[P2P-F] Fwd: why the Euro is still strong despite 'on the brink' (supposedly)

Wed Dec 7 12:36:17 CET 2011

mmt analysis of euro crisis worth reading

---------- Forwarded message ----------
From: Dante-Gabryell Monson <dante.monson at gmail.com>
Date: Wed, Dec 7, 2011 at 5:21 PM
Subject: Fwd: why the Euro is still strong despite 'on the brink'
(supposedly)
To: econowmix at googlegroups.com

Article :

http://www.counterpunch.org/2011/12/05/there-will-be-blood-2/

excerpts ( article copied below ) :

*"in this case the ECB support comes only with reduced spending via its
imposition of fiscal austerity."*

*"banks cannot lend out reserves, so increasing reserves in the banking
system is NOT inflationary per se, as the Weimar hyperinflation
hyperventilators continue to warn us."*
*
*
*"So the grand irony of the day remains this: while there is nothing the
ECB can do to cause monetary inflation, even if it wanted to, the ECB,
fearing inflation, holds back on the bond buying that would eliminate the
national govt. solvency risk but not halt the deflationary monetary forces
currently in place."*
*
*
*//*
*
*
*Dante Personal Note :*
*
*
*I do not necessarily back what is said in this article.*
*( an article which puts pressure and disapproves of Germany's current
approach, and raises fears of "Blood on the streets" )*
*
*
*While I may not necessarily agree with the author on the policies,*
*Nevertheless, it raises questions again.*
*
*
*What exactly do they want to create ? Deflation ? *
*Why not let them ( banks and nations ) go into bankruptcy ( and leave the
Eurozone ) ?... ( as happened to in Iceland recently ? Or to Argentina a
decade ago )*
*
*
*... Do they do all this merely to protect the assets of the "1%" ?*
*... and to strengthen artificial scarcity ?*
*... through austerity ?*
*
*
*Sustain Shock Therapy to modify policies and sell off public assets ?*
*Who's interests do they ( the central bankers and heads of state ) defend ?
*
*
*
*Or why not, as explaned below ( if as mentionned in the article, secondary
markets are not inflationary ??? + reserves not lended out by banks ),
enable the ECB to buy bonds directly ?*
*Why create even further government supported debt ? ( albeit european )*
*... to centralize power at a european level ? To enable plutocrats to
grapple on national democratic sovereignty ?*

---------- Forwarded message ----------
From: Dirk B
Date: Wed, Dec 7, 2011 at 10:12 AM
Subject: [gang8] why the Euro is still strong despite 'on the brink'
(supposedly)
To: gang8 at yahoogroups.com

**

Here is a good piece by Marshall Auerback on why the Euro is still strong
despite 'on the brink' (supposedly).

It (again) puts the argument about QE that reserves are not money,
aparently also made in the BIS, and of course by Geoffrey and me in

See

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1687750

Dirk

December 05, 2011
3The Costs of the ECB’s Poker Game
There Will Be Blood
by MARSHALL AUERBACK
Another week to go before the euro blows up, or so we’re told again for the
thousandth time. More likely is that the ECB does barely enough to keep the
show on the road, fiscal austerity continues and riots intensify on the
streets of Madrid, Athens, Rome and Paris.  Like the film, “there will be
blood” before there is any likely change toward a sensible growth-oriented
policy in the euro zone.

Given the travails of the euro zone, why has the euro remained relatively
robust?  Surely, a currency that is supposedly within weeks of vanishing
should be trading closer to parity with the dollar?  Yet one continues to
be struck by the divergence of opinion and actual market action.  For all
the talk about the euro possibly vaporizing by Christmas, it is striking
that it remains stubbornly stable at around $1.34 to the dollar,
substantially above the low of $1.20, which was reached in May 2010 (when
predictions of parity with the dollar were rampant).

By the same token, we have a paradox on the other side as well:  every time
it appears as if a solution to the problems posed by the euro look to be
close to resolution, the euro strengthens. Perhaps this isn’t so odd,
except that the solution that virtually everybody agrees will work –
namely, a sustained bond-buying operation taken up by the European Central
Bank (ECB) – is said to represent a form of “quantitative easing” and
aren’t we always told that “QE” represents “printing money”, which should
cause a currency to go down?  Isn’t that what all of the opponents of the
Fed’s program last year were asserting?

