Tag Archives: Monetary Policy

From Treasure Money to Fiat Currency



Quote of the Day

If you put together all the Christians in the world, with their Emperors and their Kings, the whole of these Christians, – aye, and throw in the Saracens to boot, – would not have such power, or be able to do so much as this Kublai, who is Lord of all the Tartars in the world.

Marco Polo on Kublai Khan (Grandson of Genghis Khan)


The Grandson of Genghis Khan

Remember the story of that guy, Temujin, who came to be known as Great Ruler, or Genghis Khan? As a Mongol warrior, the bought the trust of a rival warlord (his father’s blood brother) by offering him the only money at his disposal: a rare animal fur. He then went on to slay his own blood brother, who had defected to become his fiercest rival, and set out slay anyone who stood in the way of him becoming the ruler of the World. Let’s face it, he probably got the closest any single human being has every gotten to achieving that feat.

Well, sable furs are one thing, but in the space of just two generations in China, currency innovation would take a leap that The West would take centuries to orchestrate. By the time Genghis Khan was the Great Ruler of the Greater Middle Kingdom, “flying cash” was flying all over the place and was already well entrenched as the standard money-form. Genghis Khan was wise to accept and adopt this sophisticated economy with its efficient transaction mechanism.

But, Genghis Khan would not live forever. Later, his Grandson, Kublai Khan, took to power as the first Emperor of the Yuan Dynasty and he decided to experiment a little more with the notion of flying cash. “Why did the currency have to be backed by anything with a limited supply, like gold or silver?“, he thought. Money was just paper. Why couldn’t he simply just print money whenever he needed it and ignore the notion of supply and stability? Kublai Khan began to simply print paper without any anchor to tangible money, such as gold or silver. Kublai Khan was seemingly creating wealth by magic, he was printing without the inherent discipline a currency with finite supply enforces. His theory would be to encourage people to use the paper money always and thus avoid any onset of Gresham’s Law by using an ancient technique he’d learnt from this Grandfather… paper money was law and he would chop the head off any person he found not using it. Et, voila! Backed by thin air and threat, the world’s first fiat currency was born.


Pirates and Travellers

To this day, when we think of “treasure” we think of gold and silver, pearls and emeralds. Sparkly things that would be of just as much value today as they would have been a thousand years ago. We do not think of a chest full of extinct paper fiat currency. If you’re a pirate and you have paper currency, you spend it. If you are a pirate and have jewels, you put it in a chest and bury it on a tiny island in the middle of the Pacific, leaving one copy of a badly drawn map in the possession of another pirate who can immediately identify the coordinates to the inch (despite the fact it could be anywhere and looks like a 3 year old drew it with a crayon). Everybody knows this – it’s a scientific fact, it’s a mutation of Gresham’s Law.

Well, back in the West (Europe) we had a few “educated travellers” who made it their mission to scamper East to find treasures of their own while miraculously avoided being slaughtered by pirates. In the 14th century Europe had an educated traveller out of Italy by the name of Marco Polo, a man who would be the inspiration for the great discoverer, Christopher Columbus. Marco Polo decided to see what this Asian revolution was all about. He travelled through the Greater Middle Kingdom where he mingled with Kublai Khan and the Mongol elite and made some interesting observations of his own, albeit through slightly rose-tinted spectacles.


The Archives of an Educated Traveller

The beauty of what Marco Polo did was, just like Genghis Khan, he was smart enough to carefully document and archive his observations. Incidentally, while many-an-Italian will be quick to tell you that Marco Polo did not introduce pasta to Italy, most will agree that the Chinese were eating pasta-like food as early as 3000 BC. A full 4000 years before any Italian saw a plate full of linguine. But I digress. As an educated traveller with a diligence for recording observations, one could argue that the biggest treasure Mr Polo brought back was INFORMATION. After all, it was eloquent Captain Jack Sparrow himself who said: “not all treasure is silver and gold, mate“. Marco Polo’s written word was indeed a great treasure, his works are publicised in many languages and still read frequently even today. Now, I’m going to be lazy and simply quote someone else’s passage from Marco Polo on the Mongol State, because what Marco Polo observed of the new “flying fiat currency” of China is something to behold.

