Tag Archives: Germany

How Much Trouble Could Big Banks Be In? Lots!

The future of the Euro and the Eurozone is bleak and will likely look like a series of prolonged, rolling crises that slowly evolve to reveal just how critically the financial health of each country is affected by their individual sovereign debt and their failing banks.

The inevitable result will be severe Eurozone-wide stress, emergency liquidity loans from the IMF and the European Central Bank and politicians from all the countries involved increasingly attacking each other  over allegations of blame and corruption. To no good end.

Even the optimists now say openly that Europe will only solve its problems when there are no options left and time has run out. Less optimistic analysts increasingly think that the Eurozone will break up because all the proposed solutions are essentially Pollyannaish jokes. Let’s say the realists are right, and Europe starts to dissolve. Markets, investors, regulators and governments can stop worrying about interest-rate and credit risk, and start worrying about dissolution risk.

More importantly, they need to start worrying seriously about what the repricing of risk will do to the world’s thinly capitalized and highly leveraged megabanks. European officials, strangely, appear not to have thought about this at all; the Group of 20 meeting last week seemed to communicate a weird form of complacency and calm.

So, for all of the European officials and the U.S. bankers, here’s what dissolution risk means:  If you have a contract that requires you to be paid in euros and the euro no longer exists, what you will receive is not real clear. See? That’s dissolution risk.

Let’s say you have lent 1 million euros to a German bank, payable three months from now. If the euro suddenly ceases to exist and all countries revert to their original currencies, then you would probably receive payment in deutsche marks. You might be fine with this — and congratulate yourself on not lending to an Italian bank, which is now paying off in lira.

But what would the exchange rate be between new deutsche marks and euros? How would this affect the purchasing power of the loan repayment? More worrisome, what if Germany has gone back on the deutsche mark but the euro still exists — issued by more inflation-inclined countries? Presumably you would be offered payment in the rapidly depreciating euro. If you contested such a repayment, the litigation could drag on for years.

What if you lent to that German bank not in Frankfurt but in London? Would it matter if you lent to a branch (part of the parent) or a subsidiary (more clearly a British legal entity)? How would the British courts assess your claim to be repaid in relatively appreciated deutsche marks, rather than ever-less- appealing euros? With the euro depreciating further, should you wait to see what the courts decide? Or should you settle quickly in hope of recovering half of what you originally expected?

What if you lent to the German bank in New York, but the transaction was run through an offshore subsidiary, for example in the Cayman Islands? Global banks are extremely complex in terms of the legal entities that overlap with business units. Do you really know which legal jurisdiction would cover all aspects of your transaction in the currency formerly known as the euro?

Moving from relatively simple contracts to the complex world of derivatives, what would happen to the huge euro-denominated interest-rate swap market if euro dissolution is a real possibility? Guess what? No one really knows.

But, what I am really talking about here is the balance sheets of the really big banks. For example, in recently released filings with banking regulators, JPMorgan Chase & Co. revealed that $50 billion in losses could hypothetically bring down the bank. JPMorgan’s total balance sheet is valued, under U.S. accounting standards, at about $2.3 trillion. But U.S. rules allow a more generous netting of derivatives — offsetting long with short positions between the same counterparties — than European banks are allowed. HA!

The problem is that the netting effect can be overstated because derivatives contracts often don’t offset each other precisely. Worse, when traders smell trouble at a bank that has taken on too much risk, they tend to close out their derivatives positions quickly, leaving supposedly netted contracts exposed. Remember the final days of Lehman Brothers?

When one bank defaults and its derivatives counterpart does not, the failing bank must pay many contracts at once. The counterpart, however, wouldn’t provide a matching acceleration in its payments, which would be owed under the originally agreed schedule. This discrepancy could cause a “run” on a highly leveraged bank as counterparties attempt to close out positions with suspect banks while they can. The point is that the netting shown on a bank balance sheet can paper over this dynamic. And that means that JPMorgan’s regulatory filings vastly understate the potential danger.

JPMorgan’s balance sheet, using the European method isn’t $2.3 trillion, but closer to $4 trillion. That would make it the largest bank in the world. Holy Moly!

What are the odds that JPMorgan would lose no more than $50 billion on assets of $4 trillion, much of which is complex derivatives, in a euro-area breakup, an event that would easily be the biggest financial crisis in world history? Slim. And, None.