Of course, in the case of the European Monetary Union, ECB President Mario
Draghi insists that such bond buying will not take place in the absence of
proper “sequencing”, by which he means agreed fiscal austerity first, bond
buying afterward.  The effect of the former will negate any potential
impact of the latter, since the “inflation channel” (to the extent that
inflation occurs at all) can only come through fiscal policy.  And
certainly, in the teeth of a severe recession, such cuts as those proposed
by the client state governments of Italy and Greece (along with a renewed
assault by President Sarkozy on the French welfare state) will almost
certainly exacerbate the profoundly deflationary pressures now operating in
the eurozone.  Ultimately, this will surely have the result of creating
substantially more social instability and bloodshed, but it might have
little impact on the euro itself.

So what is actually happening to the euro? Let’s take a step back from the
panic talk. The most recent data from the COMEX suggests that speculators
are heavily short on the euro and yet the currency has fallen less than 10
per cent from its recent highs.   The question one might legitimately pose
is:  at what point does the current fiscal austerity produce higher
deficits, which in theory should produce a weaker euro (as the euros become
“easier to get”)?

I have been wrestling with this issue, and keep getting back to a strong
currency, even with increased fiscal deficits. Why?

For one, the ECB’s bond purchases in the secondary market are operationally
sustainable and non-inflationary.  When the ECB undertakes its bond buying
operation, the ECB debt purchases merely shift net financial assets held by
the ‘economy’ from national government liabilities to ECB liabilities in
the form of clearing balances at the ECB.  At the same time, so-called
PIIGS government liabilities shift from ‘the economy’ to the ECB.  Note:
this process does not alter any ‘flows’ or ‘net stocks of euros in the real
economy.

As long as the ECB imposes austerity terms and conditions, the bond buying
will not be inflationary. Inflation from this channel comes from spending.
However, in this case the ECB support comes only with reduced spending via
its imposition of fiscal austerity.   Draghi has now made this explicit and
it is almost certainly the German quid pro quo for tacitly supporting a
proposed expansion of the Secondary Market Program (SMP).  And reduced
spending means reduced aggregate demand, which therefore means reduced
inflation and a stronger currency.   We also know from an authority no less
than the Bank of International Settlements (ironically, the same initials
as “blood in streets”) that banks cannot lend out reserves, so increasing
reserves in the banking system is NOT inflationary per se, as the Weimar
hyperinflation hyperventilators continue to warn us.

Now consider the trade channel: despite today’s rapidly weakening economy
(Europe is almost certainly in recession today),  we are not seeing much
deterioration in the euro zone’s current account deficit. The Eurozone, in
fact, seems to be a pretty self-contained, and somewhat mercantilist
economy, which displays far less proclivity to import when the economy
slides. So even though imports go down, so too do trade deficits, due to
falling demand. Exports don’t fall and may in fact go up in this kind of
environment.

So that’s euro friendly.

As far as what happens if the ECB were to expand significantly its bond
buying program in the secondary market, the notion that the euro would fall
is akin to the reasoning that the dollar would collapse if it engaged in
QE2. And if what is called quantitative easing was inflationary, Japan
would be hyperinflating by now, with the US not far behind.

There is NO sign that the ECB’s buying of euro denominated government bonds
has resulted in any kind of monetary inflation, as nothing but deflationary
pressures continue to mount in that ongoing debt implosion. The reason
there is no inflation from the ECB bond buying is because all it does is
shift investor holdings from national govt. debt to ECB balances, which
changes nothing in the real economy.

But the question which persistently arises when one advocates a larger
institutional role for the ECB is  whether the ECB’s balance sheet would be
impaired, and the MMT contention has long been NO, because if the ECB
bought the bonds then, by definition, the “profligates” do not default. In
fact, as the monopoly provider of the euro, the ECB could easily set the
rate at which it buys the bonds (say, 4% for Italy) and eventually it would
replenish its capital via the profits it would receive from buying the
distressed debt (not that the ECB requires capital in an operational sense;
as usual with the euro zone, this is a political issue). At some point,
Professor Paul de Grauwe is right :  convinced that the ECB was serious
about resolving the solvency issue, the markets would begin to buy the
bonds again and effectively do the ECB’s heavy lifting for them. The bonds
would not be trading at these distressed levels if not for the solvency
issue, which the ECB can easily address if it chooses to do so.  But this
is a question of political will, not operational “sustainability”.

So the grand irony of the day remains this: while there is nothing the ECB
can do to cause monetary inflation, even if it wanted to, the ECB, fearing
inflation, holds back on the bond buying that would eliminate the national
govt. solvency risk but not halt the deflationary monetary forces currently
in place.

Okay, so who takes the losses?  Well, presuming the bonds don’t mature at
par, no question that a private bank which sells a bond at today’s
distressed levels might well take a loss and if the losses are big enough,
then banks in this position might well need a recapitalization program..
And in this scenario Germany too could take a hit, as does every other
national government as they use national fiscal resources to recapitalize.
And the hit will get bigger the longer the Germans continue to push this
crisis to the brink.

