Contrary to popular belief, THERE IS NO SOLUTION to the ongoing Global Financial Crisis:
The Ignorance Is Willful
By Greg hunter’s USAWatchdog.com
You might remember Dr. Michael Burry as the hedge fund manager who made hundreds of millions of dollars betting on the collapse of the housing market. You, also, might remember everyone from the mainstream media (MSM) to the Federal Reserve claimed nobody could have seen the 2008 financial collapse coming. How did Dr. Burry know a financial catastrophe was on the way while most financial experts and media were totally in the dark? This year’s commencement address at UCLA’s Department of Economics was given by Dr. Burry, and he says, “The ignorance is willful.”
“The ignorance is willful.” I think you can say the same thing about the ongoing banking crisis. Last Thursday, credit rating giant Moody’s downgraded the long-term credit ratings of 15 of the biggest North American and European banks. All but four were cut at least two notches, and these are some of the biggest banks in the world. RBC, JP Morgan, BNP Paribas, RBS and UBS are household names in Canada, U.S., France, UK and Switzerland. (Japan’s Numara and Australia’s Macquarie were downgraded earlier by Moody’s.) (Click here for a complete list of downgraded banks from Business Insider.) I can’t find a time when a major credit ratings company like Moody’s has downgraded this many major banks in so many parts of the world at the same time. Sure, critics of Moody’s will say they are way behind the curve, but the fact is the company has come out with bold and devastating bank downgrades when the world is being told it is in “recovery.” Please keep in mind, dozens of Italian and Spanish banks were, also, downgraded in the last few months by Moody’s.
The MSM greeted this enormously negative bank news with a yawn. USA Today, which touts itself as “The Nations Newspaper,” covered the story, last Friday, in the newspaper with less than 75 words! What kind of reporting is this? Both Goldman Sachs and JP Morgan were downgraded two notches by Moody’s, and both own more than 15 million shares (combined) of Gannett stock, which is the parent company of the newspaper. I am sure that had nothing to do with the very light coverage and analysis of this story. Bloomberg did a story that underplayed Moody’s downgrades titled “Bank Investors Dismiss Moody’s Cuts as Years Too Late.” The story ended by saying, “The reductions by Moody’s are “a mea culpa from 2007 and 2008,” said James Leonard, a credit analyst in Chicago at Morningstar Inc. (MORN) “The banks have gotten so much better in the last few years in terms of capital, yet their ratings keep going down. What does that tell you? That the ratings were so wrong before.” (Click here for the complete story.) As for the rest of the MSM, not a peep about this on any of the Sunday talk shows. It appears to me it is being played as no big deal.
This is the same treatment the financial press gives to what I call “government sanctioned accounting fraud” that the banks use to value underwater assets on their books such as real estate and mortgage-backed securities. The Financial Accounting Standards Board (FASB) changed the rules in 2009, and the banks can value these assets at whatever they think they will be worth at some fictional date in the future. Instead of “mark to market” accounting where assets are valued at what they will sell for today (this is how the IRS does it), you have “mark to fantasy” accounting where you value the assets at what you hope to get for them in the future. This is an insolvency problem so big that FASB had to change the accounting rules to make people think some banks are still solvent.
The same kind of accounting rule changes have taken place in Europe, where banks can “mark to fantasy” sovereign debt. It is not only the countries going broke, but the banks that hold sour debt that are insolvent. It appears things there are a bit more desperate and dire because, last week, The Guardian UK reported, “Mario Monti: we have a week to save the Eurozone . . . Italy’s prime minister . . . has warned of the apocalyptic consequences of failure at next week’s summit of EU leaders, outlining a potential death spiral that could threaten the political and economic future of Europe.” (Click here for the complete story.) What kind of financial management is this where you are down to a single week to fill an enormous financial black hole? Mr. Monti is an unelected banker, and I am sure his main concern is the survival of key European banks and not the well-being of the people. This is all about preserving the status quo and the power of the banks.
I have repeatedly said the global financial crisis is, in reality, a bank solvency crisis. The bank credit downgrades by Moody’s are another signpost on the road to perdition. Things are clearly not getting better, no matter how much the MSM underplays the crisis. The “nobody saw this coming” excuse will not work the next time there is a financial implosion, and there will be a next time. “The ignorance is willful.”
Ministry of [Un]Truth
By Eric Sprott & David Baker, Sprott Asset Management
Speaking at a Brussels conference back in April 2011, Eurogroup President Jean Claude Juncker notably stated during a panel discussion that "when it becomes serious, you have to lie." He was referring to situations where the act of "pre-indicating" decisions on eurozone policy could fuel speculation that could harm the markets and undermine their policies' effectiveness.1Everyone understands that the authorities sometimes lie in order to promote calm in the markets, but it was unexpected to hear such a high-level official actually admitto doing so. They're not supposed to admit that they lie. It is also somewhat disconcerting given the fact that virtually every economic event we have lived through since that time can very easily be described as "serious". Bank runs in Spain and Greece are indeed "serious", as is the weak economic data now emanating from Europe, the US and China. Should we assume that the authorities have been lying more frequently than usual over the past year?
When former Fed Chairman Alan Greenspan denied and down-played the US housing bubble back in 2004 and 2005, the market didn't realize how wrong he was until the bubble burst in 2007-2008. The same applies to the current Fed Chairman, Ben Bernanke, when he famously told US Congress in March of 2007 that "At this juncture…the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained."2 They weren't necessarily lying, per se, they just underestimated the seriousness of the problem. At this point in the crisis, however, we are hard pressed to believe anything uttered by a central planner or financial authority figure. How many times have we heard that the eurozone crisis has been solved? And how many times have we heard officials flat out lie while the roof is burning over their heads?
Back in March, following the successful €530 billion launch of LTRO II, European Central Bank President Mario Draghi assured Germany's Bild Newspaper that "The worst is over… the situation is stabilizing."3 The situation certainly did stabilize…for about a month. And then the bank runs started up again and sovereign bond yields spiked. Draghi has since treaded the awkward plank of promoting calm while slipping out enough bad news to ensure the eurocrats stay on their toes. As ING economist Carsten Brzeski aptly described at an ECB press conference in early June, "Listening to the ECB's macro-economic assessment was a bit like listening to whistles in the dark… It looks as if they are becoming increasingly worried, but do not want to show it."4 And the situation has now deteriorated to the point where Draghi can't possibly show it. Although Draghi does now warn of "serious downside risks" in the eurozone, he maintains that they are, in his words, "mostly to do with heightened uncertainty".5 Of course they are, Mario. Europe's issues are simply due to a vague feeling of unease felt among the EU populace. They have nothing to do with fact that the EU banking system is on the verge of collapsing in on itself.
When Prime Minister Mariano Rajoy assured the Spanish press that "There will be no rescue of the Spanish banking sector" on May 28th, the Spanish government announced a $125 billion bailout for its banks a mere two weeks later.6 This apparent deceit was not lost on the Spanish left, who were quick to dub him "Lying Rajoy". But Mr. Rajoy didn't seem phased in the least. As the Guardian writes, "Even when the outpouring of outrage forced Rajoy to call a hasty press conference the next day, he still refused to use the word "bailout" - or any other word for that matter - and referred mysteriously to "what happened on Saturday". He went as far as to say that Spain's emergency had been "resolved" ("thanks to my pressure", he said). He then took a plane to Poland to watch the national football team play ("the players deserve my presence")."7 Sound credible to you?
