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7th August 2016 – How Debt Sunk The World

Great Depression - Poverty (flickr)

Great Depression – Poverty (Wikipedia)

 

If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.

J. Paul Getty – Industrial and Oil Tycoon (ex-richest man in the World)

Great Depression - Unemployment (Wikipedia)

Great Depression – Unemployment (flickr)

I love that Getty quote. This is one of my longer pieces (sorry), but if you could sum it up in one sentence, that would be it. But we’re getting ahead of ourselves here. Our historic meanderings have lead us to the edge of an economic precipice in Europe. The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy. Those aren’t my words, those are the words of Milton Friedman, the Nobel Prize-winning economist. Seems like this is a period worth giving some attention to. Let’s start with a quote from last post:

What we are interested in is that, from an economic perspective, two things are clear:

  • How utterly intertwined monetary policy is with political policy to the point, at times, it is hard to decipher when one ends and the other begins.
  • How startlingly effective a supply standard (be it Gold or not Gold) was in bringing to heel even the most parabolic inflation of an out-of-control currency supply.

We begin with the European Union. No, I’m not about to get into another Brexit diatribe – I’ve had enough of reading about that, never mind writing about it. But, as I mentioned in my last post, monetary policy and political policy are so closely interwoven it’s actually impossible to sail a course though monetary policy events without occasionally tacking back into the headwind of international politics.

 

Dreams of a Multilateral EUtopia

The European Union (EU) was officially formed with the Maastricht Treaty of 1992, but before this, the union of Europe already existed in a different form – as the European Economic Community via the 1958 Treaty of Rome (signed in 1957). But some people have an idea that the birth of the European Union came directly after the Second World War, perhaps with the significant signatures on the Treaty of Brussels in 1948 (don’t you just love looking at government articles with the words TOP SECRET written at the top – makes me feel like James Bond). Some even believe that the founding fathers may have started the discussion before the Second World War, but few realise that actually the European Union was a product of the First World War. It may surprise some to learn that the idea of a Europe united in trade owes it conception, at least in part, to thoughts emanating from British soils.

A British civil servant called Arthur Salter was working with another chap, a Frenchman called Jean Monnet to organise shipping of war supplies from America to Europe at the outbreak of the First World War in 1914. But they grew so sick and tired of all the red tape and protectionist bureaucracy surrounding national interests within Europe, they began contemplating ways of streamlining trade transportation and circumventing the tedium. With time, they shared the international political stage as senior officials in the League of Nations (equivalent of the UN) and had now fleshed out extensive plans for economic cohesion between European states. By then, Salter was in charge of German repatriations in the League of Nations and Monnet, whose political authority and influence was growing rapidly, was the Deputy Secretary General.

They recognised the League of Nations’ fundamental flaws, such as structural impediments and politicisation of veto authority. Never-the-less, inspired by the supra-national structure and the philosophy of international cooperativeness they had witnessed in League of Nations, they wondered if such a model could be tailored for Europe. In their minds, great gains could be made by rising above national unilateralism to pursue interests of a higher, multinational, multilateral cause. But, while Monnet was, arguably, the engineer of the European Union idea, Salter was studious in thought and diligently documenting. Much later, in 1931, Salter assembled his papers into a book with an interesting title: The United States of Europe. It’s worth noting that some of this text dates back to 1919 and so some of his ideas were from before the end of the First World War.

What started out as just a “thought experiment” in the 1910’s began gathering momentum by the 1920’s and early in that gap between the First World War and the Second World War Monnet’s influence would expand and with it his theories of European integration. Monnet would go on to set the tone to a gradualist approach to integration, a evolutionary rhythm still very much the heartbeat of policy progression in Brussels today.

Weighing in on the pro-Union argument was Prime Minister of France, a chap called Aristide Briand. By the late 1920’s political traction on the idea of European integration had a global recognition and even the then British Chancellor of the Exchequer, a certain Winston Churchill, was making encouraging noises about the unification of (continental) Europe. In fact, as early as 1925 he told the House of Commons:

…the aim of ending the thousand-year strife between France and Germany seemed a supreme object. If only we could weave Gaul and Teuton so closely together economically, socially and morally as to prevent the occasion of new quarrels and make old antagonisms die in the realisation of mutual prosperity and interdependence, Europe would rise again.

Meanwhile in Germany, as described in my last post, the Schacht reforms had re-built Germany’s economy in the late 1920’s. Things were looking up for Europe… … …

… … … but in other parts of the continent a perfect storm was brewing. We shall assemble the main factors and then reconstruct this storm, then, piece, by piece…

 

Piecing the Puzzle

PUZZLE PIECE 1

  • Firstly remember last post we spoke about the powerful liberal German politician who appointed the German Economic “Magician”, Schact, in the first place…

Chancellor Gustav Stresemann, an extremely influential liberal politician who subsequently won a Nobel Peace Prize after brokering a peace deal between France and Germany following the Occupation of Ruhr (a herculean healing effort) and subsequently seeing Germany’s re-admission to the equivalent of the UN, or the League of Nations, as it was then called.

PUZZLE PIECE 2

  • Secondly, remember how in this piece when talking about the disintegration of the Prussian empire…

As an interesting sidebar, keeping our Austrian angle here for a minute, a heavy majority in both Austria and Weimar Germany wished for Austria and Germany to be reunited as a single state, but, of course, this was strictly forbidden by the other European states in one of the key articles under the Treaty of Versailles.

Now, on the surface, things were looking excitingly positive on the political stage. Ideas on the United States of Europe were flooding in thick and fast. A well-known construct was Briand’s Memorandum on the Organization of a System of Federal European Union which you can see on the World Digital Library here. Excerpt:

At the annual meeting of the Assembly of the League of Nations in September 1929, Foreign Minister Aristide Briand of France proposed the establishment of a federal European union to coordinate economic and political policies. Briand believed that the proposed union should be created within the framework of the League, and promised to submit a detailed plan for a federal union to the 27 European states that were League members…

Briand and Stresemann (Wikipedia)

Briand [left] and Stresemann [right] (Wikipedia)

 .

Europe’s Cracks of Instability

But a direct hit from two political torpedoes in 1929 would derail everything.

Firstly, relating to puzzle piece #1, the key behind the European integration idea was represented by two colossal figureheads in European politics at the time: our friend the French Prime Minister, Aristide Briand, and our friend the German liberal, Gustav Stresemann (who had appointed Schacht to dig Germany out of its hyperinflation). You see, there was a deeply intimate collaboration between Briand and Stresemann on the fabric of the union of Europe and its implementation. Pushing through an objective of this complexity and ambition required Herculean leadership, massive political will and respected kudos: Stresemann had this in abundance. Alas, German politicians seemed to make a disgusting habit of dying at the wrong time. Like his comrade President Hindenburg, Stresemann’s death was exquisitely badly timed – when Europe needed him most. It is regarded as one of the major factors which contributed to Europe’s precipitous capitulation. From this point, the foundations of the Europe’s Great Experiment seemed to crack and crumble.

Secondly, relating to puzzle piece #2, Germany and Austria sought to engage in a “Customs Union” – basically a bilateral common market arrangement. But this meant taking a head-on collision course with the Treaty of Versailles, which drew strict lines (literally) on European boundaries and co-operations between segments of the old Prussian Empire after the devastation of WW1. British Foreign Minister, Arthur Henderson, and Aristide Briand deflected responsibility for a final decision on this to the League of Nations. But this only incensed more outrage, particularly in France, for what was regarded as a blatant breach of the peace treaties, here is a quote from CQ Press

Meanwhile violent denunciation of the Austro-German action had broken out in France, where the trade pact was regarded as a first step toward Anschluss (political union of Germany and Austria), a tearing up of the peace treaties, and the ultimate execution of the Mittel-Europa project, which was to have been for Germany the result of a victorious outcome of the World War. Briand’s policy of reconciliation with Germany, his consent to a scaling down of the reparation burden and to withdrawal of the forces of occupation from the Rhineland, and his project for a “United States of Europe” were condemned throughout the length and breadth of France. Henderson was criticised for not having immediately pronounced the customs-union project a violation of treaty obligations and it was pointed out in the French press that prior to his appointment as foreign secretary in June, 1929, he had written articles in support of the Anschluss.

