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Schwab Gets It 90% Right
February 6th, 2012 | 
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This is an interesting op-ed in the morning edition of the WSJ:
We’re now in the 37th month of central government manipulation of the free-market system through the Federal Reserve’s near-zero interest rate policy. Is it working?
Business and consumer loan demand remains modest in part because there’s no hurry to borrow at today’s super-low rates when the Fed says rates will stay low for years to come. Why take the risk of borrowing today when low-cost money will be there tomorrow?
Why borrow at all, in the main? Borrowing is the taking of leverage — “gearing.” It magnifies both gains and losses, and it is the losses that turn into trouble, as often they wind up being borne by someone other than the borrower.
They’re supposed to be borne by the borrower and lender, incidentally. But the lender rarely actually eats them, especially when things get “really bad” — then the taxpayer gets soaked, directly or indirectly, as we have seen.
Federal Reserve Chairman Ben Bernanke told lawmakers last week that fiscal policy should first “do no harm.” The same can be said of monetary policy. The Fed’s prolonged, “emergency” near-zero interest rate policy is now harming our economy.
It always was Charles.
The Fed policy has resulted in a huge infusion of capital into the system, creating a massive rise in liquidity but negligible movement of that money. It is sitting there, in banks all across America, unused.
No. Capital and borrowing are not the same thing. They spend the same, but they’re not the same. Capital is economic surplus — that which you have after you earn and pay the necessities of life (or to run your business.) Borrowing is leverage — “mechanical advantage” if you will, but it is always a negative-sum game as not only does it have to be paid back but the interest expense means you must earn even more to pay it with.
The multiplier effect that normally comes with a boost in liquidity remains at rock bottom. Sufficient capital is in the system to spur growth—it simply isn’t being put to work fast enough.
The paradox of debt is that due to the negative sum nature of it there is always less of a multiplier than the liquidity increase would suggest. That is, mathematically it is a negative game for the borrower in every case. This does not mean that a borrower cannot turn that disadvantage into advantage, but it does mean that the odds are against him or her in doing so.
The poker player in Vegas is at a similar disadvantage due to the house “rake.” If six similarly-skilled players sit at a poker table in Vegas and play long enough they will all wind up broke, because the house rake will consume all their money. It is a certainty if the game goes on for long enough, the skills are evenly-enough matched, and their luck is reasonably even.
The only way for such a player to win is to be better than the other people at the table by a sufficient amount to overcome the house rake. He must also stop playing when he has amassed enough winnings and depart. This means that for the player of superior skill he is incented to play at a higher level of wager, becasue he wants the fewest number of hands dealt to make his money to keep the rake’s “rape” of his stack to a reasonable level.
We’ve also seen a destructive run of capital out of Europe and into safe U.S. assets such as Treasury bonds, reflecting a world-wide aversion to risk. New business formation is at record lows, according to Census Bureau data. There is still insufficient confidence among business people and consumers to spark an investment and growth boom.
Business formation comes from capital formation which is the product of economic surplus. That’s all. Since capital formation is born of savings, that is, economic surplus, zero interest rates destroy the incentive to do so. Low interest rates tend to cause people to borrow for uneconomic purpose, just as inflation provides incentive to buy things that aren’t really needed right now “because they’ll go up in price tomorrow.” This is all malinvestment of one form or another and it’s destructive to the health of the economy.
Just look at SYSCO, which reported results this morning. They showed that food inflation was 6.8% over the last year, contrary to the government lie that “inflation is non-existent.” Uh huh.
What Mr. Schwab is missing here is that The Fed is hardly an “independent” central bank. It is in fact beholden to Congress, which has pumped up $5 trillion in debt over the last three years. That debt has a servicing cost, and it is the “ultra low” interest rates that make this temporarily affordable.
How is Congress going to service this debt when the rate of interest rises? More to the point, where are the adults in the room in Washington DC? We’ve had this on both sides of the aisle — “we must stimulate the economy!” — with borrowed money.
Outright bribery of the electorate both hasn’t and can’t work to lead to a durable recovery. Instead, it has backed Bernanke and Congress into a corner. When rates rise to just a blended 4% Congress will be facing a $600 billion annual interest bill. From where will the money come?
This is the trap into which Japan fell and what we are facing today. It is an extraordinarily destructive cycle that is very, very difficult to break, because it requires pulling the liquidity support at the same time Congress dramatically raises taxes, cuts spending (real cuts, not the imaginary cuts from “baseline” budgeting) or both. In short it requires admitting that we took fiscal heroin to avoid pain and accepting the accumulated damage for a period of time, accepting the “deferred depression” that we all tried to hide.
Charles Schwab leaves this unsaid, of course, but then again he’s running a brokerage. Were people to think this thing through they’d realize that the mathematical conundrum presented by Schwab has no resolution that doesn’t ultimately result in that contraction asserting itself. There is always the matter of timing, but not outcome — that which is fueled by nothing other than fiscal methamphetamine either leads to a nasty crash when you stop taking or heart failure. Pick one — both suck but while one is nasty the other is fatal.
Posted in Banks, Ben Bernanke, Capital Destruction, Capital Formation, Charles Schwab, Corporatism, cost of debt, Crony Capitalism, Cronyism, Debt, Deficits, Economic Crisis, Economy, Federal Reserve, Financial System, Government, Inflation, Interest rates, Leverage, Monetary Policy, Monetary System, Money | 
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Karl Denninger, Leverage How Cheap Money Will Destroy the World
Karl Denninger with James J Puplava CFP
Leverage is an essential part of the financial system, and when used properly it allows businesses to borrow funds to invest in growth and expansion, offers opportunities for reasonably priced housing, and much more. But current imbalances in the ways in which leverage is being used by the rich and powerful in the United States and abroad have led to an alarming situation that threatens to shake the global economy to its core.
