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Reasons to be cheerful, part three
Apr. 23rd, 2012 02:09 pmSo, there was a response to my last post which said that I appeared to be a bit more optimistic of late. To which I replied, well, yes and no.
Let's take the "yes" part of the equation. As I wrote at the beginning of the crisis, when people still seemed to think that it was about liquidity (not least the board of Lehman Bros), it seemed obvious that this was a solvency crisis rather than one relating to liquidity. Or, rather, just because there's a temporary liquidity problem does not mean that if you solve that then you solve the problem.
In the three and a half years since, it's become increasingly clear that there are several types of "solvency crisis" (four spring to mind) and each of these can be either quite small or very big or anywhere in between.
The key dynamic here is, time.
So, what are the four types of solvency crisis?
1) a crisis that is going to bite you in the arse really soon, but which is getting better
2) a crisis that is going to bite you in the arse very soon, and is getting worse
3) a crisis that isn't going to bite you in the arse very soon, and it's getting better
4) a crisis that isn't going to bite you in the arse very soon, but is getting worse.
It's also possible that various parties will disagree on whether any particular problem needs solving quickly, and whether it's getting worse or getting better.
Let's have a look at these categories, and try to put in some real-life contexts:
(1) Ireland is, I think, a good example of a crisis that was short-term, needed solving quickly, but which is getting better. The Irish have, quite staggeringly, restored their international competitiveness without a devaluation. To achieve this in such a short time is terrifically impressive. So, reason to be cheerful, part one.
2) The obvious example of this is Greece. Indeed, the arse-biting has already occurred, and the world has survived. How has this happened? Simple, by the expedient of kicking the can down the road. Financial services companies were allowed to widen their margins. They used much of this generated cash to write off Greek debt that they held. In other words, the rest of Europe, facing declining living standards, helped pay off the duff Greek sovereign debt held by international companies. This was only possible because the Greek debt is small relative to the global economy. Reason to be cheerful, part two.
3) Long-term crises that are getting better are hard to find, not least because, since the crisis isn't an immediate threat, there's no impetus to solve it. On the plus side, because it's a long-term crisis, it's only a problem now if there is a collapse in confidence.
4) Long-term crises that are getting worse. A fine example of this is Italy. Sure, the economy is a mess, and there's no sign of it getting better. But it's a relatively sustainable mess. And it's no more of a mess than the UK's "pensions time bomb". The "time bomb" analogy is hopelessly misleading. We don't have the money to pay all of the pensions that people think that they are going to collect (whether the worker has contributed to that pension or not is, I fear, an irrelevancy, an accounting foible). Promises, one day, will have to be broken. But they can be broken a bit at a time. And they don't have to be broken tomorrow. That's how it is with Italy. Provided domestic savings goes into Italian debt, and provided young people can leave the country to find work elsewhere, a country whose economic system is laughable and whose production values are pathetic, can carry on for decades. In other words, provided confidence is maintained, Italy is not going to break. Reasons to be cheerful, part three.
There are other plusses. The major factor in putting off some of the recent financial threats has been the Long-Term-Refinancing-Operation (LTRO), a neat trick of free money (€1trn of it) that isn't called cranking up the printing presses. But, what is it really? The only difference between LTRO and just printing shedloads of cash is that the latter is an undated interest-free loan whereas the former is a dated low-interest loan. But if you think about it, this difference disappears, because LTRO a dated loan that, as things appear at the moment, can never been redeemed. When it's time is up in three years, it will quietly be redeemed at the same rate of interests until, in 60 years time, it just becomes part of the money supply.
As I think I wrote a couple of years ago, the problem of solving a "that money never existed" problem is finding someone to pay for it. As I also wrote, it has become clear that the borrowers have won. his might look wrong, in that it's the banks (the "lenders") that got bailed out. But this is smoke and mirrors. Banks are just brokers between those who are consuming more than they are producing and those who are producing more than they are consuming. Notwithstanding all of the public pronouncements, notwithstanding the horrors that are occurring in Greece as I write, the net overall effect of the current "solution" is that those who have consumed more than they produced over the past 12 years are not, indeed, cannot, pay it all back. And even if they tried to pay it all back, the impact on domestic and global economies would be profound. A "solution" of a transfer of wealth from savers to borrowers will "solve" this problem. Of course, it's not a solution to everyone's taste, but that's what happens when you think that a lot of wealth exists somewhere that actually doesn't exist at all.
So, what's the downside? Well, the downside is that there are other examples that are not so easily solvable. As everyone else is writing at great length, the primary one at the moment is Spain -- or, to be more specific, Spain's banks, which are relentlessly refusing to write down the value of property to a realistic value. Spain is bigger than Ireland. Spain is not making itself more competitive. Spain has very high youth unemployment.
Can it fudge through? Perhaps, but it's looking increasingly unlikely. Portugal, of course, is already a dead man walking. It's another country where it could be difficult for democracy to survive. When Portugal goes, will that drag Spain down?
