I’ve always gotten a personal pleasure from watching Nigel Farage give speeches before the European Parliament. I also happen to agree with much of what he has to say.
The people who “run” the euro project are indeed unelected technocrats who see themselves as benign despots of Europe. They have the audacity to believe that the solution to people’s problems can come from bureaucratic decree rather than from freedom and democracy.
We had an opportunity to interview Mr. Farage on Capital Account earlier this week, and we too asked him about the origins of Europe and the reemergence of Germany as a power on the European stage. I have linked to that interview below:
I like this article, because it points out just how absurd debt financing through the creation of more debt is. The EFSF is a great example of how financial alchemy works. First, you create an artificial entity, incorporated in Luxembourg of course, that can issue debt with the explicit guarantee of eurozone member states with a credit line of up to €780 billion and a lending capacity of €440 billion. Then, you go to the three major rating agencies, and ask them to slap an equally artificial AAA rating on the thing. Voila. Now you can take a largely insolvent continent, pool its insolvency together, and borrow at lower interest rates from banks who themselves, are largely insolvent due to the fact that they own public and private debt from the same countries that they didn’t want to lend to in the first place. Of course, the banks are willing to go on lending because it is the only way to keep the ponzi scheme going. Otherwise, they would have to go bankrupt now, as opposed to later.
But, apparently, this is no longer good enough. The EFSF has been forced to borrow at higher costs (breakdown of latest issue), not just in terms of nominal interest, but also relative to German bunds of similar duration, whose yields have dropped substantially year-to-date. Now, the Telegraph is reporting that the EFSF, during its latest issue this month, had to step in and buy up more than 100 million euros of its own bonds in order to achieve its funding target (basically, in order to keep it’s nominal borrowing costs down, or put another way, to keep up appearances that investors actually want to buy what it’s selling at a reasonable price). Representatives for the fund have since denied this, but whether it is true or not isn’t really the point. The point, dear reader, is that a fund that has no capital in it, and whose capacity to borrow is a derivative of the taxing authority of a very suspect and loosely organized continent of previously waring states, can technically buy, with money it doesn’t have, a stake in something that doesn’t even exist. And yet, this is where we find ourselves in today; in a derivative universe disconnected entirely from underlying values, and thus, from reality itself.
I have pasted the relevant article from the London Telegraph below, for your amusement.
The European Financial Stability Facility (EFSF) last week announced it had successfully sold a €3bn 10-year bond in support of Ireland.
However, The Sunday Telegraph can reveal that target was only met after the EFSF resorted to buying up several hundred million euros worth of the bonds.
Sources said the EFSF had spent more than € 100m buying up its own bonds to help it achieve its funding target after the banks leading the deal were only able to find about €2.7bn of outside demand for the debt.
The revelation will be seen as a major failure and a worrying sign of future buyers strike after EFSF officials and their bankers had spent recent weeks travelling the world attempting to persuade key investors, including China’s national wealth fund and Japanese government funds, to buy its bonds.
Chinese and Japanese money was crucial to last year’s first bond sales by the EFSF, but they have since been dismayed by the eurozone’s failure to resolve the worsening debt crisis and alarmed at how fund has morphed from being a rescue facility for European banks into a potentially €1 trillion leveraged first-loss insurer for eurozone governments.
Other European Union funds are also understood to have supported the EFSF’s bond sale. The failure of the EFSF will increase pressure on the European Central Bank to effectively become the lender of last resort for the eurozone, a move it has strongly resisted.
At a private breakfast organised by PI Capital last week, Mark Hoban, the Treasury minister, said: “What it doesn’t do is provide the next stage of the solution, which is how do you stop this from happening again?” he said.
The move, by the European Investment Bank, will cause more disquiet among non-eurozone EU members who have become concerned about their growing exposure to the cost of rescuing the currency bloc.
I found this nice chart on Barry Ritholtz’s blog (the source is Der Spiegel). There isn’t anything here that we haven’t seen before, but the visual display of information shows two interesting things.
The first is just how hopeless the case for Greece’s borrowing prospects are. The country is completely priced out of the marketplace. The yields that the market is pricing in for long-term sovereign debt funding are way beyond anything that the Greek government could service were it not for the ECB and the various loan programs put together that have kept Greece temporarily out of the credit markets. It is just a matter of time before Greece defaults, and prolonging the agony benefits no one in the long-run, including the people of Greece.