Then there are the bankers. Back in April, JP Morgan CEO Jamie Dimon blithely dismissed media reports as a "tempest in a teapot" that referred to massively outsized derivative positions held by the bank's traders in the Chief Investment Office in London. That "tempest" was soon revealed to have resulted in a $2 billion trading loss for the bank roughly four weeks later. In testimony before the Senate Banking Committee this past week, Dimon explained that "This particular synthetic credit portfolio was intended to earn a lot of revenue if there was a crisis. I consider that a hedge."8 He went on to add that regulators "can't stop something like this from happening. It was purely a management mistake."9 That's just wonderful. Can we expect more 'mistakes' of this nature in the coming months given JP Morgan's estimated $70 trillion in derivatives exposure? And will the US taxpayer willingly bail out JP Morgan when it does? Everyone knows the derivatives position wasn't a hedge - but what else is Dimon going to say? That JP Morgan is making reckless derivatives bets overseas with other people's money that's backstopped by the US government? Credibility is leaving the system.
There is certainly a sense that the authorities can no longer be candid about this ongoing crisis, even if they want to be. On June 11th Austria's finance minister, Maria Fekter, opined in a television interview that, "Italy has to work its way out of its economic dilemma of very high deficits and debt, but of course it may be that, given the high rates Italy pays to refinance on markets, they too will need support."10 Her honesty sent Italian bond yields soaring and earned her some harsh criticism from eurozone officials, including Italian Prime Minister Mario Monti. As one eurozone official stated, "The problem is that this is market sensitive… It's one thing if journalists write this but quite another if a eurozone minister says it. Verbal discipline is very important but she doesn't seem to get that."11 See no evil, hear no evil… and speak no evil. That's the way forward for the eurozone elites.
We have no doubt that everyone is tired of bad news, but we are compelled to review the facts: Europe is currently experiencing severe bank runs, budgets in virtually every western country on the planet are out of control, the banking system is running excessive leverage and risk, the costs of servicing the ever-increasing amounts of government debt are rising rapidly, and the economies of Europe, Asia and the United States are slowing down or are in full contraction. There's no sugar coating it and we have to stop listening to politicians and central planners who continue to downplay, obfuscate and flat out lie about the current economic reality. Stop listening to them.
NOTHING the central bankers have done up to this point has WORKED. All efforts have simply been aimed at keeping the financial system from imploding. QE I and II haven't worked. LTRO I and II haven't worked, and the most recent central bank initiatives are not even producing short-term benefits at this stage of the crisis. Just take Spain, for example. Following Rajoy's announcement of the $125 billion bailout loan for the Spanish banks on June 10th, Spanish bond yields were trading back over 7% one week later - the same yield level at which other eurozone countries have been forced to ask for further international aid.12 The market still doesn't even know what entity is going to pay the $125 billion, let alone when the funds will actually be released or whether the Spanish government will have to count it as part of its national debt. Spain is the fourth largest economy in the eurozone and larger than the previously bailedout Greece, Ireland and Portugal combined. At this point, it's not even clear if the ECB will be allowed to bail out a country of Spain's size, let alone Italy, which is now asking the ECB to use bailout funds to buyits sovereign bonds.13
The situation in Europe is becoming an exercise in futility. The positive effects of LTRO I and II, which combined pumped in over €1 trillion into European banks back in December 2011 and February 2012, have now been completely erased by the recent bank runs in Spain. Of the €523 billion released in LTRO II, roughly €200 billion was taken by Spanish banks.14 Of that amount, roughly €61 billion was estimated to have been reinvested back into Spanish sovereign bonds, which temporarily helped Spanish bond yields drop back to a sustainable level below 5.5%. Fast forward to today, and despite the LTRO infusions, the Spanish banks are all broke again after their underlying depositors withdrew billions over the past six weeks. The only liquid assets Spanish banks still own that they can sell to raise euros just happen to be government bonds… hence the rise in Spanish yields. So in essence, the entire benefit of the LTRO, which was a clever way of replenishing Spanish bank capital AND helping calm sovereign bond yields, has been completely reversed in roughly 14 weeks. It's as we've said before- it's not a sovereign problem, it's a banking problem. This is why Spanish Prime Minister Rajoy is now pleading for help "to break the link between risk in the banking sector and sovereign risk."15 Without a healthy sovereign bond market, peripheral eurozone countries simply have no way of supporting their bloated and insolvent banks.
The smart money is finally waking up to the dimension of the problem here and realizing that it's really a banking issue. Deposit flight has revealed the vulnerability of the European banking system: when depositors make withdrawals, the only assets the banks can sell to raise liquidity are sovereign bonds, which creates the vicious downward spiral that up to this point has always resulted in some form of central bank bailout. Many eurozone authorities still have trouble understanding this. As Spanish Economy Minister, Luis de Guindos, recently stated to reporters at the G20 Summit, "We think… that the way markets are penalizing Spain today does not reflect the efforts we have made or the growth potential of the economy… Spain is a solvent country and a country which has a capacity to grow."16Every country has the capacity to grow. Not every country has a domestic banking system that has already borrowed €316 billion from the ECB so far this year (pre the most recently announced bailout), and needs to rollover roughly €600 billion in bank debt in 2012.17That may be why the markets are reacting the way they are.
If you want to know what's really going on, listen to the executives of companies that actually produce and sell things. On May 24, Tiffany & Co cut its fiscal-year sales and profit forecasts blaming "slowing growth in key markets like China and weakness in the United States as shoppers think twice about spending on high-end jewelry."18 On June 8th, McDonald's surprised the market with lower than expected same-store sales growth in May, following a lacklustre April sales report that the company stated was "largely due to underperformance in the United States, where consumers continue to seek out very low-priced food."19, 20 On June 13th, Nucor Corp., the largest U.S. steelmaker by market value warned that its second-quarter profit will miss its previous guidance after a "surge" in imports undermined prices and "political and economic uncertainty affect buyers' confidence".21 On June 20th, Proctor and Gamble lowered its fourth quarter guidance and profit forecast for 2012. Factors that drove the company's challenges included "slow-to-no GDP growth in developed markets", high unemployment levels, significant commodity cost increases and "highly volatile foreign exchange rates".22 Other companies that have recently lowered guidance include Danone, Nestle, Unilever, Cisco Systems, Dell, Lowe's, and Fedex. It's ugly out there, and many companies are politely warning the market about the type of environment they foresee ahead in both the US and abroad.
To give you a hint of how bad it is in Europe today, the most recent retail sales out of Netherlands showed a decline of 8.7% year-over-year in April.23 In Spain, retail sales fell 9.8% year-on-year in April, which was 6% greater than the revised drop of 3.8% in March.24Declines of this magnitude are not normal occurrences and signal a significant shift in spending within those countries. We fear this is a sign of things to come within the broader Eurozone, which will only serve to complicate an already dire situation that much more.
The G6 central banks are out of conventional tools to solve this financial crisis. With interest rates at zero, and the thought of further stimulus rendered politically unpalatable for the time being, we cannot see any positive solutions to this problem other than debt repudiation. We continue to note the contrast between the reporting companies who by law cannot lie about their fiscal realities, versus the central planners who admit that they MUST lie to preserve calm and control. We'll leave it to you to decide whose version of the truth you want to believe.
Panic in the New World Order
For the first time in my career, I see the international establishment, sometimes called the New World Order, facing a crisis so large that its very survival is at stake. For the first time, these people are scared.
There are not many of them. In his book, Superclass, author David Rothkopf estimates that there are only about 6000 people at the top of the pyramid of world power and influence. They are mostly males, and at least a third of them have attended America's most prestigious universities. Most of the others have attended comparable universities in Europe.
The crisis in Europe is clearly beyond anything that this generation of establishment leaders has ever seen. The last time that anything like this faced the European establishment, it led to World War II.
During the entire postwar period, the United States has been the dominant force in the West. The United States government through the Marshall Plan wrote the checks to keep the European governments afloat, and it funded most of NATO, the mutual defense system that was set up to constrain the expansion of the Soviet Union.
The United States is no longer in a position to bail out anybody. It is running a massive trade deficit, and is running a massive federal deficit. Europe realizes now that, from an economic standpoint, it is on its own. If there are solutions to the European economic crisis, these solutions are going to have to be generated inside the eurozone.
