QE Verdict After Five Years: A Failure

It is now five years since the Lehman crash and the commencement of the Fed’s bond-buying policy known as QE. Since Lehman, the Fed has bought $2.8T trillion of bonds from banks, quadrupling its balance sheet from $800B to $3.6T.

Today’s topic is: How successful has QE been in delivering strong money growth, sustained economic growth, full employment, and 2.0-2.5% inflation? Answer: unsuccesful. Today, the Fed has zero credibility when it comes to market confidence in its ability and commitment to fulfill its twin mandates.

Here is the current data (percent change from year ago):

M1: 7.0%

M2: 6.6%

M3: 4.5%

M4: 3.6%

Core inflation: 1.2%

Nominal GDP: 3.1%

Real GDP: 1.6%

Unemployment rate: 7.3%

We are looking at an economy that has been stuck in second gear for four years, and employment indices that have yet to return to precrash levels. Five years after Lehman, millions of people are unnecessarily out of work and out of the workforce. 

This is because the Fed has not pursued a consistent policy of monetary expansion since 2008. The trillions that the Fed has supposedly “pumped into the economy” are nowhere to be found; they are sitting on deposit at the Fed as sterile and useless excess reserves. They are not "in the economy" and they have had no impact on money growth, inflation expectations or economic growth.

In the 1981-82 recession, Volcker grew M2 by double-digits for a year, and got things moving. Greenspan did the same thing during the 2001-02 recession, and again got things moving. Bernanke did the same thing in in 2009 and again 2011, but stopped in mid-2012, allowing money growth to fall to its current anemic levels.

Five years on, we have persistently high unemployment and very weak growth. Nominal growth at 3.1% is far too low to bring down unemployment, and risks another recession. A deflationary recession at this point in the cycle would be disastrous, and would require heroic policies to reverse.

Bernanke’s half-hearted policies have failed to raise inflation expectations. The fact that expectations remain “anchored” at a low level is a sign of failure, not success. The real funds rate needs to be substantially lower than the current minus 1%. The best way to raise inflation expectations is to explicitly target and deliver 3-4% inflation.

The Fed’s talk of tapering QE was a major policy mistake. Not because QE has worked, but because tapering signals a surrender in terms of the Fed’s commitment to fulfilling its mandate. It signals that the FOMC is OK with high unemployment and low inflation, and that that the Fed’s mandates are aspirational “goals”, which it doesn’t really need to achieve.

The  failure of QE necessitates a bolder policy, not a more timid one. Wars are not won by retreat. The Fed needs to decisively change its focus from inputs (buying $X amount of bonds each month) to economic results: money growth, inflation and nominal growth. This will require a program of shock-and awe in order to make a decisive break in inflation expectations and market behavior:

1. Target 10% money growth, 3-4% inflation, and 6-7% nominal growth.

2. Stop paying interest on excess reserves in order to encourage banks to put them to use in the economy.

3. Double the size of QE and make it open-ended until unemployment returns to a normal level, say 5%.

3. Add to the QE buy-list a trade-weighted basket of foreign government bonds, and physical gold.

4. Commit to raise the price of gold if M2 proves sticky.

5. Permanently redefine “price stability” as 3-4% inflation.

The Fed needs to restore its credibility by meeting its mandates, instead of half-heartedly trying to meet its mandates. There are no points for effort in this exercise. This is a very serious business, given the current level of unemployment and the dismal job prospects for young people.

The Next Black Swans Are Visible

Everyone is now looking under his bed for the next bubble or black swan. Some pundits are pointing to the revival of the market for risky corporate bonds. They worry what will happen when there are defaults. Well I can tell you what will happen when there are defaults: credit spreads will widen and speculators (the people who buy speculative-grade bonds) will suffer MTM losses. Big deal; this happens all the time. No one dies from it. And yes, speculative-grade bonds are speculative.