No one on these shores seems to see the storm coming. In an effort to forestall the impending global crisis, the Federal Reserve should be insisting that big U.S. banks increase their capital levels by suspending dividends, and set up emergency liquidity facilities with an emergency and across-the-board suspension of dividend payments, but it won’t. The Fed is convinced that its recent stress tests show U.S. banks have enough capital even though these tests didn’t model serious euro dissolution risk and the effect on global derivatives markets.

The Fed is dead wrong about that, and the pending Euro-crisis is very real. Our mega-banks are in no position to weather even the known storm, let alone the real storm when all the European counter-parties pony up to the bar with their real exposures, and the true sovereign debt gets exposed. Then, what do you think that means for smaller banks? 

How do you think that might affect the U.S. economic recovery? What is gold trading at? $1,575 an ounce?  Hmmmm.

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Investors: Are You Kidding Me?

I don’t have a clue as to why the Dow is still trading above 12,000. The global economy in 2013 looks awful.

The Eurozone crisis is worsening, heavy-handed, almost emotionally-driven fiscal austerity measures are deepening recessions in most member countries, continuing high oil prices and a severe credit crunch are completely undermining any prospects for recovery.

And, I am an OPTIMIST!

The Eurozone banking system is turning into isolated stovepipes as cross-border and interbank credit lines are cut off and capital flight continues. Greece’s upcoming disorderly exit from the Eurozone will create a huge, apocalyptic bank run. I have only used “apocalyptic” once once in 370 posts.

Spanish and Italian interest rate spreads are back to their ridiculous and unsustainable levels, and the Eurozone appears to need not just an international banking bailout (as happened recently in Spain) but a sovereign bailout as well. Smart money says the Eurozone goes full bore into a disorderly exit from itself in 2013.

Back at home, the US economic performance is weakening, with first-quarter growth a ridiculous 1.9%. Job creation stalled in April and May, and it is probable that the rate could completely stall out by year end. We have talked about why jobs aren’t coming back before. There is the real risk of a double-dip recession next year, as tax increases and a continuing housing market disaster will reduce growth in disposable income, consumption and confidence. Doesn’t matter who gets elected in November.

Political gridlock will continue. There will be fights over the debt ceiling, student loans, the JOBS act, fiscal policy and taxes. There will be new rating downgrades and this time, a real risk of a government shutdown, which will further depress consumer and business confidence, reduce spending and accelerate a flight to safety that should knock the Dow down to below 8,000.

China, is actually a mess. Their growth model is totally unsustainable, their leadership is way too slow in accelerating structural reforms, and its investments are heading underwater. Leadership must reduce national saving and increase consumption, but politics and a difficult leadership transition will result in policy that does too little, and does it way too late. And, how many women do you see here?

We are all tied together now on this little planet. The Global economic slowdown will create a massive drag on growth in emerging markets, given their trade and financial links with the US, China and the European Union. At the same time, government intractability in emerging markets, and a collective surge towards greater state capitalism, will slow the pace of growth and will reduce their resiliency.

If all of that isn’t freaky enough, consider the long-simmering tensions in the Middle East between Israel and the US on one side, and Iran on the other, on the issue of nuclear proliferation. The current negotiations are likely to fail, and as we have pointed out on this blog a couple of months ago, tightened sanctions will not stop Iran from building nuclear weapons. The US and Israel will not accept negotiations, so even if the rest of the world were rosy, a military confrontation in 2013 would lead to a massive oil price spike and a global recession.

If you are a Global economic leader, you’re first response should be to shy away from risk, especially when no matter in which direction you turn, you see more and more.  So, most leaders are adopting a wait-and-see position which exasperates the slowdown and makes a Global recession largely self-fulfilling.

And, if you think that we have already seen this movie in 2009-2009, and think, so … how bad can it be? Think again. Compared to 2008-2009, when policymakers had ample space to act, monetary and fiscal authorities are running out of, or have already run out of policy bullets. Monetary policy is constrained by the proximity to zero interest rates and repeated rounds of quantitative easing. And, “Twist” is a cruel joke. Cruel, because it creates a sense that Congress is actually doing something to fix the economy when the time for fixing has come and gone.

Economies and markets no longer face liquidity problems, but rather credit and insolvency crises. Meanwhile, unsustainable budget deficits and public debt in most advanced economies have severely limited any possibilities for further fiscal stimulus.

Sovereign risk has now become bank risk. In the Eurozone, sovereigns are dumping a larger fraction of their public debt onto their banks’ balance sheet.

