by David Stockman
The politicians of Europe are plunging into a form of ideological fratricide as they battle over Greece. And “fratricide” is precisely the right descriptor because in this battle there are no white hats or black hits—-just statists.
Accordingly, all the combatants—the German, Greek and other national politicians and the apparatchiks of Brussels and Frankfurt—- are fundamentally on the wrong path, albeit for different reasons. Yet by collectively indulging in the sum of all statist errors they may ultimately do a service. Namely, discredit and destroy the whole bailout state and central bank driven financialization model that threatens political democracy and capitalist prosperity in Europe——and the rest of the world, too.
The most difficult case is that of the German fiscal disciplinarians. Praise be to Angela Merkel and her resolute opposition to Keynesian fiscal profligacy and her stiff-lipped resistance to the relentless demands for “more stimulus” from the likes Summers, Geithner, Lew, the IMF and the pundits of the FT, among countless others. At least the Germans recognize that if the EU nations are going devote 49% of GDP to state spending, including nearly a quarter of national income to social transfers, as was the case in 2014, then they bloody well can’t borrow it.
Notwithstanding the alleged German led austerity regime, however, that’s exactly what they are doing. Germany has managed to swim against the surging tide of EU public debt, lowering its leverage ratio from 80% to 76% of GDP in the last four years. Yet the overall debt ratio for the EU-19 has continued to soar—meaning that the rest of the EU drifts ever closer to fiscal disaster.
Euro Area Government Debt As % of GDP
Indeed, Germany’s frustration with the rest of the European fiscal sleepwalkers is more than understandable, as is its fanatical resolve not to give an inch of ground to the Greeks. Or as Merkel’s deputy parliamentary leader, Michael Fuchs told Bloomberg,
There is no way out” for Greece from its treaty obligations….. conditions set for Greece by The Troika (EU, ECB, IMF) for bailout funds “have to be fulfilled…. That’s it, very simple.”
This isn’t just teutonic rigidity. It’s actually all about the so-called capital contribution key—-the share of the EU bailout fund that must be covered by each member country in the event of a default.
At dead center of Greece’s $350 billion of debt is $210 billion owed to the Eurozone bailout mechanism. Germany’s share of that is 27% or roughly $57 billion. Yet the prospect of tapping the German taxpayers for some substantial part of that liability in the event of a Greek default is not the main problem—-even as it would mightily catalyze Germany’s incipient anti-EU party.
The real nightmare for Merkel’s government is that the next two largest countries in the capital key are on a fast track toward their own fiscal demise. So what puts a stiff spine into its insistence that Greece fulfill the letter of its MOU obligations is that if either France or Italy is called upon to cover losses, the whole bailout scheme will go up in smoke.
There is not a snowball’s chance that the already faltering governments of either country would survive a capital call from the EU bailout funds. Indeed, the prospect of a partnership with Marine Le Pen and Beppe Grillo is undutedly what was on German Finance minister Schaeuble’s mind when this picture was snapped during his meeting with Varoufakis.
Just consider the delusionary partners Germany has at present—even before any Syriza-style election upheavals. In another of his patented outbursts of truth over the weekend, the Greek finance minister suggested that Italy was next and that it too, will discover “it is impossible to remain inside the straightjacket of austerity.”
That drew an immediate response from Italy’s Economy Minister, Pier Carlo Padoan, who tweeted to the world that Italy’s debt is “solid and sustainable”.
Is he kidding? Italy’s GDP is dead in the water and has been since 2007. Yet it has continued to run massive budget deficits—about $75 billion this year alone–so its debt to GDP ratio has gone nearly vertical.
Indeed, the very notion that the trend shown below has any resemblance to a “solid and sustainable” fiscal posture is indicative of the sheer corruption of discourse that has been introduced by the Keynesian commentariat and the policy apparatchiks of the EU, IMF and Washington.
Their specious claim that all is well in Italy rests on the fact that it has close to a “primary surplus” before interest payments.
So what! The undeniable fact is that Italy is borrowing heavily year after year to pay its interest, and is thereby impaling itself in a debt trap. That is, a situation so hopeless that no imaginable Italian government can stop the fiscal hemorrhage—- owing to the fact that the vast scale of the tax increases and spending cuts that would be necessary to reverse the debt spiral would be too toxic politically to accomplish.
And that’s the crucial point. The Keynesian modelers can always make the debt curve bend downward by assuming that the vigorous application of more of the same poison—deficit finance—can magically cause Italy’s “aggregate demand” and GDP to spring upwards and grow out from under the debt. But Europe’s fiscal crisis is no longer about whiteboard policy options; its about the absolute breakdown of fiscal governance.
