24 November 2011

A Very European Financial Coup d'état

The attempt to create a monetary union before a political and fiscal union placed the cart before the horse. Or was it... an attempt to steal the cart?

To achieve a fiscal union and political union would have required the democratic consent of the voters of each member state. Such an acceptance of this might then have implied an acceptance of a monetary union and its consequences. 'Acceptance' should not be underestimated.
Hyman Minsky: “Anyone can create money; the problem lies in getting it accepted
It was never likely that all Europeans would have accepted the idea of an United States of Europe. The  European Monetary Union was essentially an undemocratic method of press-ganging euro members into the Euro ship by financial force without their consent.

School kids are told that democracy is about listening to the people. When they grow up they are told it is about listening to the markets. Now we are all told to listen to un-elected bank clerks who (in Greece) are then forced to sign another piece of paper for approval by another set of banking clerks residing in the head office. The argument being of course one of 'trust'. Democracy, meanwhile, is forced to hide behind a tear gas mask.  In Greece there are now anit-semitic anti-islamic neo-nazies in the government.

via @Irategreek on twiiter

Why should anyone pay their taxes to pay the wages of such men? Indeed everyone has a duty not to pay for a regime that marches, increasing taxation in one step and decreasing representation in the other, towards a repressive dictatorship. It's like paying for your own firing squad.

Are economists to blame for this Euro disaster? Ancient economic papers (Monetarists, Keynesian, etc - choose your favourite school of economic thought) go back over 50 years giving detailed reasons why it would fail (see biography in this publication). Let me even apply a quote from F. A. Hayek to the Euro:
The curious task of economist is to demonstrate to men how little they really know about what they can imagine they can design F. A.Hayek The Fatal Conceit 1988)
To think of 'internal devaluation' and austerity as providing a way of adjusting to shocks that occur in the world beyond the EC borders is very naive. It is akin to a Napoleonic way of standardizing and metricizing economies into homogeneous diary products with fines on diary producers for failing to meeting these standards.  Milton Friedman, the monetarist,  made the following comment in 'The Times' (19/11/97) on the European project:
"...Europe exemplifies a situation unfavourable to a common currency. It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe". Milton Friedman
The Euro was a political exercise, but lets wipe the dust off more economic texts.

Brother Can you Spare A Euro.. "They used to tell me I was building a dream"
Or, how do we empty Greece to make the economy work?

M. Corden  (1972) warned that, if investment was sensitive to the business cycle, a monetary union would be heavily dependent on labour mobility and involve significant migration costs. United States, in the 1930's Great recession, produced "Hoovervilles"

In the 1960's, during the post-war American dream this was a more psychedelic experience, with some  'tripping' across states.

In Europe, neo-nazism rises, even becoming members of a government, Greeks emigrate to Australia and mobility tends to wear army boots 'making war 'not love'.
One of the things that makes the American common currency work across the country is we have a common fiscal authority and high migration - we're willing to allow North Dakota to become empty. In Europe, there's no fiscal authority, migration is more difficult and most of the countries are not willing to let themselves become empty.  Joseph Stiglitz: Austerity not the way to go for Europe
EuroVision and rigged voting

The European Commission's “One Market, One Money” Report (1990) concocted a modern version of Monetary Union theory. It did not deny that crises would occur but looked forward to them.
"I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created." Romano Prodi, EU Commission President. Financial Times, 4 Dec 2001
"The future will belong to the Germans... when we build the House of Europe. In the next two years, we will make the process of European integration irreversible. This is a really big battle but it is worth the fight." Helmut Kohl, German Chancellor 1982-1988
And a strong dislike of referendums and elections
"A true European cannot not want a referendum [on the European Constitution]."
Jean-Pierre Raffarin, French Prime Minister from 2002. Quoted in 2003.
(The meaning of true?  Someone with direct lineage to 'Conon the Accountant' or, culturally, not those who disagree) 
"Europe's nations should be guided towards the super-state without their people understanding what is happening. This can be accomplished by successive steps each disguised as having an economic purpose, but which will eventually and irreversibly lead to federation." Jean Monnet, Founder of the European Movement. Former Cognac salesman and bureaucrat at the League of Nations. 30 April 1952. 
French and Dutch in 2005 voted against a European Constitution. When Ireland voted no, it was made to vote a second time to get it 'right'. This time changes to European Treaties are being force through by the argument of economic necessity in a crisis; one that is supposedly caused by a small troublesome nation in the periphery.

