EUROPE’S BALANCE SHEET RECESSION IS A SYMPTOM…
Back in late 2008 I wrote one of the more prescient things I’ve written here (yes, it happens on rare occasion!):
“We have a major capital problem at the U.S. banking level. What Ben Bernanke and Hank Paulson are essentially proposing is an asset swap. The Fed will take on the toxic assets of the banks and they will receive reserves in exchange. This is important because it will alleviate the strains in the credit markets. That’s a good first step, however, it is not a solution to the problem at the household level and THAT is where the real economic weakness is. By introducing this asset swap idea Ben Bernanke is simply altering bank balance sheets. He is not fixing the economy.
So, the government has a partially correct solution. Not the BEST solution, but it gets to the core of the credit issues. They will essentially trade the bad paper for good paper and it will alleviate many of the pressures on the banks. As I have written here many times the banks are the lifeblood of the system. I like to think of the banks as the oil in the engine. If you run out oil the system begins to break down and eventually the engine stops running. You can’t have a healthy functioning economy if the banks aren’t lending. Unfortunately, because this won’t fix any problems at the household level it won’t induce any borrowing. So, it’s a clever way to resolve the banking crisis, however, it doesn’t fix the root of the problem which is at the household level.”
These were really important comments. I was, admittedly, still wrapping my head around QE, the lending facilities and what was pulverizing the US economy at the time, but I understood one big macro point – where the disease started. As any good doctor knows, this is crucial in analyzing and attacking any sickness. You can’t find a cure if you don’t understand the cause. Back in 2008 and 2009 we heard endless chatter about the “banking crisis”. But the banking crisis was a symptom of the household debt crisis. So it led policymakers to obsess over ways to fix the banks. This of course, didn’t cure the real problem – the households. And so here we are almost 4 years later still discussing what could have been and why we have a weak economy still….
And now a sad thing is occurring in Europe. I see increasing chatter about a “balance sheet recession” in Europe, debt crisis or even a potential banking crisis. But this is merely a symptom of what’s really ravaging Europe. Europe has a currency crisis. The Euro is unworkable as is. The debt crisis is nothing but a symptom of this much bigger problem. And the sad fact of the matter is, because leaders either can’t diagnose the problem or refuse to accept that their monetary system is incomplete and unworkable, we’re forcing millions to suffer and prolonging the sickness.
Let’s just get this right. Europe has a currency crisis. If you want to fix Europe you need to make these nations autonomous in the Euro or some other currency of their own. That means forming a federal government of some sort and eliminating the solvency fears (essentially a US of Europe) or starting to let some of these nations peel off. The sooner we acknowledge the actual problem the sooner we can get around to fixing it….
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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20 Comments
I for one could wish you and your economic ideas could find roots in Europe,but I fear I cannot see the AustroGermanic mindset on these views is a closed door.
Looking at these issues it is unfortunate that the only thing that actually forces that “door” to open at all is a crisis that promises to be overwhelming.
“or starting to let some of these nations peel off”
Some of these nations should never have been allowed to join the Eurozone. And now the sooner the better the GIPSIFs leave the currency union, the better for them and for the then remaining Eurozone.
As for “the banks are the lifeblood of the system” – this is unsustainable and muste be changed. The system must be organised in a way that the banks serve the societey. Not vice versa as it is the fact in the perverted anglo-american form of ‘capitalism’ where profits are being kept private, risks and losses socialized.
“Europe will become united through its money or not at all.”
Jacques Rueff.
“It was in 1950 that French economist Jacques Rueff, made this prophecy. In 1958, he was financial counselor to President De Gaulle and was instrumental in designing France’s successful 1958 reforms. We think his prophecy is about to be put to the test, given the urgent need of structural reforms for France” – Macronomics
The outcome will be binary, either full integration as you rightly said Cullen, or disintegration.
Best,
Martin
Sorry Cullen, but for my the banks are a problem, similar to cancer for the economy. Unfortunately the attempts to “cure” them are just attempts to cut the cancer in size, but leave it to grow again and become a problem again. As you as MMR-er know, the share of money creation is about 80-90% (in normal times) by the banks (it is debt masquerading as money actually).