Currency Manipulation

It will not surprise Austrian economists to hear that the biggest state monopoly concerned the money supply itself. During an era in which Europe’s rulers could do no better than clip coins, the Mongols had succeeded in instituting fiat currency across much of their empire. As Ron Paul puts it, “The emperor, like the vast majority of politicians, found the lure of paper money irresistible”. Polo remarks that the Great Khan’s mint “is so organized that you might well say that he has mastered the art of alchemy”. Indeed, whereas alchemists never did discover the secret of transforming base matter into gold, Polo notes that the Khan’s procedure of issuing paper money “is as formal and as authoritative as if they were made of pure gold or silver”. The state not only turned worthless paper into money but also profited from the wear and tear of the bills: “when these papers have been so long in circulation that they are growing torn and frayed, they are brought to the mint and changed for new and fresh ones at a discount of 3 per cent”.


Get a load of this. Not only was Kublai Khan printing his own wealth, he was accepting old notes and issuing crisp, clean new notes for a fee of 3% – the cheeky devil!! Janet Yellen, Haruhiko Kuroda, Mario Draghi you still have so much to learn!

But can you imagine the productivity, the efficiency, the sheer velocity of this new Chinese economy? The autocrats controlled and enforced the money supply and liquidity was vast; trade was booming. If the state or rulers needed more money, they would simply print wealth into existence. Had Kublai Khan, as Marco Polo inferred, conjured the magic of economic alchemy?

For a while the fantasy persisted. But, alas, utopia is not a place where authoritarians print wealth into existence. The wheels began to fall off the cart, the emperor was wearing no clothes… and many more appropriate metaphors as well. I quote again (because I’m lazy). This time a partial excerpt from A History of Money in Ancient Countries.

Population and trade had greatly increased, but the emissions of paper notes were suffered to largely outrun both, and the inevitable consequence was depreciation. All the beneficial effects of a currency which is allowed to expand with the growth of population and trade were now turned into those evil effects that flow from a currency emitted in excess of such growth.

These effects were not slow to develop themselves.cessive and too rapid augmentation of the currency, resulted in an entire subversion of the old order of society. The best families in the empire were ruined, a new set of men came into the control of public affairs, and the country became the scene of internecine warfare and confusion.

… and the same literature goes on to quote…

During the last days of the Mongol dynasty^ in 1351, an effort was made to reform the currency; but by this time the evil lay too deep for remedy; for many kinds of paper money were in circulation ” government, provincial, and private ” besides many counterfeits; and the government was powerless to limit the circulation. The notes therefore continued to depreciate.

The Chinese, once again, were millennia ahead of their time – not only with pasta, but with fiat currency too.  Where it took the Romans centuries to truly obliterate their currency the Chinese succeeded in just a couple of decades. But, while, the flying cash crashed and burn down to Earth at the first bump of turbulence, China had set a precedent. A precedent for systemic financial control, via a currency which could be magically created by the few to be consumed by the many.


*Little sidebar. Marco Polo was so intertwined with the Mongol Rulers in particularly Kublai Khan. Given that the Mongolians were admired for their amazing horsemanship in particular a game called “Polo” or The Game of Genghis Khan, it’s natural to draw the conclusion that the name polo is derived from the great explorer Marco Polo. Actually, it is thought that the name for the sport comes from a Tibetan word “pulu” which means “ball”.



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The Liquidity Paradox

Quote of the Day:

The market can remain irrational longer than you can remain liquid.

John Maynard Keynes

Everyone in the market loves that quote. It’s one of my favourites too. But these days the cautionary quote sends a little more chill down the spine; there is a menacing precariousness to the state of liquidity in the market place – and you don’t have to be a one-armed blackberry-picker in Somerset to know this.

Roubini’s article, The Liquidity Time Bomb, draws reference to the fact that we are in, what he calls a “Liquidity Paradox”. The paradox being thus: for all the liquidity being pumped into the global economic system, the net effect of policy meddling is that there is less, not more, liquidity in the financial markets. Roubini harks to a, frankly, awesome macro research piece by Citi’s Matt King. The piece is also highlighted in a ZeroHedge article, Nor Any Drop to Drink, which expounds the liquidity paradox with, of course, the satirical cynicism for which their blog is renown. The blogosphere is twittering and well-known market participants and commentators are regularly referring to it. This summer an FT article referencing the Citi research team’s liquidity paradox opened with the simple sentence: welcome to the desert. I really recommend opening this FT article, if only to look at the pictures – there are some fairly remarkable charts on trading volumes and market turnover.

