contractual agreement. If, because of some unforeseen event, either party to a contract finds itself unable or unwilling to meet its contractual commitments, then the judicial branch of the government will enforce the contract and require the defaulting party to either meet its contractual obligations or pay a sum of money sufficient to reimburse the other party for damages and losses incurred. Thus, as the biographer of Keynes, Lord Robert Skidelsky has noted, for Keynes “injustice is a matter of uncertainty, justice a matter of contractual predictability”. In other words, by entering into contractual arrangements people assure themselves a measure of predictability in terms of their contractual cash inflows and outflows, even in a world of uncertainty.
UNCERTAINTY, MONEY CONTRACTS AND LIQUIDITY
In their book, Arrow and Hahn (1971, pp 256-7 emphasis added) wrote:
"The terms in which contracts are made matter. In particular, if money is the goods in terms of which contracts are made, then the prices of goods in terms of money are of special significance. This is not the case if we consider an economy without a past or future. . . .If a serious monetary theory comes to be written, the fact that contracts are made in terms of money will be of considerable importance".
Yet all mainstream models including the Arrow-Debreu model assumes people enter into “real contracts” i.e., they “know” the future real outcome with at least actuarial certainty of any contract they sign today .Thus intelligent mainstream economists such as Arrow and Hahn in emphasizing the importance of money contracts cannot help but let their common sense intervene in their view of the economy – to the detriment of their logical consistency with their general equilibrium (Arrow-Debreu-Walrasian) model.
Keynes’s liquidity theory provides what Arrow and Hahn call “A serious monetary theory” for domestic and international transactions as a way of coping with an uncertain future.
Money is that thing that government decides will settle all legal money contractual obligations. An individual is said to be liquid if he/she can meet all contractual obligations as they come due. For business firms and households the maintenance of one’s liquid status is of prime importance if bankruptcy is to be avoided. In our world, bankruptcy is the economic equivalent to a walk to the gallows. Maintaining one’s liquidity permits a person or business firm to avoid the gallows of bankruptcy. [Yet as my good Monetarist friend Alan Meltzer has often told me “bankruptcies are good for the health of the capitalist system.”]
Thus, liquidity is at the center of the operations of our monetary economy and therefore financial markets that are well organized andorderly permit decision makers to maintain liquidity in case some unforeseen future event should make it otherwise impossible to meet a future money contractual obligation unless they can readily sell a liquid asset for money in an orderly market. system.”
Keynes provided a NEW way of economic thinking to explain the operations of a monetary economy where entrepreneurs enter into nominal contracts in order to organize production and exchange activities. The sanctity of money contracts is the essence of the capitalist system and Keynes’s liquidity analysis[9].
In Keynes’s analysis, liquidity, i.e., the ability to meet one’s money contractual commitments domestically and internationally becomes an essential foundation for understanding the operation of our entrepreneurial economy. The primary function of well organized and orderly financial and exchange rate markets is to provide liquidity so that holders of financial assets traded on such markets “know” they can make a fast exit and liquify their portfolio at a price close to the previous market price at any time they fear something bad may happen in the uncertain future. With sufficient liquidity, one can always meet one’s money contractual commitments no matter what. The maintenance of one’s liquid position is of prime importance if default and bankruptcy is to be avoided.
Once it is recognized that in a money using entrepreneurial economy decision makers “know” that the future is uncertain (in the nonergodic sense) and can be created in ways not even all decision makers understand, then the demand for liquidity as a security blanket to meet unforeseen possible dire net cash flow problems becomes paramount in decision makers’ plans
In our uncertain economic world, by entering into forward money contracts, decision makers gain some control over their future cash inflows and outflows. If market participants think the future is more uncertain than it was yesterday, then they will try today to reduce cash outflow commitments for goods and services (save more) in order to increase their liquidity position. Faced with this reduction in market demand, businesses will reduce hiring of workers.
BLAMING THE MESSENGER FOR THE MAINSTREAM MESSAGE
If the future is nonergodic, then mainstream economic theory is creating a completely artificial world remote from reality-since the theory requires the ergodic axiom. Keynes [1936, p. 192] noted that classical theorists “offers us the supreme intellectual achievement, unattainable by weaker spirits, of adopting a hypothetical world remote from experience as though it were the world of experience and then lived in it consistently”.
Mainstream economists are not wrong in the need for rigor in economic theorizing. It is not rigor and the use of mathematics perse that creates the useless economic models that make mainstream economists look so poorly. Rigor means that the only valid claims are logical deductions from specified assumptions [i.e., axioms].Consistency and rigor are features of any deductive approach, which draws conclusions from a group of axioms – and whose empirical relevance depends entirely on the validity of the axioms.
Keynes applied rigor to his general theory – but only after he threw out three classical axioms that he felt had no empirical justification. So Keynes required induction in developing his theory to check on the validity of the axioms. Accordingly Keynes did not develop a completely artificial world. Unfortunately Paul Samuelson, who grasped for the Keynes mantle immediately after the Second World War, ignored Keynes general theory. As I point out in my book THE KEYNES SOLUTION; THE PATH TO GLOBAL ECONOMIC PROSPERITY, Samuelson has admitted that he found the General Theory “unpalatable’ end incomprehensible. Samuelson said he merely assumed that the Keynes analysis was simply a Walrasian system with fixity of wages and prices. In so doing Samuelson aborted the Keynes revolution.
Since biblical times humans have tried to understand the world about them and what caused things that humans observed to happen. In general the human mind believes that there must be a cause for any event we observe.
For most of the history of mankind, it was believed that the design of God or the Gods was the cause of anything that happened in the world of experience. Beginning in the 17th century, however, philosophers believed that explanations of events that one observed could be developed on the basis of reasoning of the mind rather than religious belief. This was the beginning of the intellectual movement historians call The Enlightenment or The Age of Reason where order and regularity was seen to come from the human analysis of observed phenomena. The power of reason was not in the possession of truth, but in the acquisition of truth.
Any understanding of the world as humans perceive it always be the creation of the human mind. Reasoning involves the mind creating a deductive theory to explain what people observe happening about them (using inductive views). For example, Sir Isaac Newton saw an apple fall from the bough of a tree to the ground. Newton explained why apples always fall to the ground by the theory of gravity.
A theory is the way humans describe real world observations on the basis of a model that starts with a few axioms (hopefully based on inductive reasoning from the world of experience). An axiom is an assumption accepted as a universal truth that does not need to be proved. From this axiomatic foundation, the theorist uses the laws of logic to deduce conclusions that explains what we observe in the world of experience. All theories are generally accepted in some tentative fashion. Theories are not ever conclusively established and can be replaced when events are observed that are deviations from the current existing theory. Thus, the financial crisis of 2007-2009 should have been sufficient empirical evidence to indicate that the axiomatic basis of the mainstream theory needs to be replaced.
Economic theory is an analytical device where the economic theorist builds a model by starting with some axioms that he/she accepts as a self evident truth. The tools of logical deduction are then used to reach one or more conclusions. These conclusions are then presented to the public as the explanation of economic events that are occurring in the world of experience. The theory can then be used to suggest the cure for any real world economic problems.
Accordingly, it is perfectly acceptable to have rigor and even math in economic models – as both Marshall and Keynes had. But the axioms underlying the model must be thoroughly examined to see if they are applicable to the real world. What Samuelson, Lucas and others have done is impose axioms, such as the ergodic axiom, that have no relationship to the world we live in.
Keynes’s general theory is rigorous and consistent – and once one recognizes that the future is uncertain in terms of a nonergodic stochastic process, then one can understand the self-interest of individuals is to protect themselves from an uncertain future where bankruptcy can occur if one cannot meet one’s money contractual obligations in a capitalist system.
Thus money contracts (inflows and outflows) are used by individuals to protect themselves from adverse unmanageable net cash flows. The purpose of liquid assets[10] traded on organized and orderly financial markets is to provide a security blanket against one’s inability to meet a contractual obligation outflow.
Thus when the market for mortgage backed derivatives that were advertised to be “as good as cash” i.e., perfectly liquid (and triple A rated) collapsed, the loss of so much liquidity caused panic (a reflexivity response) in other markets for assets that had been previously thought to be very liquid. Asset holders in many markets tried to make “fast exits” and the result was a financial collapse and crisis.
In sum, Keynes’s liquidity theory of the operation of financial markets is a rigorous, logically deductive system that appears to be applicable to the real world in which we live and should replace the artificial world model of Lucas and other mainstream economists.
NOTES
REFERENCES
Arrow, K J. and Hahn, F. H.,General Competitive Equilibrium, San Francisco, Holden Day,
1971.
Bernstein, P. L.,Against the Gods, New York, John Wiley,1996.
Davidson, P.,The Keynes Solution: The Path To Global Economic Prosperity,
Palgrave/Macmillan, 2009.
A. Greenspan, October 23, 2008 testimony before the House Oversight Committee.
Keynes, J. M.,The General Theory of Employment, Interest, and Money, Macmillan, 1936.
Lucas, R. E. “Tobin and Monetarism: A Review Article”,Journal of Economic Literature,19,
1981.
Lucas, R. E., and Sargent, T. J. ,Rational Expectations of Econometric Practices, 1981
G. Soros, “Letters to the Editor”.The Economist, March 15-21, 1997 issue
G. Soros (2008) “The Crisis and What To Do About It”New York Review of Books, December
4 issue.
[1].P. A. Samuelson,[1969] “Classical and Neoclassical Theory” in Monetary Theory, edited by R.W. Clower (Penguin Books,, London) p.12.
[2].Keynes [1936, p. 3] stated that the classical economics fundamental axioms are applicable to a “special case....[that] happen[s] not to be those of the economic society in which we live with the result that its teaching is misleading and disastrous if we attempt to apply it to fact of experience”. This “special case” statement is even more applicable today, given the economic austerity discussions in Washington, the UK, Euroland, etc, and the export-led growth , i.e.,, mercantilist, policies pursued by nations such as China who are still enjoying an “economic miracle” in an otherwise depressed global economy.
[3]. Two other axioms that Keynes rejected are 1. Money is neutral (at least in the long run) so that changes in the quantity of money do not affect real outcomes, and 2. Gross substitution is ubiquitous and therefore liquid assets are good substitutes for real capital goods. (See Davidson , 2009).
[4].Consequently, government action today can only delay, but not change the long run optimal solution already predetermined by free markets.
[5].This is equivalent to thinking that drawing the sample of heights from a pygmy tribe in Africa is equivalent to drawing a sample of Swedish citizens’ height.
[6].In place of the rejected ergodic axiom Keynes argued that when crucial economic decisions had to be made, decision makers could not merely assume that the future can be reduced to quantifiable risks calculated from already existing market data. Instead they depended on “animal spirits” since most animals do not know how to calculate the moments around the mean!