In Leverage: How Cheap Money Will Destroy the World, well-known market commentator Karl Denninger literally follows the money, tracing the path it has taken through history and discovers a shocking truth—the power to control a nation’s purse strings is addictive, and when that power falls into the hands of only a select few, they will pull the levers of government and policy to enrich themselves at the expense of everyone else. History is littered with the stories of collapsed monetary systems, and in every case the debasement of the currency in question, and the disasters that followed, can be directly blamed on excessive leverage, deployed in ill-intentioned and fraudulent ways by the elite.
The current Great Recession is no exception to this rule. It was no accident, and the politicians and monied interests responsible knew that it was coming. Special interests and other influential individuals have always used leverage to enrich themselves while looting the population at large. Eventually the bill always comes due and then we all have to pay.
With Leverage in hand, we can avoid this disaster, and Denninger shows how. With practical, realistic ideas for fixing the financial system, devising sound energy policies, and more, the book stands between us and a debt we simply can’t afford.
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Author at The Market Ticker http://market-ticker.org/
Posted in Banks, Debt, Economic Crisis, Economy, Financial System, Government, Karl Denninger, Leverage, Money |
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The Danger Debt Poses to the Western World
When Carlo Ponzi, a dishwasher from Parma, Italy, immigrated to the United States in 1903, he had $2.50 in his pocket and a million-dollar dream in his head. He was able to fulfill that dream, at least temporarily.
The scheme continued. Ten investors turned into 100, and 100 investors turned into 1,000, until the scam was discovered. Ponzi spent many years in prison, and he died a pauper in 1949. But his name remains important to every criminologist today — and every economist.
Economists use the term “Ponzi scheme” to describe a disastrous mechanism in which someone pays off old debt by constantly taking on new debt. The repayment of the debt — the most recent loans, plus interest — is deferred into the distant future, fueling an eternal process of debt refinancing.
It’s the classic pyramid, or snowball scheme, practiced by thousands of con artists after Ponzi. The most spectacular case was that of New York financier Bernard Madoff, who was responsible for losses of about $20 billion by 2008. Snowballs are set into motion, becoming bigger and bigger as they roll along. In the worst case, they end in an avalanche that takes everything else with it.
Western economies have not acted much differently than the fraudster Madoff. In 2011, they were virtually inundated with bad news and old sins. Almost everyone — in Europe and in the United States — has been living beyond their means, from consumers to politicians to entire countries. Governments have become servants to the markets upon which they have become dependent.
Bigger Snowballs
On an almost weekly basis, the reports have become more worrisome and the sums of money involved more staggering. Many are now concerned that, as 2012 begins, the snowballs will only get bigger — and roll faster:
- There are the banks in Europe, which will have to repay about €725 billion in combined debt in 2012, including €280 billion in the first quarter alone. With the private market largely off-limits to them, the banks have had to rely on the European Central Bank (ECB) to bail them out. The ECB is now lending them fresh money — as much as they want — at minimal interest rates.
- There is a country like Italy, which has an exorbitant amount of debt to service at the beginning of the year. About €160 billion in debt will mature between January and April; the total for the entire year is about €300 billion. The government in Rome is already having trouble finding buyers for its bonds.
- There is the ECB, which is creating billions essentially out of nothing. On an almost weekly basis, it is acquiring bonds that no one else would buy from Portugal, Spain and Italy and, in the process, it is turning into a reluctant financier of nations. This financial aid already amounts to €211 billion.
- There is the European Commission, whose president, José Manuel Barroso, supports the use of so-called euro bonds. These bonds, which would be issued jointly by the countries in the monetary union, would amount to an accumulation of collective debt on top of national debts.
- There is the €440-billion euro bailout fund, of which €150 billion are already promised to Greece, Ireland and Portugal. But because this amount is still not enough, the finance ministers have decided to “leverage” the fund, a seemingly harmless term for bringing in additional lenders, thereby multiplying the volume of credit.
- And then there is the United States, which only remains solvent because the Congress in Washington keeps raising the debt ceiling. The American government already owes its creditors about $15 trillion. Stay tuned for the next installment.
In other words, there are plenty of snowballs that have started rolling and getting larger with each rotation. Some aspects of the economic system in the industrialized countries resemble a gigantic Ponzi scheme. The difference is that this version is completely legal.
Living on Credit
Old debts are paid with new ones, with borrowers giving not the slightest thought to repayment. This has been going on for a long time, far too long, in fact. It was only with the eruption of the financial crisis in 2007 and the outrageously expensive bailouts of banks and economies that many people realized that the entire world is living on credit.
“Debt is rising to points that are above anything we have seen, except during major wars,” economists at the Bank for International Settlements (BIS) concluded in a recent study. “The debt problems facing advanced economies are even worse than we thought.”
This is even true of seemingly rock-solid Germany. In the third quarter of 2011, German public debt amounted to €2.028 trillion, an increase of €10.8 billion over the debt level just three months earlier. Germany’s public debt grew by about €120 million a day — or more than €80,000 a minute — between July and September.
To make matters worse, this increase occurred in a quarter marked by plentiful tax revenues and a significant decline in unemployment. But debts increase independently of whether times happen to be good or bad.
The End of the System
The same thing is happening almost everywhere. In the first decade of this century, which was by no means a weak period economically, countries more than doubled the level of debt — to an estimated grand total of $55 trillion by the end of 2011.
The United States leads the pack with its national debt of $15 trillion, followed by Japan with about $13 trillion. Germany’s €2 trillion looks almost paltry by comparison. Today, the three major rating agencies award their highest credit rating to only 14 countries in the world.
The fact that nations are continually spending more than they take in cannot turn out well in the long run. The word “credit” comes from the Latin “credere,” which means “to believe.” The system will only function as long as lenders believe in borrowers. Once the belief in the creditworthiness of borrowers is destroyed, hardly anyone will be willing to buy their securities.
When that happens, the system is finished.
This is precisely what happened with Carlo Ponzi’s scheme. And now entire countries are suffering suspiciously similar fates. They are no longer being taken seriously.
Meanwhile, it is also flaring up in the United States once again, with Democrats and Republicans blaming each other for the nation’s debts. Instead of taking responsibility and consolidating the budget, President Barack Obama prefers to rail against the Europeans’ approach to crisis management. They, in turn, refuse to tolerate any interference, especially from the United States, which they blame for being the source of the financial crisis in the first place.
