Taming the Vigilant
The worst title of the year (so far) goes to Bloomberg with this stroke of idiocy: “Free Markets Show U.S. Has Tamed the Bond Vigilantes”.
Free markets! It’s a government institution – the U.S. Federal Reserve – that is providing the liquidity, via low interest rates and outright buying of government securities, to keep bond yields low. That’s the opposite of free markets.
Consider the following chart. It shows just how influential the Fed’s quantitative easing is.
And if you have a central bank Chairman stupid enough to engage in QE once, he is likely to do it again. Especially if he is subsidising his employer’s debt. Thus, liquidity is no big issue.
But the real reason credit markets are so “free” flowing is because there is nowhere else to go. Things are so bad that normally irrational behaviour becomes rational. Buying assets that have nowhere to go but down seems safe.
The danger in all this is that the Fed has put the US economy on a two edged sword. A private sector recovery will lead to a public sector crisis. As money flows from the bond markets into “higher risk” private assets, bond yields will go up and prices will fall. The bill on US sovereign debt will rocket.
And all that assumes a recovery in the first place. Without a private sector recovery, there is likely to be a deflationary spiral, which is so bad for everyone that bond profits won’t be much to cheer about.
In fact, the bullishness on bonds is a sign of bearishness on everything else. That isn’t something to celebrate and it reflects the central bank’s performance in mismanaging the economy.
The bond vigilantes aren’t tamed, they are being vigilant.
Bringing back General Franco, Georgios Papadopoulos, and Oliveira Salazar
Military coups, dictatorships and the end of democracy are on the European agenda. No, it’s not southern Europe in the 1970s, its southern Europe in 2010…
“…these countries could virtually disappear in the way that we know them as democracies.”
Sound like a load of rubbish? Well, it’s got nothing to do with your editors.
Instead, Manuel Barroso, head of the European Commission, was the one who blurted it out. Behind closed doors, of course. He was briefing trade union chiefs at the time.
Coupling Barroso’s comments with some views from French firm AXA, you get a rather concerning picture: “Axa said there was ‘no chance’ that the EU’s €750bn ‘shock and awe’ shield will succeed…”
And apparently being a former IMF official allows you to have your credibility back again:
“A number of ex-IMF officials have said the [European bailout] policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself. The IMF had floated the idea of a debt restructuring but this was blocked by Brussels.”
A quick trip to the European Commission website via Google reveals that the EC’s little mission statement goes as follows: “Serving the people of Europe.” That doesn’t gel well with Barroso’s comments. And he has been making other ones that are equally awkward:
“The commission is the economic government of Europe. That’s the only treaty-compatible reply that’s possible in trade, competition and a large swathe of budgetary surveillance issues – it is down to the commission and it is something that some of our governments should be reminded of from time to time because they haven’t attentively read the treaties it would seem, …”
The comments were largely directed at Germany and France because of their disagreements over how to deal with the Euro’s plunge and the insolvency of their various neighbours. But telling Germans to read their treaties is not constructive criticism.
Whether Barroso has a point or not is hidden somewhere in EU legislation. But it’s fair to say that a European Commission without countries to “govern” is not really a very good commission. And if Greece, Spain and Portugal are going to cease existence, while the Euro takes a dive to parity with the US dollar, it’s no surprise that the Commission is considered dead in the water by stronger EU states.
It’s every man for himself in Europe … again.
Keynes Is Back… in a Coffin
How novel that finance can bring down governments. If Barroso’s comments are honest, then this is a genuine and pressing concern for policy makers. They have tried the Keynesian solution, only to realise that they have been exhausting it for decades. Deficit figures of governments around the world suggest that governments have been burying money for the private sector to dig up all along. Only they didn’t bury it in glass bottles as Keynes suggested.
Instead, Governments have been “stimulating” the economy with cheap money, excessive social welfare and harebrained schemes of other sorts. So when the time came to give the economy a genuine kick into action, Europe discovered the Keynesian boot was already stuck halfway up the creek without a paddle… Or something like that. The point being that there wasn’t much room left for more stimulus.
So, according to Michael Stutchbury in The Australian’s opinion column, Keynes is back in his coffin. But wait a moment. Keynes is unlikely to have been a Paul Krugman. In other words, Keynes would have seen the evils of a government debt and deficit so large it chokes the economy to a depression.
Regardless of how badly put some of his stimulus ideas are, it’s not fair to claim that the Keynesian experiment has failed. It wasn’t tried properly. Going from an unsustainable deficit to a ridiculous one doesn’t jumpstart an economy. That’s all we learned.
At least we learned something. Some of us did anyway. Michael Stutchbury also points out who remains lost and confused:
“After championing last year’s huge budget stimulus packages, the International Monetary Fund now says the euro area crisis primarily results from “fiscally unsustainable policies”.”
