In the end, Steve Jobs got his revenge. Once marginalized by Microsoft and its monopoly on PC operating systems, and then kicked out of Apple, the company he founded, Jobs was recalled to Apple as it was sliding into a death spiral. He proceeded to rebuild his brain child into the most successful business corporation today. Apple is the leader of its market segment--that segment being the mobile world. It manufactures visually attractive and highly efficacious mobile devices. Okay, they had a problem with maps. But Apple has overcome its previous belly flops, and it will surely overcome this one. Its high prices may keep it out of the reach of some consumers. But those that can afford its products tend to be the well-off who are highly sought by advertisers.
By contrast, Google and Facebook are now looking at the abyss. They haven't figured out mobile, at a time when mobile products are the fastest growing consumer high tech segment. Both Google and Facebook rely heavily on advertising, but mobile screens are too small for the kinds of ads that have proven successful on PCs and traditional laptops. There isn't yet a mobile-specific advertising strategy that really works. As the world becomes more mobile, Google and Facebook face the potential for a Yahoo-style decline, unless they solve the advertising problem or find alternative revenue sources. Solving the advertising problem requires gathering more and more detailed information about individuals using their products. But that could bring them into greater conflict with governmental protections for privacy. This is a particular issue in Europe, and a growing issue in America. These privacy protections will ultimately limit the extent to which Google and Facebook can facilitate the targeting of ads. One interesting notion is perhaps Yahoo, with its banner ad business (which doesn't rely on detailed personal information), will eventually prove the tortoise in its race against Google and Facebook.
In part, Google and Facebook confront the problem of all successful high tech companies. No matter how well you're doing, the next big thing is coming and you'd better be prepared for it or others will out-innovate you and leave you in the dust. IBM didn't anticipate the PC, and it lost its standing as the predominant computer company. Microsoft didn't anticipate the ubiquity and importance of the Internet, and it's in a slow fade. RIM didn't anticipate how consumers would flock to the smart phone, and it's barely staying alive on its corporate customer base.
But failure to anticipate the next big thing isn't the only dynamic. Part of the dynamic is that Apple manufactured the next big thing. By creating products that elevated the mobile experience by quantum leaps, Apple made consumers want mobile products. By manufacturing and selling these products, Apple derives a very large part of its revenues from selling hardware and software packaged together. It doesn't give consumers stuff for free and hope that it can slip in a few ads here and there. It makes and sells stuff for cash money.
Making and selling stuff has, for millenia, been the heart of economic activity. The evolution of the industrialized world revolved around elevating the manufacturing process to a grand scale, so that vast quantities of stuff could be made efficiently and sold at prices a lot of people could afford. Steve Jobs' relentless commitment to manufacturing--and thus control over product design and quality--placed Apple at the core of the industrial process. By manufacturing high quality and innovative stuff, Apple avoided the commoditization of PCs (which bedeviled Dell, Hewlett Packard and other companies) and elevated itself to the top of the high tech world.
This isn't a sales pitch for you to run out and invest in Apple. Its stock, on a tear earlier this year, has been falling back recently. Its maps debacle hurt, and its future--always uncertain because it's in the most volatile of industries, high tech--has been made more unpredictable by the death of Steve Jobs. The point here is that Apple's business strategy of manufacturing made it strong, and is a sound idea for American economic policy. America increasingly doesn't manufacture. But you can't build a strong national economy on management consulting, investment banking, hedge funds, law practice, health care, restaurants, and services like hair salons, pet walking, personal shopping, and the secondary and tertiary retailing in websites like eBay. The foundation of a strong economy is manufacturing. Look at Germany. Look at China. America was once the manufacturing giant of the industrialized world. While it can't return to that status, it can look for ways to encourage manufacturing. We all know Apple manufactures a lot of components in China. But well under half of its revenue dollars are spent in China. Much more is allocated to spending in America, for things like retailing, distribution, employee payroll and so on. Successful manufacturing companies make their home countries strong.
Most of the debate today over fiscal policy revolves around the amounts of federal spending and federal taxation. But fiscal policy isn't just a matter of accounting. The nation benefits by spending and taxing wisely. Keeping Social Security, Medicare and Medicaid in the black will be easier if we have a robust manufacturing sector. The pie is much easier to divide if it's bigger.
Showing posts with label Germany. Show all posts
Showing posts with label Germany. Show all posts
Sunday, October 21, 2012
Saturday, September 8, 2012
What's Behind the ECB's Unlimited Bond Buying Program?
It's kind of hard not to smell a rat in Mario Draghi's proposal for the European Central Bank to make "unlimited" purchases of sovereign bonds of troubled EU member nations. According to the proposal, the ECB will buy an EU member's bonds if the member requests assistance and submits to fiscal oversight by the EU. The latter, however, has been the problem with Greece. It doesn't want to submit to the EU's fiscal oversight. And when it did agree to terms demanded by the EU, it failed to comply with them. In return, Greece has been given break after break after break. It effectively defaulted months ago, but the EU papered the default over with a loan workout that forced creditors to sustain losses (which they may have recouped via credit default swaps, so the losses actually fell on the writers of the CDSs or their unfortunate direct, secondary or tertiary counterparties who held the ultimate risk of loss). Stated otherwise, the EU has supported Greece without Greece having to do the full austerity dance it was supposed to do.
The two countries that Draghi's proposal was aimed to help, Spain and Italy, insist that they will not submit to fiscal oversight by the EU (for domestic political reasons). If they really mean it, that means they won't get bond buying assistance from the ECB. Possibly, their hardline insistence that they won't ask for help (and thereby submit to central oversight) is a bluff, meant to get Draghi to drop the fiscal oversight condition. They could simply let market forces push their bond yields higher. That would shove the EU closer to the brink. Draghi might then drop the fiscal oversight condition when the markets threaten to go haywire. Of course, the bluff isn't really aimed at Draghi, who seems amenable enough to U.S. Fed-style money printing, but at the Germans and other northern Europeans of the frugal persuasion. The Greeks have proven themselves adept at brinksmanship with Germany and its economic allies. Spain and Italy have little incentive to be any more austere.
