03 December 2011

Common Misconceptions About the Eurozone Crisis

Lately, I have been talking with friends about the financial crisis in Europe. Some of them are very well informed, others formed a basic opinion through occasional glances to online news sources. But the surprising thing is that they all share the same common misconceptions and do not know why the crisis happened and why it is very hard to solve.

I thought I should perhaps address these issues and spare my future dinner companions of long discussions by simply pointing to this post.

1) We need to save Greece (or GIIPS) out of solidarity

"We" are not bailing out or saving Greece. And what we are doing has certainly nothing to do with solidarity. What "we" are doing is bailing out and saving German and French banks. And by extension US banks.

Take a look at the two charts on that linked June post and you will see it immediately. Their exposure to Greek debt is about $120 billion. Their total exposure to Greece, Ireland, Portugal and Spain is $900 billion. Note that this is not GIIPS as Italy is not included in that exposure. You don't want to know what their exposure looks like with Italy in the equation.

And "we" are bailing out US banks by extensions. No one knows for sure the extent of their exposure because most of it is hidden through French and German banks but what is known is enough to make Fitch to ring alarm bells. You could say that it is only fair that "we" return the favor as the US bailed out many European banks (chief among them, Deutsche Bank and Société Générale) with the first TARP intervention. Without it both banks (and many others) probably would have gone bankrupt.

In fact, Greece would have been better off if "we" didn't save it, as I explained the funny math behind the so called 50 percent haircut. "We" simply saddled them with more debt, remove their ability to ever pay that debt, tear up their social fabric and in the process began buying up their most valuable assets.

At some point, they could have defaulted, left the Eurozone, impose currency restrictions for a short while, devalue the neo-drachma and focus on tourism and cheap exports to get their economy going. I was not the only person who suggested that. Academics, Nobel laureatesknowledgeable people made the same call.

That ship has since sailed. Greece will default but it will no longer be the beneficial act it could have been six months ago. In the intervening period, anyone with any liquid assets moved them out of the country. The default, when it comes now, will find a much poorer country stripped of its prized assets with a radicalized population.

2) Wasn't the crisis the result of the profligacy of politicians?

Not really. Sure, politicians did spend money. It is their job. That's how they get elected. But they are not the ones who caused the crisis. The crisis was the result of the excessive amount of money in the global system and bankers chasing more and more profits. As a well known economist blogger put it:
There is too much money chasing far too few returns.  Contrary to the idea that there isn’t enough money in the world, the problem is that there is too much, and it is chasing diminishing returns.  
On top of all the additional funds coming out of China and oil countries that needed to be invested safely, banks also used previously unusable assets to maximize their profits. With each wave of deregulation and relaxation of the rules, banks began holding less reserves and brokerage firms  found ways to not adhere to minimum capital requirements or the net capital rule.

All our current financial ills, like the real estate bubble in the US or too big to fail banks or the speculative food and commodities price increases during the last decade or the 2008 oil price hikes (collectively known as the Bubble Machine) stem from the same root cause. Too much money to invest and too little regulation.

Just as an aside, you know why Canadian banks did so much better than their US counterparts? Because the much calumniated Liberals did not go with the conservative push for more deregulation and creation of financial behemoths through mergers. Subsequently, the Conservatives took credit for Canada's financial health but if Harper was the PM at the time I am pretty sure Canada would be where Ireland is today.

So, chastise all you want your politicians but the problem is elsewhere.

3) Can Europe find a solution to the Eurozone crisis?

I am beginning to doubt that seriously.

In September, I quoted Krugman's calculations about how Germany's need for less than one percent inflation translates into 20 percent deflation for Spain and other peripheral countries. Not only is a 20 percent price fall  simply untenable, what these countries need right now is the opposite, a mild inflation.

All this talk about strengthening European Financial Stability Facility (EFSF) or making ECG the lender of last resort or creating a Eurobond to cover the whole Eurozone simply hide the fact that there is a structural incompatibility at the heart of the Euro structure.

Germany acts as if its priorities are the only ones that count and because of the way the current discourse is framed, that is, indeed, the case. For instance, a recent BBC report was quoting anonymous analysts to explain German resistance to rational solutions:
Analysts also say Berlin is opposed to wholesale intervention by the ECB because of the country's experience of hyperinflation in the 1920s.
That's unadulterated rubbish but that is the current discourse.

