Crisis At The Periphery

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–One simple way of thinking about the world’s problems is that over indebtedness is overwhelming institutions at the periphery of the global system. A few years ago, that meant margin-lenders and non-bank lenders in America’s housing market being swallowed by bigger more traditional banks that were not financed by securitisation (think Rams Home Loan here in Australia).

–But the banks weren’t well capitalised enough to withstand credit write downs so the risk had to be swallowed by an even larger party with deeper pockets (or access to your pockets). Gradually, risk of debt default has been centralised in a smaller number of institutions and governments, migrating from the private balance sheet to the public.  Instead of being disaggregated, it’s being repatriated.

–Yes, it’s kind of a boring thought to begin the week with. But it may explain a lot of what’s going on in the moment. No one wants to take losses on bad debt and have a thorough reckoning of profits and losses. So the problem is passed on like a virus to the next biggest remaining party.

–An obvious example is Ireland (and Portugal, and Greece, and Spain). Ireland’s government agreed in principal over the weekend to a bailout fund from the European Union and the International Monetary Fund. The liabilities of Irish banks have become too big a problem for Ireland’s national government to manage without destroying its own balance sheet and credit rating in the process.

–At one level this represents a victory for multi-national financial companies over the traditional nation state. Ireland ceded power and sovereignty to the EU and IMF because its banks have held a gun to its head. The banks win and Ireland’s people suffer the consequences, with terms of surrender dictated by the EU and the IMF.

–Whether or not this model of submission finance (where the banks threaten to kill the country unless their ransom demands are met) is the actual design of the banks and/or the trans national organisations is a good question. It could be that some people want weaker nation states and stronger Supra States like the EU.

–In fact, that could be the case in Ireland. In June of 2008, Irish voters rejected the EU’s Lisbon Treaty. That treaty was itself a sneaky way of forcing a European constitution on Europe after major nations like France and the Netherlands had rejected said constitution by popular vote. For unelected bureaucrats, “No” never really means “No.”

— European parliaments ratified the Lisbon Treaty and thumbed their nose at popular opposition from the little people. Like medieval landed elites and clergy, today’s governing class is not interested in the consent of the governed. It correctly realises that it doesn’t derive its power from that consent, but from the power to throw people in jail for not paying taxes or for breaking any one of myriad laws which the State has erected in private and public life.

–The Irish constitution required another vote by the people on adopting a European constitution and the Irish, being rebellious at heart, rejected it. Naturally, European power brokers in Brussels moved ahead with the project of greater economic and political integration in Europe anyway. The democratic process wasn’t meant to be an actual referendum on whether Europe should become more “one.”  The vote was just window dressing to give the European project the patina of respect from having been voted on by “the people.”

–But in the age of growing government power, the people don’t really matter, except as votes to be bought and tax serfs to be fattened and farmed.  And now Ireland, whose banks are stuffed with bad debt, finds itself having to do what its told by the EU and IMF whether it likes it or not.

–By the way, this slow motion tyranny of the ruling elite bureaucratic class is just as true here in Australia as it is everywhere else. Here, it takes the form of a government refusing to cost a $43 billion national broadband plan of dubious worth. It takes many other bi-partisan forms too, of course. Here in Victoria, it’s the enormous number of spin doctors employed by the government (at taxpayer expense) to consult on public policy and cram all sorts of propaganda down your eyeballs.

–Don’t expect an end to Europe’s crisis, though. It will just migrate to the next nation with large public sector deficits and widening bond spreads (where investors openly doubt the ability of goverments to cut spending and address structural economic weakness). Portugal is already the red hot favourite for the next crisis. But the real issue is the same everywhere: too much debt at the local level and an institutional arrangement that guarantees each local crisis will imperil the viability of the whole European project.

–That’s what you get for trying to have one monetary policy of twelve different economies.

–Meanwhile, in America, the peripheral crisis is in with State and City governments. The Federal government can always monetise the debt through the Federal Reserve, printing money to buy bonds issued by the Treasury. City and State governments enjoy no such privilege. Thus, you’ve seen falling muni bond prices and cancelled offerings as borrowers fret about investor appetite for more debt.

–What does it mean? It probably means that California or Illinois is going to go bankrupt before Washington does. And when one or two states or ten or twenty cities go bankrupt, it will put more pressure on the bankrupt Federal government in America to “do something.” Like what?

