Sunday, 16 September 2012

QE, LTRO, QEII, OMT, QEIII Spells Desperation - Part 2

Despite all the headlines, the reality is that over the last two years, the world economy has not collapsed. There is no huge Crisis of Capitalism at a global level, there is no crisis of overproduction, which is what Marxists mean by a Crisis of Capitalism, such as was manifest in the crises of the 1840's, or the First Great Depression of the late 19th century, of the Second Great Depression of the 1930's, or even the prolonged Depression of the 1980's. There is no mass of unsold goods, on the contrary, prices of many goods are rising because of rapidly rising demand due to rapidly rising living standards in Asia, Latin America, and parts of Africa. Moreover, the profitability of many large companies has remained high, despite the fact that there has been a cyclical downturn, which began at the end of 2011. That cyclical downturn, and the high degree of uncertainty caused by the Debt Crisis in Europe, and political uncertainty in the US – for example, what will happen about the so called Fiscal Cliff – means that firms have little reason to use those profits to massively increase capacity, but that is not the same as actually massively retrenching either.

The consequence of that is that money has to go somewhere, especially when more money is being printed. So long as profits continue to rise, even modestly, which they are, then, especially in an inflationary environment, shares continue to be an attractive home for all that money. The point is, that without additional productive investment i.e. actually diverting money into buying more machines, materials, hiring additional labour-power, the money that goes into stock markets, simply goes into buying the existing shares. In other words, not a lot of new shares get issued to finance productive investment. So, the money goes from one investor to another to buy existing shares, pushing the prices up in the process. The same process has pushed up bond prices in those countries, and for those companies seen as safe havens. In part, what makes it possible is the fact that large amounts of profits continue to be made from existing productive capacity, in part what makes it possible is the continual, and huge amounts of money printing by Central Banks.

So, within the Eurozone, German Bunds, French OATS etc. have risen in price, whilst the prices of Bonds in other Eurozone economies have fallen. In the case of the periphery fallen sharply. Whenever, some new announcement or promise of some new announcement is made the prices of Bonds in the latter rise, and of the former fall, because of hope that the additional money might find its way into resolving the problems of the periphery.

So, at the end of last year, with the Yields on Spanish and Italian Bonds rising sharply, the ECB announced its Long Term Refinancing Operation, through which it lends money to Eurozone Banks for three years at low interest rates. Immediately, the prices of Spanish and Italian Bonds rose sharply, whilst the prices of German Bunds, fell, in the hope that it would enable Spain and Italy to get out of their problems. The benefit was short lived, and at the beginning of this year, the ECB announced LTRO 2. Once again the prices of Spanish and Italian bonds rallied. But, once again the benefit was short lived, as markets simply took the opportunity to sell into that rally, leaving the Spanish and Italian Banks to pick up their own Governments' bonds, financed out of the cheap LTRO funds they had borrowed from the ECB. In other words, as with Greece, it was a process whereby international Money Capital was able to get out of these risky bonds, and transfer the risk back, in the first instance to national banks, and then ultimately, as these are bailed out, on to the books of the State, or quasi state bodies such as the ECB. The ECB via LTRO bought up €1.1 Trillion of Spanish and Italian debt. The same methods were used in the 1990's during the Asian Currency Crisis, when IMF funding similarly allowed Money Capital to sell their assets in those countries, and get their debts paid, before the countries themselves were left to pick up the bill.

But, LTRO II, was no more successful at dealing with the underlying problem than QEII had been in the US. Two years ago, I wrote - Why QE II Is Sunk – which set out why such money printing could not resolve the problems of the US economy, so long as the influence of the Tea Part Taliban, prevented it being combined with fiscal stimulus.

In other words in 2008 the situation was one in which there was a demand for money that was not being satisfied, and which could only be satisfied if Central Banks stepped in to fulfil their function as lenders of last resort. But, the problem today is not one of an unsatisfied demand for money. On the contrary, as I wrote recently the globe is awash with money. Microsoft has just borrowed several billion dollars even though it has nearly $50 billion of cash, simply because it can do so at ridiculously low interest rates. The problem today is not an unsatisfied demand for money requiring more Supply, it is, on the contrary, a problem of lack of demand for all of the money available.”

