18 July 2011

Who cares as long as the Euro goes ping?

Eurocrats are fumbling through the pages. They are sure that the problem lurks darkly in the morality of those who commit sinful debts. A few magic words, a legal spell, a sprinkle of accounting and a curse on agencies ... but which page is it on?
This fantasy (as described by Yianis Varoufakis) and 'the one interest rate to rule them all' has this fate. Eurocrats and leaders are still only concerned with the problem of financing unfair terms of trade. As for moral hazard, a example could be taken from this German Insurance company and have colour-coded arm-bands issued to good and bad servicing countries.

A simple story of unfair terms of trade

The surpluses and deficits build up because of competitive advantages that the one currency and the interest rate persistently give to certain members.  There is still no mechanism to address this imbalance.

The Terms of Trade (the real exchange rate) is the price of foreign goods relative to domestic prices. Exporters and importers compare the prices of goods home and aboard. 
Let (EP) = Eurozone Prices      Let Pg = Greek prices

In the Never-Never-Land of European Convergence and market fairies, we would expect Eurozone and domestic prices to be equal and a real exchange rate equal to one. This a big assumption; there are too many goblins around.  When there are serious problems of competitiveness, market power and corrupt political structures the 'law of one price' breaks down.

Greek markets are smaller, easier to control, less competitive than their Euro counterparts. Monopolies, cartels, vested interests, corruption and bureaucracy  keeps domestic prices higher, with consumers experiencing higher rates of inflation, than elsewhere in the Eurozone.  With (EP) < Pg, imports rise, exports fall and Greece has a deficit relative to its Euro partners.

The ECB/IMF's structural reforms intend to internally deflate Pg, but on who?  This is the key difference between the Government and the 'Indignants' on the squares of Greece. Reforms fail when applied on just the weaker members, and on those who join vested interest groups in order to protect themselves against the stronger ones. The political structure, itself, needs changing. It is incapable of shooting itself. However, do-it-yourself structural reforms are, I suppose possible. Here's an example happening near me.

Contrast what happens with exchange rates.  Redefine (EP) into two components: E (exchange rate) and P (foreign price level).  (EP) < Pg, means that the excess demands for partners' goods now translates as excess demand for their currency causing E to rise.  Exchange rates, moving much faster than domestic prices, move to maintain the purchasing power parity, (EP) = Pg.  There are no persistent trading surpluses and deficits so even a corrupt, inefficient and bureaucratic economy can devalue its way out difficulty. 

Forward and speculation markets are attached to exchanges rates. Without a domestic currency (fixed exchange rates), speculation moves elsewhere, on to sovereign debts and the ability to service deficits. The Euro has swapped currency risk for sovereign debt risk. The ECB's failure as 'central bank' to provide Eurobonds and act as a lender of last resort has manufactured a very volatile market in sovereign debts. This failing will undo the Euro with every global recession.

Unfair terms of trade has meant persistent trade surpluses in the euro core economies and matching trade deficits in the periphery.  This problem means that a single interest rate and monetary policy does not have equal effects on surplus countries and deficit countries.  It cannot serve both. 

In the core, the real interest rates (prices were rising slower there) meant a lower aggregate domestic demand and a lower growth in real wages for their workers.  This, however, gave the core, Germany in particular,  a competitive dominance in the internal markets of the Euro and the basis for their export led growth rates. The price of this success was paid for in the periphery. Here, the lower real interest rates (as prices were rising higher)  meant money was cheaper and sovereign debt and consumer debt could be built up fuelling construction, housing and property bubbles in the region. Countries like Greece, Portugal, Spain, and Italy were forced to accept huge and growing current account deficits that entailed borrowing.

The global crisis not only exposed but accelerated the divergence between the surplus and deficit Euro economies.  The deficit economies not only had to finance existing trade deficits but also had to face an increasing Government budget deficit, as recession and rising unemployment implies falling tax incomes and more benefit payments. Without a monetary policy, and enforced limits on fiscal policy, they were extremely vulnerable to the global recession. 

