Paul Krugman believes that American exposures to Europe is not bad enough to make a ballyhoo:
With American exports to Europe forming a small component of GDP, a European collapse would not necessarily mean a collapse in American demand:
The map above — taken from here — tells us that overall, exports to Europe are just 2 percent of GDP. Some states, notably South Carolina, are more exposed (presumably because of those European-owned auto plants). But Obama isn’t going to win South Carolina in any case. And more broadly, even a sharp fall in exports to Europe would be only a small direct hit to demand.
OK, caveats: this only measures goods exports, and we should mark the numbers up maybe 25 percent to take account of services. Also, exports aren’t the only channel: if European events cause a Lehman-type event, disrupting financial markets world-wide, all bets are off.
Um, that’s a pretty ginormous caveat. As far as I am aware, the case regarding America’s exposure to Europe has never been an issue of a collapse of demand in exports and has always been an issue of precipitating financial collapse.
The global financial system is an absurd interconnected house of cards. One falling card (like a Greek default) or ten falling cards (like the European banks who were foolish enough to purchase Greek debt) might just bring down the entire banking system, and its multi-quadrillion-dollar evil twin, the derivatives system.
And that’s not fear mongering. American banks have huge exposure to the European financial system.
I feel rather sorry for Krugman. He’s analysing a factor that traditionally is very significant in international macro. And in this case it’s almost totally negligible: the real problem isn’t the economy; it’s the monstrous beast of a financial system we find ourselves encumbered with.
Last month, I gave up writing about the European meltdown. After all, it was all so inevitable. Either Europe will take the slow and painful Japanese-American road to zombification (allowing a broken system to continue to be broken) by printing the money to support debt levels or European nations like Greece will default and all hell will break loose.
As I wrote multiple times last year, I believed the latter was far likelier, mainly because I didn’t think Germans wouldn’t stand for printing money, although so far it appears that I have been wrong.
Today channeling the inscription to the gates of hell from Dante’s inferno is none other than yet another Bundesbank board member, Carl-Ludwig Thiele, who said that “Europe must abandon the idea that printing money, or quantitative easing, can be used to address the euro zone debt crisis. One idea should be brushed aside once and for all — namely the idea of printing the required money. Because that would threaten the most important foundation for a stable currency: the independence of a price stability orientated central bank.”
Fitch meanwhile believe that the Greek default will be here by March:
Greece is insolvent and probably won’t be able to honor a bond payment in March as the country negotiates with creditors to cut its debt burden, Fitch Ratings Managing Director Edward Parker said.
The euro area’s most indebted country is unlikely to be able to honor a March 20 bond payment of 14.5 billion euros ($18 billion), Parker said today in an interview in Stockholm. Efforts to arrange a private sector deal on how to handle Greece’s obligations would constitute a default, he said.
As we learned a long time ago, big defaults on the order of billions don’t just panic markets. They congest the system, because the system is predicated around the idea that everyone owes things to everyone else. The $18 billion that Greece owes to the banks are in turn owed on to other banks and other institutions. Failure to meet that payment doesn’t just mean one default, it could mean many more. The great cyclical wheel of international debt is only as strong as its weakest link.
This kind of breakdown is known as a default cascade. In an international financial system which is ever-more interconnected, we will soon see how far the cascade might travel.
Does the hypochondriac who is ultimately diagnosed with a real, physiological illness have the right to say “I told you so”?
Well, maybe. Sometimes a “hypochondriac” might be ill all along, but those diagnosing him just did not conduct the right test, or look at the right data. Medical science and diagnostics are nothing like as advanced as we like to hope. There are still thousands of diseases and ailments which are totally unexplained. Sometimes this means a “hypochondriac” might be dead or comatose before he ever gets the chance to say “I told you so.”
Similarly, there are are many who suggest that their own nations or civilisations are in ailing decline. Some of them might be crankish hypochondriacs. But some of them might be shockingly prescient:
Is Marc Faber being a hypochondriac in saying that the entire derivatives market is headed to zero? Maybe. It depends whether his analysis is proven correct by events. I personally believe that he is more right than he is wrong: the derivatives market is deeply interconnected, and counter-party risk really does threaten to destroy a huge percentage of it.
More dangerous to health than hypochondria is what I might call hyperchondria.
