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The politicians of Northern Europe buckled. The PIIGS chuckled.
The Greeks played the Henry Paulson card magnificently. “If you don’t lend us enough money to meet interest payments, we’ll have to default. There will be a crisis. Woe, woe, woe.”
The politicians pretended to play hardball for less than three weeks. Then they folded. Let us review the timetable.
The Greek government first asked for $60 billion in euros on April 23. That was a Friday.
On Monday, April 26, the European Central Bank assured the world that there was no threat that the Greek crisis would spill over to other European countries. Bloomberg reported:
“There is no economic cause for a contagion discussion,” ECB Governing Council member Ewald Nowotny said in an interview in Washington.
Concern that Greece’s woes could spread to other indebted euro-area countries has been pushing up borrowing costs of nations including Portugal and Spain. The countries’ budget deficits as a share of gross domestic product were more than three times the European Union limit of 3 percent last year.
“Of course Spain is not Greece,” ECB President Jean-Claude Trichet said April 23 after meeting with Group of 20 finance chiefs. . . .
That indicated one of two things: (1) central bankers lie without conscience when facing a crisis, or (2) central bankers do not know what is happening in front of their collective noses.
The next day, April 27, Standard & Poor’s downgraded Greek sovereign debt to junk status, and downgraded Portugal’s debt by two notches.
On April 28, S&P downgraded Spain’s debt one notch. Spain’s Minister of Finance howled. No cause! No cause!
On May 2, northern politicians announced that Greece would get at least $145 billion in euro loans over a three-year period. This was over double the amount Greece had asked for on April 23.
On May 3, the European Central Bank said that it would not lend to Greece. It said it would lend to banks that offered Greek government debt as collateral. This was perceived as resistance.
On May 5, Greek rioters set fire to a bank. Three people inside are killed.
On May 6, England held national elections. The outcome was a nation with a hung House of Commons. Over the weekend, there was no resolution to the problem.
On Sunday, May 9, Merkel’s party lost a regional election. Her party will lose the upper house as a result. On May 9, after an all-day meeting, the EU and IMF representatives announced a $960 billion bailout of the PIIGS. Merkel announced that the upper house will approve the loan package on May 11.
Also on May 9, the Federal Reserve System announced an emergency policy of providing dollars to central banks, to stem the run-up of the dollar.
Mission accomplished. The PIIGS won.
WHY DID THE ESTABLISHMENTS CAPITULATE?
The euro zone was facing a domino effect. European banks hold at least $236 billion in Greek debt. Greece was about to default. The banks were about to face another crisis.
The ECB tried to resist, but Standard & Poor’s had begun the downgrading process. Sarkozy and Merkel spoke out against this. There is now talk that Europe, meaning the EU, will create its own credit-rating service. Why? Because the EU wants to control the ratings. Its leaders do not want to be dependent on American credit-rating services, which are beyond EU political pressures.
The crisis did threaten the profitability of the banks. The ECB finally faced the reality that it had denied on April 26. This was a systemic crisis.
The currency speculators had been shorting the euro. The hatred of currency speculators among national leaders is total. Central bankers hate them just as much. Their decisions call to the attention of the public the weakness of a threatened currency. They reveal that the politicians are lying.
The EU, ECB, and IMF joined together to stop the currency speculators. They agreed to a bailout that was 15 times greater than the $60 billion Greece had originally requested. The media dubbed this “shock and awe.”
You may remember how well shock and awe worked in Iraq. We are still there.
Already, columnists are writing articles about the possibility that this bailout will not be enough.
The Establishment has only two policies: deficits and monetary inflation. This is basic Keynesianism. Both were invoked on May 9.
Markets rallied. European bank stocks rose by over 10% as soon as the market opened. It was clear that the banks were the main winners.
The threat was always mainly a threat to banks. Banks had loaded up on Greek debt. Why? Because of higher interest rates. Why had there been higher interest rates? Because there was more risk of default.
Bankers trust governments. They trusted the Greek government to meet its next interest payment on May 19. On April 23, the Greeks began playing the Hank Paulson card. The banks saw the possibility of a default. Bank shares started falling. So, bankers got to work. They, too, played the Paulson card. The S&P downgrades added credibility to the scenario. There was a threat of a systemic breakdown.