It didn't take long for the international financial markets to see this weakness, raise interest rates on debt repayments and question the ability of the 'high' deficit countries to service their sovereign debts.  

Contractionary Fiscal Policy Makes the Long-Run Debt Problem Worse

Debt restructuring can reduce the long term debt / GDP ratio, but the primary object is to ensure that the country can service their debts.  This is one half of the story. With the interest rate on debt higher than its growth rate it is trapped a ‘vicious cycle’ of debt dynamics. The other half of the story is to encourage investment, not austerity, to increase Greece's ability to pay debts. 

To force trading accounts of countries to balance means taking from the poorest countries, reducing their ability to import (trading deficit falls), to give to the richest countries so they that can consume and import (trading surpluses falls). Not exactly Robin Hood

(The old fashion NX line. Those still using the old IS/LM-FX models will note that under fixed exchange rates and highly mobile capital markets, austerity measures are very dramatic in reducing the economy's output. To 'Euro economists', if that is not a contradiction, I would like to point out that Say's Law does not work for heavily indebted recession-hit economies) 

There must be quite a lot of magic in the idea that reducing an economy's output leads to increase in output.  Pain is good, right?  Austerity measures only exasperate the problem by reducing the debtors ability to pay, removing any remaining incentives for the electorate to support such a system.  If you want to encourage popular unrest, discontent and revolutions, austerity measures is the way to go.

A rapid economic recovery is the only thing that could materially reduce the burden of the debt over the next  years.  Reducing the burden of the debt is about making in investments in youth, not the wholesale dumping of them.  Its about investments in infrastructure, and making investments that allow all of the population to participate and be productive.  Without an expansion fiscal policy you can not restructure an economy without deepening existing injustices and creating lost generations, whose only fault was to be born at the wrong time in the wrong place 

Choices, but who chooses?

Well, as we are very sick patients, and doctors know best, is there any point in describing them. You probably won't be allowed to vote on them anyway,  You can just go straight to the video below. 

There are two main four main choices. (1) deficit countries leaving the Euro (2) surplus countries leaving the Euro, (3) insisting on default or debt restructuring (4) an European fiscal framework or investment funds to address the payments crisis called by trading imbalances.  As for the first two: it is always easier on surplus countries to leave the Euro than for deficit countries. So that's Germany's choice. As for the third, when countries can't devalue, what normally happens is that lenders accept their losses. They are not corporations that can have their assets seized.  But Greece is forced to conduct a fire sale of its assets. So is Greece still a country?

There are many styles of haircuts. One is to use the EFSF to provide Greece with funds to buy back its bonds.  Another one, proposed by Germany, is for Greece to exchange its bonds for ones that mature over a longer period.  Both are just bankers' debt servicing proposals with no hint of a mechanism, or collective action, to deal with removing permanent trading imbalance. To only focus on maintenance of debts becomes, in effect, a dictatorship by accounting books. One that leads to further austerity measures. As Paul Krugman complains: “Everything economists have spent the last three generations learning is brushed aside'. But 'you can't teach a dogma new tricks' (Dorothy Parker)

So the main focus has been on the European banking system's ability to maintain existing and future levels of indebtedness  and we are fed with wonderful stressed-out bank stress tests. Taking an analogy from an Economist blog 

'Imagine a patient clutching at his heart, complaining of sharp chest pains. A doctor arrives, examines him carefully and pronounces him healthy—provided he is not having a cardiac arrest.'

Or, rather the 'technician arrives, examines the equipment carefully, fiddles with the knobs until he can announce the results are healthy'.  But, who cares, as long as the Euro keeps going ping .....

As long as there no exchange rate, no transfer payments and no wholesale movement of populations, the only mechanism left in the Euro is through a wonderful disguised system of defaulting.  A default mechanism (a country buying back its own bonds) isn't sustainable and a poor substitute for an exchange mechanism.  