What people die from is huge positions in low-risk instruments that overnight become toxic. That’s what happened in the subprime fiasco. Here are the criteria for such an event:

Before the event:

1. The security is seen as low risk. It is rated investment grade and is thus eligible for fiduciaries to buy.

2. The security attracts a low capital coefficient under the bank capital regime.

3. The accounting treatment is to carry the security at par.

4. Systemic exposure to the security is massive.

The event:

1. The security is downgraded to speculative grade, forcing fiduciaries to sell.

2. The bank capital regime now requires a higher capital coefficient.

3. The accounting treatment changes from cost to market (MTM).

4. Large MTM losses result, rendering the most exposed players insolvent.

What asset class meets these criteria: Club Med government bonds. In declining order of risk:

1. Spain (Baa3/Negative outlook)

2. Italy (Baa2/Negative outlook)

3. France (Aa1/Negative outlook)

I include France because it has the furthest to fall, like super-senior CDOs. Today French government bonds are a risk-free security. High ratings, zero capital coefficient, carried at par. Imagine if those factors should change: a lower rating, a higher capital coefficient, marked to market. Spain may be the next Lehman, but France could be the next WW1. If French bonds begin to decline in value, there is almost nothing anyone can do about it (besides fiddle with the accounting). It would rip a huge hole in the European banking system which would be impossible to fill without high inflation.

So while we know that Spain is on a bad trajectory, we should worry that France may be too. Spain may be Lehman; but France is civilization as we know it. The next black swans are visible.

The Intellectual Fallacy Of Central Bank Financial Strength

There is an article in this month’s ECB Bulletin titled “Central bank balance sheet expansion and financial strength in crisis times: the case of the Eurosystem”. It is an extraordinary display of cant, nonsense and false assertions; in fact, it is almost Orwellian, as in 1984. Please wade through the following excerpts, and then I will comment:

“The implementation of monetary policy is inevitably associated with financial risk because it involves the provision of central bank money against assets or collateral from private agents. If a central bank is perceived to be taking excessive risk, its credibility and the public’s perception of its ability to deliver on its mandate may be affected. 

"Both in normal and in crisis times, central banks must preserve their financial strength, which means that they must always have sufficient financial resources available over time to conduct monetary policy in an independent manner, and hence deliver their policy objectives in all circumstances.  What matters in ensuring the credibility of the central bank is its financial strength across time.

“The ECB treaty prohibits monetary financing. These provisions preclude the monetising of sovereign debt. Through promoting price stability in the long term, these provisions indirectly contribute to the financial health of the Eurosystem’s balance sheet.

“The central bank’s stand-alone financial strength reinforces credibility in its capacity to always deliver on its mandate while avoiding exposure to political pressures. This helps to anchor expectations among the general public and financial market participants that the central bank is in a position to effectively deliver on its mandate and that its monetary policy decisions will not be unduly constrained by concerns about financial resources.”

--ECB Monthly Bulletin, September 2013

Let’s parse these words. Note that the tone is didactic, from “on high”, as opposed to scientific. No evidence is adduced in support of the following four palpably false hypotheses:

1. To maintain confidence and credibility, central banks must maintain a high level of standalone financial strength.

2. Central banks must always have sufficient financial resources available over time to conduct monetary policy in an independent manner, and hence deliver their policy objectives in all circumstances.  

3. The ECB’s unwillingness to engage in QE (“monetary financing”) contributes to the financial health of the Eurosystem’s balance sheet.

4. The ECB’s standalone financial strength helps to anchor expectations that monetary policy will not be constrained by concerns about financial resources.

In a nutshell: A principal policy objective of a fiat money central bank should be its standalone financial strength.

Where did this shibboleth come from? Please name the economist, in any country. This bogus platitude can be found in no economics textbook written since the end of the gold standard. It was pulled out of thin air, and what I have called “Commercial Bank Thought”, the earnest belief system of those who think that because they understand commercial banking, they must be experts at central banking. One can work for a commercial bank for decades and never learn anything about monetary policy--in fact the correlation is negative. Commercial banking is about making and collecting loans. Central banking is about delivering growth with moderate inflation. Those two Venn Diagrams don’t touch. Commercial banks (private sector, profit-seeking enterprises) inadvertently, unintentionally and unknowingly act as vectors of central bank policy.