Charts: Trading Econonomics
To their great credit, the Germans do not believe in magic napkins of either the supply side or Keynesian varieties. Accordingly, the last thing they want to test is the capacity of Italian politicians to come up with even a tiny fraction of the approximate $37 billion of Greek debt they have guaranteed. For avoidance of doubt, here is the post-crisis trajectory of Italy’s real GDP—–a curve which is heading, not surprisingly, in a decidedly southward direction.
Moreover, Germany’s nightmares as to who will ultimately pay the piper most surely do not end with the Five-Star Movement descending on Rome. France’s share of the Greek debt is appximately $42 billion. But like the case of Italy its economy is flatlining, having gained only 1% in real terms since its crisis peak.
The truth is, the French state has been meandering toward economic stasis and fiscal bankruptcy for several decades under governments of the left and right. With the state now consuming nearly 60% of GDP, it cannot reasonably expect any measureable economic growth. None. Capitalism doesn’t function when it is smothered by taxes, bureaucracy, cronyism and welfare state torpor.
So France is now experiencing a breakdown long in the making. Its rapidly deteriorating fiscal condition has nothing to do with the financial crisis or the current flurry of so-called deflation. Its economy has finally succumbed to the destructive toll of statist economics, while its public debt continues to rise inexorably. Accordingly, it too has a debt to GDP burden that is rapidly heading beyond the 100% level.
So Germany’s unbending position on the Greek debt is understandable. If the default barrier is breached, it will start a EU-wide voter run on the parliaments. Even the Dutch would be stranded high and dry in the event of a capital call—-finance ministers Dijsselbloem’s lectures to Varoufakis about fiscal rectitude notwithstanding. Indeed, just how long would he and the current Dutch government remain in office after a capital call given the debt spiral already in motion?
In short, the EU outside of Germany and rounding error states like Finland has passed the point of no return on the fiscal front. No government that has to raise it share of the default cost will survive.
Germany will be left holding the entire bailout bag. And that serves them exactly right.
Merkel and her disciplinarians may be fiscally virtuous, but they are downright dense on the matter of central banking and the monetary order. In fact, they don’t have a clue about what capitalism in the financial system even means.
To be sure, they jabber endlessly about the impermissibility of central bank finance of “state deficits”. But this whole ideology amounts to a ritualized and intellectually vacant assault on a monetary straw man. Germany went along with the ECB’s $1.3 trillion LTRO program, for instance, apparently because it did not involve the “purchase” of sovereign debt.
In fact, the ECB injected into the European financial system this massive flow of cash made from thin air by advancing three-year discounts to EU banks that were strictly collaterized by the public debt of Germany, France, Italy, Spain etc. Accordingly, the credit risk assumed by the ECB was not that of BNP-Paribas, for example, but that of the French state bonds it hocked.
Needless to say, that’s state financing by any other name. Moreover, this is not merely evidence of German hair-splitting hypocrisy on the monetary policy question.
Had they really been committed to sound money they would never have permitted the ECB to go on the money printing rampage that occurred after German governments mesmerized by the “European Project” swapped the monetary quietism and rectitude of the Bundesbank for what quickly became the energetic, Keynesian macro-management regime of the ECB.
During the 10 years culminating in Draghi’s “whatever it takes” ukase of July 2012, the balance sheet of the ECB exploded by nearly 4X. It matters not one wit that this eruption was based on sovereign collateral rather than “outright” purchases of government debt, and whether the underlying cash injections to the EU banking system were deemed to be permanent or multi-year “temporary” loans.
Under today’s worldwide money printing mania, central bank balance sheets never shrink; they metastasize endlessly. The differences between outright purchases and repo-style transactions are merely technical.
Like all central banks, the ECB has become a monetary roach motel right under Germany’s nose. The bonds go in, but they never come out. And as explained below, the recent nominal shrinkage of the ECB’s balance sheet, which Draghi has now vowed to reverse with full German concurrence, was an accounting illusion, anyway.
The fact is, the ECB has been engaging in monetization on a massive scale from its inception. So doing, it has drastically distorted price discovery in the euro bond markets and thereby aided and abetted the fiscal profligacy that rages over the entire continent.
As indicated above, the fact that the ECB’s balance sheet appeared to shrink sharply (by about 1 trillion euro) during the two years after Draghi’s ukase, and in consequence of the pay down of the LTRO discounts, was merely an exercise in monetary sleight-of-hand. The ECB’s massive haul of assets was just temporarily parked off balance sheet in the accounts of hedge fund punters and national bank fellow travelers.