BANKS AT RISK
Today, the entire banking system of Europe is at risk. The banks are highly leveraged, and they have made enormous investments at low-interest rates in bonds issued by governments that are technically insolvent. There is no possibility that any of these bonds will ever be repaid. They were never designed to be repaid. They were designed to keep the taxpayers of all European countries in permanent bondage to the banking system.
Now, in a complete reversal of fortune, the banks are increasingly dependent on the governments. The governments are now the lenders of next-to-last resort to the commercial banks. The central bank, of course, is the lender of last resort. But today, the European Central Bank has moved into neutral. It does not want to take action to bail out Greece, Spain, or Italy.
The PIIGS governments that wrote the IOUs to the banks in northern Europe are technically insolvent. When Greece defaults, which it will, there will be enormous losses sustained by some northern European banks. When Spain defaults, which it will, these losses will get far worse. When Italy defaults, which it will, the entire banking system of Europe will be busted.
The only things that can save European banking system today are the European Central Bank, which has the power to create money out of nothing, and the taxpayers of Germany, whose national leaders are relentless in their desire to expand the power of the eurozone over all of Europe. These politicians are willing to write IOUs on behalf of German taxpayers in order to extend this consolidation.
A DAISY CHAIN OF DEBT
The problem is, the Northern European governments do not have any money to serve as lenders to Greece, Spain, or Italy. They are borrowing money at rates not seen before in peacetime Europe. These governments are expected to intervene and lend money to the Greek government. But every northern European government is now faced with the additional responsibility of being the lender of next-to-last resort to the large commercial banks inside its own borders.
Who is going to lend northern European governments enough money to bail out southern European governments? Which lenders think this is a good idea today? At today's rate of interest, not that many. That is why interest rates are going to rise. But when long-term interest rates rise, that will lower the present market value of all of the bonds in the portfolios of the lenders.
So, on the one hand, investors have to pony up the money to lend to the governments, and the governments need the money to recapitalize the banks in their own borders. This leads to the next problem: in order for the lenders to lend money to a government, they have to write checks on their bank accounts. What happens if their banks should go under? Who will lend money to the governments?
In this daisy chain of fiat money, credit, and debt, the European Central Bank is the lender of last resort. It is the lender of last resort because it has the legal authority to create money out of nothing. It can buy IOUs issued by governments, and it can lend money to banks, so that the banks can buy the IOUs of governments.
DAYS OF RECKONING
The entire political system that we know as the European Union is dependent upon a system of fractional reserve banking which has overextended itself, and now faces a day of reckoning. Actually, it faces two days of reckoning.
First, there is a day of reckoning in the PIIGS countries, when depositors withdraw funds. The second day of reckoning is going to be imposed by the insolvent governments who have been borrowing hundreds of billions of euros from the banks.
The arrival of a bank run threatens the ability of the Greek government to borrow money from anybody. The Greek government is dependent upon the Greek banking system to collect taxes. If the Greek banking system goes belly-up, the Greek government goes belly-up.
In this system, only the European Central Bank has the authority to bail out the system. Every other potential source of euros is dependent on the solvency of the European banking system. But that is exactly what is at risk today.
This is why all fractional reserve banking must ultimately rest on the monopoly granted by government to a central bank. The central bank, above all, is the guarantor of the solvency of the largest banks. The central bank is the economic agent of the owners of the largest commercial banks. These owners are now facing bankruptcy. They hold shares in multinational banks whose lending officers had no understanding of basic economics. They wrote checks to the PIIGS.
In this scenario, the only way to save the system is to risk destroying it. The only way to save the euro is to risk destroying it. This is because there are only two ways to save the largest commercial banks. The first way is by hyperinflation. This will enable the banks to keep their doors open, but the borrowers will be able to pay off their loans by selling a handful of hard assets, which will raise enough money to pay off the loans with worthless euros.
The second way to save the banks, which is what the European Central Bank is attempting to do, is to avoid hyperinflation, and to inflate the money supply only to the degree that the largest banks can be bailed out by making low-interest loans available to them. They in turn must lend out the money, if they can find solvent borrowers, and if those borrowers are willing to borrow.
If the European Central Bank adopts the second approach, this is going to lead to a depression. The bank has inflated. The commercial banks have lent money to insolvent governments. These governments are going to default if there is a recession, but by refusing to expand the money supply, the European Central Bank will produce a recession. The boom that it fostered in the Greenspan years has blown up on European banks, in the same way that the boom in the United States has blown up on America's banks.
There is no equivalent of the FDIC in the European banking system. There is no single government that has the assets or the legal authority to lend to any and all of the other governments. There is no common fiscal system, which means that all the governments can run massive deficits. This means that the governments are in constant competition with each other to borrow enough money to fund their deficits.
So, the system is stretched to the limits. The few remaining lenders with capital who have enough money in their banks to write checks to insolvent governments are now refusing to write the checks. This is why Spain is paying over 7% to get lenders to fork over their money. Lenders who do this are going to wind up like the saps who loaned money to the Greek government prior to 2010. They are going to see the value of their investments collapse as interest rates go to double digits in Spain, which they are going to do unless the European Central Bank intervenes and makes fiat money loans to Spain's government.
WEEKEND SUMMITS
There is now at least one monthly emergency weekend meeting of the political authorities, accompanied by their bureaucrats from the ministries of finance. They come together on a Saturday to talk about how they can save the system. They issue a press release on Sunday. The press release is always short on specifics. Within a month, the crisis has escalated again, and there is another weekend summit meeting.
Every time there is a summit meeting, the investing public that has sufficient money to invest waits with bated breath to see if there is some solution offered on Sunday afternoon. There never is a solution offered, so the stock market drops for the first day or two after the meeting.
It is clear by now to everybody that there is no solution forthcoming. There is no agreement politically, especially between Germany and France, as to who is going to write the checks to bail out the next PIIGS government to hit the brick wall.
I can remember almost 40 years ago listening to a speech by a young hotshot economist at Yale, who informed us that there would be a new currency system established in Europe by the year 2000. This was an accurate forecast. It was established in 1999. The hotshot later moved to Harvard. He has generally disappeared from public view. But it was clear from his enthusiastic speech that he was convinced that this new currency system would create a completely new economic order in Europe. Boy, was he right!
The new economic order in Europe is now disintegrating. The establishment politicians, bureaucrats, and spokesmen are looking in horror as the system which their predecessors designed to work permanently is disintegrating. Not to put too fine a point to it, but this is reminiscent of Adolf Hitler's promise about the thousand-year Reich. It lasted 13 years. This year, the euro had its 13th birthday. So far, it has not had a happy birthday.
NO FIREWALL
The leaders of the European establishment have never had to deal with any crisis on a scale like this one. They keep talking of the need for firewalls. Until they have firewalls, nobody is willing to yell "Fire!" Yet the fire is now raging.
What kind of firewall can be created that keeps a default by one government from becoming a default by another government? What firewall is there for a large multinational bank that has just lost half of the value of the bonds that it purchased at a rate of 3%, now that the interest rate is 7%? Every time the interest rate doubles, the market value of the bonds decreases by 50%, minimum.
There is no firewall. The financial system of Europe is interrelated by way of the euro. Everybody uses the same currency in 17 countries. Everybody is dependent upon the same central bank, and that bank is not exercising leadership. The head of the bank keeps saying that the governments have to step up to the plate and take responsibility. Every time he says this, I am reminded of what Ben Bernanke keeps telling Congress.
The heads of the two largest central banks in the world keep complaining that the politicians have got to take responsibility for solving the crisis. But this is exactly what the politicians do not want to do. The politicians have always understood that the central bank would bail them out of their crisis, merely by creating new money and buying the IOUs of the government. This has always been the public justification of central banking.
The politicians seem blind to the real reason for the existence of central banking, namely, to bail out the largest commercial banks under its jurisdiction. The European Central Bank faces an enormous problem: it has under its jurisdiction the largest banks in every country in the eurozone, other than Great Britain. It has to intervene to save any large bank that is under its jurisdiction, because if it does not, there will be bank runs in that nation.