Now, I will concede that when the Fed is asked to lend dollars to foreign central banks, it must consider their ability to pay the dollars back. But normally, central banks don’t borrow from each other. It’s a tangential activity. What central banks actually do is manage the money supply by adding or withdrawing liquidity from the banking system. That means either buying bonds with newly printed currency, or selling bonds from  portfolio.

The only actors who have credit exposure to the central bank are commercial banks who keep their liquidity reserves there. Do they worry about the Fed’s standalone financial strength? No. Here’s the crucial point: the reason why JP Morgan does not have a team of analysts running the numbers on the NY Fed (where it has a lot of money on deposit) is because the NY Fed prints dollars. The NY Fed can’t run out of dollars.

Now let’s turn to other holders of dollar claims, such as the People’s Bank of China. Does the PBoC have analysts studying the Fed’s balance sheet? No, because the PBoC knows that the Fed prints dollars just as it prints RMB. There is no credit risk associated with its claims on the Fed. (The Treasury, yes, but the Fed, no.)

Bogus hypothesis: “Central banks must always have sufficient financial resources available over time to conduct monetary policy.” What does this mean? When it comes to buying things, they print money, so that is not a constraint. Now they do have to sell assets from time to time to mop up liquidity. What if they run out of bonds to sell? Then they can sell their own bonds. Not only does a fiat money central bank not require capital, it doesn’t require assets, since it can issue its own bonds.

Bogus hypothesis: “The ECB’s unwillingness to engage in QE contributes to the financial health of the Eurosystem’s balance sheet.” What the ECB is saying is that, because it won’t buy Club Med government bonds, it is maintaining the euro’s credibility by protecting it from Club Med government credit risk. The euro is backed by good Nordic assets, not dodgy Latin assets. The credibility of the euro is supported by the market’s confidence that the ECB can survive a collapse of Southern Europe. Indeed, the credibility of the euro may require the collapse of Southern Europe, which is a small price to pay for credibility.

I recently suggested that Draghi is a hired gun. His employment contract specifies price stability, and that’s what he’s delivering. I have also said that Draghi has a secret contempt for the corrupt and profligate Italian political class, and that he hopes that Italy can be reformed by austerity and deflation. Maybe, who knows? He doesn't talk to me. But I would like to think that Draghi is a man of integrity and charity, and not merely a mercenary of the Bundesbank.

So I ask myself: Did Draghi read this article, or was it written by the Bundesbank and shoved into the Bulletin? Why did he allow it to be published, when he knows that it is utter nonsense?

At some point, when X+1 millions of Europeans are out of work, I would hope that Draghi will have the courage to be the St. Thomas Moore to Jens Weidmann's King Henry VIII and say: “I can no longer support your policies. I will do what I see fit, and it will be up to you to try to stop me”.

The Bundesbank's Target2 Exposures Are Manageable

AEP at the Telegraph has a thought-provoking column about the implications of eurozone exit for the Bundesbank’s (BB) balance sheet. The concern is that, when the peripheral central banks leave the eurozone, they will default on their outstanding balances to the Eurosystem, which are called Target2 Balances. The big Target2 debtors  are the Bank of Italy and the Bank of Spain. The ECB has compensated for the withdrawal of deposits from the Club Med banks by extending ~700B* of credit to the peripheral central banks, financed mainly by the BB.

An illustrative example: Barclay’s risk committee decides move to its euro clearing accounts from Santander to Deutsche (or from its Madrid branch to its Frankfurt branch). Santander borrows the money it owes to Barclay’s from the Bank of Spain, which in turn borrows from the BB. The BB then sells securities (Bunds) to German banks to fund its new loan to the Bank of Spain.  Two weeks later, Spain exits the eurozone, redenominates all of its financial liabilities into New Pesetas (including Target2 and its own bonds), and the Bank of Spain defaults on its loans from the BB. This makes the BB insolvent (on whose balance sheet these loans are booked), thus requiring a bailout from the hapless German taxpayer**. That’s the “crisis scenario”.