So far, Germany refused to allow ECB to buy up debt, increase the EFSF substantially or to allow ECB to print Euros, something no other institution, other than the US Fed, can do without triggering significant inflation.

Why is Germany doing this? From Merkel's last speech it looks like she is offering a hard bargain for EU members. She is saying, we will agree to ECB buying up sovereign debt or maybe to a Eurobond if you agree to give up your fiscal sovereignty.

The interesting thing about the Merkel plan is that it will redefine the basic tenets of the European Union and will probably make it much harder to have government spending on redressing social or regional disparities and on social or environmental protections.

By simply rearranging the allocation of resources, Merkel's new Europe might redefine priorities and reshape societies.

4) Where are the banksters in all this?

People ask me why I keep using the word "bankster."

That is because their self-serving modus operandi is more reminiscent of gangsters than regular capitalists. They seem to be motivated solely by the size of their bonuses and could not care about the interests of their shareholders or the health of their companies or the stability of the economies in which they operate. It seems that there is nothing they will not do in the pursuit of larger bonuses. Also, like criminal enterprises that cast a long shadow on Italian politics, bankers, as Dick Durbin said of the US Congress, "frankly own the place."

So, remember the fact that Goldman Sachs helped Greece hide the extent of its indebtedness in order to push more debt? Well, the new head of the Greek debt management agency is Petros Christodoulou. Do you know where he worked previously? If you guessed it as Goldman Sachs, peddling swaps, give yourself 20 bonus points.

And what about the guy who was the head of Greek Central Bank during these debt piling and debt hiding joyful years, Lucas Papademos, whatever happened to him? Why, he is the new technocratic Prime Minister of Greece, replacing the democratically elected Mr. Papandreou.

Hmmm, who else was recently selected as another technocratic Prime Minister? Why, the new Italian Prime Minister Mario Monti of course. His profile contains this single line:
He is international advisor to Goldman Sachs.
Since we are talking about recent nominees selected to tackle the debt crisis, let's not forget Mario Draghi, the new head of the European Central Bank. Do you know where he worked before?
Draghi was then vice chairman and managing director of Goldman Sachs International and a member of the firm-wide management committee (2002–2005). A controversy existed on his duties while employed at Goldman Sachs. Pascal Canfin (MEP) asserted Draghi was involved in swaps for European governments, namely Greece, trying to disguise their countries' economic status.
Don't get me wrong, I am not suggesting that Goldman Sachs rules the world. Maybe they do but I don't know.

All I am saying that in a setting where the banksters have been doing everything to force governments to assume all existing liabilities and pay them in full, I cannot imagine the downside of having such well placed alumni.

5) What is next?

In the early days of the crisis I assumed that the banksters, having learned a valuable lesson from Ireland's foolish move to transform private liabilities into public debt, were pushing to do the same for the entire Eurozone. They indeed moved from country to country putting the screws on. It was Ireland, then Portugal, then Spain, then Italy, then France. In fact, a couple of weeks ago, they even gave Germany a wake up call.

They have the upper hand and under normal circumstances they will not wait patiently for the politicians to react and they escalate this further.

But now that Germany is offering a new fiscal union, they will wait what Germany will be asked to give in return. If Germany accepts a solution like a Eurobond that covers all existing liabilities, banskters will stand down. And the process will go back to politicians.

If Germany refuses to accept any short term solutions and will only look for a long term arrangement, the banksters will press on.

Under that kind of pressure, the Euro could shatter in the next few months. In that sense, when Jacques Attali said that the Euro might have until Christmas, he might be slightly exaggerating. After all, no less a luminary than Professor Roubini recently said that Italy may have to exit the Eurozone, causing perhaps the break up of the currency.

But despite my pessimism about the overall arrangement and the structural obstacles to a solution, I think too many interests are served by the existence of Euro. And more importantly, if it collapses, there is a reasonable risk that it could bring down the American economy with it. Which means a global meltdown.

My guess is that the crisis will be ratcheted up with breathless commentary until the public is ready to accept any and all solutions.

There will be a core group of Eurozone countries following the German conservative model. Others will either accept a decade of austerity and hardship to stay in Euro or will simply exit and revert to their national currency that they can devalue at will.

And the banksters will get their money.

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