Wednesday, February 29, 2012

Europe Money Flood

As a follow up to my recent comments about the sovereign debt crisis in Europe, I want to comment briefly about the flood of money that has just been released by the European Central Bank (ECB). Today, February 29, 2012, the ECB allowed any bank that is in a Common Market country to borrow unlimited funds at nearly zero interest rates for three years (see The total taken was 529B euros ($710B, @ 1 euro = $0.7450). This is the second such offering. Last November, the ECB loaned about 479B euros ($650B). The grand total is now 1.02T euros. Someone suggested that there was some shorter-term debt owed ECB that the banks paid back and that the net new made-up money amount was close to 600B euros ($805B).

Much of the money from last February was just put back into accounts with the ECB. That’s right, when the banks had billions sitting around doing nothing, they took billions more. What the hell, the money was nearly free.

The justification for this exercise in Disney finance was that the banks were no longer willing to make loans to. The banks were not sufficiently confident to risk making loans to nearly anyone. Interest rates for the debt of many European governments was going up, loans to businesses, especially small businesses were declining, and loans to other banks had essentially stopped, even the overnight loans. That’s right. Overnight loans to other banks were deemed to be too risky.

So now, European banks have lots of money. Lots.

What have we seen since November?

Interest rates and the availability of money to governments, even to countries with severe problems like Italy, Spain, and Portugal, has vastly improved.

Commodity prices have begun moving up again. The spot price for copper has climbed over 15% in the last couple months (when it looks like the Greek bailout would go through the copper price would go up, when not, down).

The euro has fallen against the dollar. (The euro would fall against the yen, but the Japanese are doing all they can to make the yen fall. This is the called world competition.) We can count on prices in the euro zone to begin climbing.

These are the more obvious consequences of this flood of money. I am sure that more will surface as time go by.

One interesting thing to look forward to is the time when these loans need to be paid back. Some of the bonds that the banks are buying have a longer time to maturity than three years. How are they going to get their money out? If all the banks are selling bonds at the same time what will that do to the markets and interest rates? Do the banks think that the European economy is going to be robust enough for the banks to be making money or to acquire capital? I did see that one governor of the ECB was concerned with the bank’s ability to pay back these loans. He suggested that the governments be ready to bail out the banks in three years. Which would mean more made-up money or higher government debt.

The banks also have to improve their balance sheet to meet the ECB’s new equity to loan requirements of ten percent. Where is that capital going to come from?

The ECB is prohibited by charter from buying government bonds directly from the government auctions, i.e., financing the debt of the euro zone governments. But that is what they have done by giving the banks cash. In fact, before the first set of loans had been taken, the French President suggested that the banks should put the ECB money immediately into bad bonds. It is such a bad idea. Letting interest rates come down for the problem countries makes it seem as if there isn’t much urgency for them to spend less or engage in economic reforms that are necessary if people are going to find jobs and survive. This exercise is counter-productive. The Europeans have not learned anything.

There is such a fixation with the immediate short-terms that you wonder if people have been surgically altered. To solve problems that they created a little while ago (which they aren’t willing to admit to – except for the excessive government debt to a limited extent) they engage in actions that will create greater problems just a few months later. The process is a spiral, and it is becoming tighter.

It is amazing that they think that putting 600B euros into their economy will have only good consequences.

So, everyone:

Short the euro. Go long on commodities and European stocks, as there will most likely be an equity boom. But be careful. Who knows when that bubble will bust. And, if you plan to go to Europe, you can plan on not having to spend as much. The dollar will be able to buy lots of euros, at least as long as the money that the Fed tried to put into the economy, which is twice the amount the ECB created in Europe, still sits as deposits at the Fed.

Wednesday, February 22, 2012

Germany and the Euro Problems

I think that there is one interesting aspect to the turmoil in Europe. Well, okay, two. The one I am not referring to here is the revenge of reality. Borrowing to consume, especially as a national policy is stupid. It can only be done as a direct result of determined evasion of the fact that you are still going to be alive, or be a country, in the next minute. We should be very familiar with this trend. It is what is happening in Washington today.