Of course, in the end its not just a matter of providing a fiscal stimulus to create a demand for that money – though as Martin Wolf of the FT said on Newsnight recently, even that would be beneficial. The real underlying problem facing Capital in the West, is a lack of competitiveness, based on a disproportion of Capital allocation, which can only be remedied via a significant restructuring. In other words, Capital in the US, UK and the Eurozone cannot compete in areas of mass production, such as car production, consumer goods production and so on, with China, other parts of Asia, Latin America, and increasingly Africa. Production of those things in the former countries can only continue on the basis of a lower rate of profit, or some form of protectionism. However, these former countries do have a competitive advantage when it comes to high value production, which can be high-tech production, or high quality production (for example, Mercedes cars), or even the products of highly skilled workers – luxury production, high end media, and entertainment etc.

The US is something of a special case, because it also has a huge and competitive agricultural industry. But, the US has also developed these latter high-end, high value industries. The problem is it has not developed them enough compared to its continued reliance on old style manufacturing, and services. As an example, however, of the importance of these new high value areas, its estimated that the new Apple iPhone 5 alone, will add 0.5% to US GDP in the next year. Clearly, some Capitals are continuing to invest, but as is always the point it is a question of where quantity turns into quality. Companies like Apple, Microsoft etc. have large numbers of highly skilled and educated workers continually working on such developments. This is the means by which these companies increase their revenues and profits, rather than simply an investment in more machines, more materials to produce an increased number of the same product, which is the way old style manufacturing worked. In fact, much of the actual production of iphones, iPads and so on is done in China. But, in general Capital will not invest in increased capacity where the future market for that capacity is uncertain. In the US, at the moment, the likelihood is that Obama will win the election. But, it is not clear who will have a majority in Congress. If Republicans, especially Tea Party influenced Republicans, have a majority, then the realities of the US Constitution mean that Obama could be hamstrung in trying to push through policies of fiscal expansion, just as he has been over the last two years.

In that case, whoever becomes President, the issue of the “Fiscal Cliff” presents itself. As part of resolving the issue over the US Debt Ceiling, it was agreed that measures to reduce the deficit would be put in place, and as part of the negotiations over this, it was agreed that if no compromise could be reached a series of tax rises, and spending cuts would automatically be implemented in January 2013. The Republicans have refused to agree to any tax rises on the rich, and as a result the automatic lapsing of existing tax concessions, along with the implementation of Budget Cuts are due to be introduced, unless some last minute deal is agreed. As with the Debt Ceiling Crisis, everyone knows that a deal has to be done, but the Republicans are refusing to do one, and are instead demanding that the Democrats effectively just roll over. In fact, the Republicans proposals are little better than what will happen without a deal anyway. In return for agreeing to tax concessions for workers, they insist on retaining tax concessions for the rich introduced by George Bush. Instead they want increased reliance on Budget Cuts, which will hurt the very poorest in the US, as well as the removal of some of the reforms introduced in healthcare by Obama.

The combination of tax rises and budget cuts amount to around $560 billion, and it is estimated that it would reduce US GDP by four percentage points in 2013 alone, sending the US into an outright recession. With that kind of uncertainty, combined with the uncertainty generated by the Eurozone Debt Crisis, combined with the effects of a global cyclical slow down, its no wonder that Capital is reluctant to invest on any grand scale, which then becomes a self-fulfilling prophecy. Against that backdrop, the announcement of QEIII by Ben Bernanke last week, seems rather trivial. In fact, under QEIII, the Federal Reserve will buy up $40 billion of mortgage backed securities each month, for as long as it deems necessary to reduce unemployment on a sustained basis, even into an economic recovery, and despite any consequence for rising inflation. But, in fact, this amount is only half the $75 billion a month that the Federal Reserve printed under QEII.