Why should we care? Well, the argument is that this lack of liquidity leaves us open to what Matt King and ZeroHedge call “air pockets” – asset price shocks and volatility spikes. He points to some interesting trends which illustrate just how our liquidity has deteriorated – some of which I have attached below.

But why are we worried about liquidity today? One could argue there has never been more liquidity in the World. Every single central bank in the world appears, not just to be easing, but hell-bent on unconventionally aggressive money-printing measures such as ZIRP (Zero Interest Rate Policy), outlandish dovish official guidance, Quantitative Easing and Asset Repurchases and, in China’s case, outright stock manipulation and political coercion (intimidation?) with a simple objective: to increase the supply and velocity of currency in the economic system. That is; central banks and the economic authorities seek to drown us in the most liquid asset of all: cash. I could tell you why they are doing this… but that is another story… and should be told another time… (I say that quite a lot, apologies in advance)

As usual, in the beginning, the rationale is righteous; by reducing interest rates one encourages businesses to borrow and finance capex and investment, feeding positive energy back into the economy a process which self-sustains in a phenomenon Keynesian economists often refer to as The Multiplier Effect. That’s the theory, at least. Practically, however, as the real “good inflation” (wage inflation invoked by increased economic activity) fails to take hold, in true Richard Koo-Style Balance Sheet Recession, the effects of exploding the Monetary Base mutate into a new, more sinister beast. From businesses being gently enticed into investment, we find consumers (that’s us) being pressured out of the drought-lands of conventional savings, by the pain of negative interest rates* and into either fruitless consumption or prevailing asset bubbles in property or stocks – the very assets prone to over-crowding, air-pockets and price-shocks.

The comfort of liquidity is a mirage, to use my blackberry-picking paradox: blackberries, blackberries everywhere nor any fruit to pick. Despite massive amounts of liquidity in our economic system, the ripened fruit of market liquidity is superficial, illusionary in some areas and outright delusionary in others. Where it does exist, we must often overstretch to reach it. The money-printing, liquidity-flooding philosophy of our monetary authorities even spills into the geo-political arena with new saber-rattling over currency wars – a topic which have touched on many times. But that is another story… and should be told another time…

It’s hard to overlook the irony isn’t it? In a world awash with liquidity, we are fretting about illiquidity in financial markets. So what is causing this lack of liquidity? Matt King of Citi and Nouriel Roubini argue that there are three main causes:

  • High Frequency Trading: produces unnatural surges in liquidity at certain times in the day but leaves vacuums at other times of the day, distorting volume distribution. The individual computer algorithms trading securities are, of course, highly sophisticated, but the net effect is that they exacerbate “herding mentality” of the markets – this is a characteristic the markets do not need help amplifying! There is also another aspect of herding which is interesting. During herd-like behaviour, it is as though individuals (investors) lose perspective of the world outside the herd. Perhaps it is the animal herding instinct of the “safety in numbers” at play. But, consequently, we find that prices are prone to deviate from the fundamentals of “fair valuation”. The markets are prone to trade rich and, because there is less attentiveness to absolute valuation, dealers and investors alike are more likely to be on the same side of the trade (long) for longer periods of time, offering little resistance as valuations move yet higher. Greg McKenna of Business Insider, quoting Matt King, puts this more succinctly than I can in his short piece on the topic:

The problem at the moment is that, as King says, ‘Markets are liquid when they work both ways.

But markets are all heading in the one direction because central banks are creating artificial liquidity on the way into these globally uni-directional trades where ‘market participants… find themselves increasingly needing to move the same way.’


