Tag Archives: european monetary union

Stratfor: can Europe’s banks break free from their doom loop?

Summary: Banks are the financial heart of modern nations, and Europe’s are in trouble. One of its greatest, Deutsche Bank, has severe problems. Here Stratfor looks at the perilous state of Europe’s banks, looked in a doom loop by their holdings of government bonds.

Stratfor

Can the Eurozone Break Its ‘Doom Loop’?

Stratfor, 16 February 2017.

In 2012, Europe’s sovereign debt crisis exposed the “doom loop.” Created by European banks’ tendencies to hold their home government’s debt, the vicious cycle, in theory, starts when markets lose faith in a government’s ability to pay back its debt, precipitating a sell-off of its bonds. The resulting drop in bond prices would then hit the balance sheets of the banks that still hold those bonds, making them more likely to need a bailout from their governments. This, in turn, could further erode investor confidence, leading to additional sell-offs that damage the banks even more. Despite the danger that banks’ practices pose, eurozone regulators have yet to find a way to sever the loop.

In the years since a doom loop nearly led to the eurozone’s collapse, authorities have tried (but failed) to break the bond connection between banks and their governments. A German proposal to limit the amount of their own government’s debt that banks can hold has been hotly contested by Italy and Spain, since implementing it would cause massive disruptions to their economies. Another German-led measure involved the creation of “bail-in” rules, which were adopted at the start of 2016. They required that a troubled bank’s private debtholders absorb its losses first, essentially losing their investment, before government money could be used to bail it out.

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What can we learn from Greece’s crisis?

Summary: Now the final act has probably begun in the long divorce of Greece from the European Monetary Union. Ignore the predictions. They’re just wild guesses. Rather let’s take this moment to contemplate how Greece — and Europe — got here.  {1st of 2 posts today.}

“Europe will be forged in crises, and will be the sum of the solutions adopted for those crises.”
— Jean Monnet in his Memoirs (1978). He was one of the architects of the program to unite Europe (see his Wikipedia bio).

EU flag burning on the ground

Unnecessary death of a dream.

After years of confident assurances that all would probably work out for the best, Greece has gone off a cliff. This was long expected by readers of the FM website. In July 2007 they read that the European Monetary Union probably couldn’t survive the next recession in its current form. The cracks opened in 2010; in February 2012 I predicted it would not survive the crisis.

Europe’s lending and monetary stimulus programs to the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) delayed the crack-up until 2010 and extended the slow decline since then, Now the crisis has begun. It will almost certainly bring big changes to Greece. As for the rest of Europe, and to the unification program, who can say? Greece is small, but it might create large precedents for others to follow.

While journalists report the exciting events to come — entertainment for America’s outer party (managers and professionals), because what difference does it make? — we can ponder how this happened and what America can learn from this.

We’ll see many economists explain why this resulted from incompetent politicians. This crisis would have been manageable if tenured economists at majored universities ran the world! Barry Eichengreen (Berkeley) says “Path to Grexit tragedy paved by political incompetence.” I suspect that a tag-team of Solon, Pitt the Younger, and Washington would have found this crisis difficult to handle.

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Stratfor: A high stakes cage match – Nationalism vs. the European Union

Summary:  The European Union appears to be starting its long-predicted endgame, when its  design flaws create insolvable crises. This analysis by Stratfor goes to the heart of the EU, describing the forces that seem likely to halt or reverse the 65 year-long march to unification. They make a bold prediction which, if correct, will change the course of 21st C geopolitics. {2nd of 2 posts today.}

Stratfor

How Nationalism Undermines the European Union

Stratfor, 29 May 2015

Forecast

  • The loss of economic prosperity has hurt European integration efforts. Member states will now push to devolve power from the European Union to the national level.
  • Nationalist and anti-establishment parties in member states will undermine fundamental EU policy.
  • EU institutions will be able to manage this trend in the short term, but the economy will force Brussels to reshape the European Union.
  • Over time, nationalism will trump European integration and governments will repatriate power for the first time in EU history, leading to the collapse of the union.

On May 29, 2005, French voters rejected a proposed European Constitution in a nationwide referendum. A week later, the Dutch followed suit. This clear rejection of greater European integration was an iconic moment in the history of the European Union. Although it came in the form of a nation-state constitution, the European Constitution would primarily have collated all previous EU treaties into a single document. This symbolic act, plus the granting of more legislative powers to Brussels, would have been a major step toward a unified Europe formulated in the wake of World War II.

