Sunday, 24 May 2015

Greece Is The Word

The world's political leaders, along with financial markets, seem to have discounted the potential for a Greek default, and exit from the EU, causing significant problems. They are grossly underestimating the real effects of such an event.

The reason a default has been discounted is that, not only is Greece a very small economy, but over the last five years, a large part of its debts were transferred away from the private banks and individuals that held them, and into the hands of the ECB and other European central banks. In other words, the risk has been transferred, during that time, from private money capitalists, on to taxpayers, which means European workers. That is what happened with all those private banks like Northern Rock, and RBS etc. that went bust. They were nationalised by their nation state, recapitalised, stuffed with liquidity and then sold off cheap again to the private money-capitalists.

That is what happens with all nationalisations. Its what happened with the nationalisation of the coal, steel, shipbuilding, car and other industries in Britain. It is the standard means by which the money-capitalists, when they have drained the lifeblood out of productive-capital, then obtain a transfusion, from workers, via the capitalist state, so that they can begin their vampire like activity once more. The only difference with the banks, is that this process tends to happen much more quickly, because its much easier to provide the banks with bank capital than it is to provide, say a coal industry, with all of the new machines, technology and mines it requires to function profitably.

Moreover, the state in all these cases has itself rigged the market to enable the banks and finance houses to be able to make profits more easily, by keeping official interest rates exceedingly low, for exceedingly long. There is no reason banks have to bid up deposit rates to attract savers, when they can obtain the short term funds they require, from the central bank, at virtually no cost, and then lend out those funds to borrowers, at 5-6%. You would have to be pretty incompetent not to make profits under those conditions.

When that process occurred, in the US, the US state financed it, by not only printing money, but by itself continuing its policy of fiscal expansion, which grew the economy, and thereby enabled the state to draw in additional taxes, and reduce its spending on benefits, so as to cover its borrowing, via the traditional Keynesian means, used during a period of long wave, secular growth. In Britain, the Labour government was using the same approach, up until the election of 2010. Then the Liberal-Tories, having locked themselves into a vote seeking narrative, of the need for austerity, were prevented from using that approach. The capital they provided to save the banks was taken out of the economy via taxes, and government spending. Yet even Osborne, as the effect of that tanked the economy, covertly changed course in 2012, to increase capital spending.

In Ireland, the banks simply hoodwinked the state and the people over the extent to which they had acted irresponsibly, and bankrupted themselves, and the extent, therefore, to which any rescue would require massive amounts of capital to be transferred to them. The amounts were so great that, absent any overall EU state to bring about such capital transfers, the Irish state could only replace the capital it had given to the money-capitalists, by taking it out of the Irish economy. A similar thing has happened in Portugal and Spain.

But, the Greek economy, and resources of the Greek state, were too small to perform such a function. The same methods of trying to cover some of the capital transfer, by taxing the Greek workers, and robbing them of the services and assets they had paid for, was adopted, but to no avail. Not only was the cupboard bare, but the austerity policies implemented, even began to dismantle the cupboard itself. Rather than money-capitalists lose all their money, and a global financial panic ensue, as a default prompted an unknown number of credit default swaps to be activated, global capital began to transfer the risk out of private hands into the hands of the European proto state and its institutions.

Having done so, the risk of a Greek default has now largely been discounted. But, the fact is that, not only is there still a fairly sizeable amount of debt, held in Greece, both by Greek private banks, and by the Greek central bank, but the debt held by the ECB, and other European central banks, should not be simply discounted either. In the next week or so, Greece has a number of repayments to make, to the IMF and others, which currently, its clear, it will not be able to make. Syriza's Finance Minister, Yanis Varoufakis, has made it clear that if its a choice between paying Greece's creditors or paying its pensioners and public sector workers, it will choose the latter.

An outright default of that type would  immediately cause problems, not just for Greece, but for the global financial system, and for EU institutions. It would be termed a “credit event”, which triggers a series of actions. It would probably immediately mean that Greece was cut off by the ECB, but more significantly, it would mean that a range of credit default swaps, and other complex financial derivatives would be activated.