What I want to discuss here is what is happening within and toward Germany: what the Germans are thinking and doing, and how people are acting toward Germany as Europe grapples with Greece’s very high government debt.

In more than one news article Germany has been called the paymaster, that is, ultimately, it is Germany who will provide the funds for bailing out every stupid government, that includes not just the Greeks, the Irish, the Spanish, and the Portugese, but also, when their time comes, the Italians and the French, although even German isn’t wealthy enough to save them all. In fact, the French have pushed policies recently that would have required the ECB, the European Central Bank, to fund recapitalizing the banks in France and elsewhere. That really means that Germany would be the source of the capital. The Germans said no, do it yourself.

There are other European governments besides Germany that have been more responsible in their fiscal habits that would have money to offer, but they are all small. Combined, the other governments would be dwarfed by problems in Greece. No, only Germany is large enough and wealthy enough to have the capacity to bail out a small country like Greece.

This recognition also includes the understanding that it isn’t just money that is required. This understanding comes from Germany. Others, many others, both within and outside of government, are calling for the ECB to just inflate their way out of the current mess. On some level Germany understands that doing so would destroy their wealth, and they aren’t willing to do that. So far, the ECB has been controlled by the Germans.

Then we have the people who explain the entire problem in terms of Germany’s scheme when the euro zone was established to construct it for their own benefit. The most consistent and clear statement of this view that I have seen comes from Stratfor, a private “intelligence” firm in the U.S. In a report, “Germany's Role in Europe and the European Debt Crisis”, published January 31, 2012, Stratfor argues that Germany engineered the agreements setting up the bloc and the common currency to make them wealthy.

[a cause] relates to Germany's status as the world's second-largest exporter. About 40 percent of German gross domestic product comes from exports, much of them to the European Union. For all their discussion of fiscal prudence and care, the Germans have an interest in facilitating consumption and demand for their exports across Europe. Without these exports, Germany would plunge into depression.
Therefore, the Germans have used the institutions and practices of the European Union to maintain demand for their products. Through the currency union, Germany has enabled other eurozone states to access credit at rates their economies didn't merit in their own right. In this sense, Germany encouraged demand for its exports by facilitating irresponsible lending practices across Europe. The degree to which German actions encouraged such imprudent practices -- since German industrial production vastly outstrips its domestic market, making sustained consumption in markets outside Germany critical to German economic prosperity -- is not fully realized.
True austerity within the European Union would have been disastrous for the German economy, since declines in consumption would have come at the expense of German exports. While demand from Greece is only a small portion of these exports, Greece is part of the larger system -- and the proper functioning of that system is very much in Germany's strategic interests. The Germans claim the Greeks deceived their creditors and the European Union. A more comprehensive explanation would include the fact that the Germans willingly turned a blind eye. Though Greece is an extreme case, Germany's overall interest has been to maintain European demand -- and thus avoid prudent austerity -- as long as possible.

This explanation is pure Maciovellan real politics and Marxist economics thinking that have been standard for a couple centuries. Supposedly, Germany could only become wealthy by sucking the wealth from others. Never mind that its best trading partners are other wealthy countries (or countries that are developing, like China). Never mind that the Greeks (and Spain and Italy, etc.) choose to borrow based on their own social welfare goals (that was the first cause that Stratfor mentions, but then ignores completely in its focus on Germany).

Also, in the same report, Stratfor states clearly that Greece and any of the others must stop this spending binge, without any hint of the supposed consequence to Germany. If they were consistent, they would be selling Germany short.

The Germans are well aware that they are going to be the paymaster. Even the man in the street understands the situation well enough to consider the wisdom of going ahead with the bailouts. The Greek bailout is especially irksome because the Greeks have pushed their wage rates above those in Germany (the monthly, legal, minimum wage in Greece is much higher than Germany’s, and all the other European countries), the Greeks have failed to follow through on the promises they made for the first round of the bailout, and the protestors in Greece have called the Germans names that no German can tolerate.

