Friday, 7 September 2012

A Spectre Is Haunting Europe..

Nations are wading deeper and deeper into an ocean of boundless debt. Public debts, which at first were a security to governments, by interesting many in the public tranquillity, are likely in their excess to become the means of their subversion. If governments provide for these debts by heavy impositions, they perish by becoming odious to the people. If they do not provide for them, they will be undone by the efforts of the most dangerous of all parties; I mean an extensive discontented monied interest, injured and not destroyed. The men who compose this interest look for their security, in the first instance, to the fidelity of government; in the second to its power. If they find the old governments effete, worn out and with their springs relaxed, so as not to be of sufficient vigour for their purposes, they may seek new ones that shall be possessed of more energy; and this energy will be derived, not from an acquisition of resources, but from a contempt of justice.”

Edmund Burke - “Reflections On The Revolution In France” pp 263-4

Burke is the theorist of counter-revolution. It was a phrase in the above work, which provided Marx with that opening line of the Communist Manifesto. But, his comments above are highly relevant to the current situation. The spectre haunting Europe today is not of Communism – actually as Marx and Engels admitted later in their lives, it wasn't in 1848 either – but of debt, and of the potential for reaction if that debt is not dealt with, and a financial collapse ensues.

Yesterday, the ECB, as expected, came out with a commitment, once more, to do what is necessary to deal with the sovereign debt problems of the European periphery, in order to prevent the collapse of the Eurozone. Yet, even as it does so, the chance of Greece leaving the Eurozone by the end of the year, has been raised to around 90%, by the markets. Despite the ECB, German and other Eurozone politicians, now speak openly about the possibility of such an event, even though, no one really knows what the consequences of that would be. The politicians, and the EU bureaucrats and bankers, appear to believe that, over the last two years, they have done enough to transfer the Greek debts, that were sitting on the private balance sheets of banks, and financial institutions, on to the Balance Sheets of states, or quasi-state bodies. They hope that any such exit can be contained. It might work.

On the other hand, the examples of what happened with Lehman Brothers, what has happened so far with contagion, of financial crises, within Europe, does not provide much encouragement for such hope. Yesterday's announcement, by the ECB, in a way demonstrates the problem. There is actually little in the ECB statement that had not been said before, and yet markets soared on the news. If the past is anything to go by, they are likely to reverse that in the next few days. Markets have risen by around 30% in the last year or so, but it is almost entirely a consequence of money printing by the US Federal Reserve and Bank of England. The ECB has engaged in two rounds of LTRO – Long Term Refinancing Operations – in which they lend significant sums to European Banks, for terms up to three years, at low rates of interest. Its the closest thing to money printing – Quantitative Easing – the ECB has done. Today, the ECB has said that it will buy the Bonds of countries like Spain and Italy, in the secondary markets, in order to reduce the yields on those bonds, which the ECB determines as being too high. It hasn't said exactly what level it thinks is too high, just it will say when it has intervened.

But, it will sterilise any such intervention. That is, any money it spends buying bonds, it will cover by withdrawing money from elsewhere in the system. The consequence of that could be that it funds Spain, but at the cost of causing a squeeze on available funds elsewhere in the Eurozone, which could rather nullify any effects of LTRO in providing liquidity to banks. That, at a time when those banks are already reducing lending, because of rising interbank rates. That is why banks like Santander have raised mortgage rates in Britain for example. Reducing available credit in Europe, at the moment, is likely to put further strain on an economy that is heading back into recession, and which in some countries is already at Depression levels. And, precisely for this latter reason, the buying of these bonds will do nothing for the economies of places like Spain, Italy, Portugal, Greece and so on. It isn't really intended to do so. Its intended to assuage those monied interests, and to transfer even more of those potential private losses on to the public Balance Sheet. In the meantime, its hoped it will buy more time so that in the words of Mr. Micawber, something might turn up.