Second, the light blue backdrop that represents sovereign debt purchases by the ECB (labeled state bonds) is visually misleading, because it appears overwhelming as it towers over the various yield curves displayed in the graph. The fact of the matter is that the roughly 150 billion euros worth of sovereign debt that the ECB has purchased through its Security Markets Programme (SMP) is peanuts next to the trillions of euros worth of support that the sovereign debt market in Europe will need before this entire fiasco is over and done with (assuming that Eurozone member countries, along with the ECB, will do whatever it takes to keep the nation states in EMU from leaving the single currency).
Unfortunately for the ECB, the central bank is ultimately going to have to eat huge losses as a result of its bond buying program, as well as its role as a backstop for eurozone banks. The last thing that you want to see as an investor (which the ECB becomes when it buys Greek, Spanish, Italian, etc. debt) is yields on the fixed income assets that you are buying rise after you sink your money in, because it means that the price of whatever it is that you bought is dropping in value. This nasty reality is what is giving the Bundesbank and other more hawkish players in Europe an ulcer.
Part of me feels angst over the inevitability of a Greek default, and how it will play out, but another part of me grows in excitement at the prospect that something good could come out of this entire mess.
For a very long time now, I have been saying that a Greek default is inevitable, and that eventually the country would have to exit the euro. This does not mean that euros cannot circulate in Greece, but it does mean that the government would have to return to the drachma for its public expenditures (sort of like in Argentina where pesos circulate next to dollars). This is optimal in my view.
It looks like we are coming closer and closer to that moment, though I still believe that Europe has one more can-kicking exercise in futility left in its playbook. I believe that Europe’s leaders have already decided that they cannot save the eurozone-17, and that their only hope to preserve the euro as a currency is to downsize the EMU membership so as to prevent disorderly exits and market forces from dictating who gets kicked out and how. To do this, they still need more time, and the 6th tranche may give them just enough of it to solidify their preparations.
The markets have already broken past the tipping point, and the momentum for default cannot be prevented for countries like Greece and Ireland. The run on Greek banks will continue until a default occurs, at which point capital controls will have to be implemented, or a massive liquidity intervention will have to be initiated by the ECB. I imagine that both will occur in tandem, which is why rich Greeks already moved as much money as they could outside the country in 2009 and 2010.
The most likely scenario is that the eurozone’s leaders will try and package together a Greek default with that of other eurozone countries like Ireland and Portugal. The defaults don’t have to be on 100% of the outstanding debt, but they would have to be on enough of it that markets would stop attacking those countries from a credit standpoint, as well as an investment standpoint (i.e. investors would no longer fear putting money to work in Greece because of uncertainty about its future). I don’t know what this number is, but the markets sure do, and right now they are pricing in at least 50% for Greece (though I suspect when it is all said and done, that we are looking at closer to 80% or more).
In such a scenario, the Germans will have to come to the rude realization that their enemy is not Greece, but their own financial system, and that of the world as a whole, that allowed for a model of export led growth that was simply unsustainable. Not only will they have to socialize bank losses, but they will start to lose markets for their products, because they built their factories and their capacity based on the assumption that the demand for their goods was sustainable. Too bad it was based on debt that now needs to be desperately liquidated.
Debts that cannot be repaid, will not be repaid, and it is high time that the folks over in Brussels figured this out. The first two bailouts of Greece, the bailout of Ireland, then Portugal and the ongoing bond buying of the ECB through the SMP, not to mention the loan support programs for banks soaked with peripheral sovereign debt has done nothing to address the core of the crisis, which is ultimately that certain governments in Europe are insolvent, and need to default. That means that people are going to have to take losses, and some banks are going to have to go broke and be nationalized if that’s what it takes to prevent a total meltdown.
My guess is that Papandreou’s decision to return to Greece is part of a larger realization by Europe’s leadership that they must move past the rosy scenarios and unrealistic hopes that over indebted countries could magicallly grow and cut their way out of this credit crisis, and come to the conclusion that an orderly default must now be constructed. This cannot happen in the span of the next month, which is why I think that the 6th tranche is on its way regardless, but I do believe that unlike previous loans, this one will be the last for Greece.