To try and prevent a disorderly outcome in the Eurozone is futile because of the first law of cat-herding. The current fiscal austerity needs to be implemented much more gradually, a growth contract should complement the EU’s new fiscal contract, and a fiscal union with debt mutualization (Eurobonds) should be implemented.  In addition, a full banking union, starting with Eurozone-wide deposit insurance, should be initiated, and moves toward greater political integration must be considered, even as Greece leaves the Eurozone. But, of course none of that is possible. Look no further than Germany for the answer.

Germany, understandably, resists all of these key policy measures, as it is obsessed with the credit risk to which its taxpayers would be exposed with greater economic, fiscal, and banking integration. Why on earth, should Germany carry the weight for countries who have irresponsibly led themselves into fiscal and economic policy disaster?

The Eurozone bubble may be the largest to burst, but it is not the only one threatening the global economy in 2013. Stay tuned. Sell all your equities. Stock up on canned goods and booze, and batten down the hatches.


Greece Is Lost, And So Is Europe.

There was much hoopla and relief on Wall Street and in European markets today as it appeared that Greece got some religion and voted a conservative party in to power.

A party who has contended that they would support the austerity requirements of the latest round of bailouts and keep Greece in the Union. So, to many investors, the European financial crisis appeared to have been abated for at least the time being, and maybe everything will turn out alright after all.

Here is the truth. Greece will be forced to return to the drachma and devalue, and the default will cause bank runs and money flowing into Germany and the United States as the only viable safe haven bets.  It doesn’t matter which party wins. Greece will default because there is no other choice regardless of anyone’s politics.

It will hit the European Central Bank, the banks on the other side of the derivatives contracts, all of the Greek banks who are really in default at present and being carried by Europe as well as the nation, and the Greek default will spread the infection in many places that we cannot imagine because so much is hidden and tucked away in the European financial system.

Not unlike, I suppose, Nouriel Roubini, the New York University economist, who said the subprime-debt sky was falling for a long time before it fell, I have been hammering this message home since early January.

Greece cannot afford to pay off their regional debt, and various schemes to avoid the bad guys from taking over will not work nor will the attempt to roll the problem over to the rest of Europe by Germany succeed.

One thing is for sure. The Germans will not allow their cost of funding to rise or their standard of living to decline to help the nations that have gotten themselves in trouble.

As a result, Europe is headed for a bad recession with lots of shocks to the system, and it will happen in the next four months unless there is debt forgiveness, or Europe keeps handing them money like they are a ward of the state. Neither is likely to happen.


Czech’s Say, “No Thanks!”

In my earlier post this morning, I focused on the ridiculous European Commission proposal for regulators and a European banking union. Here’s what the Czechs think about that:

The Czechs, who have been highly Eurosceptic, have absolutely no plans to join the euro zone, and have a healthy banking sector, have long opposed moves to centralize banking oversight.

The Daily Hospodarske Noviny (the Czech version of the New York Times) quoted Prime Minister Petr Necas today, as saying that regulation should be kept on a national basis. “We are convinced that the very high quality supervision by the Czech National Bank should not be diluted into some pan-European supervision,” Necas said.

Czech central bank Vice Governor Vladimir Tomsik said he was against raising moral hazard in the banking sector and creating a mismatch between national responsibilities of regulators while their authority would be moved to a European level.

“And the third pillar, a pan-European deposit insurance fund: I believe that is also unacceptable, because it is not possible for other countries to pay for mistakes of individual banks or supervisors,” he said in a transcript of a television interview posted on the central bank’s website http://www.cnb.cz.

And, as we mentioned in that earlier post, the UK is violently against any such proposal. British finance minister George Osborne said today that London will want to ensure safeguards are in place to protect its financial sector if the euro zone moves towards establishing a banking union.

“There is no way that Britain is going to be part of any euro zone banking union,” Osborne said in a radio interview.

So, now we have two Eurozone participants, Germany and England, making it crystal clear that they oppose any such move, and are joined by a conservative, non-Eurozone member with a healthy banking sector, who will also be severely impacted by frivolous proposals like this one.

Who are these guys and why are they allowed to speak in public?

While it is difficult for America to step into this mess, the situation in Europe is crying out for an intervention. Bernanke, Geithner and Obama have a herculean task on their hands just wrestling the U.S. economy back into grow mode with no assistance from U.S. banks, but they really need to get involved and act before the whole union catches fire.

The potential impact of a European banking collapse goes way beyond the $39 billion exposure our U.S. banks maintain. The end-result will be chaos that will drive the entire global banking community to freeze credit of all kinds, including government and corporate bonds, the last bastion of conservative investment safety.