For decisions that involved potential large spending outflows or possible large income inflows that span a significant length of time, people “know” that they do not know what the future will be. They do know that for these important decisions, making a mistake about the future can be very costly and therefore sometimes putting off a commitment by maintaining liquidity today maybe the most judicious decision possible.
[7].J. M. Keynes [1939],”Professor Tinbergen’s Method” Economic Journal, 49, reprinted inThe Collected Writings of John Maynard Keynes vol. 14, edited by D. Moggridge [Macmillan, London, 1973].
[8]. F. Knight, (1921), Risk, Uncertainty and Profit (Houghton Mifflin, New York) p.233
[9].The first question for theorists, therefore, is: why are all production and exchange agreements –whether between entities in the same common currency area or between entities in nations that use different monies, sealed with contracts denominated in a specific money? Why are people in the world of experience not like the people of mainstream economic theory, where all contracts are in real terms?
[10]. Keynes has an entire chapter in the GENERAL THEORY entitled “The Essential Properties of Interest and Money” in which he specifically indicates that all liquid assets have certain essential mathematical properties, namely (1) the elasticity of production is zero and (2) the elasticity of substitution between liquid assets and durable producible goods is zero. Keynes specified these elasticity properties by induction via his knowledge of financial markets.
Tuesday, April 03, 2012
Sunday, March 18, 2012
Ye Ol’ Rationality…
Ye Ol’ Rationality…
Hi… Name’s ‘Rationality’__and I’ve been around a long time, but I don’t think you realize just how long, or who I truly am__so, let me see if I may clear up this mystery a bit, just a bit. You may have me confused with my younger brother/sister ‘Reason’__No__I am not ‘Reason’__not even close__I am ‘Ratio-Logic’ leaning toward ‘Wisdom-Logic’. First off, my younger sibling thinks more about the reasons for things; whereas, I think more about the ‘Universal Mechanics’ of things, based on only the existing facts__My younger brother/sister thinks more about beliefs, opinions, feelings and judgments of such, and I more about the logical interactions of intellectual ideas and their effects, all the way from the community, state, national and international levels, but even more importantly__to the fully ‘Universal Level’. I’m in no way meaning my younger brother/sister is not just as important as I, as s/he certainly is, since s/he more thinks about the deeper, necessary and important issues of personal, family and moral community relationships, much closer to the heart, personal compassion, empathy and honesty, even though I also do consider this, but less so. We’d certainly have a far less rational world without the kind help of my younger brother/sister, and many of his/her still younger siblings, brothers, sisters and cousins alike…
‘Rationality’ is the hardest essence agent to write about, as it requires the use of rationality, or at the least some form of general cognition__whether psychological, rhetorical or logical and rational, to even begin to speak about the subject of self-rationality. The second problem is ‘Rationality’ attempts to approach the mountain-top heights of ‘Moral Wisdom’, while holding itself to some semblance of humility, not to drift into that oh so useless area of the omniscient ego, which is just as much an enemy to itself, as it also is to its younger sibling and cousin, ‘Reason’ and ‘Rhetoric’__which all, when taking the ball too far over the scrimmage line, have the habit of drifting far too far into that all too useless area of the irrational omniscient ego. Few realize both sides must be balanced by each other’s differences, along with as much middle-mental-state outside or inside support, as can be mustered__such as natural law, morality, aesthetics, esthetics and ethics__as without these extra supports, it’s far too easy to drift off the proper course of civil discourse, and on out into the barren areas of the dark egos… Whether ‘Rationality’, ‘Rhetoric’ or ‘Reason’__none of us want to be caught in the darkness__as we can’t see in the darkness__we all like the light of illumination…
And, this brings up a question; Why isn’t ‘Universal Moral Wisdom’ a more talked about subject these days, as it was years ago…? Have people become incapable of seeing above the personal, family, community, national and international levels__into the ‘Universal’? Or, what is it…? ‘Rationality’ looks at politics and law, and sees nothing but debates and arguments, or where philosophers and other intellectuals are concerned, nothing but dialectic and dialogic levels reaching no higher than the personal to the international, or as could be stated ‘The U.N.’, ‘W.T.O.’ and ‘The International Courts’ of settlements, whether law, politics or money__and never reaching into the thoroughly ‘Universal Rationale…’ Has the world of citizens completely forgot, there’s a higher level than the ‘International?’ Do they think the mind stops at the borders of the ‘International?’ This just isn’t being very creative, in my opinion. Is it because the last few hundred years’ philosophies, academicians and psychologies, etc., have totally convinced everyone on Earth, that ‘Universal Moral Wisdom’ is some foolish metaphysical utopian non-sense, or something even more dire? Can’t people any longer separate the simple metaphysical from the truer form of honest ‘Universal Thinking?’__where metaphysical has more to do with context, meaning, motives and intents, and ‘Universal Moral Wisdom’ has far more to do with the entire history of the nations’ and planet’s ‘Common Laws’ and ‘Rationality’ combined, over time, as a truly workable ‘Visual Effects Logic’ of our real world’s total actions, over time. Have people totally forgot how to ‘Reason’ and ‘Rationalize’ law’s, politics’ and economies’ goals and effects into real conceptual ideas contributing to our future betterments of our ‘Political Actions…?’
Let’s just take a quick look at one powerful ‘Universally Rational Example’__to see if we can make some sense of this. We all know there’s a major and dangerous problem developing between ‘The Western Religions’, politics and economies; and that of ‘The Muslim East’s Religious Views’__but, how many have truly looked for a ‘Higher Than International Solution?’ ‘Oh, everybody’s brains just quit working right here'__Well, let me help you out, if I may... We presently have a global problem of the ‘International Thinking’ on top, squashing most all ‘The Important Individual Thinking’ on the bottom__It’s like a pressure-cooker, where the entire world is fighting for resources, in an ever decreasing shortage of global resources, including thinking resources, and people limiting themselves to the false heights of ‘International Thinking’ is forcing the pressure-cooker to near global explosion of severe head-butting, and most likely, somewhere out in the near future, nuclear head-butting__but, does this truly need to be? If we can recover a bit of our ‘Universal Thinking’ of years’ gone by__I don’t think so. OK__we have an oil shortage, or is it really a refinery shortage? ‘News-Flash’__It’s really a refinery shortage__so, where’s the most sensible location on Earth, to place new oil refineries, to reduce Global and mainly Mid-East tensions? Israel__Think about it. If new oil-refineries, enough to over-supply all the needy nations of the Earth, were placed in Israel, just what do you think that would do to the Mid-East dynamic of ‘Radical Islamic Thought and Power?’ ‘Radical Islam’, instead of hating Israel, as much as they presently do, just may be awakened to the fact, that should the ‘Free-World’s’ supply of fully refined oil-products depend on keeping Israel safe, long out into the World’s future__they just may have to do some serious soul-searching re-thinking about that ‘Big Ol’ Satan of the West, America’ defending Israel, and wake up and realize, NOW, the entire ‘Free-World’s’ supply of fully refined oil-products and market-price dynamics would depend on Israel being protected and kept safe, by ‘Even’ such enemies as Al-Qaeda and Iran__as the ‘Dynamic of Global Protection’ would then be such a ‘Great Community of Nations’ ‘oil-necessity-locked’ against them, unless they changed their thinking toward such a new state of ‘Dynamic Universal Moral Wisdom’s, New Necessities of Self-Survival…’
The seemed ‘Great Satan’ can protect himself/herself in just such a way__Is this not a useful example of ‘New Universal Thinking…?’__’All for one, and one for all’__and yet, it simply seems to be the old, sufficiently applied to the new…
Tuesday, February 21, 2012
Europe Passes the Last Exit. A Great Crisis Lies Ahead...
Author: Fabius Maximus
Summary: Today Europe’s leaders have the last opportunity to avoid a great crisis. Will they continue to demand increasing austerity of the Greek people, pushing them further on a path devoid of hope and leading to poverty and political collapse? Or will they realize the folly of their actions?
Contents
The German people drew the wrong conclusion from their post-WWI experience. They saw the damage from the Weimar hyperinflation of 1921-1924, probably an inevitable result of the WWI settlement. They suffer amnesia about the Weimar deflation which brough Hitler to power (see A lesson from the Weimar Republic about balancing the budget). It’s sounding a fire alarm while the ship sinks. Now they repeat in different form Weimar’s mistakes of 1929-32, imposing a crippling austerity on the PIIGS while striving to balance their own budget — almost certain to result in recession and deflation (for description of this process see Debt – the core problem of this financial crisis, which also explains how we got in this mess).
The PIIGS nations grow weaker, the eurozone economy slows, and the centrist political parties lose support to extremists. Greece leads this parade, but the other PIIGS – and France — follow in its path. We can only guess at how this plays out, but it probably ends badly.
Today’s meeting of Europe’s Finance Minsters looks like the last chance to change course. Like all previous opportunities, they will almost certain drive by this last exit. They are ill-equipped to do otherwise, much like 13th century priests treating the Plaque on the basis of Scriptural precepts.
The series of posts last Fall forecast a resolution – a crisis-driven policy change — in the near future. Three months later nothing has happened. Europe leaders continue to improvise with sh0rt-term measures, while Europe — especially the PIIGS – grow weaker. Each passing month reduces their ability to avoid a crash. The devotion of Europe’s leaders — both in the North and South – to the unification project exceeds my expectations, but no longer appears rational. Perhaps they do not see the cost in broken lives. Perhaps they do, but do not care. Perhaps they value the shining dream of a future Europe more than blasted lives of proles. Collateral damage.
Next are several articles report from the Greece, the front lines of Europe, watching their society crack under the stress.
(3) “Can a return to the drachma save Greece as unemployment soars?“, Ambrose Evans-Pritchard (Business Editor), The Telegraph, 19 February 2012 — “Greece’s unemployment bomb has detonated. After a deceptive calm, the surge in job losses since last summer is shocking even for those who never believed that combined fiscal and monetary contraction could possibly lead to any result other than ruin.” Excerpt:
(5) An explanation of what’s happening and likely consequences
Summary: Today Europe’s leaders have the last opportunity to avoid a great crisis. Will they continue to demand increasing austerity of the Greek people, pushing them further on a path devoid of hope and leading to poverty and political collapse? Or will they realize the folly of their actions?
Contents
- The last exit before disaster
- “Can a return to the drachma save Greece as unemployment soars?”
- “Restructuring Greece Within the Euro is Illusory”
- Letter from Archbishop of Greece Ieronymos to the Prime Minister of Greece
- An explanation of what’s happening and likely consequences
- Other posts about the crisis in Europe
The German people drew the wrong conclusion from their post-WWI experience. They saw the damage from the Weimar hyperinflation of 1921-1924, probably an inevitable result of the WWI settlement. They suffer amnesia about the Weimar deflation which brough Hitler to power (see A lesson from the Weimar Republic about balancing the budget). It’s sounding a fire alarm while the ship sinks. Now they repeat in different form Weimar’s mistakes of 1929-32, imposing a crippling austerity on the PIIGS while striving to balance their own budget — almost certain to result in recession and deflation (for description of this process see Debt – the core problem of this financial crisis, which also explains how we got in this mess).
