German Pope, Italian Central Banker
by Gary North: The
First 15 Minutes of Regis Philbin's Career
Europe is in bad shape. This is hedge fund manager Kyle Bass's assessment
of the situation in Europe. He stated this in a rousing interview
on the BBC's TV network. Here
is the segment.
He made two
crucial points points that stock market investors are ignoring.
First, over the last nine years, there has been an increase of world
debt from $80 trillion to $210 trillion. These numbers are staggering.
Global debt over the last nine years has grown at 12% per year,
while GDP has grown at 4% per year.
While he did
not verbally spell out the conclusion for the interviewer, it is
this: when credit must grow by 12% per year in order to produce
4% GDP growth, at some point there will not be enough GDP to supply
It is time
once again to quote economist Herb Stein: "When something cannot
go on forever, it has a tendency to stop."
Bass had a
great metaphor: the PIIGS have "sailed into a zone of insolvency."
explained, the sovereign debts in Europe will be written down. There
is no other solution.
interviewer with the Oxbridge accent seemed to be doing a college-skit
imitation of Emma Thompson. She challenged him. What about Germany?
Can't Germany continue to fund Europe's "southern neighbors"? Germany
has "the earning power." (Note: this means German taxpayers.)
instantly. First, the German court has determined that any further
bailouts are unconstitutional. Second, Greece and, by implication,
the other "southern neighbors" will spend every euro it borrows
from Germany and then come back for more, threatening a default
if its demands are not met exactly what it has done so far.
This goes on until the write-down takes place, which it will.
There are two
ways of looking at this: the Bass way and the Bass-ackwards way.
The airhead chose the latter.
He draws conclusions
from the numbers. No one in the mainstream media and mainstream
investment fund world seems to be willing to do this. They talk
and invest as if the process can go on forever. Debts need not be
repaid. This is ancient Keynesian dogma that goes back to the New
Deal. "We owe it to ourselves." On the contrary, specific borrowers
owe it to specific creditors. At some point, the specific borrowers
are going to default, leaving specific creditors with huge losses.
Smith agrees with Bass. He says that there will have to be a write-down.
By "write-down" he means write-off. He estimates the losses at three
have to take the hit. The great political debate in Europe today
is over who will take this hit, and how soon.
It will be
investors. But, to forestall the day of reckoning, Europe's politicians
pretend that taxpayers' credit lines can be used by superficially
solvent Northern European governments in order to borrow more money
from creditors in order to lend to the PIIGS's governments, so that
the PIIGS's governments can continue to (1) delay real austerity
measures, i.e., massive layoffs of government workers and massive
cuts in welfare payments, and (2) make payments on what they owe
to investors, mainly banks.
that three trillion euros is a guess. Nobody knows how much bad
sovereign debt there is, so we must start somewhere. In a world
of $210 trillion worth of debt, his estimate seems reasonable to
start with the most basic fact about all this uncollectible, impaired,
bad debt: every euro of debt is somebody else's asset. Wipe out
the debt and you wipe out the asset. That's why there's no willingness
to accept the writedown of debt: somebody somewhere has to suck
up 3 trillion euros of loss.
This is the
source of Europe's present policy of "kick the can," or more accurately,
"kick the can with press releases and summits." If there were a
pain-free solution, it would have been implemented long ago.
is no way Europe is going to "grow its way out of this debt." How
much of the eurozone's "growth" was the result of rampant malinvestment
and risky borrowing? More than anyone dares admit. It won't take
austerity to crash the euroland economy, all it will take is turning
off the debt spigot.