Only time will tell, but the clock is certainly ticking.
The Greek government has reported that Prime Minister George Papandreou, has decided to cancel his previously planned trip to the United States ahead of what now appears to be a key week for the Greek government and its people.
According the widely read Greek newspaper, Kathimerini, the Prime Minister made the decision after a telephone conversation he had with his Economic Minister Evangelos Venizelos, who communicated to him a deep concern that European Union counterparts had expressed to him about the current state of the Greek economy.
Of course, this story in now generating all sorts of rumors, and this is in part justified. Some are using this as an opportunity to suggest that a Greek default is imminent, and that Papandreou’s return to Greece is in preparation for this. I doubt this will happen.
I understand that there are growing concerns that internal political opposition in countries like Germany, Austria and elsewhere to certain “emergency financial powers” for the EFSF and other bailout facilities is beginning to alarm other finance ministers and key officials in Europe who are working together in order to prevent an unraveling of the euro, the eurozone and EMU. I think this concern is justified, I just don’t think it has yet reached a point where we should expect to see our first eurozone default before the end of the week. I still think that Greece will get the 6th tranche payment this October, as it was scheduled to, regardless of whether it meets the official criterion set out by the MoU or not.
What is more likely, in my view, is that this is just a necessary step to bringing the country closer to default, as the Greek government and European finance ministers collectively spend whatever remaining political capital they have left – and as I said, I believe this capital will get them past the next tranche payment.
The markets need to come to grips with the reality of a Greek default with as much care and diligence as possible, so as to avoid a total panic and run on european sovereign debt and the european banking system. I think that the language and actions we will see come out of Greece and Europe over the days and weeks to come will be part and parcel of a strategy meant to prepare markets for this eventuality.
Let’s hope that by being the first country to default, that Greece can manage it in an orderly enough way, and with the help of eurozone partners, so as to avoid what could be a frightening collapse of the Greek economy and massive social unrest.
A very thoughtful article by George Soros is circulating on various press outlets, and I think it is worth reading. Soros ultimately believes, as he has said many times both in his books as well as in his articles, that the global financial system needs a global institutional architecture to control it. On this, we disagree, as I believe that this will only make it more difficult for humanity to escape the vices of technocrats and financiers whose power will be amplified institutionalizing their global networks through law.
However, I think that some of the things Soros wrote in this article make sense, and go further than in his previous pieces to addressing the immediate problems of Europe. I agree with his suggestion that Greece, Portugal and Ireland may be better off leaving the Eurozone, but that their exit should not be done in a heartless manner, but rather in an orderly way so that their banking systems and economies do not needlessly collapse, sending the countries into social upheaval.
I have always advocated liquidation of bad debt and bankruptcy for over leveraged institutions, but this does not mean that I think that, given where we are today that we cannot provide for some sort of orderly default process. If a bank is bankrupt, then there is no question that its equity holders should lose all their money, but a case can be made for nationalization of these banks in order to prevent a complete collapse of the deposit base. In the case of Greece, if the banks are allowed to fail organically, as they should in a free market economy, then the outcome may be worse than what we saw in Argentina.
Market manipulation and socialism for the wealthy financiers are what got us here, and any solution that is proposed should be implemented with the explicit goal of returning us toward sound money and more free market checks on credit creation, but this does not mean that we cannot try and have some sort of orderly deleveraging, which does mean that surplus countries would have to bare some of the losses of the deficit countries. It also means that savers are going to have to bail out insolvent european banks to some degree, because the alternative could be that they lose all their money as a run on deposits causes bank failures that lead to a system collapse that will serve no one.
Again, its all about the total plan. If a complete plan cannot be presented that admits why we are where we are, and punishes the culprits as part of the solution, then I would rather see a system collapse. I am tired, as I think many other are, of this “crisis-solution” paradigm that is constantly used to push through changes that ultimately lead us further down the road of serfdom.
So, enough of that. Here is Soros’ article:
The euro crisis is a direct consequence of the crash of 2008. When Lehman Brothers failed, the entire financial system started to collapse and had to be put on artificial life support. This took the form of substituting the sovereign credit of governments for the bank and other credit that had collapsed. At a memorable meeting of European finance ministers in November 2008, they guaranteed that no other financial institutions that are important to the workings of the financial system would be allowed to fail, and their example was followed by the United States.