The Ring that binds - the sovereignty debt entrapment 

How did this Press Ganging of economies into the euro ship happen?

Any country that can issue its own currency (and is not pegged to any other currency or precious metal) does not risk default solvency risk. It cannot be forced into debt. It controls its own currency and can always spend, by crediting bank accounts to create money.

Hence flexible exchange rate economies like Japan can run far higher debt to GDP ratios than Euro-zone members while still having low interest rates on their sovereign debt. Thus there is no default risk premium.

The Euro maintained a stable currency that destabilized governments with uncontrollable default risk. It achieves this in three ways by: (1) generating trading account deficit with other euro-zone economies without any automatic means (exchange rates) to adjust competitiveness;  (2) restricting the controls to finance these deficits and (3) imposing external or self-imposed fiscal discipline that renders the economy helpless in times of crisis.  With one global storm economies begin to capsize and sink.

When an economy is hit by a recession from an unexpected shock in the global economy there are automatic increases in government expenditures (social security and unemployment payments) and reductions in government's tax revenues (as output falls).  This part of the government budget deficit is 'unplanned'.

If it tries to reduce expenditures and/or raise taxes it may exacerbate the impact, by reducing aggregate demand at exactly the wrong time to do so, and deepen the recession.  An Euro-zone economy running a budget deficit means that its central bank is using up reserves from its ECB account which it will need to replace.  Individual Euro-zone governments do not have the choice of monopoly issuer of currency to create money (by crediting bank accounts) to finance its budget deficit. The Euro-zone government will need to recover this by selling bonds, adding to its sovereign debt.

Just by maintaining existing government plans, an adverse impact on the economy increases the Euro-zone government's borrowings. Sovereign indebtedness for an Euro-zone country is not a simple choice; it is often beyond its control.

The Euro Bond-Age .. 

Recessions may be beyond the control of governments but a double-dip recession is generated by their collective stupidity and a denial collective responsibly. Ponzi financing (named after a fraudster “pyramid scheme" in the 1920s) occurs when a debtor must borrow just to pay interest, which means debt grows - typically in an unsustainable manner. A government that controls its own currency can never be in this Ponzi position. A euro-zone member can.

Euro-zone members, with trading deficit accounts, are therefore exposed to debt dynamics. The more they borrow, the more the markets demand higher interest rates to compensate for the increasing risk of insolvency.  The more the government attempts to solve its budget deficit, by cutting expenditure and raising its tax, the more it cuts it growth rate and its ability to repay its sovereign debt.  Moral hazard by the government comes into play here as the covering up off statistics will aid it to obtain lower interest rates its bond issues.

At some point it goes critical, as in Ireland and Greece at about bond rates of 7%, and the government spirals into a vicious circle of borrowing more and more to pay ever higher interest rates. The government finds itself locked out of the market.  This leads the Euro nation at the mercy of the intervention of the ECB and the Euro-zone credit nations for bail outs.
... the thought that monetary union may in time force the evolution of a deeper, more fundamentally political level of unification is probably not inconsistent with what the euro’s original architects had in mind. (Benjamin Friedman (1999))
 It is also an invitation for vultures (funds) to scour for opportunities.

The Blame Game

The blame is attached to insatiable, bureaucratic, corrupt governments. Greece is an easy target since it is  in fact corrupt and bureaucratic. (eg. How German Companies Bribed Their Way to Greek Deals - Der Spiegel).  Then it is attached to ethnics, morals and latitude. Germans blame Greeks, Greeks blame Germans and trust breaks down.

It is then argued that elected governments  should not be trusted as they may be guilty actually following the wishes of their electorate and break agreed (by who? nobody was allowed vote on) the fiscal rules. Their powers are therefore removed and administrated by un-elected super authority.

