The only question I have been toying with today apart from all the other ones is whether it was the big bazooka or not. The Melbourne Age article (October 28, 2011) – Euro summit fires ‘bazooka’ at debt monster – lead me to believe that the big one had come out, but then the Financial Times article (October 28, 2011) – Merkel’s mantra works without ‘big bazooka’ – suggested the bazooka was left in the rack. Perhaps the bazooka was brought into action but the big bazooka was left at home. That conclusion would reconcile things nicely. It is very confusing though isn’t it. About as confusing as trying to work out what the EMU leaders might define as leadership. The way I understand it the only bazooka that the EMU has at their disposal refused to play ball and stayed at home in Frankfurt. The result – no matter what the political spin is and no matter how much the governments pledge to put into the EFSF or claim they can get from the Chinese the situation remains – they are recursing back to insolvency. None of the member governments can ultimately stump up the euros when Italy, then France or any other member state requires bailing out. In the end, they will be picked off one by one. I guess they did bring out some sort of bazooka – but just aimed it at themselves.
For starters, imagine that you come down from Mars and have studied basic macroeconomics. You thus know the following:
1. Spending equals income equals output which drives employment.
2. Employment growth drives tax revenue and reduces welfare outlays.
3. Budget balances are the difference between spending and revenue.
4. You note that governments issue debt to the non-government sector which matches their budget deficits although you wonder why they would do such a thing given they issue the currency that everyone uses. You muse to yourself (not being rude) – “Why do these Earthlings do such a curious thing?”.
5. You also note that some governments (over in Europe) delight in making life harder for themselves and their citizens by deliberately refraining from issuing their own currencies and instead, ceding that authority to some faceless, unelected people who are located in Frankfurt. But being polite you duly note the idiocy of this arrangement and worry about the citizens whose welfare it retards.
You land in Brussels on October 26, 2011 and the Earthling leaders (Angie, Nick, George and some others) ask you for some advice: They want smaller budget deficits although their reasoning is somewhat odd.
They think that by reducing budget deficits they will have lower interest rates, even though you tell them they already have relatively large deficits and virtually zero interest rates and show them some data from the Bank of Japan that you picked up which suggests they have had the same for 2 decades.
Not to be daunted they tell you that the other major concern is that if they don’t get the budget deficits down they will face accelerating inflation. You note again that the deficits are historically large and inflation is mostly falling. Again, you tell them that Japan has faced deflation with high budget deficits for two decades.
But then they tell you that the bond markets are attacking some of the governments under their leadership. This is a problem because these governments signed away their capacity to generate their own funds and if the bond markets don’t lend to them they cannot pay their daily bills. The bond markets are rightfully worried that they might not get their money back without some haircut because they know the governments in question do not issue their own currency. Its a no-brainer!
The terminology is curious – the earthlings keep talking about haircuts – as if they are obsessed with appearances instead of substance.
At any rate, the message is clear – they want smaller budget deficits and lower public debt so the bond markets will keep lending them money so they can keep paying their bills.
Okay, you ask them their plan. It is a polite question – because you anticipate they will say that their overriding strategic imperative is to stimulate economic growth to ensure they have enough jobs for all that want them. You are sure they will note that private spending is very flat and so they will need to replace it with public spending.
You are sure they understand that even if the budget deficit rises in the short-run, it will always come down again as GDP grows because more people pay taxes and less people warrant government welfare support. Everyone knows that you think.
You feel that – despite designing a system where the currency power lies with an unelected group that works in a building in Frankfurt and the workers in that building appear to read German economic history literature from the 1920s almost constantly but ignore the literature of the 1930s when the economy grew strongly – the Earthling leaders will tell you that they don’t really have to worry about the private bond markets anyway.
That is obvious from even the most casual observation of their system – as a result of the fact that those Frankfurter-based bankers can always deal the private bond markets out of the game by providing the necessary euro support to allow the member governments to promote growth and introduce employment guarantees etc.
So obviously, you expect them to say that the Frankfurter-based bankers will be busy crediting relevant bank accounts and doing everything that they can to ensure economic growth is strong and everyone is able to work. That will ensure all the member states achieve the leader’s goals of reducing the budget deficits and fulfilling (you presume) their major responsibility to advance the welfare of their citizens. Who would think that government would do anything different?
You realise they are a bit precious about the curious monetary arrangements they have in place but realise they can minimise the negative consequences of putting the democratically-elected leaders in the various nations into a strait-jacket by letting the Frankfurter-based bankers use their currency monopoly appropriately.
And you clearly expect them to keep their own hair in neat shape with the occasional hair cut but you clearly don’t mind someone preferring some dreads or some other hair-do. But the last thing you would expect them to do is to force the private banks that did invest funds in these member governments in good faith to cut their investments in half.
No reasonable person who understood anything about market sentiment would consider that to be a sensible signal to send to the private bond markets given that you hope that they will continue to provide loans to these artificially strait-jacketed member states into the distant future.