The PIIGS nations grow weaker, the eurozone economy slows, and the centrist political parties lose support to extremists. Greece leads this parade, but the other PIIGS – and France — follow in its path. We can only guess at how this plays out, but it probably ends badly.
Today’s meeting of Europe’s Finance Minsters looks like the last chance to change course. Like all previous opportunities, they will almost certain drive by this last exit. They are ill-equipped to do otherwise, much like 13th century priests treating the Plaque on the basis of Scriptural precepts.
- Myopically focused on the need to protect politically powerful banks,
- seeing Europe as a morality play rather than the product of cold laws,
- believing in a mixture of pseudoeconomic economic myths (eg, confidence fairies, invisible bond vigilantes and the curative power of austerity), and
- unwilling to recognize their own role in creating this crisis.
The series of posts last Fall forecast a resolution – a crisis-driven policy change — in the near future. Three months later nothing has happened. Europe leaders continue to improvise with sh0rt-term measures, while Europe — especially the PIIGS – grow weaker. Each passing month reduces their ability to avoid a crash. The devotion of Europe’s leaders — both in the North and South – to the unification project exceeds my expectations, but no longer appears rational. Perhaps they do not see the cost in broken lives. Perhaps they do, but do not care. Perhaps they value the shining dream of a future Europe more than blasted lives of proles. Collateral damage.
Next are several articles report from the Greece, the front lines of Europe, watching their society crack under the stress.
(3) “Can a return to the drachma save Greece as unemployment soars?“, Ambrose Evans-Pritchard (Business Editor), The Telegraph, 19 February 2012 — “Greece’s unemployment bomb has detonated. After a deceptive calm, the surge in job losses since last summer is shocking even for those who never believed that combined fiscal and monetary contraction could possibly lead to any result other than ruin.” Excerpt:
A variant of this lies in store for Portugal as its “internal devaluation” starts in earnest. The young Schumpeterians in charge of the Portuguese economy insist otherwise — cocksure that shock therapy will triumph without the cushion of debt relief and devaluation — but events have a habit of demolishing dreams.(3) “Restructuring Greece Within the Euro is Illusory“, Der Spiegel, 20 February 2012 — Opening:
In November alone 126,000 Greeks lost their jobs in a country of 11 million, equivalent to three and a half million Americans in a single month. The unemployment rate jumped from 18.2pc to 20.9pc. This has not yet fed through into social breakdown. Greeks receive unemployment support for an average of thirty weeks, with a ceiling of €454 a month, according to Professor Manos Matsaganis from Athens University. Those with civil service tenure are placed on labour reserve for two years at half their basic pay, or a third of their actual pay. Once these cushions are exhausted, Greeks are on their own. The monthly ratchet effect will then become painfully evident.
… Dimitra Noussi, who runs two homeless shelters and a soup kitchen for the City of Athens, said the crunch comes once people have been unemployed for five or six months and cannot pay the rent. Most fall back on the kinship network but there comes a point when critical mass overwhelms even this cultural backstop.
… One can see why the high priests of the EU Project wish to prevent elections taking place in April. The political centre is disintegrating, with the once triumphant PASOK party down to 9pc in the polls and New Democracy at 18pc – each party reduced to a pro-Memorandum rump after the mass expulsion of dissidents, and each stunned almost senseless.
The latest best-seller is the Greek translation of Heinrich Winkler’s “Weimar 1918-1933: History of the First German Democracy”, narrating how an indebted Germany pursued the same deflation policies under the Gold Standard as Greece is now pursuing under EMU — with the same results. The book culminates in the Reichstag elections of July 1932 when the Nazis and Communists between them won half the seats, and Weimar died. Such parallels are always inexact. The radical parties of Syriza and the Democratic Left are not authoritarian. Yet their ascendancy surely threatens to shatter the existing order. “If we achieve a Left-dominated government, we will politely tell the Troika to leave the country, and we may need to discuss an orderly return to the Drachma,” said Syriza MP Theodoros Dritsas, choosing his words carefully.
The news that Iceland has regained its investment grade rating — with unemployment down to 6pc – comes as a timely reminder that countries can indeed go it alone and live to tell the tale. Though of course, Iceland’s debts are in sovereign krona, not Mr Schäuble’s euro, and Iceland exports a lot of aluminium.
Mr Papademos warns that default and EMU-exit would lead to “uncontrollable economic chaos”. But is that not already the case? No Greek bank has been able to issue a letter of credit accepted anywhere in the world since November. Large Greek companies are having to relocate their headquarters to Bulgaria in order to conduct basic trade.
The “drachma risk” has already killed investment. Greece is suffering the anticipated consequences of EMU exit without the benefits, so it might as well lance the boil, impose capital controls, and create a new banking system (as Iceland did). Such catharsis might start to unlock €60bn of cash savings in gold, dollars, German euro notes (letter`X’, Greece`Y’), and such-like, sitting in the proverbial mattress. Foreign investors might start to nibble again, once the Greek exchange rate reflects reality at around seven Chinese yuan.
Europe’s finance ministers plan to approve a second bailout for Greece on Monday but Hans-Werner Sinn, the head of Ifo, a top German economic think tank, warns that the money will only help international banks — not the Greeks. He argues that Greece can only solve its crisis if it quits the euro.(4) Letter from Archbishop of Athens and All Greece Ieronymos to the Prime Minister of Greece
SPIEGEL: The finance ministers of the euro zone want to approve a new bailout for Greece this Monday. Can the additional €130 billion ($172 billion) save Greece?
Sinn:No, and the politicians know it can’t. They want to gain time until the next election. I think we’re wasting time by doing this. … Because Greece’s external debt is rising with every year that passes until it leaves the currency union. We’re getting ever further away from solving the problem. The basic problem is that Greece isn’t competitive. The cheap loans that the euro brought the country artificially raised prices and wages — and the country has to come back down from this high level.
SPIEGEL: So the euro countries shouldn’t approve the aid?
Sinn: They should give them the money to ease their exit from the currency union. The Greek government could use the money to nationalize the country’s banks and prevent the state from collapsing. The state and the banks must continue to function through all the turmoil that an exit will entail.
SPIEGEL: This turmoil would hit the population hard.
Sinn: Yes, undeniably. But the turmoil would only be temporary, it would last one to two years perhaps. This time would have to be bridged with the financial aid from the international community. But the drachma will immediately depreciate and the situation will stabilize very quickly. After a short thunderstorm, the sun will shine again.
SPIEGEL: How would a euro exit help Greece in concrete terms?
Sinn: It would become competitive again. Because Greek products would rapidly become cheaper, demand would be redirected from imports towards domestically produced goods. The Greeks would no longer buy their tomatoes and olive oil from Holland or Italy but from their own farmers. And tourists for whom Greece has been too expensive in recent years would return. In addition, new capital would flow into the country. The rich Greeks who deposited so many billions, possibly hundreds of billions of euros, in Switzerland would see the falling property prices and wages and would have an incentive to start investing in their own country again.
SPIEGEL: Does the exit from the euro zone entail Greece going bankrupt?
Sinn: No, quite the reverse. The bankruptcy forces the exit. The Greeks will immediately leave if they don’t get any more international aid because the bankruptcy couldn’t be managed within the euro system. The state would be insolvent and the banking system too. The entire payments system would fall apart. The chaos can only be avoided if Greece leaves and the currency depreciates immediately.
SPIEGEL: Does that mean Greece should be forced to leave?
Sinn: No, no one should force anyone. But at the same time Greece doesn’t have the right to receive permanent assistance from the other euro countries, and Greece’s creditors aren’t entitled to have the debt repaid by the international community. Everyone has to earn their standard of living themselves, and those who choose to earn money from risk must bear that risk.
SPIEGEL: If Greece were to exit the euro zone, would the tough austerity measures still be necessary?
Sinn: In this case, savings really only refer to a reduction in debt growth. The economist only refers to savings if debt is actually repaid. Greece is nowhere near doing that. But it’s true that Greece has gotten used to the flow of cheap credit from abroad, and that it’s politically impossible to cut wages to the extent needed to make the country competitive.
…
SPIEGEL:Why are the euro-zone countries so adamant that Greece must remain in the currency?
Sinn:This isn’t really about the country. The Greeks are being held hostage by the banks and financial institutions on Wall Street, in London and Paris who want to make sure that money keeps on flowing from government bailout packages — not to Greece, but into their coffers.
SPIEGEL: What about the contagion that a bankruptcy or a Greek exit would involve? Financial markets may speculate that other countries will suffer a similar fate as Greece.
Sinn: There may be contagion effects. But I think this argument is being instrumentalized by people who are worried about losing money. People keep on saying “the world will end if you Germans stop paying.” In truth only the asset portfolios of some investors will suffer.
Homelessness and even hunger – phenomena seen during the [Second World] war – have reached nightmare levels … A sense of patience among Greeks is running out, giving way to a sense of anger, and the danger of a social explosion can no longer be ignored.The full text in Greek is on the website of the Archdiocese of Athens.
… We must all understand the feeling of insecurity, desperation and depression in every Greek home. This, unfortunately, is continuing to causes suicide among those who can no longer stand the drama in their family and the suffering of their children. … We are being asked to take even larger doses of a medicine that has proven to be deadly and to undertake commitments that do not solve the problem, but only temporarily postpone the foretold death of our economy … And what is likely to follow are more painful, more unjust measures in the same hopeless and unsuccessful course of our recent past.
(5) An explanation of what’s happening and likely consequences
- Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
- A lesson from the Weimar Republic about balancing the budget, 10 February 2010
- All about deflation, the quiet killer of modern economies, 19 July 2010
- Government policy errors as a cause of the Great Depression, 1 November 2008
- The simple explanation of why night falls over Europe, 9 December 2011
- Explaining the gold standard, the Euro, Default, Deflation, and Hyperinflation, 12 December 2012
- The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
- Can the European Monetary Union survive the next recession?, 11 July 2008
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
- Governments cannot go bankrupt, 2 April 2010
- The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
- About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
- Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- The Fate of Europe, nearing the point of decision, 13 September 2011
- Europe drifts towards the brink of a cataclysm, 26 September 2011
- Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
- Every day the new world emerges, yet we see it not. Like today, as Europe begs China for loans, 15 September 2011
- Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
- We see the outlines of the next cure for Europe. Will it work?, 14 October 2011
- Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011
- Where to from here, Europe? Some experts share their views., 8 November 2011
- Status report on Europe’s slow re-birth (first, the current system must die), 10 November 2011
- Europe begins its endgame. Watch and learn, for Europe’s problems are the world’s., 11 November 2011
- Looking ahead to see the new shape of Europe, 22 November 2011
- Hot news! The Wehrmacht failed to take Greece. Now Germany tries again, with a different method., 28 January 2012
Tuesday, January 24, 2012
The ECB Is Engaging in Massive QE...