Either the Fed and the Administration agree that Europe can be solved by a huge stimulus influx that will be sourced in a coordinated and equal effort by the U.S., Germany, China, Korea, Japan, Middle East, The UK and the rest of Europe, both in and out of the union, or agree to let it fail and accept the global consequences. This is a lot larger problem than Lehman Brothers. Maybe we need to bring Paulsen back. He was so good at bad news.

In the very short (weeks) meantime, the Fed needs to bully/scare lawmakers into actually doing something helpful. In other words, Bernanke needs to continue pressuring Congress to act now instead of bringing the economy to a so-called fiscal cliff at the end of the year where several tax cuts could expire and the debt ceiling may need to be raised again.

If I were Bernanke, I would be yelling at Congress to do something right with fiscal policy. There can’t be any more uncertainty about the fiscal cliff at the end of the year. Democrats and Republicans have to stop playing politics and actually turn into statesmen.

The European Union itself is clearly doomed. I am starting to worry about the U.S. union as well.


George Soros Calls It Like It Is.

Billionaire George Soros delivered a speech today that absolutely nails the European financial crisis. If you want to read the whole speech, in all its brilliance, you should go to his website, http://georgesoros.com/interviews-speeches/.

It accurately and simply explains how the European Union got itself into the current mess, and what it needs to do to get out of it.  Here are excerpts:

I contend that the European Union itself is like a bubble. In the boom phase the EU was what the psychoanalyst David Tuckett calls a “fantastic object” – unreal but immensely attractive. The EU was the embodiment of an open society –an association of nations founded on the principles of democracy, human rights, and rule of law in which no nation or nationality would have a dominant position.

The process of integration was spearheaded by a small group of far sighted statesmen who practiced what Karl Popper called piecemeal social engineering. They recognized that perfection is unattainable; so they set limited objectives and firm timelines and then mobilized the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step. The process fed on its own success, very much like a financial bubble. That is how the Coal and Steel Community was gradually transformed into the European Union, step by step.

Germany used to be in the forefront of the effort. When the Soviet empire started to disintegrate, Germany’s leaders realized that reunification was possible only in the context of a more united Europe and they were willing to make considerable sacrifices to achieve it.  When it came to bargaining they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement.  At that time, German statesmen used to assert that Germany has no independent foreign policy, only a European one.

And then came the moment that German, formerly at the forefront of a federated Europe, stopped the progress dead in its tracks…

The process culminated with the Maastricht Treaty and the introduction of the euro. It was followed by a period of stagnation which, after the crash of 2008, turned into a process of disintegration. The first step was taken by Germany when, after the bankruptcy of Lehman Brothers,

Angela Merkel declared that the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly.

It took financial markets more than a year to realize the implication of that declaration, showing that they are not perfect.

This is a really huge point to grasp, because a nagging question has been: Why did the market think of Spain/Greece/Italy/Etc. as being risk-free sovereigns at one point, and then decide that they were not risk free and subject to credit risk.

Soros answer: Because they were essentially risk-free so long as the arc was always towards more integration. That ended when Merkel made that declaration.

Despite the fact that the Euro crisis has been happening for at least 3 years now, there are still many who can’t articulate the roots of it as well as Soros does in these two paragraphs:

The Maastricht Treaty was fundamentally flawed, demonstrating the fallibility of the authorities. Its main weakness was well known to its architects: it established a monetary union without a political union. The architects believed however, that when the need arose, the political will could be generated to take the necessary steps towards a political union.

But the euro also had some other defects of which the architects were unaware and which are not fully understood even today. In retrospect it is now clear that the main source of trouble is that the member states of the euro have surrendered to the European Central Bank their rights to create fiat money. They did not realize what that entails – and neither did the European authorities. When the euro was introduced, the regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital; and the central bank accepted all government bonds at its discount window on equal terms.

Commercial banks found it advantageous to accumulate the bonds of the weaker euro members in order to earn a few extra basis points. That is what caused interest rates to converge which in turn caused competitiveness to diverge. Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. Other countries enjoyed housing and consumption booms on the back of cheap credit, making them less competitive. Then came the crash of 2008 which created conditions that were far removed from those prescribed by the Maastricht Treaty. Many governments had to shift bank liabilities on to their own balance sheets and engage in massive deficit spending. These countries found themselves in the position of a third world country that had become heavily indebted in a currency that it did not control. Due to the divergence in economic performance, Europe became divided between creditor and debtor countries. This is having far reaching political implications to which I will revert.