These speculators were more than eager to front run Draghi’s warranted word that the ECB would implicitly monetize any and all sovereign issues that might be required to keep the debt markets open to EU borrowers at the most congenial rates imaginable. Since this included, especially, all of the fiscal profligates of the periphery, the front-runners feasted heartily. Capturing the soaring value of the bonds they had funded on zero cost repo or deposits, they essentially rented their balance sheets to the Frankfurt apparatchiks at what amounted to obscene profits.
Yet none of the explicit bailout of Greek debt, or the defacto bailout of Italian, Spanish, Portuguese etc. debt via the Draghi ukase, would have happened had the ECB enabled honest price discovery in the debt markets during the phony boom years prior to the crisis. In effect, the ECB became a tool of the EU superstate, flooding member state ministries and parliaments with false prices on their sovereign debt.
Actually there was no reason for government bond rates to fall drastically during the decade run-up to the 2010 crisis. Prior to the recent downward blip of the euro zone CPI owing to the global oil and commodity crash, the trend level of inflation had not changed since the turn of the century. So in massively inflating its balance sheet by nearly 4X between 2002 and 2012, the ECB was the active agent that unleashed fiscal profligacy throughout the EU.
Over that period, the euro zone CPI rose relentlessly at a 2.3% compound annual rate, while public leverage ratios climbed steadily. There was no reason, therefore, either by way of declining inflation or improving fiscal performance for bond rates to fall— in the periphery or the core for that matter.
In fact, under a sound money regime, the ECB balance sheet would have grown hardly at all after the turn of the century. What the EU countries needed more than anything else was an honest bond market to bring home to its constituent governments the true cost of permitting public debt to spiral in the face of faltering growth and a relentless tide of crippling demographics. That is, a soaring population of social insurance recipients versus plunging birth rates and future labor force shrinkage.
Stated differently, the EU states desperately needed a monetary regime that required their deficits to be financed out of private savings and capital inflows, not the central bank printing press. That would have caused a visible “crowding out” of private investment, rising interest rates and political opposition to fiscal free-booting in the EU capitals.
Indeed, central bank financial repression and monetization of sovereign debt is the arch-enemy of Germanic fiscal rectitude. But the successive governments in Berlin had no clue and still don’t.
Not surprisingly, peripheral country interest rates during the post-2000 course of the ECB’s massive monetization became a snare and delusion. In this context, it doesn’t matter whether the ECB was actually buying Italian or Greek debt at the time (it wasn’t) or what the precise composition of its balance sheet eruption actually entailed. Debt market instruments are arbitraged and fungible. The adverse impact of the ECB drastic financial repression would have happened whether it was buying Italian debt, Spanish road bonds or Greek seashells.
Spanish 10-Year Bond
Italian 10-year Bond
Greek 10-Year Bond
Needless to say, there is always a counter-party. By the time the peripheral debt crisis reached fever-pitch in 2010-2012, European banks and insurance companies had gorged on the vastly mispriced debt that had been enabled by the ECB’s drastic financial repression. Accordingly, that was the moment when the scales should have fallen from Berlin’s eyes, and when its should have recognized that the cause of the crisis was not merely profligate Latin politicians, but the Keynesian money printers at the ECB which had tossed the Bundesbank’s sound money standards into the dustbin of history.
Instead, it stumbled into a monumental error. At the peak of the crisis, all of the big German, French and Italian banks were economically insolvent because the embedded mark-to-market losses on peripheral sovereign and private debts alike were orders of magnitude larger than the balance sheet equity of these institutions.
In the case of Deutsche Bank, for instance, its $1.9 trillion balance sheet at the end of 2010 was balanced precariously on just $34 billion of tangible equity. In effect, it was leveraged at 56X. The big French banks were not much better. BNP-Paribas had $60 billion of tangible equity pinned beneath $2.1 trillion of assets including more than $600 billion of exposure to high risk loans and bonds.
Yet the insane leverage ratios sported by the big EU banks were the product of another statist policy scheme in which the German fiscal conservatives were fully complicit. Namely, the regulatory regime known as risk-based asset accounting. Under the latter, sovereign debt is not counted for the purpose of computing capital adequacy. In short, the ECB midwifed vast losses on drastically mispriced sovereign debt and the EU bank regulators said not to worry. It doesn’t count!
Outside the primitive world of Keynesian GDP flow mechanics where financial markets and balance sheets do not even exist, there are three extremely dangerous “givens” in the real world of finance.
The first is that banks are not free market institutions, but dangerous wards of the state that must be strictly regulated and supervised lest they gamble recklessly with depositor funds, investor capital and the various insurance and safety net schemes of the state.