Germany may be wealthy enough to bail out Greece. But it can't bail out both Spain and Italy, which have much larger economies. So a move by Draghi to drop the fiscal oversight condition could lead to German withdrawal from the EU. That could be catastrophic. But writing blank checks to Greece, Spain and Italy could be catastrophic for Germany, and one can't expect Germany to knowingly sign up for a catastrophe. Mario Draghi may be playing a most dangerous game, and he'd better play it well or the abyss will beckon.
The two countries that Draghi's proposal was aimed to help, Spain and Italy, insist that they will not submit to fiscal oversight by the EU (for domestic political reasons). If they really mean it, that means they won't get bond buying assistance from the ECB. Possibly, their hardline insistence that they won't ask for help (and thereby submit to central oversight) is a bluff, meant to get Draghi to drop the fiscal oversight condition. They could simply let market forces push their bond yields higher. That would shove the EU closer to the brink. Draghi might then drop the fiscal oversight condition when the markets threaten to go haywire. Of course, the bluff isn't really aimed at Draghi, who seems amenable enough to U.S. Fed-style money printing, but at the Germans and other northern Europeans of the frugal persuasion. The Greeks have proven themselves adept at brinksmanship with Germany and its economic allies. Spain and Italy have little incentive to be any more austere.
Germany may be wealthy enough to bail out Greece. But it can't bail out both Spain and Italy, which have much larger economies. So a move by Draghi to drop the fiscal oversight condition could lead to German withdrawal from the EU. That could be catastrophic. But writing blank checks to Greece, Spain and Italy could be catastrophic for Germany, and one can't expect Germany to knowingly sign up for a catastrophe. Mario Draghi may be playing a most dangerous game, and he'd better play it well or the abyss will beckon.
Tuesday, December 6, 2011
Will EU Members Learn to Share?
The latest leaks from high ranking EU officials concerning the sovereign debt crisis hint at the possibility of not one, but two bailout funds. Details are scarce; but maybe that's the idea. They can keep the palaver going as long as you don't ask what army of investors is supposed to step out front and center to fund this financial engineering. That's the key to making the bailout work--or not. Someone has to plop a lot of cold, hard cash money on the barrel head in order to truly end the crisis. S&P, however, is threatening to downgrade most of Europe. Whence will investors find the courage to buy the EU's financial engineering when they see the price of sovereign debt credit default swaps escalating?
This is something the leaders of Germany and other wealthy EU nations spend little time publicly admitting. Instead, they focus on how to impose discipline, austerity and clean living on the profligate. Greece, Ireland, Portugal, Italy, Spain and perhaps other nations would have to earn every Euro they spend, and would pay penalties for deficits, failing to wash behind their ears, and using cuss words. Somehow, enough righteousness is supposed to transport the EU to the utter bliss of true currency union.
But the EU is missing an important point. The world's most successful currency union, the United States, exists perennially in a state of financial imbalance. For over a century, the wealthy states on the East Coast, more recently with the wealthy states on the West Coast, have subsidized less wealthy states in between. These imbalances have existed in the form of federal subsidies to farmers, ranchers, the mining industry, the railroads, and more. The Interstate Highway System was another big subsidy, benefiting large, thinly populated rural states more per capita than it benefited densely populated states. But none of the United States tries to hold others of the United States to fiscal rectitude. Imbalance is implicit in the structure of the Constitution, apportioning as it does two Senators to each state no matter how large or small. And imbalance runs the other way. On a per capita basis, the less wealthy states probably provide more people to serve in the military than the wealthier states, resulting in steeper non-financial costs on the former when America goes to war. Americans tolerate imbalance because national unity is more important to them than any rigorous reconciliation of ledgers.
To make the EU really work, Europeans need more than just their economic welfare. Financial self-interest isn't the superglue required for political union. Neither is sheer power. Rome's legions, Napoleon's armies, and the Third Reich's panzers all failed to hold Europe together. Angela Merkel, Nicholas Sarkozy and other proponents of the EU have shrewdly played their cards to keep the crisis from tipping over into financial panic. But the EU needs greatness in its leadership, calls to electorates to seek a new destiny. That's missing, and given the historical divisions among Europeans, a most tribal collection of peoples, it's not surprising that issuers of EU sovereign debt credit default swaps are selling their contracts dearly.
This is something the leaders of Germany and other wealthy EU nations spend little time publicly admitting. Instead, they focus on how to impose discipline, austerity and clean living on the profligate. Greece, Ireland, Portugal, Italy, Spain and perhaps other nations would have to earn every Euro they spend, and would pay penalties for deficits, failing to wash behind their ears, and using cuss words. Somehow, enough righteousness is supposed to transport the EU to the utter bliss of true currency union.
But the EU is missing an important point. The world's most successful currency union, the United States, exists perennially in a state of financial imbalance. For over a century, the wealthy states on the East Coast, more recently with the wealthy states on the West Coast, have subsidized less wealthy states in between. These imbalances have existed in the form of federal subsidies to farmers, ranchers, the mining industry, the railroads, and more. The Interstate Highway System was another big subsidy, benefiting large, thinly populated rural states more per capita than it benefited densely populated states. But none of the United States tries to hold others of the United States to fiscal rectitude. Imbalance is implicit in the structure of the Constitution, apportioning as it does two Senators to each state no matter how large or small. And imbalance runs the other way. On a per capita basis, the less wealthy states probably provide more people to serve in the military than the wealthier states, resulting in steeper non-financial costs on the former when America goes to war. Americans tolerate imbalance because national unity is more important to them than any rigorous reconciliation of ledgers.
To make the EU really work, Europeans need more than just their economic welfare. Financial self-interest isn't the superglue required for political union. Neither is sheer power. Rome's legions, Napoleon's armies, and the Third Reich's panzers all failed to hold Europe together. Angela Merkel, Nicholas Sarkozy and other proponents of the EU have shrewdly played their cards to keep the crisis from tipping over into financial panic. But the EU needs greatness in its leadership, calls to electorates to seek a new destiny. That's missing, and given the historical divisions among Europeans, a most tribal collection of peoples, it's not surprising that issuers of EU sovereign debt credit default swaps are selling their contracts dearly.
Wednesday, November 23, 2011
The EU Sovereign Debt Crisis: Skipping a Few Dominos
A hooded figure of Death appeared at the Euro's door today, scythe in hand, beckoning insistently. Germany held an auction of 6 billion Euros worth of 10-year bonds (called "bunds") and sold only 60% of it. The German central bank, the Bundesbank, bought the rest. But that's like your right hand buying from your left hand. The German auction was catastrophically bad. And, who knows, the Federal Reserve may have contributed to the shortfall, by subtly putting pressure on U.S. banks to trim their Euro-denominated exposure (see http://blogger.uncleleosden.com/2011/11/sovereign-debt-crisis-skipping-few.html).