His key warning:

In my judgment the authorities have a three months’ window during which they could still correct their mistakes and reverse the current trends. By the authorities, I mean mainly the German government and the Bundesbank because in a crisis the creditors are in the driver’s seat and nothing can be done without German support.

We need to do whatever we can to convince Germany to show leadership and preserve the European Union as the fantastic object that it used to be. The future of Europe depends on it.

And, my money is on Germany showing a different sort of leadership and withdrawing from the European Union and from the currency. From their point of view, it is really their only way out of this mess.


Obama Goes All Firefighter.

As much as I would like to write about all of the other crazy things that are going on, the European banking thing is the gift that keeps on giving.

Now of course, the Obama administration is stepping up efforts to push Europe to deal with this debt crisis, so that he won’t have to just 5 months prior to the election. Actually, what he is trying to avoid is dealing with the pressures on the US banking system as they build to a crescendo more like 3 months prior to the election.

If the clowns in the Romney camp had any brains, they would be building a huge media plan focused on “How Obama got us into this mess.”

So, hoping to avoid a similar disaster to 2008, the administration is holding private meetings, urging officials in the 17-nation euro zone to take swifter action to calm markets, reassure depositors about their banks’ health, and prevent some of Europe’s largest countries from suffocating under high borrowing costs and weak economic growth.

They think that the lessons learned from the 2008 financial crisis includes acting quickly and decisively to stabilize the financial system and prevent investor panic.

As an example, the administration wants Europe to use the continent’s rescue fund— now around €700 billion ($866 billion)—to provide assistance to governments struggling with soaring borrowing costs. Allowing the rescue fund to directly recapitalize banks, instead of forcing the struggling governments to borrow first from the rescue fund, would help prevent bank failures and enable the banks to continue lending, which would help support economic growth, the officials believe. Under this approach, the governments wouldn’t have to boost their own debt loads by borrowing from the fund.

How this works, by the way, is that the U.S. yells directly at the International Monetary Fund, in which it is the largest shareholder. The IMF has been urging Europe to use the rescue fund for that purpose, but the idea is opposed by Germany because they rightfully fear they will be left holding a huge bag of defaults.

The administration has also pushed Europe to build a larger rescue fund, or so-called firewall, believing a bigger war chest would ease investors’ concerns about governments beyond long-troubled Greece. But, that won’t work this time as investors are now much more cynical than they were in 2007, and they no longer trust governments to get their bailouts right.

And, to further complicate the situation, (as we have faithfully reported here) risks are rising that the financial turbulence in Spain—Europe’s fourth-largest economy—could deepen even before Greek voters go to the polls in two weeks to decide their fate in the currency union.

On Wednesday, Mr. Obama and leaders from Germany, France and Italy held an hour-long videoconference to discuss the euro-zone crisis, following up on a meeting of the Group of Eight major advanced economies hosted by the White House just one week ago.

These meetings were planned before Spain’s borrowing costs shot up this week. But they underscored the administration’s rising worry about how the euro-zone crisis could drag down the weak U.S. recovery for the third straight spring.

In a Gallup poll released Thursday, 71% of Americans said they are at least somewhat concerned about the effect of the European financial crisis, but only 16% said they understood the danger to the US markets . The data suggested worries could rise as the troubles weighed on U.S. markets and gained more attention in the U.S. Among the 16% of people who said they are paying very close attention to the news about Europe’s financial situation, 95% said they are concerned. Unfortunately, that still means only 15% of the US population is concerned about this very serious and impossibly huge disaster waiting just off-shore.

What those 15% fear is that a cascading crisis across the European banking system, triggered by Spain, or Greece, or another unseen banking revelation, could cross the Atlantic and hit the U.S. financial system. As we said in a prior post, we have a $39 billion KNOWN exposure to the European banks. Almost any result imaginable will translate into less business investment and hiring and less bank lending, triggering yet another, and deeper recession.

I love him, but this one will belong exclusively to Obama. Better act NOW.


And By the Way, Close Your Borders!

The fabric of the European Union is becoming frayed around the edges. George Friedman of Stratfor has pointed out in writing for that site that immigration is a much higher priority among many European voters than maintaining the euro. It is not talked about in polite circles, but it shows up in the polls. In line with that thought, Dennis Gartman, who has never been accused of being politically correct, asks some very hard questions. In a few paragraphs with the provocative heading “And By the Way, Close Your Borders Too While Your At It…” He writes:

“The enmity between Greece and her northern European ‘cousins’ such as Germany and Austria is already high and wide, but it is growing higher and wider by the moment. It is almost to the point where the polite bounds of political correctness are about to be broken asunder, for German and Austrian political figures are now asking that Greece seal her borders and stop the flow of ‘foreigners’ through Greece and into the rest of the EU.