The ECB has also said that it will intervene to buy only short term Bonds i.e. those with a duration of up to three years. One consequence of that may well be that holders of ten year bonds, switch out of them in favour of Spanish or Italian 1, 2 or 3 year Bonds, which will now have a floor put under their prices as a consequence of the ECB guarantee. The other side of that, is selling of ten year bonds, and a consequent rise in their Yields. It may also pose a problem for the UK, as I'll come back to later.

Liberal-Tory Incompetents - Campo, Foggy Osborne, and Clegg
Already, the international Bond Markets are looking extremely bubbly, and at some point, someone will get an itchy trigger finger, and decide to get out of Bonds that are already at stratospheric levels, when it comes to the US, UK, Germany and Japan, because no one will want to be second in line, when the selling actually does start. In this context, the UK looks most at risk, because there is little reason for UK Gilts to be at their current levels outside the huge money printing by the Bank of England. The UK is not really a safe haven in the way that the US or Germany or Japan are. The US is a safe haven because of the huge size of its economy, and because of the role of the dollar. Germany is a safe haven, because of the strength of the German economy. Japan is a safe haven because of its huge foreign exchange reserves, and strength of its exports. The UK is a relatively small economy compared to the US, Japan, China and Europe. The UK does not have the global competitiveness of Germany, Japan or China. The UK Government is increasingly seen as economically incompetent, a fact that was highlighted by the comments of former US Treasury Secretary Larry Summers on Newsnight on Wednesday. None of the Liberal-Tory economic prognostications have proved correct, the centrepiece of their economic strategy – deficit reduction based on austerity – is in tatters, as austerity has resulted, as I and many others, long ago predicted it would, in the economy tanking, and the deficit increasing as a consequence.

With inflation in the UK rising, interest rates already about as low as they can go, past exercises in QE having bailed out the banks, but done nothing for the economy, other than to raise inflation, and decimate pensions and savings, there is little reason for the UK to be saved by the kindness of strangers lending it money at record low rates. And, when those rates start to rise, as I said recently, the consequence will be that it will crater the housing market even faster than it is already declining. Arrears are at extended levels, whilst real incomes are falling. When Banks worry that they may not get their money back on all the houses they have mortgaged, they will start to foreclose. I was watching “A Place In The Sun” yesterday, which was featuring a load of luxury homes in Florida that are being “short sold” by the banks. A luxury 6 bedroom house was being sold for £97,000, which is a fraction of what it was a few years ago. But, that will also collapse the banks when that happens, which is why the banks and the Government and Bank of England have been doing everything they can to prevent it. Not out of concern for home buyers, but out of concern for the banks!

That is what happened in Ireland where the Banks made lots of these irresponsible loans that blew up a housing bubble, which then collapsed, taking property prices down 60%, and bankrupting the Irish Banks. If you want to buy a cheap house at the moment, Ireland is the place. The Irish State then bailed them out, and mirroring Burke's comments above, “provide(d) for these debts by heavy impositions” on the people, manifest in swingeing cuts in state spending on welfare etc. They did so, rather than upset “the most dangerous of all parties; (the) extensive discontented monied interest, injured and not destroyed.” That monied interest in western economies, has been dominant for the last 30 years. It has predominated over the productive capitalists who were on the back foot during the Long Wave downturn. The monied interest, has been injured by the Financial Meltdown, but it is most certainly not destroyed, and its interests continue to be represented through the Tory Party, even at the expense of productive capital, which would actually benefit from a collapse of the speculative bubbles, which have diverted financial resources away from productive investment, and raised the Value of Labour Power, by increasing the cost of housing for workers. Huge amounts of Surplus Value is drained from Productive Capital, as a result of the interest payments that workers make on their credit cards, student loans, mortgages and so on. That is all money, which otherwise would have gone to buying commodities.

A similar process to what happened in Ireland is occurring in Spain. It has been proposed to establish a so called Bad Bank. The idea is that the Spanish Banks and Cajas, who have lent money recklessly over the last 10 years or so, and blown up a huge property bubble, will be able to transfer all of their effectively worthless property portfolio to the Bad Bank. Depending upon the prices they are paid for that, it means those banks essentially get a “Get Out Of Jail Free” card. If the Bad Bank, buys those properties at their book value i.e. the value the bank placed on them when they made the loan, not the fraction of that which they are worth today, the bank will have lost no money for its reckless behaviour. Instead, the Bad Bank will assume it all. Then, the Bad Bank will get a bail-out for all the losses on these properties from the EU via the EFSF or ESM. Ultimately, the burden will fall on EU taxpayers.