A BANK RUN
Depositors can go down to their banks and have money transferred to a bank outside the country. Usually, this is going to be a German bank. Legally, the recipient bank can refuse to take a deposit, but what bank would dare not take deposits? Any bank that would say that it was not taking deposits from any other bank would be sending a signal to the media that the other bank is bordering on insolvency. That is the last thing that any bank in northern Europe wants to do with respect to any bank in Greece, Spain, or Italy.
The European Central Bank is sitting on a powder keg. The fuse has already been lit. That fuse is connected to the Greek banking system. If the Greek banking system blows up, by which I mean implodes, that will light another fuse. The other fuse leads to Spain. I could be wrong. There may be two fuses, one leading to Spain, and the other leading to Italy.
There is no firewall. The only firewall would be for banks in northern Europe to refuse to take new accounts from people who were closing out their accounts in southern Europe. But if they do not stop the bank runs from taking place in Greece, the Greek government is going to default on its debt and pull out of the eurozone. It will have no choice. If its banks are collapsing, how will it be able to fund its debt? How will it be able to collect taxes?
You can see what is at stake here. A small-scale bank run has been going on for at least a year in Greece, and it is now threatening to escalate into a full-scale run. Northern European banks could refuse to take new deposits in euros from existing depositors in Greece. But they would all have to do this at once. If only one or two major banks in northern Europe refuse to accept new accounts from Greeks, this will send a message to all the other Greeks: "You had better get your money out of your bank, fast, and get it into a northern European bank that has not yet closed off new deposits." The bank run escalates.
Because not all of the banks are under the same banking laws, and because no regulatory agency can tell them what to do, Europe has a system in which depositors in PIIGS nations can create massive bank runs against the banks in their own nations.
There is no firewall against this. The bank runs have begun in Greece. Banks outside of the eurozone can refuse to take on new deposits, but banks inside the eurozone cannot do this without threatening the survival of the entire banking system. Furthermore, if they do not create a firewall, the collapsed banks of Greece, Spain, and Italy will lead to the bankruptcy of their respective governments, and that in turn will lead to massive losses in northern European banks.
You do not see a detailed discussion of this in the mainstream press, for very good reason: the mainstream press is afraid of being blamed for triggering a bank run out of Greek banks. Everybody in authority knows a Greek bank run has begun, but this is not front page news. It is certainly not a story on the evening television news shows. Maybe "The PBS News Hour" will bring in two or three experts to discuss it, who will offer rival views, but the network news will not talk about the Greek bank run until it is in its terminal stage.
So, the people who run the new European order sit there, helpless, completely dependent upon decisions made by depositors in Greek banks. At any time, a wave of fear could spread through Greece, and a majority of depositors will start lining up to get their money. If they take out their money in currency, this collapses the local bank, which has to sell assets to buy the currency from the European Central Bank in order to hand the currency to the depositor. That kind of bank run is bad for a single bank, but usually depositors spend the money. When a depositor spends the money, the business that receives the money re-deposits the money in its bank. So, a bank run into currency is not a huge threat to the Greek banking system as a whole.
In contrast, however, is a bank run in the form of the transfer of digital money out of the country. All of the Greek banks are facing this threat today. Once the euros leave the Greek banking system, they are not redeposited in the Greek banking system.
What we are seeing is the collapse of the Greek banking system. Unless the European Central Bank intervenes again, by the end of the year, there is not going to be a Greek banking system. All of the banks will be busted.
There is nothing that the Eurocrats can do about this. The only agency that has the power to stop this is the European Central Bank, which can do whatever it wants to do, ultimately, which means lending money to Greek banks based on any collateral they want to put up, especially IOUs issued by the Greek government.
CONCLUSION
Angela Merkel can scream, yell, and hold her breath until she turns blue, but ultimately she has no power over the European Central Bank. Ultimately, no politician has any power over it. No politician really wants power over it. Why not? Because that politician would then be responsible for coming up with the money that the European Central Bank was about to come up with, but which was stymied by the politician.
This is why the European Central Bank is going to inflate, inflate, and inflate. The head of the bank can make all the comments he wants about the responsibility of politicians to intervene to keep the structure going, but he is ultimately the bagman of the system. He is the guy who has control over the printing press. He is the only person, along with his colleagues, who is in a position to keep the system afloat.
There is no firewall. There is only the ability of the European Central Bank to create money, and to do so by lending it to commercial banks or directly to governments. It does not matter what kind of rules and regulations are in place that were supposed to prohibit this back in 1999.
In the midst of a conflagration, nobody in power is going to point a finger at the European Central Bank when the bank intervenes to bail out a government that is about to default on its debt. The reason is clear, or at least is clear to me: no politician wants to be responsible for coming up with the money to bail out the largest banks in his country, all of which will be threatened with insolvency because of the default of Greece and Spain, because that will produce a domino effect by all of the PIIGS governments.
June 23, 2012
Gary North [send him mail] is the author of Mises on Money. Visithttp://www.garynorth.com. He is also the author of a free 20-volume series,An Economic Commentary on the Bible.
Copyright © 2000 Gary North
The G20 on the eurozone and fiscal policy
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The Ignorance Is Willful
By Greg hunter’s USAWatchdog.com You might remember Dr. Michael Burry as the hedge fund manager who made hundreds of millions of dollars betting on the collapse of the housing market. You, also, might remember everyone from the mainstream media (MSM) to the Federal Reserve claimed nobody could have seen the 2008 financial collapse coming. How did Dr. Burry know a financial catastrophe was on the way while most financial experts and media were totally in the dark? This year’s commencement address at UCLA’s Department of Economics was given by Dr. Burry, and he says, “The ignorance is willful.”
“The ignorance is willful.” I think you can say the same thing about the ongoing banking crisis. Last Thursday, credit rating giant Moody’s downgraded the long-term credit ratings of 15 of the biggest North American and European banks. All but four were cut at least two notches, and these are some of the biggest banks in the world. RBC, JP Morgan, BNP Paribas, RBS and UBS are household names in Canada, U.S., France, UK and Switzerland. (Japan’s Numara and Australia’s Macquarie were downgraded earlier by Moody’s.) (Click here for a complete list of downgraded banks from Business Insider.) I can’t find a time when a major credit ratings company like Moody’s has downgraded this many major banks in so many parts of the world at the same time. Sure, critics of Moody’s will say they are way behind the curve, but the fact is the company has come out with bold and devastating bank downgrades when the world is being told it is in “recovery.” Please keep in mind, dozens of Italian and Spanish banks were, also, downgraded in the last few months by Moody’s.
The MSM greeted this enormously negative bank news with a yawn. USA Today, which touts itself as “The Nations Newspaper,” covered the story, last Friday, in the newspaper with less than 75 words! What kind of reporting is this? Both Goldman Sachs and JP Morgan were downgraded two notches by Moody’s, and both own more than 15 million shares (combined) of Gannett stock, which is the parent company of the newspaper. I am sure that had nothing to do with the very light coverage and analysis of this story. Bloomberg did a story that underplayed Moody’s downgrades titled “Bank Investors Dismiss Moody’s Cuts as Years Too Late.” The story ended by saying, “The reductions by Moody’s are “a mea culpa from 2007 and 2008,” said James Leonard, a credit analyst in Chicago at Morningstar Inc. (MORN) “The banks have gotten so much better in the last few years in terms of capital, yet their ratings keep going down. What does that tell you? That the ratings were so wrong before.” (Click here for the complete story.) As for the rest of the MSM, not a peep about this on any of the Sunday talk shows. It appears to me it is being played as no big deal.