   [Source: Citi Research]

  • Prolonged extreme (accommodative) monetary policy is repressing investors out of safety. Many of the securities traded these days, like government bonds and corporate bonds (e.g. investment grade and high yield straight bonds and convertible bonds) are traded OTC. Firstly, these are inherently less liquid. This is not much of a problem, normally speaking, but the herds of investors are migrating into these OTC bond markets motivated, not by the pull-effect of tantalizing fresh pastures but, rather, the push-effect of a barren liquidity/return on “cash equivalents”. Just like I, the consumer, under the gloom of negative real interest rates, is being coerced out of keeping my money in the bank account and into precarious asset bubbles, investors used to transacting in the low volatility, very liquid, very short-term investments – such as Commercial Paper, Repos and short-term govvies – are now being coerced into using the longer, riskier OTC bond markets as their “pseudo-cash equivalents”. Note: if we’re using the word “pseudo” and “equivalent” in the same sentence we’re already a long way from sensibl
    To make matters worse, there is mismatch in the investment horizon building across the OTC bond markets, generally. Previously, long term investors, such as Pension Funds and Insurance Companies used to own large segments of the OTC bond markets. These days, though, their dominance is being dwarfed by a massive growth in mutual funds. Again, this is in part due to us, the retail investor, being forced out of an easy-access savings account and into what your bank manager may call “a managed fund”.  Either way, because these funds are open-ended – I, the retail customer, can withdraw my funds at any time. The long term investment market of OTC bonds is being dominated by funds with short term money flows. That’s a recipe for disaster, indeed, ZeroHedge say mutual funds “may be setting the stage for a veritable maturity mismatch massacre”.chart2                                         [Source: Citi Research]
  • Volcker Rule is taking the liquidity-providers out of the game. In the old days, banks, with their beefy facilitation books and prop books, which could use balance sheet and were not subject to fickle investor-flows, would add a level of objectivity to market in-flows (selling into a rising market) and a degree of cushion on an air-pocket-induced falls and outflows (buying on the dips). The Volcker Rule means this mechanism has all but vanished. The financial markets are effectively speeding down the freeway without a liquidity seat-belt.

Roubini calls it a “Time Bomb”, ZeroHedge use the phrase “powder keg” whereas commentators like El Erian have the slightly less alarmist tone pointing to a “Quiet Financial Revolution”. But what is becoming clear, is that there are asset bubbles within the financial markets which have been fueled by central planners and policy-makers (primarily our central banks) in a reaction to a financial crisis caused, in the first place, by the collapse of an asset bubble (Sub-Prime Asset-Backed Securities). A bubble which, in turn, was caused primarily by excessively accommodative stance by central planners – see a trend here? Welcome to Hair of the Dog Monetary Policy. We are suffering from the ingestion of a poison and the only cure we can think of is to drink yet more of the very same poison. The irony of the liquidity debate is not lost either – in the honorable desire to increase liquidity, we are also destroying it and creating a complex web of market distortions which is herding investors further and further from rationality.

Don’t get me wrong, investing in financial assets has yielded amazing results over the last 5 or 6 years while the cost of holding cash has been high. I have no idea how much longer this can go on for, but it can’t go on forever. The question is; how rational do you think you are? Are you tempted to jump on the next asset price gravy train? John Maynard Keynes was correct, but the real question may not be whether the market can remain irrational longer than you can remain liquid, but, rather, whether the market can remain illiquid longer than you can remain rational.


*I don’t know about you, but my bank effectively gives me negative nominal interest rates when one accounts for fees, penalties, cost, taxation and commissions. When one accounts for inflation then the “real interest rate” is harshly punitive (negative). It actually costs me to hold my money at the bank, which almost compels me to take my money out of the safety of my account and into the welcoming arms of the next potentially calamitous asset bubble. Our savings are continuously in danger of becoming what Mauldin refers frequently to as a “bug in search of a windshield”. And remember, many people think they put their money in the bank for safe-keeping, that’s what central planners would like you to believe, but try telling that to the owners of Northern Rock accounts. Upon inspection what we are actually doing is more accurately described as lending money to a bank – which then goes and churns it into a leveraged banking system via a process known as fractional reserve banking. Why did Bank of England Governor, Mervin King, hesitate before bailing out Northern Rock? What was all that hot air about “Moral Hazard”? The reality is Mervin King did not bail out Northern Rock because he wanted to help all those little old ladies who had their life-savings deposited there. Merv “the Swerv” King bailed the bank out because he had no choice – had he not done so he would not have had a banking system left to preside over…but, of course, that is another story… and should be told another time…