Which brings us to the attitude of the Greeks, themselves. A few have shown that they understand the situation. That seems to include a few politicians. To begin to move the government toward policies that Germany would accept, the Greeks had to make a man prime minister who was not a politician. When Germany demanded a lot more than promises, the politicians dithered for days. And when the vote was actually taken, many politicians in the largest parties voted against the bailout.

The Greek technocrat government does recognize that the country is bankrupt. The bailout offered by the other European countries is not to actually make them whole, but to give them the time to put themselves right. This isn’t a free lunch, just a little support. The support gives them the cash necessary to redeem debt falling due in March and the money to meet payrolls and continue operating without resorting to adding more debt to their total (and nationalize the banks). The Greek government must still find ways to spend less and income sources to pay off more debt. By 2020 it is suppose to reduce its debt from 160% GDP to 120%. For a country that does not produce much, in which the government accounts for about 40% of the economy, which has a culture of avoiding work and accepting corruption, and sees no connection between receiving money and production, getting the government to change its budget from a big annual deficit to a surplus is an overwhelming task. I don’t think that it can be done in a few months or a few years.

Then we have the Greek people. This is a democracy in the finest sense of the word. The population seems to think that it is fine for others to sacrifice and pay for the Greek life style. We have the government workers, who tend to not work, but spend their days shopping and sitting in cafes. We have the workers at government owned companies, who expect to be taken care of regardless of their lack of productivity and their willingness to cause disruption within the company and within the country. You have the employees of private companies who see government controls as the way to keep their job and income without regard to their productivity or the company’s financial health. You have the retired or the soon to be retired who were promised certain pensions and are angry that there is no money to meet those promises. These groups may not add up to the majority but they (and their relatives) are still a large enough portion of the population to be the deciding factor in elections. All of these groups have indicated they are angry about the changes required by the Euro Zone counties, led by Germany. What these elements of the Greek population think should be done hasn’t been reported that I know of. But, when interviewed, they all seem to think that their benefits should remain in place. How? Somehow!

So Germany is singled out for abuse. Memories (by people who weren’t there, for the most part) of past German sins are recalled. Ignoring the difference between sending troops to kill and providing money to maintain irrational finances, Germans are damned as dictators and Nazis. Some of the Greeks proclaim that the answer is communism, ignoring that it also failed the same way Greece is failing and that it has killed more people than the Nazis did.

One would expect that the Germans are angry about their treatment from the Greeks. I am sure that many Germans would prefer to just let the Greeks sink and be done with them. The more responsible of the Germans are not willing to do so. They do recognize that doing so would have very negative consequences for Germany for some time. I could argue that the long-run, self-interest of the Germans would be better served by unentangling themselves from their self-destructive neighbors, that their neighbors are going to continue to be problems and will require more and ever larger amounts of money. But that would be too selfish, and too painful in the short run, I suppose.

What Germany is looking at is that if Greece goes then Spain, Ireland, Portugal, and then Italy and probably France, too. They are thinking that solving the Greek problem will tend to prop up the others and they all can begin healing together. It is a pipe dream, but it is also the consequences of the premises with which Germany began. I do expect that Germany did expect the other governments to behave and control their fiscal budgets. That was a delusion and the Germans kept that delusion and tended to ignore what the other countries were actually doing. Germany is kind of an anomaly in that it is a social welfare state with a post WW2 tradition of some fiscal responsibility. It has even demonstrated how to absorb a backward country, East Germany, and grow. One has to have a certain respect for how Germany functions. Yet, they are still pretending that their own demographics problem doesn’t exist and they won’t have the same major debt problem as the rest of us. They still only pay attention to the next moment in time. They are still only a democracy that will tear itself apart under pressure. But they are holding themselves together much better than Italy or France.

So, to avoid the very nasty problems that letting Greece go to pieces, the Germans are willing to take on the obligations of bailing them out. The just completed bailout package includes sections intended to keep the Greeks on course, which the Greeks find insulting. Interesting isn’t it that the Greeks failed to follow through on their previous promises when they received money, and they are now insulted because their saviors don’t trust them.

