Have to agree on that one
The old "inflate or die"
Reality Check - Europe: German Pope, Italian Central Banker
Gary North's Reality Check [[email protected]]
Sent: Wednesday, November 23, 2011 9:07 AM
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Issue 1120 November 22, 2011
EUROPE: GERMAN POPE, ITALIAN CENTRAL BANKER
Conclusion: Europe is in bad shape. This is hedge fund
manager Kyle Bass's assessment of the situation in Europe.
He stated this in a rousing interview on the BBC's TV
network. Here is the segment:
http://bit.ly/GermanPope
He made two crucial points -- points that stock market
investors are ignoring. First, over the last nine years,
there has been an increase of world debt from $80 trillion
to $210 trillion. These numbers are staggering. Global debt
over the last nine years has grown at 12% per year, while
GDP has grown at 4% per year.
While he did not verbally spell out the conclusion for
the interviewer, it is this: when credit must grow by 12%
per year in order to produce 4% GDP growth, at some point
there will not be enough GDP to supply sufficient credit.
It is time once again to quote economist Herb Stein:
"When something cannot go on forever, it has a tendency to
stop."
Bass had a great metaphor: the PIIGS have "sailed into
a zone of insolvency."
Second, he explained, the sovereign debts in Europe
will be written down. There is no other solution.
The airhead interviewer with the Oxbridge accent
seemed to be doing a college-skit imitation of Emma
Thompson. She challenged him. What about Germany? Can't
Germany continue to fund Europe's "southern neighbors"?
Germany has "the earning power." (Note: this means German
taxpayers.)
Bass responded instantly. First, the German court has
determined that any further bailouts are unconstitutional.
Second, Greece -- and, by implication, the other "southern
neighbors" -- will spend every euro it borrows from Germany
and then come back for more, threatening a default if its
demands are not met -- exactly what it has done so far.
This goes on until the write-down takes place, which it
will.
There are two ways of looking at this: the Bass way
and the Bass-ackwards way. The airhead chose the latter.
He draws conclusions from the numbers. No one in the
mainstream media and mainstream investment fund world seems
to be willing to do this. They talk and invest as if the
process can go on forever. Debts need not be repaid. This
is ancient Keynesian dogma that goes back to the New Deal.
"We owe it to ourselves." On the contrary, specific
borrowers owe it to specific creditors. At some point, the
specific borrowers are going to default, leaving specific
creditors with huge losses.
How huge?
THREE TRILLION EUROS
Charles Hugh Smith agrees with Bass. He says that
there will have to be a write-down. By "write-down" he
means write-off. He estimates the losses at three trillion
euros.
Someone will have to take the hit. The great political
debate in Europe today is over who will take this hit, and
how soon.
It will be investors. But, to forestall the day of
reckoning, Europe's politicians pretend that taxpayers'
credit lines can be used by superficially solvent Northern
European governments in order to borrow more money from
creditors in order to lend to the PIIGS's governments, so
that the PIIGS's governments can continue to (1) delay real
austerity measures, i.e., massive layoffs of government
workers and massive cuts in welfare payments, and (2) make
payments on what they owe to investors, mainly banks.
Smith admits that three trillion euros is a guess.
Nobody knows how much bad sovereign debt there is, so we
must start somewhere. In a world of $210 trillion worth of
debt, his estimate seems reasonable to me.
Let's start with the most basic fact about all
this uncollectible, impaired, bad debt: every
euro of debt is somebody else's asset. Wipe out
the debt and you wipe out the asset. That's why
there's no willingness to accept the writedown of
debt: somebody somewhere has to suck up 3
trillion euros of loss.
This is the source of Europe's present policy of "kick
the can," or more accurately, "kick the can with press
releases and summits." If there were a pain-free solution,
it would have been implemented long ago.
There is no way Europe is going to "grow its way
out of this debt." How much of the eurozone's
"growth" was the result of rampant malinvestment
and risky borrowing? More than anyone dares
admit. It won't take austerity to crash the
euroland economy, all it will take is turning off
the debt spigot.
Europe is facing the problem that Bass raised when he
spoke of 12% per year increases of credit and 4% increases
per year of GDP. There is no way to grow your way out of
this. This is not just Europe's problem. It is the world's
problem. But Europe is facing it now because the debts are
coming due now. They must be rolled over. Creditors must
agree to re-lend. But why should they?