In this fashion, the Old World and the New World are tossing the blame back and forth, while confidence in politics and its ability to avert collapse is dwindling on both sides of the Atlantic. Is there still a way to stop the avalanche, or at least to diminish is destructive force? Why do countries that collect taxes have to borrow money in the first place?
Part 2: Of Good Debt and Bad Debt
Lutz Goebel is used to borrowing money. The 56-year-old businessman is the managing partner of the Henkelhausen Group, a German mid-sized company that specializes in motors in the western German city of Krefeld, with 240 employees and €65 million in annual sales. The debt Goebel incurs is of a completely different nature than the country’s debt.
Five years ago, Goebel had the opportunity to buy another company’s gas-engine service division. Goebel was convinced that it was a worthwhile investment, and that the resulting net revenues would ultimately exceed the €1.5 million he had to borrow to pursue the deal. “It paid off,” he says today.
As president of the German Association of Family-owned Businesses, Goebel represents the interests of 5,000 companies throughout the country. The owners of these businesses usually borrow funds only when they intend to make significant changes or build something new. For them, debt is a necessary part of developing their companies.
There are undoubtedly good reasons to go into debt. Companies use debt to finance investments. Private citizens use it to pay for major acquisitions, like automobiles or real estate. Most are aware that they have to economize as long as they are using current revenues to pay off the principal and interest on their debt.
It can also make perfectly good sense for governments to go into debt, such as when a government seeks to stabilize its economy with additional spending to ward off a recession. It particularly makes sense when governments borrow money to pay for real assets that will also benefit future generations, like a bridge or a kindergarten.
Everyone Benefits
Finance experts call this form of the solidarity principle “pay as you use,” in which future generations are expected to pay for the rest. In addition to leaving the assets — bridges, kindergartens and the like — to its children and grandchildren, the current generation also leaves a portion of the financing up to future generations, and everyone benefits from it.
The only problem is that countries hardly ever use this instrument in such a productive and far-sighted manner. Nowadays, governments usually borrow money to finance their daily expenditures, like paying the salaries of government employees or servicing existing debt.
Of course, there are also people who live unrestrained financial lives. Readily available credit at every bank makes it more likely than ever that they will be tempted to abuse it. Living on credit used to be considered somewhat disreputable, but not anymore. In the third quarter of 2011, Americans had $700 billion in outstanding credit card debt. There are likewise undoubtedly many companies with lax payment policies. The number of major corporations with excellent credit ratings has been consistently declining for years.
Nevertheless, there is still a difference between private and public debt. Citizens and companies usually have real assets to serve as collateral against their debt. The value of a government, on the other hand, is — with the exception of a few companies, properties and land — primarily virtual, namely, that it enjoys the priceless privilege of being able to issue bonds. It borrows money from citizens who, in return, receive a bond that promises repayment of the principal plus interest.
In the 14th century, northern Italian rulers applied this principle for the first time. The British historian Niall Ferguson sees the invention of the government bond as “the second great revolution” in the economic world, following the introduction of credit by banks. It served as the foundation for the ascent of money, according to Ferguson.
No Incentive for Responsibility
Since then, the state has been able to constantly print new securities, which it uses to replace the old ones. Debts are not repaid but “refinanced.” In other words, they are passed on to future generations. This trick seduces governments into treating their finances with less solemnity, and it deprives them of any incentive to live within their means.
They have also provided the securities with a special advantage: Banks, savings banks and insurance companies, the main purchasers of European sovereign bonds, are not required to back the bonds with equity capital, unlike with loans to private citizens or companies. The bonds have been treated as “especially safe” — at least until now.
Everyone benefits from this system. Through the bonds, the banks acquire from the issuing governments apparent security on their balance sheets, fictitious assets. And, for governments, the banks serve as constant new buyers for their securities.
The state creates the illusion of freedom from risk to satisfy its self-indulgence, at least until the Ponzi moment arrives: when the last shred of confidence has been gambled away and no one buys bonds anymore.
Were a business owner to run a business in the same way, he or she would soon be forced to declare bankruptcy. “Family business owners borrow money to invest it. Usually the government borrows money to consume today,” says German business leader Goebel. And, he adds, “while a businessman takes on the risk and liability for his company, in the case of countries, it is almost always the next generation that suffers.”
Debt is thus a double-edged sword. When used prudently and in moderation, it enhances prosperity. “But, when it is used imprudently and in excess, the result can be disaster,” the BIS economists warn in their study. Today’s world has become a Ponzi planet.
Part 3: Germany’s True Liabilities
Just how much the German government struggles with financial planning is evident in its handling of pensions for the country’s 1.7 million civil servants. The 16 German states already spend about 15 percent of their tax revenues to pay for the retirement benefits of government employees, a percentage that Bernd Raffelhüschen, an economist in the southwestern city of Freiburg, predicts will grow considerably. In fact, he sees a veritable wave of costs rolling toward Germany in the middle of the coming decade.
All of the civil servants who were hired in the 1970s and 80s will soon go into retirement. German federal, state and local governments hired so many people between 1970 and 1980 that personnel costs tripled to about €75 billion.
Raffelhüschen, working for the Market Economy Foundation, regularly investigates which financial obligations the government and the social insurance agencies enter into without establishing any reserves for the time when the benefits will come due. His conclusions represent Germany’s true debt burden.
In addition to the official national debt of roughly €2 trillion, there are €4.6 trillion in future benefit promises to retirees, the sick and people requiring nursing care — commitments that are not documented anywhere. When these commitments are included, Germany’s real debt is not 80 percent of GDP, as quoted officially, but 276 percent.
Simply Doesn’t Concern Them
The social security coffers contain absolutely no reserves for members of the baby-boomer generation. “As a result of our government’s generosity, we are creating substantial financial burdens for future generations,” says economist Raffelhüschen. But no one really wants to hear this. Besides, all of this will happen so far in the future that many feel it simply doesn’t concern them.