The European project was falling apart at the seams before it had even begun. But Briand may have had his reasons for pondering over the Austro-German customs union. This was, in part, because the first step of his strategy towards European union was indeed a trade pact based on equal multilateral trade duties or, in effect, a customs union. Just the sort that Germany and Austria had tried to arrange. So, in the back of his mind, he may well have thought that the Austro-German deal could be the first symbolic step to this new European dream. Convincing the Germans of this was easy, if only he could convince his own countrymen… Again from CQ Press

The Customs Union and the United States of Europe

In Germany the proposed customs union is represented, not as a first step toward political union with Austria, but as a first step in the execution of Briand’s project for a United States of Europe. It is worthy of note in this connection that when the United States of Europe project was advanced by Briand at the Tenth Assembly of the League of Nations, in September, 1929, he envisaged a European customs union as a necessary prelude to European political union. “Where you have a group of peoples, grouped together economically as in Europe,” he said, “there ought to be some federal link between them. …It is this connecting link which I desire to establish, and obviously the most important component of this connecting link will be economic agreement, and I believe that in the economic sphere agreement can be reached.”

 

Briand, Monnet, Salter and the rest of the powerful pro-Union activists were talking about economic and trade union and a “Zollverein” – common market. There was talk of preserving sovereignty for member states with a supra-national “common political authority”. All the stuff we talk about today – and this was nearly a century ago! They came so close…

But, critically, the whole Austro-German customs union affair had damaged relations between France and Austria… and the project relied heavily on trust.

To make matters worse, after the “roaring twenties” decade, speculation and credit extension towards asset prices had overreached and a stock market, which had been running on fumes, suddenly imploded in the “Great Crash” of October 1929.

Great Depression - Car For Sale (flickr)

Great Depression – Car For Sale (flickr)

 

Why are we printing so much currency?

At this point I’m going fast forward in our time machine to the present day to get some insight from our friend and famous historian Adam Fergusson, speaking about current monetary policy, money printing and QE…

I think the position is, of course, terribly serious right through (again) the Western economies. I don’t see that any of these economies is going to be able to grow its way out of the extraordinary debts they have. The logic of that: if you can’t grow your way out of your debt, you have to repudiate that debt. And there is only one serious way of repudiating your debt and that is by inflating.

Here’s a simplified conceptualisation…

My dad could have had a mortgage of 25k in 1970, just before Fergusson’s book came out. It wasn’t until the mid-seventies when rates started to spike – so he could have got a fixed rate mortgage at relatively low rate in 1970 (base rates would rise as high as 17% by 1979). At the time, 25k was a pretty big mortgage – he may have been earning £5k per annum, so his mortgage would be five times his salary. Now, for the sake of argument, imagine his dad (my grandad) offered to pay his (fixed) interest for the rest of his life. Fast forward to today, 40 years later; even if my dad hadn’t paid a single penny of his mortgage principal down and just allowed my grandad to only pay the fixed interest, the resulting mortgage of 25k today is a mere pittance in the scheme of things. Because today his salary may be £50k; ten times higher than it was 40 years ago. So inflation has effectively paid down his mortgage for him. Thus we can say; on a relative basis, inflation has the effect of eroding the principal value of debt. Note: one can make the same argument by saying, even if he had to pay the interest himself; wage inflation should increase roughly in line with interest rates making this relatively painless. On the flip side, imagine if a normal salary in 1970 was £500k per annum and he’d got a mortgage for five times his salary – £2.5million. In a mirrored deflationary environment his salary would have deflated to £50k today – what we would consider pretty normal now-a-days. Here’s the problem, the debt doesn’t deflate. He still has a £2.5million mortgage! With a £50k salary… Game over. He might as well declare bankruptcy. This is because on a relative basis, deflation has the effect of expanding the principal value of debt.

So, just like the Weimar hyperinflation killed all the savers, the place you do NOT want to be is in a deflationary environment holding a significant amount of debt. Here’s the scary bit. Just look at these two charts of our debt-to-GDP ratios in Western Economies and you will never again need to ask the question: why are all central banks hell bent on cranking the printing machines and inflating the bejeezus out of their currencies?

McKinsey Chart on how global debt has seen a massive $57tillion increase in the last few years – full 136-page report (recommended reading) here.

Mckinsey Global Debt

Mckinsey Global Debt

Trend of US Federal Debt to GDP

US Federal Debt-to-GDP

US Federal Debt-to-GDP

G10 Debt Distribution

G10 Debt Distribution

G10 Debt Distribution

UK’s huge financial (private) debt is on account of the massive influence London’s financial sector has on the economy. Doesn’t look great, though, does it? Let’s be clear here. GDP is the ECONOMIC OUTPUT OF THE ENTIRE COUNTRY. Tax receipts are just a fraction of this. So when we say total debt is 100%, 200% 1000% of GDP, that’s a percentage which relates to the size of the entire economy. There does come a point when just the interest payments on government debt alone are bigger than entire tax receipts of the nation. That’s when you have that Wilde-Coyote-running-off-a-cliff moment – your economy’s about to plummet to the bottom of the canyon… then an ACME anvil is gonna fall on your head.

Now, knowing what we know about deflation, inflation and debt, it becomes more understandable when Fergusson says:

…there is only one serious way of repudiating your debt and that is by inflating.

That’s why the central banks around the globe; the BoE, the BoJ, the ECB, the Fed are all printing the crap out of currency – we’re at war, a currency war, a race to the bottom. Who can devalue their currency the fastest? And it’s why we’re soon to have negative interests rates across all developed economies, it’s why your bank is about to charge you for holding DEPOSITS (not overdrafts) with them. With negative interest rates, banks are effectively being punished for not making loans to customers and customers are being punished for not piling on more debt. Why? Because the government and the central banks effectively want to stoke an inflationary fire in order to engineer an inflation ‘soft default’ on the massive mountain of debt in the economy – and they want you, the diligent middle class saver, to pay for it. Is there some sort of ‘moral hazard’ associated with this monetary sleight of hand? You betcha, there is.

 

Debt and Deflation in Europe in the 1930’s

But let’s get back in the time machine and head back to the 1930’s and to Europe.

France and Austria’s relationship after the Austro-German customs union debacle is now unquestionably tarnished. Why did I mention the relationship between debt and deflation? Well, you see, at the time Europe was crippled with debt. Every government had borrowed to finance WW1. Indeed in just 5 short years British national debt increased from £650m in 1914 to a whopping £7.4 billion in 1919 (more than a 10 fold increase)! The rest of Europe was in the same treacherous boat and then, of course, after the war more spending was needed to rebuild infrastructure and the economy.

Furthermore, financial institutions were extending credit liberally, whether it was banks offering mortgages to fuel the property boom or brokers offering low margin requirements for highly leveraged stock broking accounts. One bank in Austria, called Creditanstalt, was the top bank in the country. In a pre-globalisation context, I guess you could say it was the European 1920’s equivalent of a bank like HSBC. This was a bank which, in the 1850’s had had an IPO wildly oversubscribed at 43 times. Indeed, it must have been the financial equivalent of launching The Titanic. While it came with a Titanic reputation as “unsinkable”, in the throes of choppy and icy waters of the 1930’s it was making a few wrong turns. Poor management and lack of organisational dexterity meant that in bad times, Creditanstalt found itself scraping the barrel of the loan market as more nimble operatives picked off the lower-risk opportunities. Also, being the ‘Motherbank’ of Austria, when things started to go pear-shaped the Austrian government coerced (forced?) the responsibility of more bad loans on to Creditanstalt’s huge balance sheet.