When prices of Bonds, Shares other assets fall, it means
you can buy an increasing amount on a regular basis for the
same amount of money.  It also means the yield rises on these
 investments, which can be used to make larger payments of
 Pensions, or can be reinvested with the dramatic effect
 of compounding.
But, sooner or later EU taxpayers, for which read workers, will tire of bailing out bankers. It will become “odious” to them. At that point, the issue arises what happens when the people refuse to bail out the bankers? In the past, I've suggested that the longer term consequences might not be as bad as everyone expects. As stated above, there are good reasons for believing that a thorough Financial Meltdown would have a purifying effect. In the US people just walked away from their houses, and the debts on them, leaving the problem with the banks, which is why prices their have fallen so much, and now stabilised. A huge fall in share prices would not change the profits that real productive companies make, or the dividends they pay out. That would benefit Pension Funds, which pay out pensions from the income they receive, and who would be able to buy many more shares at their new lower levels. The same with Bond Prices. If Bond prices fell, and yields rose to more normal levels, Pension Funds would be able to buy more Bonds, and receive a higher income on them. It would also mean that Annuities would rise, so that Pensions paid out would be much higher. Finally, if house prices fell back to their long term average levels, it would mean a fall of around 75-80%, which would mean housing costs, including rents would fall. Workers would have more disposable income, and would be able to afford to buy a house once again. As in the US, it would stabilise the market at this new lower level, and probably create the basis for more house building. But, as Burke suggests, its not likely that this “most dangerous party” would simply take that lying down.

As Paul Mason writes in his blog,

Third problem - a region like Valencia, where I've just returned from: the city of Valencia is home to numerous multi-million pound building projects paid for by a government that is on the verge of bankruptcy.

Without the ability to lard the palms of property developers and architects and numerous vested interest, both political parties - the People's Party happens to be in charge in Valencia but this phenomenon goes nationwide - may begin to lose their grip on middle class voters, much as happened to Pasok in Greece, which is now being out polled by a bunch of violent, Nazi-saluting fascists.”


On Tuesday next week there is set to be the mother of all demonstrations in Barcelona against this, and it will be one of those demos where the risk assessment for journalists will have to include getting blinded by the flashing diamonds on the wrists and fingers of the middle class ladies who will flock down the Ramblas holding "Goodbye Spain" placards, alongside gritty communists with hammer and sickle flags.”

One of the most notable features of politics across Europe, and to an extent the US, is the absence of anything like the mass workers parties of the past – or even mass parties of the bourgeoisie – instead, what we see in abundance is a range of populists and demagogues. That is very dangerous from the perspective of the working class.

The Tories are largely talking nonsense when they repeat the mantra that you can't solve a debt problem by taking on more debt. Of course, you can. If additional borrowing allows you to increase your income substantially – which is what businesses do when they borrow to invest, and what individuals do when they borrow to buy a car that enables them to take a job that otherwise they could not – then, of course this is a way of resolving a debt problem! But, at the same time, they are right in another sense. That is, if you borrow simply to pay off your existing debts then you will get into deeper problems. Each additional loan, not only drives you further into debt, it also drives you further into the hands of more usurious lenders, like the pay day loan sharks. Unfortunately, that is the situation Greece and Portugal have been driven into. At the moment it is the approach of the ECB, and Eurozone politicians. Simply, lending more money, even at lower rates to Spain and Italy, will not resolve the problem. On the contrary, to the extent it is tied to the requirement that these countries undertake further measures of austerity, which tends to be the opposite of encouraging investment, it will only make things worse. Its like telling someone they have to cut back, and sell their car, which then causes them to lose their job!!