Next to pensions, health insurance is the second-largest item on Raffelhüschen’s list, accounting for a shortfall of €2 trillion. The inevitable aging of society will only exacerbate the problem. With age or, more precisely, with the number of old people, healthcare spending rises dramatically.
In Germany, a gainfully employed person under 65 costs the government health-insurance system an average of €134 a month. The average for people older than 65 is €379, or almost three times as much.
As a result, an invisible mountain of social insurance debt rests on every German citizen’s shoulders. According to Raffelhüschen, to pay off this debt, each citizen would have to pay the government €307 a month throughout his life — all because the government makes financial promises it cannot keep. It even touts its promises as benefits, and yet citizens are the ones paying for them in the end. The method has been part of the system for generations.
A Short History of Debt
There was a time when the government had no trouble amassing reserves. In the 1950s, then-Finance Minister Fritz Schäffer took in so much revenue — or spent so little — that he was able to save. There was talk of the so-called “Schäfferturm,” or Schäffer Tower, an allusion to the Julius Tower in Berlin, where the Germans stored the gold paid to them by the French in war reparations following the Franco-Prussian War in 1870-1871.
Of course, Schäffer benefited from the fact that the 1948 monetary reform provided West Germany with a new fiscal start. The old money was hardly worth anything anymore, with 100 Reich Mark being exchanged for 6.5 deutschmark. In addition, the country’s liabilities were reduced — by a factor of 10 to 1. In other words, the conditions were favorable for the pursuit of sound economic policy.
Six finance ministers later, when Social Democrat Alex Möller assumed the office in 1969, the zeitgeist had changed — and so had the payment morale. The economy was booming, there was more work than available labor, and it seemed that the coalition government of the center-left Social Democratic Party (SPD) and the pro-business Free Democratic Party (FDP) could pay for anything, including such extras as winter bonuses for construction workers, bypass roads for rural communities and fitness programs sponsored by the government health-insurance system to combat the adverse effects of affluence. The government health-insurance system more than doubled its expenditures between 1970 and 1975.
When Möller resigned in 1971 to protest such profligacy, his fellow Social Democrat Karl Schiller (“Don’t congratulate me; send me your condolences instead”) took his place. But Schiller lasted only a year, and when he resigned he said he was unwilling to support the government’s devil-may-care policy.
A Taste of What Was to Come
That, though, was just a taste of what was to come. The economy began to slow, especially after the oil price shocks of 1973 and 1979, and unemployment rose steadily, but the government of then Chancellor Helmut Schmidt (SPD) behaved as if Germany were still in the midst of its economic miracle, spending far more than it took in. During Schmidt’s chancellorship, sovereign debt grew from €39 billion to €160 billion. It was this ballooning debt that eventually brought down Schmidt’s governing coalition in 1982.
The next surge of new borrowing occurred seven years later, after the fall of the Berlin Wall. Instead of just raising taxes, then Christian Democratic (CDU) Chancellor Helmut Kohl decided to finance German reunification on credit. Some €1.5 trillion in costs relating to reunification remain unpaid to this day. Most of the money went into consumption — far too little was used for investment. It was the same old mistake.
Finally, it was the financial crisis that, beginning in 2008, sharply drove up the national debt once again. The bank bailouts in addition to the economic stimulus packages have been a heavy burden on public coffers. The German government has forked over about €80 billion for various programs, including the controversial cash-for-clunkers program.
Governments are invoking John Maynard Keynes, the great British economist, as they use borrowed money to stimulate the economy, and yet they are consistently ignoring the second, unpleasant part of the equation: paying off the debt. Not a single German finance minister has balanced the budget since 1970.
Part 4: The Failures of the Political Class
Why is this the case? For Lars Feld, the answer is short and unambiguous: “political failure.” The 45-year-old Freiburg-based academic, the youngest member of the German Council of Economic Experts, which advises the government on economic issues, combines economic expertise with insights from other disciplines, especially political science. For Feld, the concept of “fragmentation” is essential to explaining the tendency to accumulate debt.
According to the fragmentation concept, debt levels increase the more parties are involved in the government — and competition there is for funds among cabinet ministers to satisfy their respective constituents. The Americans refer to this as pork barrel politics. Each tries to take as much as possible while contributing as little as possible.
For politicians, this means: “Every member of parliament tries to bring as many public projects as possible into their election district in order to secure re-election, hoping to distribute the costs across the entire population,” Feld explains. It is also true that the more often a government is replaced, the faster the government debt increases.
Is a Dictatorship More Responsible?
The reverse is also true. Strong governments with absolute majorities have the lowest tendencies to incur debt, especially when a powerful finance minister remains in control for a long period of time. Does this suggest that parliamentary democracy, which naturally promotes fragmentation, is to blame for unsound fiscal policy? Or, to put it cynically: Is a dictatorship more responsible when it comes to fiscal policy?
Aside from the fact that dictators have also been known to devastate their countries financially, voters ultimately have themselves to blame for the excesses. Scientists refer to “rational ignorance” when citizens deliberately avoid dealing with uncomfortable issues. People overestimate the benefit of current tax cuts and fail to recognize that today’s debts are automatically tomorrow’s debts, as well. In other words, people want to be deceived.
Politicians are all too happy to adhere to this pattern of behavior, while at the same time mercilessly taking advantage of it. In his dissertation, Berlin economist Gerrit Köster found that, between 1964 and 2004, German finance ministers tended to plan tax cuts so that they would come into effect in election years.
Perhaps this also explains why the Social Democratic heads of government in the city-state of Bremen remain popular, despite the fact that Bremen, with a per capita debt of €27,000, is Germany’s most heavily indebted state. It is often precisely those municipalities that can least afford it that are the most lavish spenders.
Two Portable Toilets
Economist Adolph Wagner observed the phenomenon in the mid-19th century and used it to formulate his “law of expanding state activity.” Wagner contends that the state constantly seeks new activities without paying heed to whether the expansion is even necessary and, most of all, whether it will pay off. Expansion serves primarily one purpose: to justify a government’s existence. Many of the things for which cities, states and the federal government borrow money turn out to be pure waste.