Meanwhile, back in the rest of Europe, governments, banks, businesses and individuals were already laden with debt and, as we now know, the worst thing that can happen to a severely indebted economy is the onset of dreaded deflation… but Europe’s worst fears were coming true. Because, as people lose confidence and as anxiety grows, business activity slows and slowing business activity is effectively the root cause of deflation. Because the entire banking system and economy works by a series of confidence tricks, the very existence of overbearing debt backs consumers into a causal loop, a self-fulfilling prophecy… the more debt you hold, the more you fear deflation… the more you fear deflation, the more likely it is to happen.

To make matters worse, in 1930 France, a number of banks collapsed. The banks were small enough to be absorbed by the economy in normal conditions but matters were made worse when some became embroiled in scandal involving government officials which inevitably led to the collapse of the French government. The worst case scenario for the indebted economies ensued… the chill of deflation became entrenched in Western Europe.

By May of 1931, Creditanstalt collapsed under the weight of its own debt and non-performing loans on its balance sheet. The bank had owed about $20 million, which was a lot of money in those days, and had only $7 million in capital. The Austrian government, together with the newly formed Bank for International Settlements arranged a loan but it simply wasn’t close to being enough. Creditanstalt was not only too big to fail, it was also too big to save for the Austrian government. Furthermore, still reeling from damaged relationships over the Austro-German customs union affair, France was unwilling to help bail the Austrians out… and just like that… BOOM! A powder keg was lit… the Austrian ship was going down, sinking into a dark, deflationary abyss… and it was taking everyone with it.

 

History Lessons

What happened next was so catastrophic it would go down in the annals of history as the worst ever global financial disaster and would never be forgotten. It would consume entire continents and it would be known as The Great Depression. The public swarmed to recover capital and there was a run on the banks, the banks stampeded and ran on each other and eventually demanded gold conversion for currencies including dollars which, of course, exported the crisis to America with devastating effect.

Furthermore, the rise in poverty and unrest caused by the depression gave opportunity to a Nazi propagandist called Joseph Goebbels. He would become Hitler’s right hand man and together they would form the darkest and most sinister plots on all humanity.

So in the 1930’s The Great Depression was a debt-induced banking crisis of European making which we exported to America – a favour they would pay us back for handsomely in 2008. But let’s be clear, the failure of Creditanstalt and subsequent effect was a bigger deal than the collapse of Lehman and the Financial Crisis of 2008. The devastation of the latest financial crisis simply does not measure up to the Great Depression of the 1930’s… but national debts are still rising and central bank impotence in fighting deflation/disinflation is becoming more and more alarming every day… so season monetary impotence with a bit of political absurdity and we still have time to put our black mark on history.

So now I’ve put the pieces of one puzzle together, why don’t you try your own hand at this game?

  1. Given we know that we, the largest and most developed global economies, are at record levels of total indebtedness.
  2. Given that we know the Great Depression was precipitated by a collapse of a bank who had been coerced into taking bad loans.
  3. Given we know that negative interest rates in Europe are putting exogenous pressure on banks by punishing them for not making loans.

What does this say for the future quality of loans European banks are taking and thus the health of European bank balance sheets (and thus the health of the European banking system)?

Hint. Hint. Hint. Hint. Hint. I’ll leave you with a quote from Fortune Magazine this week:

“The EU is making the same mistakes over and over and over again,” says Viral Acharya, a professor at NYU’s Stern School of Business. “They’re not demanding that the banks be recapitalized as they should be, and allowing things to get worse by enabling lenders to keep zombie loans they should have dumped years ago.”

 

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24th July 2016 – The Re-Birth of Germany: Power and Money

I’m Winston Wolfe – I solve problems.

Harvey Keitel [quote from the film; Pulp Fiction]

 

Schacht - Wikipedia

Schacht – Wikipedia

The Man with Two Names

Horace was a complicated character. Not an easy man to read, perhaps because he never really knew himself or perhaps because he did, yet changed with the weather like and philosophical cameleon. While unquestionably intelligent, maybe he lacked conviction and confidence or what we call “political spine”. His background and upbringing was atypical for a German growing up in the early twentieth century. Even his name was something of an enigma. His father, who had lived in America, had named him Horace Greely, after the famous activist politician and anti-slavery campaigner. But apparently a rather unruly grandmother insisted he be called by a Danish first name – Hjalmar. So from then on he was known as Hjalmar – but one wonders if he secretly preferred Horace.

His education was equally hard to pin down. Having studied Medicine, then Philosophy, then Politics, he was not the obvious choice for President of the Reichsbank in 1923, where the main contingent came directly from an education in economics. Germany was suffering from bouts of hyperinflation so violent, they were literally tearing the country to shreds, this was no time for an amateur at the helm. But perhaps it was time to think outside the box. He was appointed by an interesting duo; two of the three most powerful men in German politics at the time (the third being Adolf Hitler). The first was President Hindenburg, who many considered to be the only viable opponent capable of disrupting and defeating Hitler’s rise to power. The second was Chancellor Gustav Stresemann, an extremely influential liberal politician who subsequently won a Nobel Peace Prize after brokering a peace deal between France and Germany following the Occupation of Ruhr (a herculean healing effort) and subsequently seeing Germany’s re-admission to the equivalent of the UN, or the League of Nations, as it was then called.

These two men of German political prominence, President Hindenburg and Chancellor Stresemann, must have recognised that solving the hyperinflation problem was not about continuing a textbook approach to economics or politics. Not only was the country in a mess, it was a complicated sociological, economic and political mess that school and theory does not prepare you for. After Queen Victoria’s son-in-law Emperor Wilhelm II loaded up on debt and printed the heck out of the currency, Germany’s Gold Standard collapsed along with its economy after WWI (as described in an earlier post – Turbo-printing). Printing more paper money for WWI repatriations had sucked Germany into the swirling vortex of a hyperinflation death-spiral.  Furthermore, the German financing mechanism was destroyed and, even if she wanted to go back to the gold standard, there was simply no gold left in its banking coffers. Perhaps a tough and immeasurable problem needed a tough and immeasurable man to tackle it.

 

Enter The Wolf

I could go into detailed into on Schacht’s life but let’s just say he had a chequered history having just been fired by his previous employer, General Karl von Lumm, the Banking Commissioner for the then Occupied Belgium. Schacht had allegedly favoured his old employer, Dresdner Bank, for financing state transactions in Belgium. But Schacht’s reputation as an extremely proficient trouble-shooter or “fixer-of-problems” echoed through the halls of the then Weimar Republic with an imposing resonance. Despite his past, it speaks volumes of both the stature of his intelligence and the desperation of the times that he should be Hindenburg and Stresemann’s go-to-man for what basically seemed like Mission Impossible (cue the music). Perhaps we could view him as the Early-Twentieth-Century German-Politico-Economic Equivalent of The Wolf, in Pulp Fiction. You got a problem that needs fixing but looks impossible to fix…? Call The Wolfman… and he should be with you directly…

I’m fascinated by Schacht’s strange mixture of intelligence, humility, arrogance and cowardice. Despite his position and the enormity of the challenge before him, Schacht incredulously had no staff, save for his secretary, a certain Fraulein Steffeck, and set up his office in an old cleaning lady’s cupboard. Fraulein Steffeck’s occasional sideways gaze as he paced around the fog of his own cigarette smoke would provide a unique insight into the profile of a man deep in thought, with the weight of a giant nation on his shoulders. Even by Schacht’s exemplary standards, this challenge was a BIG one. In case there is any doubt about the magnitude of the task before him, let’s just quote a passage from Adam Ferguson’s legendary book from 1975, When Money Dies (a fascinating but perhaps not-so-gentle read for the beach?) which described the monumental “hospital ball” he’d received.

