December 23, 2013
What’s worse? Having to listen to a Portuguese communist telling us that the Euro was a victim of Ireland? Or having to listen to our own guy, when the EU has just nailed his ass to a post, telling us there is “no row” between Ireland and the EU President?
I don’t remember voting this guy to be President of anything, do you?
Now the so-called EU President went on to suggest that that chances were slim of Ireland getting a post dated cheque for paying the bondholders and “taking one for the team”. This statement comes on the same day as the former head of the IMF mission to Ireland tells us we should have burned the bondholders – as this column was arguing all along.
The notion that the Euro was not a major factor in the boom/bust cycle of not just Ireland but Spain, Portugal and Greece, is simply implausible. You may remember in the period from 2000-2007, the flow of funds from the core to the periphery was trumpeted as evidence of the success of the Euro. This argument, proposed by the Euro-enthusiasts, was that capital flowing from Germany to Ireland looking for yield was a sign that the system was working.
In 2005, in the Pope’s Children, I invented a fictitious elderly German saver to represent what was happening to German savings and how they were being recycled out of Germany to fuel booms in places like Ireland, Spain and Greece. This warning about the day that the German might want his savings back was scoffed at by the Euro enthusiasts who refused to countenance the argument that the Euro would cause too much money to flow into the periphery in good times and too little in bad times.
The minute the crisis hit, these positive “flows” of capital suddenly became negative “imbalances” which need to be fixed. The narrative changed from the capitalist free flow of capital from the core to the periphery, to a quasi socialist tract– except it was only socialist for the rich – which contended that the taxpayers of the peripheral countries should pay the debts of the banks.
The argument back then articulated by the likes of Barroso and the IMF was that the State must bail out the banks because this was the only way of saving contagious bank runs all over the continent. This interpretation of the way financial markets operate, resulted directly in the “taking one for the team” story.
But anyone who has worked in financial markets knows that the markets have no memory and events of the past remain in the past. The markets also know that if your problem is too much debt, your situation is made more sustainable by less debt not more debt. The solution therefore is to do debt deals, maybe not paying principal, maybe not paying money now and kicking out the debt for years to come.
In Greece, the EU oversaw a €100billion default of sovereign debt and what happened to the price of Greek debt after that? It rallied massively. In Ireland, the official line was that any changing of the terms of our debts (a default by any other name) would cause the markets to take flight. What actually happened when we didn’t pay back the promissory note on the day we were supposed to? Surely by not abiding by the terms of the contract, the markets would take fright? The opposite actually happened: the day the promissory note was not paid, and it was announced that it wouldn’t be paid for a few decades, Irish bond prices rallied!
So the interesting thing about the Barroso view of the world, is that is has actually being wrong at every juncture. And now, realizing just how wrong the official Brussels position was, the IMF have changed their position on the whole thrust of policy.
According to the IMF this week, we shouldn’t have paid the senior bondholders at all. How does that make you feel?
But the saga is not over yet because the legacy of the massive movement of capital from one bank to another, from one country to another resulted in massive malinvestment. Malinvestment is what happens when there is so much capital about that huge investing mistakes are made but those mistakes are only evident after the event.
The bad investment sits on the balance sheets of the banks for years because the banks’ initial reaction is that the market will come back and if they can just service the interest on the loans, the banks don’t have to write the loans off.
But as the handmaiden of the crash in asset values is a credit crunch and typically a period of deflation, the loan’s chances of being repaid are minimal with a bout of inflation.
As the European economy is in the grips of deflation, not inflation, eventually the banks’ balance sheets get worse and worse and the banks become Zombies. A Zombie bank is nothing more than a government backed safe deposit box for depositors – or at least that’s what the large depositors of Cyprus thought until their deposits were confiscated.
In order to fix the Zombie banks, the ECB came up with a ruse, which extended cash to them in return for their dodgy loans, only if the banks then bought high yielding government bonds. So for the past two years, Eurozone banking policy has been one where the central bank lends to bust banks who lend in turn to bust governments. The higher yield on the bust government bonds flows directly to the banks, so not only do the governments look like a better bet but the banks look profitable too. That’s only as long as the debt isn’t rolled over at the new lower rates, at which time the banks go bust again.
Draghi knows this and in an effort to put some sanity into the Eurozone banking system, he has ordered a stress test.
What do banks do when faced with a stress test?
They stop lending and hoard capital. The less loans they have out, the smaller the risk of bad loans and the less capital they have to raise to leap over the stress test hurdle. This means that the stress test, part of the great lurch forward to a banking union, has actually prolonged the credit crunch!
We see that in Ireland with bank lending falling all the time. The same is the case for the rest of Europe. Ireland for many businesses has become a cash economy, devoid of credit. Figures for the rest of Europe show the same story.
The other thing that banks do when they are trying to build up their capital is that they sell assets abroad and repatriate money. This may be why the Euro has been stronger of late because billions of Euro is flowing back to Europe as banks sell foreign positions.
Therefore, European businesses trying to export get the double negative whammy of banks hoarding capital and an overvalued exchange rate.
As you can see the Euro is at the epicenter of all this. Its travails are the cause, not the consequence of the banking problems and the proposed cure to the banking system’s woes lumbering the bank debt onto the citizens, playing with bond yields and now exacerbating the credit crunch with the stress test, appears like economic lunacy.
As to why the Irish economy is still breathing and beginning to recover, look no further than across the water to the booming UK, our largest single trading partner, which surprise, surprise doesn’t have to put up with the whimpering of Mr Barroso.
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