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28th August 2012: “Convertibility” – The September Buzz-word

The new Buzz-Word for September will likely be “Convertibility”…
For simplicity, in a perfect world with perfect assumptions:
  • >> Portuguese $ denominated debt of T years may be priced at 6%, German $ denominated debt of years may be priced at 1%.
  • >> There is a 5% differential due to creditworthiness disparity.
  • >> But Portuguese EURO denominated debt of T years may be priced at 7%, German EURO debt of T years may be priced at 0.75%.
  • >> There is now a 6.25% differential… WHY?
  • >> Because of the issue of convertibility … investors are putting a premium on the break up of the Euro… they don’t want Euro-denominated Portuguese debt for fear that upon break up of Euro (or splintering/temporary exit of Portugal) they may end up with debt denominated in Portuguese Escudos … or some native equivalent.
So when Draghi talks about protecting the Euro at all costs, capping peripheral debt and/or vents at people “betting against the break up of the Euro”…you know what he’s talking about… and when the media keeps using the “convertibility” word… you know what they are saying…
I recommend you read these two articles (especially the second one from my favourite Euro-skeptic Meagan Greene):
Leave a comment

Posted by on August 28, 2012 in Bond Markets, Central Banks, ECB, Euro, Europe, Mario Draghi


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12th June 2012: The Mantra Of Astro-Economics: Do Not Listen To Economists – The Drugs Don’t Work

Quote of the Day:

The drugs don’t work…, they just make you worse…

The Verve

Macro Overview


  • 2 days ago I said we were all cyclical beings born into a cyclical world. Our very behaviour is not only responsive to cyclicality, billions of years of evolution have actually made us, indeed all life-forms, dependent on cyclicality.
  • 1 day ago I said that both economists and quantum physicists are ignorant. The only difference is that a quantum physicist recognizes the limitation of his knowledge – an economist does not.
  • Hey, by the way, if you want to think about the limitations of quantum physics watch this clip, WARNING: this made me feel very small.
  • I digress… and perhaps that was a little harsh on our esteemed academic class – I do know some very humble economists… but not many. However, the thought I wish to convey is that even the smartest of our academic gurus can only work within the constraints of the human mind and its ability to interpret. There are many things we can “understand”, but what does it mean to understand? We have many answers … but there are many, many more questions to which there are no answers. It’s the same in economics and finance – sometimes we should be humble enough to say: we do not know and therefore we do not have a solution to this problem.

Don’t Listen To The Smart Guys

  • But moving on. For all these economic wizards advising our political elite, they did not stop the Japanese from stagnating for a generation, they have not managed to halt the train-wreck in Europe and they’re failing to de-odorize the stench of a stagnant workforce, gangrene growth and a rotting housing market in the US. They all have many complicated theories, most of which I’m too stupid to understand. So I revert to what all ignorant people revert to: common sense.
  • Both expansionary/Keynesian and austere/Austrian policies have not worked thus far and there are many instances in which they have not worked in the past. Do the proponents of each doctrine humbly admit they’re wrong? No… of course they don’t. I don’t think they ever will. Instead, they all stare blankly for a moment and then stamp their feet and, red-faced, hiss the same response: “No! NO! It didn’t work because you did not do ENOUGH of it!!” Austerity in Spain/Britain did not work because we did not do enough of it. Stimulus in Japan/US did not work because we did not do enough of it!
  • Right. That’s because your education is based on theories which are largely empirical – economics is, I’m afraid, largely an observational science, not a pioneering one. The ideas of policy makers and their so-called Nobel Prize winning wiz kids are not based on hard fool-proof theory nor are they pragmatic within the political and historical context.
  • If someone tells me they can design a solar powered helicopter which works in the dark and it turns out they cannot, then their concept is flawed because their theories did not take into account all the practical considerations and the context of the experiment (because, that was what it was, let’s face it). “But, but, wait…. in theory there’s enough moonlight, I just didn’t think of the weight of the…”  aaah… forget it mate… just admit you were wrong… and I was a fool for believing you.
  • If someone tells me they can revive the economy by either spending more or with more austerity and it turns out they cannot, then I’m a fool for believing them and their concept is flawed because their theories did not take into account all the practical considerations and the context of the experiment (because that was what it was, let’s face it). “But, but, wait…. in theory we can revive the economy, Congress is in gridlock! Young Greeks are on the streets! The banks won’t lend!” …  aaah… forget it mate… just admit you were wrong and I was a fool for believing you.