Europe is facing
the problem that Bass raised when he spoke of 12% per year increases
of credit and 4% increases per year of GDP. There is no way to grow
your way out of this. This is not just Europe's problem. It is the
world's problem. But Europe is facing it now because the debts are
coming due now. They must be rolled over. Creditors must agree to
re-lend. But why should they?
world of crony capitalism speaks of "re-structuring" the debt. What
does this mean? Smith does not pull any punches.
is a code word for writeoffs. Here, let me "restructure" the euro
bond you bought at a 4% coupon yield. Now you're going to get 2%,
and you're going to like it. Bang, your bond just lost half its
market value, but everyone gets to keep it on the books at full
value. Nice, until you have to sell it to raise cash. Oops, the
euro has slipped in value so you lost more than 50%.
The banks keep
the assets on the books at face value. The underlying value is down
by at least 50% for Greek bonds. The European experts admit this.
(Why the debt is worth that high a percentage is beyond me.) The
Greeks are going to default, one way or another.
Who will take
the hit? Smith writes: ""There's a fundamental truth that everyone
has to understand: what the government spends, the public will pay
for sooner or later, whether in taxes or inflation or having their
debt defaulted on." This is reality. But it's not precise enough.
IS THE PUBLIC?
If there is
hyperinflation price inflation above 30% per year for a decade
or more the public that takes the hit will be almost everyone
inside the eurocurrency zone. There will be almost universal hardship.
On the other
hand, if monetary inflation ceases for more than a few months, there
will be a depression. Big banks will fail. Their depositors will
lose everything. The money supply will shrink. It will be 1930-38
all over again.
do not allow such things. The European Central Bank will try to
walk the tightrope, just as the national central banks in Europe
did after World War II. The ECB will pursue boom-bust policies,
refusing to capitulate either to a Great Depression or hyperinflation.
But how can
it walk this tightrope? The losses will be huge for large banks.
The politicians will try to transfer the cost of bailing out Europe's
banks to Germany. But the debts are too large.
will try to do what the BBC interviewer suggested: get northern
Europe to fund a never-ending series of rollover loans to the PIIGS.
This is standard wisdom. But the numbers are too large.
Then what will
happen? Europe will adopt the American solution. The ECB will not
allow large banks to default. It will inflate to buy the bad assets
or else buy the bonds of the governments, so they can make payments.
Then the bankers will put this money into excess reserves. New lending
to businesses will cease. The West will go into permanent recession
or no-growth stasis. The governments will absorb an ever-larger
percentage of the region's capital: bond sales. Private firms will
not be able to borrow at low rates. Capital development will crease.
Europe is more
dependent on bank financing than the USA is. Europe is therefore
headed for a long era of very low growth or else recession. The
governments will suck up the credit because they must keep the payments
system alive. The banks will not be allowed to collapse. Neither
will the money supply.
The ECB does
not want hyperinflation or a Great Depression. The alternative is
the transfer of capital to PIIGS on a long-term basis. The states
will absorb the savings of the region.
what has been done to voters by the bankers by way of the politicians.
There is nothing new here. It goes back to Walter Bagehot's description
of "moral hazard" in the mid-nineteenth century.
who made the risky bets have diverted the risk to others: taxpayers
or the general public who holds currency. The gains from the bets
are private, and theirs to keep, but all the losses are distributed
to the public via government bailouts or money-printing. The first
shifts the losses to the taxpayer, and the second shifts the losses
to everyone holding the currency being devalued.
This has worked
because all of the governments' bills have not come due. The rollovers
have been sequential. The big debtor states Spain and Italy
have not yet reached the edge of the abyss that Greece is
staring at. But they are getting close.
on the winners and the losers in all this.
only has the risk been palmed off onto unsuspecting chumps, the
returns have been concentrated into the few hands that control the
big bets. This is the ideal setup for the stupendous gains and zero
risk that characterize crony-capitalism: make the big bets with
leverage and borrowed money, and skim the vast profits. Then when
the bets sour, demand a bailout from the Central State, the ECB,
the Fed, etc., which promptly socializes the losses and distributes
them over the entire populace of taxpayers or holders of currency.
that the only thing that can stop this is the rebellion of the new
works beautifully until the debt-serfs rebel. The EU's politicos
are begging to start the printing presses, as that is the only way
they can retain their power in the face of the debt-serfs' revolt.