The bankers’ solution is the tried and true strategy of moral hazard, described by Walter Bageot in the late 19th century. The banks are bailed out by politicians and central banks. Losses are transferred to the taxpayers by way of bailouts and currency depreciation. The day of reckoning is postponed.
For the first time in Western history since the late nineteenth century, a few million voters are beginning to catch on. They don’t understand fractional reserve banking, but they understand when politicians raise the national debt to bail out people who cannot pay their interest on time.
Voters in Germany resisted. This accomplished nothing. As they were going to the polls, Merkel was selling them out to the PIIGS and the banks that trusted the PIIGS, especially French banks, which own a third of Greek debt.
It is beginning to dawn on a minority of voters that the political game is rigged in favor of big banks. It has taken a century for this to begin to register. This is a threat to Establishments everywhere. This was the #1 secret that the Establishments have attempted to conceal.
TAX REVOLT? NOT YET.
The Establishments for a century have used the greed of the voters to create a money tree for bankers. Here is how it has worked, ever since the years just prior to World War I.
The politicians promise the voters revenue from the rich. The voters are promised government jobs, government support for labor unions, and old age pensions. The welfare state grows.
The politicians refuse to raise taxes enough to meet these commitments. They use “pay as you go” accounting.
The governments run debts. Investors buy these debts, because they are guaranteed by the government. The debts are seen as risk-free.
Wars break out. Governments then run larger deficits. These debts are never repaid. They always increase. Old debts are rolled over.
The governments keep selling promises to voters. The voters keep believing they will be paid off someday.
When tight times hit, central banks buy government debts with fiat money. They roll over these debts. The debts grow.
Any threat of default threatens the commercial banks. When a crisis arrives, governments and central banks bail out the largest commercial banks.
The voters do not revolt because they are up to their elbows in personal debt. They have no savings. They rely on government promises. They do not want a default.
Keynesianism is an economic system that praises government debt as the source of stability and long-run prosperity. Original Keynesianism argued that government debt could be reduced in boom years. It has never happened anywhere. Politicians raise the debt load, year by year. The debt grows.
The voters dare not stage a tax revolt, because they might threaten the solvency of the government. The government might cut back on welfare spending for the aged and for the unemployed.
This is a daisy chain of promises (debt), all resting on taxation.
Government writes IOU’s. Banks and insurance companies buy these IOU’s. The government writes more IOU’s. In a crisis, the central bank buys these IOU’s. The voters grouse, but they do not revolt.
Whenever the voters say no to bailouts, the politicians ignore them. They know that the voters do not really want to cut spending.
Banks want more government debt to buy. Governments want more debt to buy more votes. The voters want to believe that the promises will be kept.
It’s a ménage à trois of seduction. Each participant promises to love two others forever. Bankers promise to buy the government’s IOU’s. Governments promise not to default. Bankers promise depositors they can withdraw their money at any time. The government guarantees the depositors that their deposits are insured (in the United States — not Europe). Voters promise to keep voting for the party that forks over the most welfare to their special interest groups.
As the madam in charge, the central bank promises the governments to serve as lender of last resort. It promises bankers low interest rates. It promises voters to act in the interest of voters to keep down inflation and keep employment high.
The arrangement is now breaking down. The level of debt is creating opportunities for currency speculators to expose the lies of governments and central bankers. There are huge profits at stake in this showdown.
ROLLOVER AND FIAT MONEY
The game is the rollover of debt. In 1980, there was a low-budget movie, Rollover, with Kris Kristofferson and Jane Fonda. It dealt with the rollover of Arab oil money. It had the basic scenario correct. The threat really did exist in 1980. But the Federal Reserve let interest rates climb, and the prices of oil and gold fell. The day of reckoning was deferred.
The threat has reappeared. This time it is not Arab oil money. This time it is the unthinkable: sovereign debt defaults. The stakes are far higher. The agencies of the bailout now need bailing out.
Because the entire credit structure rests on the continuation of the rollover of sovereign debt, the Greek crisis, which began on April 23, escalated into a trillion-dollar guaranteed bailout within three weeks. The ECB said “no problem” on April 26. On May 9, it completely capitulated.