The Drugs Don’t Work

  • So here’s an experiment I have tried many times and come to only one conclusion. If you drink many pints of Belgian beer… you’re gonna have a hangover. There ain’t much you can do about it… yeah I’ve tried all the techniques. Like drinking a pint of water before you go to bed only to see it re-emerge with startling ferocity. Eating a kebab at 3 in the morning on your way home… … … only to see it re-emerge with startling ferocity. I’ve tried the old alka-seltzer too… same result – fizzy and ferocious. The drugs don’t work… they just make you worse. How about hair-of-the-dog? Yeah right – its barf will be louder than its bite. So look, if you’ve done such a monumental job of screwing your guts up by downing copious amounts of booze in a single night, there ain’t much you can do about it the morning after the night before … you just have to get through it… somehow.
  • Here’s a novel thought. Policy makers of a by-gone era prostituted economic HIV and now economically, we’re at a place for which there is no practical cure. There is no magic remedy for the disease we have spent the last 20 years getting ourselves into. As ZeroHedge put it today: By Incentivizing Debt, We’ve Guaranteed Debt Serfdom and Stagnation. We just have to deal with it – austerity won’t work it just makes it worse. Stimulus won’t work – it just makes it worse. We were all present at the orgy and had our noses in the punch-bowl, scoffing like swine at a trough for so long we didn’t realize how much we were screwing up our intestinal organs… now we have a hangover, a big hangover… and we just have to get through it.
  • We’ve strayed beyond the limitations of our theoretical responses from our limited theoreticians. The drugs don’t work, they just make you worse.

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11th June 2012: Deeper Forays Into “Astro-Economics”

Quote of the Day:

Each thing is of like form from everlasting and comes round again in its cycle.

Marcus Aurelius – 161 to 180 AD


Macro Overview

The Inevitability Of Cyclicality

  • So, as I commented yesterday, last weekend my herb garden was the source of my ponderings. We are cyclical animals, born into a cyclical world. The circular movements of the planets create cycles which we see so often that we are not even aware that we move effortlessly in synchrony with them. What is interesting is that most of these movements which define our very lives, our existence, our entire experience of this thing we call “life” is this… they are all circular in nature. The Earth itself is a 3 dimensional circle – a sphere. It “spins” on an axis, so every one of us is experiencing a circular spin towards and away from the sun (the sun rising and setting). In turn, the Moon circles the Earth and the Earth circles the sun. We call this observation of a circular motion from a singularity a cycle.
  • Here is an interesting thought, life has existed on Earth for about 4 billion years – give or take a hundred million or so years. So think about it, every aspect of every living thing that has ever existed on Earth has had to adapt to these cycles (in fact, everything that has ever lived in this universe, actually). The day and night, the rotation to the sun and sidereal days, the axial tilt and seasonal cycles, the moon and tides and its lunar cycles.
  • As a consequence we have adopted our own cycles:  emotional cycles, energy cycles, menstrual cycles, economic cycles and perhaps the biggest cycle of all – the cycle of life. For, just like parsley seeds I planted today, life is born into a cyclical world and before it perishes it reproduces offspring and another life enters the clock we live on… it is the cycle of life and we, like every other form of life on this planet are by definition cyclical organisms. It is part of our blood, our DNA, through billions of years it has been etched into our skin, hard-coded into our brain, it’s in the substance of our bones and the very existence of our soul. Not only do we depend on cyclicality, we embrace it… for it is life, we love the pattern of cyclicality, we embrace the concept of consistent and repetitive change (which is all that a cycle is). We are cyclical beings, born into a cyclical world – not only do we expect cyclicality. We live for it, we thrive on it… it is the very substance of what makes us living beings.