Angela Merkel then declared that the guarantee should be exercised by each European state individually, not by the European Union or the eurozone acting as a whole. This sowed the seeds of the euro crisis because it revealed and activated a hidden weakness in the construction of the euro: the lack of a common treasury. The crisis itself erupted more than a year later, in 2010.
There is some similarity between the euro crisis and the subprime crisis that caused the crash of 2008. In each case a supposedly riskless asset—collateralized debt obligations (CDOs), based largely on mortgages, in 2008, and European government bonds now—lost some or all of their value.
Unfortunately the euro crisis is more intractable. In 2008 the U.S. financial authorities that were needed to respond to the crisis were in place; at present in the eurozone one of these authorities, the common treasury, has yet to be brought into existence. This requires a political process involving a number of sovereign states. That is what has made the problem so severe. The political will to create a common European treasury was absent in the first place; and since the time when the euro was created the political cohesion of the European Union has greatly deteriorated. As a result there is no clearly visible solution to the euro crisis. In its absence the authorities have been trying to buy time.
In an ordinary financial crisis this tactic works: with the passage of time the panic subsides and confidence returns. But in this case time has been working against the authorities. Since the political will is missing, the problems continue to grow larger while the politics are also becoming more poisonous.
It takes a crisis to make the politically impossible possible. Under the pressure of a financial crisis the authorities take whatever steps are necessary to hold the system together, but they only do the minimum and that is soon perceived by the financial markets as inadequate. That is how one crisis leads to another. So Europe is condemned to a seemingly unending series of crises. Measures that would have worked if they had they been adopted earlier turn out to be inadequate by the time they become politically possible. This is the key to understanding the euro crisis.
Where are we now in this process? The outlines of the missing ingredient, namely a common treasury, are beginning to emerge. They are to be found in the European Financial Stability Facility (EFSF)—agreed on by twenty-seven member states of the EU in May 2010—and its successor, after 2013, the European Stability Mechanism (ESM). But the EFSF is not adequately capitalized and its functions are not adequately defined. It is supposed to provide a safety net for the eurozone as a whole, but in practice it has been tailored to finance the rescue packages for three small countries: Greece, Portugal, and Ireland; it is not large enough to support bigger countries like Spain or Italy. Nor was it originally meant to deal with the problems of the banking system, although its scope has subsequently been extended to include banks as well as sovereign states. Its biggest shortcoming is that it is purely a fund-raising mechanism; the authority to spend the money is left with the governments of the member countries. This renders the EFSF useless in responding to a crisis; it has to await instructions from the member countries.
The situation has been further aggravated by the recent decision of the German Constitutional Court. While the court found that the EFSF is constitutional, it prohibited any future guarantees benefiting additional states without the prior approval of the budget committee of the Bundestag. This will greatly constrain the discretionary powers of the German government in confronting future crises.
The seeds of the next crisis have already been sown by the way the authorities responded to the last crisis. They accepted the principle that countries receiving assistance should not have to pay punitive interest rates and they set up the EFSF as a fund-raising mechanism for this purpose. Had this principle been accepted in the first place, the Greek crisis would not have grown so severe. As it is, the contagion—in the form of increasing inability to pay sovereign and other debt—has spread to Spain and Italy, but those countries are not allowed to borrow at the lower, concessional rates extended to Greece. This has set them on a course that will eventually land them in the same predicament as Greece. In the case of Greece, the debt burden has clearly become unsustainable. Bondholders have been offered a “voluntary” restructuring by which they would accept lower interest rates and delayed or decreased repayments; but no other arrangements have been made for a possible default or for defection from the eurozone.
These two deficiencies—no concessional rates for Italy or Spain and no preparation for a possible default and defection from the eurozone by Greece—have cast a heavy shadow of doubt both on the government bonds of other deficit countries and on the banking system of the eurozone, which is loaded with those bonds. As a stopgap measure the European Central Bank (ECB)stepped into the breach by buying Spanish and Italian bonds in the market. But that is not a viable solution. The ECB had done the same thing for Greece, but that did not stop the Greek debt from becoming unsustainable. If Italy, with its debt at 108 percent of GDP and growth of less than 1 percent, had to pay risk premiums of 3 percent or more to borrow money, its debt would also become unsustainable.