–All of this roughly fits in with the idea we laid out in Friday’s subscriber-only update for Australian Wealth Gameplan: global growth is not going to come from debt-laded OECD countries. If it’s going to come, it’s going to come from the BRIICS. But those countries (Brazil, Russia, Indonesia, India, China, and South Africa) are sorting out whether they want to continue devalue their currencies (as they must in an export-driven growth model) or begin relying more on domestic demand and allowing for currency appreciation to stem inflation concerns.

–Speaking of which, Ben Bernanke had a go at China in a speech he gave in Germany on Friday. He said that, “For large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.”

–He went on to claim that the running up of large current account surpluses destabilised global growth. And more importantly, he claimed that artificially suppressed currencies didn’t’ allow for the needed rebalancing in the global economy. It was Fed speak for, “You’re doing it all wrong, China.”

–That’s a pretty audacious claim for a man who’s taken U.S. monetary policy into completely unchartered waters and kicked off a migration into higher risk assets and commodities.

–Where does that leave Australia as we begin the week? Good question. The risk of China over-tightening its bank lending to contain inflation would definitely be bearish for Aussie resources. But for now, no one seems overly concerned that un-sound monetary policy is going to affect Aussie asset prices. Maybe they should be.

–Or maybe we worry too much.  But we can’t help it. And what we ‘re worrying/wondering about now is if China, too, is at the periphery of the global credit boom, inasmuch as it created tremendous productive capacity to fuel credit-driven consumption in the West. What if a lot of China’s boom vanishes with the inevitable deleveraging and debt-deflation in the West?

–Hmm. That’s a lot to think about it. Let’s see what the market does and get back to you tomorrow. Until then.

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Talk to us about commodities, and gold and oil. Is the flush of cheap US$ going to elevate prices because OPEC don’t want to be paid $82/barrel in American Raffle tickets, or is the Europe thing going to throw the whole world into recession/lack of demand, and batter commodity prices. We saw the week before last (when the Saudi’s announced that they thought $90/barrel was not unreasonable (vis, they were going to let it happen), then just as oil was doing $87, Ireland came into view and commodities nose – dived. Perhaps i am naive but doesn’t the $600 billion QE2 somewhat trump whatever the problems the Irish have. I know that UK banking has a big stake in Ireland, but does anybody know how many people we are talking about here: 4,470,700. How bankrupt can they get? Ireland has always been bankrupt, they only did well when they came into the EEC (not unlike Greece!!!!!!!!!!!) There had never been any serious industry there, other than that propped up by the pro-Irish US. Wages are too high, it cannot command economies of scale, has no home market and to top it off, everything it ships to Europe (if in deed it does ship anything anywhere) has to go on a boat. Beggars belief why the developed EEC nations ever let the likes of countries such as this (and Poland in). My theory is that France wants to keep the common agricultural policy going as long as it can, and other mud-hut countries (i.e. the PIGIS) are always going to vote favourably for maintaining it (they all have their noses in the trough and are being supported by the industrially developed nations like Germany and the UK). Ireland has always been bust, it’s just that nobody ever noticed til now. It’s a bit like global warming, we are snatching at whatever data there is and jumping to the conclusions we wanted all along. Not saying it’s not going to fall in a heap (it surely is), but come on, we need to base our analysis on better stuff than 4.47 million Guinness drinking peat diggers.

    Reply
  2. Smallcap

    I agree entirely with your article and have been saying the same things since emigrating from Ireland 20 years ago about the Irish “economic miracle”.
    What I find disappointing and concerns me is your racist 18th century stereo typical rant against Ireland and the Irish. A mud-hut country?… noses in the trough? …. Guinness drinking peat diggers?
    If this crisis worsens will you then pepper your ignorant and stupid comments with comments about Goatbangers, Polacks, Paella Eaters and Dagos?
    I see that you call yourself smallcap presumably as you only need a smallcap for your small brain and narrow mind. Get with the rest of the world.

    Terry, living in 2010
    November 24, 2010
    Reply
  3. “Get with the rest of the world”

    What does that mean?

    “Goatbangers”

    Never thought of that one. We must mix in different circles.