This is the same treatment the financial press gives to what I call “government sanctioned accounting fraud” that the banks use to value underwater assets on their books such as real estate and mortgage-backed securities. The Financial Accounting Standards Board (FASB) changed the rules in 2009, and the banks can value these assets at whatever they think they will be worth at some fictional date in the future. Instead of “mark to market” accounting where assets are valued at what they will sell for today (this is how the IRS does it), you have “mark to fantasy” accounting where you value the assets at what you hope to get for them in the future. This is an insolvency problem so big that FASB had to change the accounting rules to make people think some banks are still solvent.
The same kind of accounting rule changes have taken place in Europe, where banks can “mark to fantasy” sovereign debt. It is not only the countries going broke, but the banks that hold sour debt that are insolvent. It appears things there are a bit more desperate and dire because, last week, The Guardian UK reported, “Mario Monti: we have a week to save the Eurozone . . . Italy’s prime minister . . . has warned of the apocalyptic consequences of failure at next week’s summit of EU leaders, outlining a potential death spiral that could threaten the political and economic future of Europe.” (Click here for the complete story.) What kind of financial management is this where you are down to a single week to fill an enormous financial black hole? Mr. Monti is an unelected banker, and I am sure his main concern is the survival of key European banks and not the well-being of the people. This is all about preserving the status quo and the power of the banks.
I have repeatedly said the global financial crisis is, in reality, a bank solvency crisis. The bank credit downgrades by Moody’s are another signpost on the road to perdition. Things are clearly not getting better, no matter how much the MSM underplays the crisis. The “nobody saw this coming” excuse will not work the next time there is a financial implosion, and there will be a next time. “The ignorance is willful.”
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By Eric Sprott & David Baker, Sprott Asset Management
Speaking at a Brussels conference back in April 2011, Eurogroup President Jean Claude Juncker notably stated during a panel discussion that "when it becomes serious, you have to lie." He was referring to situations where the act of "pre-indicating" decisions on eurozone policy could fuel speculation that could harm the markets and undermine their policies' effectiveness.1Everyone understands that the authorities sometimes lie in order to promote calm in the markets, but it was unexpected to hear such a high-level official actually admitto doing so. They're not supposed to admit that they lie. It is also somewhat disconcerting given the fact that virtually every economic event we have lived through since that time can very easily be described as "serious". Bank runs in Spain and Greece are indeed "serious", as is the weak economic data now emanating from Europe, the US and China. Should we assume that the authorities have been lying more frequently than usual over the past year?
When former Fed Chairman Alan Greenspan denied and down-played the US housing bubble back in 2004 and 2005, the market didn't realize how wrong he was until the bubble burst in 2007-2008. The same applies to the current Fed Chairman, Ben Bernanke, when he famously told US Congress in March of 2007 that "At this juncture…the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained."2 They weren't necessarily lying, per se, they just underestimated the seriousness of the problem. At this point in the crisis, however, we are hard pressed to believe anything uttered by a central planner or financial authority figure. How many times have we heard that the eurozone crisis has been solved? And how many times have we heard officials flat out lie while the roof is burning over their heads?
Back in March, following the successful €530 billion launch of LTRO II, European Central Bank President Mario Draghi assured Germany's Bild Newspaper that "The worst is over… the situation is stabilizing."3 The situation certainly did stabilize…for about a month. And then the bank runs started up again and sovereign bond yields spiked. Draghi has since treaded the awkward plank of promoting calm while slipping out enough bad news to ensure the eurocrats stay on their toes. As ING economist Carsten Brzeski aptly described at an ECB press conference in early June, "Listening to the ECB's macro-economic assessment was a bit like listening to whistles in the dark… It looks as if they are becoming increasingly worried, but do not want to show it."4 And the situation has now deteriorated to the point where Draghi can't possibly show it. Although Draghi does now warn of "serious downside risks" in the eurozone, he maintains that they are, in his words, "mostly to do with heightened uncertainty".5 Of course they are, Mario. Europe's issues are simply due to a vague feeling of unease felt among the EU populace. They have nothing to do with fact that the EU banking system is on the verge of collapsing in on itself.
When Prime Minister Mariano Rajoy assured the Spanish press that "There will be no rescue of the Spanish banking sector" on May 28th, the Spanish government announced a $125 billion bailout for its banks a mere two weeks later.6 This apparent deceit was not lost on the Spanish left, who were quick to dub him "Lying Rajoy". But Mr. Rajoy didn't seem phased in the least. As the Guardian writes, "Even when the outpouring of outrage forced Rajoy to call a hasty press conference the next day, he still refused to use the word "bailout" - or any other word for that matter - and referred mysteriously to "what happened on Saturday". He went as far as to say that Spain's emergency had been "resolved" ("thanks to my pressure", he said). He then took a plane to Poland to watch the national football team play ("the players deserve my presence")."7 Sound credible to you?
Then there are the bankers. Back in April, JP Morgan CEO Jamie Dimon blithely dismissed media reports as a "tempest in a teapot" that referred to massively outsized derivative positions held by the bank's traders in the Chief Investment Office in London. That "tempest" was soon revealed to have resulted in a $2 billion trading loss for the bank roughly four weeks later. In testimony before the Senate Banking Committee this past week, Dimon explained that "This particular synthetic credit portfolio was intended to earn a lot of revenue if there was a crisis. I consider that a hedge."8 He went on to add that regulators "can't stop something like this from happening. It was purely a management mistake."9 That's just wonderful. Can we expect more 'mistakes' of this nature in the coming months given JP Morgan's estimated $70 trillion in derivatives exposure? And will the US taxpayer willingly bail out JP Morgan when it does? Everyone knows the derivatives position wasn't a hedge - but what else is Dimon going to say? That JP Morgan is making reckless derivatives bets overseas with other people's money that's backstopped by the US government? Credibility is leaving the system.
There is certainly a sense that the authorities can no longer be candid about this ongoing crisis, even if they want to be. On June 11th Austria's finance minister, Maria Fekter, opined in a television interview that, "Italy has to work its way out of its economic dilemma of very high deficits and debt, but of course it may be that, given the high rates Italy pays to refinance on markets, they too will need support."10 Her honesty sent Italian bond yields soaring and earned her some harsh criticism from eurozone officials, including Italian Prime Minister Mario Monti. As one eurozone official stated, "The problem is that this is market sensitive… It's one thing if journalists write this but quite another if a eurozone minister says it. Verbal discipline is very important but she doesn't seem to get that."11 See no evil, hear no evil… and speak no evil. That's the way forward for the eurozone elites.
We have no doubt that everyone is tired of bad news, but we are compelled to review the facts: Europe is currently experiencing severe bank runs, budgets in virtually every western country on the planet are out of control, the banking system is running excessive leverage and risk, the costs of servicing the ever-increasing amounts of government debt are rising rapidly, and the economies of Europe, Asia and the United States are slowing down or are in full contraction. There's no sugar coating it and we have to stop listening to politicians and central planners who continue to downplay, obfuscate and flat out lie about the current economic reality. Stop listening to them.
NOTHING the central bankers have done up to this point has WORKED. All efforts have simply been aimed at keeping the financial system from imploding. QE I and II haven't worked. LTRO I and II haven't worked, and the most recent central bank initiatives are not even producing short-term benefits at this stage of the crisis. Just take Spain, for example. Following Rajoy's announcement of the $125 billion bailout loan for the Spanish banks on June 10th, Spanish bond yields were trading back over 7% one week later - the same yield level at which other eurozone countries have been forced to ask for further international aid.12 The market still doesn't even know what entity is going to pay the $125 billion, let alone when the funds will actually be released or whether the Spanish government will have to count it as part of its national debt. Spain is the fourth largest economy in the eurozone and larger than the previously bailedout Greece, Ireland and Portugal combined. At this point, it's not even clear if the ECB will be allowed to bail out a country of Spain's size, let alone Italy, which is now asking the ECB to use bailout funds to buyits sovereign bonds.13
The situation in Europe is becoming an exercise in futility. The positive effects of LTRO I and II, which combined pumped in over €1 trillion into European banks back in December 2011 and February 2012, have now been completely erased by the recent bank runs in Spain. Of the €523 billion released in LTRO II, roughly €200 billion was taken by Spanish banks.14 Of that amount, roughly €61 billion was estimated to have been reinvested back into Spanish sovereign bonds, which temporarily helped Spanish bond yields drop back to a sustainable level below 5.5%. Fast forward to today, and despite the LTRO infusions, the Spanish banks are all broke again after their underlying depositors withdrew billions over the past six weeks. The only liquid assets Spanish banks still own that they can sell to raise euros just happen to be government bonds… hence the rise in Spanish yields. So in essence, the entire benefit of the LTRO, which was a clever way of replenishing Spanish bank capital AND helping calm sovereign bond yields, has been completely reversed in roughly 14 weeks. It's as we've said before- it's not a sovereign problem, it's a banking problem. This is why Spanish Prime Minister Rajoy is now pleading for help "to break the link between risk in the banking sector and sovereign risk."15 Without a healthy sovereign bond market, peripheral eurozone countries simply have no way of supporting their bloated and insolvent banks.