This is the condition under which people are unshakeably sure that they are fine. They might sustain a severe physical injury and refuse medical treatment. They brush off any and all sensations of physical illness. They suffer from an interminable and unshakeable optimism. Government — or, at least, the public face of government — is littered with them. John McCain blustered that the economy was strong and robust — until he had to suspend his Presidential campaign to return to Washington to vote for TARP. Tim Geithner stressed there was “no chance of a downgrade” — until S&P downgraded U.S. debt. Such is politics — politicians like to exude the illusion of control. So too do economists, if they become too politically active. Ben Bernanke boasted he could stanch inflation in “15 minutes“.
So, between outsiders like Ron Paul who have consistently warned of the possibility of economic disaster, and insiders like Ben Bernanke who refuse to conceive of such a thing, where can we get an accurate portrait of the shape of Western civilisation and the state of the American empire?
Professor Alfred McCoy — writing for CBS News — paints a fascinating picture:
A soft landing for America 40 years from now? Don’t bet on it. The demise of the United States as the global superpower could come far more quickly than anyone imagines. If Washington is dreaming of 2040 or 2050 as the end of the American Century, a more realistic assessment of domestic and global trends suggests that in 2025, just 15 years from now, it could all be over except for the shouting.
Despite the aura of omnipotence most empires project, a look at their history should remind us that they are fragile organisms. So delicate is their ecology of power that, when things start to go truly bad, empires regularly unravel with unholy speed: just a year for Portugal, two years for the Soviet Union, eight years for France, 11 years for the Ottomans, 17 years for Great Britain, and, in all likelihood, 22 years for the United States, counting from the crucial year 2003.
Future historians are likely to identify the Bush administration’s rash invasion of Iraq in that year as the start of America’s downfall. However, instead of the bloodshed that marked the end of so many past empires, with cities burning and civilians slaughtered, this twenty-first century imperial collapse could come relatively quietly through the invisible tendrils of economic collapse or cyberwarfare.
But have no doubt: when Washington’s global dominion finally ends, there will be painful daily reminders of what such a loss of power means for Americans in every walk of life. As a half-dozen European nations have discovered, imperial decline tends to have a remarkably demoralizing impact on a society, regularly bringing at least a generation of economic privation. As the economy cools, political temperatures rise, often sparking serious domestic unrest.
Available economic, educational, and military data indicate that, when it comes to U.S. global power, negative trends will aggregate rapidly by 2020 and are likely to reach a critical mass no later than 2030. The American Century, proclaimed so triumphantly at the start of World War II, will be tattered and fading by 2025, its eighth decade, and could be history by 2030.
Significantly, in 2008, the U.S. National Intelligence Council admitted for the first time that America’s global power was indeed on a declining trajectory. In one of its periodic futuristic reports, Global Trends 2025, the Council cited “the transfer of global wealth and economic powernow under way, roughly from West to East” and “without precedent in modern history,” as the primary factor in the decline of the “United States’ relative strength — even in the military realm.” Like many in Washington, however, the Council’s analysts anticipated a very long, very soft landing for American global preeminence, and harbored the hope that somehow the U.S. would long “retain unique military capabilities… to project military power globally” for decades to come.
No such luck. Under current projections, the United States will find itself in second place behind China (already the world’s second largest economy) in economic output around 2026, and behind India by 2050. Similarly, Chinese innovation is on a trajectory toward world leadership in applied science and military technology sometime between 2020 and 2030, just as America’s current supply of brilliant scientists and engineers retires, without adequate replacement by an ill-educated younger generation.
Wrapped in imperial hubris, like Whitehall or Quai d’Orsay before it, the White House still seems to imagine that American decline will be gradual, gentle, and partial. In his State of the Union address last January, President Obama offered the reassurance that “I do not accept second place for the United States of America.” A few days later, Vice President Biden ridiculed the very idea that “we are destined to fulfill [historian Paul] Kennedy’s prophecy that we are going to be a great nation that has failed because we lost control of our economy and overextended.” Similarly, writing in the November issue of the establishment journal Foreign Affairs, neo-liberal foreign policy guru Joseph Nye waved away talk of China’s economic and military rise, dismissing “misleading metaphors of organic decline” and denying that any deterioration in U.S. global power was underway.
Frankly — given how deeply America is indebted, given that crucial American military and consumer supply chains are controlled by China, given how dependent America is on foreign oil for transport and agribusiness — I believe that the end of American primacy by 2025 is an extraordinarily optimistic estimate. The real end of American primacy may have been as early as 9/11/2001.