Until, the EU combines the ECB intervention – which will have to move to money printing to avoid simply causing a credit crunch somewhere else within the system – with a strategic plan for investment across Europe, measures like those yesterday can only be palliatives, which assuage the money interest at the expense of everyone else. Ultimately, they will not assuage the money interest either. The real problem in the US, in Ireland, in Spain, in Italy, and in the UK has not been Public Debt, it has been private debt. In the US, it was the private debt built up over nearly thirty years, and which erupted via the sub-prime crisis that broke the banks. That is still not over, because in the US, the next big area is student debt, which stands at over $1 trillion, and is now more than Credit Card debt. The same was true in Ireland. It was the decision of the State to bail out the banks, which created its sovereign debt crisis. The same is true in Spain. Its economy is not the most efficient and globally competitive in the world, but the real problem in Spain has again been private debt blown up by a twenty year property bubble, that still has not really popped. In the UK, the same is true. Private debt in the UK is more than twice the Public debt, and once again it has been built up on the back of a huge, unsustainable property bubble, which has yet to pop, but which inevitably will.

All austerity does, is to make that private debt problem worse, because it means that workers lose their jobs, their incomes fall etc. and so they cannot pay their mortgage, their credit card bill and so on. Eventually, after a long period of arrears, of going to ever higher interest lenders, there is nowhere else to go, but to simply walk away from the debts. Then the banks are left holding worthless assets, but now the State cannot bail them out, because the economy has been too weakened to sustain the bail-out. There is not enough people in work, not even business etc. to pay the taxes to cover the bail-out. You end up like Greece.

Two years ago, I thought that the permanent state bureaucrats were smart enough to realise that. I thought the Big Productive capitalists would impose that message on Governments. In the US, they were, and they did. In the UK, and parts of Europe they have not done so. But, slowly the message seems to be getting across. The ECB decision yesterday seems to be part of that. The conditions that will be imposed on Spain, are likely to be lighter than those imposed on Greece or Portugal or Ireland – which begs the question why those countries will not seek a renegotiation. As Paul Mason puts it,

So the Spain problem as a whole weighs heavily on the conditionality debate. Nothing I have seen today dissuades me from the hunch that German Chancellor Angela Merkel has had enough of inducing political collapse in Southern Europe and will go along with a relatively mild conditions regime for Spain.”

But, my hunch is that simply lighter conditions will not cut it. What is required is not lighter conditions, but a wholesale reversal of policy, and the introduction not of austerity, but of fiscal expansion, based around a programme of investment in infrastructure, and in a restructuring of Capital towards areas of production that can be globally competitive. Without that, it will not take long for global capital markets to realise that the problem has not been solved, and in fact, it might even have been made worse.

Two years ago, I wrote a blog - A Momentous Change – which argued that there were two ways things might go, particularly in Europe. It starts from the premise that we are in a Long Wave Boom, likely to last until around 2025. On that basis it argues that, European politicians could take the sensible decisions, as described above, and the European economies could gradually heal themselves within the benign conditions the Long Wave Boom provides. On the other hand, and I thought it probably more likely, they would dither, they would face problems of persuading electorates and so on, and the markets would lose patience creating a further, more serious Financial Meltdown, that would look something like the Great Depression of 1930-33. The key factor in bringing that about would be the property market. That still looks correct to me. I should add, that in that analysis I also argued that, because we are in a global Long Wave Boom, the consequence of such a Depression, unlike the 1930's, would be a very sharp rebound from it.

The reason there will be a sharp rebound is that the Long Wave Boom creates the potential for massive growth. In China and elsewhere, whose economies are not burdened by debt, that potential is being realised. Look at companies like Microsoft or Apple. They are making massive profits. Most of that profit goes not to build additional capacity for additional production, as used to happen in previous decades. Both companies, and many more like them, do not increase their revenues or profits by investing in additional capacity. Micrososft increases its revenues and profits, by introducing a new version of Windows, or Office, Apple by introducing a new iPhone, or iPad, and so on. In the US, Corporations have around $15 Trillion of cash waiting to be invested, and there are no shortage of potential new products to be invested in. But, why would you do so, when the immediate future looks so uncertain. Why would you do so, when investing not in production, but in shares can bring you a 30% Capital Gain in a year?

