Golden Cognitive Dissonance

Simon Jack of the BBC asks a question that many of us have already answered:

Gold v paper money: Which should we trust more?

Fortunately, this gives way to some relatively fair coverage:

Detlev Schlichter is a former banker and the author of Paper Money Collapse and he says the current system is fatally flawed.

“The problem is that what we use as money can be created and produced by the privileged money producers – which are the central bank and the banking system.They can produce as much of this money as they like. And so the supply of this form of money is entirely elastic, it is entirely flexible.”

Detlev Schlichter believes this will, ultimately, lead to people losing faith in our current system of elastic money and turning to something that does not stretch – like gold.

The key point to add to this of course is that gold is not just insurance against dilution, it is more importantly insurance against counter-party risk:

Counter-party risk is the external risk investments face. The counter-party risk to fiat currency is that the counter-party — in this case the government — will fail to deliver a system where that fiat money will be acceptable as payment for goods and services. The counter-party risk to a bond or a derivative or a swap is that the counter-party  will default on their obligations.

Gold — at least the physical form — has negligible counter-party risk. It’s been recognised as valuable for thousands of years.

Counter-party risk is a symptom of dependency. And the global financial system is a paradigm of interdependency: inter-connected leverage, soaring gross derivatives exposure, abstract securitisations.

When everyone in the system owes shedloads of money to everyone else the failure of one can often snowball into the failure of the many.

Unfortunately, the BBC then embarks on an inane and pointless discussion on the merits of gold as an enforced monetary standard, a completely different topic to whether or not individuals should trust paper assets or hard money.

DeAnne Julius of Chatham House is quoted as saying:

If the amount of money in the system was limited by pegging it to gold it would limit economic growth, which is the last thing we need right now.

I think to put your faith in gold as the basis of a country’s monetary system would be extremely foolish.

This is not actually true — every single historical example of the gold standard has allowed for the expansion and contraction of the money supply as per the market’s desire for money — it can be mined, it can be recirculated, it can be credited, it can be imported, it can be devalued, or it can be supplemented with silver and other substances. The “problems” with gold only really began in the 1930s when central banks started imposing policies of forced contraction over extended periods — ignoring true market preferences.

The gold exchange standard period, which followed WW2, was a period of unprecedented and unparalleled expansion, productivity growth, technological innovation, and financial stability.

The Bank of England’s recent report on the gold standard periods concluded:

Overall the gold standard appeared to perform reasonably well against its financial stability and allocative efficiency objectives.

The BBC concludes by quoting former Chancellor of the Exchequer Lord Lawson:

You can’t force a government to stay on gold, so therefore gold has no credibility.

Do you see the cognitive dissonance here? If we are to believe Lord Lawson, gold has no credibility, because governments have previously proven themselves untrue to their word. Surely the thing that has no credibility is not gold, but government promises? And that is the answer to the BBC’s initial question.

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Those Lazy Greeks

Or, not.

From the Guardian:


Sadly, it’s not quite as simple as that.

From the BBC:

Greeks are working longer and harder than anyone else in Europe. But they’re still producing less than many other nations who are working a lot less hard. The OECD suggest that this is due to the shape of the Greek labour market:

Pascal Marianna, who is a labour markets statistician at the OECD says: “The Greek labour market is composed of a large number of people who are self-employed, meaning farmers and – on the other hand – shop-keepers who are working long hours.”

Still, I think it’s high time we put the lazy Greek myth to bed, because the evidence just doesn’t support it.

The Greek Non-Rescue

So Greece has been “rescued”.

Or, not.

From Robert Peston:

What we had overnight is an agreement in principle, not a final definitive rescue of Greece. Before we crack open the vintage Ouzo, let’s just see how it goes down with the relevant private-sector lenders, politicians in the only creditor country that really matters — Germany — and Greek citizens.

That “agreement in principle”?

From Zero Hedge:

  • Even under the most optimistic scenario, the austerity measures being imposed on Athens risk a recession so deep that Greece will not be able to climb out of the debt hole over the course of the new €170bn bail-out.
  • Even in best case scenario, the country will need at least €50 billion on top of €136 billion.
  • A German-led group of creditor countries – including the Netherlands and Finland – has expressed extreme reluctance since they received the report about the advisability of allowing the second rescue to go through.

The deeper truth emerges from the BBC:

“The funds that are coming in are not staying in Greece, are not being invested in Greece, are not here to help the Greeks get out of this crisis,” Constantine Michalos, president of the Athens Chamber of Commerce and Industry, told the BBC.

“It’s simply to repay the banks, so that they can retain their balance sheets on the profit side.”

This reminds me of a comment made by Andrei Canciu yesterday:

I think that even the original (i.e. current) architecture of the Euro would have been workable if it were not for the “innovations” in the banking system during the last 10 years. That is, overindebtedness would have always been solved through defaults by punishing the the irresponsible lenders (i.e. those tight spreads between Northern and Southern European countries), while the defaulting countries would have gotten some post-default aid.

I read somewhere that a Greek default would have been totally manageable 10 years ago. That’s no longer the case with the shadow banking system and the incomprehensible web of derivatives.

