The New European Serfdom

So let’s assume Greece is going to leave the Eurozone and suffer the consequences of default, exit, capital controls, a deposit freeze, the drachmatization of euro claims, and depreciation.

It’s going to be a painful time for the Greek people. But what about for Greece’s highly-leveraged creditors, who must now bite the bullet of a disorderly default? Surely the ramifications of a Greek exit will be worse for the international financial system?

J.P. Morgan — fresh from putting an LTCM alumnus in charge of a $70 trillion derivatives book (good luck with that) — is upping the fear about Europe and its impact on global finance:

The main direct losses correspond to the €240bn of Greek debt in official hands (EU/IMF), to €130bn of Eurosystem’s exposure to Greece via TARGET2 and a potential loss of around €25bn for European banks. This is the cross-border claims (i.e. not matched by local liabilities) that European banks (mostly French) have on Greece’s public and non-bank private sector. These immediate losses add up to €400bn. This is a big amount but let’s assume that, as several people suggested this week, these immediate/direct losses are manageable. What are the indirect consequences of a Greek exit for the rest?

The wildcard is obviously contagion to Spain or Italy? Could a Greek exit create a capital and deposit flight from Spain and Italy which becomes difficult to contain? It is admittedly true that European policymakers have tried over the past year to convince markets that Greece is a special case and its problems are rather unique. We see little evidence that their efforts have paid off.

The steady selling of Spanish and Italian government bonds by non-domestic investors over the past nine months (€200bn for Italy and €80bn for Spain) suggests that markets see Greece more as a precedent for other peripherals rather than a special case. And it is not only the €800bn of Italian and Spanish government bonds still held by non-domestic investors that are likely at risk. It is also the €500bn of Italian and Spanish bank and corporate bonds and the €300bn of quoted Italian and Spanish shares held by nonresidents. And the numbers balloon if one starts looking beyond portfolio/quoted assets. Of course, the €1.4tr of Italian and €1.6tr of Spanish bank domestic deposits is the elephant in the room which a Greek exit and the introduction of capital controls by Greece has the potential to destabilize.

A multi-trillion € shock — far bigger than the fallout from Lehman — has the potential to trigger a default cascade wherein busted leveraged Greek creditors themselves end up in a fire sale to raise collateral as they struggle to maintain cash flow, and face the prospect of downgrades and margin calls and may themselves default on their obligations, setting off a cascade of illiquidity and default. Very simply, such an event has the potential to dwarf 2008 and 1929, and possibly even bring the entire global financial system to a juddering halt (just as Paulson fear-mongered in 2008).

Which is why I am certain that it will not be allowed to happen, and that J.P. Morgan’s histrionics are just a ponying up toward the next round of crony-“capitalist” bailouts. Here’s the status quo today:

Greece no longer wants to play along with the game?

Okay, fine — cut them out of the equation. In the interests of “long-term financial stability”, let’s stop pretending that we are bailing out Greece and just hand the cash over to the banks.

Schäuble and Merkel might have demanded tough fiscal action from European governments, but they have never questioned the precept that creditors must get their pound of flesh. Merkel has insisted that authorities show that Europe is a “safe place to invest” by avoiding haircuts.

Here’s my expected new normal in Europe:

After all — if the establishment is to be believed — it’s in the interests of “long-term financial stability” that creditors who stupidly bought unrepayable debt don’t get a big haircut like they would in a free market.  And it’s in the interests of “long-term financial stability” that bad companies who made bad decisions don’t go out of business like they would in a free market, but instead become suckling zombies attached to the taxpayer teat. And apparently it is also in the interests of “long-term financial stability” that a broken market and broken system doesn’t liquidate, so that people learn their lesson. Apparently our “long-term financial stability” depends on producing even greater moral hazard by handing more money out to the negligent.

The only real question (beyond whether or not the European public’s patience with shooting off money to banks will snap, as has happened in Greece) is whether or not it will just be the IMF and the EU institutions, or whether Bernanke at the Fed will get involved beyond the inevitable QE3 (please do it Bernanke! I have some crummy equities I want to offload to a greater fool!).

As I asked last month:

Have the 2008 bailouts cemented a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

And will the inevitable 2012-13 bailouts of European finance cement this aristocracy even deeper and wider?

35 thoughts on “The New European Serfdom

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  4. Something I’ve pondered as of late: can we really separate the evil banks from the poor people that need help? Isn’t a good part of that debt actually sitting as the pensions and savings of honest people and companies in various countries? Maybe we’re dealing with a problem of too much imaginary wealth that has been created – at all levels of the economy – not just at the level of evil banks?

    • Maybe we’re dealing with a problem of too much imaginary wealth that has been created – at all levels of the economy – not just at the level of evil banks?

      Agreed. Excess credit creation beyond the economy’s productive capacity is very dangerous.