But that is a separate issue from the question of whether the bond buying
program per se will pose a threat to the ECB’s balance sheet. It will not:
a big income transfer from the private bond holders who sell to the ECB,
which can build up its capital base via the profits it makes on purchasing
these distressed bonds.  So again, the notion of an ECB being capital
constrained is insane.

By contrast, the status quo is a loser for everybody, including Germany.  A
broader ECB role as lender of last resort of the kind the Germans are still
publicly resisting, along with their unhelpful talk of haircuts and greater
private sector losses, actually do MUCH MORE to wreck Germany’s credit
position than the policy measures which virtually everybody else in Europe
is recommending.  Why would any private bondholder with a modicum of
fiduciary responsibility buy a European bond, knowing that the rules of the
game have changed and that the private buyer could find himself/herself
with losses being unilaterally imposed?  The good news is that there
finally appears to be some recognition of the dangers of this approach.
Per the Wall Street Journal

“Ms. Merkel signalled on Friday that she is having second thoughts about
the wisdom of emphasizing bondholder losses: ‘We have a draft for the ESM,
which must be changed in the light of developments’ in financial markets
since the Greek-restructuring decision in July, she said after meeting
Austria’s chancellor in Berlin.

Austrian Finance Minister Maria Fekter, speaking at a conference in Hamburg
on Friday, was more direct. ‘Trust in government treasuries was so
thoroughly destroyed by involving private sector investors in the debt
relief that you have to wonder why anyone still buys government bonds at
all,’ Ms. Fekter said.”

There are other issues which are making Germany’s position increasingly
untenable, notably on the political front, in particular the mounting
strains between France and Germany.  Wolf Richter notes that virtually
every leading candidate in the French Presidential campaign envisages a
much more aggressive role for the ECB going forward.  If Chancellor Merkel
thinks she’s going to have a tough time now, wait until she is potentially
dealing with Francois Hollande, the French Socialist Presidential
candidate, who is now ahead in all of the polls, and who advocates with a
five-point plan which is anathema to Germany’s governing coalition:

Expand to the greatest extent possible the European bailout fund (EFSF)
Issue Eurobonds and spread national liabilities across all Eurozone
countries
Get the ECB to play an “active role,” i.e. buy Eurozone sovereign debt.
Institute a financial transaction tax
Launch growth initiatives instead of austerity measures.
As Richter notes, issues 1, 2, 3, and 5 are all non-starters amongst
Berlin’s policy making elites.  Even more extreme are the views of
Socialist candidate, Arnaud Montebourg, who has openly spoken of “the
annexation of the French right by the Prussian right.”

On the right, things are not much better.  French President Nicolas Sarkozy
risks being outflanked by National Front leader, Marine Le Pen, (her father
is Jean Marie Le Pen) who is adopting an explicitly anti-euro candidacy ,
which is gaining traction as France’s new austerity measures continue to
bite into economic growth.   In his futile attempts to maintain France’s
AAA credit rating via increased fiscal austerity, Sarko risks being hoist
by his own petard, as the likely impact of such measures will be to take
French unemployment back into double digits.  Paying obeisance to the
shrine of Moody’s, Fitch and S&P via fiscal austerity is the economic
equivalent of seeking to negotiate a peace treaty with Al Qaeda.

True, Germany might well decide that enough is enough, that the ECB’s
actions represent “printing money” and may therefore initiate a process of
leaving the euro zone.  But let us be clear about the consequences:  Were
it to adopt this approach, Germany would likely suffer from a huge trade
shock, particularly as its aversion to “fiscal profligacy” would doom it to
much higher levels of unemployment (unless the government all of a sudden
experienced a Damascene conversion to Keynesianism – about as likely as a
Klansman attending a Presidential rally for Barack Obama) or reverting to
its former policy of dollar buying. It might also affect the living
standards of the average German as well because Germany’s large
manufacturers originally bought into the currency union because they felt
it would prevent the likes of chronic currency devaluers, such as the
Italians, to use this expedient to achieve a higher share of world trade at
Germany’s expense. Were they confronted with the loss of market share,
German multinationals might simply move manufacturing facilities to the
new, low cost regions of Europe to preserve market share and cost advantage
or, at the very least, use the threat of moving to extort cuts in wages and
benefits to German workers as a quid pro quo for remaining at home.
Perhaps there would be blood in the streets of Berlin at that point as well.