The entente is no longer so cordiale. As the big credit rating firms assess whether to strip France of its prized AAA status, Bank of France chief Christian Noyer this week produced a long list of reasons why he believes the agencies should turn their fire on Britain before his own country.
France’s finance minister François Baroin put things even more bluntly: “We’d rather be French than British in economic terms.”
But is the outlook across the Channel really better than in Britain? Taking Noyer’s reasons to downgrade Britain – it “has more deficits, as much debt, more inflation, less growth than us” – he is certainly right on some counts.
Britain’s deficit will stand at 7% of GDP next year, while France’s will be 4.6%, according to International Monetary Fund forecasts. But Britain’s net debt is put at 76.9% of GDP in 2012 and France’s at 83.5%. UK inflation has been way above the government-set target of 2% this year and the IMF forecasts it will be 2.4% in 2012. In France the rate is expected to be 1.4%.
On growth, neither country can claim a stellar performance. France’s economy grew 0.4% in the third quarter and Britain’s 0.5%. Nor has either a particularly rosy outlook. In Britain the economy is expected to grow by 1.6% in 2012. But in the near term there is a 1-in-3 chance of a recession, according to the independent Office for Budget Responsibility. In France, the IMF predicts slightly slower 2012 growth of 1.4%. But in the near term France’s national statistics office predicts a technical, albeit short, recession.
There is one significant factor everyone is overlooking.
While we sympathize with England, and are stunned by the immature petulant response from France and its head banker Christian Noyer to the threat of an imminent S&P downgrade of its overblown AAA rating, the truth is that France is actually 100% correct in telling the world to shift its attention from France and to Britain.
France should quietly and happily accept a downgrade, because the worst that could happen would be a few big French banks collapsing, and that’s it. If, on the other hand, the UK becomes the center of attention then this island, which far more so than the US is the true center of the global banking ponzi scheme, will suddenly find itself at the mercy of the market.
And why is the debt so high? Well, the superficial answer is that the UK is a “world financial centre”. The deeper answer is that the UK allows unlimited re-hypothecation of assets. Re-hypothecation is when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations. In the US brokers can re-hypothecate assets up to 140% of their book value.
In the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. Brokers are free to re-hypothecate all and even more than the assets deposited by clients. That is the kind of thing that creates huge interlinked webs of debt. And much of Britain’s huge debt load — particularly in the financial industry — is one giant web of endless re-hypothecation. Even firms (e.g. hedge funds) that do not internally re-hypothecate collateral are at risk, because their assets may have been re-hypothecated by a broker, or they may be owed money by a firm that re-hypothecates to high heaven. The problem here is the systemic fragility.
Simply, the UK financial sector has been attracting a lot of global capital because some British regulations are extremely lax. While it is pleasing to see the Vickers report, that recommends a British Glass-Steagall separation of investment and retail banking, becoming government policy, and while such a system might have insulated the real economy from the madness of unlimited re-hypothecation, the damage is already done. The debt already exists, and some day that debt web will have to be unwound.
Now Britain does have one clear advantage in over France. It can print its own money to recapitalise banks. But with inflation already prohibitively high, any such action is risky. If short sellers turn their fire on Britain, we could be in for a bumpy ride to hell and back.
UPDATE: Readers wanting to understand the true extent of economic degradation in some parts of the UK ought look no further than a recent post…
My chart of the day, illustrating a pretty brutal reversion to the mean:
Of course, all interest rates in a fiat system are artificial. Interest rates are the price of money, and if a central bank is determining the level of money, then they are in effect determining the level of interest, which is one reason why sovereigns who borrow in their own currency do not tend to face a danger of rising interest rates even at high levels of borrowing.
The post-Euro low-rates euphoria was a cunning trick: the single monetary policy disguised each state’s true fiscal picture. Fiscal union might have prevented this blowup, but introducing it now seems unlikely given Germany’s severe aversion to such a thing.
If AIG is considered ‘too big to fail’ what does that make the Eurozone given the very high levels of integration across the global economy today? (I don’t have the answer, but I think we can all guess).
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.
Ms Merkel agreed that private sector bondholders would not be asked to bear some of the losses in any future sovereign debt restructuring, as she had insisted this year in the case of Greece’s second bail-out. However, future eurozone bonds will still include collective action clauses providing for potential voluntary rescheduling of private debt.