From the €130,000 a year the northern city of Lübeck spent to rent two portable toilets to the €11,000 the western town of Büren paid for four alpenhorns so that local musicians could play music with guests from the Austrian sister town of Mittersill, each year Germany’s taxpayers’ association documents cases of how poorly government entities manage their funds — especially when the economy is doing well — and how little willingness there is to economize.
At least Bremen has now vowed to curb government spending. The state plans to reduce annual new borrowing from the current level of €1 billion to €120 million. It should be noted, however, that these figures apply to the gradual reduction of new borrowing, not the debt itself.
“Bremen can no longer extract itself from this debt spiral on its own,” says Bettina Sokol, the president of the state audit office. But how else is it to do so?
Part 5: Strategies for Reducing Debt
What can a country do to not only curb increasing debt, but also to reduce the size of its overall debt? There are many possibilities, and they are differentiated mainly by the magnitude of the sacrifices, and by who bears most of the burden.
The most brutal method is the debt haircut, which is reserved for hopeless cases like Greece. Creditors are forced to give up a large share of the funds they are owed. Banks and insurance companies and, ultimately, ordinary savers and the insured, whose portfolios and policies also contain Greek bonds, are the ones who suffer.
A government bankruptcy — which is precisely what a debt haircut amounts to — is by no means an unusual occurrence in economic history. France declared bankruptcy eight times between 1500 and 1800, while Spain could not meet its obligations seven times in the 19th century alone. “The progress of the enormous debts which at present oppress, and will in the long-run probably ruin all the great nations of Europe, has been pretty uniform,” Adam Smith, the Scottish philosopher, wrote in 1776.
In the early 19th century, as a consequence of wars and revolutions, Greece spent half of its time in insolvency or debt-restructuring. The euro-zone countries ought to have been forewarned when they accepted the Greeks into the currency union.
Greece experienced a particularly unusual bankruptcy in 1922, when then Finance Minister Petros Protopapadakis ordered that all banknotes be cut in half. The one half remained currency, but was worth only half as much as the original note, while citizens were required to exchange the other half for a government bond. A quite literal debt haircut.
From Flirtation to Marriage
A softer, almost elegant strategy to achieve debt relief is the path leading through inflation. Prices increase, as do incomes and taxes, while debts remain nominally the same, thereby losing value in relative terms. They are essentially eliminated by means of inflation, with citizens being partly expropriated in the process.
If an inflation rate of 4 to 6 percent were tolerated for several years in a row, as American economist Kenneth Rogoff argues, countries would be able to make significant strides in the direction of solving the debt problem. However, the rate of inflation cannot be controlled at will. As the saying goes, if you start flirting with inflation, you will have to marry it.
Most of all, the inflation solution is only effective for getting rid of old debt. For each new euro a country borrows, creditors will demand higher interest in return, which ultimately increases the debt level even further.
Which leaves the two conventional methods of debt reduction.
First, the government can increase its revenues by simply raising taxes. The financial basis for such an emergency move certainly exists: Germans possess total net monetary assets of about €3 trillion, as well as real estate assets worth about €5 trillion. But the most likely candidate is the inheritance tax. Despite the estimated €300 billion in assets that are transferred to heirs each year, in 2010 Germany collected only €4.4 billion in inheritance tax. Even the electricity tax generates more revenue, at €6.2 billion.
The second option is for the government to reduce spending by limiting goods and services. The government will in fact be forced to take this cost-cutting approach because new debt ceiling limits will soon apply. Under these rules, the federal government’s new borrowing is limited to 0.35 percent of GDP, which is currently about €9 billion. The instrument inspires hope that the trend to incur more and more new debt can finally be stopped. It is “the only correct approach,” says entrepreneur Goebel.
Far More Difficult to Generate Growth
But there are also exceptions to the law. The government can loosen the debt brake during economic downturns, as well as in the case of natural disasters. What is also missing is a clause stipulating that surpluses in good years be used to pay off old debts — and not for tax cuts.
But a consolidation of finances is certainly possible, as Italy, Spain and Belgium demonstrated in the late 1990s. These countries managed to substantially reduce their debt levels. Spain, for example, trimmed its debt from 67 to 36 percent of the country’s economic output within 10 years. Of course, this sort of turnaround was also made possible by the fact that Spain’s economy proved to be so dynamic at the time.
Growth is undoubtedly the best way to get out of the debt trap. After World War II, the American economy grew at a faster rate than the national debt. As a result, the debt ratio was automatically reduced.
Nowadays, however, an aging and shrinking population makes it far more difficult to increase economic output. This means that slow-growing countries like Japan or Germany can hardly serve as the reliable borrowers of tomorrow. Rising economies like China, India, Indonesia, the Philippines or Vietnam offer more security. Ironically, for the rating agencies, it is the shaky candidates of the past that could very well be the most reliable economies of the future.
In the West, on the other hand, it is now the state that must increasingly assume the role of growth engine. To do so, it borrows money and tries to reduce government debt with the additional value added. Kurt Biedenkopf (CDU), the former governor of the eastern German state of Saxony, describes this as a fatal process in which the government takes on new debt to finance growth in order to pay off old debt.
The Power of the Purse
Biedenkopf recently proposed a concept with which he argues the debt burden could be paid off within a generation. Under the concept, all liabilities would be transferred to a foundation, dubbed the “German Financial Agency,” to which a portion of tax revenue would be allocated in order to slowly reduce the debt, thereby bypassing the parliament. But it is questionable whether the members of that parliament would readily agree to be deprived of the power of the purse.
A plan unveiled by the German Council of Economic Experts in November seems more realistic. The council proposes establishing a fund that would assume all the debts of euro member states that exceed the Maastricht ceiling of 60 percent of economic output. Under this plan, the total debt of about €2.5 trillion would be paid off within 20 to 25 years, partly through tax surcharges.
Whatever approach the Western world uses to combat its debt crisis — be it austerity measures, taxes, inflation or, what is most likely, a mixture of the three — solving this problem will shape the lives and work activities of a generation.
