April 3, 2012
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“Recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested element of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another crisis ahead. Particularly, our story provides a presumption against remedial measures which work through money and credit. For the trouble is fundamentally not with money and credit, and policies of this class are particularly to keep up, and add to, maladjustment, and to produce additional trouble in the future.”
Douglas V. Brown1
The drinks are on us
This just in from Bloomberg (with thanks to ZeroHedge): “The Bank of Israel will begin today a pilot program to invest a portion of its foreign currency reserves in U.S. equities…A small number of central banks have started investing part of their reserves in equities. About 9 percent of the foreign-exchange reserves of Switzerland’s central bank were invested in shares at the end of the third quarter, the
Swiss bank said on its web site.” Israel initially plans to devote 2 percent of its $77 billion of reserves to equities but hopes to ultimately allocate about 10 percent of its assets to the riskiest asset class. When two of the world’s soundest central banks start investing their reserves in stocks (the Bank of Israel is run by the highly respected Stanley Fischer for God’s sake!), one has to wonder what the world is coming to. Apparently the global saloon is expanding its boundaries. No doubt we will soon hear the European Central Bank (ECB) is merging with the London Stock Exchange.
While it was not a Greek but a German waiter that accidentally poured four tall glasses of beer down the back of German Chancellor Angela Merkel at a Christian Democratic Union meeting last week, it should not surprise anybody that one of her own countrymen was guilty of the deed. First of all, a bathing the Chancellor in beer is fitting in view of the fact that the European Central Bank (ECB) is bathing European banks in money. Further, Germans aren’t very happy with their Chancellor these days The heat is rising on Frau Merkel for her support of the second in what is certain not to be the last bailout of Greece. Even her own Interior Minister, Hans-Peter Friedrich, is taking issue with her seeming obsession with keeping Greece enslaved within the Euro. “The chances that Greece can renew itself and become more competitive are surely greater outside the currency union than within it,” Herr Friedrich told Der Spiegel, the German weekly magazine. The Minister, obviously a fan of The Godfather, added that while Greece shouldn’t be booted out of the European Union, it should be given incentives “that they can’t refuse.” Herr Friedrich is the first minister to publicly break ranks with Frau Merkel, but opposition to the financial risks that Germany is running is increasing within her party. An increasing number of politicos are coming to believe that a Greek departure from the union would not be the financial cataclysm once feared. The Bundesbank is also getting extremely edgy. Bundesbank Chairman Jens Weidmann sent a very public private letter to ECB Chairman Mario Draghi “suggesting” that the ECB rethink its December decision to accept a wider variety of collateral from borrowing banks and to consider the wider risks this is storing up in the financial system (apparently Israel and Switzerland were not copied on this letter). German opposition to the ECB’s promiscuous monetary policy is hardly surprising, and Mr. Draghi himself indicated this week that European banks should not expect any more gifts like the LTRO. Of course, the next time the global financial system is greeted with a beer shower, we will have an opportunity to test Mr. Draghi’s resolution.
Despite winning approval of the €130 billion bailout by a significant majority, 496-90, the Chancellor failed to win a so-called chancellor’s majority in the Bundestag. By failing to gain the necessary 311 votes from her own party that would have represented an absolute majority of the 620 seats in Parliament, Frau Merkel failed to win a symbolic victory that weakened her political position. She acknowledged her difficulties as she spoke to the Bundestag: “Some people ask whether Greece isn’t a bottomless pit, a hopeless case, whether it wouldn’t be better for all if Greece just reintroduced the drachma. The opportunities outweigh the risks of turning away from Greece now. I believe these risks are incalculable and therefore irresponsible.” In other words, she believes it is better to embrace the devil she knows instead of the devil she has not yet met. She is increasingly likely to meet that other devil, however, is she persists on her current path. Her failure of imagination is likely to haunt her and the rest of the European Union (EU) for years to come. For the moment, however, her parliamentary victory allowed her to negotiate the final details of the bailout package and inflict large losses on bondholders but leave Greece on a steady path to becoming not only a ward of her own country but a failed state.
To give just a small idea of how bad things are in Greece, the Markit Greece Manufacturing
Purchasing Manager’s Index has been in sub-50 territory for 30 straight months and fell to a survey low of 37.7 in February. Markit described an economy in shambles: “Underlying the steep deterioration in operating conditions in February were the most severe reductions in output and new orders recorded in nearly 13 years of data collection. Respondents commented on shortages of working capital at their plants and amongst clients, while austerity measures continued to undermine demand. Sales of Greek manufactured goods were down from both domestic and foreign sources: new export orders fell for a sixth consecutive month and at the steepest pace since May 2010.” (bold in original)2 Markit also reported significant job losses, reduced working hours, vendors demanding cash payment for the delivery of raw materials, and higher raw material costs. The Greek economy is in the midst of a total meltdown and, in the latest twist in this melodrama, the German-led coalition decided to hold back half of the €130 billion of promised aid until they are certain Greece can deliver on its austerity commitments. They are shooting bullets into a corpse.
The real question is why European officials remain intent on pursuing policies that are virtually certain to be unsuccessful. German Finance Minister Wolfgang Schauble warned in a letter to legislators late last week that “this may not be the last time” that Europe (i.e. Germany) would be asked to extend a lifeline to Greece. He might have added that the next time won’t be the last time either because Greece is a black hole of liabilities. And the parts of the black hole not created by the Greeks are being created by the European authorities imposing such stark austerity measures that Greece’s economy can never hope to generate sufficient tax revenues to meet its obligations. Bond spreads may be tightening in Italy andSpain, but they remain too high. Spain just reported that it will miss EU-mandated deficit limits by a larger than expected 1.4 percent while EU officials debate whether they will “allow” the country to breach its deficit target of 4.4 percent of economic output in 2012. As for Portugal, that country remains next in line for a bailout. Finally, Ireland has announced that it will hold a referendum on the Eurozone fiscal pact, a decision that could cast a pall of uncertainty over the region for months. The Irish have twice already rejected EU treaties only to approve them in second referendums, and this vote will prove to be politically divisive and distracting to European leaders as they deal with more severe challenges to the south. It is fair to say that the Eurozone debt crisis, and the drama surrounding it, is far from over despite politically-driven sound-bites to the contrary by political candidates like Nicholas Sarkozy.
1. Douglas V. Brown, The Economics of the Recovery Program (New York: McGraw-Hill, 1934), reprinted in Sylvia Nasar, Grand Pursuit: The Story of Economic Genius (New York: Simon & Schuster, 2011), p. 337.
2. Markit Economics Limited, Markit Greece Manufacturing PMI, “Operating conditions in Greek manufacturing deteriorate at survey-record pace,” March 1, 2012.
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