The entire package is intended to assist the Greeks to lower their debt level from 160% of GDP today to 120.5% by 2020 (isn’t it interesting that they think that they can be so precise?). Usually, projections like this tend to have growth levels that can’t be maintained and the whole thing is fantasy. I expect that the projected growth levels in the bailout projections aren’t high at all, but I bet that the Europeans expect the Greek economy to begin growing sometime within the next couple years. I don’t know why. All of the capital within the country is either being soaked up by taxes or bonds, or has left the country. Who wants to invest in Greece? Is a Greek worker worth the effort? Has the Greek government actually made it easier or even possible for an investor to safely put his money there, let alone expect profits? According to online sources, manufacturing is only 18% of the economy. Production has been leaving Greece because of the business climate and the Greek worker. Why go back? As far as I can see, what has happened so far will not lead Greece to a growing economy and that means that it is going to continue to shrink, the government budget will not generate a surplus, debt will not decline (and will probably increase), the percentage of debt to GDP will not get anywhere near to 120%, and Greece will default with very messy consequences. Germany will have poured real money down a deep hole.

Friday, February 17, 2012

Why is it important to watch Europe now?

With so many battles to fight today in the U.S., you might wonder why I am spending time watching and writing about Europe. You could also point out that the U.S. is a vastly different sort of place. Policies and doctrines common in Europe since the fall of the Roman Empire were rejected in the U.S. We just do not have the socialist history that they have.

Unfortunately, the argument that everyone else is socialist is becoming accepted in the U.S. That was a big point in the argument for ObamaCare. We are becoming more like Europe. Our government has become a democracy in that demands for government controls and redistribution of wealth are now openly accepted as reasonable political discourse. Our government is spending like a drunken social democrat. Certainly our entitlement commitments are like what is happening in Europe. The problems they are seeing result from the same policies pursed by our own politicians of either party. The concept that made the U.S. different, individual rights, is just as unknown here today as it is in Europe.

Further, the economic policies practiced in Europe are based upon the same economic theories as is used by Bernanke, the Treasury, and the advisors of either U.S. party. Government action, focus on spending (consumption) as the power in the economy, regarding jobs only as a way to acquire income, and ignoring any real issue of production is standard everywhere.

The consequence is that the U.S. is moving toward a situation like that found in Greece, Spain, and Italy just as rapidly as France and Germany. I don’t know which large country will reach disaster first.

It is the case that our economy is not as regulated as those in Europe, although we are moving that direction rapidly. There is a lot of attention being paid to the steps required in Greece and Spain to make it a little easier to hire and fire an employee. But the controls and even the availability of capital aren’t changing much. Many core, important European industries are state owned and the labor unions have more sway than managers.

What is becoming understood, by many modern economists who regard themselves as scientists in some fashion, is that there are limits to the amount of debt that a government can sustain. This point was substantiated in a book, This Time is Different, by Carmen M. Reinhart and Kenneth S. Rogoff. For anyone who is serious about economics and the consequences of debt, I recommend this book. It is written by two modern economists, which means that their understanding and conclusions are superficial. They completely fail to recognize the difference between individual actions and those based upon force. Nevertheless, they provide important information and do offer some insight as to what the problems are in Greece, and soon the rest of the social welfare states.

The historical record is undeniable. If a government amasses debt amounting to more than sixty percent of their total production (considering only consumer goods), then they are tending toward trouble. Governments with more than one hundred percent are in trouble and there will soon be a financial crisis of some sort. The book does not mention interest rates, but certainly, if rates raise, the trouble is greater. From other sources, many modern economists seem to be convinced that the national production will be lowered by about one percent when government debt reaches ninety percent.

The U.S. will reach a government debt of one hundred percent of national production of consumer goods (called GDP) this year.

The book does not suggest what the financial crisis will be like. The world has not experienced a government debt crisis in an advanced technological country like ours, with the power that our government has amassed.

So I watch Europe to see how they are dealing with their problems and to see reality take its course. I watch to see if anyone questions their premises. I watch to see if any of the politicians choose to act intelligently or only with regard to their confused voters (see this article about the German PM) It is interesting that the Germans are now trying to put off the pending big, Greek bailout until after the April Greek elections.