In fact, it is doubly ironic that Germany chastises its neighbors for their
“profligacy” but relies on their “living beyond their means” to produce a
trade surplus that allows its government to run smaller budget deficits.
Germany is, in fact, structurally reliant on dis-saving abroad to grow at
all. Current account deficits in other parts of the euro zone are required
for German growth. It is the height of hypocrisy for Germans to berate the
southern states for over-spending when that spending is the only thing that
has allowed Germany’s economy to grow. It is also mindless for Germans to
be advocating harsh austerity for the south states and hacking into their
spending potential and not to think that it won’t reverberate back onto
Germany.

Now, of course, German Chancellor Angela Merkel may not consciously know
all of these things.  In fact, she termed accusations of Germany seeking to
dominate Europe “bizarre”.  But it is clear to any objective observer that
the political quid pro quo for greater ECB involvement in dealing with
Europe’s national solvency crisis is German control over the overall fiscal
conduct of countries like Greece, Italy, etc. Mario Draghi is Italian, but
the ECB head is playing a German game of chicken: he is embracing exactly
the strategy that Angela Merkel’s political director, Klaus Schuler, laid
out several weeks ago: holding out for fiscal union commitments from the
weaker “Club Med” countries, in return for turning the ECB into a lender of
last resort.  So whilst many Germans might think they want a smaller, more
cohesive euro zone without the troublesome profligates, the policy elites
in fact recognize that a “United States of Germany” under the guise of a
United States of Europe, actually suits their aspirations to dominate
Europe politically and economically.  Which is why the outlines of a deal
along the lines of increased ECB involved as a quid pro quo for greater
German control of fiscal policy across the euro zone, is emerging.   It’s
the equivalent of the golden rule:  “He who has the gold, rules.”

It is high stakes poker, and one which will ultimately lead to far more
bloodshed.  The reality is that there is no plan B.  Just keep raising
taxes and cutting spending even as those actions work to cause deficits to
go higher rather than lower. So while the solvency and funding issue is
likely to be resolved, the relief rally in the markets won’t last long as
the funding will continue to be conditional to ongoing austerity and
negative growth. And the austerity looks likely to not only continue but
also to intensify, even as the euro zone has already slipped into
recession. So there appears to be no chance that the ECB would fund and at
the same time mandate the higher deficits needed for a recovery, In which
case the only thing that will end the austerity is blood on the streets in
sufficient quantity to trigger chaos and a change in governance.

And by the way, the notion suggested by some that this horrible dynamic
could be arrested by the Fed acting as a kind of global central banker of
last resort is asinine.   As Bill Mitchell noted recently:

As of today, the 1 Euro = 1.3294 U.S. dollars. So just purchasing the PIIGS
debt to fund their 2010 deficits would have required the US Federal Reserve
sell around 347,024 million USD which is about 5.8 per cent of the US GDP
over the last four quarters. That is a huge injection of US dollars into
the world foreign exchange markets.

The volume of spending that would be required are even larger than the
estimates provided here. That is, because to really solve the Euro crisis
the deficits in (probably) all the EMU nations have to rise substantially.

What do you think would happen to the US dollar currency value? The answer
is that it would drop very significantly. The word collapse might be more
appropriate than drop…At this point in the crisis, there is nothing to be
gained by a massive US dollar depreciation and the inflationary impulses
such a large depreciation would probably impart.

Blaming the Fed for a failure to backstop the eurozone’s bonds is akin to
blaming a bystander for not standing in front of a bullet when he witnesses
somebody taking out a gun, and shooting another person.  The triggerman
bears ultimate responsibility.  By the same token, the euro crisis is a
crisis which has its roots in the eurozone’s flawed financial architecture
(no less an authority than Jacques Delors has recently admitted this)  and
can only be solved by the Europeans, specifically, the ECB, which is the
only institution in the EMU that can spend without recourse to prior
funding, due to the flawed design of the monetary system that was forced
upon the member states at the inception of the union.  But Mario Draghi
accepts the German political quid pro quo: in order to act, he will insist
on greater fiscal austerity as a necessary condition, which will perversely
have impact of deflating these economies into the ground further and
engender HIGHER public deficits.  Obviously this is one reason the Germans
felt so comfortable in naming an Italian to the ECB. Trojan horses
apparently don’t just come in Greek forms these days. A Europe, where
countries such as Italy and Greece become client states of Germany provides
a much more effective outcome for Germany than, say, trying to do the same
thing via another destructive World War.

MARSHALL AUERBACK  is a portfolio strategist with Madison Street Partners,
LLC, a Denver based investment management group, and a Fellow with the
Economists for Peace and Security. He can be reached at MAuer1959 at aol.com

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