Author: Marshall Auerback
So the ratings agencies have finally followed through on the big threat and downgraded a number of the eurozone’s credit ratings, including France and Austria, both of which have now lost their coveted Triple AAA status. Italy, Portugal and Spain were downgraded a further two notches.
What does this mean and why does it matter?
Investors (often badly informed) use ratings agencies like Fitch, Moody’s and S&P as an indicator of default risk of a country. Countries that receive lower credit ratings are at a disadvantage when they sell bonds because buyers will not pay as much for bonds from a country perceived to be at risk. In effect, ratings agencies are able to bully countries into adopting policies that are friendly to the ratings agencies’ investors. A compliant government often reacts like Pavlov’s dog to the threat or implementation of a downgrade, putting aside the interests of its citizens and starting to introduce discretionary contractions in its net spending, which it does by either raising taxes or cutting spending.
My take is that the ratings downgrade causes a vicious cycle in which countries will end up adopting policies that will put their economies even more at risk than they were already. The reason for this is that in Europe, you’ve got a flawed financial structure that can’t be fixed by austerity measures because it is incapable of dealing with huge external shocks to the demand for goods and services on the part of consumers.
As readers of this blog are well aware, Eurozone countries have faced two types of problems by entering the euro regime that have made them unstable.
First, they have given up their monetary sovereignty by giving up their national currencies and adopting a supranational one. By divorcing the fiscal authority (that which governs a country’s public treasury) from the monetary authority (that which governs the supply of money) member countries have relinquished their public sector’s capacity to provide high levels of employment and output because they are restricted in what they can spend and how they can introduce stimulation in the form of jobs programs or infrastructure projects.
Second, by entering the eurozone, these countries have also agreed to abide by something called the Maastricht Treaty, an agreement which created the European Union and led to the creation of the euro in 1992. This treaty restricts each member country’s budget deficit to only 3 % and debt to 60% of GDP. Therefore, even if a country is able to borrow and finance its deficit spending, like Germany and France, it is not supposed to use fiscal policy above those limits. So countries have resorted to different means to keep their national economies afloat, from trying to foster the export sector, as Germany does, to cooking the books through Wall Street wizardry, like Greece and Italy did. Nations that exceed the limits by the greatest amounts are punished with high interest rates that drive them into a vicious death spiral because deficits rise and lead to further credit downgrades. That is what has happened to Greece, Ireland, Portugal, etc., and now threatens Italy and Spain. Vultures will soon be looking further into the core to places like France.
By contrast, a sovereign government which issued its own currency (such as the US or Canada) could respond to a huge drop in economic activity by expanding fiscal stimulus, or allowing the currency to fall (thereby enhancing growth through exports). On the other hand, eurozone governments ceded their national currencies to the European Central Bank (ECB), the sole entity that can issue unlimited amounts of euros. That is why we’re left with a situation in which the solvency crisis can only be solved by the ECB: It is the only entity which is in a position to buy unlimited quantities of national sovereign bonds in order to ensure that these countries do not continue to pay ruinous rates of interest and suffer further declines in economic activity as a consequence. Fiscal austerity only adds to the problem.
And despite the ongoing hawkish rhetoric from the ECB, there are signs that they are getting it: The LTRO can’t work, as you’re essentially just swapping one liability for another one (albeit more long term in duration, therefore making it better for the banks).
But note the way the ECB balance sheet is expanding: The consolidated assets of the European system of Central Banks is now 4.4 billion euros or $5.7 billion. In effect, the consolidated ESCB balance sheet is almost two times that of the Fed and its increase over the last 6 months is almost equal to the entire increase in the Fed’s balance sheet over the last several years.
The figures on the ESCB balance sheet neither includes the recent half billion euro Long Term Refinancing Option (LTRO) introduced last December, nor further mooted policies in that direction. CLSA has suggested that the speculation on the February 29th LTRO is EUR1trn. Some have suggested even higher numbers.
Bottom line: the system of European Central Banks (ESCB) has been engaged in massive QE and much more is in the pipeline.
With such massive injections of “liquidity” into the European banks, a European Lehman type failure with Lehman’s systemic consequences becomes ever less likely.
Some might argue that the ECB’s balance sheet would be impaired by buying up the government debt of countries in distress. But this is not true, because by definition, the “profligates” cannot default. In fact, as the monopoly provider of the euro, the ECB could easily set the rate at which it buys the bonds (say, 4% for Italy) and eventually it would receive a profit on those loans, which addresses the endless issues about the ECB’s supposed balance sheet risk.
Speaking of which, I have seen so many pieces on this alleged Target 2 problem and I think it’s another misguided panic, much like the hyperinflationists were venting about the dangers of QE in the US last year. And maybe the Germans are guilty about this misguided thinking because they somehow think that because their claims increase on the ECB (which effectively takes on the liabilities of the other NCBs), they are exposed in the event that the ECB goes bust. Why should the ECB go bust?
Look at this another way:
-German net exports to the eurozone entail a surplus in target 2 and thus for the Bundesbank.
-The ECB runs the SMP on the ESCBs balance sheet (ESCB comprises 28 central banks. ECB plus ALL 27 EU central banks, BoE included!).
-In case of euro bond default, these would be losses to the Bundesbank.
This seems to be a reading that goes beyond the “spirit of the Treaty” (as they say), considering that the ECB does not have a statutory minimum capital requirement. It transfers profits to national governments but in times of losses it can only request a capital injection should its capital be depleted.The European Council (which is representative of elected governments) is not compelled to accede to this request.
Hence, the ECB is a perfect balance sheet to warehouse risk since it’s losses need not become a fiscal transfer as it can rebuild its profits via seignorage over a number of years, as I wrote in a recent NEP piece. So there’s no losses to Germany and the Germans are going nuts over nothing. In the end, the “senior creditor” argument explains an unwarranted fear of the Germans.
The Weimar stuff may be for public consumption, but the BUBA default stuff is not any better?
And despite Draghi’s public statements, this time the central banks and governments are committed to move heaven and earth to prevent such a repeat. Hence the $650 bullion three year ECB loan facility and more if it is needed (which doesn’t solve the underlying problem, but defers it for a long time).
The ECB acting this way flies in the face of many of Mario Draghi’s public statements and in light of ongoing German opposition, many think a vast expansion of the ECB’s balance sheet is well nigh politically impossible. But democracies don’t “do” deflation very well. Contrary to conventional wisdsom, it’s the eurozone’s currently ruinous fiscal austerity policies that are truly politically unsustainable. They will not only cause more economic and social misery, but they undermine much of the residual political support for the common currency. Consider the case of Austria, which lost its AAA rating along with France. The leader of Austria’s far right FPÖ, H.C. Strache, has embraced an explicitly anti-euro position, and he is gaining political traction in the polls, as is Marine Le Pen, leader of the National Front in France, where Presidential elections are due to be held in 3 months’ time.. Both oppose the euro — to be fair — for the right reasons. The only problem is that the rest of their policies are a dystopian nightmare. Similarly, in an interview with German daily Die Welt (and the choice and location of publication is extremely important), the new head of Italy’s “technocratic” government, Mario Monti, lamented that despite Italy’s considerable fiscal austerity measures, they aren’t seeing lower interest rates. Fiscal austerity in the midst of a recession is bad policy at the best of times, but Monti did what he was told and now he’s got nothing to show for it. Has he become the victim of a German “Italian Job” (all you Michael Caine fans will know what I’m talking about here).
Monti has pointed to the threat that Italian sentiment is finely balanced. Make the wrong decision now, he said, and the populists will take control. With that in mind, observe that the Italian Social Democrat party commented last week that it would like to see Italy leave EMU.
Are we about to re-enact the 1930s? Perhaps the ECB is finally realising that the stakes are too high, even in the midst of their Bundesbank-like Germanic posturing.
Also see:
So the ratings agencies have finally followed through on the big threat and downgraded a number of the eurozone’s credit ratings, including France and Austria, both of which have now lost their coveted Triple AAA status. Italy, Portugal and Spain were downgraded a further two notches.
What does this mean and why does it matter?
Investors (often badly informed) use ratings agencies like Fitch, Moody’s and S&P as an indicator of default risk of a country. Countries that receive lower credit ratings are at a disadvantage when they sell bonds because buyers will not pay as much for bonds from a country perceived to be at risk. In effect, ratings agencies are able to bully countries into adopting policies that are friendly to the ratings agencies’ investors. A compliant government often reacts like Pavlov’s dog to the threat or implementation of a downgrade, putting aside the interests of its citizens and starting to introduce discretionary contractions in its net spending, which it does by either raising taxes or cutting spending.
My take is that the ratings downgrade causes a vicious cycle in which countries will end up adopting policies that will put their economies even more at risk than they were already. The reason for this is that in Europe, you’ve got a flawed financial structure that can’t be fixed by austerity measures because it is incapable of dealing with huge external shocks to the demand for goods and services on the part of consumers.
As readers of this blog are well aware, Eurozone countries have faced two types of problems by entering the euro regime that have made them unstable.
First, they have given up their monetary sovereignty by giving up their national currencies and adopting a supranational one. By divorcing the fiscal authority (that which governs a country’s public treasury) from the monetary authority (that which governs the supply of money) member countries have relinquished their public sector’s capacity to provide high levels of employment and output because they are restricted in what they can spend and how they can introduce stimulation in the form of jobs programs or infrastructure projects.
Second, by entering the eurozone, these countries have also agreed to abide by something called the Maastricht Treaty, an agreement which created the European Union and led to the creation of the euro in 1992. This treaty restricts each member country’s budget deficit to only 3 % and debt to 60% of GDP. Therefore, even if a country is able to borrow and finance its deficit spending, like Germany and France, it is not supposed to use fiscal policy above those limits. So countries have resorted to different means to keep their national economies afloat, from trying to foster the export sector, as Germany does, to cooking the books through Wall Street wizardry, like Greece and Italy did. Nations that exceed the limits by the greatest amounts are punished with high interest rates that drive them into a vicious death spiral because deficits rise and lead to further credit downgrades. That is what has happened to Greece, Ireland, Portugal, etc., and now threatens Italy and Spain. Vultures will soon be looking further into the core to places like France.
By contrast, a sovereign government which issued its own currency (such as the US or Canada) could respond to a huge drop in economic activity by expanding fiscal stimulus, or allowing the currency to fall (thereby enhancing growth through exports). On the other hand, eurozone governments ceded their national currencies to the European Central Bank (ECB), the sole entity that can issue unlimited amounts of euros. That is why we’re left with a situation in which the solvency crisis can only be solved by the ECB: It is the only entity which is in a position to buy unlimited quantities of national sovereign bonds in order to ensure that these countries do not continue to pay ruinous rates of interest and suffer further declines in economic activity as a consequence. Fiscal austerity only adds to the problem.
