THE USA DOES NOT HAVE A “GREECE PROBLEM”
It’s time to understand that there is a fundamental difference between Greece and the US.
To paraphrase Shakespeare, things are indeed rotten in the State of Denmark (and Germany, France, Italy, Greece, Spain, Portugal, and almost everywhere else in the euro zone). An entire continent appears determined to commit collective hara-kiri, while the rest of the world is encouraged to draw the wrong kinds of lessons from Europe’s self-imposed economic meltdown. So-called “serious” policy makers continue to legitimize the continent’s full-fledged embrace of austerity on the allegedly respectable grounds of “fiscal sustainability.”
The latest to pronounce on this matter is the Governor of the Bank of England, Mervyn King. This is a particularly sad, as the BOE – the Old Lady of Threadneedle Street – has actually played a uniquely constructive role among central banks in the area of financial services reform proposals. King, and his associate, Andrew Haldane, Executive Director for Financial Stability at the Bank of England, have been outspoken critics of “too big to fail” banks, and the asymmetric nature of banker compensation (”heads I win, tails the taxpayer loses”). This stands in marked contrast to America’s feckless triumvirate of Tim Geithner, Lawrence Summers, and Ben Bernanke, none of whom appears to have encountered a banker’s bonus that they didn’t like.
But when it comes to matters of “fiscal sustainability,” King sounds no better than a court jester (or, at the very least, a member of President Obama’s National Commission on Fiscal Responsibility and Reform). In an interview with The Telegraph, the Bank of England Governor suggests that the US and UK — both sovereign issuers of their own currency — must deal with the challenges posed by their own fiscal deficits, lest a Greece scenario be far behind:
“It is absolutely vital, absolutely vital, for governments to get on top of this problem. We cannot afford to allow concerns about sovereign debt to spread into a wider crisis dealing with sovereign debt. Dealing with a banking crisis was bad enough. This would be worse.”
“A wider crisis dealing with sovereign debt”? Anybody’s internal BS detector ought to be flashing red when a policy maker makes sweeping statements like this. The Bank of England Governor substantially undermines his own credibility by failing to make three key distinctions:
1. There is a fundamental difference between debt held by the government and debt held in the non-government sector. All debt is not created equal. Private debt has to be serviced using the currency that the state issues.
2. Likewise, deficit critics, such as King, obfuscate reality when they fail to highlight the differences between the monetary arrangements of sovereign and non-sovereign nations, the latter facing a constraint comparable to private debt.
3. Related to point 2, there is a fundamental difference between a sovereign government’s public debt held in its own currency and public debt held in a foreign currency. A government can never go insolvent in its own currency. If it is insolvent because it holds foreign debt, then it should default and renegotiate the debt in its own currency. In those cases, the debtor has the power, not the creditor.
Functionally, the euro dilemma is somewhat akin to the Latin American dilemma, which countries like Argentina regularly experienced. The nations of the European Monetary Union have given up their monetary sovereignty by giving up their national currencies and adopting a supranational one. By divorcing fiscal and monetary authorities, they have relinquished their public sector’s capacity to provide high levels of employment and output. Non-sovereign countries are limited in their ability to spend by taxation and bond revenues. This applies perfectly well to Greece, Portugal and even countries like Germany and France. Deficit spending in effect requires borrowing in a “foreign currency.”
King implicitly recognizes this fact, as he acknowledges the central design flaw at the heart of the European Monetary Union — “within the Euro Area it’s become very clear that there is a need for a fiscal union to make the Monetary Union work.”
This is undoubtedly correct. To eliminate this structural problem, the countries of the EMU must either leave the euro zone or establish a supranational fiscal entity that can fulfill the role of a sovereign government and deficit spend to fill a declining private sector output gap. Otherwise, the euro zone nations remain trapped — forced to forgo spending to repay debt and service their interest payments via a market-based system of finance.
But King then inexplicably extrapolates the problems of the euro zone, which stem from this design flaw unique to the euro, and exploits it to support a neo-liberal philosophy fundamentally antithetical to fiscal freedom and full employment.