As with every other announcement of money printing, stock markets soared, whilst the Bonds of safe havens fell, and those of more risky countries rose. But, it is likely to be short lived, and possibly more short lived than with all the other similar announcements. When I was a kid, I suffered very badly with asthma, and had pneumonia twice, at a time when the only anti-biotic was penicillin. During those two bouts, I struggled to breathe for about two weeks. Fortunately, the first asthma inhalers were being introduced, which basically used adrenalin. But, you could only use them once an hour. As the time for the next dose arrived, I experienced sense of relief on the basis of the expectation. The medication itself brought a real sense of relief, as my lungs relaxed. But, within about ten minutes or so, the effect had worn off. Then, in fact, things got worse, because you immediately think, “I've had the medication, and it hasn't helped”. The next dose seems a long way off. I suspect that the markets will have a similar reaction to the last dose of adrenalin provided by the Federal Reserve and ECB. But, the point is now after several years of such medication, when it fails to work this time, the markets are likely to begin to ask “Well what now?”

When I was 16, I was given a new asthma inhaler. As I understood the instructions from the doctor, I could use it whenever it was needed. A new paradigm you might say. Not long after I had it, I felt ill and began to use it, in that way. But, after a while, I began to feel worse not better. My parents called the doctor, who said I'd almost killed myself through an overdose of adrenalin, and my heart was beating way too fast. I had to spend about 12 hours overnight sitting on a straight backed chair, not moving, to allow it to work out of my system. I suspect that the answer to the markets question might end up being something similar.

Either, the huge amount of money printing that has been done will need to be diluted by diverting it into real economic activity, into investment in productive assets, into infrastructure and so on, and thereby create real Value in the economy, or else the markets having asked “What next?”, and finding no adequate reply is returned will crash, followed by a long period of economic inactivity.

As I set out recently, the ECB proposals for OMT, that is buying up the bonds of Spain and Italy will not resolve the economic problems of those economies, and the Eurozone periphery. In fact, by sterilising the money they use to do that, by taking it out of the system, elsewhere, they are likely to simply cause a restriction on credit, and slowdown of economic activity elsewhere, simply adding to the economic slowdown of Europe caused by the recession in the periphery. Moreover, on the back of the announcement of the OMT, the bonds of Spain and Italy rallied, which then caused the Spanish Prime Minister to announce that, on that basis, he saw no need to apply for a bail-out!!

Yet, the reality of the Spanish economy is worse than the superficial appearance would suggest – and that is bad enough. It is not just that much of the Spanish economy is not globally competitive, that it suffers as - Paul Mason – has described, from corruption, or that it has Depression levels of unemployment, a rapidly falling GDP, and a million and a half empty houses. It is that on top of all this, which makes it more difficult to resolve, the country has huge amounts of hidden debt that are not accounted for in the bail-out proposals. Spain's Federal system means that each region has huge amounts of debt, which ultimately the central government will have to pick up. We are just seeing those regions begin to demand funds from the government, but as has been the case throughout this debt crisis, the final amounts required are likely to be much more than the opening salvoes. But, much more significant is the masses of essentially worthless property that the banks have lent money against.

I was in Spain in April/May this year looking for a house to buy. Prices have undoubtedly fallen. The places we were looking at were around half what the asking prices were a couple of years ago – though selling prices back then were at a considerable discount to asking prices. Yet, even at these lower prices, prices are hardly cheap in Spain. Even compared with the hugely inflated prices of houses in Britain, house prices in Spain are not cheap, and compared with the price of houses now in the US or Ireland, they are still positively astronomical. Yet, even were Spain not essentially suffering a Depression, property prices in Spain should be considerably lower than in the UK. It is a big country with lots of available land. In the last ten years, lots of marginal farmers have sold land that should be extremely cheap, for building purposes. If builders have overpaid for it, it is only because the bubbly property market led them to believe they could pass on the overpayment to buyers. Spain is only thirty years past being essentially a Third World economy under Franco, wages in Spain are low compared to the UK, so the cost of building property should be lower than here too. Yet, property prices have been bid up by cheap money to hugely unrealistic levels, and as is always the case when people have overpaid for an investment those who made the mistake are loathe to accept it, and to take the necessary loss. So, sellers continue to hold out for prices they are never going to get.