A credit default swap, was originally intended, to reduce risk and volatility, by providing insurance. The risk, taken by any individual lender, of lending to any individual borrower, that the borrower may default, was reduced by allowing the lender to take out a CDS. It was insurance. If the borrower defaulted, the lender would claim on the insurance. As with all such derivatives, the way this worked, was by allowing the wisdom of crowds to operate.

The basis of the wisdom of crowds, verified by mathematics is that, if a large number of people are asked to guess say the weight of a cow, or the distance from A to B, or what the price of oil may be next year, although there will be a very wide range of responses, the average response will always be more accurate than any individual estimate. So, by selling such derivatives, there will always be some who think the chance, of say Greece defaulting, is high, and some who think it is low. Some will, therefore, be prepared to provide insurance that it will not default, whilst others will want to gamble that it will.

By providing liquidity into this market, the cost of the insurance is thereby reduced. But, the other consequence is that anyone can buy such a CDS, whether they have lent money to Greece or not. In effect, like most other things in global financial markets today, it is simply a matter of operating within a casino, speculating with money, not to earn income, but with the hope of obtaining a huge capital gain, if a bet pays off. The reality is that no one actually knows how many of these CDS's and other financial derivatives are out there waiting to be triggered, by some credit event, such as a Greek default.

What we doknow is that Deutsche Bank alone, is reported to have debts hidden in its balance sheet, via such derivatives, to be equal to the value of the global GDP! Deutsche Bank is not the world's largest bank, and so it can be surmised that other, larger banks both in Europe, Asia and North America, have much larger exposure. Because anyone can bet on such a default, and can bet using huge sums of money, which is itself connected to borrowing via a range of further derivatives, so that, as happened in 2008, someone who thought they were just investing their savings in a safe bank in a village in Norway, finds that their money has gone to finance mortgage backed securities that went bust in the US, so a Greek default, could start a chain reaction that will bring down the entire global financial system.

Besides that, we have a situation where all of that debt that has already been turned over to the ECB and other central banks would be destroyed. The debt takes the form of bonds and other securities provided by the Greek state and banks to the ECB, as collateral for money-capital loaned to the Greek state. The truly fictitious nature of this capital is highlighted under such conditions, because these bits of paper, become just that, worthless bits of paper. But, for the ECB, as for any bank, these worthless bits of paper are part of the capital superstructure of the bank itself. Its on the back of this bank capital, that the bank both lends money to borrowers, and itself borrows money from others, using this bank capital, as its own collateral against which such borrowing is undertaken. If the bank capital gets reduced, as it would be if all of the Greek debt it holds on its books was written off, that would leave the ECB itself with a capital hole in its balance sheet, which means its own ability to lend to EU banks would be curtailed. Ultimately, the ECB itself, like all other central banks, has to recover that lost capital, from taxation. In other words, it has to increase the interest rate it charges the state for the money-capital it lends to it, and the state can only pay that higher interest by raising taxes.

At a time when the ECB is trying to engage in QE in Europe, and when EU states are facing slow growth, as a result of the austerity measures already introduced across Europe, in the last five years, that is not the direction they want to be going in. Already, the ECB is reportedly having difficulty with its QE programme. The reason that yields on European sovereign bonds, including those of countries like Spain, has fallen, over the last year or so, is two-fold. Firstly, the ECB had said it would “do whatever was necessary”, and had begun its LTRO programme of very cheap lending to European banks. The banks, rather than lending to the economy, bought the sovereign bonds of their own state, behind which they believed that the ECB and the new programmes, such as the ESM, were now standing.

The second reason was that, after the US started to taper its own QE programme, this caused the dollar to begin to rise, and the currencies of a range of emerging market countries to fall. Their inflation rates rose, as the cost of their imports increased, due to the falling currency. Sharply higher inflation rates sent their bonds down, as money left them in search of the safety, capital gain and currency gain to be obtained from buying US, UK and European sovereign bonds.