“Yesterday, the Austrian Home Affairs Minister, Ms. Johanna Miki-Leitner, minced few words and opened the rather racist front when she said, ‘We need to put real political pressure on Greece to implement their asylum authority as rapidly as possible. This border is as open as a barn door.’

“There you have it … out in the open for all to see: northern European dissatisfaction and open disdain for the South and for ‘foreigners’ generally. And it is not just Greece that the Austrians and Germans fear as a port of entry for ‘foreigners’ into Europe; they fear Italy too, for Italy has been a port through which North Africans, fleeing the lesser chaos of Tunisia but the greater chaos of Libya and of Egypt, have arrived in shockingly large numbers to European shores. Indeed, more ‘foreigners’ have gotten access to Europe through Italy than have through Greece, but for the moment it is easier for an Austrian official to take on Greece than it is to take on Italy, and so Greece bears the burden at this point.

“As the German Minister of Justice, Mr. Hans-Peter Friedrich, rather ominously said yesterday, ‘The question remains, what happens when a country is not capable of securing its borders, as we see in Greece. Is it possible to reinstate border controls? I want to clarify that this is still part of our discussion.

“Which then raises the question: Will Germany take it upon itself to secure Greece’s borders? Oh my, we don’t want to go down that path now, do we?”


Greece, Germany And The Endless Dance.

My view on Greece, the Eurozone, the endless talks and Germany. It seems that the only common view among the participants in the various talks, is a desire to try to avoid a disorderly default.  Beyond that, there is a severe disconnect fostered by parallel realities that seem unable to intersect. Accordingly, a deal that can hold up both in the streets of Greece and in the markets, is both illusive and unlikely.

The following appears to be the pretty-universally-held German policy position:

Yes, since 2004 we have been in surplus and have benefited tremendously from debt fueled over-consumption in the periphery.

Yes, we provided the loans (together with our core partners) to irresponsible borrowers who lacked the fiscal fortitude to protect our money.  Shame on us, but we still want our money back (Greece is the only exception we believe we will have to make – and even then, only the private sector will suffer losses).

Yes, we were a little irresponsible in the early days of monetary union, when the periphery was enjoying the benefits of competitive wages and the global situation was not as unbalanced.  But we quickly recognized the error of our ways, remembered that we are Germans, and took steps to cut our deficit.

What you Americans don’t understand is that after we entered surplus and could have shrunk our debt-to-GDP ratio using growth alone, we flogged ourselves with policy aimed at limiting consumption, increasing savings and avoiding a renewed encounter with the dreaded One Hundred Trillion Reichsmark Note inflation that we fear every day of our lives.

And during the Great Recession we didn’t just lay off all our workers like you did – we are civilized, we shared jobs (kurzarbeit).

And by the way, before you tell us how to handle our periphery, you must remember that you in the U.S. were incredibly irresponsible too and destroyed the entire world economy, and now you are obsessed with deflation and are printing money like drunken sailors which will, of course, inevitably result in the dreaded One Hundred Trillion Reichsmark Note inflation that we fear every day of our lives.

Yes, yes, we studied Brüning and the deflation of the early 30′s that you say really brought about the National Socialism that nearly destroyed us and resulted in global horror, but we nevertheless attribute the trouble to the Weimar inflation.

Don’t blame us for being incredibly productive and economically abstemious, we can’t help it if we make the best cars and everyone wants to buy them.  And it is not our fault that the countries of the periphery are unproductive anachronisms that make nothing anyone wants to buy at the prices for which they want to sell their goods. OK, we should have noticed the latter before we lent them all the money (and probably should have looked more closely at their books) – but it was the euphoria of European unification that made us do it, we’re only human.

No full fiscal union, no Eurobonds….don’t even think about it.

It’s one thing for Bavarians to share their wealth and income with northern and eastern Germany, but you must be kidding if you think we can get our electorate to support sending their money to support slothful southerners.

We will never permit the ECB to monetize the sovereign debts of its member countries the way you have done in the U.S., the U.K. and Japan. Not only isn’t that the deal we made with each other but it will tank the Euro and result in the dreaded One Hundred Trillion Reichsmark Note inflation that we fear every day of our lives.

