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Too connected to fail
May. 15th, 2010 05:53 pmIt all keeps coming back to Germany. Rumours in El Pais this morning (normally quite a reliable source) that Sarkozy was the main driver of the €750bn rescue package, by the simple expedient of losing his temper and banging the desk at Angela Merkel, who was worried about how the package would play with the German electorate. Sarkozy got his way by effectively saying "if you don't go with this, the euro is dead, from Monday".
At which point the politics and the economics collide. Because, economically, Merkel should surely say "thank fuck for that". But politically, the future federalist nature of Europe is so tied into the euro that to accept the end of the euro is to accept the end of the EU as we know it. And the German leadership isn't ready for that. France probably isn't either, but Sarkozy is presumably a better poker player.
German politicians and the German people still seem to be taking the line of "why should we bail out these bastards, when we've just spent more than a trillion euros paying for German unification?" To which the answer perhaps could be, "well, that was your choice".
But where the Germans are wrong is in thinking that they have a choice. The relationship between Germany and Greece is, in a way, a bit like China and the USA. Just as those who predict the collapse of the dollar miss the fact that China's leadership is in no way likely to ask for the USA to pay back all of the money that China has lent it over the past decade (in the form of buying US Treasuries), so the German leadership cannot afford to ask for Greece, and the other PIIGS to pay back the money that Germany has lent it since 2000. Merkel and the leadership know this, but the German people can't quite see it.
Indeed, the best that Germany can hope for is for the Greek debt not to get worse, and for a payback of around 50% of the money it lent in the past.
The point is, the world economy is too interconnected to fail. If Germany tried to get its money back straight away, not only would it not get its money back, but it would shatter the eurozone economy and, implicitly, the euro itself. Similarly, why should China give to its masses all of the wealth that they have been producing over the past decade? Sudden increases in living standards do little for political stability, and that is the major aim of the Chinese leadership, not increases in personal incomes.
All of this has led to the ECB "fudge" that is more and more beginning to look like Quantitative Easing, with the ECB turning into the investor of last resort, the bad bank, call it what you will.
That isn't a solution. It's just lending more money. The impact, one assumes, will be similar to that in the UK over the past 18 months -- recoveries in equities. But Jean-Claude Trichet already seems to me to be resorting to the "big lie" in an attempt to convince the world that the ECB knows what it is doing. He said that it was a "complete fallacy" that fiscal soundness damped growth, assserting that it was "exactly the contrary", that it was "the absence of fiscal credibility which damps growth".
Really? Tell that to Ireland and Spain over the past few years. Tell it to the US economy after Greenspan referred to "irrational exuberance". I didn't hear any cries from the markets of "hmm, this fiscal approach doesn't have much credibility, best to pull in my horns".
The more I look at this, the more I can't see an answer. Mervyn King nailed it earlier in the week. He said, quite correctly, that the answer for the UK basically relied on bringing consumption and production back into balance. We can't go on consuming four loaves for every three that we produce, and sending an IOU to another country for the additional loaf. The only country that can get away with that for another score years or so is the US, simply because it is so big in terms of the gloab economy.
The problem for the UK is that this solution is a bit like that of the CEO in a mature market. He says that the company plans to grow by 5% next year. How?, asks the analyst. "By increasing our market share", says the CEO. "Hmm", says the analyst, "strange that you should say that, because that's exactly what one of your rivals said yesterday, and what another one of your rivals said the day before that". "Yes", says CEO, "but they are wrong and I am right".
King's solution might work for the UK, if we can get it right (which of course is in itself a very big "if") but it's not a global solution. There's a whole queue of countries that have to consume less and produce more, and the only way that they can all do this is for another raft of countries to consume more and produce less.
Well, I can't see a request to India and China (and Germany) to produce less as being a plan that will get off the drawing board. So you have to get them to consume more.
In other words, there's a possible solution for the UK that will not entail a global solution (in private company terms, we take more market share in a mature market). But for a global solution the ask is just too great. Some countries consuming less, some consuming more, some producing more, some producing less. It ain't gonna happen.
Let's just take one side of this four-sided equation -- the growing countries. India and China are growing by 7% to 8% a year. Both have current account surpluses (not sure of the numbers offhand, but let's say 10%). So, for the deficit countries (3% contraction, deficit of 10%) the requirement is that the developing countries transfer HALF of their growth to the deficit countries (this would vary depending on the relative sizes of the combined economies, but the general principle remains) and that the deficit countries transfer ALL of their deficit consumption to the developing countries.
I mean, this is fantasy. It just won't happen. While King's solution for the UK is, perhaps, just about feasible, on the global scale, the answer is not there.