The likelihood is that the result of that will be an avalanche of defaults, forced sales, and losses for the banks. That is why the Bad Bank is being proposed. But, all the calculations of how big a bail-out will need to be, are based on wholly unrealistic valuations for that property. My guess is that the total of bad debt on Spanish property will be many times what is currently being estimated,and even under the current ECB proposals that debt will have to be channelled through the Spanish State. My guess is that the funds available through the ESM, EFSF and OMT will not be sufficient to cover it. My guess, also is that when the markets begin to realise that, and do their own calculations rather than believe the fairy stories put out in respect of the Bank Stress tests, they will panic and begin to once more sell Spanish Bonds, wholesale. Already, as Paul Mason points out, €98 billion left Spain's banking system in May and June alone.

And, as I pointed out recently, even if the ECB/EU allows Spain to take a bail-out with milder conditions attached to it than those imposed on Greece, Ireland and Portugal, I'm not at all convinced that now just lighter conditions will cut it. Recession and stagnation are becoming entrenched, and to reverse it will require fiscal stimulus not just milder fiscal contraction. Paul writes,

But right now I am pretty sure how it ends. The tell-tale signs are the briefing notes from the perennial pessimists among analysts, warning of "longer-term problems unresolved".

When I receive such notes I become pretty sure that the short-term problems are being resolved.”

That may be right, but I think the time period between long-term, and short term may have become considerably compressed. Short-term may well be what crisis is resolved for this week, whereas long-term is what crisis do we think is going to emerge next month? Already we know that Spain has to borrow €30 billion from the markets before the end of October. It needs to borrow a lot more than that in the next few months. The ECB has agreed to buy Spanish debt, but only short duration debt up to three years. But, for stability, countries need to borrow over much longer maturities between 10 and 30 years. Spain might find considerable difficulty still in doing that, and borrowing at shorter dated maturities may simply increase its overall borrowing costs.

In short, the continued reliance on Monetarism to rescue the financial system has come to the end of the road. The recent announcements smack of desperation. But, I agree with a statement Paul made on Newsnight on Thursday describing the events in the five years after the collapse of Northern Rock. What we have seen has been more fiasco and political mistakes than a Crisis of Capitalism.


GrahamB said...

ECCL is another one to add to the list of acronyms...

Enhanced Conditions Credit Line is the conditionality for the OMT sterilised bond buying programme - a euphemism for imposed austerity.

Boffy said...


Yes, but I tend to agree with Paul Mason that there is an attempt to make those conditions less onerous than those that were imposed on Greece etc. My point, in response as I said, is that what is required from the perspective of Capital - and short of the revolution by workers too - is not lighter conditions, but a fiscal stimulus.

However, thinking as a politican and someone who has been involved in negotiating, I sense something else going on. If there is going to be a United States of Europe - this would apply to a Workers Europe too - individual states DO have to give up control of their budgets. You can't have a centralised state, responsible for financing, which lacks control over the individual states. You can see the problem of that in Spain now.

As part of the gradual bureaucratic move towards such a Federal State, nation states have to have that levered out of their grip, and the people of those states have to agree to it, as being in their immediate interests.

When you have done that, a centralised State can then exercise control not just for austerity measures, but for fiscally expansive measures too, directing money towards investment rather than construction, for example. Were I Germany - which has done lots of spending of money in other countries in E. & C. Europe for investment - I would definitely want to have control over money I gave to Greece, Spain, Portugal etc. to ensure it went into investment rather than into the pockets of corrupt politicians and bureaucrats in the way Paul Mason describes.

I still see the short run cycle turning up next year, which will create slightly better conditions, unless markets have lost patience, which I think is likely, and may indeed cause the "October Crash" I referred to earlier.

In short a crisis created out of political incompetence, not just over the last two years, but over the last 20 years or more of bureaucratic European construction.

Boffy said...

That should have said towards investment rather than consumption.