“Get Your Money Out While You Can”

One can only wonder how long it will take before Europeans particularly in Spain, Greece and Italy, begin to take that advice.

The Euro system amplifies shocks. Monetary union without fiscal union, economic integration without high levels of interstate mobility, enforced austerity in the weakest economies. And now the precedent of deposit confiscation. The only indicator that seems to be rising throughout the Eurozone is the number of protest signs comparing Angela Merkel to Hitler.

Romano Prodi famously noted that the Euro system was weak, and that necessary reforms would be made when the time came in order to make it sustainable. Well, the Cyprus bailout and deposit levy, the national and international outcries and the subsequent “no” vote in the Cypriot parliament are all signs that in the wake of all the bailouts of the periphery that Europe is far from fixed. The necessary measures have not been taken. While the ECB may have taken measures to lower government borrowing costs in the periphery, the situation is in many ways — especially unemployment — still deteriorating. In fact, it seems like Eurocrats are trying to enforce the opposite of what might be necessary for sustainability — rather than installing a mechanism to transfer money to weakened economies suffering from high employment, Eurocrats seem to be trying to do everything to drive unemployment higher in the periphery, spark bank runs, as well as aggravate tensions with Russia.

This is a crisis of institutions and a crisis of leadership as well as a crisis of economics. Merkel cannot lead Europe and Germany at the same time, because taking steps to revive the ailing Southern economies hurts her standing with the German and Northern public.

The Eurocrats have asked for a bank run by demanding depositor haircuts in Cyprus. The public would not be at fault for giving them one. Farage’s advice is wise.

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The Welfare Kings of Europe

In spite of the fact that 85% of Greeks want to stay in the Eurozone, I was reasonably confident that Greeks would support Syriza to a first-place finish, and elect a new government willing to play chicken with the Germans. However Greeks — predominantly the elderly — rejected change (and possible imminent Drachmatization) in favour of the fundamentally broken status quo.

But although Syriza finished second, the anti-bailout parties still commanded a majority of the votes.

And New Democracy may still face a lot of trouble building a coalition to try to keep Greece in the bailout, and in the Euro . There has long been a rumour that Tsipras wanted to lose, so as to (rightly) blame the coming crush on the status quo parties. What fewer of us counted on was that the status quo parties wouldn’t want to win the election either. The pro-bailout socialists Pasok have thrown a monkey wrench into coalition-building by claiming they won’t take part in any coalition that doesn’t also include Syriza. This seems rational; when the tsunami hits, all parties in government will surely take a lot of long-term political damage. Pasok have already been marginalised by the younger and fierier Syriza, and Pasok presiding over an economic collapse (for that is undoubtedly what Greece now faces) would surely have driven Pasok into an abyss. The economy is such a poisoned chalice that parties seem willing to fight to keep themselves out of power.

And with more austerity, it’s only going to get worse. Once a society is hooked on large-scale debt-fuelled state spending, austerity in the name of government deleveraging is tough enough when the economy is booming, but during a depression as spending falls, tax revenues fall, very often producing (as has been the case in Greece, Spain, Portugal and the UK) even bigger deficits.

So let us not forget who the most welfare-dependent nations (i.e. the ones who would be hurt the most by attempting an austerity program during an economic depression) are in Europe (clue — it’s not Greece):

International economics is a fast game. It’s only sixty years since America was exporter and creditor to the world. It’s only fifteen years since the now-booming German economy was described as the “sick man of Europe”.

The same Euro system that is slamming Greece, Portugal, Spain and Italy today — in the aftermath of bubbles caused by easy money flowing into these countries as a result of the introduction of the Euro — could (if it were to somehow survive)  do the same thing to Germany in ten or twenty or thirty years.

A monetary union without a fiscal union is a fundamentally unworkable system and Westerwelle, Schauble and Merkel insisting that Greece play by the rules of their game is just asking for trouble. And trying to introduce a fiscal union over a heterogeneous, tense and disagreeable land as Europe is just asking for political trouble.