“If history is a model, we can expect to see many years of debt repayment,” the McKinsey management consulting firm predicts in a study. In other words, the debt avalanche is inevitable, and the only question is whether countries can protect themselves in time.
It is not as much a question of putting a stop to speculators or penalizing rating agencies. Such skirmishes are merely a distraction from the responsibility that politicians bear when they constantly incur new debt to service old debt. But it is also the responsibility that voters bear for rewarding such behavior, and that the banks bear for being so consistently dependent on the government to bail them out whenever they gamble away their money.
Secretly, they all know that a Ponzi scheme has never turned out well.
Alexander Jung – Spiegel
Posted in Banks, Corruption, Crime, Criminals, Cronyism, Debt, Deficit Spending, Deficits, Economic Crisis, Economy, EU, Euro, Europe, European Union, Financial System, Fraud, Government, Leverage, Liars, Lies, Money, politicans, Politics, Ponzi |
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A Very Scary Christmas And An Incredibly Frightening New Year
Can you hear that? It almost sounds like a little bit of peace and quiet. This year, the holiday season has been fairly uneventful, and for that we should be very grateful. But it isn’t going to last long. 2012 is going to be a much more difficult year for the U.S. economy and the global financial system than 2011 has been. So if things are going well for you right now, enjoy this little bubble of peace and tranquility while you can. Because while things may look calm on the surface right now, the truth is that this is a very scary Christmas for financial professionals and world leaders. Most of them know how fragile the global financial system is at the moment. Most of them know that we are living in the greatest bubble of debt, leverage and financial risk that the world has ever seen. As I wrote about the other day, world leaders would not be throwing huge bailouts around like crazy if everything was going to be just fine. The truth is that we are rapidly approaching another financial crisis that may end up being even worse than the horrific crash of 2008.
Despite unprecedented efforts by the European Central Bank, the yield on 10 year Italian bonds is nearly up to 7 percent again.
Keep an eye on the yield on 10 year Italian bonds. That is going to be one of the most important financial numbers in the world in the coming months.
But Italy is not the only problem. The reality is that several European governments are teetering on the verge of default right now. Meanwhile, confidence in the European financial system has been absolutely shattered and a devastating credit crunch has set in. Nobody (other than the ECB) wants to loan money to the banks and the banks are massively cutting back on loans to businesses and consumers. This is causing the money supply to fall. The ECB is trying to hold things together with chicken wire and duct tape, but it isn’t going to work.
In major financial centers such as the City of London, this is a very scary Christmas and the outlook for the new year looks very frightening. Because financial activity has dried up so dramatically, a number of firms are already shutting down. The following comes from a recent Bloomberg article….
London’s stockbrokers are shrinking as Europe’s sovereign debt crisis and competition from international firms squeezes revenue and fees.
“This isn’t just a blip, this is much worse,” said Tim Linacre, who is stepping down as chief executive officer of Panmure (PMR) Gordon & Co., a 135-year-old brokerage. “It’s a desert for activity, which is why you are seeing some firms throw in the towel.”
In the past month, Altium Capital closed its securities unit. Evolution Group Plc (EVG), Merchant Securities Group Plc, Arbuthnot Securities Ltd. and Collins Stewart Hawkpoint Plc have all accepted takeover offers from larger competitors.
“It feels worse than any other time,” said Lorna Tilbian, an executive director at Numis Corp. who began her career in 1984. “All I hear about is people putting up a white flag.”
Many out there are wondering if we are about to face another crisis like the one we saw back in 2008.
Unfortunately, none of the underlying problems that caused that crisis were ever really fixed.
We did not learn from history so now we are in for another round of pain.
In fact, Chris Martenson believes that this next crisis will be even worse than 2008….
There are clear signs of a liquidity crunch in the asset markets right now, and the question I keep hearing is, Is this 2008 all over again?
No, it’s worse. Much worse.
In 2008 there was a lot more faith and optimism upon which to draw. But both have been squandered to significant degrees by feckless regulators and authorities who failed to properly address any of the root causes of the first crisis even as they slathered layer after layer of thin-air money over many of the symptoms.
Anyone who has paid attention knows that those “magic potions” proved to be anything but. Not only are the root causes still with us (too much debt, vast regional financial imbalances, and high energy prices), but they have actually grown worse the entire time.
Frightening stuff.
A couple of months ago, I wrote about the coming derivatives crisis that could potentially wipe out the entire global financial system.
When the next great financial crisis strikes, there is going to be a lot of focus on derivatives once again.
Top global financial authorities such as Ben Bernanke continue to insist that derivatives are perfectly safe.
But there are other voices in the financial world that are warning that we are heading for financial armageddon. For example,just check out what Mark Faber is saying….
“I am convinced the whole derivatives market will cease to exit. Will become zero. And when it happens I don’t know: you can postpone the problems with monetary measures for a long time but you can’t solve them… Greece should have defaulted – it would have sent a message that not all derivatives are equal because it depends on the counterparty.”
That is very strong language.
Faber also believes that the stock market is going to get hit really, really hard during the coming crisis….
“I am ultra bearish. I think most people will be lucky if they still have 50% of their money in 5 years time. You have to have diversification – some real estate in the countryside, some gold and some equities because if you think it through, say Germany 1900 to today, we had WWI, we had hyperinflation, WWII, cash holders and bondholders they lost everything 3 times, but if you owned equities you’d be ok. In equities in general you will not lose it all, it may not be a good investment, unless you put it all in one company and it goes bankrupt.”
Some of the top financial officials in the entire world have also used some very scary language in recent weeks.
The head of the International Monetary Fund, Christian Lagarde, recently stated that we could soon see conditions “reminiscent of the 1930s depression” and that no country on earth “will be immune to the crisis”….
“There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super-advanced economies that will be immune to the crisis that we see not only unfolding but escalating”
But most people are so busy opening up the cheap plastic presents under their Christmas trees (that were mostly made overseas) that they aren’t even paying attention to these warnings.
Look, when the money supply falls significantly it is almost impossible to avoid a recession. Just look at the historical numbers.