But I don’t think that the situation is really so dire. First of all, I believe that the BB’s exposure is to the eurosystem as a whole, and not to the Bank of Spain. So the default causes a solvency problem for the ESCB, not the BB. The ESCB is rendered insolvent, and would require a bailout from its owners (mainly, Germany). Minor difference, but a difference.

[Nomenclature alert: The ECB = the Federal Reserve Board; the European System of Central Banks = the Federal Reserve System; the Bundesbank = the NY Fed, which has the bulk of the system’s assets and liabilities on its balance sheet. Neither the FRB nor the ECB has a balance sheet. They are the boards of directors for their systems, which are made up of regional central banks. Most of the business conducted by the FRB and the ECB is handled by their “lead” banks, the NY Fed and the Bundesbank. The terms “the Fed” and “the ECB” are merely shorthand for the Eurosystem and the Federal Reserve System, banking groups with centralized governance but regional operating entities. The US system has the advantage that its regional central banks are not creatures of the 50 states, and not subject to local political influence. Bill Dudley (NYF) does not confer with Andrew Cuomo (NYS) on monetary policy.]

Furthermore, there is no need for a bailout of the ESCB or the BB. A bailout would be required if the eurosystem was on the dollar standard or the gold standard; in other words, if its liabilities were denominated in a currency that it can’t print. But the ECB prints euros, at no cost to anyone. A printing press doesn’t need capital because it prints its own money. The ECB would not require a bailout from anyone other than its own printing press. The eurozone’s money supply would not be affected, because the eurosystem’s assets have no impact on the monetary aggregates (money is claim on the banking system, not an asset of the central bank). It would be very different if the ECB were on gold, but it’s on Monopoly Money. If you or I were to xerox a euro note, it would be worthless. If the ECB does, it’s money. Photocopied euros are not legal tender. Printed euros are legal tender.

It is true that the eurozone as a consolidated entity would “lose” the amount of money defaulted upon by Spain, but that would have no economic, monetary or fiscal impact.

Take a look at the dollar zone: Imagine that Texas announced that it planned to secede, resulting in a global run on Texas banks. That would require the Dallas Fed to fund the banks by borrowing from the system (i.e., the NY Fed). Then, when Texas does secede from the US, it redenominates into its own domestic currency and defaults on its liabilities to the system. The Fed would lose the amount lent to the Dallas Fed, which would appear on the balance sheet of the NY Fed, as an accounting entry and nothing more. (I’m making the simplifying assumption that Texas nationalizes the Dallas Fed, and that its only members are Texas banks.) No one would worry about the solvency of the NY Fed, or of the FRB. The remaining reserve banks can still print dollars, and the ex-Texas money supply would be unaffected. (The status in the US of currency printed by the Dallas Fed would be problematic, as it would be in the case of Spain. Know your bank notes!)

This discussion harks back to prior conversations about the meaninglessness of central bank solvency, and the option of central bank debt forgiveness as a way of reducing government debt. The difference is that, instead of forgiveness on a planned and orderly basis, the default method would be a fait accompli, but otherwise similar.

I have undoubtedly made a few technical errors in my analysis, but I doubt that they would change my overall conclusion, which is that  Target2 balances don’t matter in economic, financial or fiscal terms.

However, T2 balances are a valid index of the market's assessment of redenomination risk, as the BIS has pointed out***.

___________________________________________________

*http://www.eurocrisismonitor.com/index.htm

**http://www.cesifo-group.de/de/ifoHome/publications/working-papers/CESifoWP/CESifoWPdetails?wp_id=19094645

***http://www.bis.org/publ/work393.pdf

Is Spain Systemically Important?