And there we have our problem: this isn’t really about Greece at all. It’s about the fundamentally perverse nature of the global economic system that cannot withstand a default or liquidation without bringing down the entire system. Even if China and Japan threw all their FX reserves into bailing out the Eurozone this would merely postpone the systemic breakdown. Because, the problem is the system. The global economic system needs to be able to withstand defaults, liquidations, crises. It needs to be robust. And the Byzantine workings of the shadow banking system — where everyone owes money to everyone else, and if one falls they all fall — is a hyper-fragile juggernaut that is bound to come down eventually. If it’s not Greece it will be something else. And that will be a good thing — because we will be abe to switch to an economic system less prone to absurd bubbles, hyper-fragility, and forced bailouts.

Anyway, I am still virtually certain that this bailout is a total sham, and — even if stomached by Germany and international creditors — is doomed to abject failure.

Why?

It’s demanding even greater and deeper austerity from an already-bleeding Greek nation. As I’ve said before, austerity in a depressed economy usually results in larger budget deficits as a result of falling tax revenues. Simply, this medicine is poison. Very shortly, Greece may well be back in the hole.

Ken Rogoff’s Chart of the Year

Migraine inducing, but thought provoking.

From the BBC:

Rogoff adds:

The blue line is global average of public debt relative to GDP. The yellow bars denote the percent of countries in a state of default or restructuring on external debt. The dark pink bars that sometimes rise above the percent of countries in default or restructuring denotes countries with inflation over 20%. The chart suggests that if the historical pattern is followed, there will be soon a wave of sovereign defaults. Needless to say, we appear to be on the cusp of such an event in the eurozone and central Europe, and possibly some countries elsewhere.

The Wasteland

The BBC presents an interactive debt chart to demonstrate who owes what to whom:

This morass of interconnected debt rather reminds me of T.S. Eliot’s Wasteland:

That corpse you planted last year in your garden,
Has it begun to sprout? Will it bloom this year?
Or has the sudden frost disturbed its bed?

No flowers shall bloom from the stinking cadavre of interconnected debt . As I have explained, the lack of any real debt liquidation or deflation post-crisis has turned much of the global economy into a walking zombie, weighed down by an excessive debt load, and politically and socially incapable of addressing structural issues.

Dead bodies cannot return to the earth to grow anew unless they are allowed to decompose. But policymakers cannot countenance any kind of decomposition.

So the corpse sits in a tank of formaldehyde:

The Domino Effect?

The BBC has an interesting (and very deluded) article on Europe, Greece, Germany, etc & their debt problems:

In October, Europe’s leaders reached yet another wide-ranging deal to prevent economic problems from causing financial meltdown in the eurozone.

For many onlookers, the issues they face may seem complicated and interconnected.

But essentially they boil down to four big dilemmas:

  1. Borrowers vs Lenders
  2. Austerity vs Growth
  3. Discipline vs Solidarity
  4. Europe vs the Nations

Actually, I think we can simplify much further.

There is one big dilemma:

  1. Delusion vs Reality
That delusion is that the global financial system can be so interconnected, and so leveraged that it can continue to exist in a state whereby the default of one small country can trigger a death spiral so severe that much of the system has to be bailed out over and over just to avoid the dreaded default cascade, and mass insolvency. The reality is that the system is so interconnected and leveraged (“too big to fail”) that it will keep failing and failing and failing until it is allowed to fail. Interconnection and leverage means fragility. What we need is independence (so that fragile things can fail without bringing down the entire system).

European Leaders Scrabble For Agreement

From the BBC:

The outline of a large and ambitious eurozone rescue plan is taking shape, reports from the International Monetary Fund (IMF) in Washington suggest.

It is expected to involve a 50% write-down of Greece’s massive government debt, the BBC’s business editor Robert Peston says.

The plan also envisages an increase in the size of the eurozone bailout fund to 2 trillion euros (£1.7tn; $2.7tn).

European governments hope to have measures agreed in five to six weeks.

The bizarre thing is that the real issue is not whether or not some agreement can be reached, but whether or not any agreement will really have any real effect on the state of the European financial system. I am extremely dubious that the thrifty Scandinavian and Germanic nations will commit huge swathes of their wealth to save the Mediterranean ones. But even if an expanded EFSF can be brought together to successfully bail out Greece and recapitalise European banks who have to write down significant chunks of Greek debt, there is no guarantee whatever that any of these measures will address the underlying fracture in European budgeting. Namely, that European governments are spending like they are monetarily sovereign — in other words, behaving as if they can print as much money as they want to cover debts — when they are not.

Of course, there is no real guarantee that Europe will even effectively stabilise its banking system.

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Black Clouds Over UBS?

From the BBC:

Police in London have arrested a 31-year-old man in connection with allegations of unauthorised trading which has cost Swiss banking group UBS an estimated $2bn (£1.3bn).

Kweku Adoboli, believed to work in the European equities division, was detained in the early hours of Thursday and remains in custody.

UBS shares fell 8% after it announced it was investigating rogue trades.

The Swiss bank said no customer accounts were affected.

One question is what ramifications such a write-down might have on the bank’s liquidity. In this cloudy and dark financial atmosphere, fire-sales of assets to pay down such a loss might spark panic.

Another question is how — after the Jerome Kerviel and Nick Leeson debacles — does a large financial fail to effectively monitor its staff’s trading activities? Hasn’t investment banking experienced enough of these rogue trading shocks to put a system in place to prevent these kinds of activities?

After all, if a too-big-to-fail bank suddenly implodes, the state is perfectly willing to stand-by to inject in the earnings of future generations to “save the system”