The Bank of England Governor and others of his ilk are misguided and disingenuous when they seek to draw broader conclusions from this uniquely euro zone-related crisis. Think about Japan — they have had decades of deflationary environments with rising public debt obligations and relatively large deficits to GDP. Have they defaulted? Have they even once struggled to pay the interest and settlement on maturity? Of course not, even when they experienced debt downgrades from the major ratings agencies throughout the 1990s.
Retaining the current bifurcated monetary/fiscal structure of the euro zone leaves individual countries within the EMU in the death throes of debt deflation, barring a relaxation of the self-imposed fiscal constraints or a substantial fall in the value of the euro (which will facilitate growth via the export sector, at the cost of significantly damaging America’s own export sector). This week’s €750bn rescue package will buy time, but will not address the insolvency at the core of the problem. And it may well exacerbate it, given that the funding is predicated on the maintenance of a harsh austerity regime.
José Luis Rodríguez Zapatero, Spain’s Socialist prime minister, angered his trade union allies but cheered financial markets on Wednesday when he announced a surprise 5 percent cut in civil service pay to accelerate cuts to the budget deficit.
The austerity drive — echoing moves by Ireland and Greece — followed intense pressure from Spain’s European neighbors and the International Monetary Fund on the spurious grounds that such cuts would establish “credibility” with the markets. Well, that wasn’t exactly a winning formula for success when it was tried in East Asia during the 1997/98 financial crisis, and it is unlikely to one this time.
Indeed, in the current context, the European authorities are simply trying to localize the income deflation in the “PIIGS” through strong, orchestrated IMF-style fiscal austerity, while seeking to prevent a strong downward spiral of the euro. But the contradiction in this policy is that a deflation in the “PIIGS” will simply spread to the other members of the euro zone with an effect essentially analogous to that of a competitive devaluation internationally.
The European Union is the largest economic bloc in the world right now. This is why it is so critical that Europeans get out of the EMU straightjacket and allow government deficit spending to do its job. Anything else will entail a deflationary trap, no matter how the euro zone’s policy makers initially try to localize the deflation. And the deflation is almost certain to spread outward if sovereign states such as the US or UK absorb the wrong lessons from Greece, as Mr. King and his fellow deficit-phobes in the US are aggressively advocating.
There are two direct contagion effects from the fiscal retrenchment being imposed on the periphery countries of the euro zone: first, on the banking systems of the periphery and core nations, as private loan defaults spread on domestic private income deflation induced by the fiscal retrenchment; second, to the core nations that export to the PIIGS and run export-led growth strategies. So 30-40% of Germany’s exports go to Greece, Italy, Ireland, Portugal and Spain directly, while another 30% to the rest of Europe.
These are far from trivial feedback loops. And the third contagion effect is to the rest of world growth as domestic private income deflation, combined with a maxi euro devaluation, means exporters to the euro zone and competitors with euro zone firms in global tradable product markets are going to see top line revenue growth dry up before year end.
Let’s repeat this for the 100th time: the US government, the Japanese Government, and the UK government, among others, do NOT face a Greek style constraint — they can just credit bank accounts for interest and repayment in the same fashion as they would buy some helmets for the military or some pencils for a government school. True, individual American states do face a fiscal crisis (much like the EMU nations) as users of the dollar. That is why some 48 out of 50 now face fiscal crises (a problem that could easily be alleviated were the US Federal Government to undertake a comprehensive system of revenue sharing on a per capita basis with the various individual states). But, if any “lesson” is to be learned from Greece, Ireland, or any other euro zone nation, it is not the one that Mr. King is seeking to impart. Rather, the lesson is the futility of imposing arbitrary limits on fiscal policy devoid of economic context. Unfortunately, few are recognizing the latter point. The prevailing “lesson” being drawn from the Greek experience, therefore, will almost certainly lead the US and the UK to the same miserable economic outcome, along with higher deficits in the process. As they say in Europe, “Finanzkapital uber alles”.
* Marshall Auerback has 27 years experience in the investment management business, serving as a global portfolio strategist for RAB Capital Plc, a UK-based fund management group with $2bn under management since 2003 and co-manager of the RAB Gold Fund.