So the IMF is now urging for fiscal austerity. The IMF is usually wrong, and this is no exception, merely a more complicated situation than usual. If Europe does implement the austerity that Barroso and the IMF so dearly desire, what will happen to their private sector economy?
If the government switches from a spender to a saver, something’s gotta give. All those who rely on government for their income and employment will have their plush carpets pulled from underneath their feet. Pretty soon, the private sector will feel the strain.
When things start getting bad again and the depression word comes out to play, maybe Keynes will make another comeback. The Americans, who are sticking to their stimulus stories, will feel smug watching Europe struggle. But as their unfunded liabilities come due, they will find themselves in the same situation, with or without stimulus.
Austrian Theory from the Reserve Bank of Australia
Here in the land of Oz, the RBA has stumbled accross some Austrian economic theory from behind. The Austrian School of Economics has a habit of doing that. It causes government institutions to stumble and fall flat on their face. But the RBA has glossed over their obvious glitch.
“High levels of foreign investment could trigger a domestic financial crisis, the Reserve Bank has warned.”
Hmm. But how Deputy Governor Rick Battellino?
”Credit is misallocated and eventually there is some form of a domestic financial crisis.”
Ahh, so there we have it. Credit is misallocated. But hold on. Paul Krugman, Milton Friedman and other economists claim that can’t happen. So, you have differed with Keynes and Friedman, what is left, Mr Battellino?
Here is a clue:
“Drawing a parallel to the lead up of the subprime crisis in the US, Mr Battellino said once a country became an attractive destination for foreign investors, ‘capital floods in, overwhelming the capacity of the economy to use it productively’.
So, the Australian situation resembles the US subprime crisis. Many economists agree that excessively low interest rates funded that boom to its dramatic bust. So, if a financial crisis brought about by excess credit can happen from foreign capital flows, it must be able to happen from domestic flows too.
And where do excessive domestic credit flows come from? The central banks. Only a central bank can expand the monetary base to mislead the economy about the levels of credit available.
Thus, RBA, you have illustrated the validity of the Austrian Business Cycle Theory. Sadly, a true believer of this business cycle hypothesis would abolish the RBA, but we don’t see its Deputy Governor doing so anytime soon.
But in the USA, there are quite a large number of people who would like to abolish the Federal Reserve. Legislation to that effect has been thwarted repeatedly, but is gaining traction. For now, an audit of the central bank is on the books. But instigator Congressman Ron Paul has one hell of a PR machine to go up against.
The institution charged with gradually debasing the currency, although it’s stepping up its efforts recently, has been painted as an angelic hero by the media. Ron Paul is branded otherwise.
Greek debt is now junk. Why? “Substantial risks”. Oh, ok.
To be more specific, it was the austerity measures that caused the downgrade. Yes, austerity measures make government debt riskier. That is because it puts economic growth at risk. Of course the economic growth that will disappear will be the economic growth that was bogus in the first place. But to debt ratings agencies, GDP is all important, no matter who makes the transactions.
The irony is of course that any downgrade makes it that much more difficult for the Greek government to recover. So, austerity measures are bad, downgrades are bad, excessive spending is bad, but what is left? Not much, just a recession.
But first, there will be a funding squeeze for Europe’s banks. As the risk free status of sovereign debt securities crumbles, the capital bases of the banks holding those securities will likewise crumble. That’s causing problems in equity markets as well as debt markets.
Nobody wants to buy a stock in an insolvent company (banks are inherently insolvent), and nobody wants to lend one money. And when credit markets dry up, those needing to roll over debt are in big trouble. The question is whether the European banks would be in big enough trouble to be bailed out. And who would do the bailing?
The German Bild newspaper interviewed Denis Snower from the Institute of World Economics, who reckons there is no risk of inflation over the next two years. But he also says that if the American recovery continues rapidly, there could be a risk of inflation from that point on.
What a load of Schwarzwaelderkirschtorte! What rapid American recovery? Also, Snower seems to believe that inflation is an increase in prices due to economic activity. As an economist specialising in employment, he probably believes in the Phillips Curve, which has been abandoned by economists including former Federal Reserve Chairman Paul Volker.
Inflation is an increase in the money supply. The resulting price increase is the symptom. That’s why price controls never curb inflation. They treat the symptom, not the cause.
Luckily the Germans have got a better grip on the situation than most eminent economists. Your editor is informed that German students learn a saying in primary school (or used to): “Geld vermehrung ist Geld entwertung”. In English: “Money increases is money depreciation.”
Germans look at Trichet and his quantitative easing and hear their teacher’s voice repeating the words that kept the Bundesbank on the straight and narrow for so long. They know that the QE is inflation, not that it will lead to inflation.
In the US, normal people are willing to sign petitions to increase inflation to 100%, so we can give up on them.
Until next week,
The Daily Reckoning Week in Review