There will be no exiting of any country from the Euro System. The System was only designed as part of a continuum leading to the full unification of greater Germ…uh…Europe.

But we are not yet in a position to support the transfer of national authorities, and we Germans are not prepared to surrender national sovereignty (but we really did think that the suggestion for installing an Oberführer to supervise Greece was a nifty idea and aren’t sure why it got people so upset). [Fine, no one really used the word Oberführer]

Finally, we believe in the written word – in law and in treaty.  We can make more promises to each other and – unlike the last two times – we can this time honor them. Why do you doubt that?

All of this ends with a full-throated advocacy of the concept that has become known as “expansionary austerity” which forms the bedrock of German and other core nations’ policies towards the massively over-indebted periphery:  Countries that have been irresponsible borrowers need only to demonstrate their fiscal discipline and prudence, reduce their indebtedness and reform their inefficiencies and over-regulation and investment and growth will resume because markets will once again have confidence in the economies of those countries.

Yes, there it is…the return of the same confidence fairy that supply-siders hold out as the magic pixie dust that allows economies to fly once more, without regard to the adequacy of demand, or the competitiveness of a given nation relative to others.

There are many quite practical reasons why “Austerianism” will not work, and countless others have written on the subject at length.  Here are three important ones:

  1. The continuing presence of several of the GIPSI’s within the Euro System effectively blocks two of the three transmission mechanisms that would otherwise enable those countries to re-balance trade.  They can neither devalue their currencies nor, given their membership in the EU, can they restrict trade and take action (which would be highly unlikely anyway) to internalize production.
  2. The world in general is fighting over insufficient demand relative to a global glut in the supply of labor, productive capacity and capital.  Within the Eurozone, the countries of the core have been the principal beneficiaries of whatever internal and external demand exists.  Yes, this results from their superior productivity and manufacturing talents, but – relative to global demand – is substantially enhanced by the weakness of the Euro relative to the value of former or reconstituted core currencies.  Even if the German view were to suddenly change relative to ECB monetization, the devaluation would be universal (throughout the zone) and would not re-balance trade amongst the 17 member countries.
  3. The core-recommended re-balancing transmission mechanism – internal devaluation (falling wages and prices – to the level of depression if the pixie dust doesn’t work its magic) – is functionally impossible.  It is the economic equivalent of ancient bloodletting.  Not only does it it result in killing off even more internal demand, but it necessitates a level of austerity that cannot possibly be tolerated by citizens of countries that still enjoy sovereign borders and popularly elected governments, merely to repay foreign creditors.  They will simply refuse, at the ballot box or through other means.  To believe otherwise is very much akin to believing in fairies.

A friend of mine who is into Opera (and I am not), likened the German response to Eurozone realities, to Act II of Richard Wagner’s ring series opera, Seigfried.  As Fafner the dragon is awoken from his slumber and warned by the conniving Alberich that the hero Siegfried is on his way to kill Fafner, the fearless dragon dismisses Alberich’s warning and returns to sleep.

The world cannot afford the luxury of sleeping on this.  What is at stake here is more than the issue of recovering monies lent to Greece.  A very substantial amount of European capital is at stake and plans to recover it by placing the populations of the GIPSI’s  (Greece, Ireland, Portugal, Spain and Italy) under indentured servitude to their creditors are the stuff of fairies and pixie dust.

It is past time to tighten the belt at both ends, recognize the money that has been lost throughout the periphery, recapitalize core institutions and bite the bullet on the secession of the defaulting nations. It’s inevitable anyway.


Chafing at Insults, Germany Loses Patience with Greece.

Two thirds of Germans surveyed said they doubted Greece’s determination to make savings.

Germany is running out of patience with throwing money into the “bottomless pit” of Greece’s debt crisis and any lingering sympathy in Berlin is being undermined by anti-German slogans on the lips of politicians and austerity protesters in Athens. It should be noted however, that Germany and her investors has profited deeply from the euro at the expense of their Mediterranean neighbors.

Without the euro, Italy and Greece could have indulged their workers with higher and higher bonuses while sporadically devaluing their currencies and making their countries more competitive. The euro prevented that. The only benefits from the euro went to Germany, where a low performing periphery weakened the currency, which made German exports extremely attractive abroad. Like China, Germany’s competitive edge had currency manipulation at its heart. 