Elected officials its seems are corrupted by the voters. Unelected officials are not. European Commission President José Manuel Barroso spending a week on the yacht of the Greek shipping billionaire Spiro Latsis (a month before the approval of 10.3 million euro of Greek state aid for Latsis' shipping company). They just like swimming together.

The financial coup d'état is completed

with the creation of a euro-zone Ministry of Finance justifying its un-elected authority to oversee national budgets and other economic policies. Germany and France propose new intrusive powers over Eurozone budgets on the moral argument that gains should then to the virtuous and pain should to sinners.

The defunct electorate or sinners may tell them to go to hell.

......so there is just the small matter of pacifying the natives (when they stop blaming each other). Supply-side economics is then reduced to a form of crowd control encouraging the demand for new consumer products, such as this one from Taiwan

Mount Doom:

There is, however, one small problem. The ECB itself. To be effective, a central bank must act as a monopoly."It, just like Sauron, must control all." (FTalphavillebut...

The ECB not a real monopoly. It controls euro reserves but there are no common Euro bonds and individual Euro-zone central banks issue their own. Before the 2007-8 global crisis sovereign default risk did not seem to matter. Those with greater dependency on ECB liquidity, as in the case of Greece, found more of their bonds ending up at the ECB. The less bonds available for the market, the smaller the market and the more vulnerable it becomes. Holding a monopoly of them has little value, if no one wants your bonds.

The solution to this is a common euro bonds with collectively responsibility of sovereign debts. But, in order to be 'saved' by this, each member must not only surrender its sovereignty but also yield to a budgetary slavery that whips financial indiscipline.

There is a problem, the 'one ring of power' corrupts its owner. The present ring bearer (Germany) does not yet want to yield this power and agree to Eurobonds. The ECB, with the EFSF, is running out of time, and cannot forever support the bonds of Euro-zone states who are insolvent.

Austerity everywhere cannot last. Once one of the major Euro-zone economies, Spain or Italy, goes pass the point of no return (in its bond rates) everything falls. A bailout for one will trigger a chain reaction.
@Nouriel (Nouriel Roubini on twitter):  To rescue Italy, Spain & Belgium for 3 years you need at least a €2trillion rescue package. Hard to see how EZ & intl comm can mobilize that
@Nouriel It took 4 months to convince core EZ parliaments to approve modified 440bn EFSF. How long - 1year? - to have them vote a €1tr ESM, 2X original?

Pity the real world doesn't have a pause button.

18 November 2011

A Shot Gun Wedding

The Euro-zone is a tragedy. There is no automatic mechanism for adjusting the relative competitiveness of its members and no mechanism to compensate for this gap by recycling surpluses from one part of the Euro-zone to another.

And so the sovereign debt crisis refuses to go away. There is no more road to kick the can down. The Euro-zone will either quickly move to a political fiscal union backed by Eurobonds or disintegrate. Euro Leaders are loading their shot-guns.

There is no exchange rate to restore competitiveness and the absence of any sense of 'community' is resulting in the removal of democracy and the brutal repression of wages of citizens unfortunate enough to be living in the Euro-zone's periphery.  Uneven competitiveness produced trading account surpluses in the core economies and were matched by trading deficits in the periphery. It is this internal trading imbalance, or fault-line, that splits the Euro-zone and continues to shake its financial institutions to the ground. After a wasting two years in taxpayer financed 'theological' debate on sinning, the crisis will be resolved in a short period of time by separation or by the complete removal of sovereignty.

A Failed Romance.

This failure is a story of unresolved differences in the relative competitiveness of Euro-zone members, and one re-told by Breaking Up? A Route Out of The Eurozone Crisis (C. Lapavitsas et.al. RMF Occasional report 3 Nov 211). The three graphs below, taken from this report, capture the story.

Germany's competitive advantage in the Euro-zone did not result from gains in productivity but rather from applying severe wage restraint on German workers.

Wage restraint on German Workers gave Germany a competitive advantage over its Euro partners 

This graphs indicates a weakness in German productivity. Even Ireland and Greece performed better. 