By contrast, the U.S. Treasury Department today sold $29 billion of 7-year Treasury notes, receiving three times as much in bids as it was offering (or close to $100 billion in bids). Even though the U.S. may be approaching another credit rating downgrade, the greenback remains a sturdy oak in a forest of blighted trees.
That the German bund auction went so badly means the European sovereign debt crisis is fastfowarding more rapidly than anyone anticipated. Next to topple were supposed to be Italy, Spain, France, Belgium, and Austria. Then, the Netherlands, Finland and Luxembourg would be at risk. But Germany was seen as the last bastion of stability, the wealthy uncle who could save the family if disaster struck. Indeed, the latest concept being proposed for salvation, the Eurobond that was to be backed on the entire EU, would be feasible only if Germany's creditworthiness was beyond question. That's no longer true. If Germany can sell only 60% of a bund auction, how could the EU as a whole sell a Eurobond auction?
The sovereign debt crisis has skipped the intermediate dominos and smashed directly into Germany. The German government continues its opposition to Eurobonds. At this point, that may be irrelevant because the viability of the Eurobond has been called into question. One naturally asks what else might be on the table. That's the really scary part. There is no Plan B. Germany has always been the fallback, the backup, and the backup to the backup. After Germany there's no one, not the IMF, not America, not China, not Russia and not Brazil.
The EU sovereign debt crisis is now proceeding at warp speed. That doesn't mean collapse is imminent. Experience teaches that the financial markets hear what they want to hear and need only one or two rosy press releases from prominent government officials to stage a relief rally. Time and time again, that's the way the EU has kicked the can down the road and avoided the moment of truth. But the EU's principal tactic has been to substitute new debt for old debt, offering promises to replace the promises that this member nation or that couldn't keep. Actual transfers of wealth to reduce debt doesn't seem to be on the agenda. But this paper-for-paper game keeps expanding the amounts of debt outstanding, and investors will eventually tire of playing (as they did with the German bund auction today). When that happens, the Grim Reaper will be waiting to collect his due.
By contrast, the U.S. Treasury Department today sold $29 billion of 7-year Treasury notes, receiving three times as much in bids as it was offering (or close to $100 billion in bids). Even though the U.S. may be approaching another credit rating downgrade, the greenback remains a sturdy oak in a forest of blighted trees.
That the German bund auction went so badly means the European sovereign debt crisis is fastfowarding more rapidly than anyone anticipated. Next to topple were supposed to be Italy, Spain, France, Belgium, and Austria. Then, the Netherlands, Finland and Luxembourg would be at risk. But Germany was seen as the last bastion of stability, the wealthy uncle who could save the family if disaster struck. Indeed, the latest concept being proposed for salvation, the Eurobond that was to be backed on the entire EU, would be feasible only if Germany's creditworthiness was beyond question. That's no longer true. If Germany can sell only 60% of a bund auction, how could the EU as a whole sell a Eurobond auction?
The sovereign debt crisis has skipped the intermediate dominos and smashed directly into Germany. The German government continues its opposition to Eurobonds. At this point, that may be irrelevant because the viability of the Eurobond has been called into question. One naturally asks what else might be on the table. That's the really scary part. There is no Plan B. Germany has always been the fallback, the backup, and the backup to the backup. After Germany there's no one, not the IMF, not America, not China, not Russia and not Brazil.
The EU sovereign debt crisis is now proceeding at warp speed. That doesn't mean collapse is imminent. Experience teaches that the financial markets hear what they want to hear and need only one or two rosy press releases from prominent government officials to stage a relief rally. Time and time again, that's the way the EU has kicked the can down the road and avoided the moment of truth. But the EU's principal tactic has been to substitute new debt for old debt, offering promises to replace the promises that this member nation or that couldn't keep. Actual transfers of wealth to reduce debt doesn't seem to be on the agenda. But this paper-for-paper game keeps expanding the amounts of debt outstanding, and investors will eventually tire of playing (as they did with the German bund auction today). When that happens, the Grim Reaper will be waiting to collect his due.
Tuesday, September 13, 2011
Why the EU Has No Policy Options
Why has it been so difficult for the EU to resolve its sovereign debt crisis? Because it has no policy options.
Fiscal policy is limited by the EU's ostensible restriction of government deficits to 3% of GDP. Virtually all EU members, including powerhouse Germany, have violated this commandment. With deficits already exceeding 3%, EU members can't go Keynesian (more so than they already have).
The European Central Bank, guardian of the Euro, is constrained by its charter to promote currency stability, meaning that it is duty bound to keep inflation low. At 2.5%, inflation in the Euro zone is moderate. But the ECB can't take the low road of expediency and inflate the Euro in order to ease the burden of repaying the EU's sovereign debt and make the Euro zone more competitive internationally. Aside from violating its charter, the ECB would rile up the Germans, for whom inflation is anathema and perhaps cause enough to leave the EU.
Germany was the wealthiest proponent of the EU, and created the union in its own image. Fiscally prudent and indefatigably vigilant against inflation, the EU allows member nations to combat excessive debt only by enhancing the productivity of workers and elevating economic growth. A very German solution, but not all of the EU is German or inclined toward that persuasion.
So what's left? Right now, talk therapy is being offered. Rumors of Chinese interest in Italian bonds surfaced first. These preliminary discussions are less than first touted, focusing on strategic investments in Italian companies than Chinese purchases of Italian government bonds. In other words, the Chinese are trying to cherry pick the best of Italy's assets in a moment of Italian weakness. That ain't a bailout in anyone's book. The Chinese premier has also made noise about Chinese support for EU debt, but only if China gets improved trade access to Europe. That's just talk for now. Europe's immediate cash flow needs won't be served by this proposal.
Rumor mongers also proffer tales of Brazilian and other BRIC interest in Euro zone sovereign debt purchases. But these eager whispers appear to be just an agreement to meet and talk next week in Washington. The market has bobbed up and down the last couple of days. Its modest rises may be little more than short covering by hedge funds that don't want their butts fried in case some outside money actually wants to bet on Euro debt.