A decade since the Dutch and French referendums, the European project is in its deepest crisis. The economic turmoil that began in 2009 and produced the eurozone crisis has awakened nationalist instincts that undermine pan-Europeanism. These centrifugal forces have always been present and, historically, led some members to opt out of certain initiatives. The key difference in 2015, however, is that nations will choose to backpedal on integration — a first in EU history.

Integration and Sovereignty

The contest between nationalism and pan-Europeanism has been at the core of the European Union since it was first formulated in Rome in 1957. The union is an attempt to create a transnational entity out of a group of nation-states defined by different economies and political traditions, divided by a history of conflict. To unify these states, the European Union promised peace and economic prosperity. The resulting organization was a hybrid between a unified pan-European entity and a community of sovereign nation-states. In the ensuing decades, these competing visions have continued to clash, with nationalism succeeding several times in slowing the integration process.

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Today began the next phase of the great monetary experiment, as reality plays a trump card.

Summary: Today began the next phase of the great monetary experiment, the collision of Central Bankers’ bold promises with reality.  History suggests skepticism about the odds of CB’s success (e.g., see the many unbreakable currency pegs and unions which broke). Today the Swiss National Bank folded its cards. Here we discuss the significance of this to them and to us.  This is part one; see tomorrow’s post for the conclusion.

Wizard of Oz

Bow before our Monetary Wizards!

Since the crash, governments of the western nations have conducted the greatest economic experiment ever, with us as the subjects of unprecedented monetary and fiscal stimulus. We have had massive deficits, long periods of zero interest rates (for some now, negative interest rates), and repeated rounds of quantitative easing (in various forms). So far the results have varied by nation from good to great. But as with any experiment, preliminary results often don’t match the final tally. Today we began the next phase.  First here’s some background.

Switzerland’s bold monetary experiment.

“The minimum exchange rate remains for the foreseeable future the key monetary policy instrument. We’re prepared to buy unlimited amounts of foreign currencies and, if necessary, take further measures …. We will continue to defend the minimum exchange rate with utmost determination …”

— Thomas Jordan, President of the Swiss National Bank, 23 September 2014 — Speech in defense of the 1.20 peg to the Euro set in September 2011.

To keep their exports competitive in September 2011 the Swiss National Bank (SNB) set a minimum exchange rate (a ceiling to the Swiss Franc vs the Euro). In September 2014 President Jordan promised to print unlimited Swiss Francs to defend this level. Some were skeptics, such as the people at Grant’s Interest Rate Observer, 19 September 2014 — Excerpt:

Like a celebrity in flight from the paparazzi, the Swiss Confederation demands protection from its pesky admirers. … The {Swiss franc} is still, for many, the monetary bolt-hole of choice. To the Swiss, whose exports generate 54% of Switzerland’s GDP, it’s a kind of popularity they can live without — indeed, they insist, must live without. So the SNB prints francs.  It drew a monetary line in the sand three years ago: The franc shall not rally through the 1.20-to-the-euro mark, the authorities commanded in September 2011. To enforce this dictum, they bought euros with newly created francs (the cost of production of the home currency being essentially zero).

What to do with the rising euro mountain? Invest it, of course. CFA fashion, the central bankers are diversifying across asset classes and currencies. Among these asset classes are equities, and among these currencies is the dollar. As of June 30, the Swiss managers held $27 billion in 2,533 different U.S. stocks, according to the bank’s latest 13-F report …

Here’s a metaphysical head scratcher. The Europeans conjure euros, which the Swiss buy with their newly materialized francs. The managers exchange the euros for dollars (also produced by taps on a keyboard) and with that scrip buy ownership interests in real businesses. The equities are genuine. The money, legally and practically speaking, is itself real.. But what is its substance? We mean, how is it different from air?

… In these stupendous interventions, the SNB is hardly unique. Nor is it alone as it attempts to undo, through administrative means, the distortions it creates through monetary policy. New “macro- prudential” directives have tightened standards for home-loan amortization schedules, minimum down payments, affordability, bank capital ratios, etc.

Grant’s recommendation:

{W}e venture that the SNB will sooner or later be forced to permit the franc to appreciate and thus to enrich the holders of low-priced, three-year call options on the Swiss/euro exchange rate. It’s a long shot, to be sure — the options are cheap for a reason — but we judge that the prospective reward is worth the obvious risk.

Four months later their recommendation paid off — big. Bloomberg describes the fireworks:

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What’s happening in Greece? News from the front lines of Europe!

Summary:  The euro crisis began 30 months ago. The cheers for each new solution proved unwarranted. Likewise the fears of the skeptics, as the periphery nations have held together under horrific stress. So far. Here we look at public sentiment in Greece. See the For More Information section at the end.