And despite the ongoing hawkish rhetoric from the ECB, there are signs that they are getting it: The LTRO can’t work, as you’re essentially just swapping one liability for another one (albeit more long term in duration, therefore making it better for the banks).
But note the way the ECB balance sheet is expanding: The consolidated assets of the European system of Central Banks is now 4.4 billion euros or $5.7 billion. In effect, the consolidated ESCB balance sheet is almost two times that of the Fed and its increase over the last 6 months is almost equal to the entire increase in the Fed’s balance sheet over the last several years.
The figures on the ESCB balance sheet neither includes the recent half billion euro Long Term Refinancing Option (LTRO) introduced last December, nor further mooted policies in that direction. CLSA has suggested that the speculation on the February 29th LTRO is EUR1trn. Some have suggested even higher numbers.
Bottom line: the system of European Central Banks (ESCB) has been engaged in massive QE and much more is in the pipeline.
With such massive injections of “liquidity” into the European banks, a European Lehman type failure with Lehman’s systemic consequences becomes ever less likely.
Some might argue that the ECB’s balance sheet would be impaired by buying up the government debt of countries in distress. But this is not true, because by definition, the “profligates” cannot default. In fact, as the monopoly provider of the euro, the ECB could easily set the rate at which it buys the bonds (say, 4% for Italy) and eventually it would receive a profit on those loans, which addresses the endless issues about the ECB’s supposed balance sheet risk.
Speaking of which, I have seen so many pieces on this alleged Target 2 problem and I think it’s another misguided panic, much like the hyperinflationists were venting about the dangers of QE in the US last year. And maybe the Germans are guilty about this misguided thinking because they somehow think that because their claims increase on the ECB (which effectively takes on the liabilities of the other NCBs), they are exposed in the event that the ECB goes bust. Why should the ECB go bust?
Look at this another way:
-German net exports to the eurozone entail a surplus in target 2 and thus for the Bundesbank.
-The ECB runs the SMP on the ESCBs balance sheet (ESCB comprises 28 central banks. ECB plus ALL 27 EU central banks, BoE included!).
-In case of euro bond default, these would be losses to the Bundesbank.
This seems to be a reading that goes beyond the “spirit of the Treaty” (as they say), considering that the ECB does not have a statutory minimum capital requirement. It transfers profits to national governments but in times of losses it can only request a capital injection should its capital be depleted.The European Council (which is representative of elected governments) is not compelled to accede to this request.
Hence, the ECB is a perfect balance sheet to warehouse risk since it’s losses need not become a fiscal transfer as it can rebuild its profits via seignorage over a number of years, as I wrote in a recent NEP piece. So there’s no losses to Germany and the Germans are going nuts over nothing. In the end, the “senior creditor” argument explains an unwarranted fear of the Germans.
The Weimar stuff may be for public consumption, but the BUBA default stuff is not any better?
And despite Draghi’s public statements, this time the central banks and governments are committed to move heaven and earth to prevent such a repeat. Hence the $650 bullion three year ECB loan facility and more if it is needed (which doesn’t solve the underlying problem, but defers it for a long time).
The ECB acting this way flies in the face of many of Mario Draghi’s public statements and in light of ongoing German opposition, many think a vast expansion of the ECB’s balance sheet is well nigh politically impossible. But democracies don’t “do” deflation very well. Contrary to conventional wisdsom, it’s the eurozone’s currently ruinous fiscal austerity policies that are truly politically unsustainable. They will not only cause more economic and social misery, but they undermine much of the residual political support for the common currency. Consider the case of Austria, which lost its AAA rating along with France. The leader of Austria’s far right FPÖ, H.C. Strache, has embraced an explicitly anti-euro position, and he is gaining political traction in the polls, as is Marine Le Pen, leader of the National Front in France, where Presidential elections are due to be held in 3 months’ time.. Both oppose the euro — to be fair — for the right reasons. The only problem is that the rest of their policies are a dystopian nightmare. Similarly, in an interview with German daily Die Welt (and the choice and location of publication is extremely important), the new head of Italy’s “technocratic” government, Mario Monti, lamented that despite Italy’s considerable fiscal austerity measures, they aren’t seeing lower interest rates. Fiscal austerity in the midst of a recession is bad policy at the best of times, but Monti did what he was told and now he’s got nothing to show for it. Has he become the victim of a German “Italian Job” (all you Michael Caine fans will know what I’m talking about here).
Monti has pointed to the threat that Italian sentiment is finely balanced. Make the wrong decision now, he said, and the populists will take control. With that in mind, observe that the Italian Social Democrat party commented last week that it would like to see Italy leave EMU.
Are we about to re-enact the 1930s? Perhaps the ECB is finally realising that the stakes are too high, even in the midst of their Bundesbank-like Germanic posturing.
Also see:
- Why Investors will buy Italian bonds after ECB monetisation from Nov 2011
- On the ECB’s Long-Term Refinancing Operation and 2012 macro ideas for investors from Dec 2011
Wednesday, January 18, 2012
A Comment to Satyajit Das Post...
Satyajit Das I
Satyajit Das II
I thought this short comment, by Richard Wood to Satyajit Das' post at Roubini's blog, placed the horse in the field, where he belongs...
"I should have summarise my proposal.
Throughout the centuries governments have had two options: they could finance their budget deficits by printing money or by borrowing from the public. When inflation is high, or a threat, then it is appropriate to finance the deficit by borrowing money from the public. But when public debt is already very high it is appropriate to print money to finance the budget deficit.
When unemplyment is high it is essential to run budget deficits, to put more money into the economy than you take out, to raise demand.
It is not the budget deficit as such that is the problem in periphery countiries today. Rather it is the manner of their financing, borrowing from the public, that is the problem. With aggregate demand depressed the way forward for periphery countries is to stimulate by financing the on-going budget deficit wirh new money creation. In this way the rise in public debt is stopped and debt default can be avoided. Inflation can be avoided by sterilisation as appropriate. Austerity is unnecessary and takes the economy into depression. "
Richard Wood
Satyajit Das II
I thought this short comment, by Richard Wood to Satyajit Das' post at Roubini's blog, placed the horse in the field, where he belongs...
"I should have summarise my proposal.
Throughout the centuries governments have had two options: they could finance their budget deficits by printing money or by borrowing from the public. When inflation is high, or a threat, then it is appropriate to finance the deficit by borrowing money from the public. But when public debt is already very high it is appropriate to print money to finance the budget deficit.
When unemplyment is high it is essential to run budget deficits, to put more money into the economy than you take out, to raise demand.
It is not the budget deficit as such that is the problem in periphery countiries today. Rather it is the manner of their financing, borrowing from the public, that is the problem. With aggregate demand depressed the way forward for periphery countries is to stimulate by financing the on-going budget deficit wirh new money creation. In this way the rise in public debt is stopped and debt default can be avoided. Inflation can be avoided by sterilisation as appropriate. Austerity is unnecessary and takes the economy into depression. "
Richard Wood
Friday, January 13, 2012
Clearing House Interbank Payments System...
Check out the statistics at CHIPS...
http://www.chips.org/docs/000652.pdf
And the BIS...
http://www.bis.org/statistics/otcder/dt1920a.pdf
Oughtta' warm your heart... Those are all 'trillions of dollars' statistics...
http://www.chips.org/docs/000652.pdf
And the BIS...
http://www.bis.org/statistics/otcder/dt1920a.pdf
Oughtta' warm your heart... Those are all 'trillions of dollars' statistics...
Tuesday, December 13, 2011
Eurozone Leaders Rendezvous at ‘The Last Chance Saloon’?
(NEW) Fragile and Unbalanced in 2012 http://www.economonitor.com/nouriel/2011/12/15/fragile-and-unbalanced-in-2012/?utm_source=contactology&utm_medium=email&utm_campaign=EconoMonitor_Highlights%20-%20A%20Weekly%20Recap%20of%20some%20of%20the%20Best%20Pieces%20on%20EconoMonitor_10_27_111 Author: Nouriel Roubini
(NEW) http://mobile.nytimes.com/article?a=882026&single=1&f=28 Will China Break?, Paul Krugman
Author: Satyajit Das
(Note: I highly recommend Satyajit's work, especially his book; "Traders, Guns and Money" on the global derivatives toxicity; "Knowns and Unknowns In The Dazzling World of Derivatives." You can read no-one with more real world ground experience and authority in the banking and derivatives trading business. This 2006 book is even better than his newest... Also, this most recent article sums the world problems most succinctly...)
European summits – over twenty at last count – have produced little. The planned summit on 9 December 2011 may well be the last chance for Euro leaders and Euro-crats to avoid a financial disaster. Unless European leaders overcome their common sense deficit, which is proving as intractable as budget and trade deficits, this may not end well.
The last comprehensive and final plan – the fourth in the last 18 months – failed to mollify investors and markets. The crisis is now engulfing Italy, Spain and now re-infecting Ireland and Portugal. Stronger countries like France (at risk of losing its AAA credit rating) and Germany are increasingly vulnerable.
Standard & Poor’s is reviewing the ratings of a number of 15 Euro-zone countries with negative implications. This action was “prompted by … belief that systemic stresses in the Euro-zone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the Euro-zone as a whole.” The rating agency highlighted tightening credit conditions across the Euro-zone, higher funding costs for many Euro-zone sovereigns, high levels of government and household indebtedness, the rising risk of an European recession and a lack of agreement among European policy makers on tackling problems.
Critical Points…
The curious pas de deux between European banks and sovereigns has reached a critical stage. Needing to raise money and keep interest costs down, governments are pressuring banks to buy their bonds and use them as collateral to raise fund from central banks and the European Central Bank (“ECB”). At the same time, European banks exposed to the risk of large losses on holdings of sovereign bond, which would render them potentially insolvent need governments to support the banking system.
Time is running short. European Sovereigns and banks need to find Euro 1.9 trillion to re-finance maturing debt in 2012. Italy alone requires Euro 113 billion in the first quarter and around Euro 300 billion over the full year. European banks need Euro 500 billion in the first half of 2012 and Euro 275 billion in the second half. This means they need to raise Euro 230 billion per quarter in 2012 compared to Euro 132 billion per quarter in 2011. Since June 2011, European banks have been only able to raise Euro 17 billion compared to Euro 120 billion for the same period in 2010.
There has to be acknowledgment that austerity – draconian budget cuts and tax increases – to bring budget deficits and public debt under control cannot deal with the problem – the deflation of the debt-fuelled bubble. There also has to be acknowledgment that Europe doesn’t have a “liquidity” problem which can be alleviated by substituting fleeing private sector lenders with official lenders such as the European Union (“EU”), ECB or the International Monetary Fund (“IMF”).
The European Financial Stability Fund (“EFSF”), the European bailout fund, is now largely irrelevant, It lacks the resources to quarantine Spain and Italy as well as, increasingly, Belgium, France and Germany from contagion.