Unfortunately, money supply numbers all over Europe are falling dramatically right now as an article in the Telegraph recently noted….
All key measures of the money supply in the eurozone contracted in October with drastic falls across parts of southern Europe, raising the risk of severe recession over coming months.
Confidence in the banking system in Europe has never been this low in the post-World War II era. Sadly, most people simply do not understand how bad things have gotten for major European banks. One Australian news source recently put it this way….
“If anyone thinks things are getting better, they simply don’t understand how severe the problems are,” a London executive at a global bank said. “A major bank could fail within weeks.”
Others said many continental banks, including French, Italian and Spanish lenders, were close to running out of the acceptable forms of collateral, such as US Treasury bonds, that could be used to finance short-term loans.
Some have been forced to lend out their gold reserves to maintain access to US dollar funding.
The outlook is very ominous.
Financial professionals all over the globe are telling us what is coming if we are willing to listen.
The following comes from a report recently produced by Credit Suisse’s Fixed Income Research unit….
“We seem to have entered the last days of the euro as we currently know it. That doesn’t make a break-up very likely, but it does mean some extraordinary things will almost certainly need to happen – probably by mid-January – to prevent the progressive closure of all the euro zone sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks.”
The first six months of 2012 are going to be a very key time. National governments and big European banks are scheduled to roll over huge mountains of debt. But if they can’t find any takers that could bring the global financial system to a moment of great crisis very quickly.
The following is how former hedge fund manager Bruce Krasting recently described the problem that Italy is facing….
At this point there is zero possibility that Italy can refinance any portion of its $300b of 2012 maturing debt. If there is anyone at the table who still thinks that Italy can pull off a miracle, they are wrong. I’m certain that the finance guys at the ECB and Italian CB understand this. I repeat, there is a zero chance for a market solution for Italy.
But even if we don’t see a formal default by a major European nation such a Italy, that doesn’t mean that major European banks are going to make it through the crippling recession that has now begun in Europe.
Charles Wyplosz, a professor of international economics at Geneva’s Graduate Institute, is absolutely convinced that we are going to see some major European banks collapse….
“Banks will collapse, including possibly a number of French banks that are very exposed to Greece, Portugal, Italy and Spain.”
Authorities in Europe are saying the “right things” publicly, but privately they are preparing for the worst.
As the Telegraph recently reported, the British government is now making plans based on the assumption that a collapse of the euro is only “just a matter of time”….
A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time.
Yes, we are heading for a huge financial collapse and massive economic trouble.
So enjoy the good times while we still have them.
They are not going to last too much longer.
Posted in Banks, Collapse, Corruption, Debt, Depression, Economic Crisis, Economy, Financial System, Leverage, Liars, Money |
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MF Global: The SERIOUS Issues Reach Mainstream Media
As I opined rather quickly when MF Global collapsed, the real risk is not that a futures merchant went under. Brokerages go under all the time — I went through two “consolidations” after 2000 and in both cases my assets and trading accounts were simply moved over to a new entity. How “forced” those were is open to some question, but from my perspective I went to bed one day with an account at “X” and woke up with one at “Y”. Nothing disappeared.
The problem occurs when you wake up and assets have disappeared. This has become a disturbingly-common pattern of late, from Bernie Madoff to Stanford and now MF. As Reuters reports:
(Business Law Currents) A legal loophole in international brokerage regulations means that few, if any, clients of MF Global are likely to get their money back. Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients.
MF Global’s bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.
Yep.
What most people don’t understand is that when you open a brokerage account you allow your assets to be used to ”borrow, pledge, repledge, transfer, hypothecate, rehypothecate,loan, or invest any of the Collateral”
Absolutely standard boilerplate language.
But here’s the problem — this is “in accordance with Applicable law.”
This use, incidentally, is why brokers scream that trades are “just $5!”
Well, yes. But your money is being used by the brokerage, more or less, as collateral.
But there’s a difference between earning on your funds and securities (which brokerages do all the time) and stealing your assets. The latter occurs when the law is circumvented — whether legal or not.
And it appears that it was — UK laws appear to contain no limits on the amount of hypothecation or re-hypothecation that can take place. MF Global thus appears to have transferred client assets outside of US jurisdiction where they were then subject to much looser — effectively zero — in the way of risk controls!
But the underlying means by which this escaped surveillance is the same means by which both Lehman and Enron blew up — the use of off-balance-sheet vehicles to hide total risk exposure.
Specifically, these “repo to maturity” deals which our current law permits to be booked as “purchase and sale” agreements, thus realizing the expected coupon flows as “profit.”
The flaw in this reasoning is that a “true sale” must be just that — it must leave you with no obligation beyond the execution. But that’s not true here — if the collateral declines in value either in the interim or at maturity the entity can be forced to make up that shortfall either through posting more margin or through an offsetting settling charge.
As such allowing this to be taken off the balance sheet is an outrage, as there is a continuing obligation and risk of loss that goes beyond the date when the agreement is consummated. That is, it’s not a “true sale” despite being able to be counted as one under existing law.
The myth that is operative here is that lending to sovereigns is “zero risk” and thus the face value of a sovereign bond is the value at maturity. This fiction leads to the accounting treatment. But this is a factual lie — not only now, but always, because lending to a sovereign is nearly always, as a matter of both fact and law, unsecured.
As such there is nothing other than a bare promise standing behind these loans – and governments break promises all the time.
If you remember some of my earliest rants from 2007 they focused on the off-balance-sheet games that were being played at the time. I called them nuclear financial weapons of mass destruction because they are — such vehicles are always a scam in some form, as the only reason to use them is to hide from customers, regulators and the common public the amount of risk you have on.
That is, they have as their essential purpose in each and every case the intentional hiding of the amount of leverage that the entity involved has taken on, and thus it serves to intentionally overstate the amount of loss that entity can absorb before it is rendered bankrupt.
In short, in each and every case the intent is to deceive and thus induce other parties to enter into transactions at terms they would not be willing to transact under were they to know the truth.