Once the uncertainty is removed, once the froth is taken out of financial markets and speculation, the conditions exist for a massive expansion of productive investment, and economic growth. On the other hand, its possible that economies may bumble along. Markets might give politicians time, and the ECB has shown as, Paul Mason comments, that super states like the Eurozone, do have massive power to use, when they think markets are dysfunctional. Today, we will get US payroll numbers. The ADP report yesterday was much better than expected. For the last thirty years at least, there has been a three year cycle. It coincided with the 2008 Financial Meltdown, which made it worse, and it began around the third quarter of 2011, which is why there has been a cyclical downturn in the US, UK, Europe and China since then. But, this cyclical downturn lasts usually for only around 3-4 quarters. By that token, it should begin to reverse by the end of this year/beginning 2013. That is possibly why the US economy seems to be improving again, despite the Republicans trying to scupper it. Depending upon how strong the cyclical upturn is, and whether it is not overpowered by incompetent measures adopted by politicians. They might just dodge the bullet. Personally, I wouldn't bet the house on it.


David Timoney said...

An excellent summary. I'm interested in your comments re the ECB plan and sterilisation, i.e. the likely restriction on liquidity that this will give rise to. You imply later that this will fail: "[the ECB will] move to money printing to avoid simply causing a credit crunch somewhere else within the system".

But a credit crunch will not necessarily be coterminus with the Eurozone. The ECB can discriminate as to where it restricts liquidity, i.e. at a bank level. Isn't there the possibility that politics will intrude here and result in some banks being disfavoured over others - i.e. beggar thy (weaker) neighbour?

Boffy said...


Thanks for your comments. As I understand the way the ECB sterilises funding, its via Open Market Operations. That is it sells Government Bonds its holding into the system, which are then paid for in Euros i.e. those Euros are then taken out of the system.

To be honest I'm not clear about whether the ECB can do that as a restricted sale to only Eurozone Banks. Logically, as long as it withdraws Euros, it doesn't matter where they come from. Also logically, the most likely purchasers will be Banks and Institutions in a relatively strong position.

I suspect that in the background, there is a belief that - as in the US - there are way to many Banks at a Euroopean level, and there needs to be considerable amalgamation. I don't think the calls for breaking up the banks should be given much heed. In Spain, huge numbers of banks have disappeared and been merged.

If you are going to have a Banking Union, it needs to be manageable, which means a limited number of large bodies, operating within a controlling organisation.

The specific answer to your question is that politics already has intruded. Switzerland has set a cap on the Euro/Swissy exchange Rate, because a sharply rising Swissy was damaging Swiss exports. Switzerland prints money to keep the Exchange Rate down. Money printing by large economies always ends up forcing other economies to follow suit. The ECB will have to openly print money for that reason. Its politics, which is preventing that happening at the moment.

I think the larger picture is that without the economy itself generating additional demand (which might happen next year if the cycle turns up) then money printing goes not into additional borrowing to finance investment - or even consumption when individuals try to delever - but either sits on Bank balance sheets, or is used by Banks for speculation - most of the data suggests that retail investors are largely out of the markets - which pushes up financial asset prices, which creates a self-sustaining upward spiral, until the bubble bursts.

The more money you print, the more likely it is that this happens, and that at a certain point the bubble bursts. Therefore, as keynes pointed out Monetary Policy without a supporting fiscal policy is like pushing on a string. The question then is, how do you create a fiscally stimulative environment that directs the money into productive investments, which are globally competitive, and provide high value employment - what I understand Ed Miliband is now calling "Pre-distribution".

In a comman economy like China you can do that. Japan and other Asian economies succeeded to an extent. In the 1960's, part of the rationale of the EEC was to develop the Nuclear Industry and so on. Wilson's "White Heat of Technology" and the IRC were not so succesful. Probably, Britain does not have the same culture of statism that exists in France, germany and Japan where industrialisation was udnertaken by Bonapartist regimes.