The fourth option is to engage in structure reforms by an expansionary European investment program.

Yianis Varoufakis and Stuart Holland have put forward the “Modest proposal.” which (1) recommends a large part of the Greek debt be taken on as ECB bonds, allowing a longer period to repay; (2) cleansing the banks of questionable public and private paper assets by a recapitalization through the EFSF; (3) for the European Investment Bank to launch a “New Deal” for Europe, using existing and new new Eurobonds, to drive investment.  Barry Eichengreen (niversity of California) adds his voice to a “New Marshall Plan.” which could help finance government support for the unemployed, indigent and elderly and the victims of the financial crisis. A good account of the above options is found here. 

However, there cannot be a fiscal authority without the democratic consent of the European electorate.  They didn’t vote for the system, and no one explained the system to them.  If Greeks, and the European electorate, are to accept the blame for the state that they are in, then they cannot be blamed and deprived of the right to change it.

An European Fiscal authority cannot exist with major democratic reforms.  We are back to square one.  The 'Indignants' are right to complain and demand changes.

9 July 2011

Beyond the Fringe

Yesterday's Tweets
@paulmasonnews Investment bank note (Jefferies): "is Trichet really Keyser Soze?" (I was thinking more like Europe's Andrew Mellon)
@Sysparatem @paulmasonnews Is Trichet actually living in an episode of Fringe in which he has crossed over into a similar but different universe?
@paulmasonnews @Sysparatem sadly we all are

Keyser Soze the mythical-like criminal in the film 'Unusual Suspects'
Mellon, who, as secretary of the US Treasury in the Great Depression, advised Herbert Hoover to "liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life.
Fringe is an American TV series that follows a FBI "Fringe Division" using unorthodox 'fringe science' and FBI investigative techniques to investigate a series of unexplained, often ghastly occurrences, which are related to mysteries surrounding a parallel universe.

The Universe of Mr Trichet and Mr Juncker 
Long live the Euro!  The Greek crisis is caused by Greeks.  “Between 1999 and 2010, wages rose by 106.6 percent, even though the economy did not grow in equal measure. The wage policy went completely out of control, while productivity was not taken into consideration,” said Mr Juncker.

(Time Series rant: Would Mr Juncker, on finding fires engines at the scenes of fire, blame fire engines for causing the fires?  A blindness - a case of Very Awful Regressions, where the ECB's insistence on a prior belief that confuses Cointegration with European integration has differenced a population to eat their own (unit) roots to make it so. A plague of RATS, or a Granger for causing the Eurozone to walk with a case of bad posteriors

Every economic ill in the world is blamed on the poor having too high wages. Mr Trichect and Mr. Juncker's fantasy that the global and EC financial crisis is the result of the poorest members of the Eurozone having too high wages is the latest addition to this. 

The Other Universe 

Imagine a place where one person earns 91,000 euros and 9 others earn 1,000 euros. Now try and tell these people that, as their average wage is 10,000 euros, they are earning too much and so they must all accept a cut in their wages. How would you expect them to react?

If the average wage must be reduced to 9,000 euros, then what are the chances that  9 out of 10 people would accept a 'wage cut' to 9,000 euros. The average wage is not what the average person receives. Greek statistics refer to a different universe.

Like most of my neighbours in Greece, the last 10 years has witnessed a decline in living standards.  Incomes, in nominal terms, from property rents and dividends rose four times as fast as wage incomes. Inflation in Greece has always been significantly higher than Germany and other Euro Zone countries. Cartels, monopolies and a weaker buying power for smaller business in wholesale markets have made it so. 

A bottle of Greek olive oil can be found cheaper in a Scottish supermarket. The basket of the typical Greek Mediterranean lifestyle, so desirable in Western European supermarkets, has become expensive for Greeks. Many items have been replaced by cheap German processed substitutes.  Fish is too expensive to buy. The typical family restaurants and cinemas that use to fill the city have long since gone. 