Schemes to increase the capacity of the EFSF – borrowing to leverage the fund or partial guarantees or seeking Chinese funding – are simply far fetched or incomprehensible. The EFSF’s attempt to raise money to meet existing commitments has run into problems, meeting lack lustre support and a sharp increase in costs.
In the event that the AAA guarantors are downgraded, the EFSF structure, as originally envisaged, becomes unworkable. Rating agencies have signalled that the EFSF’s AAA rating is under threat. The risk that the cost of funding for the bailout fund is greater than the rate that it can charge is now increasingly evident.
European countries have a “solvency” problem – they have debt that they can never seriously expect to pay back. Stronger nations cannot save the peripheral nations without ultimately destroying their own credit and ability to raise funds.
Commonly touted solutions, such as fiscal union (greater integration of finances where Germany and the stronger economies subsidise the weaker economies) or debt monetisation (the ECB prints money) are unworkable.
Germany and France are unwilling or unable to increase the size of their commitments. Restricted by the German Constitutional Court’s decision, for the moment, Germany cannot or will not go above Euro 211 billion in guarantees for the bailout funds already committed –about 7% of its GDP. Fiscal integration would have a higher cost than Germany is willing to pay or can sustain without affecting the country’s creditworthiness.
France is at the limit of its financial capacity and at risk of losing its AAA credit rating. Fragile coalition governments in Netherlands and Finland are increasingly reluctant to increase their commitments to the bailout process. These constraints make full fiscal union difficult.
Stronger European countries have seen a sharp increase in the cost of their financing. Netherlands 10 year debt is trading around 0.40% above Germany, down from a November high of 0.68% but well above the 0.10% where it traded historically. Austria’s 10 year rate relative to Germany fluctuated between 0.80% to 1.90% in November, up from an average of 0.23% over the last 10 years. Finland’s 10-year spread to German bonds reached 0.79% in November, well above the low of 0.07% in January 2011 and an average of 0.35% over the last year. Finland’s 10 year bonds are trading at around 1.00% over that of neighbouring Sweden, down from a high of 1.37% but well above an average difference of 0.04% since the introduction of the Euro in 1999.
The higher rates and increased volatility of rates has made it increasingly difficult for these countries to finance, despite relatively sound public finances. For Finland, where 75% of its debt is sold to foreign investors, this is increasingly problematic.
The ECB is not allowed and also unwilling to print money. Germany’s Bundesbank opposes debt monetisation. The accepted view is that, in the final analysis, Germany will embrace fiscal integration or allow the printing of money. This assumes that a cost-benefit analysis indicates that this would be less costly than a disorderly break-up of the Euro-Zone. This ignores a deep-seated German mistrust of modern finance as well as a strong belief in a hard currency and stable money. Based on their history, Germans believe that this is essential to economic and social stability. It would be unsurprising to see Germany refuse the type of monetary accommodation and open-ended commitment necessary to resolve the crisis by either fiscal union or debt monetisation.
Printing money may buy some time. But it does not deal with the level of debt, the problems related to bank holdings of sovereign bonds (a small fall in value may affect the solvency of many institutions), allowing countries to regain access to investors on a sustainable basis or economic competitiveness.
If fiscal union and debt monetisation are unavailable, a “controlled” debt restructuring of some nations may be the only option available.
Contagion…
What happens in Europe will not stay in Europe. The shock will be rapidly transmitted through trade, investment and the financial system to the rest of the world. Problems in international money markets will not be welcome for America businesses and the Federal government, which relies on foreign investors for financing. It may truncate the nascent American recovery.
Not only are their financial health and savings affected by what happens in Europe, if the International Monetary Fund (“IMF”) gets involved American will be bearing around 16% of the bill for any European bailout.
The US and Europe account for around 40% of world GDP and 25% of trade. They also make up around 60% of direct investment flows and 60% of financial assets. Europe and the US is each other’s most important market for goods and services.
In 2010, the EU purchased just over $400 billion worth of US goods and services, around 20% of total exports. US exports to Asia are frequently components of or driven by exports to Europe.
The expected economic slowdown in Europe will affect US exports, one part of the American economy that is doing well growing are around 11%, the fastest rate for more than a decade. The slowdown in emerging markets that trade with Europe will have secondary effects on America’s economic activity.
A September 2011 report prepared by the Congressional Research Services estimated that American banks exposure to Greece, Ireland, Italy, Portugal, and Spain — some of the most heavily indebted euro zone economies — amounted to $641 billion. US banks direct exposure to European sovereigns is around $100 billion. The net exposure is probably lower due to hedges.
Indirect exposure via dealings with banks exposed to Europe is larger. American banks have exposure to German and French banks are greater than $1.2 trillion, about 10% of total commercial banking assets in the United States. US banks also have substantial open derivatives contracts with European banks, face value of around $750 billion although the current value of the positions is much lower.
In case of defaults or debt restructuring of one or more European nations or distress of a major European bank, US banks would suffer both direct and indirect losses, such as failed hedges. MF Global’s losses and bankruptcy are a stark reminder of the risks.
US retirement investments in European securities are at risk. Indirect exposure to losses on European securities is even greater. Around $800 billion of China’s currency reserves are invested in Europe.
Losses would reduce this savings pool which would affect China’s ability to purchase US Treasuries.
The problems of European banks, previously active in financing local businesses, will compound the problem. These banks are required to increase capital to cover losses, including those on their sovereign bond investment. As they can’t or do not want to issue equity at deeply discounted prices and the limited investor appetite for such issues, the banks may sell assets or reduce lending to raise the required capital. Estimates suggest that these banks could have to sell (up to) $2.5-3.0 trillion in assets, resulting in a sharp contraction in availability of credit.
While they are not a significant component of lending to American businesses, in 2007, European banks accounted for 30% of loans in Asia-Pacific. This has fallen by around half to 15-16% and is likely to shrink further as a result of the problems of these banks. Troubled French banks account for about 11% of maturing loans in Asia Pacific in 2012. It is unlikely that these banks will maintain their level of commitment. Asia-Pacific banks have taken up the slack but are not sizeable enough to fill the gap completely. The absence of credit will affect Asian businesses, which will then flow through to the US through reduced exports.
Recent action by central banks to lower the cost of US dollar funding via liquidity swaps for non-American banks was designed to alleviate some of these pressures. While they have had some effect, the funding position of European banks remains fragile.
The US will be affected through the appreciation of the dollar against the Euro. The Euro has declined in value by already 5% in a few weeks and further falls are possible. This will reduce the competitiveness of America exports, particularly relative to European businesses. Continued decline in the Euro will have a substantial adverse impact on US exports.
Historically, growth in the two economies is highly correlated. A slowdown in Europe is generally reflected in lower growth in the US reflecting the economic linkages. US growth may slow in response to Europe’s problems.
Stock markets are also correlated. American companies, especially with major European operations, have already signalled lower earnings as economic activity slows. Firm affected includes bellwether businesses like GE and McDonald’s. Automobile companies, with sales of nearly 25-30% in Europe, food and tobacco companies are exposed.
Continued problems are likely damage weak consumer and business confidence affecting the recovery.
American investors and financial institutions have reduced exposure to European debt and investments. The US Federal Reserve has provided dollars via European Central banks to help calm markets and avoid a dollar liquidity crunch. But beyond these measures, Americans are largely spectators to the events in Europe.
Nien or Non…
Early signs are not good. The French President has pronounced that no European country will be allowed to default. Germany has placed its faith in more austerity without increasing her financial commitment, proposing a revised treaty between Euro-Zone members to reinforce a commitment to fiscal discipline. Automatic, court-enforced sanctions on countries that exceed 3% of GDP on budget deficits and 60% of GDP on debt are laughable. The bulk of Euro-Zone countries do not and can not meet these limits now or in the forseeable future. As for the proposed fine, they would have to borrow the money to pay them.
Plans to leverage the EFSF are to be tabled, although no one honestly knows whether any investor will support it with cash. The Chinese have said “nein, danke” and “non, merci“.
The ECB will probably slash Euro interest rates and lengthen the term of emergency funding of banks to say two years with easier collateral rules. European central banks may provide money to the IMF to provide money to beleaguered nations. But IMF funding would rank above ordinary creditors and impede the receipt’s access to commerical funding complicating the problem.
No restructuring of the Euro is contemplated as the French, Germans and the EU appear hopelessly devoted to the common currency.
European leaders seem content to discuss long term lifestyle changes with the near death patient in ER.
(NEW) http://mobile.nytimes.com/article?a=882026&single=1&f=28 Will China Break?, Paul Krugman
Author: Satyajit Das
(Note: I highly recommend Satyajit's work, especially his book; "Traders, Guns and Money" on the global derivatives toxicity; "Knowns and Unknowns In The Dazzling World of Derivatives." You can read no-one with more real world ground experience and authority in the banking and derivatives trading business. This 2006 book is even better than his newest... Also, this most recent article sums the world problems most succinctly...)
European summits – over twenty at last count – have produced little. The planned summit on 9 December 2011 may well be the last chance for Euro leaders and Euro-crats to avoid a financial disaster. Unless European leaders overcome their common sense deficit, which is proving as intractable as budget and trade deficits, this may not end well.
The last comprehensive and final plan – the fourth in the last 18 months – failed to mollify investors and markets. The crisis is now engulfing Italy, Spain and now re-infecting Ireland and Portugal. Stronger countries like France (at risk of losing its AAA credit rating) and Germany are increasingly vulnerable.
Standard & Poor’s is reviewing the ratings of a number of 15 Euro-zone countries with negative implications. This action was “prompted by … belief that systemic stresses in the Euro-zone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the Euro-zone as a whole.” The rating agency highlighted tightening credit conditions across the Euro-zone, higher funding costs for many Euro-zone sovereigns, high levels of government and household indebtedness, the rising risk of an European recession and a lack of agreement among European policy makers on tackling problems.
Critical Points…
The curious pas de deux between European banks and sovereigns has reached a critical stage. Needing to raise money and keep interest costs down, governments are pressuring banks to buy their bonds and use them as collateral to raise fund from central banks and the European Central Bank (“ECB”). At the same time, European banks exposed to the risk of large losses on holdings of sovereign bond, which would render them potentially insolvent need governments to support the banking system.
Time is running short. European Sovereigns and banks need to find Euro 1.9 trillion to re-finance maturing debt in 2012. Italy alone requires Euro 113 billion in the first quarter and around Euro 300 billion over the full year. European banks need Euro 500 billion in the first half of 2012 and Euro 275 billion in the second half. This means they need to raise Euro 230 billion per quarter in 2012 compared to Euro 132 billion per quarter in 2011. Since June 2011, European banks have been only able to raise Euro 17 billion compared to Euro 120 billion for the same period in 2010.