Schachter was faced with incredible disorder. During the previous ten days expenditure had exceeded revenue by 1,000 times. The floating debt had been increased fifteen times. The government would shortly be unable to pay cash wages to the Army, to the police or to its own officials. Already the officers of the Ministry of Finance itself were being paid in part in potatoes. The budgetary estimates included on every page the outrageous reminder, in brackets, that all figures were in quadrillions…

 

Enter the Rentenmark

What would you do, if you were Schacht, dear reader? I’m not too ashamed to admit that, I’d revert to my special “baby defence mechanism”…I’d soil my pants, throw up and then start wailing in despair until Fraulien Steffeck came to clutch me close to her warm and welcoming bosom. And yet Schacht did none of this. Instead he would conjure a solution to all Germany’s monetary woes with a shockingly simple master stroke. Enter the Rentenmark.

There is a, quite wonderful, quote from a Forbes Magazine article entitled In Hyperinflation’s Aftermath, How Germany Went Back to Gold where the author in turn quotes the great Adam Fergusson’s cult book.

“Dr. Schacht sat in a single room which had once been used as a charwoman’s cupboard, looking on to a backyard in the Ministry of Finance. From this post he transformed the German financial system from chaos to stability in less than a week. His secretary, Fraulein Steffeck, was later asked to describe his work as commissioner:

What did he do? He sat on his chair and smoked in his little dark room which still smelled of old floor cloths. Did he read letters? No, he read no letters. Did he write letters? No, he wrote no letters. He telephoned a great deal–he telephoned in every direction and to every German or foreign place that had anything to do with money and foreign exchange as well as with the Reichsbank and the Finance Minister. And he smoked. We usually went home late, often by the last suburban train, traveling third class. Apart from that he did nothing.

Farmers accepted the rentenmark in trade for their crop, and the crisis was resolved. A new reichsmark replaced the rentenmark a year later, at 1:1, putting Germany’s return to a gold standard on a more long-term basis.

So we see that it takes almost nothing to adopt a gold standard system. The Rentenbank held little if any gold. The rentenmark was not convertible into gold. No preparation was necessary. No staff was necessary. No time was necessary. The only thing that was necessary was a clear policy, namely to maintain the value of the rentenmark equivalent to a prewar gold mark, and a clear means to accomplish this policy, by restricting the supply of rentenmarks to maintain its value.

Renten is the German word for “mortgage”. What Schacht did was audacious. He needed a mechanism to stabilise the currency, but there was no gold supply left to back the currency. So he effectively backed the German Rentenmark with the only thing with more quantifiable, more transparent supply than gold: German land. The very agricultural land farmers were using to yield crops, the very commercial land manufacturers and service-providers were using to produce output became the yardstick to which German money supply was pegged. I’ll admit, it was a bit of a confidence trick. But isn’t all modern monetary policy? In any case, it worked. At inception, one Rentenmark started out its life equal to one trillion of the old German paper Marks and strict limits were put on how and when to print more currency.

What followed was quite an astonishing turnaround. Indeed, the only thing more remarkable than the speed of Germany’s economic collapse was the speed at which Germany was able to rebound, once a currency of trustworthy supply was in place. It is worth bearing in mind that only a few years after a complete annihilation of the economy, Germany had amassed a military machine on a scale the World have never before seen.

 

Hindenburg and Hitler - Wikipedia

Hindenburg and Hitler – Wikipedia

 

And the rest, as they say, is History…

Which guy in this picture looks the happier? Hitler’s largest political obstacle, indeed I think it fair to call him Hitler’s political adversary, was President Hindenburg. But he was getting old and by the time he was re-elected he was 84 years old, understandably weak and the weight of warfare and political turbulence seemed to have literally sucked the life out of him.

Schacht played an interesting role here too and this is where the complexity of Schacht’s character is hard to fathom. Schact clearly supported Hitler apparently from a strategic perspective – because he felt the country needed strong leadership. But was he just a cowardly populist and political momentum junkie? Hindenburg would use what strength he had in him to subdue Hitler’s insistence on wanting a prominent seat at the table and openly stated that “a presidential cabinet led by Hitler would necessarily develop into a party dictatorship with all its consequences for an extreme aggravation of the conflicts within the German people”. Alas, at 85 years of age, physically weak and mentally exhausted, Hindenburg eventually caved in to political pressure from his inner circle and appointed Hilter as Reich Chancellor.

Hindenburg died only a year later, in 1934 leaving a power-vacuum Hitler was all too quick to step into – announcing himself as Head of State and Head of Government only 2 hours after Hindenburg’s death. Schacht would eventually became Hitler’s banker and Minister of Economics and his deft stewardship of both the German economy and facilitation of Hitler’s financial might led him to become a recipient of the honorary membership to the Nazi Party and was awarded the somewhat dubious honour of the “Golden Swastika” in 1937. There is no doubt in my mind, Schacht did a lot to pave an economic pathway to pay for Hitler’s rearmament policies.

How much Schacht supported Hitler’s eventual brand of Facism is another matter open to debate. Schacht’s vision of “strong leadership” was clearly different to Hitler’s and he opposed The Fuhrer’s seemingly profligate military expenditure and the nature of his rule. Schacht would eventually become part of a stealthy collective who would form the Resistance Movement in Germany – their ultimate aim being to end Hitler’s reign in a violent coup d’etat. But, 72 years ago, the 20th July assassination attempt failed and thus opposing Hitler, even politically, was a dangerous place to be in Germany. Schacht was arrested and spent the rest of WWII in concentration camps.

Still, it’s hard to place Schacht’s views politically or make sense of his philosophical or ideological direction. Schacht said, in 1946, once the war was over:

I have never believed in war. It is a crime against humanity whether you win or lose. I just read an article in this magazine I have in my hands that one day the moon will fall on the earth, but it is my feeling that until then, we should try to make the world a better place to live in.

But perhaps we should leave the judgement of his character and political ambition to others closer to the matter, such as Chief Prosecutor at the Nuremberg Trials and US Solicitor General and Attorney General, Robert H Jackson, who described him as…

The most dangerous and reprehensible type of all opportunists, someone who would use a Hitler for his own ends, and then claim, after Hitler was defeated, to have been against him all the time. He was part of a movement that he knew was wrong, but was in it just because he saw it was winning.

A pretty damning assessment of his character indeed. Schact had managed to produce a monetary magic trick but he was not a politico-economic Winston Wolfe. Winston Wolfe was a comic book hero in a Quentin Tarantino movie, but this was no movie… and this was no comic.

 

Learning from History…

However, this is not the place to dissect Schact’s character or his political integrity, I’ll leave that to the historians to debate. What we are interested in is that, from an economic perspective, two things are clear:

  1. How utterly intertwined monetary policy is to political policy to the point, at times, it is hard to decipher when one ends and the other begins.
  2. How startlingly effective a supply standard (be it Gold or not Gold) was in bringing to heel even the most parabolic inflation of an out-of-control currency supply.

But we should end on an economic note, so I leave you with quotes, once again, from our friend, the great economic historian, Adam Fergusson [emphasis mine].