While many richer Greeks have found their purchases fall in price, the middle wage earners, and particular the poor, have faced very high inflation rates. The percentage of income spend on rent and food has dramatically increased. Credit cards were thrown at middle and poor consumers so they could keep up.  Greek society was reaching breaking point prior to the crisis.  Majority of Greek wage earners, particular the young who had even called themselves the 800 (euro) generation by 2008, never really got that far beyond poverty levels.  

There are public sector workers who travel vast distances as doctors or teachers to different parts of Greece as the states directs them.  Some keep their foothold in the system as permanent temporary employees, employed and fired every year.  This desperation for job security is reinforced by the awful unspoken conditions of the private sector.  The incompetent slow legal system means that many rights written in law never see the light of day BUT serves to produces data and statistics that reflect the official not the actual version of the economy. There was a corner not far away where workers would gather every morning to be picked up for work on a daily basis. Those were good times. Immigrants have even less rights.

The increasing Euro trade imbalance, the swapping of melons for imitation corn fakes, has left a large deficit and a credit bubble to support it.  German and French companies dominate the markets. The local EC institution, not far from where I live, pays the staff transported from Berlin high German wages rates and pays it Greek staff very low local rates. Feels like a colonial institution the more times I drive past it. Ironically this particular EC institution's function is supposedly to do with youth re-training and unemployment. There is also Siemens Unit not far away. Siemens was is famously involved in a scandal that allegedly brought both of the main political parties in Greece. Of course both political parties are trying to bury the scandal.  The average Greek has less money to bribe his own government with.

I will keep saying the cause of the Crisis is the design of the Eurozone – not Greece, Ireland, Italy, Portugal, Spain, rating agencies, Anglo Saxons, morals, DNA or even Canadians (blame South Park for this). 

As James K. Galbraith, in today's Deutsche Welle, writes the Euro is a flawed construction:

"Europe's structure is also suspended between two stable formations: the federated nation state and the international alliance. This in-between structure is called a confederacy, and it is something that was tried and which failed in North America on two occasions, most recently in 1865."

(For me, the EC and its struggle against the global markets is like a high speed re-run of the 17th Century French Monarchy's struggle to compete with East Indian Trading Company. One winded up as a revolution (the king over-taxed) and the other (it could re-finance) a precedent for corporate imperialism. )

James K. Galbraith continues to describe the situation as intolerable:

     "Today Greece - under a resolute government and against heavy internal protest - has met the onerous conditions imposed on it. But for what?
For loans that are immediately recycled to the European banks, adding nothing to Greece's prospects except more debt? This will not lower interest rates, restore growth, or bring success to ongoing internal reforms. It is an intolerable situation and it will not continue for long.
     Along one road there lies a future of defaults, panic, dissolution of the eurozone, and hyperinflation in the exiting countries, with a collapse of the export markets for those that remain.
     The final consequence will be large population movements - as happened from the American South. For if Europe insists on reducing its periphery to poverty, it cannot expect those affected to sit still and accept their fate."

One in five young Europeans is out of a job - a waste of Europe's most productive resource.
Source: http://www.economist.com/blogs/freeexchange/2011/07/youth-unemployment?fsrc=scn/tw/te/bl/alostgeneration

Europe is dysfunctional and inefficient when it claims to increase 'competitiveness' by reducing the ability of its youth to compete. Greece is a land of imported milk and exported honey with 42.5 (today's) percent unemployment between the age of 15 to 24, where more substantial issues loom large.

One Ring to rule them all? Who does interest rate serve?

The recent ECB decision to raise interest rates to 1.5% from 1.25% deepens the fault-line. The ECB sets the interest rate set according to its fear of inflation in the Eurozone's biggest economy and does this in complete disregard of the peripheral economies. Countries that have mountains of debt caused by an increasingly unbalanced system are now faced with increases in the cost of borrowing and costs of mortgages. It is particularly bad news for those who are a statistic in the diagram above

Image an economy as a pond and we want more fish per cubic meter. The ECB has solved this problem by draining water out of the pond. Both fish per cubic meter rises and its fear of water is reduced. The fish float to the surface accepting their fate.