THEY ARE THUS INHERENTLY FRAUDULENT CONSTRUCTS IN EACH AND EVERY CASE AND IF WE HAD AN ACTUAL JUSTICE SYSTEM IN THIS COUNTRY EACH AND EVERY INSTANCE OF THESE CONSTRUCTS WOULD BE TREATED AS A SERIOUS FELONY RESULTING IN ARREST, INDICTMENT, PROSECUTION AND IMPRISONMENT.
We learned this when ENRON blew up with their infamous “barge” transactions and then once again in 2008. Yet despite these two stunning examples and absolute proof that the essence of these transactions is the intentional hiding of risk and deception of clients and counterparties we have refused to prosecute these “instruments” as unconditionally unlawful acts despite the fact that their essential purpose is in every case the deception of others.
And now we have farmers and others who did the right thing — who engaged in ordinary financial practices that have existed for centuries and which should have involved no execution risk of materiality at all – who once again got robbed through the intentional hiding of risk and this intentional deception.
The damage is to systemic liquidity and confidence. The games are still being played this morning over in Europe in a furious attempt to “restore confidence” but in point of fact the underlying scam lies here — and until it is addressed and stopped there will be no resolution or stability.
The Agriculture Committee this morning is once again playing “dog and pony show” while Eric PlaceHolder refuses to indict and Obama says that “nobody did anything unlawful.” This is a blatant and outrageous lie by all parties in the government — off-balance sheet acts are in each and every case an act undertaken with fraudulent intent as their entire purpose is to conceal the risk and size of a given transaction.
And finally, let me reiterate what I’ve said since this story broke: So long as there are off-balance-sheet liabilities and derivative contracts have preference over deposits — both of which are true in the present time — this very same risk is present for anyone with a BANK OR INVESTMENT ACCOUNT OF ANY TYPE in The United States. If you believe otherwise you are wrong.
Posted in Banks, Corruption, Crime, Criminals, Debt, Economic Crisis, Economy, Financial System, Fraud, Leverage, Liars, Lies, MF Global, Money |
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Karl Denninger, Tea Party Founder Writes ‘How Cheap Money Will Destroy The World’
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What do 1637, 1873, 1929, 2000 and 2007 have in common? Why has our economy refused to recover after the 2007 housing market implosion? Is there some sort of simple solution, or even a means of protecting oneself from the ongoing stress in the labor and financial markets when your neighbor loses half the value in his 401k and you receive a pink slip with your paycheck?
Throughout history it is the serial and intentional abuse of financial markets and the unholy alliances that are formed between banking and governments that lead to the worst economic catastrophes.
“Irrational exuberance” is often given the blame, but intentional distortion of factual information, such as the credit quality of a borrower, is not “irrational” — it is an active deception undertaken for profit.
Governments are driven by the same sort of mentality as are private businesses when it comes to willful blindness or outright false statements of fact. It is very convenient for a government to borrow and spend just a few more dollars than they manage to tax from their citizens, satiating their demand for services of all sorts, just as it is convenient for a household to borrow against alleged home equity so as to be able to live a lifestyle that is unsupported by its earnings power. Financial deceptions tend to start small and are justified as being temporary or trivial, especially when they support the holy grail of all economies — growth.
But arithmetic does not care about politics or the personal ethics of politicians, businesspeople or homeowners. The fundamental nature of compounding is often cited as the “most powerful factor working in your favor” when you save and invest, yet that same nature makes fiscal deficits, no matter where they exist, a dangerous drug that addicts with its siren song and then bites back with vicious yet unavoidable consequence.
“Throughout history it is the serial and intentional abuse of financial markets and the unholy alliances that are formed between banking and governments that lead to the worst economic catastrophes.”
Karl Denninger Author, “Leverage”
America has a 30 year record of addiction in this regard. From 1980 until the collapse in 2008 there was not one three month period where growth in GDP exceeded that in total systemic debt. We thus generated alleged growth in our economy that was factually false over a 30 year period and built into our economy false signals of demand. The mathematical laws governing exponential growth made certain the outcome of 2007, where we reached more than 6 dollars of additional debt for each dollar of added GDP, just before the subprime crisis led to the near-collapse of our banking and financial systems. Unfortunately rather than both allowing those who made imprudent bets to fail while holding the people who intentionally misled to account we bailed out the institutions that knowingly took dangerous bets under the rubric of systemic risk but left the market to ravage the common American.
“Leverage” is about these abuses and their impact on real people. It chronicles the abuse of debt financing and fiscal deficits while demonstrating the fundamental mathematical relationships that underlie all financial systems and cannot be avoided.
You can read dozens of books on the 2008 collapse and the incestuous interconnectivity between big business, finance and the political system, but most remain within their narrative focusing on the bad actors or try to provide a guide for personal protection of one’s assets from what appears to be certain economic calamity to come.
“Leverage”, however, spends half of its easily-understood pages in a different endeavor: Real solutions in the political and policy space that, while unable to prevent what is mathematically inevitable, will soften the blow while realigning our nation to restore the rule of law, render banking safe and sound into the indefinite future, address our unsustainable entitlement promises, return both capital and manufacturing to our nation and provide the underlying and necessary energy resources that America needs for a vibrant economy.
Karl Denninger founded The Market Ticker®, a blog dedicated to uncovering market mischievousness. He is also a columnist on SeekingAlpha.com and has appeared on MSNBC, CNBC, and is a frequent guest on WBAL talk radio in Baltimore. He produces a weekly Internet radio segment on BlogTalkRadio with real-time call-ins from listeners and occasional invited guests. Karl is also one of the original founders of the Tea Party movement, and, along with FedUpUSA, launched the first financial protests related to the bailout of banking institutions after the failure and forced takeover of Bear Stearns. Previously, he was CEO of Macro Computer Solutions, and is a self-made
entrepreneur and millionaire.
Email me at bullishonbooks@cnbc.com
— And follow me on Twitter @BullishonBooks
Posted in Banks, Corruption, Debt, Economic Crisis, Economy, Federal Reserve, Financial System, Fraud, Government, Karl Denninger, Leverage, Money |
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There is only one answer for the world economic situation; monetary reform.
1. No More National Debt
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