You would also not expect them to suggest that they will solve their problem by insisting that all member states guarantee some central fund contributions in the currency that none of them issue and who ultimately might need to call on should the bond markets not feel very good about having half their hair cut off.
Prior to meeting the Earthling leaders, you had a brief visit to the empty housing estates surrounding Dublin and being briefed by the New Beginning Organisation in Ireland where you learned that there are “621 ghost estates across the Irish Republic now … One in five Irish homes is unoccupied”.
You also spent a day or two in Athens where you learned that the suicide rate in Greece has doubled in the last year.
So you wonder how this crisis persisted for so long when everywhere you go there are idle people, boarded up buildings and factories and no apparent reason why all these workers and machines shouldn’t be working to their potential.
Anyway, then they tell you about their bazooka – or whatever it is – that took them hours behind closed doors to come up with. Upon hearing the plan you immediately send a text message back to your fully-employed and well-paid mates back on Mars which Google would translate as:
These Motherfu#%ing fuc@#ers are %@cked. Earthlings are imbeciles.
The Melbourne Age article – Euro summit fires ‘bazooka’ at debt monster – told us that:
After more than eight hours of heated talks that went to the brink of collapse, European leaders have hammered out a financial rescue plan for the euro that they hope will stave off a double-dip recession.
The deal includes creditors agreeing to halve Greek debt, a plan to recapitalise the region’s banks to protect them against losses and the boosting of the main bailout fund into a €1 trillion ($1.32 trillion) “bazooka”.
The only problem is that they aimed the bazooka at themselves. The real bazooka that could have been brought into play to stop this crisis immediately stayed in its shed in Frankfurt.
The French President was quoted as saying:
Because of the complexity of the issues at stake it took us a full night. But the results will be a source of huge relief worldwide.
The economic issues are not complex at all. The Eurozone leaders deliberately built a monetary system that was not capable of withstanding a major asymmetric demand shock across its regional space.
They also introduced a Stability and Growth Pact (SGP) which has been neither stabilising nor supportive of growth.
As an aside, the Germans only wanted to call the SGP the Stability Pact, reflecting the fact that their collective memory conveniently stopped accumulating data after about 1926. I guess they would want to wipe the next 20 years out but they should just get over their obsession – it helps no-one.
Then a major negative demand shock hits the system and some governments face insolvency because they signed away their currency powers. The reasons for why some nations are in dire trouble and other EMU nations are not in as much trouble (yet) shouldn’t really be the issue.
The whole region needs to grow. But our erstwhile Euro leaders decide to do the exact opposite and kill growth – which is the only way out of this mess. The bond markets realise that austerity is likely to worsen their prospects of getting their money back and so rebel.
The Euro leaders impose more austerity. The situation gets even more dire. And the Euro leaders have to stay up all night to work out a plan which will make the current situation worse!
This is all because they refuse to order the ECB to take the responsible role of funding growth right across the region – which means they have to fund every member state’s budget deficits and those deficits have to be as large as is required to fill the spending gaps in their respective economies.
The economics is not complex at all. The politics is the problem and the cultural differences.
The EC President was quoted as saying:
These are exceptional measures for exceptional times … Europe must never again find itself in this situation.
They are half-baked measures for dire times and unless these power elites take an ego loss and redesign or abandon their monetary system – Europe will certainly find itself in that situation again and meanwhile they will be impoverishing their citizens.
The Greek Prime Minister was quoted as saying:
We can claim that a new day has come for Greece, and not only for Greece but also for Europe.
The sun rises each day. But the Euro leaders have nothing to do with that thank g#d! If they could get their incompetent hands on the Earth’s path around the Sun who knows what would happen.
The deal ensures that the Greek government continues to punish its people in a most extreme manner and cede democracy to the power elites in Brussels.
Apparently our famous Euro leaders threatened the private banks with “the nuclear option” which would involve Greek bankruptcy. I find this a most repugnant part of the deal.
These champions of free markets and entrepreneurship then put on their jack boots and bludgeon the banks and insurance funds, who we have no reason to assume didn’t invest in good faith, into taking losses. What would you do if you were a funds manager as a result of that bullying nonsense?
Given you owe your “investors” due diligence and have a fiduciary duty to them, would you be so keen to invest in these governments again any time soon? Especially when the outlook is to have very low growth rates into the distant future?
I believe it is the right of the people of a nation to democratically decide to restore its own currency and offer creditors re-negotiated arrangements in that new currency. It is then up to the creditors to determine whether they want to convert. If not, bad luck. Their participation is not required anyway.
But it is entirely different for a group of elites to bludgeon investors in this way, especially when the real bazooka is sitting smugly by in Frankfurt hold farewell parties for their outgoing boss and crowing on about how successful the EMU has been since inception.
You would not be able to write fiction with as much farce and tragedy and comedy as this sort of stuff provides.
The most reasonable path would have been to fully nationalise all the exposed banks using the ECB to capitalise them, writing down all debts in the public interest and fully funding growth policies in the member-state economies.