Outside money would appear to be Europe's only hope. It can't use fiscal policy, nor can it deploy monetary policy. But outside money may be far from a panacea. It can be profitably invested in EU sovereign debt only at a discount, something that by definition would preclude a bailout. And, even if the BRICs are willing to lend a helping hand, the hundreds of billions (and maybe more) of hinky Euro sovereign debt may defy the best of BRIC intentions. The BRICs are growing quickly, but don't by themselves have the sheer financial horsepower to haul Europe back from brink.
Europe remains a wealthy part of the world, with substantial economic resources. Europeans won't have to live on air. But the vision of living ever larger indefinitely into the future dangled by EU enthusiasts is as mythical as the chimera. The only way for the EU to survive is to endure a long, painful test of shared sacrifice and loss, leavened only by disappointment and disillusionment, before a true United States of Europe can be forged. And it's far from clear that Europeans will meet that test.
Fiscal policy is limited by the EU's ostensible restriction of government deficits to 3% of GDP. Virtually all EU members, including powerhouse Germany, have violated this commandment. With deficits already exceeding 3%, EU members can't go Keynesian (more so than they already have).
The European Central Bank, guardian of the Euro, is constrained by its charter to promote currency stability, meaning that it is duty bound to keep inflation low. At 2.5%, inflation in the Euro zone is moderate. But the ECB can't take the low road of expediency and inflate the Euro in order to ease the burden of repaying the EU's sovereign debt and make the Euro zone more competitive internationally. Aside from violating its charter, the ECB would rile up the Germans, for whom inflation is anathema and perhaps cause enough to leave the EU.
Germany was the wealthiest proponent of the EU, and created the union in its own image. Fiscally prudent and indefatigably vigilant against inflation, the EU allows member nations to combat excessive debt only by enhancing the productivity of workers and elevating economic growth. A very German solution, but not all of the EU is German or inclined toward that persuasion.
So what's left? Right now, talk therapy is being offered. Rumors of Chinese interest in Italian bonds surfaced first. These preliminary discussions are less than first touted, focusing on strategic investments in Italian companies than Chinese purchases of Italian government bonds. In other words, the Chinese are trying to cherry pick the best of Italy's assets in a moment of Italian weakness. That ain't a bailout in anyone's book. The Chinese premier has also made noise about Chinese support for EU debt, but only if China gets improved trade access to Europe. That's just talk for now. Europe's immediate cash flow needs won't be served by this proposal.
Rumor mongers also proffer tales of Brazilian and other BRIC interest in Euro zone sovereign debt purchases. But these eager whispers appear to be just an agreement to meet and talk next week in Washington. The market has bobbed up and down the last couple of days. Its modest rises may be little more than short covering by hedge funds that don't want their butts fried in case some outside money actually wants to bet on Euro debt.
Outside money would appear to be Europe's only hope. It can't use fiscal policy, nor can it deploy monetary policy. But outside money may be far from a panacea. It can be profitably invested in EU sovereign debt only at a discount, something that by definition would preclude a bailout. And, even if the BRICs are willing to lend a helping hand, the hundreds of billions (and maybe more) of hinky Euro sovereign debt may defy the best of BRIC intentions. The BRICs are growing quickly, but don't by themselves have the sheer financial horsepower to haul Europe back from brink.
Europe remains a wealthy part of the world, with substantial economic resources. Europeans won't have to live on air. But the vision of living ever larger indefinitely into the future dangled by EU enthusiasts is as mythical as the chimera. The only way for the EU to survive is to endure a long, painful test of shared sacrifice and loss, leavened only by disappointment and disillusionment, before a true United States of Europe can be forged. And it's far from clear that Europeans will meet that test.
Sunday, September 11, 2011
Is the EU Sunk?
Is it even possible to solve the European debt crisis?
An old adage goes, "lie to me once and shame on you; lie to me twice and shame on me." The financial markets seem to have taken that thought to heart, and now disdain the half-measures peddled by Euro zone leaders as solutions to the crisis. These leaders aren't stupid or uninformed. They know the score. The fact that they won't get to the bottom line suggests the bottom line is ugly.
A standard measure of a nation's ability to service its sovereign debt and still maintain healthy economic growth is that the debt be no more than 60% of GDP. Indeed, the EU theoretically requires new members to have a debt-to-GDP ratio of not more than 60%. What is the reality?
Today, the debt-to-GDP ratio of the EU as a whole is around 90%. Germany, which would be the locomotive for any true EU rescue of its spendthrift members, has a debt-to-GDP ratio of about 80%. Not the best starting point for a bailout. Moreover, Germany's GDP amounts to some 22% of the EU's GDP. With Greece, Ireland, Portugal, Spain and Italy all going the way of dominoes, it's doubtful Germany has the ability to uplift all the sinners.
These figures understate the extent of the problem. The European banking system is one of the largest creditors of the dodgy debtor nations, and would very possibly be insolvent if things fell apart. Indeed, the simple exercise of marking to market European bank holdings of EU debt would likely indicate that the major European banks are insolvent. So the EU would have to guarantee the indebtedness of the major European banks. That would include vast amounts of interbank borrowings, commercial paper, repurchase transactions, and other debt, and all derivatives liabilities (an almost unknowable quantity given the opacity of the derivatives market). How much more would that add to the EU's burdens? It's hard to say, but the amount could easily run into trillions (of dollars or Euros, take your pick).
Measured by typical standards, it would appear that the EU couldn't save itself even if it wanted to. There is, however, one way out. That would be for the European Central Bank to print vast amounts of Euros to create inflation, drive living standards down, and make the Euro zone more competitive worldwide. Such a course of action would violate the ECB's charter, which requires it to stabilize the Euro. Many Europeans surely realize now that the mandate to stabilize the Euro gave profligate EU members an arbitrage opportunity. In other words, they could take the path of expediency, and borrow at the lower rates fostered by a stable Euro in order to raise their living standards. These lower rates were available because the markets assumed all Euro denominated sovereign debt was implicitly guaranteed by Germany and the other economically strong EU nations. With access to unduly cheap credit, the spendthrift nations could live large without having to work hard for the productivity improvements that otherwise would have been required. Give people a choice between hard work and expediency, and what precisely do we think they will do?