I spent my professional career in credit (1978-2007). I must have seen thousands of credits of every description, from Drexel to Mexico to Russia to Enron to Lehman to Greece. Over time, one develops instinctual, or gut, feel. Among the indices of a good credit are: good financial  disclosure; a useful website; a helpful CFO who builds trust and never lies; a CEO who understands credit (rare, outside of Wall Street). In non-anglophone countries: fluency in English and an English-language annual report, which are highly predictive: at least you are both on the same planet. Obviously, there are good credits that don’t meet this criteria (e.g., Norinchukin) and bad credits that do (certain large Swiss banks). But generally, transparency is a useful data point for creditworthiness.

Readers know that I tend to focus on the financial situation of the PIIGs and their financial systems as the source of the next global convulsion. To do this, I must rely on public data, as I am not a client of the NSA. For a highly-developed country such as the US, this not a challenge. The US is a cornucopia of public financial data, right down to the Fed’s weekly balance sheet and the Treasury’s monthly revenue and disbursements. An analyst of the US government and financial system is not handicapped by a lack of data. To a great extent this is also true of the rest of the anglosphere: English-speaking countries are serious about disclosure. After that, you fall off the Continental Shelf.

The ROW (or rest of world) views economic and financial data as national security secrets or, alternatively, window dressing (the national honor depends on it). There are three problems with ROW data: availability, usefulness, timeliness and reliability. There is a very distinct hierarchy in this regard, and to a great extent, I believe that it is credit related.

Let’s take the PIIGS. I know for a fact that Draghi is very concerned about the financial data emanating from the PIIGS. How do I know? Because he said so. The PIIGS generally rank low on the transparency scale (aside from anglophone Eire, which is a serious country). Greece has prosecuted state statisticians for telling the truth; no joke. Greek statistics fall into the category of Soviet data. They have zero information content, like those of Uzbekistan or North Korea. We can live with that because we know that Greece is a failed state, whose most recent president was a member of the Communist Party. (You have to love facts.)

We probably don’t need to care too much about the quality of Portuguese statistics; Portugal is not a “systemically important country”. When they go under, no one will notice. But Spain is a completely different story. Spain is systemically important, so the quality, availability, timeliness and reliability of its statistics are relevant to global financial stability, whether we like it or not.

I think that Spain is a systemically important  credit. I think we all agree about this, although I would challenge any of you to put a number on that datum. What is the size of Spain’s total (general) government debt and that of its banks? Good luck finding that data on an official website. I always begin with FRED, compiled by the St. Louis Fed, which is an enormous boon to economists everywhere. FRED is the Vatican of economic data, and those who toil there are heros.

Go to FRED and look up Spain. Try to find the size of government debt and of the liabilities of the Spanish banking system. Then go to the Banco de Espana, the ECB and Eurostat. Then appreciate my frustration. Spain is the biggest bad credit in the world, and its statistics are state secrets. In desperation, I turn to Moody’s, which has proprietary data and estimates available only to subscribers (somebody has to pay for this). It won’t open: the story of my life.

The Banco de Espana website offers me data on the liabilities of Spanish banks--right up to September 2008. What a curious date! The number then was 4.5T, if I read it right. The European Banking Federation gives the current number of 3.6T. So we know we are in the ballpark. My recollection  is that general Spanish government debt (center plus regions) is around 1T, which would give us a credit between 4-6T, which is systemically important: ten times the size of Lehman.  Is Mariano Rajoy the next Dick Fuld?

It is only a matter of time until this ~5T edifice is downgraded to junk by the rating agencies. Will that force European banks to mark Spanish debt to market, or to assign impairment reserves? Will that affect ECB collateral standards? Will that affect global concentration limits for Spain and its banks? Yes, yes and yes, unless Mickey Mouse is able to seize control of the global financial system.

We have been here before. Remember those fabulous credits called “Latin America”? Well, now we have shifted to “Latin Europe”. The difference is that the global financial system was able to absorb the Latin defaults between 1982 and 1992. It is not clear that there is sufficient profitability in the European banking system to write-off Spain. Especially in Spain.