I am looking to see how France and Germany confront their own fiscal/debt problems. Will they do something to actually improve their economies or not. France is headed for another Socialist government, it seems. The Socialist party is offering straight contradictions as its platform. It should be interesting.

I am not ignoring the U.S. and its impending problems. I just note that the big battle waged on the occasion of the vote to raise the U.S. government debt limit was over nothing. The amounts of the so-called cuts and what programs those cuts were suppose reduce were all inconsequential. It was all for show. A show that is now generally forgotten and ignored.

The only way that this country is going to avoid the gapping pits that Europe and the rest of the world are staggering toward is for some new group to make the obvious real to people. That means we have to do it. There is no other source for that understanding.

P.S. I watched Yaron Brook’s presentation as to why our country continues to make the same mistakes repeatedly and doesn’t seem to learn. (It was one of the videos at the bottom of the email I got from ARI. Number 191, I think.) It was excellent, and even if you know the issue, Dr. Brook’s phrasing and brevity in this complex subject is worth hearing.

Saturday, February 11, 2012

A Note on Greek Banks Recapitalization

A Note on Greek Banks Recapitalization

You might have noted in the news stories about the Greek government debt problem that there was talk of needing to recapitalize the Greek banks later. What is going to happen, one way or another, is that the Greek banks, as well as other banks all over Europe eventually (and maybe a few elsewhere), will have to recognize, on their balance sheet, that the Greek government bonds that they hold are worth less than when they were purchased. It is true that the Greek government debt has been worth less on the secondary market for some time, but accounting rules do not necessarily require that that change be recognized on a balance sheet at that time. (I will let an accountant explain that issue, which isn’t necessarily corrupt.)

For the bondholder, buying the bond is the same as loaning money. The bond will pay a certain interest rate for its lifetime, and at a certain point, the issurer, which could be a government or a business, will return the borrowed amount, called a redemption. It is a timed, interest-only loan.

The bank holds the loan as an asset, just as it does all of its loans. But it does have to evaluate the loans that it has on its books. Are they performing? That is, is the borrower following the terms of the loan? Will the borrower be able to pay back the loan?

Accounting rules for banks recognize that loaning money is a risky business. Borrowers can get into trouble and fail to pay the interest and fail to repay the loan itself. In order to protect itself, a bank has to maintain reserves against potential default of a borrower. With this reserve the bank is protected from becoming insolvent and bankrupt when borrowers default. The reserve is actually capital. The more reserves a bank holds against potential loan losses the more of its capital it has tied up. That capital cannot be working and adding to the revenue or profit of the bank when it is held as a reserve. (Do confuse reserves the bank has with “reserves” required by banking authorities, such as the Fed. Those are not reserves in fact, but deposits that provide no protection or income for the bank.)

Due to the standard statist misunderstanding of how banking works, how capitalism works, and what the real benefits of government controls are, governments have established regulations as to what percentage of reserves a bank must have in its loss-loan reserves for different types of loans. Banks in the European Common Market have been heavily regulated for at least as long as U.S. banks, most likely much longer. They are well used to doing what they are told. I think that the experience and knowledge of how to properly rate the risk of most loans does not exist in Europe. Furthermore, the government decisions as to what percentage of a loan the bank must hold in reserve is heavily influenced by political considerations and populist biases. Certainly, if the ability to repay debt were a consideration, the debt of most of the European nations would be rated very low.

The developed governments of the world have gotten together over the years in Basel Switzerland to establish international standards of loan-loss reserve percentages, hence, the Basel Accords and Basel I and Basel II (Basel III is in the works, I think). They agreed that loans to sovereign, national governments required either low or zero percentage reserves. That’s right, a loan to Greece was considered safer than a loan to Apple or Microsoft or GE.

What banks did was to load up on government loans because those loans required fewer reserves. Reserves cost money, that is, reserves are idle cash. If no reserves are required, then the bank’s funds can be loaned and contribute to operating income, and maybe profits and bonuses for employees. Even European banks have some characteristics of a business.