Amending the ECB's charter to allow it to inflate the Euro would contradict the most strongly held German imperatives. Rampant inflation after World War I, coupled with enormous war reparations to the victorious Allies, put Germany economically in extremis and opened the door for National Socialism. Germans today would have to stop being German in order to consent to inflation.
The hard data shows the EU is swirling in the porcelain bowl. The political realities of implementing the only feasible solution--inflation--require that Germany, the most powerful EU member, cease being German. Where is there daylight at the end of the tunnel? The EU seems to be gradually realizing how deep in the septic tank it's sunk. The question now isn't how to get out, but whether there even is a way out. And the answer doesn't look pretty.
An old adage goes, "lie to me once and shame on you; lie to me twice and shame on me." The financial markets seem to have taken that thought to heart, and now disdain the half-measures peddled by Euro zone leaders as solutions to the crisis. These leaders aren't stupid or uninformed. They know the score. The fact that they won't get to the bottom line suggests the bottom line is ugly.
A standard measure of a nation's ability to service its sovereign debt and still maintain healthy economic growth is that the debt be no more than 60% of GDP. Indeed, the EU theoretically requires new members to have a debt-to-GDP ratio of not more than 60%. What is the reality?
Today, the debt-to-GDP ratio of the EU as a whole is around 90%. Germany, which would be the locomotive for any true EU rescue of its spendthrift members, has a debt-to-GDP ratio of about 80%. Not the best starting point for a bailout. Moreover, Germany's GDP amounts to some 22% of the EU's GDP. With Greece, Ireland, Portugal, Spain and Italy all going the way of dominoes, it's doubtful Germany has the ability to uplift all the sinners.
These figures understate the extent of the problem. The European banking system is one of the largest creditors of the dodgy debtor nations, and would very possibly be insolvent if things fell apart. Indeed, the simple exercise of marking to market European bank holdings of EU debt would likely indicate that the major European banks are insolvent. So the EU would have to guarantee the indebtedness of the major European banks. That would include vast amounts of interbank borrowings, commercial paper, repurchase transactions, and other debt, and all derivatives liabilities (an almost unknowable quantity given the opacity of the derivatives market). How much more would that add to the EU's burdens? It's hard to say, but the amount could easily run into trillions (of dollars or Euros, take your pick).
Measured by typical standards, it would appear that the EU couldn't save itself even if it wanted to. There is, however, one way out. That would be for the European Central Bank to print vast amounts of Euros to create inflation, drive living standards down, and make the Euro zone more competitive worldwide. Such a course of action would violate the ECB's charter, which requires it to stabilize the Euro. Many Europeans surely realize now that the mandate to stabilize the Euro gave profligate EU members an arbitrage opportunity. In other words, they could take the path of expediency, and borrow at the lower rates fostered by a stable Euro in order to raise their living standards. These lower rates were available because the markets assumed all Euro denominated sovereign debt was implicitly guaranteed by Germany and the other economically strong EU nations. With access to unduly cheap credit, the spendthrift nations could live large without having to work hard for the productivity improvements that otherwise would have been required. Give people a choice between hard work and expediency, and what precisely do we think they will do?
Amending the ECB's charter to allow it to inflate the Euro would contradict the most strongly held German imperatives. Rampant inflation after World War I, coupled with enormous war reparations to the victorious Allies, put Germany economically in extremis and opened the door for National Socialism. Germans today would have to stop being German in order to consent to inflation.
The hard data shows the EU is swirling in the porcelain bowl. The political realities of implementing the only feasible solution--inflation--require that Germany, the most powerful EU member, cease being German. Where is there daylight at the end of the tunnel? The EU seems to be gradually realizing how deep in the septic tank it's sunk. The question now isn't how to get out, but whether there even is a way out. And the answer doesn't look pretty.
Monday, August 22, 2011
Merkel Has the Bazooka, Not Bernanke
The eyes of the financial markets are on Federal Reserve Chairman Ben Bernanke, who will give the Federal Reserve's unofficial annual Financial State of the Union Address at the Kansas City Fed's Jackson Hole conference on Friday, Aug. 26, 2011. Bernanke will almost surely announce one policy measure or another. QE3 is unlikely; QE2 has turned to be largely a bust. The Fed may well choose something like adjusting the mix of maturities of its bond portfolio, shifting toward greater emphasis on the long end in order to push down longer term interest rates. Such a shift may moderately reduce longer term rates. But those rates are already lower than a snake's belly. So the impact of a portfolio shift on economic growth isn't likely to be more than a sacrifice bunt.
Bernanke's problem is that the markets expect him to expend all ammunition. Primarily because of Bernanke's own predilection toward policy action, and his predecessor's issuance to the financial markets of the Greenspan put, the Fed no longer has the option of holding its fire. The markets expect the Fed to maintain its covering fire, and have priced continuing Fed activism into the market. In effect, the Fed has already fired all its ammo, and will be punished with a market rout if it fails to fire. Bernanke surely knows this and is mustering his now meager forces on the firing line.
Governmental action can give the markets a lift when it's unexpected. The one thing the markets don't expect is for Germany and France to sign off on the concept of Euro bonds. At the moment, the world's biggest economic problem isn't America, but the European Union and its spiraling debt crisis. Things have been going from bad to worse, and may lead to another financial crisis a la 2008. Perhaps the one clear way out of the mess would be for the EU to combine and issue Euro bonds, community-wide debt to replace the sickly sovereign debt of profligate members like Greece, Ireland and Portugal, and possibly Spain and Italy. But Euro bonds would amount to a massive transfer of wealth from Germany, and to a lesser degree France, to the weaker nations. The German electorate has yet to wrap their brains around this concept, and it may take a few centuries before they do. They can't simply hand over the wealth--that would feel like they were held up. But imposing strict fiscal controls over beneficiary nations would bring back images of storm troopers goose stepping into foreign capitals. For some reason, many European nations have a problem with this.
Nevertheless, Merkel holds the bazooka. She can surprise the markets by endorsing Euro bonds. It's doubtful she will. But if we're going to have a big upside surprise this August, it will come from Germany, not Jackson Hole.
Bernanke's problem is that the markets expect him to expend all ammunition. Primarily because of Bernanke's own predilection toward policy action, and his predecessor's issuance to the financial markets of the Greenspan put, the Fed no longer has the option of holding its fire. The markets expect the Fed to maintain its covering fire, and have priced continuing Fed activism into the market. In effect, the Fed has already fired all its ammo, and will be punished with a market rout if it fails to fire. Bernanke surely knows this and is mustering his now meager forces on the firing line.
