Friday, May 25, 2012

Don't let's be beastly to the Germans

Don't let's be beastly to the Germans

When our victory is ultimately won.

It was just those nasty Nazis who persuaded them to fight,

And their Beethoven and Bach are really far worse than their bite.
Let's be meek to them
And turn the other cheek to them
And try to bring out their latent sense of fun.
Let's give them full air parity
And treat the rats with charity,
But don't let's be beastly to the Hun.
--Noel Coward

In July of 1914, Germany was presented with an unpalatable historic choice: whether to force its only ally, Austria, to back down in the face of intolerable provocation by nasty little Serbia; or, to enter into a world war against Russia, France and Britain. To choose the former would send the signal that the Central Powers lacked the will or the means to defend their legitimate rights; to choose the latter was to risk a prolonged bloody war and unforeseen consequences. Having to choose between honor and dishonor, Germany chose honor, and paid a heavy price.

A century later, Germany is faced with another Hobson’s choice: whether to jeopardize everything that she has achieved since the war in terms of wealth, prosperity and sound money by handing over its credit card to the eurozone; or, to stand by and watch as the eurozone collapses into chaos.

I do not envy them that choice. As bystanders, we (Americans) should hope that Germany “does the sporting thing” and hands over its credit card. This would prevent a global depression (with unforeseen consequences). It would be very costly and humiliating for Germany, but everyone would be better off in the end.

But to argue blithely that the Germans should be good citizens and just write the big check ignores a century of German history. Germany was not treated very well by the first half of the 20th century. In 1945 her country was a pile of rubble, cut in half by the victorious powers, deeply humiliated, roundly hated by everyone, indeed viewed by Europe as a criminal people.

What did the beastly Hun do then? They became Europe’s model nation: open, free, democratic, peaceful, and rich. They have done no harm to anyone since 1945. They have expiated their sins, they have paid their dues. They have embraced Europe and subsidized it for decades. There is nothing they could have done that they haven’t done to pay for their sins.

And now, having proven that they are good and can be trusted, they are being asked to pay some more, a lot more, a blank check. Because they are guilty, because they are Germans. They are being called Nazis in Greece because they aren’t donating fast enough for the tastes of the marxist unions.

It is true that, in a purely rational analysis, Germany would be better off if she paid the bill. But leaving rational calculation aside, why should she? Because she will never have to stop paying blackmail? Because her citizens won’t be welcome on Greek beaches? This is asking a lot to ask of a proud people with a lot to be proud about.

Europe wants three things from the Germans: their money, their credit, and their currency. They want Germany to keep funding the bailouts despite noncompliance with the agreed terms. They want Germany to give them its credit rating (without any control) so that they can all borrow as much as they wish. They want Germany to abrogate the treaty establishing the ECB, to allow it to become the piggy bank for eurozone governments.

In today’s Le Monde, Bundesbank president Jens Weidmann pushes back very hard on these arguments:

“The pooling of debt is just one side of a coin where federalism is the other. Governments who are in favour (of eurobonds) fail to point this out,” German central bank head Jens Weidmann told the French daily Le Monde in an interview. “In those countries which are calling for eurobonds, France included, there is no public debate or public support for the transfer of sovereignty that that would entail. But it's precisely this debate we should be having,” Weidmann said.

France's new President Francois Hollande is spearheading a drive for eurobonds, in effect pooling the debt of eurozone countries, in order to raise fresh debt funding. But Germany is firmly opposed to such a move, arguing it takes away the pressure for reform in spendthrift countries and also undermines market discipline. In contrast, France and some other eurozone states say that eurobonds could fund desperately needed growth policies after years of austerity have pushed the economy into recession.

“It is illusory to believe that eurobonds would resolve the current crisis,” Weidmann continued. Common bonds “can only come at the end of a long process, which, among others, would require several states to change their constitution, modification of treaties and the creation of more of a budgetary union,” he said. “You don't give your credit card to someone who can't keep their spending under control,” Weidmann added.

So at present we have the German chancellor saying no to eurobonds, and we have the German central bank saying no to eurobonds (and no to further ECB emergency lending).

In the London Sunday Times, Niall Ferguson argues that Germany will ultimately capitulate to the logic of federalism and eurobonds. I think that they are more likely to continue to say what they have been saying: that individual countries, if they wish to obtain assistance from the EU and the ECB, must cut their spending, reform their economies, balance their budgets and recapitalize their banks. I see little evidence that this position will be reversed, no matter how hard Francois Hollande stamps his feet.

If I am right, that means that the world will soon experience a global financial crisis on a scale not seen since 1929-33. In my next post, I will try to sketch out how I would see such a crisis play out.