What will stop the whole edifice collapsing at the end of this year is that the US dollar remains the only game in town (apart from gold and the art market, and look how well they are performing at the moment). The Chinese will eventually take a haircut on their loans to the US (through inflation reducing the value of their dollar holdings).
But the EU's anti-inflation strategy and the nature of the eurozone makes this answer difficult, nay, impossible for Greek debt to Germany. Which is why I think some kind of monetary answer will have to be introduced. How can that be done? Well, it's not even on anyone's agenda at the moment, so I can't really say. But what I could imagine would be some kind of euro-split without the euro absolutely dying. How could that be done? Well, the cash element of the euro would have to remain the same (because the notes are liquid), but a non-cash euro in Greece could stop being the same as a non-cash euro in Germany.
In a sense, this process is underway. Greek debt is being bought by the ECB at par for German debt -- an exchange rate proving rather attractive to the markets. But suppose the "at par" nature is changed slightly. You only need to establish the principle (99.5%, for example) for it to become a fiscal weapon.
+++++++++++++++
The 500 euro note was always an example of politics over economics. It was introduced because there was a DM1,000 note and Germany was helped into the euro by matching euro notes to their Deutschmark equivalent.
But there's a big difference between a DM1,000 note in Germany and a note of equivalent value for the entire eurozone. Large cash notes are conveniently anonymous and easy to move around. It was estimated that 90% of 500 euro notes were in the hands of criminal-related enterprises (with the other 10%, from my memory, to be found on the European Poker Tour).
So, why not withdraw a note that is clearly mainly used by drug dealers?
Well, if half of all money is used for criminal activity, the ECB derives a considerable gain from this -- it's an interest-free loan from the criminal fraternity to the ECB. If the 500 euro was taken away and, magically, a $500 note was introduced, that loan would go to the US Treasury.
But where the ECB gains, government treasuries lose. There isn't going to be a $500 note. So the removal of the 500 euro note would almost certainly lead to an unwilling but necessary increase in declaration. For legal activities, cash transactions become a bit more of a pain. Marginally, more money will be declared "because it isn't worth the hassle". For illegal activities, it becomes harder to stick to pure-cash economies. So you launder the drugs money into legal businesses. Once again, the taxman gains.
In other words, at the moment, the ECB is coining it in at the expense of the national treasuries. One way it could put some of that money back (without resorting to QE at all!) would be to dump the 500 euro note.
However, the squeals of anguish at the €10k poker tournaments would be loud indeed.
______________
At which point the politics and the economics collide. Because, economically, Merkel should surely say "thank fuck for that". But politically, the future federalist nature of Europe is so tied into the euro that to accept the end of the euro is to accept the end of the EU as we know it. And the German leadership isn't ready for that. France probably isn't either, but Sarkozy is presumably a better poker player.
German politicians and the German people still seem to be taking the line of "why should we bail out these bastards, when we've just spent more than a trillion euros paying for German unification?" To which the answer perhaps could be, "well, that was your choice".
But where the Germans are wrong is in thinking that they have a choice. The relationship between Germany and Greece is, in a way, a bit like China and the USA. Just as those who predict the collapse of the dollar miss the fact that China's leadership is in no way likely to ask for the USA to pay back all of the money that China has lent it over the past decade (in the form of buying US Treasuries), so the German leadership cannot afford to ask for Greece, and the other PIIGS to pay back the money that Germany has lent it since 2000. Merkel and the leadership know this, but the German people can't quite see it.
Indeed, the best that Germany can hope for is for the Greek debt not to get worse, and for a payback of around 50% of the money it lent in the past.
The point is, the world economy is too interconnected to fail. If Germany tried to get its money back straight away, not only would it not get its money back, but it would shatter the eurozone economy and, implicitly, the euro itself. Similarly, why should China give to its masses all of the wealth that they have been producing over the past decade? Sudden increases in living standards do little for political stability, and that is the major aim of the Chinese leadership, not increases in personal incomes.
All of this has led to the ECB "fudge" that is more and more beginning to look like Quantitative Easing, with the ECB turning into the investor of last resort, the bad bank, call it what you will.
That isn't a solution. It's just lending more money. The impact, one assumes, will be similar to that in the UK over the past 18 months -- recoveries in equities. But Jean-Claude Trichet already seems to me to be resorting to the "big lie" in an attempt to convince the world that the ECB knows what it is doing. He said that it was a "complete fallacy" that fiscal soundness damped growth, assserting that it was "exactly the contrary", that it was "the absence of fiscal credibility which damps growth".