Ms Merkel said it was imperative to show that Europe was a “safe place to invest”.
To understand just how stupid this is, all you need to do is go back and read Michael Lewis’s Ireland article. The fateful decision in Ireland was to take the insolvent banks and give them a blanket bailout, with the banks’ creditors all getting 100 cents on the euro. That only served to put a positively evil debt burden onto the Irish people, forcing a massive austerity program and causing untold billions of euros in foregone growth, while bailing out lenders who deserved no such thing.
Are we really going to repeat — on a much larger scale — the very same mistake that Ireland made? Does no one in Europe realize that this is the single worst thing they can do?
Salmon is correct, but there is a bigger issue at play here — this kind of nonsensical rubbish is exactly what has turned first Japan, and now America into zombie economies.
Showing that Europe is a “safe place to invest” effectively means rigging the market to eliminate sovereign default, or any kind of behaviour that threatens “systemic stability”. Of course, as the last few years have shown, the system is too interconnected for large entities fail. The reactionary perspective on this is to bail out everything again and again and again. The realistic perspective is that no such system is sustainable. Worse, no such system allows for any kind of capitalism.
Capitalism means both successes and failures. It is a fundamentally experimental system, with a continuous feedback mechanism — the market, and ultimately profit and loss. Ideas that work are rewarded with financial success, and ideas that don’t are punished with failure. With capitalism, systems, ideas and firms that fail to produce what the market wants fail. They go bankrupt. Their assets, and their debt is liquidated.
When that mechanism is suspended by a government or central bank that thinks it knows best — and that a system that is too interconnected to fail is worth saving at any cost — the result is almost always stagnation. This is for a number of reasons — most obviously that bailouts sustain crippling debt levels, and are paid for through contractionary austerity, which is what Salmon was getting at. But it is larger than just that.
In nature, ideas and schemes that work are rewarded — and ideas and schemes that don’t work are punished. Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish.
These bailouts have tried to turn nature on its head — bailed out bankers and institutions have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure.
The darkest side to this zombification is that it takes resources from the productive, the young, the creative, and the needy and channels them to the zombies. Vast sums spent on rescue packages to keep the zombie system alive might have been available to increase the intellectual capabilities of the youth, or to support basic research and development, or to build better physical infrastructure, or to create new and innovative companies and products.
Zombification kills competition, too: when companies fail, it leaves a gap in the market that has to be filled, either by an expanding competitor, or by a new business. With failures now being kept on life-support, gaps in the market are fewer.
Japan has experienced twenty hellish years of zombification, all because they suspended capitalism in favour of systemic stability and creditors getting their pound of flesh. America did virtually the same thing, and the result has been three years of stagnation. Now — if Merkel gets here way — Europe will face the same thing.
Without experimental capitalism societies stagnate. That is the lesson policy makers — especially Europe’s new Führer — need to learn.
German Chancellor Angela Merkel has said Europe is working towards setting up a “fiscal union”, in a bid to resolve the eurozone’s debt crisis.
She told the Bundestag that a new EU treaty was needed to set up such a union and impose budget discipline.
On Monday she is to meet French President Nicolas Sarkozy, who has also called for EU treaty changes.
EU leaders have been under pressure to do more to tackle the debt crisis, amid concern about the survival of the euro.
In her speech, Mrs Merkel promised “concrete steps towards a fiscal union” – in effect close integration of the tax-and-spend polices of individual eurozone countries, with Brussels imposing penalties on members that break the rules.
In hindsight, perhaps this was always Germany’s favoured course.
The idea [of Euro bonds] was immediately rejected by German Finance Minister Wolfgang Schaeuble, who said such bonds would undermine the basis for the single currency by weakening fiscal discipline among member states.
“I rule out euro bonds for as long as member states conduct their own financial policies, and we need differing interest rates so that there are possibilities of incentives and sanctions to force fiscal solidity,” he told Der Spiegel weekly.
“Without that kind of solidity, there is no foundation for a joint currency,” he added, according to extracts of an interview released ahead of publication.