The deatial surrounding govt fiat currency system is of a secondary importance according to me. It is absolutely true that the PIIGS have sovereign debt issues because of the EUR design. But this is more of a distraction from the real problem – fractional reserve lending with no checks and balances. This system is now eating up the real productive economy as a cancer. The central banks are hiding behind their “ensuring system stability / orderly markets etc.” to constantly protect a racket scheme (heads I win a big bonus / tails the taxpayer foots the bill). And govts provide fiscal presents / bailouts and lack of reform or criminal prosecution.
So yes, the EUR is a problem. But at the root cause of all crises is FRL and the corruption it has caused on all relevant institutions.
Taking your logic further would seem to imply that “the problem” is not so much debt as it is a lack of growth. Sure you can be heavily indebted but if you are earning the cash to cover then it’s all good aint it. When growth hits a road block and debts pile up then bankruptcy or a real cut in expenditure is what you are facing. This applies to an individual, company or country. Seems like a lot of countries are trying the export model, currency weakness thing. (Not if u are a PIIG )unfortunately. Companies cut back on personell and individuals, well they just go BK, and move in with the in-laws. Which brings us back to square 1 , “how do u stimulate growth” so people can get jobs and pay thier debts, taxes etc and get the system going again. Or is this something that we took for granted that we would always have growth. What if it’s a muddle through and meager growth and we just have to mark time and work off the debt ??
The reason you do not get growth is simple – your so called “growth” has been predicated mainly on accelerating (debt/GDP) increase over the last 10-20-30 years.
Consuming on credit = negative capital formation
Now you have a temporary offset by the high fiscal deficits, but a) how long will it last?; b) what is now the true multiplier of govt expenditures – zero or below 1 or above 1 – various people give you different numbers (I guess it is below 1 on average)
Growth forever is physically impossible. Remember the rule of 72. A 5% growth rate implies a doubling time of 72/5 or about 14 years. Even a 2% growth rate is a doubling time of 36 years. How many doubling times before the number of people is greater than the earth can hold? People forget that the economy is still a physical system in a finite universe. Growth requires energy, other resources, and space to expand. Once energy production stagnates, so does growth. If a practical way is found to convert matter completely into energy, the entire solar system could be colonized in a massive spurt of growth. Human population could expand to the thousands of trillions. If the speed of light could be exceeded, then the entire galaxy and beyond could be colonized in a massive spurt of growth, until the local group of galaxies is full. Then growth would have to stop again.
thanks Pragcap for your writting. It’s very helpfull.
Cullen, Recapping the obvious: The reason the banks were bailed out early on was because it was a liquidity crisis and jeopardized the entire system. Their insolvency at the time was just a political decision and we know now that the DC/Wall Street deal was to extend and pretend the banks true situation.
But, Why didn’t the Fed/Treasury help the households? I suspect that their psychoeconomic models (they have them, of course), showed that to retrain the American consumer to respect money and debt again many Americans would have to “financially suffer” for x amount of time. I know that my attitudes have changed…and probably for the longer term. If more Americans have converted this way, then the extended wait will have been worth it.
Hi Chuck, this is an interesting point but I think you give the Fed/Treasury far to much credit. I think the real problem that they have in helping households is that of “moral hazard” in that if they help those who are in trouble it would make it so that those who have been prudent would feel like they got the shaft for their efforts. The same moral hazard is seen in the way people look at the bailout for Wallstreet and the industry.
Bruce,
I am reluctant to use the word “moral” in any sentence with the Fed. Snark off
I can not accept comments that the Fed is uninformed or rudderless given the fact that they have hundreds of economic quants and dozens of supercomputers running 24/7, they are assuredly looking at behaviorial issues related to currency valuation very seriously….particularly since it is all we have left.
Of course, moral hazard considerations are important, but I wonder how large the coefficient is in front of that term in the Fed’s algorithm versus in front of the terms related to “smart domestic consumer” or “prudent investor” if you prefer.
I’d love to see their algorithms/matrices(fat chance, I know). Particularly of interest are the terms related to lowering corporate tax rates to say?? ,15%, and how that effects trade imbalance and employment. I suspect that lower corporate taxes will be the action that boosts American activity and will finally put a dagger in the bogus “free trade” mantra of the internationalists. Once we aggressively play the currency game from an employment basis this chapter of the game will be over. Did I just endorse a Jobs Guarantee? Not quite…
It’s a political crisis.