The important thing about the Schact Reforms was that the Reichsbank stopped discounting treasury notes and so inflation stopped “just-like-that” with astonishing speed…

… the effect of having the Rentenmark and a currency everyone believed in was very remarkable. In the first place, because people believed in it, the food started flowing from the country into the towns again…

… it had another effect, that all the revolutionary movements that were taking place in Germany at the time (and Hitler’s beer cellar Pusch) that had happened in early November [of 1923]… …With the introduction of the Rentenmark… all these political movements left or right, ceased to trouble… which was, again, an extraordinary thing. It was at that point, then when something began to grow again…

 

There are a million random walks I could have taken. I’m sure in the future I will read this all again and take a different journey through the history of money. That’s the beauty of reviewing our monetary ancestors. But, my dear and patient readers, we have gone from Caveman Capital, the Birth of Money and the First Bankers… to Roman Emperor Nero’s Debauchment of the Denarius… to Marco Polo’s account of Kublai Khan’s “flying paper money”… to The World’s First Central Bank, thanks to William of Orange … to a descendent of that, somewhat Germanic, British monarchy, Emperor of Prussia Wilhelm II, and the First World War and the subsequent Weimar Republic and Hyperinflation… and then, in this post, to Schacht’s Monetary Magic Trick and Germany’s economic rebound…

 

Where on Earth will we go next? I tell you, the chapters to come are the most enthralling of all…

 

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1st July 2012: Referenda On The Agenda – A Democratic Revolution In Europe?

… are the Germans getting used to defeat in Europe?

Quote of the Day:

What is needed is a tenable, medium-term solution to the euro-area crisis, which is affecting financial markets and real economic output beyond its borders.

Paton Odom, Dallas Fed report global economic growth, June 27th 2012.

Macro Overview

Europe Is Everybody’s Problem

  • Great little program by The BBC’s Newsnight – worth a watch for everyone whether European, Asian, American… and it sets the tone for today’s comment. I’d watch it as soon as you can as, no doubt, it’ll soon get pulled from YouTube.
  • Europe is everybody’s problem. For those who think that Europe is a place too far away to affect them, I highlight a couple of excerpts today from the Dallas Fed report on growth momentum in the World economy:

Global gross domestic product (GDP) growth forecasts have moderated in the second quarter, with industrial production and purchasing manager indexes reflecting restrained activity in advanced and emerging economies. Uncertainty regarding near-term stability of the euro area, which appears to be in recession, remains the most important determinant of expansion. While large emerging economies such as Brazil, Russia, India and China have led growth following the global financial crisis, their expansion has cooled to reflect slowing trade activity with advanced-economy partners as well as internal adjustments. Inflationary pressures and commodity prices have moderated.

Reflecting On Merkel’s “Defeat”

  • That said, with Merkel’s current line going down exceptionally well with the German electorate, I’m skeptical as to how this U-turn can be engineered without:

a)      incurring more dept on sovereign balance sheets with highly stringent conditions to the effective creditors (i.e.Germany) causing wider political and social split within the Eurozone

b)      significantly subordinating existing debt holders in Europe–causing wider financial and economic split in the market place. It would be a dangerous game to turn the entire European bond market into a retrospective CDO market. The ECB tried it in Greece, remember – the bond market got very squeamish.

  • Then, suddenly, out of the blue come Europe’s “begging men” (Monti, Hollande and Rajoy) announcing that they have indeed found a perfect “solution” which involves directly bailing out the Spanish banks without the Spanish government incurring more debt while simultaneously protecting the seniority of existing investors in the Eurozone bond markets! I could go into detail here but there is little point, that was essentially the crux of it – or at least the most important part. For those of us following Euro-politics closely, it was indeed a WOW moment…
  • It appeared Merkel had buckled under the pressure from her Southern Counterparts and was seen as the big loser in the Eurozone showdown. Global indices were off to the races on Friday. A rapid transformation for The Iron Lady of Europe, who had been dubbed as “Frau Nein” in the Eurozone media, was now suddenly crowned “Countess Capitulate” (by me)!!
  • This is politics in Europe at its most exciting (believe it or not). But there were mutterings that Merkel, like her national soccer team, had been simply blindsided, or blackmailed (“erpressen” as popular German Magazine, Der Spiegel, put it – Google, rather more kindly translates the verb erpressen as “to extort”) by the shrewd and powerful men from Southern Europe. It almost seems that Monti and Rajoy simultaneously threw their teddies out of the pram in a kind of pre-empted, orchestrated tantrum. They threatened to simply “block everything” if she persisted on her political tact. Merkel had to yield; no German leader wants the dubious honor as the protagonist of a political and diplomatic collapse in the Eurozone – that’s a burden the German public understand all too well. I remember Michael Lewis’ great article, It’s The Economy Dummkopt, (another MUST read) where he says:

The streets of Berlin can feel like an elaborate shrine to German guilt. It’s as if the Germans have been required to accept that they will always play the villain. Hardly anyone still alive is responsible for what happened: now everyone is. But when everyone is guilty, no one is.

Reactions back home were devastating, and there were even calls for pushing back key parliamentary votes on the permanent euro bail-out fund, known as the European Stability Mechanism (ESM), as well as Merkel’s fiscal pact scheduled for Friday evening. In fact, the vehemence of the attacks seems to have taken even Merkel’s advisers by surprise.

  • Ultimately, Merkel is merely a foil for German public opinion. So what happened? Did she truly get blindsided/blackmailed/out-maneuvered, was she astutely calculative of Germany’s inherent guilt over past failures in Europe and its desire to cement harmony with its neighbours… or is something else in play?

Potential Political Revolution in Europe

  • I have my doubts that Merkel has simply crumbled without a plan, for one, she has a pretty good record at reading the political landscape and at horse-trading and bartering for political power amid the chaos in Europe. With back-door meetings between the begging-men of Europe, she must have anticipated this kind of mutiny. So let’s examine exactly what may be happening in Euroland politics here.
  • Firstly, let’s be clear, the Eurozone crisis has not been “solved”, what has happened is that there is potentially a solution for the Spanish banking problem (and a bit of concurrent relief for Ireland too). Let’s also be clear that nothing is set in stone … yet. So far though it looks as though the European politicians have indeed bought more time. This does not surprise me in the least, remember in only my last comment, Eurocidal Tendencies, I wrote:
  • I predict that the politicians will do just enough to prevent an all-out collapse on Monday morning, perhaps even a little bounce, but not enough to reassure investors over the medium term. Then we’ll look forward to the next “summit to save the World”. With all this can-kicking I’m surprised the European politicians do not have sore feet?!
  • So buying more time is all that has happened… or is it? I have to admit, this is a breakthrough in terms of a change of tactic and change of direction and a change of attitude among all Europeans of all political persuasion towards the European experiment. This is squeaky bum-time at its squeakiest. There has been a distinct change of mood here in Europe over the last week.
  • I feel a bit of a political and even cultural revolution taking place on this, most diverse, most intriguing, most complicated continent of ours. For the first time ever, I feel Europeans all over are simultaneously beginning to objectively consider the true nature of their ambitions and desires towards a European political union. Do we really want to be The United States of Europe, as Axel Merk brands it, and (more importantly) are we willing to make the sacrifices required to achieve that objective?
  • The answer to this question is not necessarily: “no”.
  • Here in Britain, only this week, the most pro-Euro politicians were pointing to the inevitability of a Euro-referendum (something that would have been unheard of a year ago). Incidentally, good to see Britain has learnt its lesson in Europe and has opted not to run headlong into the Euro-debate guns blazing and, rather, wait and see how the political crisis inEurope resolves itself first.
  • Now, even in Germany, the prospects of a Euro referendum are clearly being openly debated after German Finance Minister, Wolfgang Schauble kicked the proverbial hornets nest on the matter, last week. Zerohedge even speculate that the Merkel “defeat” was merely part of a strategic maneuver towards a German referendum.
  • It’s tempting to be a little anxious about all this unrest, all this upheaval and political revolution. But, for once, it seems the politicians are having to turn to the people and resort to (heaven forbid) a democratic process to base their Euro-policies. Ultimately, even in bureaucratic Brussels, the people do seem to have the power – which would mean that, no matter what the results of the process are, it will likely have more credibility and therefore more stability both politically, economically and within the financial markets.
  • Despite my skepticism about the actual substance of the latest “can-kick” by the European elite, I too am changing my attitude towards the specter of Europe and therefore my approach to the political challenge and… in this respect, for some unknown reason, I feel a twinge of optimism this rainy Sunday afternoon… not a big one… but a twinge never-the-less…
 

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15th April 2012: The Spanish Imposition And The Old Economic Growth vs Austerity Tradeoff

 

Mariano Rajoy - deer in the headlights?