The ECB’s earlier decision to buy Greek bonds had been highly controversial; Axel Weber, the ECB’s German board member, resigned from the board in protest. The intervention did blur the line between monetary and fiscal policy, but a central bank is supposed to do whatever is necessary to preserve the financial system. That is particularly true in the absence of a fiscal authority. Subsequently, the controversy led the ECB to adamantly oppose a restructuring of Greek debt—by which, among other measures, the time for repayment would be extended—turning the ECB from a savior of the system into an obstructionist force. The ECB has prevailed: the EFSF took over the risk of possible insolvency of the Greek bonds from the ECB.
The resolution of this dispute has in turn made it easier for the ECB to embark on its current program to purchase Italian and Spanish bonds, which, unlike those of Greece, are not about to default. Still, the decision has encountered the same internal opposition from Germany as the earlier intervention in Greek bonds. Jürgen Stark, the chief economist of the ECB, resigned on September 9. In any case the current intervention has to be limited in scope because the capacity of the EFSF to extend help is virtually exhausted by the rescue operations already in progress in Greece, Portugal, and Ireland.
In the meantime the Greek government is having increasing difficulties in meeting the conditions imposed by the assistance program. The troika supervising the program—the EU, the IMF, and the ECB—is not satisfied; Greek banks did not fully subscribe to the latest treasury bill auction; and the Greek government is running out of funds.
In these circumstances an orderly default and temporary withdrawal from the eurozone may be preferable to a drawn-out agony. But no preparations have been made. A disorderly default could precipitate a meltdown similar to the one that followed the bankruptcy of Lehman Brothers, but this time one of the authorities that would be needed to contain it is missing.
No wonder that the financial markets have taken fright. Risk premiums that must be paid to buy government bonds have increased, stocks have plummeted, led by bank stocks, and recently even the euro has broken out of its trading range on the downside. The volatility of markets is reminiscent of the crash of 2008.
Unfortunately the capacity of the financial authorities to take the measures necessary to contain the crisis has been severely restricted by the recent ruling of the German Constitutional Court. It appears that the authorities have reached the end of the road with their policy of “kicking the can down the road.” Even if a catastrophe can be avoided, one thing is certain: the pressure to reduce deficits will push the eurozone into prolonged recession. This will have incalculable political consequences. The euro crisis could endanger the political cohesion of the European Union.
There is no escape from this gloomy scenario as long as the authorities persist in their current course. They could, however, change course. They could recognize that they have reached the end of the road and take a radically different approach. Instead of acquiescing in the absence of a solution and trying to buy time, they could look for a solution first and then find a path leading to it. The path that leads to a solution has to be found in Germany, which, as the EU’s largest and highest-rated creditor country, has been thrust into the position of deciding the future of Europe. That is the approach I propose to explore.
To resolve a crisis in which the impossible becomes possible it is necessary to think about the unthinkable. To start with, it is imperative to prepare for the possibility of default and defection from the eurozone in the case of Greece, Portugal, and perhaps Ireland.
To prevent a financial meltdown, four sets of measures would have to be taken. First, bank deposits have to be protected. If a euro deposited in a Greek bank would be lost to the depositor, a euro deposited in an Italian bank would then be worth less than one in a German or Dutch bank and there would be a run on the banks of other deficit countries. Second, some banks in the defaulting countries have to be kept functioning in order to keep the economy from breaking down. Third, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Fourth, the government bonds of the other deficit countries would have to be protected from contagion. The last two requirements would apply even if no country defaults.
All this would cost money. Under existing arrangements no more money is to be found and no new arrangements are allowed by the German Constitutional Court decision without the authorization of the Bundestag. There is no alternative but to give birth to the missing ingredient: a European treasury with the power to tax and therefore to borrow. This would require a new treaty, transforming the EFSF into a full-fledged treasury.
That would presuppose a radical change of heart, particularly in Germany. The German public still thinks that it has a choice about whether to support the euro or to abandon it. That is a mistake. The euro exists and the assets and liabilities of the financial system are so intermingled on the basis of a common currency that a breakdown of the euro would cause a meltdown beyond the capacity of the authorities to contain. The longer it takes for the German public to realize this, the heavier the price they and the rest of the world will have to pay.