Thursday, May 24, 2012

France: The socialist candidate turns out to be a socialist

President Hollande has begun to show his true stripes. It turns out he wasn’t kidding, and meant what he said during the election. You may recall that we were confidently told that there was little difference between Hollande and Sarko besides personality (Sarko mercurial, Hollande stable), and that once in office, Hollande would follow in Sarko’s prudent footsteps.

Au contraire.

Instead, he turns out to be an honest, naive little man (just like he looks). Like Nixon with Vietnam, he had a secret plan to solve the riddle of the eurozone: he would gather together all of the needy in the eurozone and order Merkel to guarantee a joint eurobond. He flew to Berlin and demanded a eurobond. Angela said no. He flew to Camp David and caucused with Club Med, ganging up on Merkel to make her relent. He made a grand entrance at the recent Brussels summit, walking in with Spain, leaving the Chancellor to walk in alone.

We are now being told by the media that all of this has been for home consumption in France, and that it is not to be taken too seriously. I see no reason to think this. I think that Hollande is quite sincere, and that he does not see a double-dose of austerity as the eurozone’s salvation. He believes that growth via greater fiscal unity is the only way out.

He may be right, but it’s not going to happen. He wants the eurozone to issue a bond with the joint and several guarantees of its members. As the guarantee is several, it means that the German people will agree to guarantee (assume) the debt of all of the other members, including Greece, Italy, Spain, Portugal, Ireland and--yes--France. Good old AA- France.

As a former rater, I will point out that when a guarantor guarantees something small, it gets his rating. But when it guarantees something enormous (like a continent) it gets a blended rating. That means you have to calculate standalone ratings for each country, multiplied by each country’s weighting (GDP or whatever). It also means that the guarantee has to be credible and irrevocable, which this one is unlikely to be.

But that aside, there is no way that Germany is going to become a part of a large mediocre sovereign credit that they do not control. Even in 1789, no one asked New York to guarantee the debts of the other twelve states. (New York was a good credit once).

To allow Hollande to save face, Merkel has said that she will “study” the idea of some sort of a joint bond. The SDP opposition has criticized her for being intransigent on this. But that is completely disingenuous. If the shoe were on the other foot, they’d do what she’s doing. The SPD is German long before it is socialist. (Most of Germany’s recent structural reforms were implemented by the SDP under Schroeder.)

All of this would be light opera if Europe were not teetering on the edge of the abyss. Right now, big decisions have to be made. Since there won’t be a deus ex machina from a German bailout, what can be done to save the eurozone? To what extent, if any, will Germany contribute to an enhanced ESM? To what extent, if any, can the Bundesbank be persuaded to provide unlimited liquidity to troubled banking systems? Will or won’t the ECB directly buy the bonds of the peripherals?

And, in Hollande’s own yard, whither French austerity? His first act as president was to lower the retirement age from 62 to 60, a pretty clear signal that he is not afraid of reversing engines.

So we now find that Hollande is not a sheep in wolf’s clothing, but indeed a wolf. At the very moment when the French people must decisively signal that they are Northern European, they have elected a man who prefers to hang out with the deadbeats in Club Med.

And the media is still telling us how awful Sarko was, and what a nice man Hollande is. I hate to say it, but the people of France have made a very serious mistake. They will realize that before the end of the summer.

Wednesday, May 23, 2012

Wrong again!

A week ago I swore that Greece was on the verge of exploding. Once again I was directionally correct but premature. I underestimated the degree to which the EU will do anything to keep Greece afloat. The EU blinked and released bailout funds to allow Greece to recapitalize its banks, allowing the ECB to resume its “normal” lending operations. Catastrophe averted.

The EU would like to keep Greece alive until the Greek election next month. If an austerity government can be formed, the EU can continue to disburse funds as agreed. It is anybody’s guess how the election will turn out; it is pretty unlikely that it will be possible for any government to implement the agreed austerity policy. I do not think that a military coup is likely now; that would come later, after complete chaos. The military is not chomping at the bit for such an opportunity.

As long as the EU continues to disburse bailout money and the ECB continues to fund Greek deposit outflows, disaster is postponed. But already today, the Bundesbank has begun to make unhappy noises:

"Greece is threatening not to implement the reform and consolidation measures that were agreed in return for the large-scale aid programmes. This jeopardises the continued provision of assistance. Greece would have to bear the consequences of such a scenario".

The Bundesbank is saying that the game is up unless the new government is foursquare in favor of the agreed “reform and consolidation measures”.  Today’s media contains speculation about this weekend for the “Grexit”. I wouldn’t expect it until the voters have spoken in June. The current caretaker government doesn’t have the authority to do anything besides holding the next election. So we should have a few weeks of respite.