Great article. Thanks.
I get the whole vertical money issue. What still bothers me is the bond auctions. Why do countries with a printing press still issue bonds? It appears to make no sense whatsoever. Anyone know the answer?
Somehow not even our host wants to answer so let me try. The problem is that technically government can not and does not print money. The Central Bank does. In the US the supply of money is regulated by the Fed and nobody else. If the government is running a deficit it needs to get the money somewhere to cover the deficit. So it goes to the market and sells bonds. Now in theory it could just sell these bonds to the Fed but if that happens you would basically monetize this debt and in turn increase the money supply in the economy. When you deal with fiat currency monetization may increase the risk of either inflation (you increased the aggreagate demand with aggregate supply unchanged so there is more money chasing the same amount of goods and services) or currency debasement (you currency loses its relative value). If the deficit isn’t large you are ok (with for example 3% deficit inflation will eat away most of it anyway) but if you run 10% annually and would immediately monetize it selling the bonds directly to the Fed you risk either of the two to become a real problem.
“So 30-40% of Germany’s exports go to Greece, Italy, Ireland, Portugal and Spain directly”
12.2% of Germany’s exports in 2009 went to the PIIGS directly. Do facts matter?
More nonsense. No wonder the US blew up along with western europe. Its embraces theories by fools and semi retards. Where in practice has any of this stuff worked? Never. Never in history has it worked.
Perhaps you can explain to me how an alchemist goes bankrupt?
If the alchemist’s debts are payable in gold there is no way he will go bankrupt but won’t there come a time when his creditors and vendors will realize that his gold is as common as dirt and force him to pay any new debt or purchase new goods with another medium of exchange?
To use your business card economy as an example: What happens when your kids want to buy a new bike from from the neighbors bike store and the store tells them that they only take Poker Chips and not business cards and the bike costs 200 poker chips? But, since they are nice the kids can trade 2000 business cards for a poker chip. This may not be the best analogy but what I’m getting at is the point where other countries decide that the purchasing power of the dollar is degraded and thus more and more dollars are required to purchase needed goods and resources. Isn’t inflation the ultimate threat here rather than a Greek style crisis? I’ve read most of your explanations regarding inflation but I must still be missing a crucial perspective. Any explanation would be appreciated.
These are valid points and you pinpoint the key issue – inflation. Unfortunately, despite the cries of inflation, I still don’t see it. Every time we have these episodes of “fiat currency” fears where gold spikes, we also see the dollar spike and commodities get hammered. This is 2008 all over again. A blatantly deflationary fear-filled environment.
I’ve had hundreds of emailers and commenters attempt to convince me that we are experiencing some sort of massive inflation, but I still am not even remotely convinced. All I see is a world in debt and a private sector in the US that is underwater, deleveraging and afraid to borrow more. You can call the governments CPI figures baloney if you’d like, but does that mean the bond market is lying? Why are long bond rates so low if US paper is at risk of inflation?
See my comments here on deflation. http://pragcap.com/why-deflation-remains-the-greater-risk
As for your poker chip analogy – well, I’d just ask you to show me an example of someone that won’t accept dollars. If I went to the busiest street corners in the 100 most populated countries in the world and started handing out dollars a fight would break out in an attempt to get those dollars. There is mass demand for dollars. In fact, I would argue that in these deflationary times, there are still not enough dollars to go around.
Does that help clarify at all?
Agree with TPC that inflation, in terms of CPI, is not a problem with such slack demand (i.e., no velocity = no money supply = no inflation). But I do wonder if the liquidity flood causes “inflation” in asset prices. Foregive my extremely amateurish description, but it strikes me that the increased monetary base isn’t escaping the financial system to the “real” economy (whether because banks don’t want to lend or people / businesses don’t want to borrow, other than to repay old debt – probably both) but it is going into financial markets producing instant asset price reflation. Not sure if this is blatantly incorrect, but would like your take on it.
What I would refer to as malinvestment. For instance, handing bankers $1T so they can pile it into various markets and line their pockets. That is the ultimate slap in the face for Main St and an impediment to organic economic growth.