Who cares if the Germans think the Greeks are lazy or that Greeks are continually being reminded by Greek daily Eleftherotypia cartoonist Stathis that they haven’t left their past behind.
For example, this cartoon is typical of the cultural wars that the crisis has spawned:
They all need growth and starving the periphery will starve the whole system.
The Financial Times article – Merkel’s mantra works without “big bazooka” – said that:
The outcome was not a big “bazooka”, with trillions of euros designed to spread shock and awe through the markets. It will not be a one-off solution to the crisis, for much still depends on other players, including international banks and bondholders, and on other governments in the eurozone. But there is German handwriting all over the conclusions, reinforcing budget discipline and strengthening the rules for future behaviour. All the partners in the common currency have now committed themselves to putting a German-style “debt brake” – requiring a balanced budget – into their constitutions, or the legal equivalent.
Apart from all the anti-democractic “(i)ntrusive surveillance of national spending plans” that “will be the norm from now on” and the EC “given new powers to blow the whistle on national profligacy”, the Summit result fails to address the fundamental problem – the need for growth.
The French suggestion to have “the European Central Bank … provide the EFSF with unlimited liquidity” was rejected. As noted above and given the already flawed design of the EMU, the French suggestion really was the only viable medium- to long-term solution (that is, without all the austerity tacked onto it).
The Summit also accepted the logic of the German fiscal obsession and they will now talk more about:
… amending European treaties to set budget discipline in European law …
So they will call meetings and serve sumptuous meals and drink fine wines and waste more time designing anti-growth measures.
I agree with the line that Financial Times columnist Wolfgang Münchau took today in his blog – Half measures will not end the crisis – who concludes that “none of this is going to end the crisis”.
First, he concludes that the haircut deal is not binding on the banks and that “(m)any banks would be better off if the haircut was involuntary, given their offsetting positions in credit default swaps”.
Second, he doesn’t believe the EU forecasts which have been used to model the public debt to GDP ratios that have been central in this deal. He says that:
They misjudged the impact of austerity on economic growth and public sector deficits. This misjudgement is the reason why the voluntary bank haircut of 21 per cent, agreed in July, has now grown to 50 per cent. What happens if the outlook were to deteriorate further? There is no sign yet of a turnaround.
The whole plan is anti-growth because it doesn’t reverse the austerity. It just keeps the dependency of the member nations on the private bond markets at bay for some time yet. The ECB has been doing that anyway via their secondary bond market purchases. The scale will ramp up if the bond markets turn on Italy and France (and there are signs that is now happening). In that case the EFSF will not be sufficient no matter how much they put in. It will be left to Germany as the system recurses back to total insolvency.
Münchau reinforces this point by saying that the EFSF has only limited capacity:
Banks can only do this because central banks and governments act as ultimate guarantors of the financial system. There exists an implicit insurance of unlimited liability. In the case of the European financial stability facility the very opposite is the case: there is an explicit insurance of limited liability. Germany wants its exposure capped to a maximum of €210bn. I doubt that global investors will rush into the tranches of the special purpose vehicle through which the eurozone wants to leverage the EFSF. I struggle to see how this structure can lead to a significant and sustained fall in bond spreads.
Especially when the Euro leaders are trying to enforce losses on the very investors they want to duchess.
Münchau also notes that the EFSF can only work “if the eurozone were willing to provide an unlimited backstop. This would be either in the form of an explicit lender-of-last-resort guarantee by the European Central Bank, or through a eurobond – or ideally both”.
He calls that “a comprehensive agreement” but because the Euro leaders do not have the capacity to embrace it the “crisis, meanwhile, continues”.
My final comment relates to the Euro leaders now thinking they can solve the problem by borrowing abroad. As if they don’t understand the limitations that they already have placed on their member governments they are now hunting around the world (China and Brazil – courtesy of the IMF) to see if they can worsen the problem by borrowing in foreign currencies.
Bad way to head into the weekend.
And need I make it worse by noting that UK consumer confidence hits 2-year low. They are categorically proving they are not the Ricardian agents that my profession eulogises – in the fiction world of mainstream macroeconomics.
Tomorrow I will be speaking at the – Building a Creative Economy Conference – in Sydney from around 14:00. Hope to see some Sydney-siders there.
Psychological advice for the goldbug who is struggling
This is for all those goldbugs out there who are feeling a little wan because they have been taking losses as the price of gold started tumbling in early September (2011).
You can now have a single coin worth $A50 million and know that it is the largest gold coin around (1,012 kgs and 99.99 per cent pure gold).
This ABC news story (October 27, 2011) – Perth Mint unveils world’s biggest gold coin – tells all.
The regular Saturday Quiz will also be back tomorrow – and will be easier than usual because I am worried that too many people are not escaping the neo-liberal ranks quickly enough! We need a solid MMT army not stragglers struggling with the demons of the past (-:
That is enough for today!