It might be worth noting what the bond market currently thinks about the weak sisters in the eurozone. The market has priced the bonds of Cyprus and Portugal for default (Caa), and prices Spain and Italy as speculative (Ba). Cypus has not yet asked for a bailout, but it will have to do so or follow Greece out of the euro. Portugal will stay alive as long as the government sticks to its austerity plan.

Wednesday, May 16, 2012

Greek explosion imminent, I swear

I’ve called it prematurely for over two years, but now I am pretty sure that Greece is about to go under. This is for two reasons: (1) the run on Greek banks is accelerating; and (2) the ECB has reportedly begun to turn off the liquidity spigot for a number of Greek banks because they are hopelessly insolvent.

When the lender of last resort cuts off a bank facing a run, the bank is dead and will shortly default on its deposits. While the Greek central bank and the Greek government will do whatever they can to prevent bank failures, the remorseless arithmetic is decisive, because neither Greece nor its central bank can print euros. It appears that the ECB is now playing the game of chicken with the EU: If you want us to prevent a Greek collapse, then recapitalize its banking system with EU money.

I’m sure that the EU wants to prevent a Greek collapse, but I don’t see where they can get the money to recap Greek banks. That is a fiscal job for the government, not a liquidity job for the ECB. The Greek government isn’t going to get an open line of credit until it implements the austerity plan already agreed to. And it can’t implement the austerity plan because there won’t be a Greek government until a month from now, if then.

So unless the EU blinks, Greece won’t be able bail out its own banks, and they will have to close their doors. Once one Greek bank defaults on its deposits, all banks will be subject to massive wholesale and retail runs. This means that Greece will have to impose a deposit freeze pretty quickly. But the only way to reopen the banking system is with a currency Greece can create, which means leaving the eurozone. (This decision will have to be made by an unelected government without a parliamentary majority; how convenient for Greek politicians.)

Leaving the eurozone will necessitate not only redenomination but also default upon all external debts denominated in euro, which Greece can’t pay. Greece has the choice of repudiating its foreign debt or denominating it in drachma at par, and then paying it off Zimbabwe-style. Either way, it will totally screw the ECB and the rest of the eurozone. Their collapse will cost Europe something between EUR 500 and 900 billion. A small country, but a big price tag.

Greece is facing a “hard constraint”: bank insolvency and illiquidity. This is not a problem that can be resolved by negotiation, riot, or military coup. It can only be resolved by leaving the eurozone and massive external default.

I have to assume that the focus of attention in Brussels and Frankfurt now is deciding whether to push Portugal off this same cliff, since it is inevitable, and maybe Ireland too. They have to build a firewall around Spain because Spain is too big to fail. The Spanish firewall will have to involve the ECB, because only the ECB has unlimited resources in euro. The EU can help to recapitalize Spanish banks, but it can’t stem deposit outflows; only the ECB can do that. This will require an endless three-way conference call between Paris (Hollande), Berlin (Merkel) and Frankfurt (Draghi and the ECB board).

This crisis comes at an awkward time for France, which has taken its first step down the Greek anti-austerity road.  The people of France have voted against austerity and in favor of growth. They are going to get austerity.

Monday, May 7, 2012

Greek elections: Bad news for French socialists

I don’t know if Greece matters anymore. It has already defaulted on most of its debts, and aside from its debt, who cares what happens to it? It could just be another bankrupt Balkan (as it has been many times before).

The Greeks just voted in national parliamentary elections, and did not give a majority to the major parties which sought to pursue continued bailout money in exchange for fiscal reform. Even in coalition, it appears that New Democracy/PASOK cannot form a government. Without a government, it’s hard to see how parliament can implement the fiscal measures which are a condition of more bailout money.

Assuming that Germany sticks to its guns, it looks like the money pumps will be turned off next month, and Greece will have to start paying its bills in neodrachma or some such scrip. Short term, this will lead to utter chaos and financial collapse (Russia, 1998).

There are several possible financial implications of a Greek collapse: (1) it could serve as an object lesson to the rest of Club Med to get its act together; (2) it could spook the debt markets and cause funding crises for Club Med; (3) it could scare Europe into mounting a major exercise to ring-fence Club Med including both the ESM and the ECB; or (4) no impact at all, with Greece being viewed as another bankrupt Balkan.

My money is on #2: that it would alert the markets to the fact that the alternative to austerity is financial collapse (not growth, pace Krugman), and that Club Med is getting tired of austerity (which has only begun to be felt). The ECB has unlimited firepower to fight back against the markets, but the Bundesbank just reiterated today that this is not an option. At this point, Germany wants to wash its hands of all things Greek, and would be happy to see Greece settle Titanic-style to the bottom of the Mediterranean.