The smart money is finally waking up to the dimension of the problem here and realizing that it's really a banking issue. Deposit flight has revealed the vulnerability of the European banking system: when depositors make withdrawals, the only assets the banks can sell to raise liquidity are sovereign bonds, which creates the vicious downward spiral that up to this point has always resulted in some form of central bank bailout. Many eurozone authorities still have trouble understanding this. As Spanish Economy Minister, Luis de Guindos, recently stated to reporters at the G20 Summit, "We think… that the way markets are penalizing Spain today does not reflect the efforts we have made or the growth potential of the economy… Spain is a solvent country and a country which has a capacity to grow."16Every country has the capacity to grow. Not every country has a domestic banking system that has already borrowed €316 billion from the ECB so far this year (pre the most recently announced bailout), and needs to rollover roughly €600 billion in bank debt in 2012.17That may be why the markets are reacting the way they are.
If you want to know what's really going on, listen to the executives of companies that actually produce and sell things. On May 24, Tiffany & Co cut its fiscal-year sales and profit forecasts blaming "slowing growth in key markets like China and weakness in the United States as shoppers think twice about spending on high-end jewelry."18 On June 8th, McDonald's surprised the market with lower than expected same-store sales growth in May, following a lacklustre April sales report that the company stated was "largely due to underperformance in the United States, where consumers continue to seek out very low-priced food."19, 20 On June 13th, Nucor Corp., the largest U.S. steelmaker by market value warned that its second-quarter profit will miss its previous guidance after a "surge" in imports undermined prices and "political and economic uncertainty affect buyers' confidence".21 On June 20th, Proctor and Gamble lowered its fourth quarter guidance and profit forecast for 2012. Factors that drove the company's challenges included "slow-to-no GDP growth in developed markets", high unemployment levels, significant commodity cost increases and "highly volatile foreign exchange rates".22 Other companies that have recently lowered guidance include Danone, Nestle, Unilever, Cisco Systems, Dell, Lowe's, and Fedex. It's ugly out there, and many companies are politely warning the market about the type of environment they foresee ahead in both the US and abroad.
To give you a hint of how bad it is in Europe today, the most recent retail sales out of Netherlands showed a decline of 8.7% year-over-year in April.23 In Spain, retail sales fell 9.8% year-on-year in April, which was 6% greater than the revised drop of 3.8% in March.24Declines of this magnitude are not normal occurrences and signal a significant shift in spending within those countries. We fear this is a sign of things to come within the broader Eurozone, which will only serve to complicate an already dire situation that much more.
The G6 central banks are out of conventional tools to solve this financial crisis. With interest rates at zero, and the thought of further stimulus rendered politically unpalatable for the time being, we cannot see any positive solutions to this problem other than debt repudiation. We continue to note the contrast between the reporting companies who by law cannot lie about their fiscal realities, versus the central planners who admit that they MUST lie to preserve calm and control. We'll leave it to you to decide whose version of the truth you want to believe.
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By: Gary North
There are not many of them. In his book, Superclass, author David Rothkopf estimates that there are only about 6000 people at the top of the pyramid of world power and influence. They are mostly males, and at least a third of them have attended America's most prestigious universities. Most of the others have attended comparable universities in Europe.
The crisis in Europe is clearly beyond anything that this generation of establishment leaders has ever seen. The last time that anything like this faced the European establishment, it led to World War II.
During the entire postwar period, the United States has been the dominant force in the West. The United States government through the Marshall Plan wrote the checks to keep the European governments afloat, and it funded most of NATO, the mutual defense system that was set up to constrain the expansion of the Soviet Union.
The United States is no longer in a position to bail out anybody. It is running a massive trade deficit, and is running a massive federal deficit. Europe realizes now that, from an economic standpoint, it is on its own. If there are solutions to the European economic crisis, these solutions are going to have to be generated inside the eurozone.
BANKS AT RISK
Today, the entire banking system of Europe is at risk. The banks are highly leveraged, and they have made enormous investments at low-interest rates in bonds issued by governments that are technically insolvent. There is no possibility that any of these bonds will ever be repaid. They were never designed to be repaid. They were designed to keep the taxpayers of all European countries in permanent bondage to the banking system.
Now, in a complete reversal of fortune, the banks are increasingly dependent on the governments. The governments are now the lenders of next-to-last resort to the commercial banks. The central bank, of course, is the lender of last resort. But today, the European Central Bank has moved into neutral. It does not want to take action to bail out Greece, Spain, or Italy.
The PIIGS governments that wrote the IOUs to the banks in northern Europe are technically insolvent. When Greece defaults, which it will, there will be enormous losses sustained by some northern European banks. When Spain defaults, which it will, these losses will get far worse. When Italy defaults, which it will, the entire banking system of Europe will be busted.
The only things that can save European banking system today are the European Central Bank, which has the power to create money out of nothing, and the taxpayers of Germany, whose national leaders are relentless in their desire to expand the power of the eurozone over all of Europe. These politicians are willing to write IOUs on behalf of German taxpayers in order to extend this consolidation.
A DAISY CHAIN OF DEBT
The problem is, the Northern European governments do not have any money to serve as lenders to Greece, Spain, or Italy. They are borrowing money at rates not seen before in peacetime Europe. These governments are expected to intervene and lend money to the Greek government. But every northern European government is now faced with the additional responsibility of being the lender of next-to-last resort to the large commercial banks inside its own borders.
Who is going to lend northern European governments enough money to bail out southern European governments? Which lenders think this is a good idea today? At today's rate of interest, not that many. That is why interest rates are going to rise. But when long-term interest rates rise, that will lower the present market value of all of the bonds in the portfolios of the lenders.
So, on the one hand, investors have to pony up the money to lend to the governments, and the governments need the money to recapitalize the banks in their own borders. This leads to the next problem: in order for the lenders to lend money to a government, they have to write checks on their bank accounts. What happens if their banks should go under? Who will lend money to the governments?
In this daisy chain of fiat money, credit, and debt, the European Central Bank is the lender of last resort. It is the lender of last resort because it has the legal authority to create money out of nothing. It can buy IOUs issued by governments, and it can lend money to banks, so that the banks can buy the IOUs of governments.
DAYS OF RECKONING
The entire political system that we know as the European Union is dependent upon a system of fractional reserve banking which has overextended itself, and now faces a day of reckoning. Actually, it faces two days of reckoning.
First, there is a day of reckoning in the PIIGS countries, when depositors withdraw funds. The second day of reckoning is going to be imposed by the insolvent governments who have been borrowing hundreds of billions of euros from the banks.
The arrival of a bank run threatens the ability of the Greek government to borrow money from anybody. The Greek government is dependent upon the Greek banking system to collect taxes. If the Greek banking system goes belly-up, the Greek government goes belly-up.
In this system, only the European Central Bank has the authority to bail out the system. Every other potential source of euros is dependent on the solvency of the European banking system. But that is exactly what is at risk today.