These are big questions that require big solutions, and at the moment there's no sign that anyone is going to come up with them. Most of the other problems in Europe (including France and its horrific exposure to Italian debt) are big problems, but they don't require immediate solutions unless there is a crisis of confidence. Spain could require an immediate solution, relatively quickly.
The question is, what kind of fudge/can-kicking/radical solution can Europe come up with? Strange as it may seem, there are a number of options available. This problem is, after all, no worse than the rural bank crisis that hit China in 1999. How was that solved? By the simple expedient of bringing in foreign cash. The same could be done in Spain, if the Spanish could swallow their pride. And that, of course, is the nub. There are many solutions to what is a not-very-big-problem in the grand scheme of things, but every one of those solutions goes against the grain with at least one interested and powerful party. The IMF fixers, the Eurozone bully-boys, Merkel, the World Bank, and Spain's government itself are all opposed to solutions that might be acceptable to four or five of the other parties. If all of them dif in their heels, then Spain could head perilously close to default or, more likely, a confidence crisis that no number of crisis meetings could solve.
Will that happen? My guess would be, 30:70 (i.e., 70% that it won't). The doomsayers are confusing the long-term threats with the short-term threats, the big dangers with the small dangers. The short-term threat, even a €500bn short-term threat such as Spain, does not have to be solved all at once. As we have seen with Greece, if you can solve a bit now, and a bit next year, then you can stave off the apocalypse.
But the long-term systemic problems remain. The euro as it is is unsustainable -- we are seeing creeping fiscal union, although the one "never" candidate here is likely to be Germany, which is quite happy being part of a group telling another country what to do, but definitely doesn't like the idea of all the other countries pointing out that the German financial system is, er, not that hot, and needs changing.. But the whole euro structure as is, cannot survive. That does not mean that the euro can't survive; it can, and I think that it will. It just won't survive in its current form. The solution that I think might get past all the objections is a kind of "two-track" euro. This will enable two interest rate levels (and you can switch from one to another) and currency movement controls between countries. Sure, there would be cash smuggling, but you could have a "soft euro" and a "hard euro" with stamps on the soft euro, That could have a nominal 1:1 exchange rate that might change down the line. If a country moved from soft euro to hard euro, there could be currency exchanges. It would not need to be an overnight announcement (which is what we would need to head back to pesetas or drachma).
Inflation is coming, equities will be the best long-term bet (especially those with defensive pricing capabilities and with exports to the Far East). Democracy might die in a few Eeuropean countries. Isolationism will gain in popularity. Free movement, free trade, and a rather pleasant globe-trotting world, might become something we look back on fondly. The future isn't bright, or orange, but I don't think that it will be apocalyptic.
++++++++++++
Let's take the "yes" part of the equation. As I wrote at the beginning of the crisis, when people still seemed to think that it was about liquidity (not least the board of Lehman Bros), it seemed obvious that this was a solvency crisis rather than one relating to liquidity. Or, rather, just because there's a temporary liquidity problem does not mean that if you solve that then you solve the problem.
In the three and a half years since, it's become increasingly clear that there are several types of "solvency crisis" (four spring to mind) and each of these can be either quite small or very big or anywhere in between.
The key dynamic here is, time.
So, what are the four types of solvency crisis?
1) a crisis that is going to bite you in the arse really soon, but which is getting better
2) a crisis that is going to bite you in the arse very soon, and is getting worse
3) a crisis that isn't going to bite you in the arse very soon, and it's getting better
4) a crisis that isn't going to bite you in the arse very soon, but is getting worse.
It's also possible that various parties will disagree on whether any particular problem needs solving quickly, and whether it's getting worse or getting better.
Let's have a look at these categories, and try to put in some real-life contexts:
(1) Ireland is, I think, a good example of a crisis that was short-term, needed solving quickly, but which is getting better. The Irish have, quite staggeringly, restored their international competitiveness without a devaluation. To achieve this in such a short time is terrifically impressive. So, reason to be cheerful, part one.
2) The obvious example of this is Greece. Indeed, the arse-biting has already occurred, and the world has survived. How has this happened? Simple, by the expedient of kicking the can down the road. Financial services companies were allowed to widen their margins. They used much of this generated cash to write off Greek debt that they held. In other words, the rest of Europe, facing declining living standards, helped pay off the duff Greek sovereign debt held by international companies. This was only possible because the Greek debt is small relative to the global economy. Reason to be cheerful, part two.
3) Long-term crises that are getting better are hard to find, not least because, since the crisis isn't an immediate threat, there's no impetus to solve it. On the plus side, because it's a long-term crisis, it's only a problem now if there is a collapse in confidence.
4) Long-term crises that are getting worse. A fine example of this is Italy. Sure, the economy is a mess, and there's no sign of it getting better. But it's a relatively sustainable mess. And it's no more of a mess than the UK's "pensions time bomb". The "time bomb" analogy is hopelessly misleading. We don't have the money to pay all of the pensions that people think that they are going to collect (whether the worker has contributed to that pension or not is, I fear, an irrelevancy, an accounting foible). Promises, one day, will have to be broken. But they can be broken a bit at a time. And they don't have to be broken tomorrow. That's how it is with Italy. Provided domestic savings goes into Italian debt, and provided young people can leave the country to find work elsewhere, a country whose economic system is laughable and whose production values are pathetic, can carry on for decades. In other words, provided confidence is maintained, Italy is not going to break. Reasons to be cheerful, part three.