Quote of the Day:

While ECB intervention could buy some more time for Spain in the short-term, it is extremely unlikely to fundamentally change Spain’s fiscal or economic trajectories. In the absence of economic growth,Spain will eventually be forced to request official financing, potentially as early as next year.

Meagan Greene – Roubini Global Economics

Macro Overview

Spain: The Vital Statistics

  • So what do we know about Spain– other than the fact that they play the best football (soccer) in the world?
  • Well, both economically and geographically Spain is regarded as being on the periphery of Europe– the Southwestern corner of the continent and the “S” in PIIGS. Europe cannot afford Spain to go the same way as Greece, it is one of two PIIGS (Italy being the other) regarded as being “too big to bail”. But that is where the similarities with Italy ends. Numerically, Italy’s main problem is the sheer mountain of accumulated debt, but Italy’s financing issues (like Japan’s) are highly dependent on internalized, domestic funding channels and are therefore not as immediate as Spain’s (for now), despite its high debt to GDP ratio.
  • Spain, on the other hand, has the rather dubious honour of being the largest lender to Portugal (another PIIGS economy in the headlights) and, while it’s total debt accumulation is not all that high – a “meager” (ahem!) 80% of GDP this year – there are massive immediate problems with the rate at which new debt is being added to the economy (i.e. deficits), the rate of unemployment (especially among the younger generation), lack of growth and devastation in the property markets.
  • The Spanish influence in Europe should not be taken lightly, however, with a population approaching 50 million and a land mass of over 500,000 square kilometers (larger than the state of California, for example) this is a big cog in the Eurozone wheel.
  • Both Portugal and Spain sit in the “entrance” to the Mediterranean with having huge sandy coastlines on both the Atlantic of Southern Europe and the Western Mediterranean Sea making them Europe’s most popular tourist destination (second largest tourist industry in the World).
  • Despite their recent malaise, the economies of Italy and Spain rank 3rd and 4th in the Eurozone respectively, behind Germany and France and 8th and 12th in the World (India, Canada and Russia coming between them) … so these economic regions should not be viewed in the same light as, say, Greece – which ranks somewhere around 30 (and falling rapidly) below both Iran and Colombia.

The Pain In Spain

  • Fast forward to 2012; if you remember Spain has a newly elected (pro-austerity) leadership in the form of the centre-right Popular Party and its leader Mariano Rajoy. At least the Spanish population have the comfort that this is a leadership they actually elected (unlike Greece). However, as we’ve seen in Italy and Greece (and, indeed, integral to the construction of the European Commission), democracy in the Eurozone occasionally seems like an after-thought.
  • Rajoy (pictured above) is the new face of austerity in Spain, a country in the throes of great change. That, said, Rajoy’s task is far from easy and, just recently, Rajoy announced that Spain would miss its deficit target (again!), and not by a slim margin either… by a country mile. Instead of a “mere” 4.4.% deficit, he pulled a 5.8% clanger out of the bag – that comes after last year’s target was missed by an equally astounding margin (8.5% vs 6.0% target).
  • This did not please council of leaders at the European core, who outwardly hissed disapproval towards Spain and it’s smaller sister, Portugal, while inwardly praying it would not be them in the austerity hot-seat next. Some would say it was rather embarrassing for Spain– others (like my cynical self) would say it was politically predictable. A new administration often takes an economic bath up front so it can be blamed on the previous administration (although two baths in 6 months is perhaps pushing it a little).
  • Again, predictably, support for the People’s Party recently fell quite dramatically in the polls as the reality of austerity hits home to many voters with Spain unveiling the deepest budget cuts in 30 years. According to Bloomberg’s Business Week, Rajoy was recently quoted as saying:

Spain is facing an economic situation of extreme difficulty, I repeat, of extreme difficulty, and anyone who doesn’t understand that is fooling themselves

  • So far Rajoy and the People’s Party are trading their economic deficit for a deficit in popularity internally – or at lease, they’re trying to. They are towing the EU line of growth-crunching austerity to bring Spain’s economic criteria in line with the Eurozone core (and its convergence criteria) but this comes at a heavy price.
  • Just like in Greece, the administration is being torn between the demands of the political elite in the EU and the wants of their people. There are signs of trouble brewing internally with skirmishes between protestors and police becoming quite commonplace. Mind you, with massive austerity and youth unemployment at 50%, this is not surprising. What we must instead monitor is the momentum of the movement and the rate of increase in social unrest (if that is even possible to calibrate).
  • But social unrest is a symptom; the issue at the core is growth and with it the prospects for unemployment – which defines the cultural ambition of an economy and the confidence of the business community. So, what is a little more intriguing is the market action recently, it would appear that the Spanish leaders have a clear and unified focus and objective – to slash the budget and get Spain’s deficits in order. Unity and focus are not things often associated with European politics, so this is certainly a good thing… only it’s still not really working is it? As far as austerity goes it’s looking a little ominous for Spain– it’s as if she’s damned if she does and damned if she doesn’t.
  • I can’t explain it any better than Meagan Greene and, seeing as she’s been my flavour-of-the-week, I’ll leave it to her to succinctly summarize the situation in her latest article (Why Spain Won’t Regain Market Confidence)…

Bad News Up Ahead for Spain
As Spanish government bond yields began to soar in early April, the government announced on April 9th an additional €10bn in spending cuts. This came just days after prime minister Mariano Rajoy announced €27bn in austerity measures and tax hikes in the 2012 budget. Markets weren’t at all impressed by the additional cuts and bond yields rose further, proving that the Spanish government is truly in a no-win austerity/recession spiral.

If the Spanish government does not announce further austerity measures, the markets think it is not serious about hitting its fiscal targets and shun Spanish sovereign debt. If the Spanish government does announce additional austerity measures, however, the markets fret that the wingeing cuts will pushSpainfurther into recession and shun Spanish government debt. No matter what the Spanish government does, investors are spooked, and this is unlikely to change over the next year unless Spain shows signs of being on a path towards sustainable growth.

 

How likely is it Spain will show signs of a return to sustainable growth any time soon? Not very.Spain’s unemployment rate hit nearly 23% in the final quarter of 2011 (youth unemployment exceeded 50% for the first time in January). The latest purchasing manager’s index (PMI) for Spain for March showed the worst result in 11 months at 44.5 (a reading lower than 50 indicates a contraction compared with the previous month). Worryingly, there was a substantial reduction in new orders, an indication that Spain’s PMI score will continue to deteriorate in the future. The Spanish property market has not found a floor yet, and will continue to undermine the quality of household and bank balance sheets. The government is implementing aggressive austerity measures and structural reforms, both of which significantly undermine growth in the short-term.