I’ve been flipping back and forth on Germany’s political machinations (and should probably be treated for whiplash). Sometimes the Germans seem to realize what they are doing (i.e. their own experience post WW-I); sometimes they seem as “Bundesbank” as ever. I remember a few years after German reunification, there were lots of businessman/economists regretting that the East was locked into the strong German currency, that perhaps they should have run two economic (and currency) systems for a few years to let the East adjust. The Germans know from this experience what happens when you lock a low productivity region into a strong currency. It took a massive investment/transfer (I think something like a 1-2 percent of West German GDP for maybe 10 years and for a region half it’s size) to integrate it. This seems to be missing from German discourse, and there seems to be no urgency to unite Europe as there was to unite Germany. I’m flipping back again to PIGS (i.e. but not Italy) being out within a few years, but maybe the Germans will surprise me once again.
Some very insightful comments in there that I haven’t picked up elsewhere.Thanks.
Andrew P’s comment on earlier post: “…LTRO is a mechanism to re-nationalize EU Sovereign debt, and thus make the dissolution of the EuroZone a more realistic possibility. Essentially, if most Sovereign debt is held by a State’s own banks, it is easier for that State to say goodbye to the EuroZone without all its banks going under at once. It appears that the EU States are also in the earliest beginnings of re-nationalizing the other side of the ledger as well, by forcing their citizens to repatriate their bank deposits….”
Any responses to this analysis?
I have not picked up on anything meaningful re repatriation of funds on deposit.Indeed finding them woudl be the first big problem because there is no law of specific disclosure in most of the European banking and taxation system. That was all wrapped up several years ago in the EU Directive how it was to be treated and I don’t think there’s been much movement since in respect of inidividual countries agreeing to supply information outside of that agreement.
Spain has just required its citizens to report foreign bank accounts for the first time (other EU States are considered “foreign”), and Greece has been in discussions with the EU to force Greek account holders in Switzerland to repatriate those funds (according to Krasting). However, to the best of my knowledge those Greek discussions have not produced any result to date.
It is still early though. EU States are not yet desperate enough to take really drastic measures.
Cullen- You’ve outlined a solution generally in your last paragraph. Having been with you for this long I know you could have a workable solution for Europe if they just let you in the meetings. Being an outsider you’d probably get more done given you have no interest to protect.
That being said….how difficult would it be to enact the changes you’ve suggested? Keeping in mind they’ve done some drastice manEUvering to get this far that wasn’t forseen by the many experts.
I’d hate to assume the worst in Europe when the fix could be more easy then many of us think. Could it be easy? How many laws would have to be sidestepped to do it? When the alternative appears terrible.
Europe has a spending crisis. The periphery governments have too many expenses and don’t take in enough taxes. They have aging populations and economies designed to move exchange payments to non-working people.
(Ireland is maybe an exception — the banks went broke and the government stupidly took on their loans.)
In order for Italy and Spain and and France to pay their bills, they need to borrow money … Euros, dollars, little gold coins, whatever. But who will lend them money when they can’t pay it back?
Answer: Someone will give them money. Who is that someone? Either Germany, or, better still, a printing press operated by the Germans.
This is madness. Over the past 10 years, we’ve watched Greece implode when they were offered free money, no string attrached. Now the solution is to offer them more Euros, (more resources from the Germans) this time without having to pay any of it back?
The “real” problem is a function of perspective.
If you are unemployed, the problem is a failure of government to ensure a fair distribution of leisure time and work among the population, assuming that the government cant increase total employment in a meaningful and politically acceptable way in the short term.
If the US moved to 4 weeks annual leave, the same as Australia, most of the unemployment would be able to be absorbed. The cost to those who had extra leave (in terms of lost wages) would be offset about 30% by lower tax. The loss of the tax revenue from those taking the extra leave would be largely offset by lower costs of unemployment, foodstamps and possibly health and some tax revenue from those newly employed.
Other ways of reducing unemployment that have been used in the past have been increasing retention in education and facilitating earlier retirement.
What would unemployment be now if the retention rates and retirement ages were as per 1960?
I am amazed at what Europe and the US have done to 10 to 20% of their population, and particularly to youth through high unemployment, effectively establishing a long term second world community within their borders, one that will persist over time as the long term unemployed youth of today will likely always be first off, assuming they ever get into the legal economy.
I guess that makes me a social democrat.
I don’t buy it. If the US had 4 weeks annual leave, currently employed people would have to work harder when they were not on leave, and unemployment would go up because prices would go up to pay for the overtime. Most of the unemployed are unemployed because the things they do best are not so much in demand anymore. Things like construction and manufacturing, for instance.