Governmental action can give the markets a lift when it's unexpected. The one thing the markets don't expect is for Germany and France to sign off on the concept of Euro bonds. At the moment, the world's biggest economic problem isn't America, but the European Union and its spiraling debt crisis. Things have been going from bad to worse, and may lead to another financial crisis a la 2008. Perhaps the one clear way out of the mess would be for the EU to combine and issue Euro bonds, community-wide debt to replace the sickly sovereign debt of profligate members like Greece, Ireland and Portugal, and possibly Spain and Italy. But Euro bonds would amount to a massive transfer of wealth from Germany, and to a lesser degree France, to the weaker nations. The German electorate has yet to wrap their brains around this concept, and it may take a few centuries before they do. They can't simply hand over the wealth--that would feel like they were held up. But imposing strict fiscal controls over beneficiary nations would bring back images of storm troopers goose stepping into foreign capitals. For some reason, many European nations have a problem with this.
Nevertheless, Merkel holds the bazooka. She can surprise the markets by endorsing Euro bonds. It's doubtful she will. But if we're going to have a big upside surprise this August, it will come from Germany, not Jackson Hole.
Saturday, August 13, 2011
Where Europe is Heading
Italy has just called for the issuance of Euro bonds that would substitute for the sovereign debt of individual EU member nations. An EU-controlled entity would issue these bonds in exchange for the sovereign debts of each member nation, and could impose continent-wide taxes to pay off the Euro bonds. Greece, badly battered by the debt crisis, shouted a heartfelt "amen" to Italy's proposal.
The UK seconded the sentiment, proposing fiscal union for the EU. Fiscal union is about effectively the same as the Euro bond concept. Why would Italy, Greece and the UK publicly talk up European unity? Because they can see the handwriting on the wall. Unity is, in their view, the only alternative to the septic tank.
Germany, on the other hand, is reaching for as much garlic as it can find, in the hope of warding off fiscal union. It would have to pick up most of the tab for true European fiscal unity, and the German electorate has yet to wrap their heads around that concept.
Europeans basically have two options. One is to unite. They would become something similar to the United States, with a continent-wide government controlling fiscal policy and having taxation powers. The current nations would become more like America's states, controlling local matters but subordinate to the bureaucrats and legislators in Brussels. While Europe would probably never be as tightly united as America under the Constitution (that is, after the Civil War and the adoption of the 13th, 14th and 15th Amendments), its survival would require greater union than achieved by the original thirteen American states under the Articles of Confederation.
Europe's second option would be for Germany and maybe other fiscally strong northern EU nations to leave the EU and strike out on their own, issuing their own national currencies again. Germany would probably strengthen economic ties with Eastern Europe, the Baltic republics, and the southeastern portions of the former Soviet Union (such as Ukraine, Moldova, etc.). These nations are of historical German interest, dating back even to the excursions of the Teutonic Knights during the Middle Ages. Southern European nations would be left on sidelines, muttering something about dancing with the one you brung.
Germany's chancellor, Angela Merkel, and France's president, Nicholas Sarkozy, meet on Tuesday, Aug. 16, 2011. With all this talk of European union, the media will fixate over their every smile, frown, and arched eyebrow. Merkel, more than anyone, will be the decider. Although she has talked the talk on requiring southern European nations to pay their own way, she has reluctantly slid down the slippery slope toward comprehensive EU assumption of the sovereign debt of member nations. It would be politically impossible for her to reverse course now (although she won't openly support Euro bonds because that would be political suicide). A change of political control in Germany would required for option two. That's not yet likely, although it's possible. Political turmoil there would translate into more stock market volatility in Europe and America.
More than anything else, Europe's response to its sovereign debt crisis will dictate the direction of Europe's and North America's economies and stock markets. Europe's recent piecemeal ban on naked short selling of bank stocks is akin to shooting the messenger. But the EU approach to its debt crisis has certainly been lathered with expediency. Next week, the EU may stir up a good deal of market volatility. The U.S. Congress can't do its share to screw things up, since it's thankfully out of Washington for the August recess. Keep an eye on events across the pond.
The UK seconded the sentiment, proposing fiscal union for the EU. Fiscal union is about effectively the same as the Euro bond concept. Why would Italy, Greece and the UK publicly talk up European unity? Because they can see the handwriting on the wall. Unity is, in their view, the only alternative to the septic tank.
Germany, on the other hand, is reaching for as much garlic as it can find, in the hope of warding off fiscal union. It would have to pick up most of the tab for true European fiscal unity, and the German electorate has yet to wrap their heads around that concept.
Europeans basically have two options. One is to unite. They would become something similar to the United States, with a continent-wide government controlling fiscal policy and having taxation powers. The current nations would become more like America's states, controlling local matters but subordinate to the bureaucrats and legislators in Brussels. While Europe would probably never be as tightly united as America under the Constitution (that is, after the Civil War and the adoption of the 13th, 14th and 15th Amendments), its survival would require greater union than achieved by the original thirteen American states under the Articles of Confederation.
Europe's second option would be for Germany and maybe other fiscally strong northern EU nations to leave the EU and strike out on their own, issuing their own national currencies again. Germany would probably strengthen economic ties with Eastern Europe, the Baltic republics, and the southeastern portions of the former Soviet Union (such as Ukraine, Moldova, etc.). These nations are of historical German interest, dating back even to the excursions of the Teutonic Knights during the Middle Ages. Southern European nations would be left on sidelines, muttering something about dancing with the one you brung.
Germany's chancellor, Angela Merkel, and France's president, Nicholas Sarkozy, meet on Tuesday, Aug. 16, 2011. With all this talk of European union, the media will fixate over their every smile, frown, and arched eyebrow. Merkel, more than anyone, will be the decider. Although she has talked the talk on requiring southern European nations to pay their own way, she has reluctantly slid down the slippery slope toward comprehensive EU assumption of the sovereign debt of member nations. It would be politically impossible for her to reverse course now (although she won't openly support Euro bonds because that would be political suicide). A change of political control in Germany would required for option two. That's not yet likely, although it's possible. Political turmoil there would translate into more stock market volatility in Europe and America.