The Establishment world of crony capitalism speaks of
"re-structuring" the debt. What does this mean? Smith does
not pull any punches.
"Restructuring" is a code word for writeoffs.
Here, let me "restructure" the euro bond you
bought at a 4% coupon yield. Now you're going to
get 2%, and you're going to like it. Bang, your
bond just lost half its market value, but
everyone gets to keep it on the books at full
value. Nice, until you have to sell it to raise
cash. Oops, the euro has slipped in value so you
lost more than 50%.
The banks keep the assets on the books at face value.
The underlying value is down by at least 50% for Greek
bonds. The European experts admit this. (Why the debt is
worth that high a percentage is beyond me.) The Greeks are
going to default, one way or another.
Who will take the hit? Smith writes: ""There's a
fundamental truth that everyone has to understand: what the
government spends, the public will pay for sooner or later,
whether in taxes or inflation or having their debt
defaulted on." This is reality. But it's not precise
enough.
WHO IS THE PUBLIC?
If there is hyperinflation -- price inflation above
30% per year for a decade or more -- the public that takes
the hit will be almost everyone inside the euro-currency
zone. There will be almost universal hardship.
On the other hand, if monetary inflation ceases for
more than a few months, there will be a depression. Big
banks will fail. Their depositors will lose everything. The
money supply will shrink. It will be 1930-38 all over
again.
Central bankers do not allow such things. The European
Central Bank will try to walk the tightrope, just as the
national central banks in Europe did after World War II.
The ECB will pursue boom-bust policies, refusing to
capitulate either to a Great Depression or hyperinflation.
But how can it walk this tightrope? The losses will be
huge for large banks. The politicians will try to transfer
the cost of bailing out Europe's banks to Germany. But the
debts are too large.
The politicians will try to do what the BBC
interviewer suggested: get northern Europe to fund a
never-ending series of rollover loans to the PIIGS. This is
standard wisdom. But the numbers are too large.
Then what will happen? Europe will adopt the American
solution. The ECB will not allow large banks to default. It
will inflate to buy the bad assets or else buy the bonds of
the governments, so they can make payments. Then the
bankers will put this money into excess reserves. New
lending to businesses will cease. The West will go into
permanent recession or no-growth stasis. The governments
will absorb an ever-larger percentage of the region's
capital: bond sales. Private firms will not be able to
borrow at low rates. Capital development will crease.
Europe is more dependent on bank financing than the
USA is. Europe is therefore headed for a long era of very
low growth or else recession. The governments will suck up
the credit because they must keep the payments system
alive. The banks will not be allowed to collapse. Neither
will the money supply.
The ECB does not want hyperinflation or a Great
Depression. The alternative is the transfer of capital to
PIIGS on a long-term basis. The states will absorb the
savings of the region.
MORAL HAZARD
Smith describes what has been done to voters by the
bankers by way of the politicians. There is nothing new
here. It goes back to Walter Bagehot's description of
"moral hazard" in the mid-nineteenth century.
Those who made the risky bets have diverted the
risk to others: taxpayers or the general public
who holds currency. The gains from the bets are
private, and theirs to keep, but all the losses
are distributed to the public via government
bailouts or money-printing. The first shifts the
losses to the taxpayer, and the second shifts the
losses to everyone holding the currency being
devalued.
This has worked because all of the governments' bills
have not come due. The rollovers have been sequential. The
big debtor states -- Spain and Italy -- have not yet
reached the edge of the abyss that Greece is staring at.
But they are getting close.
Smith comments on the winners and the losers in all
this.
Not only has the risk been palmed off onto
unsuspecting chumps, the returns have been
concentrated into the few hands that control the
big bets. This is the ideal setup for the
stupendous gains and zero risk that characterize
crony-capitalism: make the big bets with leverage
and borrowed money, and skim the vast profits.
Then when the bets sour, demand a bailout from
the Central State, the ECB, the Fed, etc., which
promptly socializes the losses and distributes
them over the entire populace of taxpayers or
holders of currency.
Smith says that the only thing that can stop this is
the rebellion of the new serfs: voters.
It works beautifully until the debt-serfs rebel.