This increase in the interest rate tilts the system even further and will probably result in more insulting attacks from Mr. Juncker. I suggest he try the following

So Bravo. The decision by rating agencies to downgrade PIIGs to junk has now been justified by this single brutal act of the ECB to increase the interest rate. We could blame the rating agencies, but better, still, blame Canada.  The potential political impact? The ECB may just have signed its own suicide note

4 July 2011

The Official End of Greek Independence?

--> An edited Extract from Reuters:

Greek sovereignty to be massively limited: Juncker

Greece faces severe restrictions on its sovereignty and must privatize state assets on a scale similar to the sell off of East German firms when Germany unified in the 1990s Eurogroup Jean-Claude Juncker said.

"The sovereignty of Greece will be massively limited," he told Focus magazine, adding that teams of experts from around the euro zone would heading to Greece.  "For the forthcoming wave of privatizations they will need, for example, a solution based on a model of Germany's 'Treuhand agency'," Juncker added, referring to the privatization agency that sold off 14,000 East German firms between 1990 and 1994.

Greeks are acutely sensitive to any infringement of their sovereignty or suggestions of foreign "commissars" getting involved in running the country.
Athens must sell off five billion euros in state assets this year alone or risk missing targets set under its EU/IMF program, which could cut off its funding.

Once the world's biggest holding company, Treuhand was supposed to sell off state property at a profit but closed its books with a huge deficit and a legacy of bitterness among the legions of workers whose jobs it destroyed.
Four million Germans were employed by Treuhand-owned companies in 1990 but only about 1.5 million jobs were left in 1994 when the agency closed. Instead of reaping profits to be distributed to all east Germans, as it was designed to do, it ran up debts of 270 billion marks ($172 billion) in the fire sale of assets. (End of extract)

More information about Asset Stripping can be found here

Asset Stripper redefined

A corporate entity, posing as an transnational institution, who discovers that a country will create more profit by liquidating the parts rather than through its business operations. Asset stripping can be seen when a ruthless agent controls a government, through its ability to refinance debt, under the pretence of restructuring the economy to return it to profitability. However, the intention is to liquidate all of the country's assets and sell them individually at a profit.

Introducing the Management Team
J-C Juncker: (Euro Group and E-coffin president

Junker study attained a Master of Law degree in 1979. In 1989, after a serious road traffic accident and spending two weeks in a coma, Juncker Euro became one of the major architects of the Maastricht Treaty. In particular, the section on the economic and monetary union was largely drafted himself. Following the 2008 financial crisis he was named 2008 European Banker of the Year.  The 1989 coma incident has no connection with the present state of the Greek Economy.

Junker is immensely suitable for the post.  In 2004 Juncker was made an honorary citizen of Orestiada in Greece. (the source is here)

Juncker was also a of Governor of the World Bank.  The current president of the World Bank, Robert Bruce Zoellick,  was previously a managing director of Goldman Sachs and holds the  Knight Commander's Cross of the Order of Merit of the Federal Republic of Germany for his achievements in the course of German reunification.

Mario Draghi (New European Central Bank president)

From 1984 to 1990 he was Executive Director of the World Bank.  Draghi was a vice chairman and managing director of Goldman Sachs International and a member of the firm-wide management committee (2002–2005).  Pascal Canfin (MEP) asserted (video here) Draghi was involved in swaps for European governments, namely Greece, trying to disguise their countries' economic status.

EU President Herman van (the man) Rompuy

Her_man at the EC.  His view on asset stripping is not so well known. Nothing should be inferred from his recent comments on Europe being so irresistibly sexy.

I found this posted at KTG

What is happening to George?