There has to be acknowledgment that austerity – draconian budget cuts and tax increases – to bring budget deficits and public debt under control cannot deal with the problem – the deflation of the debt-fuelled bubble. There also has to be acknowledgment that Europe doesn’t have a “liquidity” problem which can be alleviated by substituting fleeing private sector lenders with official lenders such as the European Union (“EU”), ECB or the International Monetary Fund (“IMF”).
The European Financial Stability Fund (“EFSF”), the European bailout fund, is now largely irrelevant, It lacks the resources to quarantine Spain and Italy as well as, increasingly, Belgium, France and Germany from contagion.
Schemes to increase the capacity of the EFSF – borrowing to leverage the fund or partial guarantees or seeking Chinese funding – are simply far fetched or incomprehensible. The EFSF’s attempt to raise money to meet existing commitments has run into problems, meeting lack lustre support and a sharp increase in costs.
In the event that the AAA guarantors are downgraded, the EFSF structure, as originally envisaged, becomes unworkable. Rating agencies have signalled that the EFSF’s AAA rating is under threat. The risk that the cost of funding for the bailout fund is greater than the rate that it can charge is now increasingly evident.
European countries have a “solvency” problem – they have debt that they can never seriously expect to pay back. Stronger nations cannot save the peripheral nations without ultimately destroying their own credit and ability to raise funds.
Commonly touted solutions, such as fiscal union (greater integration of finances where Germany and the stronger economies subsidise the weaker economies) or debt monetisation (the ECB prints money) are unworkable.
Germany and France are unwilling or unable to increase the size of their commitments. Restricted by the German Constitutional Court’s decision, for the moment, Germany cannot or will not go above Euro 211 billion in guarantees for the bailout funds already committed –about 7% of its GDP. Fiscal integration would have a higher cost than Germany is willing to pay or can sustain without affecting the country’s creditworthiness.
France is at the limit of its financial capacity and at risk of losing its AAA credit rating. Fragile coalition governments in Netherlands and Finland are increasingly reluctant to increase their commitments to the bailout process. These constraints make full fiscal union difficult.
Stronger European countries have seen a sharp increase in the cost of their financing. Netherlands 10 year debt is trading around 0.40% above Germany, down from a November high of 0.68% but well above the 0.10% where it traded historically. Austria’s 10 year rate relative to Germany fluctuated between 0.80% to 1.90% in November, up from an average of 0.23% over the last 10 years. Finland’s 10-year spread to German bonds reached 0.79% in November, well above the low of 0.07% in January 2011 and an average of 0.35% over the last year. Finland’s 10 year bonds are trading at around 1.00% over that of neighbouring Sweden, down from a high of 1.37% but well above an average difference of 0.04% since the introduction of the Euro in 1999.
The higher rates and increased volatility of rates has made it increasingly difficult for these countries to finance, despite relatively sound public finances. For Finland, where 75% of its debt is sold to foreign investors, this is increasingly problematic.
The ECB is not allowed and also unwilling to print money. Germany’s Bundesbank opposes debt monetisation. The accepted view is that, in the final analysis, Germany will embrace fiscal integration or allow the printing of money. This assumes that a cost-benefit analysis indicates that this would be less costly than a disorderly break-up of the Euro-Zone. This ignores a deep-seated German mistrust of modern finance as well as a strong belief in a hard currency and stable money. Based on their history, Germans believe that this is essential to economic and social stability. It would be unsurprising to see Germany refuse the type of monetary accommodation and open-ended commitment necessary to resolve the crisis by either fiscal union or debt monetisation.
Printing money may buy some time. But it does not deal with the level of debt, the problems related to bank holdings of sovereign bonds (a small fall in value may affect the solvency of many institutions), allowing countries to regain access to investors on a sustainable basis or economic competitiveness.
If fiscal union and debt monetisation are unavailable, a “controlled” debt restructuring of some nations may be the only option available.
Contagion…
What happens in Europe will not stay in Europe. The shock will be rapidly transmitted through trade, investment and the financial system to the rest of the world. Problems in international money markets will not be welcome for America businesses and the Federal government, which relies on foreign investors for financing. It may truncate the nascent American recovery.
Not only are their financial health and savings affected by what happens in Europe, if the International Monetary Fund (“IMF”) gets involved American will be bearing around 16% of the bill for any European bailout.
The US and Europe account for around 40% of world GDP and 25% of trade. They also make up around 60% of direct investment flows and 60% of financial assets. Europe and the US is each other’s most important market for goods and services.
In 2010, the EU purchased just over $400 billion worth of US goods and services, around 20% of total exports. US exports to Asia are frequently components of or driven by exports to Europe.
The expected economic slowdown in Europe will affect US exports, one part of the American economy that is doing well growing are around 11%, the fastest rate for more than a decade. The slowdown in emerging markets that trade with Europe will have secondary effects on America’s economic activity.
A September 2011 report prepared by the Congressional Research Services estimated that American banks exposure to Greece, Ireland, Italy, Portugal, and Spain — some of the most heavily indebted euro zone economies — amounted to $641 billion. US banks direct exposure to European sovereigns is around $100 billion. The net exposure is probably lower due to hedges.
Indirect exposure via dealings with banks exposed to Europe is larger. American banks have exposure to German and French banks are greater than $1.2 trillion, about 10% of total commercial banking assets in the United States. US banks also have substantial open derivatives contracts with European banks, face value of around $750 billion although the current value of the positions is much lower.
In case of defaults or debt restructuring of one or more European nations or distress of a major European bank, US banks would suffer both direct and indirect losses, such as failed hedges. MF Global’s losses and bankruptcy are a stark reminder of the risks.
US retirement investments in European securities are at risk. Indirect exposure to losses on European securities is even greater. Around $800 billion of China’s currency reserves are invested in Europe.
Losses would reduce this savings pool which would affect China’s ability to purchase US Treasuries.
The problems of European banks, previously active in financing local businesses, will compound the problem. These banks are required to increase capital to cover losses, including those on their sovereign bond investment. As they can’t or do not want to issue equity at deeply discounted prices and the limited investor appetite for such issues, the banks may sell assets or reduce lending to raise the required capital. Estimates suggest that these banks could have to sell (up to) $2.5-3.0 trillion in assets, resulting in a sharp contraction in availability of credit.
While they are not a significant component of lending to American businesses, in 2007, European banks accounted for 30% of loans in Asia-Pacific. This has fallen by around half to 15-16% and is likely to shrink further as a result of the problems of these banks. Troubled French banks account for about 11% of maturing loans in Asia Pacific in 2012. It is unlikely that these banks will maintain their level of commitment. Asia-Pacific banks have taken up the slack but are not sizeable enough to fill the gap completely. The absence of credit will affect Asian businesses, which will then flow through to the US through reduced exports.
Recent action by central banks to lower the cost of US dollar funding via liquidity swaps for non-American banks was designed to alleviate some of these pressures. While they have had some effect, the funding position of European banks remains fragile.
The US will be affected through the appreciation of the dollar against the Euro. The Euro has declined in value by already 5% in a few weeks and further falls are possible. This will reduce the competitiveness of America exports, particularly relative to European businesses. Continued decline in the Euro will have a substantial adverse impact on US exports.
Historically, growth in the two economies is highly correlated. A slowdown in Europe is generally reflected in lower growth in the US reflecting the economic linkages. US growth may slow in response to Europe’s problems.
Stock markets are also correlated. American companies, especially with major European operations, have already signalled lower earnings as economic activity slows. Firm affected includes bellwether businesses like GE and McDonald’s. Automobile companies, with sales of nearly 25-30% in Europe, food and tobacco companies are exposed.
Continued problems are likely damage weak consumer and business confidence affecting the recovery.
American investors and financial institutions have reduced exposure to European debt and investments. The US Federal Reserve has provided dollars via European Central banks to help calm markets and avoid a dollar liquidity crunch. But beyond these measures, Americans are largely spectators to the events in Europe.
Nien or Non…
Early signs are not good. The French President has pronounced that no European country will be allowed to default. Germany has placed its faith in more austerity without increasing her financial commitment, proposing a revised treaty between Euro-Zone members to reinforce a commitment to fiscal discipline. Automatic, court-enforced sanctions on countries that exceed 3% of GDP on budget deficits and 60% of GDP on debt are laughable. The bulk of Euro-Zone countries do not and can not meet these limits now or in the forseeable future. As for the proposed fine, they would have to borrow the money to pay them.
Plans to leverage the EFSF are to be tabled, although no one honestly knows whether any investor will support it with cash. The Chinese have said “nein, danke” and “non, merci“.
The ECB will probably slash Euro interest rates and lengthen the term of emergency funding of banks to say two years with easier collateral rules. European central banks may provide money to the IMF to provide money to beleaguered nations. But IMF funding would rank above ordinary creditors and impede the receipt’s access to commerical funding complicating the problem.
No restructuring of the Euro is contemplated as the French, Germans and the EU appear hopelessly devoted to the common currency.
European leaders seem content to discuss long term lifestyle changes with the near death patient in ER.
Thursday, December 01, 2011
Europe's Seemingly Inevitable Slide Towards Financial Disaster...
Posted At : November 27, 2011 11:03 AM | Posted By : Satyajit Das
Related Categories: Global Sovereign Debt Crisis
A crucial element of the plan is the ability of Spain and Italy to take action to improve their finances and maintain access to funding at reasonable cost. The EU communique specifically refers to the need for actions by these two members at some length. There is considerable doubt as to whether this will occur.
Spain’s economy is weak, with low growth, low productivity and high reliance on debt. As the country has sought to bring its finances under control, Spain’s growth has slowed with an increase in the unemployment rate to 21% and youth unemployment above 40%. Spain’s banking sector remains heavily heavily exposed to the real estate with the likelihood of further losses. It is difficult to see Italy, weakened by internal political strife, making rapid progress to making required structural changes to its economy and cutting public debt.
The austerity and balanced budget measures, reinforced and reiterated in the plan, cannot deal with the primary problem - the deflation of the debt-fuelled bubble. Strict enforcement of limits on deficits and level of debt would prevent counter cyclical spending by Governments undermining economic recovery and lock the Euro-zone into a death spiral of budget deficits, further budget cuts and low growth.
The problem is compounded by the competitiveness gap between Northern and Southern countries, estimated at 30% difference in costs. For many of the weaker countries, the best option would be to devalue its currency in the same way that the US and Britain are debasing dollars and sterling respectively. The EU’s refusal to contemplate a break-up or restructuring of the Euro makes dealing with this problem difficult.
Unable to devalue or control interest rates, these weaker countries are trapped in a vicious and ultimately self-defeating cycle of cost reduction.
An additional problem is the internal imbalances exemplified by Germany’s large intra-Euro-Zone trade surplus at the expense of deficit states, especially the Club Med countries like Greece, Portugal, Spain and Italy. German reluctance to boosting spending and imports makes any chance of resolving the crisis even more remote.