The second is that politicians must face the true economic cost of borrowing or they will be endlessly tempted to perpetuate their power and prerogatives by dispensing free lunch entitlements, subsidies and tax subventions to organized interest groups and crony capitalist plunderers. State borrowing has to hurt real world constituencies, not merely offend the requisites of fiscal virtue.
Finally, financial markets are the vital core of capitalism, but by their very nature they attract gamblers and risk-takers. Accordingly, the most dangerous enemy of capitalist prosperity is not really the political left. Instead, it is the insuperable “moral hazard” that results when agencies of the state—-including the fiscal authorities and central banking branches alike—-bailout the mistaken wagers, soured bets and excesses of reckless greed that inexorably arise in the financial markets.
It goes without saying that the German fiscal disciplinarians ignored all three of these cardinal rules when they partnered up with the Keynesian apparatchiks in Brussels and Frankfurt to bailout the entirety of the soured peripheral country debt at 100 cents on the dollar. So doing, they committed an immense act of statist folly.
In the first instance, they stripped European financial markets of whatever vestiges of discipline and honest price discovery which then remained; allowed the financial executives and traders responsible for loading their institutions’ balance sheets with drastic losses to go unscathed; and taught the gamblers unleashed by the ECB and EU bailouts that the sky was the limit.
No longer was their any risk of loss. In the event of even brief spats of market turmoil and modest sell-offs, the Germans made it clear that the EU superstate would come running with safety nets and subventions. The sorry spectacle of the hedge fund gamblers buying up Italian and Spanish bonds, and even Greek bank equities prior to Syriza’s emergence, and riding them for massive gains after Draghi’s ukase was the inevitable result of what amounts to the EUs quasi-nationalization of the sovereign debt markets.
Yes, this papered over the insolvency of Europe’s banking sector. But even on that score, the Germans are deeply culpable. There was no necessity whatsoever to shield banks and other investors from losses on their holdings of Greek and other peripheral debt. If they had wanted to protect purportedly innocent depositors and the financial system generally, they could have permitted Greece to tumble into bankruptcy back in 2010 and the losses to be taken on other peripheral debt in the years thereafter—and then recapitalized the banking system with public money, new leadership and an effective and honest regime to insure bank safety and soundness going forward.
At the end of the day, the statist road chosen by the Germans has become a dead end. And it was the German government that ultimately choose the route of money printing and bank bailouts because no other EU country had the financial resources and credibility to make it happen.
The massive transfer of bank and speculator losses to the peripheral nations has inherently resulted in the destruction of democratic sovereignty in the bailed-out nations. And this extends far beyond the blatant usurpation that occurred when Brussels virtually deposed the elected governments of Italy and Greece during the heat of the crisis.
The fact is, the hated Troika “program” and MOU would not exist absent the statist depredations of the Germans. In its absence, by contrast, the elected governments of the bankrupt EU nations would have needed to design and impose their own “austerity” programs in order to compensate for the absence of borrowed cash and to earn their way back into the capital markets on the basis of their own credit profile.
So Syriza is right to say that the devastated citizens of Greece do not owe Deutsche Bank and the rest of the bankers and punters a dime for the Greek bonds that their earlier governments imprudently issued and which the traders and managers of these institutions foolishly bought. The fact that German government caused these debts to be transferred to their own taxpayers is Berlin’s problem, not Athens’.
Indeed, that is the towering irony of the current fiasco. At the end of the day there will be no “mutualization” of the bailout debt of Greece or any other peripheral nation. It will all end up on Germany’s account because any other government which attempts to pay its share will end up like the Samaras government two weeks ago—that is, running off with the state’s internet passwords and office supplies in the middle of the night.
So the bailouts were one of the greatest acts of fiscal folly of all time—performed by the only fiscal disciplinarians left in Europe.
There could now be only one greater act of statist folly left on Berlin’s docket. The German’s could loose their nerve, allow Greece to stay in the EU without adherence to its commitments, and embrace Syriza’s out-and-out socialist plan for a modern day “New Deal” in the entire EU funded by the European Investment Bank (EIB).
Well, that would be debt mutualization of an even more cancerous type. Surely by now Frau Merkel has learned her lesson and will decline the offer to jump from the fiscal frying pan she has created into the raging fires that the populist left in Europe will otherwise stoke-up if given the chance.
In short, Germany has no choice except to let Greece go and to allow the entire EU bailout state to unravel, and then to pay the piper for its statist follies.
The alternative is an all-powerful superstate in Brussels and Frankfurt that will necessarily extinguish whatever remains of political democracy and capitalist prosperity in Europe.
The latter would also permanently bury German taxpayers in other people’s debt. The fiasco in Greece has already proven at least that much.
Leave a Reply