      But the bottom line here is that the people who put in the money in and created the credit/debt must be held responsible. Greece could never have lived beyond its means without people who were willing to buy the debt despite Greek budget indiscipline. If it’s a pension fund holding the money then we need better pension funds, and that will only come with market discipline.

      • The sad thing is that EU/EMU would have had much time to correct things/imbalances and perform structural reforms, if certain structures were put in place (but were not due to German stubbornness – like Eurobonds). See for example the UK where there’s flight to safety just because the UK actually appears stable and not about to implode every couple of weeks (even though the UK has poor fundamentals at the moment).

        • UK has absurdly poor fundamentals, mostly an overhang from the pre-Glass Steagall years where TBTF banks took their rehypothecation to London…

        • To clarify what I meant about the UK etc.; the game of musical chairs (scrambling for real quality assets – gilts are viewed like gold or works of art in that there is trust they will have a relatively stable purchasing power over the short to medium term) needn’t have begun for EMU if trust was established through Eurobonds, even though the imagined wealth of EU was in excess of that implied by the global real flow of goods and services. On the other hand, deadlock situations like those we’re experiencing right now in the EU may be helpful in that they’re a wake-up call that the imbalances between the “imagined” and real wealth have become too great.

          About the IMF and Buddy’s points; this is strange, it seems the poor IMF is vilified by everyone: those funding the IMF because they think they lose money, and the recipients of the IMF funds because they think IMF is exploiting people to earn interest on their loans in exchange for austerity.

  5. Your picture is wrong. You forgot to put a box with my tax payer money (And I suppose all reader’s tax money) that was promised by my Australian Government and your government, via the IMF.

    This is the letter I wrote to the Australian Treasurer that I was telling you about, and that they said that money was lent (we’ll get it back with interest) and is guaranteed by the balance sheet of the IMF member states. Good luck with that!

  6. Buddy Rojek, B.Comm., CPA
    280 Pipers Creek Rd
    Kyneton Vic 3444
    Honourable Wayne Swan
    Deputy Prime Minister
    CC – Felicity Ryan
    Departmental Liaison Officer – Economic
    Office of the Deputy Prime Minister and Treasurer
    P.O. Box 6022
    Parliament House
    Canberra ACT

    Dear Deputy Prime Minister,

    I am writing in response to the attached letter (copy) dated 16 December 2011.

    Please explain the profit we have made by contributing to the IMF since 1947, and do the contingent loan commitments provide a risk reward interest payment to reflect increasing global risk?

    My main concerns are overspending socialist governments need to be bailed out. Effectively Australia is funding the welfare States of Europe and the USA. If the USA is the main donor of the IMF, and is nearly bankrupt, does this mean Australia’s contribution to the IMF is at risk? I was taught Keynesian economics, but now I am a proponent of Austrian school theories.

    I have converted my SMSF to cash and productive agricultural land. Sadly I have lost confidence in all Parties (I am a swinging voter). No one keeps their promise, which effectively is their contract for my vote.

    Since you were awarded the award of Treasurer of the year (I assume you have now spent Australia’s surplus before the real financial collapse is to begin) can you please provide a detailed response instead of hand balling my questions to a junior bureaucrat that I am funding with my tax dollars. The explanation was lacking details and links to verifiable facts. Is this the response you give to concerned citizens who expertise is in finance and economics?

    Do a Google search of my name, and see the issues I am concerned about. I plan to run as an Independent Senator, to keep Australia a land of opportunity for all.

    Yours sincerely,

    Buddy Rojek, B,Comm, CPA

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  8. There are a few big Greek bonds due in the next few days, and no Greek government.
    What a mess. But…
    “potential loss of around €25bn for European banks. This is the cross-border claims (i.e. not matched by local liabilities) that European banks (mostly French) have on Greece’s public and non-bank private sector”

    Thats not actually all that bad, 25 billion, and it includes private sector lending. So the threat that seemed to guarentee immediate calamity in ther banking sectror looks relativelly managable.
    As long as the contagion doesn’t sread, it might actually be containable.

    ” Merkel has insisted that authorities show that Europe is a “safe place to invest” by avoiding haircuts.” I dont think this peice of insanity actually made it into the new fiscal treaty, fortunatelly.

    • Just as “assets” can get multiplied up by rehypothecation, so liabilities are multiplied up by default chains… $25 billion sounds manageable, but as Mike Tyson put it “everyone has a plan until they get punched in the face”. French banks are already overleveraged, and a lot of American banks have serious exposure to them.

      One thing I am virtually certain about is that when it blows we will get a big liquidity injection, probably both sides of the Atlantic.

      By the way I saw your link on Golem XIV’s blog.


    • About those TARGET 2 claims much trumpeted by ZH and others:

      “Even if countries told each other to go to Hell, the euro would simply cease to exist and the Bundesbank could write a cheque to itself. There would be no inflation and no loss to the German taxpayer,” he said.
      “We live in a world of fiat currencies, not the Gold Standard. People making these claims don’t understand how a central bank works,” he said. His views are shared by ECB experts.