This is very much a different issue altogether. I’ve covered this pretty thoroughly. Government spending thus far has been misguided and poorly targeted in my opinion (which is partially why it hasn’t been inflationary). That is why much of the money is sitting on the floors of various bank vaults (or more accurately, in on-line accounts).
A $1T tax cut or job program would have been 1 million times wiser than bailing out bankers who are not reserve constrained.
First of all Auerback is either an idiot (and can’t read with understanding) or is just manipulative. If you read the quote King never does not compare the situation in UK or US to Greece. He is just pointing out that there are risk related to loss of confidence in the sovereign debt. And i guess its obvious to everybody (except Auerback) that such a significant loss of confidence by the market would cause serious dislocations. Loss of trust in the sovereign debt or fiat currency would have very negative impact on the already weak recovery in US or Europe. You already see a panic in the precious metals market just imagine what happens when people completely lose confidence and gold goes to $3000 per oz or even much higher (where it would equal broad monetary base) Is that a great scenario for the economies around the world?
The example of Japan is just silly. They have an enormous savings rate and deflationary economy in a mess for the last 20 years. And by the way poverty rate has doubled over that time. I guess its great for Auerback.
He just seems like some junior trainee with textbook knowledge citing definitions but without any understanding of the broader issues.
As for your alchemist. He will technically never go bankrupt, however two things may unfortunately happen to him as you well know. He is fine as long as what he is producing is perceived as “value”. So as long as its gold then fine. The problem starts when he produces so much of it that it is no longer seen as “gold” but becomes just some “yellow crap”. As he is still producing like crazy then you have a lot of “yellow crap” chasing fewer goods and everybody sees it (inflation) or if he needs to import anything to his great kingdom of alchemy no one wants to trade with him and he needs to produce and pay more and more “yellow crap” to foreigners.
First of all, let’s take it easy with the name calling. You don’t know Auerback from Adam so it’s entirely unnecessary and contributes nothing to the conversation.
I have just one question for you: do you not want your dollars? Can I have them please? You imply that demand for dollars is falling because of all this “money printing”, but for some reason the dollar index keeps rising as people can’t get enough dollars. Care to explain that?
TPC:
ok name calling i guess you are right here i just lost it a little. And since i did it in your “house” i a sorry. But i do feel like he is implying things which King never said.
Secondly please read my post once again. I have never said that we have inflation and i am not saying there is a serious risk of dollar debasement in the near future. I am using a word increased risk instead. With continuing deficits of 10% p.a there is a risk that either one of these will materialize. You are right we don’t have it yet but the risks are growing and the behavior of the PM markets is worrying. Secondly with running such high deficits there is increased risk of serious dislocation to issuance of sovereign debt here or in Europe. Then you will be forced to monetize it by selling to the Central Banks and again i think it will greatly increase the risk of inflation and/or debasement. And i never said anything more than that.
No need to apologize. Name calling is just not productive. I have been guilty of it though so I know from experience
Thanks for clarifying. We totally agree on your point. I would argue, however, that we have a decent buffer for continued high deficits because deflation remains the near-term risk.
California just announced over $13b of austerity measures. “US doesn’t have a Greece problem”
Wake up TPC!
Would it be in the interest of CA to default? Does it need to?
No doubt there are continuing problems at the state and private sector level, but CA is not going to default and it will not cause the USA to default. In fact, both would be impossible. No one is saying that the USA doesn’t have enormous problems to tackle, but default is out of the question. We are not in the same position as Greece who has no monetary independence.
Printing money is just another form of default. the outcome of both (Greece, US) is the same: lower standard of living
That’s the typical gold standard argument: “the USD has lost 90% of its value over the last 100 years.”
Did the American standard of living fall 90% also? Or are we fatter and richer than ever?
has lost 90% of value against what?
Just quoting a Bill Bonner piece here:
“Since we were born, right after World War II, the dollar has lost about 90% of its purchasing power.”
http://www.lewrockwell.com/bonner/bonner251.html
The inflationista argument always implies that the dollar has fallen dramatically over the last 75 years or so and is therefore diminishing our livelihood, but everywhere I look I see fatter and richer Americans who have become complacent and lazy.