German competitive advantage in the Euro-zone produced trading surpluses from across the Eurozone. Competitive disadvantage, particularly for Greece, appears in the periphery's trading deficits. Austerity has closed the gap in competitiveness by harshly reducing in wages in the periphery.
Trading account imbalance between members: how was this financed? 

The sovereign debt crisis emerges from how these trading imbalances were financed. While ECB kept interest rates low, Euro core banks, particularly French and German banks, maintained the financing. Lending jumped again after the 2008 Lehman collapse. The assumption that sovereigns would not be allowed to default (moral hazard) increased the over-exposure of these banks. 

Banks in the periphery also had access to cheap funds to expand their assets. Cheap credit fueled an illusion of high GDP growth rates in trading deficit countries (particularly Greece). The crisis of 2007 exposed the illusion, laying bare the divergence in competitiveness. Periphery countries found themselves heavily in debt and in Greece a large amount of this public debt was now owned by foreign lenders

The 2008 Lehman collapse was a shock to all parts of the Eurozone as exports and investment fell. The recession induced both automatic increases in government expenditure (e.g unemployment benefits) and falling tax revenues, which in turn increased Government deficits. Rescuing private sector banks from the impact of the Lehman's collapse, increased the deficit further. 

The financing of increasing budget deficits increased the growth sovereign debts in the periphery. When it became clear that the core economies, mainly Germany, would not take any responsible for theses debts, the sovereign debt crisis switched from a liquidity to a solvency crisis. Individual debtor economies no longer had the ability or growth to support such large debts.  Austerity measures reduced the ability to pay back debts even further.  The core economies instead focused on only the effects a default on an economy's sovereign debts would have on their own banks - the very banks that had become over exposed by taking advantage of the common currency. The welfare of the periphery economies was secondary to the goal of protecting the Euro and the banking system that sat on it. 

The euro project had failed to achieve any real convergence between its economies. But like a scandal, It is the cover-up that does a great deal of of the damage. Differences in the euro-zone economies, in terms of human, capital and physical resources, were left exposed without an counteracting mechanism to replace exchanges rates. Instead, the Euro-zone economies diverged whilst cheap credit and the Euro banking system financed the illusion.  In the case of an inefficient small economy like Greece, the lack of internal competition (localized monopolistic and cartels) translated into a higher rate of inflation than the core Euro-zone economies. The inflation rate hides another further distortion - relative price changes.  Since the introduction of the Euro, the costs of basics (food, fuel, rents, mortgage payments, etc) increased sharply while many "luxury" items (TVs, cars, electronics,etc) fell . There is no mechanism to fix this. It also means that the poverty wage line has increased. 

FISTal consolidation:  the beating of an economy into shape.  Any shape will do, but it must submit

Due to the changers in relative prices in basics to luxuries, forcing Greece go back to 2001 wage levels will create third world poverty conditions and political instability. By blaming sovereign debt on sovereign states, treating the symptom and ignoring the cause of the crisis, Euro leaders are playing a dangerous blame game encouraging nationalism and racism whilst exploiting the fear of financial instability to place the Euro-zone under an un-elected centralized authority. The secret hope is that European voters will welcome this as an alternative to austerity. National government will applied the stick and the fiscal authority may promise some goodies.

In the meantime, Euro Leaders are loading their shot-guns to forced member states to appear at a new 'Lisbon' marriage ceremony. Divorce is not in the statue book.


The Golden Wig Award

The Golden Wig award this year goes to Herman Van Rompey for his uncanny Woody Woodpecker impersonation in..

But who cuts the hair of the Barber of Seville?

And finally ...  how does one measure success?  

According to the new Technocrat Italian PM Monti  "What we're witnessing today is GREAT SUCCESS of Euro and the most concrete demonstration of that SUCCESS is Greece"

"I'm hungry" - The real face of Greece's bailout deal

Less hope for less success.

8 November 2011

Unfair for one, unfair for all

The world is in trouble. The Greek parliament is vacant; its members are vacant. Superhuman efforts do nothing. The crisis rolls on. It's out of balance, steering out of control. We need  ....

Pumping more air into the tyres isn't going to help get the tandem moving

The German flaw and why Germans should not be happy.