      *When I said clarify previously, I should have said “or confuse” – sorry but I just don’t speak the economists language (nor do I give too much damn trying), though I trust there’s still value in what I say

      • I agree with Hans-Werner Sinn. This is anti-democratic.

        And what Professor Whelan said strikes me as kind of absurd; of course there is inflation in a fiat currency pump, even if that inflation is temporarily hidden by central banking skulduggery.

        That is pretty much what I expect, by the way. An (inflationary) pump to bail out creditors, while the afflicted nations go their own way and devalue.

        • Yes, but strictly discussing the mechanisms of TARGET 2, he seems to be wrong (and if he doesn’t understand the technicalities, perhaps he shouldn’t throw qualitative judgments at it). If there will be inflation, it seems that’s exactly Germany that will not see it.

        • They throw enough money at trying to “fix” the banking system and everyone will experience it, which I think is why they’ve desperately tried to avoid all of this, to the extent of ignoring it and hoping it will go away.

          By the way, as a follower of FOFOA, are you aware that Another/FOA may well have been involved in constructing the Euro system?

        • Sort of, I remember I read some innuendos regarding this. But, but… I fail to see where’s the glory and pride in this… Did those guys try to build a system that would blow itself up so that FOFOA’s theories would then come to the fore as the best replacement, or what?

        • Well everyone makes mistakes. The key point is I think the Euro system is a good implementation of the principle of gold as a store of value and fiat as the unit of account and medium of exchange, which is very much the de facto reality today. The IMF have been buying more, and so have China.

          I should have thought (this is a guess) that the architects of the Euro system, including Another, most probably were swamped by politics. For one thing it was quite well understood at the Euros inception that unless there was a federalisation of fiscal policy, the thing would be endangered; Prodi admitted it in 2001. And especially with the admission of countries like Greece who were not a good fit for the currency zone. So to some degree I think the Euro may have been a good project in essence, a bad project in implementation and a disaster in outcome. Nonetheless there are still some very enthusiastic proponents, even here in the UK. So I don’t think this thing is finished. In fact I don’t see any reason for the entire Eurozone to collapse with the Southern European exists, especially if the Bundesbank is willing to splash some recapitalisation cash.

        • Or maybe let me know here if you know better; he’s still in my Google Reader, but I haven’t followed him that closely after I thought I generally got what he means. And his theories are plausible, but IMO could only come to fruition in an extremely multi-polar world where a breakdown in trust will lead to the choice of gold instead of IMF PhD-designed money.

        • Actually I worked out the brilliant thing about FOFOA, and he retweeted me when I said this earlier on Twitter, so I presume he agrees with me.

          The point about FOFOA is he doesn’t have to be “right” and his ideas don’t have to be implementable . The key concept at the heart of it all is that gold is the store of value and fiat is the medium of exchange and unit of account. That’s becoming the reality whether we like it or not.

        • I don’t know, for me there are still too many variables. If you look at Roubini’s Twitter feed, you will see that intelligent clear thinking economists still see no value in gold. And gold hasn’t been a store of value and hasn’t followed inflation for the whole period of 1971 until today. It seems that it functioned more like just another currency; and people put less trust in it than in the dollar for most of that period. Seems plausible to me, but not necessarily what will definitely happen (though I hope that something similar to it will come to fruition rather than some IMF funny money).

        • Roubini’s Twitter feed is in all likelihood the last place I’d look for monetary insight. Roubini is probably the biggest paperbug around, he relishes it, and he buys all that Munger/Buffett/Keynes barbarian bullshit.

          I’ll look to the PBOC’s output… that gold is hard currency (i.e. a store of value) and essential wealth protection.

        • Well, that’s why I follow him, you have to know your enemy. But he does seem reasonable most of the time (I mean, I sometimes read his tweeted articles). And the idea of money seems to be very psychologically complicated. Even Gartman’s idea that the reserve currency will belong to the country that has the strongest military isn’t entirely off. People may doubt China in spite of her economical strength because of their unclear political system (even if it has a high degree of legitimacy even today – although it doesn’t have the form of a traditional democracy). If gold was just as easy to work with as a normal currency, I have no doubt it would quickly become the reserve currency of choice as a result of a Hayekian competition between alternative currencies (I wrote a comment a few months ago on your blog talking about banks treating gold as a currency and having the infrastructure behind it all, to account for full physical backing of all transactions).

  9. If there will be inflation, it seems that’s exactly Germany that will not see it.

    I meant inflation in case of complete break-up when those supposed TARGET 2 claims will have to be “enforced”.

    • Although, if I’m not mistaken, the ultimate effects will be that Germany will be left with an inflated DEM monetary stock in her banking system (which was the former euro sent in by other countries). Will have to study this more. Though most likely Germany will experience a deflationary shock in the aftermath.

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