 

  • I feel sorry for the young people in Spain. They’ve still got their football, but that is small consolation. It was not their generation who racked up crippling debt and ruined the property market, but they, the young, will have to pay for it somehow. They have austerity imposed on them directly by their own government and indirectly by the Euro elite (and the ECB via cost-of-living inflation). The scars and pain will last long after the Eurozone crisis is over – it’s not exactly fair on them. But this is the nature of The Spanish Imposition.
 

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12th April 2012: “Squeaky Bum Time” Looms Over Europe

Quote of the Day:


They [Arsenal] have a replay against Chelsea and if they win it they would face a semi-final three days before playing us in the league. But then they did say they were going to win the Treble, didn’t they? It’s squeaky bum time and we’ve got the experience now to cope.

Sir Alex Ferguson – Manchester United Manager

Macro Overview

Did Meagan Hit The Bulls-eye (of the storm)? 


  • You gotta give credit where it is due. Meagan Greene looked a little crazy when she wrote about the Eurozone crisis back in March (I had an excerpt in my Tonsillitis Economy piece) a time when all seemed to be rosy. Stocks were hitting new highs, credit spreads and borrowing costs of European nations were closing in on new lows. Was that really the right time to be saying: “hey don’t be fooled – this is just the eye of the storm”?
  • Well, for a while Meagan looked like a rather lonely kill-joy but these days she’s looking pretty smart, huh? The reality is, as Meagan correctly alludes to, nothing has really been “solved” at all in Europe.
  • As I wrote about way back in 2011, an all encompassing solution would involve three types of action:
    • Short Term Relief – Extreme action at the ECB
    • Medium Term Security – a direct and heavy participation of tax-payers at the core of Europe (EFSF and ESM)
    • Long Term Structure – Treaty Change at the heart of Eurozone political structure.
  • While, under Super Mario, the ECB is has literally exploded onto the scene with Euro-note-firing big monetary bazookas and Treaty Change happened as I anticipated about way back in September 2011, the medium term leg of the stool (a direct and heavy participation from the taxpayers at the core) has largely gone missing.
  • Here is Meagan’s excerpt again:

The third way the troika has tried to buy time is with a so-called firewall consisting of EU bailout funds and bilateral loans to the IMF. This is designed to take Italy and Spain out of the markets for a few years should they face unsustainably high borrowing costs. The hope is that these countries would be able to implement structural reforms and see those reforms boost growth by the time a return to the markets is required.

But for the firewall to work both its EU and IMF elements must be large enough. This is far from guaranteed, and failure on this point could trigger a massive escalation of the crisis. On the EU side of the firewall, there are currently two funds in place, the European Financial Stability Facility (EFSF), which has around 250 billion euros in available funding, and the 500 billion euro European Stability Mechanism (ESM). The former is due to replace the ESM in June 2012, but the only way to amass enough funds to cover Italy and Spain’s financing needs for a few years is to run the EFSF and ESM concurrently. However, German Chancellor Angela Merkel remains — for now, at least — vehemently opposed to this idea. Similarly on the IMF side, many countries have indicated their reluctance to contribute to a firewall until the Eurozone devotes more of its own collective resources to solving its crisis.

Figure 2: Composition of the Firewall vs. Financing Costs for the PIIGS (€, billions)

* Note; the trajectory of the bottom row (Total Cumulative PIIGS Financing Needs) on Meagan’s table.

The Third Leg Of The Eurozone Solution Stool Is Largely Missing

  • The medium term leg of this three-legged stool is essential because it connects the superficial short term remedies (money-printing) to their long term objectives (full political unity). The absence of this essentially adhesive part leave the project with a soft underbelly, prone to attack. Until investors have a comfort level that this Eurozone experiment is succeeding, they will always err towards putting pressure on the peripheral Eurozone economies via the markets.
  • Simplistically speaking, German taxpayers, and others at the core, need to put their hands in their pocket if they truly want the Euro-dream to succeed, but, so far, investors feel that this essential part of the plan is falling well short of what is needed.
  • The Eurozone politicians (bless them) have tried every trick in the book to polish this turd including: creating new shells under the impression that they are well-capitalized funds, turning the bailout fund into a Giant CDO and begging the Chinese. But we kinda know… you can’t really polish a turd.
  • In hoping that massive ECB stimulus (in my opinion, a short term solution) is continually repeated ad nauseum for a period long enough to bridge over the medium term to give time to the long term adjustments of real, integrated fiscal consolidation (Confederative Treaty Change) to gain traction is a real long shot, and, in my opinion a very risky strategy.
  • Aside from the political nightmare of Eurozone fiscal and political collaboration (right now this is a goal post moving further away from Europe with time, not getting closer) there are real risks to inflation here and (more poignantly) to the credibility of the ECB as it reaches further and further beyond its rather purist, single mandate.
  • Much has happened in the last few months. Let’s not underestimate the progress that has been made to-date. The Treaties have been worked out with alarming efficiency, the ECB is ready to inflate with Mario’s gleefully hovering over the “PRINT” button. Also, despite the fact that the ECB turned the entire Eurozone debt market into a retroactively risky, pseudo CDO-like minefield, Greece has finally defaulted and the process is in the latter stages of workout.
  • But rest assured, the future of the Eurozone is still in the balance – this ain’t over yet. In fact, as Meagan Greene implies and as Manchester United manager, Sir Alex Ferguson would say: the “squeaky bum time” in Europe may be ahead of us, not behind us.
 

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15th February 2012: An Ancient Greek Problem

Quote of the Day:

Insanity: doing the same thing over and over again and expecting different results.

Albert Einstein – German Theoretical Physicist

Macro Overview

A Duty To Write

  • Great quote from Einstein – if it indeed was his quote. But it’s a shame German finance ministers do not follow the same logic as their famous scientists.
  • Today I’m getting nostalgic. It’s good to look back in time every now and again and contemplate the positions and opinions you held one or two or even five years ago. It helps us to learn from our mistakes and our achievements. Some psychological analysis suggests that we tend to remember only a fraction of the truth or only the bits we want to remember. The truth is, it’s much more complicated than this, but we do not really know the whole truth about even our own, most intimate, past because we do not know what we forget, we only know what we remember. This is why I write a blog. I don’t need to, it’s not my vocation nor is it required of me, but I see it as a matter of discipline and convenience, which, by chance, has also become a rather rewarding hobby.
  • Firstly, as an investor I think it’s essential that one commits to definitive view points on many things – especially micro economics, macro economics, and increasingly, sociology and politics. I can’t help feeling that many people still have an apprehensive attitude towards airing opinion. It does not matter if one is proved wrong or has to admit defeat, that’s how we all learn. But as we get older we get lazy, as our knowledge increases out intelligence (as defined by our “learning curve”) decreases.
  • Secondly, as a professional or amateur working within a team it’s important one maintains an open communication on opinions and views both macro and micro. For a professional, it is equally important that one documents or stores those opinions in a manner which is easy to refer to and archive. That’s the primary reason I write a blog – the rest is just all just a bonus to me (don’t get me wrong it’s a great bonus, which I cherish).
  • I should be more humble, I get things wrong a lot of the time… only recently I had to admit that, after praising Germany’s clear stance on Greece I may have underestimated the political motivations at play within the dark corridors of Brussels. Indeed only this week I wrote:

It is becoming clear now where Germany’s path is diverging from idyllic (naïve?) suggestions I have made in the past – I forgot that there was politics involved, which means unfortunately there is constant opportunity for politicians on all sides to power grab.

A Snapshot in Time

  • So, what was I blogging this time 2 years ago: 15th February 2010? Well if the truth be told I was on holiday in Australia with my wife and kids on that exact date. But my friend Omar Sayed and I had spent a lot of early 2010 writing about one specific topic, which was insignificant to some people, but not us. It was a small economy in the south of Europe: Greece. Here is an excerpt from that piece, exactly a year ago today.