More than anything else, Europe's response to its sovereign debt crisis will dictate the direction of Europe's and North America's economies and stock markets. Europe's recent piecemeal ban on naked short selling of bank stocks is akin to shooting the messenger. But the EU approach to its debt crisis has certainly been lathered with expediency. Next week, the EU may stir up a good deal of market volatility. The U.S. Congress can't do its share to screw things up, since it's thankfully out of Washington for the August recess. Keep an eye on events across the pond.
Sunday, July 24, 2011
With the Second Greek Bailout, Will Greece Become Germany or Germany Become Greece?
The second Euro zone bailout for Greece confirms what was pretty clear from the tea leaves: the political leadership of the EU intends to stand behind all the public debt and all of the banks of all its members. This bailout gives the can another kick down the road, pushing back debt maturities but still leaving Greece facing an unsustainable debt load. While there is a provision for an exchange of bonds by private holders that would involve a 20% loss for them, that's a pretty generous deal considering that these bonds traded at a 50% discount in the open market. You can call it bailout light. The bond exchanges won't do much to reduce Greece's total debt load. More bailouts loom.
The Greek Bailout, Part Deux, necessitates more austerity. A nation where the public sector is 40% of GDP, Greece is looking at years of constraint in government spending. Politically, that will be a challenge. But the alternative--departure from the Euro zone to pursue other interests--would be worse. So Greece will have to man up and tighten its belt. Right?
Well, not so fast. The second bailout requires closer political supervision of Athens by Brussels than ever before. The same will be true for Ireland, Portugal and other nations, if they tap into the brave new bailout facility. The Euro zone is cruising toward political union. For a while, no high ranking European officials will say so. But political union is essential to prevent the bailout process from fostering an ever bigger sovereign debt bubble. Otherwise, the bailees could allow their public debt to keep growing, and stick the costs on their wealthy northern European benefactors. Greece, therefore, must become Germany.
But will it? There are obvious cultural, historical and linguistic differences between the two nations, differences that have existed for thousands of years. There are also lingering memories of World War II, in which Greece suffered under harsh German occupation. Greece won't transform itself over the next five years into the new Pomerania.
The very concept of political union implies a melding of traditions and cultures. All member nations of the EU will have a political voice, and they will have to listen to each other. All will influence the others. Such is the case with political amalgamation. The Roman Empire, at its indolent, libertine, epicurean peak, was a far cry from the relatively simple, disciplined world of Cincinnatus. America, the world's melting pot, has grown far from the spare, repressed, colorless culture of the Puritans, absorbing words, foods and values from wave after wave of immigrants. As the EU becomes the United States of Europe, Germany will absorb ideas and values from other members, including Greece. Southern Europe will also change to more closely resemble its northern neighbors. But the final outcome is unpredictable. Consider Daimler-Benz's acquisition of Chrysler Corporation.
Daimler-Benz merged with Chrysler in 1998. The idea was to give Daimler-Benz a bigger presence in North America, while joining Chrysler with a company that had much higher product quality standards. The Mercedes vehicles of the 1980s and early 1990s generally had excellent reviews for quality, reliability and safety. Chrysler, it was hoped, would become Mercedes.
That didn't happened. During the decade that Daimler-Benz was affiliated with Chrysler, Mercedes' products frequently got mediocre reviews for quality and reliability and Chrysler's products remained as crummy as ever. (See Consumer Reports.) In other words, Mercedes became Chrysler. Things got so bad the two companies went their separate ways.
Maybe Germany will become Greece. With a raucous, unruly union on its hands, Germany may find it easier to defer problems than face the pain of resolving them. The second Greek bailout's tack of pushing debt maturities back--another kick down the road for the can--doesn't portend well for a Germanic EU. Actual reduction of Greek and other sovereign debt loads is the litmus test for the EU's viability, and that fat lady ain't singing yet.
It will be up to the legislatures of individual Euro bloc nations to approve the second Greek bailout. Chances are they will, maybe with a teaspoon or two of rancor. The chances of a major financial crisis from the EU's sovereign debt problems have diminished for a couple of months, perhaps. But don't let your guard down. The American debt ceiling squabble is accelerating rapidly from 60 to 120. Ireland and Portugal may take their hats into their hands, and line for their second turns at the bailout trough. Ours is a world living on borrowed money, and consequently, we're never truly in control of our lives.
The Greek Bailout, Part Deux, necessitates more austerity. A nation where the public sector is 40% of GDP, Greece is looking at years of constraint in government spending. Politically, that will be a challenge. But the alternative--departure from the Euro zone to pursue other interests--would be worse. So Greece will have to man up and tighten its belt. Right?
Well, not so fast. The second bailout requires closer political supervision of Athens by Brussels than ever before. The same will be true for Ireland, Portugal and other nations, if they tap into the brave new bailout facility. The Euro zone is cruising toward political union. For a while, no high ranking European officials will say so. But political union is essential to prevent the bailout process from fostering an ever bigger sovereign debt bubble. Otherwise, the bailees could allow their public debt to keep growing, and stick the costs on their wealthy northern European benefactors. Greece, therefore, must become Germany.
But will it? There are obvious cultural, historical and linguistic differences between the two nations, differences that have existed for thousands of years. There are also lingering memories of World War II, in which Greece suffered under harsh German occupation. Greece won't transform itself over the next five years into the new Pomerania.
The very concept of political union implies a melding of traditions and cultures. All member nations of the EU will have a political voice, and they will have to listen to each other. All will influence the others. Such is the case with political amalgamation. The Roman Empire, at its indolent, libertine, epicurean peak, was a far cry from the relatively simple, disciplined world of Cincinnatus. America, the world's melting pot, has grown far from the spare, repressed, colorless culture of the Puritans, absorbing words, foods and values from wave after wave of immigrants. As the EU becomes the United States of Europe, Germany will absorb ideas and values from other members, including Greece. Southern Europe will also change to more closely resemble its northern neighbors. But the final outcome is unpredictable. Consider Daimler-Benz's acquisition of Chrysler Corporation.
Daimler-Benz merged with Chrysler in 1998. The idea was to give Daimler-Benz a bigger presence in North America, while joining Chrysler with a company that had much higher product quality standards. The Mercedes vehicles of the 1980s and early 1990s generally had excellent reviews for quality, reliability and safety. Chrysler, it was hoped, would become Mercedes.