In addition, European banks are much closer to their governments than U.S. banks. They are sensitive to the interests, biases, policies, and intentions of the ruling politicians. They have to be. The politicians have a lot of power and use it against the banks if they wish. What the politicians have wanted, in all of the European countries, is for the banks to help fund the government spending, cheaply. The banks have helped the central European bank and each country central bank to keep interest rates on government debt low by buying significant amounts of government bonds. The Greek banks have done this perhaps more than others and hold massive amounts of Greek government debt (which is a direct path of the country’s savings into the hands of the government, which spent it in a continuous, drunken shopping spree – buying votes, really). The estimate I have seen is 50B euros.

As a result of the various government actions and the way the governments have set things up, the Greek banks are now looking at losses on Greek government debt of seventy percent or more, yes, that is 70% losses. Losses for which they have little or no loss reserves. This degree of loss means that the banks’ total capital, its investment from its shareholders, whatever profits it has ever retained, and all of the reserves of any kind, have been wiped out. The Greek banks are bankrupt. They are bankrupt right now. It just hasn’t appeared on their balance sheet yet.

So, if there are to be any banks in Greece, they need to have an injection of capital. Not loans, but new ownership money. The requirement being discussed is ten percent of loans by 2013. Remember, Greece is something like five percent of the Euro zone. I have seen estimates that the recapitalization of all Euro zone banks, with all of the Euro debt problems, is one trillion euros, which is about $1.3T.

Who would want to put money into Greek banks? Not foreign investors. Not domestic investors (if there is anyone with real money to invest). No, there is only one source: the government.

Yes, the bankrupt Greek government is going to put money into Greek banks. The Greek government doesn’t have any money so it aquire the funds from outside the country, just as the government is doing for all of the other help the government is getting. The way it will probably work is that some one like the IMF, the European Central Bank, or one of the two entities that have been created to deal with the sovereign debt crisis will give/loan the money to the Greek government which will then put the money into the banks.

But, the Greek government won’t just hand over the money to the banks. No. It will “invest” the money, i.e., it will buy stock. The Greek government will nationalize the banks. There is some talk about making the stock the government buys a special, non-voting stock, thus preserving an illusion that the original owners have some standing in the bank’s ownership. But, that is what it is, an illusion. The banks will be even more tied to the Greek government than they were.

So, as an overview, here is what we have:
The Greeks (actually you can insert any European Common Market country you want because the pattern is consistent throughout) borrowed from anywhere they could for a massive spending spree.
They required the banks to be a major lender.
They required the banks to have little or no reserves against the loans to the government.
The government can’t repay the loans.
The banks are failing.
The government, with money acquired from elsewhere because it has done stupid, insane things, is going to buy the failed banks.
The banks are even more tied to government policies than before.
The government has ownership and control of the banks.
Does anyone think that the Greek banks will be better off?

Makes sense, doesn’t it. When you live by force, you “win” by force. And you all go down the tubes together. Moreover, I have seen no comment or hint that anyone writing about the European situation has anything to say about the matter. Perhaps they haven’t even noticed.

But the failure of putting two and two together is a common theme in the entire European debt crisis. It is most blatant with the Greeks.

This week there have been more “strikes,” riots, and protests against the terms required by the agencies that would bail out the Greeks. Many of the chanted slogans and posters and banners declare that the foreigners are dictators and imperialists. The protestors want the politicians to “resist”! The Greeks appear like angry four year olds who have been told that they can’t have the toy on the shelf because mommy doesn’t have the money. How and what are the politicians suppose to resist? They are suppose to resist the requirement that they do not incur more debt. They are suppose to resist the requirement that they try to pay back their existing debt. They are suppose to resist the requirement that if they are given money they spend it wisely instead of like a drunken sailor (my apologies to sailors). The Greek protestors have no contact with reality. None. They have no idea that money has some connection to real things. That real things are made by someone who wants to be paid for their efforts. That borrowing actually means that the lender expects to be paid back. The Greek country is a testament to modern education and economic “thinking.”