No matter how many nations are browbeaten by fear into committing to the status quo, it still won’t be sustainable. Greeks (and the other peripheral populations) can commit to austerity from here to eternity, but it won’t stop those policies resulting in deeper contraction, and more economic catastrophe.

But the collapse of the Euro would at most-recent estimates cost the core and particularly Germany a lot more than handing over the money to the PIGS. Eventually they will hand over the money to shield themselves from falling masonry. The real question is whether or not the entire system will spiral into pandemonium before Germany blinks.

Will Tsipras Blow Up Europe?

The world’s eyes are on the Greek election, and whether or not Greeks will elect New Democracy’s Samaras (widely-assumed to be pro-bailout, pro-status quo), or SYRIZA’s Tsipras (widely-assumed to be anti-bailout, anti-status quo).

The Eurocrats have very sternly warned Greece against voting against austerity. Merkel said:

It is extremely important for Greeks to elect lawmakers who would respect the terms of the bailout.

In recent days, opinion has swung back toward the status quo, with Intrade rating New Democracy’s chances of winning the largest number of seats at 65%, and SYRIZA at just 33%.

While I cannot rule out New Democracy winning, I think that I’d flip those odds. Greece widely reviles German-imposed austerity, but fears the consequences of leaving the Euro — 85% of Greeks want to stay in. A vote for New Democracy would reflect fear of Drachmatization. Meanwhile, a vote for SYRIZA would seem to reflect the idea that through brinkmanship and the threat of Euro collapse, Greece can negotiate their way to a much more favourable bailout position.

So why do I think SYRIZA are the likelier winner? The election is on a knife-edge, so I think the difference might be football.

Greece — against all odds — managed to bumble through the Euro 2012 group stage, beating Russia 1-0 and likely setting up a poetic quarter final against Germany. I think that that victory against Russia will fire enough Greeks to try their luck and assert themselves against austerity.

For Greece, this is an important election. Inside the euro, their heavily state-dependent economy will continue to suffer scathing austerity. Outside the euro, they can freely debase, and — as Nigel Farage has noted — enjoy the benefits of a cheaper currency like renewed tourism and more competitive industry. If Greeks want growth sooner rather than much later, they should choose life outside the euro (and by voting for Tsipras and trying tough negotiating tactics, they will be asking to be thrown out).

But for the rest of the world, and the rest of Europe, this is all meaningless. As Ron Paul has noted, when the banking institutions need the money, central banks — whether it’s the ECB, or the Fed, or the BoE, or a new global central superbank — will print and print and print. Whether Greece is in or out, when the time comes to save the financial system the central bankers will print. That is the nature of fiat money, as much as the chickenhawks at the ECB might pretend to have hard-money credentials.

Tsipras, though — as a young hard-leftist — would be a good scapegoat for throwing Greece out of the Eurozone (something that — in truth — the core seems to want).

The real consequence throughout Europe as austerity continues to bite into state-dependent, high-unemployment economies will be more political fragmentation and support for political extremes, as the increasingly outlandish and unpopular political and financial solutions pushed by Eurocrats — specifically more and deeper integration, and banker bailouts — continue to help special interests and ignore the wider populations.

Italian Gold Heading to China?

James Rickards and Max Keiser suggest one of the logical conclusions of the Italian-debt blowup is that Italian gold will be auctioned off, perhaps to China:

With Italian external debt standing at $2.2 trillion, and Italy’s 2,400 tonne gold holdings worth only $137 billion, gold would have to rise pretty significantly for that option to come into play.

Of course, these figures ram home the idea that gold is significantly undervalued relative to current credit/debt levels. America’s external debt stands at $14.3 trillion, yet its gold reserves are worth just less than $500 billion.

Officially, gold is not money. Officially, levels of debt should have no tie to gold reserves (i.e., the ability to pay in the 6,000-year old store of value).