Unlike Greece….
…we in the US have full employment,
…about 60% of the employed are working for the private sector,
…the 40% working in the public sector are not getting twice the private wages for the same job,
…our GDP is growing way faster, than the growth of all the spending programs and entitlements,
…you see, we can print all the money we “need” and think we will not have inflation,
…US can fool themselves and others, that no matter what, everything is going to be just fine
No regular reader would ever accuse me of being super optimistic about the macro outlook for the USA. But understanding that there is no solvency risk here is vitally important. Otherwise, we too implement unnecessary austerity plans and unjustly punish our citizenry simply because the govt is inept and doesn’t understand how the monetary system works.
Or worse, we bailout bankers and line Wall Street’s pockets while ignoring the people who matter….This is what happens when you have misguided monetary & fiscal policy. Unfortunately, the Europeans are repeating our mistakes.
I understand that we do not have a solvency problem,but we are becoming a indebted slaves to a government, that is wasting money giving them away for no reason (bailouts, stimulus – same thing – all stolen)
I bet most of “the people” haven’t seen any stimulus money either
You think austerity plans are not necessary? Explain why for the same job public “servant” gets twice the pay of what private employee gets. Who pays the wage of the public employee?
What happens when everyones taxes go up to pay for the bailouts and the stimulus?
How come that just a few of them benefited from those programs, but all of us will be “required” to pay our “fair share” of taxes to tackle the debt and deficit problems of the USA?
That’s the point. Our taxes have no need to go up as they don’t fund spending. People don’t get this. If our govt wasn’t run by morons they would understand that we need LOWER taxes.
If they spent more wisely and understood the monetary system they wouldn’t need to implement these austerity plans in the first place….
Now I fully agree with you!
“Why are long bond rates so low if US paper is at risk of inflation?” I don’t understand why lng bonds rates so low, but oil price up and gold price up at the same time. Could you kindly expalin, thanks.
The fundamentals for both oil and gold are very good. There is a currency premium built into gold with I believe is misplaced, but only time (a lot of it) will tell if I am right.
Oil is 50% off its highs and 15% off the recent highs since the Euro crisis started in earnest. Either way, the dollar is rallying and so are bonds so where is the paper deterioration here? The inflation argument doesn’t hold water.
Why are long bond rates so low if US paper is at risk of inflation?”
Part of the answer may be in asking who other than the Fed is purchasing those bonds?
Investment banks borrow money from the fed at 0% and lends it back to the Government at 3% plus.
How would you like to borrow at 0% and turnaround and leverage your position 10 times or more to purdhase a 10 years AAA US T bills at 3.50% for a net 35% return.
Investment banks did not record a loss in any of the 63 trading days in the last quarter. Does any one realy think this is possible?
What a way to monetizes the debt.
With the possible exeption of needed “temporary” liquidities as a bridge to prevent panics, all this printing “you can’t go brooke theory” to fund the deficit and try to recreate a real economy will end this way: The Deficits and printing will = the artificial recovery will = 0
Eventualy the “FUNNY MONEY” will get out and it’s probably not to far away.
Deficit spending if taxed will always take back what it gave and if not taxed it will always lead to inflation. What we have now is uncontrolled deficits wich will eventualy lead to uncontrolled inflation.
Polititians can talk about changes and miracles all day long but at the end of the day there is no cheating, A) We pay and we cut the spending or B) We get devaluated. Guess what they will chose? $$$$$$$$
In the early 1920s in Germany inflation was not apparent it began showing up in 1921 and was at its worst in the second half of 1923.
I rememer some famous expert(may be Greenspan, but I am not 100% sure) said, LONG term interest rate is decided by market even FED can not influence (“change”) it, but FED does able to influence SHORT term interest rate. I am very confused by the FACT that long term interest rate is at history low and gold price is at history high(oil price today is much higher 10 or 20(30, 40,…)years ago.). Could some one explain?(English is not my mother language, but I hope my question can be understand)