Spain Is The Next Lehman

“Where’s the next Lehman?”

--lead article in this week’s Economist

“We still view the Spanish banking system as weak given the ongoing deterioration in asset quality, and further capital injections will probably be required. It is also becoming more likely that any future capital injections would be achieved by bailing in bank creditors - particularly junior creditors - before resorting to the ESM support package.”

--Moody’s credit opinion for Spain

My answer to the Economist’s question is: Spain is the next Lehman. The ECB’s upcoming Asset Quality Review (this winter) will reveal a number of insolvent banks that will require recapitalization. Moody's already rates seven Spanish banks below investment grade . Now financing the recapitalizations shouldn’t pose a problem, because Spain still has a 50B euro credit line from the ESM. The ESM gives Spain the money, and they use it to recap the bad banks. Problem solved.

The problem would be solved were it not for the eurozone’s new “No Bailout Principle”, which requires “bailing in” creditors prior to the disbursement of ESM funds. In other words, banks must default before they can be recapitalized. The patient must die before he can be treated. Query: Once a bank has defaulted, why bother to resuscitate it? The damage is done, and the bank is taking up space.

It is conceivable that a bail-in of Spanish banks could be conducted in such a way that depositors, counterparties and interbank lenders would be protected. If so, it would be very helpful if the Troika could make such an announcement now, rather than waiting for the inevitable funding crisis this winter.

If no such reassurances are given, rational actors will further reduce their exposure to weak Spanish banks (correction: all Spanish banks). Presumably this funding could be replaced with funds from the ECB, but that is not a path to viability.

I would add that the Spanish government’s rating is teetering on the brink of junk status. It is now rated Baa3/Negative Outlook. Moody’s observes: “We would consider downgrading Spain in the event of an inability to implement the fiscal and structural reforms that are aimed at stabilising its debt burden, and/or in the event of a loss of access to private markets.”

Spain will stabilize its debt burden the same way that Greece and Cyprus did: default.

Is There A Chance For a "European Spring"?

“Mr Tajani said the crisis is compounded by the tight monetary policy of the European Central Bank, which has failed to alleviate a serious credit crunch for small firms. ‘We need a real central bank, like the US Federal Reserve or the Bank of England, willing to promote growth,’ he said, in an unusually blunt criticism of a fellow EU institution.

Guy Verhofstadt, leader of the European liberals, said it is time to broaden the ECB mandate to include growth, warning that the eurozone is at risk of chronic stagnation and a ‘Japanese winter’ unless the central bank goes beyond short-term measures.”

--Ambrose Evans-Pritchard, Daily Telegraph, Sept. 8th, 2013

A little background: Antonio Tajani, the EU commissioner for industry, is an Italian politician close to Berlusconi which in eurospeak makes him a “liberal”. (In Europe, liberal means capitalist.) Guy Verhofstadt, a former prime minister of Belgium, heads the liberal faction in the European Parliament. He is touted as the next president of the European Commission. It sounds like both of them are reflationists.

I wrote previously that, if an uprising ever comes in the eurozone, it would have to come from the left, except for the fact that the European left doesn’t understand monetarism. Maybe I was wrong. Not about the left being ignorant of monetarism, but about the right's embrace of deflation. There are now stirrings of reflationism on the right, which is potentially good news for unemployed and/or starving Europeans. If the right starts openly pushing against austerity and deflation, I have little doubt that the left will jump on the bandwagon. The left has never had its heart in Austrian economics.

The Social Democrats’ problem has been their desire to maintain credibility as a responsible governing party, and to be seen as as willing to make “hard choices” even if it hurts workers. The socialists’ ignorance of monetarism has left socialists such as Francois Hollande with the false choice between austerity and utter collapse. In the US, respected left-wing economists such as Paul Krugman and Joseph Stiglitz can call for fiscal and monetary stimulus with impunity, but there is no such freedom on the left in Europe. In today’s Social Democracy, to advocate inflation is a personality disorder, or crypto-communism. Wealth confiscation, government defaults, bank failures: yes! Reflation: no. Eat your gruel.