That didn't happened. During the decade that Daimler-Benz was affiliated with Chrysler, Mercedes' products frequently got mediocre reviews for quality and reliability and Chrysler's products remained as crummy as ever. (See Consumer Reports.) In other words, Mercedes became Chrysler. Things got so bad the two companies went their separate ways.
Maybe Germany will become Greece. With a raucous, unruly union on its hands, Germany may find it easier to defer problems than face the pain of resolving them. The second Greek bailout's tack of pushing debt maturities back--another kick down the road for the can--doesn't portend well for a Germanic EU. Actual reduction of Greek and other sovereign debt loads is the litmus test for the EU's viability, and that fat lady ain't singing yet.
It will be up to the legislatures of individual Euro bloc nations to approve the second Greek bailout. Chances are they will, maybe with a teaspoon or two of rancor. The chances of a major financial crisis from the EU's sovereign debt problems have diminished for a couple of months, perhaps. But don't let your guard down. The American debt ceiling squabble is accelerating rapidly from 60 to 120. Ireland and Portugal may take their hats into their hands, and line for their second turns at the bailout trough. Ours is a world living on borrowed money, and consequently, we're never truly in control of our lives.
Tuesday, May 3, 2011
Is the Federal Reserve Following Germany's Example?
Germany is Europe's economic engine. Its recent recession wasn't Great, like America's. Its unemployment levels didn't rise as sharply as America's. It has a trade surplus and a strong manufacturing sector at the core of its economy. Considering that West Germany had to absorb moribund formerly Communist East Germany during the past 20 years, one has to wonder how the Germans did it.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Monday, November 29, 2010
Bondholder Bonanza in Europe
If you believe in reincarnation, think seriously about coming back as a holder of Euro-denominated bonds. (Or, skip the reincarnation part and just buy some.) Today, the bailout of Ireland makes clear that every nation in the European Union guarantees the obligations of every other EU nation, and also the obligations of every bank in every EU nation. Holders of European debt are in Heaven, dancing cheek to cheek with EU taxpayers.
The Germans (and French, kind of) made some noise about bondholders sharing in the losses from future national financial crises. But when push comes to shove, which could be in a week or two with Portugal, it's essentially a certainty that the dour Chancellor Merkel and frenetic President Sarkozy will hold their noses and sign another blank check. That's because the real beneficiaries of these bailouts aren't Ireland, Greece or whoever. They're German, French and other EU banks, which hold shiploads of Irish, Greek, etc. debt. A default by these nations would put the banks down the street from Chancellor Merkel's or President Sarkozy's office at risk, and those banks and their various constituencies are the real reason the wealthy EU nations are spreading Christmas cheer to the poorer EU nations.
It doesn't have to be this way. The sovereign debt crisis began with a dust up in Dubai about a year ago. While Dubai's problems quickly moved off the front page with the revelations of Greece economizing on the truth about its budget deficit, a workout continued quietly. Not long ago, the Dubai debt problem was resolved with some bond holders taking losses. Farther back in time, international financial crises in Latin America during the 1970s and 1980s involved banks taking losses on their loans. There is nothing magical about being a creditor that necessarily insulates one from loss.
The distressed nations can't devalue their currencies to boost their economies through exports (a standard maneuver in such circumstances). They all use the Euro, and its value is maintained by the European Central Bank. Only the long, poorly paved road of austerity and higher taxes is open to them. Without bailouts, defaults would loom and the debtor nations might have to leave the Euro bloc. Since Germany and France want the Euro to work, they are left with little choice except to make nice-nice with bondholders.
But just as American taxpayers are tired of bailing out bankers in New York, German taxpayers may eventually tire of bailing out the money men in Frankfurt. The poorer EU nations aren't leaving the Euro bloc--with Germany backstopping them, they have every incentive to stay. The Germans may, in the end, be the ones who leave. The more the Germans bail out profligacy in other nations and reckless lending by their own banks, the more their own financial condition will deteriorate. If Germany guaranteed all EU sovereign and bank debt, it would be in lousy shape. Since it more or less implicitly has done just that, it is. German taxpayers have already carried the substantial burden of incorporating East Germany in the West. They very possibly won't want the burden of incorporating the entire EU into Germany.
The Germans (and French, kind of) made some noise about bondholders sharing in the losses from future national financial crises. But when push comes to shove, which could be in a week or two with Portugal, it's essentially a certainty that the dour Chancellor Merkel and frenetic President Sarkozy will hold their noses and sign another blank check. That's because the real beneficiaries of these bailouts aren't Ireland, Greece or whoever. They're German, French and other EU banks, which hold shiploads of Irish, Greek, etc. debt. A default by these nations would put the banks down the street from Chancellor Merkel's or President Sarkozy's office at risk, and those banks and their various constituencies are the real reason the wealthy EU nations are spreading Christmas cheer to the poorer EU nations.
It doesn't have to be this way. The sovereign debt crisis began with a dust up in Dubai about a year ago. While Dubai's problems quickly moved off the front page with the revelations of Greece economizing on the truth about its budget deficit, a workout continued quietly. Not long ago, the Dubai debt problem was resolved with some bond holders taking losses. Farther back in time, international financial crises in Latin America during the 1970s and 1980s involved banks taking losses on their loans. There is nothing magical about being a creditor that necessarily insulates one from loss.
The distressed nations can't devalue their currencies to boost their economies through exports (a standard maneuver in such circumstances). They all use the Euro, and its value is maintained by the European Central Bank. Only the long, poorly paved road of austerity and higher taxes is open to them. Without bailouts, defaults would loom and the debtor nations might have to leave the Euro bloc. Since Germany and France want the Euro to work, they are left with little choice except to make nice-nice with bondholders.
But just as American taxpayers are tired of bailing out bankers in New York, German taxpayers may eventually tire of bailing out the money men in Frankfurt. The poorer EU nations aren't leaving the Euro bloc--with Germany backstopping them, they have every incentive to stay. The Germans may, in the end, be the ones who leave. The more the Germans bail out profligacy in other nations and reckless lending by their own banks, the more their own financial condition will deteriorate. If Germany guaranteed all EU sovereign and bank debt, it would be in lousy shape. Since it more or less implicitly has done just that, it is. German taxpayers have already carried the substantial burden of incorporating East Germany in the West. They very possibly won't want the burden of incorporating the entire EU into Germany.
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