    It was a serious observation as to the importance that has been placed by many (particularly the US) on the demise of Europe and the Euro. Any comment re mud hut economies was merely an attempt at light hearted humour. I do think the US is eager assign the Euro to the wastepaper basket and are over eager to over respond (negatively) to the present goings on in on the continent. If you watch CNBC, the presenters positively do hand springs at any bad news from the continent. However, I do draw a distinction between a failure of either Holland, Germany, the UK or France as opposed to a failure in Ireland, or Poland or Greece.
    The European Common Agricultural Policy is a trough, or hadn’t you noticed. Australia and New Zealand suffered terribly at the hands of the ECAP, which specialised in subsidised purchasing of European farm produce, at the expense of ‘foreign’ produce. Then storing it at great expense, then giving it away on the quiet. I can hear the violin in your posting, Irish. So in the great cosmic balance sheet that is Irelands financial contribution to Europe, is the figure a positive or a negative?
    :-)
    Wonder when the world will decide to base commodity prices on the Swiss Franc, and how that would please the US.

    What do you think Irish?
    (And try to maintain a civil Irish brogue will ya)

    Reply
  4. Ireland was not “bust” it was a “stagnant” country.. zero growth.
    The inflationary boom times that the foreign money brought to Ireland over the last decade or so has ruined the country…

    You look at all the other countries that have so called “boomed” have boomed also on credit and the growth is proving to be false, no different to Irelands.

    There are more Irish living outside of Ireland than in Ireland.. Seeking growth that was not available there, the recent growth has been imported from other countries with borrowed money and was never going to last.

    The low company tax rate of 12.5% is incentive for companies to set up there and to stay there..

    Like many other countries the economy went on the boil and a many got burnt holding the pot…

    Stillgotshoeson
    November 28, 2010
    Reply
  5. Oops, i seem to have caused offence to Shoes as well. We seem to have a fixation with semantics here, but i think that modern economic thinking is that if we are not growing, the the eventual outcome will be that we will not be able to compete or pay for our ageing populations. Anyway,my original point (and it is probably a crap one), is that Ireland is not the centre of the manufacturing universe. To my knowledge, it doesn’t have a car manufacturing plant, it doesn’t have major ship building and any other major manufacturing base (though someone will doubtless correct my ignorance). I am fairly sure that it isn’t much of a commercial centre either. I have not Googled its GDP or other financial figures. I do know that it has no commodities (may have natural gas???) and only 4.477 million inhabitants, which is slightly more than Boston and slightly less than Sydney. My original point was that, it seems a long stretch to condemn the whole of the whole European economy based on a satellite of the EEC. That’s it, that’s all. Doubtless, if we had given Ireland the sum of the monies which were knocked off world share markets as a result of the news of its doom, everyone living there would have been given a $ million tax rebate. Oh, and if anybody is interested, Iceland has a population of 277,000, which is about the same as my local pub on a Saturday evening (apologies in advance for my use of humour again).
    The US announced that it was pushing 600b into the economy, the news pushing up the markets, and the Ireland news took them to below the start point. Just seems odd to me and a bit of a stretch. You may all rest in peace, this is my last posting – oh fragile ones.

    Reply
  6. Not offended at all…

    Ireland was worth $1
    Many overseas companies invested many (borrowed) dollars in Ireland, Mostly due to the low company tax rate. However close proximity to the US (New York)and cheap (relative to other parts of “Europe”)
    These dollars also brought from overseas.. “Workers” and Ireland had a shortage of housing.. borrowed dollars went into housing, housing became very expensive very quickly.. housing became oversupplied, the line of credit was stopped and the existing borrowings crippled the banks and the “investors”
    Take all that away and Ireland is still worth a dollar… and no biker I do not mean it in the literal sense.

    Major Industry is Agriculture.. Both grown and livestock. Cereals, Potato of course, Dairy Produce.

    Industries include Copper, Lead and Silver mining, Chemical Manufactoring, Fertiliser, Machinery and Pharmaceuticals.

    My family have a large pig farm an hour or so from Cork..
    Ship “Building” in Ireland is not as strong an industry as it once was, however ship repair/maintenance is a large industry, the dry dock of Harland and Wolff shipyard, builders of the RMS Titanic, is the largest in the world

    Stillgotshoeson
    November 28, 2010
    Reply
  7. The US announced that it was pushing 600b into the economy, the news pushing up the markets, and the Ireland news took them to below the start point. Just seems odd to me and a bit of a stretch. You may all rest in peace, this is my last posting – oh fragile ones.

    The concern is not Ireland directly but that the crisis is not contained as first thought and will spread from Ireland to Europe. The fundamentals of Ireland are quite sound.. It is the foreign money that is in danger in Ireland.. The concern is if Ireland needs money how bad are the other countries with less sound fundamentals..

    Most of us are not fragile either ;) No need to be fragile yourself and not post here again ;)

    Stillgotshoeson
    November 28, 2010
    Reply

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