This is why all fractional reserve banking must ultimately rest on the monopoly granted by government to a central bank. The central bank, above all, is the guarantor of the solvency of the largest banks. The central bank is the economic agent of the owners of the largest commercial banks. These owners are now facing bankruptcy. They hold shares in multinational banks whose lending officers had no understanding of basic economics. They wrote checks to the PIIGS.
In this scenario, the only way to save the system is to risk destroying it. The only way to save the euro is to risk destroying it. This is because there are only two ways to save the largest commercial banks. The first way is by hyperinflation. This will enable the banks to keep their doors open, but the borrowers will be able to pay off their loans by selling a handful of hard assets, which will raise enough money to pay off the loans with worthless euros.
The second way to save the banks, which is what the European Central Bank is attempting to do, is to avoid hyperinflation, and to inflate the money supply only to the degree that the largest banks can be bailed out by making low-interest loans available to them. They in turn must lend out the money, if they can find solvent borrowers, and if those borrowers are willing to borrow.
If the European Central Bank adopts the second approach, this is going to lead to a depression. The bank has inflated. The commercial banks have lent money to insolvent governments. These governments are going to default if there is a recession, but by refusing to expand the money supply, the European Central Bank will produce a recession. The boom that it fostered in the Greenspan years has blown up on European banks, in the same way that the boom in the United States has blown up on America's banks.
There is no equivalent of the FDIC in the European banking system. There is no single government that has the assets or the legal authority to lend to any and all of the other governments. There is no common fiscal system, which means that all the governments can run massive deficits. This means that the governments are in constant competition with each other to borrow enough money to fund their deficits.
So, the system is stretched to the limits. The few remaining lenders with capital who have enough money in their banks to write checks to insolvent governments are now refusing to write the checks. This is why Spain is paying over 7% to get lenders to fork over their money. Lenders who do this are going to wind up like the saps who loaned money to the Greek government prior to 2010. They are going to see the value of their investments collapse as interest rates go to double digits in Spain, which they are going to do unless the European Central Bank intervenes and makes fiat money loans to Spain's government.
WEEKEND SUMMITS
There is now at least one monthly emergency weekend meeting of the political authorities, accompanied by their bureaucrats from the ministries of finance. They come together on a Saturday to talk about how they can save the system. They issue a press release on Sunday. The press release is always short on specifics. Within a month, the crisis has escalated again, and there is another weekend summit meeting.
Every time there is a summit meeting, the investing public that has sufficient money to invest waits with bated breath to see if there is some solution offered on Sunday afternoon. There never is a solution offered, so the stock market drops for the first day or two after the meeting.
It is clear by now to everybody that there is no solution forthcoming. There is no agreement politically, especially between Germany and France, as to who is going to write the checks to bail out the next PIIGS government to hit the brick wall.
I can remember almost 40 years ago listening to a speech by a young hotshot economist at Yale, who informed us that there would be a new currency system established in Europe by the year 2000. This was an accurate forecast. It was established in 1999. The hotshot later moved to Harvard. He has generally disappeared from public view. But it was clear from his enthusiastic speech that he was convinced that this new currency system would create a completely new economic order in Europe. Boy, was he right!
The new economic order in Europe is now disintegrating. The establishment politicians, bureaucrats, and spokesmen are looking in horror as the system which their predecessors designed to work permanently is disintegrating. Not to put too fine a point to it, but this is reminiscent of Adolf Hitler's promise about the thousand-year Reich. It lasted 13 years. This year, the euro had its 13th birthday. So far, it has not had a happy birthday.
NO FIREWALL
The leaders of the European establishment have never had to deal with any crisis on a scale like this one. They keep talking of the need for firewalls. Until they have firewalls, nobody is willing to yell "Fire!" Yet the fire is now raging.
What kind of firewall can be created that keeps a default by one government from becoming a default by another government? What firewall is there for a large multinational bank that has just lost half of the value of the bonds that it purchased at a rate of 3%, now that the interest rate is 7%? Every time the interest rate doubles, the market value of the bonds decreases by 50%, minimum.
There is no firewall. The financial system of Europe is interrelated by way of the euro. Everybody uses the same currency in 17 countries. Everybody is dependent upon the same central bank, and that bank is not exercising leadership. The head of the bank keeps saying that the governments have to step up to the plate and take responsibility. Every time he says this, I am reminded of what Ben Bernanke keeps telling Congress.
The heads of the two largest central banks in the world keep complaining that the politicians have got to take responsibility for solving the crisis. But this is exactly what the politicians do not want to do. The politicians have always understood that the central bank would bail them out of their crisis, merely by creating new money and buying the IOUs of the government. This has always been the public justification of central banking.
The politicians seem blind to the real reason for the existence of central banking, namely, to bail out the largest commercial banks under its jurisdiction. The European Central Bank faces an enormous problem: it has under its jurisdiction the largest banks in every country in the eurozone, other than Great Britain. It has to intervene to save any large bank that is under its jurisdiction, because if it does not, there will be bank runs in that nation.
A BANK RUN
Depositors can go down to their banks and have money transferred to a bank outside the country. Usually, this is going to be a German bank. Legally, the recipient bank can refuse to take a deposit, but what bank would dare not take deposits? Any bank that would say that it was not taking deposits from any other bank would be sending a signal to the media that the other bank is bordering on insolvency. That is the last thing that any bank in northern Europe wants to do with respect to any bank in Greece, Spain, or Italy.
The European Central Bank is sitting on a powder keg. The fuse has already been lit. That fuse is connected to the Greek banking system. If the Greek banking system blows up, by which I mean implodes, that will light another fuse. The other fuse leads to Spain. I could be wrong. There may be two fuses, one leading to Spain, and the other leading to Italy.
There is no firewall. The only firewall would be for banks in northern Europe to refuse to take new accounts from people who were closing out their accounts in southern Europe. But if they do not stop the bank runs from taking place in Greece, the Greek government is going to default on its debt and pull out of the eurozone. It will have no choice. If its banks are collapsing, how will it be able to fund its debt? How will it be able to collect taxes?
You can see what is at stake here. A small-scale bank run has been going on for at least a year in Greece, and it is now threatening to escalate into a full-scale run. Northern European banks could refuse to take new deposits in euros from existing depositors in Greece. But they would all have to do this at once. If only one or two major banks in northern Europe refuse to accept new accounts from Greeks, this will send a message to all the other Greeks: "You had better get your money out of your bank, fast, and get it into a northern European bank that has not yet closed off new deposits." The bank run escalates.
Because not all of the banks are under the same banking laws, and because no regulatory agency can tell them what to do, Europe has a system in which depositors in PIIGS nations can create massive bank runs against the banks in their own nations.
There is no firewall against this. The bank runs have begun in Greece. Banks outside of the eurozone can refuse to take on new deposits, but banks inside the eurozone cannot do this without threatening the survival of the entire banking system. Furthermore, if they do not create a firewall, the collapsed banks of Greece, Spain, and Italy will lead to the bankruptcy of their respective governments, and that in turn will lead to massive losses in northern European banks.
You do not see a detailed discussion of this in the mainstream press, for very good reason: the mainstream press is afraid of being blamed for triggering a bank run out of Greek banks. Everybody in authority knows a Greek bank run has begun, but this is not front page news. It is certainly not a story on the evening television news shows. Maybe "The PBS News Hour" will bring in two or three experts to discuss it, who will offer rival views, but the network news will not talk about the Greek bank run until it is in its terminal stage.
So, the people who run the new European order sit there, helpless, completely dependent upon decisions made by depositors in Greek banks. At any time, a wave of fear could spread through Greece, and a majority of depositors will start lining up to get their money. If they take out their money in currency, this collapses the local bank, which has to sell assets to buy the currency from the European Central Bank in order to hand the currency to the depositor. That kind of bank run is bad for a single bank, but usually depositors spend the money. When a depositor spends the money, the business that receives the money re-deposits the money in its bank. So, a bank run into currency is not a huge threat to the Greek banking system as a whole.