Just as the European Money Union' was being formulated, structural labour reforms were being agreed upon in Germany that would prevent real wages of workers from rising.  Increases in productivity were not rewarded by increases in wages.

This gave German firms a competitive edge over the Eurozone periphery.  German exports exceeded their imports from the Eurozone periphery producing an intra-trade surplus and corresponding trading deficits in the eurozone's periphery's. Trading surpluses from the north fed easy credit and bubbles in the south.
'Germany lost the advantage of low interest rates after the introduction and in part because of the euro. This led capital to pour into the countries of the periphery, while investment stagnated in Germany or even declined, leading to low growth, low inflation and persistently high unemployment. What Mr Pettis calls “excessively low interest rates” were actually too high for Germany in this monetary union' The Economist (Germany suffered from its surpluses):
But how was this 'capital' used in the periphery? Capital that poured into the periphery did not spur direct real investment. An increase in German wages could have restored the relative competitiveness of periphery and even encouraged more direct investment.  Instead, the surpluses that repressed German wages helped to create fed bubbles in Spain and Ireland and fiscal mismanagement. These bubbles and practices were popped and laid to wastes by the 2007-8 global financial crisis. (see also Minsky’s financial instability hypothesis)

The periphery was in desperate need for direct investment to improve competitiveness and catch up with the core.  Instead it got debt financing geared to consumption, providing credit facilities and the means to buy exports, corruption, suspicious deals and debt servicing.

The focus on debt refinancing, instead of direct productive investment in the periphery persists. Trading deficits that had accumulated, now increasingly replaced by debt servicing, continues to damage the periphery long term growth prospects.  Instead of allowing German wages to rise, internal devaluation and wage suppression is now being imposed on the periphery.  The cost of financing debts has increased, the ability to pay them back is shrinking, and the periphery economies move towards insolvency.

So the initial benefits to German economy may have had may well turn into long term losses. This is not just due falling eurozone demand for its products from the periphery, but mainly due the eventual bill that is left behind by insolvent countries.

Europe is actually a rich net capital exporter, and yet the peripheral Euro members cannot get finance due questions concerning solvency.

The unfairness to the German worker, in terms of being not rewarded their gains in productivity, translates as an unfairness to those in the periphery trying to compete against an unfair German export advantage.  Would German workers wouldn't mind having some extra money on a sinful holiday in Greece? Is an 'internal revaluation' any less crazier than internal devaluation?

The result of the first 10 years of the Euro, is an Eurozone split into two, moving in opposite directions covered by a veneer of financial arrangements. The 2007-8 global financial crisis (an asymmetric shock) exposed this and destabilized Europe. It has not recovered or found the means to re-balance. In the absence of a mechanism to maintain the relative competitiveness of euro economies, EC governments and institutions have stepped deeper and deeper into the murky world of weird toxic financing arrangements. One cannot fix or institutionalize macroeconomic disequilibria by pronouncing laws forbidding them to exist.

Two Greeks Phd. holders. One is has a job and the other doesn't have work.  They meet. The one without the job asks the one with the job: "Can I have a hamburger without ketchup. please


Incidentally, in case you are wondering where all that "Greek" Bailout money is going here is a diagram I 'lifted' from Zerohedge blog
"The bulk of the money that Greece is "getting" comes right back to the rest of the EU. Whatever posturing is going on, Greece will get away without meeting any of its stated goals, or at least it will until the EU decides it has written down enough principal and that the ECB can handle the shock."

There is still time to order the  new collectible edition of the Euro

Hurry as the offer in not indefinite

Further reading:

3 November 2011

2011 - Euro Odyssey

Live from the Euro Space Centre

 Koyaanisqatsi: Life Out of Balance, is a 1982 film directed by Godfrey Reggio with music composed by Philip Glass and cinematography by Ron Fricke).

The launch sequence is magnificent.
Then you slowly notice the rocket is leaning.
Something is wrong.
You realize it when you see it flying almost horizontally...
"If Merkel/Sarkozy dig precious things from Greek land, they will invite disaster".
- variation of the opening line of the Hopi prophecy

Credit to @stefanbjork