As the demand for European bonds rose, pushing yields down, sometimes into negative territory, this has made it increasingly difficult for the ECB to find such bonds to buy. QE works by the ECB buying bonds from the EU banks, and electronically printing money, by making a deposit in the banks' accounts, in return for the bonds it has bought from them. But, it can only buy those bonds if there are enough of them available.

But, there are a number of reasons why this process itself could go badly wrong. One of those countries that faced a falling currency and sharply rising interest rates, for example, was Russia. But, in the last few months, despite the global price of oil still being half what it was, at its peak, Russia's economy has withstood, not just that onslaught, but the trade boycott, which seems to have done far more damage to Germany's economy than it has done to Russia's. The Rouble has risen sharply against the dollar in recent weeks, and it has begun to reduce, rather than increase, its interest rates. But, they remain very high compared to those in the US, UK and Europe.

This is theprocess I outlined last year. At a certain point, the currencies of these economies, like Russia, begin to look cheap, especially as their interest rates look extremely attractive. What used to be called “hot money” in the 1960's, then swishes back into these economies, in search of the higher yields available, but also, in the short term, in search of the significant capital gains to be made by a rise in the price of the bonds, and the value of the currency.

With the US tightening monetary policy, and the yields on its bonds rising by around 30%, in the last few weeks, and a similar pattern in the UK, and with the yield on the German Bund having risen by 1000%, in the same period, the last thing the EU needs, at the moment, is any sign of instability and panic arising from Greece, because that will only further increase the surge of money-capital away from the EU, and into these emerging markets.

That comes at a time when, despite all of the media hype about deflation, at the moment, the conditions are ripe for a dose of very high inflation. Whether, the oil price has bottomed or is set for another major leg down, as supply does not yet seem to have been contracted enough to remove the excess in the market, the fact remains that, in the next few months, that over supply will have been removed, and global prices will stabilise at around $70-80 a barrel. Compared to the prices experienced in the last few months, that will manifest itself in the economy as a significant upward pressure on costs.

Its is not the only one. In the US, Wal-Mart and Target have raised their minimum wage levels, ahead of increased competition for labour-power, as capacity constraints already begin to be seen in various areas. Los Angeles has just introduced a $15 per hour Minimum Wage. At the same time, productivity levels are falling. Productivity in the UK is appalling, in large part due to the fact that the Thatcher government introduced a low pay/low skill/high debt economic model, in the 1980's, and that has set the mould for the economy in the period since, but global productivity is slowing down, just because of the phase of the long wave it is going through, when all of the base technologies developed in the 1980's have already been introduced into a range of devices, and their effects are now dwindling.

As Marx describes, it is not rising wages that cause inflation. Wages are the phenomenal form of the value of labour-power, which is determined by the cost of reproducing it. If the price of commodities required for the reproduction of labour-power rises, then the value of labour-power rises, and so ultimately do wages. That means that profits fall as a result. For the last thirty years, the process has been in the other direction, and capital has also been able to depress wages below the value of labour-power. That is why the share of profits in national income has been rising as against wages – the rate of surplus value.

But, the first response of capital, as wages rise, and as it faces rising costs of other inputs, will be to try to protect its profits by using the vast oceans of liquidity that have been pumped into the global economy, over the last thirty years, to increase prices, because capital, and its ideologists, do not understand the actual source of profits as stemming from surplus value. They think that profits are merely an additional percentage amount on top of their production costs. With such vast amounts of money having been printed, and yet so little of it having found its way into the real economy – in fact, because it pumped up the prices of fictitious capital, it may actually have acted to drain liquidity from the real economy, and thereby caused the deflation there – the tap could be quickly turned on, sending a flood of this liquidity into the economy, pushing up commodity prices, and then wages in a traditional inflationary spiral, in the same way it did previously in blowing up speculative bubbles.

But, the other side of that is that those speculative bubbles in shares, bonds, and property themselves then get burst. Greece could yet be the spark that ignites the gas in all these bubbles.

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