If I am right (that Greece will blow up next month), it will mean that M. Hollande’s honeymoon will be very brief. Unless he can say something quite dramatic in the next few weeks, such as “I hope no one really believed what I said about austerity”, he will learn that the bond market is not your friend.

Personally, my contempt for Hollande and the French left is so strong that I am hoping for the worst.

Thursday, May 3, 2012

End China's human rights abuses now!

The history of American foreign policy is not a fun read. As long as America’s foreign policy objective was continental conquest, all was well. But that ended in 1846, when the US conquered New Spain and pushed the British out of the Pacific Northwest. Since then, it’s been one embarrassing blunder after another. (Please point out to me to the part in the Constitution about Puerto Rico.)

Today, in my opinion (and Donald Trump’s) we have one major foreign policy problem: Not Iran or Korea, but China, or to be more specific, the Chinese trade imbalance. As in, we buy their exports and they buy our debt obligations.

For the purposes of this discussion, I will ask the reader to stipulate that the hollowing out of America’s manufacturing base by the Chinese is a bad thing for our economy, and that a principal cause of the imbalance is China’s mercantilist currency and policies. (These policies are probably in China’s interest, but not ours.)

China supports the export sector and discourages imports by overvaluing the RMB versus the dollar and the euro. In addition, they pose innumerable and inscrutable nontariff trade barriers to US manufactured goods.

All US administrations and both political parties have agreed that US policy must be aimed at inducing China to float the RMB to float and for it to be made convertible. (In other words, there should be a free cross-border market in RMB and RMB-denominated financial assets.)

But the US has never actually stuck it to the Chinese, despite twenty years of whining and pleading. Why is this?

The reason is that the Chinese are smarter and wilier than we are. Diplomatically, China makes Britain look like Belize. China has been engaged in active diplomacy for 3000 years, and they have the written records to prove it. They had diplomats before the dawn of European civilization.

The Chinese are masters of the art of distraction. To analogize: Let’s say that I have built my house on my neighbor’s property line, and he knows it and is not happy. What do I do? Well, if I’m China, I park my cars on his grass, give loud parties, and paint my house purple. When he knocks on my door to complain, I make sure that he plenty to complain about. He’s so worked up over the parked cars, the loud music and the horrible paint that he never gets around to the property line issue. (The Soviets were pretty good at this sort of thing too.)

In China’s case, they know that we are steamed up about the disappearance of our manufacturing industry. So what is their response?

They pay the Kims to build rockets, make big explosions inside their mountains, and to move “fuel rods” around. If things die down, they ask the Kims to fire at villages, fishing boats and submarines, or to shoot at tourists, or border guards.

The Chinese have great fun watching as Jimmy Carter and Hillary Clinton shuttle back and forth to Beijing to deal with each new Chinese-manufactured Korean “crisis”.

China also claims the entire South China Sea, and builds aircraft carriers and stealth fighters to protect them, causing regular “incidents” with foreign craft.

China demonstrates her ability to shoot down satellites.

She makes friends with Iran and vetos sanctions so that we wil use our “diplomacy” to induce them to go our way.

She plays games in Africa in order to keep the CIA busy.

And finally, and most diabolically, China create human rights abuses in her own country, just as the Soviets did. Instead of saying “let’s talk about trade imbalances”, we play into their game by saying “let’s talk about human rights in China”. That is precisely what they want to talk about, because it has no economic consequence and it distracts our fruit-fly-like attention span.

You cannot win when the other guy says “do what I want or I’ll torture this puppy” when he has 1.2 billion puppies to torture. You cannot win this game. We say that we do not negotiate with terrorists, pirates or hostage-takers because it only encourages them. And yet we have spent decades negotiating with the Chinese about taking their own people hostage.

American diplomacy in China should be one note: trade, and then trade, followed by trade. Not DPRK, not the Spratley’s, not weapons systems or satellites, not Iran, not Africa and certainly not Chinese human rights.

And we can also play their own nefarious games. Don’t bloviate about trade because it is a waste of time; just take hostages. Accuse them of  WTO violations, impose countervailing tariffs and antidumping duties. When they complain, close the Bank of China in New York for two months for foreign exchange irregularities and money laundering. When they complain about that, expel 500 “diplomats”, 1,000 “students” and 5,000 “businessmen” for spying. When they complain about that, turn off all of their satellites for 12 hours by “mistake”. Have the longshoremen close our Pacific ports (like they’re doing already). There is no end to the ways that we can harass China.

I am not up on the legislative activity on China, but I do know that Senators Lieberman, Schumer and Graham periodically introduce punitive legislation in connection with “currency manipulation” which they always allow themselves to be persuaded to withdraw. Passing their bill  (25% tariff) would certainly be a start. This should not be a partisan issue.