But with the current malfunction in the global economic system, which soon may have to deal with the consequences of Euro breakdown, or an oil shock, or a new middle eastern war, it is perfectly plausible (or even likely) that the newer fiat monetary systems — all of which are subject to counter-party risk — will crumple, and bring the old currency — gold — back into play.

While a chance of systemic collapse remains, nobody will be keen to see their gold reserves sold off. Nations with less gold than their rivals — particularly China who have recently shown particular interest in converting their FX hoard into gold — will be keen to see the system live on for as long as possible (to cash out into physical assets and gold).

And that is the fundamental contention — the Eurozone wants to keep its gold, but fear the catastrophic impact of Euro-breakdown — and the Chinese want to keep the system going while slowly accumulating gold.

I can see that there is quite a lot of scope for a middle ground. The real question is how much would a Sino-European bailout-for-gold deal cause gold to spike…

Will the Fed Trigger Big Inflation?

What now after the Italian downgrade?

From Forbes:

Standard & Poor’s pulled another late move on Monday, downgrading Italy’s sovereign credit rating by one notch to A/A-1.  The credit rating agency cited weakening economic growth prospects as public and private borrowing costs rise, and a fragile political coalition failing to adequately respond to a challenging economic environment.

While the downgrade doesn’t come as a shock, as S&P had Italy under a negative outlook since May, it will rattle markets.  Europe’s sovereign debt woes have grappled nervous markets the last couple of weeks, with every word coming from Greece, Germany, or the ECB sparking massive moves on both sides of the Atlantic.

This has sent certain (risk-addled) European banks spiralling downward, leading the European Systemic Risk Board to warn policy-makers that the time may soon come to make a massive liquidity injection into European markets (i.e., throwing money at saving bad banks)

BNP Paribas:



SocGen:

In America, traders today were in a more bullish mood.

From Zero Hedge:

Shrugging off Italy’s rating downgrade (somewhat expected but continued negative outlook), funding stress in Europe (Libor levitating and Swiss/French banks divergent), cuts in global growth expectations (IMF and World Bank), concerns over systemic risk contagion (ESRB and World Bank), and escalating rhetoric in Sino-US trade wars, US equities have managed to reach up to Friday’s highs as rumors of AAPL being added to the Dow seemed enough for hapless traders.

More significant than excitement over Apple — and the main reason that markets today are levitating, in spite of all the turmoil — is the hope that Bernanke will throw more policy tools at the American economy.

Will he?

Although I have been specific about the idea that QE3 is definitely coming I don’t foresee QE3 being initiated this week. Why?

Firstly, because I think Joe Biden promised Wen Jiabao that America would hold off QE3 in the short-term to preserve the value of Chinese holdings.

Bernanke will probably initiate a program to roll the Fed’s holdings onto the long-end of the spectrum of bonds: as 2-year bonds in the Fed’s portfolio reach maturity, the Fed will replace those with 10-year bonds, to reduce net interest rates.

More significantly, I expect Bernanke to announce that the Federal Reserve will announce that it will no longer pay interest on excess reserves. Banks have accumulated massive excess reserves since the 2008 crisis, when the Fed determined to pay interest on reserves not lent — ostensibly to increase flexibility in the banking system in case of further collapse:


In theory, unleashing these excess reserves into the economy would get capital to productive ventures without infuriating bondholders and retirees any further with more quantitative easing. But in practice a surge in lending might do the precise opposite — unleashing a tidal wave of inflation, further diminishing the purchasing power of dollars.

The potential loans possible on these reserves could be up to $16 trillion. GDP is currently $14.99 trillion. Unless the GDP keeps pace with the money supply, these new loans would create the potential for substantial amounts of inflation.

Could this be the spark that triggers a runaway inflationary spiral? It could be. It’s not in the interest of either debtors, nor creditors — but that doesn’t remove the risk.