Greece

Today examples of debt profligacy surround us each day and no more so than the crisis surrounding Greece.  Greece will not be able to repay its debts on its own.  I am not talking about the short term and whether the EU will extend bilateral loans and other arrangements.  This “fix” is merely a stop-gap measure.  Rather in the years ahead Greece will not be able to take the steps it needs to bring downs its debts to a manageable position on its own.  There needs to be a debt write-down or a bail-out.

The EU is expecting Greece to shrink fiscal spending by 5%-10% of GDP per year for three years.  There is no clear incentive or penalty if the goal is not achieved.  Tax officials, doctors, teachers and civil servants have all held strikes over the past month against austerity measures that are not nearly austere. Sweden called Greece’s fiscal deficit data “fraudulent” after it was three times what official numbers stated. Greece hid E40 billion of debt from the public and the EU.  The Transparency International Corruption Perceptions Index ranks Greece dead last in the euro-zone with the “shadow” economy being worth 28% of GDP (the U.S. is 8%).  Where do you get tax revenue if 28% of GDP is in the “shadows”? Greece’s debt load is €254 billion.  It needs to refinance €64 billion of debt this year and €30 billion over the next few months.

  • Today’s headlines, 2 years and hundreds of billions of dollars later, read:
    • Greece Talks Hit A Snag – Bloomberg
    • Greece Spiralling Into Catastophic Depression – The Independent
    • Greece Battles To Salvage Bailout Package – Reuters
  • It’s all getting very messy again. Hey, it’s Deja vu every day in Europe – they got some serious “glitches in The Matrix” going on.
  • Poor Venizelos, he was supposed to be the placid “technocrat” mediating between the Greek public and the EU elite. Now both sides are hating and slating him so, like a cornered boxer, he hit back at the EU core elite accusing them of forcing Greece out. Yet still the blessed politicians forge forward to batter another austerity bill into the Greek economy. Hmmm… what was that Albert Einstein quote again?
 
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Posted by on February 15, 2012 in Debt, EU, Europe, Fiscal Policy, Germany, Greece, PIGs, Politics

 

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14th February 2012: Moody’s Gets Moody Over Europe’s Austerity Overdose

Quote of the Day:

We can and want to help only if there is a quid pro quo on the Greek side

Philipp Roesler – Germany Economy Minister

Macro Overview

Moody Moody’s

  • Too much of anything is bad for you, that’s what my Mom said… even austerity. Today Moody’s mood finally swung on Europe. They downgraded a bunch of Southern European sovereigns and put France and the UK on negative outlook. This seemed to dominate the morning chatter, apparently rating agency deductions are important news. I beg to differ, its importance is questionable… but it certainly isn’t news. Even if S&P and Moody’s downgraded France and the UK this year, they’d be about 2 years too late, in my opinion.
  • See comment on S&P downgrade “massacre” last month. I quoted an old piece of mine.

You know my opinion; one must earn an AAA rating – it is not bestowed on any profligate nation with the biggest printing press. In any case, AA is not the end of the World – it hasn’t affected Japan much. It just means your house is not as perfect as it could be – I don’t know any American that would not admit that. But, alas, the US should have been downgraded much earlier. S&P’s main crime was not that they screwed up the maths, it was that they were too late in finally downgrading nations with explosive debt trajectories, which could potentially be financially gridlocked in political disharmony. Farcically, Moody’s and Fitch, on the other hand, have little to gain, politically, by doing anything other than keeping mum and towing the party (i.e. whichever party is in the White House!) line. And, yes, France and the UK should probably lose their AAA status too – or at least be on negative watch. In the case of the UK, it should probably have been downgraded years ago.

London, 13 February 2012 — As anticipated in November 2011, Moody’s Investors Service has today adjusted the sovereign debt ratings of selected EU countries in order to reflect their susceptibility to the growing financial and macroeconomic risks emanating from the euro area crisis and how these risks exacerbate the affected countries’ own specific challenges.

Moody’s actions can be summarised as follows:

-Austria: outlook on Aaa rating changed to negative

-France: outlook on Aaa rating changed to negative

-Italy: downgraded to A3 from A2, negative outlook

-Malta: downgraded to A3 from A2, negative outlook

-Portugal: downgraded to Ba3 from Ba2, negative outlook

-Slovakia: downgraded to A2 from A1, negative outlook

-Slovenia: downgraded to A2 from A1, negative outlook

-Spain: downgraded to A3 from A1, negative outlook

-United Kingdom: outlook on Aaa rating changed to negative

Please see the individual country specific statements below for more detailed information relating to the rating rationale and the sensitivity analysis for each affected sovereign issuer.

The implications of these actions for directly and indirectly related ratings will be reported through separate press releases.

The main drivers of today’s actions are:

– The uncertainty over (i) the euro area’s prospects for institutional reform of its fiscal and economic framework and (ii) the resources that will be made available to deal with the crisis.

-Europe’s increasingly weak macroeconomic prospects, which threaten the implementation of domestic austerity programmes and the structural reforms that are needed to promote competitiveness.

– The impact that Moody’s believes these factors will continue to have on market confidence, which is likely to remain fragile, with a high potential for further shocks to funding conditions for stressed sovereigns and banks.

To a varying degree, these factors are constraining the creditworthiness of all European sovereigns and exacerbating the susceptibility of a number of sovereigns to particular financial and macroeconomic exposures.

Moody’s has reflected these constraints and exposures in its decision to downgrade the government bond ratings of Italy, Malta, Portugal, Slovakia, Slovenia and Spain as listed above. The outlook on the ratings of these countries remains negative given the continuing uncertainty over financing conditions over the next few quarters and its corresponding impact on creditworthiness.

In addition, these constraints have also prompted Moody’s to change to negative the outlooks on the Aaa ratings of Austria, France and the United Kingdom. The negative outlooks reflect the presence of a number of specific credit pressures that would exacerbate the susceptibility of these sovereigns’ balance sheets, and of their ongoing austerity programmes, to any further deterioration in European economic conditions and financial landscape.

Santorum Rising?

  • What’s this I see, Santorum takes the lead in the GOP race, CBS reports. It’s a strange race, isn’t it? Romney is clearly the leading candidate but he’s like what a Brit might call a “Marmite Candidate”… you either love him, or you hate him and it seems half the Republicans cannot stand him. That’s why the challengers seem to be continually revolving.
  • It was also interesting to see Ron Paul ranking ahead of Gingrich at 12 percent (I was honestly expecting him to be in the single-digits). He’ll never get to be a challenger of course, but he may get to the point where he has significant influence. For what it’s worth (and it isn’t worth much, I admit), I still think Romney wins and I also think he’s the Republican most likely to beat Obama, given that he holds a greater pull in the middle-ground among swing-voters and independents.

Big Day For Macro Data Tomorrow

  • Big day for macro data tomorrow – see the macro alerts in my Market Nightshift commentary – see http://marketnightshift.wordpress.com for more regular updates.
  • The largest European economies all set to report GDP growth. The numbers are all expected to be below zero … the question, just how far below zero will they be? It could all go swimmingly, but I’d be surprised if the equity markets do not break out of the range they’ve been in for this week and last.
  • It’ll set the tone for the rest of the month and don’t forget the discussions taking place between EU finance ministers on the next Greek bailout package. All this ahead of Germany’s finance minister, Schauble saying that he feels the Europe is “better prepared” for a Greek default – is he trying to manage expectations? A Bloomberg article today quotes someone succinctly describing Greece’s predicament as an “overdose of austerity”, will EU finance ministers agree on this? Watch the news and data out of Europe tomorrow.

Greek GDP Growth (Source: Bloomberg)

 

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