But at least one populace of tax-serfs (Germany) is rebelling against
sucking all the losses via a massive reduction of purchasing power.
But the debt-serfs
do not see it. They cannot stop their governments. They are not
united against the bailouts. Each new government pursues business
the "Occupy Wall Street" movement. They are mostly socialists and
welfare statists. They want more regulation and higher taxes on
the rich the New Deal extended. This program has not reduced
inequality since 1933. The protesters are not demonstrating in front
of the regional branches of the Federal Reserve. They still have
no idea of how central banking is at the center of the economy,
and has been in the USA ever since it opened its doors for business
who made the bets should rightly lose everything yes, be
wiped out. If risk and return are actually causally linked, then
this is the only result of a big bet that sours: those who placed
the bets should be wiped out. That includes money managers, bank
honchos, bond-fund gurus, and everyone else who foolishly bought
all this debt without investigating the risks.
But that means
the big banks. If they fold, the entire monetary system goes into
mass deflation of money first, then prices. The world goes
back to 1930-33. There is no way to avoid this, according to Keynesians,
monetarists, supply-siders, and even Austrians. Here is where there
is universal agreement. If the large banks go under, then the Great
Depression returns. Then the governments that have bailed out the
PIIGS go under, too.
recommend this in order to get back to true pricing of capital.
All other schools of economic opinion want to prevent this by means
of central bank inflation. The Austrians say "let the sucker go
down." Then the recovery will begin. First pain, then joy: like
a woman in childbirth. Politically, this is an impossible marketing
job. It will not be allowed to happen. Governments will bail out
the big banks. They will borrow to do this. If this requires a violation
of the European treaties, either the treaties will be changed by
parliaments or else they will be ignored.
This is moral
hazard in action. It never changes in principle. The numbers just
get larger. Economic interdependence gets larger. The division of
labor is extended. The system relies more and more on fiat money
and bookkeeping deceptions.
some sort of firewall for the bankers and the voters. The loss should
should not suck a loss are those who did not stand to gain: the
taxpayers and holders of the currency. To repeat: the most basic
fact about all this uncollectible, impaired, bad debt is that every
euro of debt is somebody else's asset. Wipe out the debt and you
wipe out the asset.
the assets of the largest and most leveraged banks will be wiped
out. Then the banks will be wiped out. They will fail. This means
failure at the heart of the European economy. The crash will spread
around the world. There is no firewall other than fiat money.
is no way to avoid the 3 trillion in losses. The only question is
who should absorb those losses: those who stood to gain, or the
innocent chumps whose only crime was being a taxpayer or owner of
euros? If there is any justice (or classical Capitalism) at all
in Euroland, then those who made the bets and invested capital in
the bets to reap a return are the ones who should absorb the losses.
All true. But
the masses have their money in commercial banks, pension funds,
and mortgaged homes. Monetary deflation will impoverish them. The
masses are trapped, one way or another.
He says, "Life
will go on if the banks are wiped out and closed, pension funds
and insurance companies take losses, etc." In a world with an extended
division of labor, which is also a world regulated from the top
by bureaucrats, if the big banks really do go down, life may not
go on for millions. The division of labor depends on the money economy.
The money economy is leveraged at 40 to 1. What if the money supply
falls by (say) a factor of 40? This is the curse of moral hazard.
draws a conclusion.
those who made the bets for their own private gain aren't forced
to absorb the risk, then we don't live in either capitalism or democracy;
we live in a financial-fascist tyranny.
this is exactly where we live. That
was my point back in February 2009.
of kick the can will continue. The best summary of the outcome was
made by a Spanish government worker on Sunday, November 20, the
day of national elections. The socialists were thrown out of office.
He said this: "We can choose the sauce they will cook us in, but
we're still going to be cooked."
The whole urban
world is in the same pot. We get our choice of sauce.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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