While officially hailing the Greek parliament‘s approval of the savings package required for a new 130 billion-euro bailout, Berlin signaled this would not automatically mean more aid, as the feeling grew that Greece should not be saved at any cost.

With Finance Minister Wolfgang Schaeuble warning “Greek promises aren’t enough for us anymore”, and Economy Minister Philipp Roesler saying “fear of Day X (a Greek euro exit)” is fading, Germany seems to have tired of issuing threats that it would never follow through.

“Berlin threatens Greeks with end to aid,” read the front page of the Sueddeutsche Zeitung newspaper, while Die Welt wrote: “Schaeuble warns Greeks: no savings, no money.”

The sight of Greek anti-austerity protesters and politicians blaming Chancellor Angela Merkel for their plight provoked anger in the patriotic pages of Germany’s best-selling daily, Bild.

Greeks and other European recipients of aid to which Germany is the biggest single contributor “should put flowers outside our embassies and send the chancellor thank-you notes.”

“Instead the demonstrators insult their German helpers and liken our government to Nazis, which is intolerable,” it said.

Officially, Merkel’s government remains committed to enabling another aid package for Greece and doing what it can to avoid the first sovereign default in the euro zone.

“The chancellor knows her place in history is tied to Greece and she won’t want to be remembered as the one responsible for a default,” said a conservative lawmaker, asking not to be named.

But the MP said the Greek parliament’s approval of the unpopular savings plan, including a 22 percent cut in the minimum wage, did not arouse much interest in Berlin “because nobody really believes any more that Greece will deliver.”

Greece has an interesting history of sovereign defaults which began with Dionysius, the ruler of Syracuse in Greece during the fourth century B.C., who had an entertaining habit of stamping a two-drachma mark on one-drachma coins to pay off his debts. Around the same time, thirteen Greek city states defaulted on their loans from the Temple of Delos — the first recorded default in history. In the modern era too, Greece never enjoyed sound finances; it defaulted at least five times (1826, 1843, 1860, 1894 and 1932), and the messiest default in 1826 shut it out of international capital markets for 53 years. So, this is a country that is used to this sort of mess, and as I have stated several times in previous posts, Greece would be far better off by taking whatever it can get from Germany and the IMF/ECB and running. If they default on all of their debt, drop out of the euro and devalue their currency, Greece would be in wonderful shape and it would not have to implement any of these austerity measures that all of its citizenry hates.

‘NOT THE END OF THE WORLD’

While Merkel’s own Christian Democrats (CDU) remain largely on message with the chancellor and European Commission on the need to keep Greece in the euro, more eurosceptic allies from the Christian Social Union (CSU) and Roesler’s Free Democrats (FDP) are taking a more aggressive line with the Greeks.

“There can be no more concessions. Now only deeds count,” said the FDP Foreign Minister Guido Westerwelle while CSU leader Horst Seehofer spoke of German referendums on future bailouts – something Merkel’s spokesman Steffen Seibert ruled out.

Hans Michelbach, an MP on the budget committee in the Bundestag (lower house) which exerts some control over the bailout payments, said Athens should not be under any illusion that its parliament’s vote meant the release of fresh aid would be automatic.

“Even the best agreements are no use without an efficient administration. Unfortunately so far we don’t get the impression that the governments in Athens have really made a serious commitment,” said Michelbach, a CSU deputy.

Schaeuble reinforced this impression by telling lawmakers last Friday that even the latest Greek savings plan would not put the country on track to cut public debt to 120 percent of gross domestic product by 2020 – its chief condition for aid.

Such dogged insistence on strict terms for aid is one of the reasons Merkel has kept a lid on growing skepticism in Germany about how deserving Athens is of such largesse. In one recent opinion poll, two thirds of Germans surveyed said they doubted Greece’s determination to make savings.

For Erik Nielsen, global chief economist for Unicredit, an Italian bank, the chancellor’s unmatched success in preventing the rise of a major eurosceptic backlash is down to her heeding the “German public’s sensitivities to lending their tax money to a country that does not implement very many of its promises.”

But with her finance minister talking of Greek aid as “a bottomless pit” and growing incredulity about Athens meeting such conditions, Merkel must be worried about the Bundestag’s special session on the second Greek bailout due on February 27.

Merkel narrowly avoided disaster – for the euro and her own political fortunes – in September’s vote in the Bundestag on the current bailout mechanism (the European Financial Stability Mechanism). She cannot afford more lawmakers to start thinking like CDU MP Christian von Stetten, who told one paper: “A Greek exit from the euro zone would not be the end of the world.”