There are other plusses. The major factor in putting off some of the recent financial threats has been the Long-Term-Refinancing-Operation (LTRO), a neat trick of free money (€1trn of it) that isn't called cranking up the printing presses. But, what is it really? The only difference between LTRO and just printing shedloads of cash is that the latter is an undated interest-free loan whereas the former is a dated low-interest loan. But if you think about it, this difference disappears, because LTRO a dated loan that, as things appear at the moment, can never been redeemed. When it's time is up in three years, it will quietly be redeemed at the same rate of interests until, in 60 years time, it just becomes part of the money supply.
As I think I wrote a couple of years ago, the problem of solving a "that money never existed" problem is finding someone to pay for it. As I also wrote, it has become clear that the borrowers have won. his might look wrong, in that it's the banks (the "lenders") that got bailed out. But this is smoke and mirrors. Banks are just brokers between those who are consuming more than they are producing and those who are producing more than they are consuming. Notwithstanding all of the public pronouncements, notwithstanding the horrors that are occurring in Greece as I write, the net overall effect of the current "solution" is that those who have consumed more than they produced over the past 12 years are not, indeed, cannot, pay it all back. And even if they tried to pay it all back, the impact on domestic and global economies would be profound. A "solution" of a transfer of wealth from savers to borrowers will "solve" this problem. Of course, it's not a solution to everyone's taste, but that's what happens when you think that a lot of wealth exists somewhere that actually doesn't exist at all.
So, what's the downside? Well, the downside is that there are other examples that are not so easily solvable. As everyone else is writing at great length, the primary one at the moment is Spain -- or, to be more specific, Spain's banks, which are relentlessly refusing to write down the value of property to a realistic value. Spain is bigger than Ireland. Spain is not making itself more competitive. Spain has very high youth unemployment.
Can it fudge through? Perhaps, but it's looking increasingly unlikely. Portugal, of course, is already a dead man walking. It's another country where it could be difficult for democracy to survive. When Portugal goes, will that drag Spain down?
These are big questions that require big solutions, and at the moment there's no sign that anyone is going to come up with them. Most of the other problems in Europe (including France and its horrific exposure to Italian debt) are big problems, but they don't require immediate solutions unless there is a crisis of confidence. Spain could require an immediate solution, relatively quickly.
The question is, what kind of fudge/can-kicking/radical solution can Europe come up with? Strange as it may seem, there are a number of options available. This problem is, after all, no worse than the rural bank crisis that hit China in 1999. How was that solved? By the simple expedient of bringing in foreign cash. The same could be done in Spain, if the Spanish could swallow their pride. And that, of course, is the nub. There are many solutions to what is a not-very-big-problem in the grand scheme of things, but every one of those solutions goes against the grain with at least one interested and powerful party. The IMF fixers, the Eurozone bully-boys, Merkel, the World Bank, and Spain's government itself are all opposed to solutions that might be acceptable to four or five of the other parties. If all of them dif in their heels, then Spain could head perilously close to default or, more likely, a confidence crisis that no number of crisis meetings could solve.
Will that happen? My guess would be, 30:70 (i.e., 70% that it won't). The doomsayers are confusing the long-term threats with the short-term threats, the big dangers with the small dangers. The short-term threat, even a €500bn short-term threat such as Spain, does not have to be solved all at once. As we have seen with Greece, if you can solve a bit now, and a bit next year, then you can stave off the apocalypse.
But the long-term systemic problems remain. The euro as it is is unsustainable -- we are seeing creeping fiscal union, although the one "never" candidate here is likely to be Germany, which is quite happy being part of a group telling another country what to do, but definitely doesn't like the idea of all the other countries pointing out that the German financial system is, er, not that hot, and needs changing.. But the whole euro structure as is, cannot survive. That does not mean that the euro can't survive; it can, and I think that it will. It just won't survive in its current form. The solution that I think might get past all the objections is a kind of "two-track" euro. This will enable two interest rate levels (and you can switch from one to another) and currency movement controls between countries. Sure, there would be cash smuggling, but you could have a "soft euro" and a "hard euro" with stamps on the soft euro, That could have a nominal 1:1 exchange rate that might change down the line. If a country moved from soft euro to hard euro, there could be currency exchanges. It would not need to be an overnight announcement (which is what we would need to head back to pesetas or drachma).
Inflation is coming, equities will be the best long-term bet (especially those with defensive pricing capabilities and with exports to the Far East). Democracy might die in a few Eeuropean countries. Isolationism will gain in popularity. Free movement, free trade, and a rather pleasant globe-trotting world, might become something we look back on fondly. The future isn't bright, or orange, but I don't think that it will be apocalyptic.
++++++++++++