Soon: the Golden Dawn of Greece!

My guess: Europe’s leaders continue their program of austerity plus government loans. They see this as penicillin. In fact it’s a toxic brew of hemlock and morphine. Europe’s economies will continue to deteriorate, but the political situation will remain stable until social cohesion breaks somewhere.

This poll gives us a status report from Greece. Even there a majority remain loyal to the great unification project (which US conservatives falsely describe as forced upon Europe by its elites). But as the depression deepens, an increasingly number of defectors give their loyalty to extreme parties. Greece and Spain are the fault lines; watch there for something to snap.

From Sky News of Greece (ΣΚΑΪ), 17 September 2012 — via Google Translate:

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Last week they spoke comforting words, but I saw only the frightening aspects of the euro-crisis

Summary:  Although entertaining as gallows humor, last week’s statement by ECB President Mario Draghi illustrates important but seldom discussed aspects of the euro-crisis. Here we read and annotate the text.

It’s an oddity of our time that people tend to rely on secondary sources — journalists and pundits — to learn what the world’s leaders say.  Twenty years ago major papers, such as the New York Times, ran their speeches in full. Thanks to the Internet we can do so as well.  Here we feature a major speech, with some information and analysis accompanying it to provide context.

The EU’s preferred policy solution

Contents

  1. An annotated speech by the President of the ECB
  2. They know what they want. They don’t see why their actions almost guarantee failure.
  3. They are relying on hope
  4. Other posts reporting Europe’s slow march to the cliff

(1) An annotated speech by the President of the ECB

In our world few things are as they seem to be. There are hidden complexities. There are hidden truths. There are lies and misrepresentations. Here we examine this important speech by a high European official, a speech which has electrified not just Europe, but investors around the world (mostly for wrong reasons). Draghi speaks candidly. But to correctly interpret his words we must understand his orientation — described in the annotations.

Speech by Mario Draghi, President of the European Central Bank at the Global Investment Conference in London 26 July 2012

… I think the best thing I could do   is to give you a candid assessment of how we view the euro situation from Frankfurt. And the first thing that came to mind was something that people said many years ago and then stopped saying it: The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does.

He refers to the widespread forecasts at its beginning by economists that the euro-system could not and would not work. For details see Can the European Monetary Union survive the next recession?, 11 July 2008. Next he explains the results to date of the euro experiment:

So the euro was a bumblebee that flew very well for several years. And now – and I think people ask “how come?” – probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis.

Paul Krugman gives a more accurate explanation:

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The hidden goal of Europe’s leaders. See it and then their actions make sense.

Summary:  As the euro-crisis, now in its third year, grows in breadth and intensity, many analysts conclude that Europe’s leaders are stupid. Perhaps not.  Perhaps they pursue hidden goals.  Goals important to them, if not to Europe’s peoples.

Many people writing about the euro-crisis conclude that Europe’s leaders are stupid.  How else to explain the long series of late, slow, half-measures which never address the core problems?

In a recent post about Obamacare Chet Richards advises us to take  John Boyd’s advice and beware of such facile analysis. If we understand people’s orientation, we might see their actions as logical.  For example, we might believe them stupid because we do not see their goals.

We know that Europe’s leaders seek to protect their banks (and bankers). They seek to preserve the European Monetary Union, and continue progress to eventual unification. Perhaps there is a third goal in the shadows. Massive deficits combined with recessions — even depressions — provide the opportunity to break Europe’s social welfare systems, including the unions and legislation that empowers workers.

The same dynamic is at work in America.

Why do they think this will work? Because it worked in Germany. And it’s working now in the periphery of Europe.  But pursuing this goal while protecting the banks means they’ve not taken the reforms necessary to preserve the EMU (one cannot do everything at once). So they might achieve their two lessor goals, but in doing so wreck their greater dream of a unified Europe, for which they have worked so hard since WWII.

For details about their success in Germany see this excerpt from a report by Joshua Rosner of GrahamFisher, 17 July 2012 (Hat tip to Yves Smith at Naked Capitalism):

In 2002, with the unemployment rate at 8.7% and still increasing, German Chancellor Schroeder  asked his friend Peter Hartz, former Human Resource Director at Volkswagen, to chair a  commission tasked with restructuring the German labor market.  Under Hartz’s leadership the  commission redefined the German workforce, reducing traditional full time employment and  introducing the concept of “minijobs.” These so called “minijobs” provided German companies  with the ability to hire short term workers without restrictions on hours worked and who were  terminable at will.  While “minijob” workers did not pay taxes on earnings; the earnings maxed  out at a meager €400.

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