Compare this with the United States, from the first weekend of September to the middle of October. Paulson nationalized Fannie Mae and Freddie Mac in early September. A week later, Lehman Brothers went bankrupt. On October 3, Congress voted for the $700 billion bailout. That was three weeks.
If the system is reliable, why do these crises keep happening? If there was a solution to the bad debt problems in late 2008, why did there have to be a $960 billion bailout this week?
It is the rollover problem. That was what took down Bear Stearns. That was what took down Lehman Brothers. In just days, these two giants could not find buyers for their debt. They had leveraged themselves by 30-to-one on the assumption that the rollover would continue forever. It didn’t.
This is the threat to the European banking system. When a sovereign nation defaults, it calls into question the continuation of the rollover. That calls into question the entire world economy.
Everything rests on lines of credit: promises. These promises can be broken at any time, for any reason. The debtor just stops paying. When a national debtor stops paying, the dominoes begin to fall.
The dominoes were ten days from the first toppling: May 19. The politicians, the central bankers, and the IMF decided on Sunday that the risk was too great. They paid off the G-PIIG. They sent a message to the other PIIGs that the trough would be filled up with euros, just as every PIIG knew it would be.
The voters can protest, but if they are unwilling to get their snouts out of the government troughs, they can expect no relief. I do not think they are ready to do this. So, the rollovers will continue. The level of sovereign debt will rise.
As for cutbacks in Greek spending, ho, ho, ho. As for austerity in Southern Europe, ha, ha, ha. Once you owe the banks up north a trillion dollars, you will get the politicians up north to sell more debt, so that you can meet your interest payments to their banks, and then sell more debt at low rates.
Debt will rise. That is the inescapable reality of moral hazard. Bank profits will go on, because bank losses are transferred to sovereign governments. Nothing has changed. The same old system rolls on.
It has come to England. It is about to come to Germany. In 2011, it is likely to come to the United States. At that time, there will be no spending cuts, but there will be resistance to any further expansion of programs. The debts never fall lower. The built-in spending will be sufficient to keep the deficits high.
The United States annual budget deficit to GDP ratio is around 10. In Greece, it is 14. It has been around 6 in northern Europe, excluding Ireland and Great Britain. Northern Europe’s will now rise because of the bailouts. The Greek debt disease has spread to the north. That was the price of keeping the Greek default disease from spreading through the south.
The gridlock will slow down the extension of the debt a little, but the built-in increases in old age spending are enough to guarantee another crisis. The banks in Europe are still highly leveraged. They are not writing down these debts. The result is continuing vulnerability.
The speed of the crisis indicates that the next crisis will take even more money to paper over. Political gridlock will make it harder next time to persuade the politicians to put their careers on the line for the sake of the banks. The ECB will have to intervene as the lender of last resort. It will resist, but its job is to save the large banks. The large banks will again need saving.
The size of the bailout indicates that the leaders really did panic over the weekend. The markets moved higher on the assumption that an extra trillion dollars of government debt will be no problem. There will be buyers. The PIIGS will get their rollover money from the banks, because the banks have gotten the go-ahead guarantees from the more solvent north.
We see no solution. We only see political kick-the-can. The politicians believe that rising government debt is forever. It can rise without meaningful cost. There will always be buyers. The banks and insurance companies trust the promises of the politicians, who write IOU’s on behalf of the voters.
When the voters resist, the central banks come to the rescue. They play demure briefly. They say “this time, but never again.” But they always capitulate.
The day a major central bank really does stabilize money is the day that the dominoes really will fall. The rollovers will at last end.
It will not be because debt is too big to roll over. It is never too big to roll over. It will end only because central bankers see that monetary inflation will undermine the national currency through hyperinflation. That will threaten their pensions. Their pensions are funded, for the bank has the power to fund them. But if the money is worthless, the central bankers will lose. If they cease inflating, they will win. They will have money to spend in a time of depression and deflation.
That is not today. With short-term rates under 1%, and consumer prices not rising, the central banks are not facing an immediate crisis. When the next one arrives, they will do whatever is necessary to keep the rollovers going.
The welfare state is going bust. The level of sovereign debt guarantees this. The politicians will take on as much debt as it requires to keep the rollovers going.
May 12, 2010
Copyright © 2010 Gary North