Saturday, June 11, 2011

The European Situation

I thought I would make a brief return again, as I have been watching the slide of Europe into a morass with that feeling of watching a slow motion car crash. I am writing this as a very general post, without referring to the specifics of individual countries, but highlighting the principles of why the European financial crisis just will not go away. There are differences in detail and circumstance, but I think that the general principles will hold. As a light introduction, I just saw an amusing Youtube clip, which seems (in a simlistic but effective way) to sum up the madness that is facing the EU.

Since the alarm bells about the debt of Greece, Ireland, Italy, Portugal and Spain were first rung, there have been a series of deals, bailouts, negotiations, austerity measures, and on and on...but still the crisis pops back into life. The problem is something I have long discussed, which is that you cannot easily reverse the direction of an economy. In all of the above cases, the economies were living on too much borrowed money, and that borrowed money shaped the structure of the economies. The direction of that money was into consumption, and the consumption beyond the actual income was unsustainable. However, a county that has lived on borrowed money has developed an economic structure to support the consumption of the wealth creation of other countries.

In simplistic terms, this translates into the means of importing and distributing goods and services paid for by the wealth creation of other countries. In practical terms this means the over-development of retail, the restaurant and entertainment sectors, the government services, and all of the infrastructure that supports these. In a madly self-destructive cycle, the more the country borrowed, the more the activity in the economy, the higher the employment and the higher the reports of GDP, and the greater the confidence of lenders to keep on lending. The problem with the cycle is that it keeps feeding on itself right up to the point that it does not. It does not even matter what finally triggers the loss of confidence by creditors, as at some point there must be a moment of realisation of the inherent unsustainability of the cycle.

The problem with the policy actions of all of the parties seeking to save Europe from the crisis is that, once the cycle breaks, the real underlying economy emerges. As the flood of borrowed money diminishes, all of the activities that were supported by borrowed money go into reverse, unemployment rises, GDP sinks, and government revenues fall. The debt to GDP ratio starts spiralling, and fresh borrowing comes at an ever greater cost as the weakness of the economy becomes apparent. The ability to service existing debt dimimishes, and the crisis emerges once again in full force, as the downward spiral continues. Even as bailouts are calculated and handed over, the ability for the country in question to support the existing debt (let alone the new debt) is diminishing. The bailouts are chasing a downwards moving target.

In the end, the only answer is austerity. Somehow, it is necessary for consumption within a crisis country to come back into balance with the wealth creating capacity of the country. The problem is that, the deeper and longer the debt accumulation, the more the structure of the economy will have been distorted towards the consumption of debt. The real income per capita, without the addition of debt into the economy, is much, much lower than people had come to believe. It is as if the entire country has been spending their salary X, but were unkowingly supplementing their income with a slowly rising credit card debt of Y.

When the credit stops flowing into the country, and the supplement of the borrowing disappears, it is apparent what the actual income is. It is far lower than everyone thought. As it is, there are large numbers of people who are actually supplementing their income with debt, but they were unaware of how much additional debt they were personally liable for when their government borrowed. They were also unaware of how much of the whole economy was reliant on the continual debt accumulation, and can not understand why their job has evaporated. And that of their neighbour. And their brother. It is no surprise that they feel angy. They just did not realise that the promises made by their governments were not built upon sound foundations, and that the shiny new businesses making so much money were reliant upon borrowing for their survival. That is, the aggregate borrowing over the whole economy was supporting so many businesses, so much employment.

It is quite understandable that people were deceived. When all around you, you see the signs of growing wealth, it seems only natural that it must be built upon real wealth creation. It is the great illusion that debt equals wealth. The reality is that debt for consumption equals a higher quality of life, right up to the point that the debt becomes due. Then, as has always been the case, ruin follows. What we are watching in the ongoing European crisis is the slow and painful emergence of the real size of the economies in question. The problem is that, when looking at many of the non-crisis economies, they also look to be troublingly reliant upon debt.


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  2. The other part of what we're seeing is that the French/German/Dutch/(British in the case of Ireland) governments are doing whatever they can to force Ireland and Greece to take extra loans to pay back those French/German/Dutch/British banks with, because they do not want to have to explain domestically why they allowed their banks to lend so much money to those countries.
    As for 'austerity': the troubling part about it is that it is being used everywhere as a class warfare project. First of all, for some reason only programs that benefit the poor have to be cut, while things like raising the income tax on the upper income brackets is never even considered (moreover, in Greece, just like in the UK, the most effective tax avoiders are the rich rather than the poor, so that raising taxes won't do much good). And secondly, the crisis is being used as an excuse to strip a lot of assets from the (Greek) state; that is, to steal from the (Greek) public. And even though pretty much everybody acknowledges that the sale of these assets will never yield enough money to pay back the original debts with -- let alone the €200 billion that the EU has forced them to accept since then -- nobody in power wants to officially acknowledge this, as it might "hurt the banks". They utterly refuse to talk about the fact that the banks and other investors will have to accept haircuts first, rather than 'some time down the road, purely because they want to strip the Greek state of as many assets as they can before finally "recognizing" that "it did not work." In stead, they are doing their darnedest to make sure the banks can extract interest payments on the levered loans on the one hand, and to turn this crisis into another privatization fest, with "great" opportunities for western investors to make billions off the forced (and time-constrained) sale of a lot of public property on the other.
    And of course the other place where austerity is needed is never even mentioned. Because the other area where we have seen a bubble is in Western pension funds. Because pretty much one of the only reasons why they could grow during the past decade was precisely because of these high-yield loans that were extended to the 'peripheral' Eurozone, and Eastern European countries. And it seems that, whatever else happens, national politicians do not want to have to admit that this growth was basically only 'bubble' growth as well, because the standard of living of French/German/Dutch retirees is of course far more important to National (and a lot of European) politicians than the standard of living of all Greeks/Irish/Spanish citizens. And the best way to understand this is by watching the EU/ECB in action. Because once the pensions go, there might be questions why people like Tony Blair, and his contemporaries Wim Kok (dutch ex-PM) and Lubbers (dutch ex-PM) stole so much money from the different national pension funds. And that would really open a can of worms.