In theory (ignoring the lack of a economic common culture, lack of labour market flexibility, lack of a common language, etc, etc) this would have made Europe a viable monetary union. In practice, no amount of “budget discipline” can now reverse the ongoing confidence panic — essentially a run on the Euro — stemming from the mediterranean budgetary disasters. Fiscal union might have prevented this mess from developing, but once the mess has developed, it won’t do anything to contain or reverse it. The fact that policy makers seem to be making things up as they go along is not exactly inspiring confidence, either. The only hope for temporarily reversing the run on Europe (and kicking the can down the road into Euro zombification — or, as Obama calls it, “recovery”) is a massive money printing operation.
Will the cathedral of teutonic monetarism (also known as the ECB) allow for it? No — that’s why they’re trying for fiscal union as an alternative.
In any case, such a fiscal union will surely prove deeply unpopular with a Europe growing sick of top-down technocratic integrationism, and frankly seems bound to fail. Why? Because it almost certainly means stern teutonic austerity — a policy which will surely cause yet more economic contraction, more pain, and more of a mess.
9.18am: Just in case anyone was in doubt about the situation today, EU monetary effairs commissioner Olli Rehn has warned that Europe has just 10 days to “complete and conclude” its crisis response.
The markets for the last six months (and longer) have been crying out for the ECB to go postal, print a tsunami of new paper, buy every troubled asset going, and (ahem) “save the world”.
Stern teutonic monetarism has won the day.
Either that, or Eurocrats see this as a fantastic opportunity to consolidate the Eurozone into a full blown fiscal union:
Now it’s the turn of Herman Van Rompuy, president of the European Council, to sound the alarm. He just told a conference of EU ambassadors that Europe is trapped in a “systemic…full-blown confidence crisis.” Some may blame it on the irrationality of the market. But it’s a fact and we need to confront it.” What’s the solution? Van Rompuy argued that Europe must swallow closer fiscal union (as Germany, for example, has long demanded): “We need a significant step forward towards a real economic union commensurate with our monetary union.”
Don’t these people understand that such measures always come with massive unforeseen consequences? Here’s a rule of thumb any idiot can use: more centralisation means more systemic fragility. Proponents of any such centralisation have to weigh the benefits against the fragility, because when the black swans begin to flock excessive fragility tends to mean collapse.
Basically they look identical all through the year up until November and then BAM. Finnish yields are exploding higher, right as Swedish yields are blasting lower.
The only obvious difference between the two: Finland is part of the Eurozone, meaning it can’t print its own money. Sweden has no such risk.
This is a narrow version of something that much of the media picks up on earlier last week that UK gilts were trading with a lower yield that German bonds, a reflection of the same principle: In UK the government can print. In Germany, it can’t.
Yes — investors are happier with the idea of buying bonds which may be debased by money printing, than they are with the idea of buying bonds which may be defaulted on because the sovereign cannot print. But there is another element at play here, which may be much bigger.
Easing, of any sort won’t solve the underlying global problem — as explained by Reinhart and Rogoff in better detail than I have ever done — of excessive debt levels. By conducting QE (i.e. taking sovereign debt out of the market) governments are simply artificially contracting the supply, and in my view pumping up a debt bubble.
It’s important to consider Japan here — yields in Japan are as low as ever, and creditors are still taking their pound of flesh. That can’t be a bubble, can it? Creditors aren’t losing their money? Well, it depends how you define return on investment. Investors in Japanese bonds may be getting their money back, but Japanese society is slowly being strangled by a lack of organic growth and a lack of any real kind of creative destruction. Wages and living standards fall while unemployment rises. So Japan has become zombified, and in theory similar cases like the United States and Britain should follow down the path of death by slow Keynesianism (they won’t, because they are far more combustible societies than Japan, but that is another story for another day).
In light of all that, while the Teutonic monetarist hawkery may superficially look stupid, if we look at the resulting Euro-implosion as a potential trigger to crash global markets, burst the global bond bubble, trigger a cascade of AIG -esque events, culminating in the breakdown of the global financial system, a debt reset, and a new global financial order well then it’s really quite clever. Ultimately, a debt reset is what is needed to effectuate new organic growth and new jobs, and to clear out the withered remains of umpteen bubbles that have been created in the last twenty years through easy money.
I doubt that the stern bureaucrats at the ECB are anywhere near as clever or far-sighted as this (their most significant concern appears to be sound monetarist economics) but there is quite possibly genius in this stupidity.
So — rather than death by hawkery, I foresee rebirth.
Of course, on the other hand the “hawks” may just end up printing like their American counterparts.
azizonomics 