Economists And Other Ignorant Academics

  • Greenspan-worshippers praise “the Maestro” for trying to suppress the cyclicality of the economy, for trying to iron out the volatility in the markets. I say he’s a fool for doing so, not only is this (as we have seen) impossible, it is actually counter productive in the long run. And THAT ladies and gentlemen, is how planting marjoram in my herb garden, is related to capital markets and monetary economics – through the medium of astro-economics!
  • Greenspan was the original sinner, let’s not forget what damage his monetary ambivalence has done. This is not an argument about Keynesianism and Austrian Economics, it is about common sense. If indebtedness is allowed to propagate through an economic system unchecked it does not dispel the rules of cyclicality. The “economic energy” in the system remains the same, it merely alters the frequency and the magnitude of the cycle – both on the upside AND the downside.
  • It’s been a long enough reading session. But next time let’s talk about how ignorant we all are – especially the smart people like quantum physicists (no that’s not oxymoronic) and especially the so-called smart economists. I’m not clever, but I admit it. The best quantum physicists are, by their own admission, ignorant – indeed the only difference between an economist and a quantum physicist is that the economist is generally less humble – economists think they have the answers to everything, at least physicists accept that they don’t.

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20th May 2012: Death By A Million Debts

Quote of the Day:

What begins as a temporary program of providing liquidity becomes a permanent program of printing money needed in order for the system to merely function.

Chris Martenson


Macro Overview

The First Thing I Noticed When I Got Back  

  • Apologies to readers for the “radio silence”, I’ve been away for 3 weeks inHong Kong. As usual, there are, of course, a few things to report from my observations in the East. Some of them may surprise you, but let’s leave that for another day.
  • The thing I noticed as soon as I logged in to check my blog statistics was that the articles I had written a long time ago on Greece (in an attempt to simplify the explanation of how Greeks had gotten themselves into a debt trap) had generated a lot of renewed attention. It’s surprising because I wrote these two articles a year ago and yet readers clearly think it has relevance today… the sad truth is that it does. Here we are 3 years into Greece’s woes and the same old problem persists with the Eurozone now bracing itself for “GREXIT” – the exit of one of its members, Greece, from the Monetary Union.
  • I turns out the word “solidarity” may have a different meaning when it’s vented from a European politicians mouth. If the Greeks exit they take not just themselves but also the credibility of all Eurozone politicians. Who’s gonna believe Van Rompuy or Merkel or Rajoy when they say that “Portugual/Ireland/Spain [insert your favorite peripheral nation here] will definitely not exit the Eurozone”?
  • For those of you that care, here are the two articles, apologies for the gross simplifications, the articles are intended to be soft humor, not condescending in any way.
  1. The Greek Sovereign Debt Crisis, Part 1 – Thomas The Tank Engine Economies
  2. The Greek Sovereign Debt Crisis, Part 2 – The Greek Tragedy
  • In the first article I quoted Chris Martenson’s piece Death by Debt. This is a great article, I suggest you read it – it too was written a year ago but still has relevance today.


Death By A Million Debts

  • You see, I have old fashioned principles. I believe that if one is in debt to someone else, one only has two options: repayment or default. It’s really that simple.
  • There are those who believe that government debts (in particular Treasuries) do not need to be repaid, the laws of logic are corrupted, bent and therefore rendered mute, in these special cases. They believe that debts can be magically printed out of existence. If this is the case then, by definition, they are not debts, they are something else … and the market will eventually treat them accordingly; assigning the relevant risk premium to both the debt instruments and/or the paper currency in which they are denominated.
  • For now, though, let us go along with the charade and simply understand the risks the Feds around the globe are undertaking on our behalf… the markets are down, even inflation is a little softer, even oil has come off the highs… so what are the headlines du jour? More QE of course! QE in the UKQE in the USQE in EuropeQE in Japan… QE forever! If we all print those suckers fast enough nobody will owe anybody anything and everything will be better…
  • But look around you; everything is not better is it? Although suffering may be drawn out over a longer time to reduce the visible impact, the tragic reality is that everything will not be better, most of us will suffer terribly under this monetary overkill. A small proportion of the victims will suffer and understand the root of this suffering … and a smaller proportion still will know root causes and have the fortitude to do something about it.
  • I leave you once again with Chris Martenson’s quote:

What begins as a temporary program of providing liquidity becomes a permanent program of printing money needed in order for the system to merely function.


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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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