    Anyway, one last thing to note: the introduction of the Euro has resulted in rather a lot of 'stealth' (in the sense of politically denied) inflation. And as a result, returning to their pre-bubble incomes and employment levels will likely mean that life will be a lot harder than before the introduction of the Euro. This problem was largely caused by Germany's devaluation of its own currency at the time of entry, which has given it a pretty strong, but very antisocial, competitive advantage. Austerity alone will not fix this issue.

  3. See, for example,

  4. "What we are watching in the ongoing European crisis is the slow and painful emergence of the real size of the economies in question. The problem is that, when looking at many of the non-crisis economies, they also look to be troublingly reliant upon debt."

    If there are economies in the world that turn out to be smaller than people thought, does that mean that there are some economies that are correspondingly bigger than people thought? Hard to imagine that the Chinese economy could be any 'bigger', and at first glance the Chinese economy has expanded only to service the West's consumption, making it look as though we are saying that the entire global economy is smaller than everyone thought - which is presumably not possible! But I guess this is the devalued yuan question, and the wealth that has been effectively denied to the Chinese people..?

  5. Another welcome return. Please keep them coming.
    A few points strike me:
    First, the PIGS ran into difficulty in differents ways, e.g. Greece's excess borrowing was governmental, whereas Eire's was private - for property speculation - until their government chose to bail the banks out.
    Second, membership of the Euro now makes their problems insoluble. They can't print money or devalue or inflate the debts away, so they have to cut spending. But that also cuts revenue, so they have to cut again, and so on. They can't even leave the Euro and devalue, even if there was a mechanism for doing that, because their debts are denominated in Euros: the burden would actually increase. The only ways out would seem to be Germany and a few others leaving the Euro and revaluing, or the PIGS defaulting, or the Euro area become a fiscal as well as a monetary union and arranging huge transfer payments. Maybe that was the plan all along?
    Meanwhile, German taxpayers are being told that Germany is sound but everyone else was reckless. Understandably, they resent bailing out spendthrifts. They won't be impressed when it transpires that German banks were gambling with their savings.

  6. Good to see you back.
    Every think you said would happen is unfolding.
    Very slowly as govenments try to keep the plates spining. Printing borrowing more.etc.
    Have you any new thoughts as to the road ahead ?
    I read yesterday that even the chinese are trying to help fund the euro zone. How far away is banking crisis mark 2 ?

  7. Apologies for the long delay in the publication of replies, but I was in China, and there were problems reaching the blog due to the 'great firewall of China'. I hope to post again reasonably soon, but just have a few matters to cover before I can put the time in. Thanks for the comments, which are always good, and appreciated.

  8. Has it really been 3 years since "A Funny view of Wealth"? Those old posts are really something.
    Great to find you have returned.

  9. "What we are watching in the ongoing European crisis is the slow and painful emergence of the real size of the economies in question."

    I think what we are watching is the take down of the sovereign state IMF style, one by one.

    It goes something like this.

    Step one, persuade the conniving politicians to load up their nations with debt.

    Step two. Nations embark on the mother of spending binges. Borrowing more funny money on the way.

    Central banks pull the plug, oh my god we're broke.

    What was/is QE 1,2,3? all about?

    Step three. IMF come galloping in with offers of bailout but with strings attached.
    Euphemistically called austerity measures where IMF take over running of government.

    Strings attached mean private corporations hoovering up the nation's assets at fire sale prices.

    People don't like it and take to the streets, game on.

    This is where we're at.

    In Britain it's a sick joke, the deficit is measure in gazillions, the debt can never be paid off, never! Cameron is even borrowing more money to fund overseas aid commitments.

    Cameron had the idea (but now abandoned) of selling off our forests even before the IMF came on the scene.

    We had similar circumstances during the '70's, in those days it was called stagflation. (Low economic activity with inflation.)

    There is no engine for growth except continuance of mass immigration, in fact it's official green policy to cut back industry and consumption. Note Germany's cancellation of nuclear power programme.

    Windmills are not going to cut it.

    The world's industrial output has migrated eastward - never to return.

    Western civ is being downgraded to meet up with the third world.

    America is tanking terminally.

    It's all going to plan, this is not an accident, it's not chance, it is not insanity, it is deliberate.

    There's stacks more stuff but that's enough for now.

    I'll be back.


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