The question is whether the German public can be convinced of this argument. Angela Merkel may not be able to persuade her own coalition, but she could rely on the opposition. Having resolved the euro crisis, she would have less to fear from the next elections.
The fact that arrangements are made for the possible default or defection of three small countries does not mean that those countries would be abandoned. On the contrary, the possibility of an orderly default—paid for by the other eurozone countries and the IMF—would offer Greece and Portugal policy choices. Moreover, it would end the vicious cycle now threatening all of the eurozone’s deficit countries whereby austerity weakens their growth prospects, leading investors to demand prohibitively high interest rates and thus forcing their governments to cut spending further.
Leaving the euro would make it easier for them to regain competitiveness; but if they are willing to make the necessary sacrifices they could also stay in. In both cases, the EFSF would protect bank deposits and the IMF would help to recapitalize the banking system. That would help these countries to escape from the trap in which they currently find themselves. It would be against the best interests of the European Union to allow these countries to collapse and drag down the global banking system with them.
It is not for me to spell out the details of the new treaty; that has to be decided by the member countries. But the discussions ought to start right away because even under extreme pressure they will take a long time to conclude. Once the principle of setting up a European Treasury is agreed upon, the European Council could authorize the ECB to step into the breach, indemnifying the ECB in advance against risks to its solvency. That is the only way to forestall a possible financial meltdown and another Great Depression.
Here is another video of me at the RT studio in Washington D.C. discussing the latest developments in the Eurozone.
It’s been very difficult to really assess how much of the news coming out on Greece is real and how much of it is manufactured. There is no doubt that default “chatter” is the highest I have ever heard it, but I don’t believe that we are going to see a unilateral Greek default at the current time (still…this is how Black Swann’s come to pass). I think things are clearly escalating, but I would expect that the entrance of China on the European stage and the increasing visibility of Tim Geithner and the Obama administration in eurozone debt talks will only increase the pressure on France and Germany to make sure that Greece does not leave EMU anytime soon.
It’s definitely tough hearing these rumors about Greece, on a personal level, because I feel that the country is not prepared for what a default will mean. I have been an advocate of unilateral default for sometime, but I also want a government that is, in good faith, preparing for this eventuality. Right now, there is no indication that PASOK has taken any steps to mitigate the fallout from a default and euro exit, and this is truly the most frightening aspect of this entire game.
Above is an in-studio interview that I did for Russia Today from Washington D.C. yesterday. I am currently working on a new show, and have moved here for the foreseeable future.
Any fans of this blog who are D.C. natives are more than welcome to give me pointers on where to live as I am still subletting a place and won’t have to commit to an area until early October.
I was thinking DuPont Circle area. Any suggestions?
With the onset of fall, the squeeze is back on in the Greek capital, as we always knew it would be. Strung out on debt, the Greek government is now back on its knees, begging for the next 8 bln euro tranche of its original 110 bln euro loan package from the Troika agreed to over one year ago.
At risk in June, when the fifth installment was being withheld, were government salaries and interest payments for the month of July. Today, the story is much the same, with the Greek government scheduled to be 1.5 bln euros underwater by October 17th – about one month out – without the release of the 8 bln euro tranche.
But the release of the latest tranche is by no means a foregone conclusion. Every time the Greek government has to jump through these European hoops, more and more political capital gets expended in the process, and this only makes it more difficult for the Greek government to raise money from private investors. This effect could be seen this past Thursday, after Greek commercial banks failed to cover the sum of 300 million euros of supplementary, noncompetitive bids for Tuesday’s auction of government debt, providing only half that sum (155 million). The shortfall could be interpreted as a message by Greek banks to the government that they are unwilling to continue taking on more and more government paper at a time when their own balance sheets are fatally exposed to a Greek default.
And of course, with the Greek banking sector expected to support a market for government debt borrowing while at the same time facing rising liability concerns of its own, it should be no surprise that borrowing costs for average Greek businesses and households have shot up. According to the latest data from the Bank of Greece, the spread between deposit and lending rates widened to 4.30 percentage points in July, up from 3.68 a year earlier, while the average floating rate for consumer loans climbed to just over 11 percent.
Where else can this situation inexorably lead but to default?