Really? Tell that to Ireland and Spain over the past few years. Tell it to the US economy after Greenspan referred to "irrational exuberance". I didn't hear any cries from the markets of "hmm, this fiscal approach doesn't have much credibility, best to pull in my horns".
The more I look at this, the more I can't see an answer. Mervyn King nailed it earlier in the week. He said, quite correctly, that the answer for the UK basically relied on bringing consumption and production back into balance. We can't go on consuming four loaves for every three that we produce, and sending an IOU to another country for the additional loaf. The only country that can get away with that for another score years or so is the US, simply because it is so big in terms of the gloab economy.
The problem for the UK is that this solution is a bit like that of the CEO in a mature market. He says that the company plans to grow by 5% next year. How?, asks the analyst. "By increasing our market share", says the CEO. "Hmm", says the analyst, "strange that you should say that, because that's exactly what one of your rivals said yesterday, and what another one of your rivals said the day before that". "Yes", says CEO, "but they are wrong and I am right".
King's solution might work for the UK, if we can get it right (which of course is in itself a very big "if") but it's not a global solution. There's a whole queue of countries that have to consume less and produce more, and the only way that they can all do this is for another raft of countries to consume more and produce less.
Well, I can't see a request to India and China (and Germany) to produce less as being a plan that will get off the drawing board. So you have to get them to consume more.
In other words, there's a possible solution for the UK that will not entail a global solution (in private company terms, we take more market share in a mature market). But for a global solution the ask is just too great. Some countries consuming less, some consuming more, some producing more, some producing less. It ain't gonna happen.
Let's just take one side of this four-sided equation -- the growing countries. India and China are growing by 7% to 8% a year. Both have current account surpluses (not sure of the numbers offhand, but let's say 10%). So, for the deficit countries (3% contraction, deficit of 10%) the requirement is that the developing countries transfer HALF of their growth to the deficit countries (this would vary depending on the relative sizes of the combined economies, but the general principle remains) and that the deficit countries transfer ALL of their deficit consumption to the developing countries.
I mean, this is fantasy. It just won't happen. While King's solution for the UK is, perhaps, just about feasible, on the global scale, the answer is not there.
What will stop the whole edifice collapsing at the end of this year is that the US dollar remains the only game in town (apart from gold and the art market, and look how well they are performing at the moment). The Chinese will eventually take a haircut on their loans to the US (through inflation reducing the value of their dollar holdings).
But the EU's anti-inflation strategy and the nature of the eurozone makes this answer difficult, nay, impossible for Greek debt to Germany. Which is why I think some kind of monetary answer will have to be introduced. How can that be done? Well, it's not even on anyone's agenda at the moment, so I can't really say. But what I could imagine would be some kind of euro-split without the euro absolutely dying. How could that be done? Well, the cash element of the euro would have to remain the same (because the notes are liquid), but a non-cash euro in Greece could stop being the same as a non-cash euro in Germany.
In a sense, this process is underway. Greek debt is being bought by the ECB at par for German debt -- an exchange rate proving rather attractive to the markets. But suppose the "at par" nature is changed slightly. You only need to establish the principle (99.5%, for example) for it to become a fiscal weapon.
+++++++++++++++
The 500 euro note was always an example of politics over economics. It was introduced because there was a DM1,000 note and Germany was helped into the euro by matching euro notes to their Deutschmark equivalent.
But there's a big difference between a DM1,000 note in Germany and a note of equivalent value for the entire eurozone. Large cash notes are conveniently anonymous and easy to move around. It was estimated that 90% of 500 euro notes were in the hands of criminal-related enterprises (with the other 10%, from my memory, to be found on the European Poker Tour).
So, why not withdraw a note that is clearly mainly used by drug dealers?
Well, if half of all money is used for criminal activity, the ECB derives a considerable gain from this -- it's an interest-free loan from the criminal fraternity to the ECB. If the 500 euro was taken away and, magically, a $500 note was introduced, that loan would go to the US Treasury.
But where the ECB gains, government treasuries lose. There isn't going to be a $500 note. So the removal of the 500 euro note would almost certainly lead to an unwilling but necessary increase in declaration. For legal activities, cash transactions become a bit more of a pain. Marginally, more money will be declared "because it isn't worth the hassle". For illegal activities, it becomes harder to stick to pure-cash economies. So you launder the drugs money into legal businesses. Once again, the taxman gains.
In other words, at the moment, the ECB is coining it in at the expense of the national treasuries. One way it could put some of that money back (without resorting to QE at all!) would be to dump the 500 euro note.
However, the squeals of anguish at the €10k poker tournaments would be loud indeed.
______________