It looks like the eventual leadership of the revolution against austerity and deflation will come from the right. Perhaps this is not so surprising, considering that Sarkozy, Berlusconi and Rajoy have criticized the “hard euro” policy in the past, and that the new head of the BofE is a closet inflationist. Hard currency is not a tradition in Latin Europe, nor in Anglo Europe.

The challenge for Europe is whether these murmurs can be forged into an outright revolt, as opposed to banter at the kaffeeklatsch. Europe needs a statesman like William Jennings Bryan who understands economics and can forcefully articulate the need for a revolution before it is too late.

But I think it is already too late or, rather, that the cause is hopeless. Let me explain why:

1. Fear of Germany

Europe has an irrational fear of alienating Germany. Aside from the small matter of 20th century history, the fear emanates from the fear of being “cut off” from the German Treasury. In other words, the fear of not getting bailed out. What is irrational about this fear is that Germany has already decided to cut off the rest of Europe. Weidmann's "No Bail-Out Principle" means no bailouts.

2. The Single Mandate

It will be difficult for the revolutionaries to get control of the ECB as long as its mandate is unchanged. To change the mandate  will require treaty revision, which is next to impossible so long as Germany is in the EU. It is true that, if the  ECB board were to vote to reflate, that could be an end-run around the mandate, but Germany would object.

3. ECB Independence

Even if the reflationists win political control of the EU, that does not change the independence of the central bank. New governments could appoint doves to the ECB board, but that would take years. At present, board members are prohibited from taking direction from their home-country governments. They do not represent their home countries, unless they are German.

While I would like to convince myself that there could be a light at the end of the eurozone tunnel, I really doubt it. It will take a lot more than a few off-hand comments to the Telegraph to make a revolution. It is deeply ironic that the Italian left succeeded in destroying Berlusconi, the only man who could have saved Italy from becoming Greece. And ditto for France, which rejected a right-wing reflationist (Sarkozy) in favor of a left-wing austerian (Hollande).

I'm not going to hold my breath waiting waiting for a European Spring.

The Cyprus Experiment: Part II

Money doesn’t matter. The real economy exists independently of the money supply. An economy can grow in the midst of deflation. The world economy could be conducted using a single penny.

These are interesting, if stupid, hypotheses. But God hasn’t given us laboratories to test them. He has given us no “play economies” where we can turn the dials and see what happens--except Cyprus! God gave us one play economy where human suffering doesn’t matter. We can conduct whatever sadistic experiments we want without consequence, outside of heaven. Cypriots aren’t really people, they are economic pawns, ants.

So, the geniuses in Brussels and Frankfurt decided to perform an experiment on Cyprus: they cut its money supply by 30% to see what would happen. Hoover did that in the early thirties, but not in one day. Even he didn’t have the sang froid to do that. One minute Cyprus has 70B in bank deposits, the next minute it had 50B. Shazam! Cool!

That happened a couple of months ago, so it’s early days. It will take a year to see if Cypriot school children are actually eating out of garbage cans, which would be a coincident indicator of policy failure (or evidence of successful structural reform?).

Because Cyprus is situated between Saturn and Uranus, its economic telemetry is delayed by about six months. The eurozone is balkanized when it comes to the quality, timeliness and reliability of economic statistics. Maybe at some point we will begin to get transmissions about the post-nuclear Cyprus economy.

Well, here’s a hint: it won’t be pretty. The good news is that the Cyprus is the “Israel of the Hellenesphere”, and they are highly resourceful.  Most Cypriots are running at least three businesses in Cyprus, plus a few restaurants and dry cleaners in London. But nobody, no matter how smart,  can thrive in the midst of a massive decline in the money supply. The unemployment rate in Cyprus one year from now will be 20%, which will take a toll on almost everyone.

This experiment will play out the way that pouring gasoline on an ant colony would play out: not too good.