In contrast, however, is a bank run in the form of the transfer of digital money out of the country. All of the Greek banks are facing this threat today. Once the euros leave the Greek banking system, they are not redeposited in the Greek banking system.
What we are seeing is the collapse of the Greek banking system. Unless the European Central Bank intervenes again, by the end of the year, there is not going to be a Greek banking system. All of the banks will be busted.
There is nothing that the Eurocrats can do about this. The only agency that has the power to stop this is the European Central Bank, which can do whatever it wants to do, ultimately, which means lending money to Greek banks based on any collateral they want to put up, especially IOUs issued by the Greek government.
CONCLUSION
Angela Merkel can scream, yell, and hold her breath until she turns blue, but ultimately she has no power over the European Central Bank. Ultimately, no politician has any power over it. No politician really wants power over it. Why not? Because that politician would then be responsible for coming up with the money that the European Central Bank was about to come up with, but which was stymied by the politician.
This is why the European Central Bank is going to inflate, inflate, and inflate. The head of the bank can make all the comments he wants about the responsibility of politicians to intervene to keep the structure going, but he is ultimately the bagman of the system. He is the guy who has control over the printing press. He is the only person, along with his colleagues, who is in a position to keep the system afloat.
There is no firewall. There is only the ability of the European Central Bank to create money, and to do so by lending it to commercial banks or directly to governments. It does not matter what kind of rules and regulations are in place that were supposed to prohibit this back in 1999.
In the midst of a conflagration, nobody in power is going to point a finger at the European Central Bank when the bank intervenes to bail out a government that is about to default on its debt. The reason is clear, or at least is clear to me: no politician wants to be responsible for coming up with the money to bail out the largest banks in his country, all of which will be threatened with insolvency because of the default of Greece and Spain, because that will produce a domino effect by all of the PIIGS governments.
June 23, 2012
Gary North [send him mail] is the author of Mises on Money. Visithttp://www.garynorth.com. He is also the author of a free 20-volume series,An Economic Commentary on the Bible.
Copyright © 2000 Gary North
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And, in summation:
By Martin Wolf
“Against the background of renewed market tensions, euro area members of the G20 will take all necessary measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks. We welcome the significant actions taken since the last summit by the euro area to support growth, ensure financial stability and promote fiscal responsibility as a contribution to the G20 framework for strong, sustainable and balanced growth. In this context, we welcome Spain’s plan to recapitalize its banking system and the eurogroup’s announcement of support for Spain’s financial restructuring authority. The adoption of the fiscal compact and its ongoing implementation, together with growth-enhancing policies and structural reform and financial stability measures, are important steps towards greater fiscal and economic integration that lead to sustainable borrowing costs. The imminent establishment of the European Stability Mechanism is a substantial strengthening of the European firewalls. We fully support the actions of the euro area in moving forward with the completion of the Economic and Monetary Union. Towards that end, we support the intention to consider concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance. Euro area members will foster intra euro area adjustment through structural reforms to strengthen competitiveness in deficit countries and to promote demand and growth in surplus countries. The European Union members of the G20 are determined to move forward expeditiously on measures to support growth including through completing the European Single Market and making better use of European financial means, such as the European Investment Bank, pilot project bonds, and structural and cohesion funds, for more targeted investment, employment, growth and competitiveness, while maintaining the firm commitment to implement fiscal consolidation to be assessed on a structural basis. We look forward to the euro area working in partnership with the next Greek government to ensure they remain on the path to reform and sustainability within the euro area.”
This was the section of this week’s G20 communiqué that dealt with the eurozone.
Let us examine it closely.
“Euro area members of the G20 will take all necessary measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks.”
The crucial word here is “necessary”. We can safely say that agreement on what this means is altogether lacking.
“We welcome the significant actions taken since the last summit by the Euro Area to support growth, ensure financial stability and promote fiscal responsibility as a contribution to the G20 framework for strong, sustainable and balanced growth.”
If you believe these actions have been “significant”, given the potentially catastrophic pressures now working on both the public finances of Spain and Italy and the eurozone economy, then you are living in dreamland.
“In this context, we welcome Spain’s plan to recapitalize its banking system and the eurogroup’s announcement of support for Spain’s financial restructuring authority.”
The deal to recapitalise Spain’s banks, at the expense of the solvency of the Spanish state, is almost certainly a disastrous error.
“The adoption of the fiscal compact and its ongoing implementation, together with growth-enhancing policies and structural reform and financial stability measures, are important steps towards greater fiscal and economic integration that lead to sustainable borrowing costs.”
The fiscal compact will do nothing to help in the current situation, unless it encourages Germany to release the purse strings (on which I am sceptical). In my view, it will also prove inoperable. As to “growth-enhancing policies”, the problem now is the weakness of demand, something that nobody who matters in the eurozone, including the European Central Bank, has the will to do much about.
“The imminent establishment of the European Stability Mechanism is a substantial strengthening of the European firewalls.”
It is something, but it is also obviously inadequate and unlikely to get any bigger, as Gavyn Davies notes in a particularly important post. A firewall that is too small is useless.
“We fully support the actions of the euro area in moving forward with the completion of the economic and monetary union. Towards that end, we support the intention to consider concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance.”
This is important if something on a large enough scale is agreed soon. That seems inconceivable. A big choice has to be made between resolution, which means losses for creditors, and recapitalisation, which requires a large increase in eurozone fiscal resources. The European Stability Mechanism cannot be used for both recapitalisation of banks and financing Spain’s government: at €500bn, it is just not big enough.
“Euro area members will foster intra euro area adjustment through structural reforms to strengthen competitiveness in deficit countries and to promote demand and growth in surplus countries.”
This is, once again, a repetition of the old mantra that what matters is “structural reforms”, which are supposed to deliver everything, including “demand and growth in surplus countries”. For the eurozone, which suffers deficient aggregate demand, this is not going to work over the relevant time horizon.
“The European Union members of the G20 are determined to move forward expeditiously on measures to support growth including through completing the European Single Market and making better use of European financial means, such as the European Investment Bank, pilot project bonds, and structural and cohesion funds, for more targeted investment, employment, growth and competitiveness, while maintaining the firm commitment to implement fiscal consolidation to be assessed on a structural basis.”
I cannot make head or tail of this. But it seems inconceivable that this will be more than window-dressing. The means currently available to the EU (or the eurozone) are just too small to make much of a difference to growth in the near term.
“We look forward to the euro area working in partnership with the next Greek government to ensure they remain on the path to reform and sustainability within the euro area.”
Good luck!
This, then, is depressing. Here is a very different succeeding paragraph:
“All G20 members will take the necessary actions to strengthen global growth and restore confidence. Advanced economies will ensure that the pace of fiscal consolidation is appropriate to support the recovery, taking country-specific circumstances into account and, in line with the Toronto commitments, address concerns about medium term fiscal sustainability. Those advanced and emerging economies which have fiscal space will let the automatic fiscal stabilizers to operate taking into account national circumstances and current demand conditions. Should economic conditions deteriorate significantly further, those countries with sufficient fiscal space stand ready to coordinate and implement discretionary fiscal actions to support domestic demand, as appropriate. In many countries, higher investment in education, innovation and infrastructure can support the creation of jobs now while raising productivity and future growth prospects. Recognizing the need to pursue growth-oriented policies that support demand and recovery, the United States will calibrate the pace of its fiscal consolidation by ensuring that its public finances are placed on a sustainable long-run path so that a sharp fiscal contraction in 2013 is avoided.”
The section I have put in bold shows a genuine interest in fiscal policy. That is encouraging, as Jonathan Portes has noted even if too late and probably too little.
But this reconsideration of fiscal policy seems to apply to the US far more than the EU. The paragraph on the eurozone is essentially a supply-side paragraph. The following one, which refers to the US, emphasises demand.
The Atlantic remains very wide.
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