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“It’s a bit like botox. It looks good for a while but will eventually start to sag again.” ~ Katherine Garrett-Cox
Mrs. Cox is the chief executive of England’s Alliance Trust investment fund. She has dismissed Europe’s attempts to solve its debt crisis as “economic cosmetic surgery”, warning there is “more pain” to come over the next few months. So we read in the London Telegraph.
The media are beginning to smell blood in the water. Like sharks, they are heading for the source: the European Monetary Union (EMU). Unlike an emu, the EMU cannot move very fast. But like the emu, it turns out that it cannot fly.
THE SLIPPERY SLOPE
Reuters ran this headline: “Sliding toward financial crisis.” The article began with this accurate paragraph: “Three years after the collapse of Lehman Brothers, the world’s financial system is sliding toward another major crisis.”
It pointed out that the economic recovery in Europe is on the line. Over the weekend, finance ministers of the European nations met in Poland to discuss the extent of the fallout from the default by the Greek government on its debt. Nothing was resolved.
What, if anything, can the European Union do? Not much. What can Germany, France, and solvent Northern European nations do? Send more money to be deposited in the rathole known as Greece.
The voters in Germany are adamantly opposed to using tax money to fund Greece, when it is clear to investors that the risk of a Greek default is high. The interest rate on one-year Greek government notes on September 9 was 93%. On September 11, it was 106%. On September 14, it was 117%. It should be clear where Greece is headed: default. Yet European stocks rose in response on September 15 and 16. Why? Rumors about another bailout circulated.
Another bailout? It is not clear that the existing promise of the next €8 billion of aid is going to be honored this month. Greece is expected to run out of money to pay interest on its debt if the aid — more debt — is delayed.
On Monday, September 19, European stock markets fell sharply. They had been up the previous week. It is clear that stock investors do not know what is going to happen. Stocks rise on rumors of bailouts, when it is clear that even with the bailouts, Greece is going to default. Then reality reappears, and stocks fall.
AT THE EDGE OF THE ABYSS
Stock investors want desperately to believe that this Greek default can be avoided. That default, if official, will devastate European banks’ holdings of Greek government debt. Reuters reported on September 18,
The challenge for the Group of 20 talks in Washington on Thursday and Friday is to prevent a sovereign debt crisis centered in Greece from turning into a full-blown banking crisis. Such a crisis could engulf other indebted European countries, lead to messy defaults and plunge the region and world back into economic and financial turmoil.
“We have entered a dangerous new phase of the crisis,” said Christine Lagarde, managing director of the International Monetary Fund, last Thursday. “To navigate it, we need strong political will across the world — leadership over brinkmanship.”
World Bank President Robert Zoellick a day earlier said: “The time for muddling through is over.”
There is still some vague hope that the G-20 can come up with a permanent solution. There is hope that this crisis will calm.
But how? There is no agreement on which countries will give how much to Greece. Then there are Portugal and Italy on the sidelines.
Investors are pulling money out of French banks, which have over €670 billion in PIIGS bonds on their books.
DECISIONS THAT SOLVE NOTHING
The article then announces:
To support growth and ease lending costs, a growing number of central banks worldwide are loosening monetary conditions — an action likely to win the G20’s endorsement for countries where inflationary pressures are in check.
This plan makes sense only on the assumption that Greece defaults. The problem Greece faces is not a liquidity problem. It is a solvency problem. How will more non-Greek central bank inflation change anything? The money winds up as excess commercial bank reserves. So, what is this new fiat money supposed to do? Answer: bail out Europe’s largest banks.
The Federal Reserve will play its part on Wednesday when it is expected to announce a plan to lower longer-term interest rates by shifting the balance of its $2.8 trillion securities portfolio away from short-term debt. How aggressively it does this, and whether it also cuts the interest rate paid to banks on their excess reserves held at the Fed, an idea gaining traction in markets, will signal the Fed’s degree of concern over the economic slowdown.
This makes no sense. Why should the FED’s purchase of long-term T-bonds do anything to solve the Greek default crisis? Also, what does it matter if the FED cuts the rate paid on excess reserves? It is under 0.25%. This low rate is irrelevant to bank decisions. If the rate fall to zero, banks will still keep their money as excess reserves. Yet some official who talked with the Reuters reporter must have told her that all this is important. It isn’t.
To address concerns about the ability of governments to service their debt, European finance ministers are considering proposals to leverage their 440 billion-euro European Financial Stability Fund, which should be up and running by month’s end. The United States has suggested increasing the EFSF firepower roughly ten-fold to give it the capacity to handle a sovereign bailout the size of Italy or help recapitalize banks.
So, the long-heralded EFSF is not even in operation yet! Talk about slow responses! The financial world watches in amazement as the political leaders of Northern Europe mouth platitudes about the need to defend the euro, but sit nearly immobile. The politicians assure the public that the euro is forever, and then they do nothing relevant to solve the problem of a Greek default and withdrawal from the EMS.
We are told:
Leveraging the EFSF costs European governments nothing upfront, they duck the political difficulty of raising more funds if a major EU country runs into trouble, it provides funds to recapitalize banks if needed and would earn them market confidence. Semi-annual meetings at the International Monetary Fund and World Bank this week give EU leaders a further chance to discuss its merits.