The EU's politicos are begging to start the
printing presses, as that is the only way they
can retain their power in the face of the
debt-serfs' revolt. But at least one populace of
tax-serfs (Germany) is rebelling against sucking
all the losses via a massive reduction of
purchasing power.
But the debt-serfs do not see it. They cannot stop
their governments. They are not united against the
bailouts. Each new government pursues business as usual.
Typical is the "Occupy Wall Street" movement. They are
mostly socialists and welfare statists. They want more
regulation and higher taxes on the rich -- the New Deal
extended. This program has not reduced inequality since
1933. The protesters are not demonstrating in front of the
regional branches of the Federal Reserve. They still have
no idea of how central banking is at the center of the
economy, and has been in the USA since it opened its doors for
business in 1914.
Smith offers a solution.
Those who made the bets should rightly lose
everything--yes, be wiped out. If risk and return
are actually causally linked, then this is the
only result of a big bet that sours: those who
placed the bets should be wiped out. That
includes money managers, bank honchos, bond-fund
gurus, and everyone else who foolishly bought all
this debt without investigating the risks.
But that means the big banks. If they fold, the entire
monetary system goes into mass deflation -- of money first,
then prices. The world goes back to 1930-33. There is no
way to avoid this, according to Keynesians, monetarists,
supply-siders, and even Austrians. Here is where there is
universal agreement. If the large banks go under, then the
Great Depression returns. Then the governments that have
bailed out the PIIGS go under, too.
The Austrians recommend this in order to get back to
true pricing of capital. All other schools of economic
opinion want to prevent this by means of central bank
inflation. The Austrians say "let the sucker go down." Then
the recovery will begin. First pain, then joy: like a woman
in childbirth. Politically, this is an impossible marketing
job. It will not be allowed to happen. Governments will
bail out the big banks. They will borrow to do this. If
this requires a violation of the European treaties, either
the treaties will be changed by parliaments or else they
will be ignored.
This is moral hazard in action. It never changes in
principle. The numbers just get larger. Economic
interdependence gets larger. The division of labor is
extended. The system relies more and more on fiat money and
bookkeeping deceptions.
WHAT FIREWALL?
Smith assumes some sort of firewall for the bankers
and the voters. The loss should be contained.
Who should not suck a loss are those who did not
stand to gain: the taxpayers and holders of the
currency. To repeat: the most basic fact about
all this uncollectible, impaired, bad debt is
that every euro of debt is somebody else's asset.
Wipe out the debt and you wipe out the asset.
This means the assets of the largest and most
leveraged banks will be wiped out. Then the banks will be
wiped out. They will fail. This means failure at the heart
of the European economy. The crash will spread around the
world. There is no firewall other than fiat money.
There is no way to avoid the 3 trillion in
losses. The only question is who should absorb
those losses: those who stood to gain, or the
innocent chumps whose only crime was being a
taxpayer or owner of euros? If there is any
justice (or classical Capitalism) at all in
Euroland, then those who made the bets and
invested capital in the bets to reap a return are
the ones who should absorb the losses.
All true. But the masses have their money in
commercial banks, pension funds, and mortgaged homes.
Monetary deflation will impoverish them. The masses are
trapped, one way or another.
He says, "Life will go on if the banks are wiped out
and closed, pension funds and insurance companies take
losses, etc." In a world with an extended division of
labor, which is also a world regulated from the top by
bureaucrats, if the big banks really do go down, life may
not go on for millions. The division of labor depends on
the money economy. The money economy is leveraged at 40 to
1. What if the money supply falls by (say) a factor of 40?
This is the curse of moral hazard.
Smith draws a conclusion.
If those who made the bets for their own private
gain aren't forced to absorb the risk, then we
don't live in either capitalism or democracy; we
live in a financial-fascist tyranny.
http://bit.ly/3twritedown
But this is exactly where we live. That was my point
back in February 2009.
http://www.lewrockwell.com/north/north683.html
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CONCLUSION
Europe's game of kick the can will continue. The best
summary of the outcome was made by a Spanish government
worker on Sunday, November 20, the day of national
elections. The socialists were thrown out of office. He
said this: "We can choose the sauce they will cook us in,
but we're still going to be cooked."
The whole urban world is in the same pot. We get our
choice of sauce.
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