German banks lent money to many countries to finance exports, which benefited Germany. Germany also gained export competitiveness from a weaker. Reluctance to confront these problems makes a comprehensive resolution of the crisis difficult.
The latest plan has bought time, though far less than generally assumed. The European debt endgame remains the same: fiscal union (greater integration of finances where Germany and the stronger economies subsidise the weaker economies); debt monetisation (the ECB prints money); or sovereign defaults.
The key element of the 27 October Plan was the unwillingness or inability of Germany and France to increase the size of their commitments. Germany is increasingly unwilling to increase its commitments. It is restricted by the German Constitutional Court’s decision, which makes it difficult to increase support for bailouts without a new constitution.
For the moment, Germany cannot or will not go above Euro 211 billion in guarantees for the bailout funds already committed –about 7% of its GDP. Fiscal integration would have a higher cost than Germany is willing to pay or can sustain without affecting the country’s creditworthiness. France is at the limit of its financial capacity. France’s GDP is around US$2 trillion and its debt to GDP around 82%. Following the assumption of the liabilities of the failed Franco-Belgium financier Dexia, the rating agencies have indicated that France faces a rating downgrade.
Netherlands, Finland and Luxembourg are too small to make much difference. Fragile coalition governments in Netherlands and Finland are increasingly reluctant to increase its commitments to the bailout process.
The ECB is not allowed and seemingly unwilling to print money. Theoretically, it would need a change in European Treaties although the ECB has stretched its operational limits. Germany’s Bundesbank opposes debt monetisation. There would be deep-seated unease about printing money in Germany, which is still haunted by the memory of hyperinflation in the Weimar period.
The accepted view is that, in the final analysis, Germany will embrace fiscal integration or allow printing money. This assumes that a cost-benefit analysis indicate that this would be less costly than a disorderly break-up of the Euro-zone and an integrated European monetary system. This ignores a deep-seated German mistrust of modern finance as well as a strong belief in a hard currency and stable money. Based on their own history, Germans believe that this is essential to economic and social stability. It would be unsurprising to see Germany refuse the type of monetary accommodation and open-ended commitment necessary to resolve the crisis by either fiscal union or debt monetisation.
Unless restructuring of the Euro, fiscal union or debt monetisation can be considered, sovereign defaults may be the only option available.
© 2011 Satyajit Das All Rights Reserved. Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (November 2011)
Spain’s economy is weak, with low growth, low productivity and high reliance on debt. As the country has sought to bring its finances under control, Spain’s growth has slowed with an increase in the unemployment rate to 21% and youth unemployment above 40%. Spain’s banking sector remains heavily heavily exposed to the real estate with the likelihood of further losses. It is difficult to see Italy, weakened by internal political strife, making rapid progress to making required structural changes to its economy and cutting public debt.
The austerity and balanced budget measures, reinforced and reiterated in the plan, cannot deal with the primary problem - the deflation of the debt-fuelled bubble. Strict enforcement of limits on deficits and level of debt would prevent counter cyclical spending by Governments undermining economic recovery and lock the Euro-zone into a death spiral of budget deficits, further budget cuts and low growth.
The problem is compounded by the competitiveness gap between Northern and Southern countries, estimated at 30% difference in costs. For many of the weaker countries, the best option would be to devalue its currency in the same way that the US and Britain are debasing dollars and sterling respectively. The EU’s refusal to contemplate a break-up or restructuring of the Euro makes dealing with this problem difficult.
Unable to devalue or control interest rates, these weaker countries are trapped in a vicious and ultimately self-defeating cycle of cost reduction.
An additional problem is the internal imbalances exemplified by Germany’s large intra-Euro-Zone trade surplus at the expense of deficit states, especially the Club Med countries like Greece, Portugal, Spain and Italy. German reluctance to boosting spending and imports makes any chance of resolving the crisis even more remote.
German banks lent money to many countries to finance exports, which benefited Germany. Germany also gained export competitiveness from a weaker. Reluctance to confront these problems makes a comprehensive resolution of the crisis difficult.
The latest plan has bought time, though far less than generally assumed. The European debt endgame remains the same: fiscal union (greater integration of finances where Germany and the stronger economies subsidise the weaker economies); debt monetisation (the ECB prints money); or sovereign defaults.
The key element of the 27 October Plan was the unwillingness or inability of Germany and France to increase the size of their commitments. Germany is increasingly unwilling to increase its commitments. It is restricted by the German Constitutional Court’s decision, which makes it difficult to increase support for bailouts without a new constitution.
For the moment, Germany cannot or will not go above Euro 211 billion in guarantees for the bailout funds already committed –about 7% of its GDP. Fiscal integration would have a higher cost than Germany is willing to pay or can sustain without affecting the country’s creditworthiness. France is at the limit of its financial capacity. France’s GDP is around US$2 trillion and its debt to GDP around 82%. Following the assumption of the liabilities of the failed Franco-Belgium financier Dexia, the rating agencies have indicated that France faces a rating downgrade.
Netherlands, Finland and Luxembourg are too small to make much difference. Fragile coalition governments in Netherlands and Finland are increasingly reluctant to increase its commitments to the bailout process.
The ECB is not allowed and seemingly unwilling to print money. Theoretically, it would need a change in European Treaties although the ECB has stretched its operational limits. Germany’s Bundesbank opposes debt monetisation. There would be deep-seated unease about printing money in Germany, which is still haunted by the memory of hyperinflation in the Weimar period.
The accepted view is that, in the final analysis, Germany will embrace fiscal integration or allow printing money. This assumes that a cost-benefit analysis indicate that this would be less costly than a disorderly break-up of the Euro-zone and an integrated European monetary system. This ignores a deep-seated German mistrust of modern finance as well as a strong belief in a hard currency and stable money. Based on their own history, Germans believe that this is essential to economic and social stability. It would be unsurprising to see Germany refuse the type of monetary accommodation and open-ended commitment necessary to resolve the crisis by either fiscal union or debt monetisation.
Unless restructuring of the Euro, fiscal union or debt monetisation can be considered, sovereign defaults may be the only option available.
© 2011 Satyajit Das All Rights Reserved. Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (November 2011)
Wednesday, November 16, 2011
Ancient Monetary System Mechanics…
"New"__The Main Event – The U.S. Debt Crisis
S___, the solution was offered by Plato some 2400 years ago__Nobody has eyes or ears__Yet...!!!
S___, the solution was offered by Plato some 2400 years ago__Nobody has eyes or ears__Yet...!!!
"--- The citizen of the ideal state will require a currency for the purpose of every day expenses; This is practically indispensable for workers of all kinds and for such purposes as the payment of wages to wage earners. To meet these requirements, the citizen will possess a currency which will pass for value among themselves, but will not be accepted outside their own boundaries. But a stock of some currency common to the Hellenic world generally i.e., of international currency, will at all times be kept by the state for military expenditures or official missions abroad such as embassies and for any other necessary purposes of state. If a private citizen has occasion to go abroad, he will make his application to the government and go; and upon his return if he has any foreign currency left over in his possession, he will hand it over to the state receiving in exchange the equivalent in local currency." Plato
I and hundreds of heterodox economists have followed on in Plato's footsteps, as did Benjamin Franklin, in offering similar systems' models__Not our fault, if the world is too dumb to listen... It seems the world can't hear intelligence__only inanity and insanity...
"--- We need a fixed value monetary system. At the present time, we have none. Under floating exchanges, America is simply a powerful ship on an ocean, with no rudder. Old gold, silver, and other known standards will no longer work. They will not work due to the massive increases in communication's speed, the varied endowments of nations' natural resources, and encrypted international speculative opportunities. Therefore, we need a new system. INTERNAL EXCHANGE CLEARING is such a system. It is an entirely new fixed value enhancing - [production standard] - monetary system, to benefit all humankind."
You can argue any of the thousands of other models, to the ends of the Earth__The only one that works, is the one that offers a clearing system of currency mechanics, to eliminate inter-nation manipulation__Which the above systems mentioned__Do...
"---There's a wolf in the system... He was born of your laws. He roams from Maine to California - Alaska to Florida - Hawaii to D.C., and Chicago to New York... He is a hungry wolf. He tears into your hind quarters, clear to the bone, with a vicious set of teeth. He is simply after your wallet. He is the [international] speculation wolf, and he operates legally under your floating exchange law system, to rip the very soul from your nation. He will succeed unless you try to understand how he feeds............"
"If we set a [production] standard of value (to control inflation and exchange rates) in one fifth of the entire economy, we can make real unlimited use of the printing press –– while liquidating all state debts."
This last one really makes you choke, don't it S____. A high enough constructive intellect can understand it__though...
S____, just to show you a major fallacy in your thinking, I'll take this example statement of yours...
China is purposely buying up dollars to manipulate their currency low. They are simply central banking every Treasury Dollar they buy from us, even though the value is slightly decreasing, but not by much, as China is controlling the band within its own trade-weighted advantage point. This mechanical trick actually puts extra pressure on China's own internal poorer classes, as the money's not added to its real internal economy, from the Treasury purchases, as doing so would raise the value of China's currency, which China is fighting to its last breath, to keep from happening. The total cost benefit analysis to greater China's position is net positive, by being able to buy cheap commodities, metals, etc., from many nations pegged to China's currency, thus keeping these costs low, while exporting finished products to the high currency nations, which China is Purposely creating, by this Treasury Manipulation Market, a manipulated low currency export status__While the Rich nations all suffer, by exporting jobs and Treasury values to China__Due exactly to China's Manipulation Policies__It's called Mercantilism, and is the oldest unfair trading practice in all of economic history... All you have to do to see who's guilty of currency manipulation practices is look at the global figures for massive balance of payments surplusses__And you'll find China leads the pack. Years ago, the gold and silver standards re-balanced the balance of nations' payments, by forcing nations to give up gold and or silver if they didn't. No nation wanted to then lose its currency base, so re-balance they did__But, with the present's free-for-all fiat-system, there's no means of punishment, in the international system, to force the older style re-balancings of out of balance, balance of payments__Thus we got this giant fiat-system of collapsing imbalancing of currency systems__The only cure of which is New Clearing System Laws Between Nations To Re-Balance The National-Fiat-Frauds...
It's not difficult to understand it S____... It just takes looking at it, at the Balance of Payments Reality Position... China is simply hoarding, just the same as someone stuffing their bank account in their private mattress, so the rest of the economy has no access to the funds__which clearly subtracts from the Global Economies__Which is exactly what all Massive Balance of Payments Surplusses are truly doing__These nations are robbing the Global Economies Blind__And most all political and economic pinheads are too blind to see it is nothing more than a Massive Global Currency War__Taking Place__Now__Everywhere...!!!
Comparative Advantage and Supply and Demand have turned to Outright Comparative Dis-Advantage, Through Massively Imbalanced Currency Manipulation Mechanics... So, you better start looking at the real figures, say at the I.M.F., B.I.S. and C.H.I.P.S....
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