I ask: If this solution costs nothing up-front, why was there resistance to Timothy Geithner, who flew to Europe last Friday to pitch this solution to the assembled finance ministers? How is leveraging the EFSF by ten-to-one accomplished? What difference will this make to the Greek government?
On sovereign solvency, governments continue to make progress, albeit slow, in reducing budget deficits. Italy last week adopted a plan for a balanced budget by 2013. In the United States, President Barack Obama on Monday lays out his preferred course for medium-term deficit reduction.
A promise by an Italian politician to balance the budget in 2013 means about as much as President Obama’s plan to do lower the deficit (not balance it) by having Congress tax the rich. Does anyone expect the Republicans in the House to vote for that? Of course not. But some unnamed source told the Reuters reporter that all this shows hope.
The final ingredient is the political resolve to stick to this package of programs. Eswar Prasad, senior fellow at the Brookings Institution, said the job of the IMF this week is to nudge countries in this direction and highlight serious dangers ahead.
“The alternative is political paralysis, which we are seeing in many of these countries and could lead to very substantial risks for the longer term. And that’s the big concern,” he said.
But political indecision and paralysis are all that Europe’s leaders have displayed ever since the Greek crisis began in April 2010. The crisis gets worse, and Europe’s leaders show no sign of knowing what to do about it.
What does all this mean? It means that Europe has no clear solution to the threat of a Greek default. Yet the Greek government may default this month. Greek voters will not tolerate the “austerity” cuts in government spending.
A DREAM IN RUINS
In a remarkable article, British columnist Janet Daily argued that the entire New World Order dream of a united Europe is in ruins. This was stretching it, I think. But it is clear that public confidence is eroding. The assurances are falling on skeptical ears.
She had always expected the experiment to fail, but gradually. Instead, it is coming apart at the seams rapidly.
What I expected was growing disillusionment followed by an almost imperceptible unwinding which would be finessed with political double-talk and diplomatic duplicity. The implosion would come, but it would be with a whimper, not a bang. Faces would be saved and enormous numbers of lies would be told, and somehow the thing would be brought to an end — or made so vestigial that it would no longer matter.
Well, so much for that idea. This is going to be huge: so cataclysmic that it may summon up forms of ugliness that we have not seen walking abroad in Western Europe for half a century. This is where the story goes beyond irony.
Is this forecast too good to be true? Could it be that the decades of careful planning by promoters of the United States of Europe are about to be blown up by the Greek debt crisis? She thinks it is. The politicians are trying to overcome the voters and the currency markets. They can’t.
The EU leadership and the Greek prime minister announce implacably that Greece will not leave the euro (ever), as if their uttering of the words made them indisputable. In fact, this is simply a statement of political will that dares the world to defy it.
It seems that the European political class still thinks that an assertion of its mystical belief can alter reality: that what it insists is so, will be so. If its idea of itself and its design for the future are in conflict with the facts of economics or life as it is actually lived, then it is those facts that will give way. (A German Christian Democrat politician once said to me, “The single currency will work because we will make it work.”) Those facts now include not only Greek debt but the democratic wishes of electorates who have a sentimental belief in their right to hold their own governments to account. This is where we are: up against the unavoidable contradiction of the European federal project. The complaint that the EU is lacking in strong political leadership is misconceived: it has had altogether too much “leadership” — which is to say, domination from political and bureaucratic authorities determined to lead with as little interference from real people as possible.
The centralists are fighting political reality now. The voters do not want fiscal union. The voters want their politicians to be answerable to them. The centralists will not tolerate this opposition, she says. But the voters will not tolerate the goal of unification.
Consider Merkel. “She cannot commit herself to endless bail-outs and the under-writing of infinite Mediterranean debt, just as the Greek government cannot deliver the EU’s austerity measures — because the people of both these countries do not wish it. The irresistible force has met the immovable object.”
The centralists are going to try to ram through their plans, but they will fail. Voters in Greece will not surrender their sovereignty to the Eurocrats. They are not alone.
The rage and anxiety over this loss of national self-determination are already taking sinister forms in the rise of aggressively nationalist parties and neo-fascist movements in the most unlikely “liberal” countries. Add to that the fears of those recent EU member states — the former Warsaw Pact countries — which still look anxiously to the East toward a rampant Russia. Here is a recipe for real conflict both within and between the countries of Europe.
We are seeing the beginning of the breakup of the European experiment in unity. The critics of unification are gaining ground politically. The planners did not see the Greek crisis coming. The leaders are scrambling around, trying to come up with something that will end the crisis. But the crisis is accelerating.
The planners believed that they could substitute their will for the will of democratic electorates. They also believed that they could manage the currency better than a free market could. They have proven wrong on both counts.
The free market is bringing judgment against the eurocrats. It does not care that they say the euro is forever. It cares only for profitability.
The central bank will not let the largest European banks fail. But it will not be able to bail out the Greek government indefinitely — not with Greek bond interest rates above 100%. The market will dispose of all assurances that the euro is forever. The botox facelift will fail.
September 21, 2011
Copyright © 2011 Gary North