Friday, July 15, 2011

The fate of the euro is in the hands of Germany. Angela Merkel must set course...?

The fate of the euro is in the hands of Germany.

Angela Merkel must set course for full integration or pull out of the common currency.

The Italian parliament’s endorsement of a £40 billion austerity package has temporarily eased the turmoil in the eurozone but will not end it.

Yesterday’s vote in the senate, to be confirmed by the lower house today, marked a truce in the political in-fighting in Rome that had placed the debt reduction strategy in peril.

A successful, if expensive, sale of Italian government bonds also helped steady nerves amid fears that the eurozone contagion was spreading to one of its biggest economies.

Speculation that the European Central Bank stepped in to buy Italy’s debt has not been confirmed, but would be significant if true.

It would suggest that the ECB is finally trying to put together a strategy to contain the crisis. The piecemeal approach it has so far adopted is simply not good enough.

Indeed, further turbulence could well be triggered today when stress tests on European banks are published to reveal how exposed they are to sovereign debt.

As David Cameron said in the Commons on Wednesday: “Eurozone countries have to recognise that they have to do more together and faster; they have to get ahead of the market rather than just respond to the next crisis.”

But how? Restoring fiscal credibility by reducing deficits is essential. Unless the countries that gorged on cheap credit are now prepared to cut back substantially, the bail-out budget will not be enough to cover the worst-case scenarios, in which Italy and Spain would need rescuing.

Economists believe the existing rescue fund might need to be raised to a colossal two trillion euros to end market fears that indebted eurozone countries cannot be supported.

This, of course, goes to the heart of the matter: the refusal of the eurozone, and Germany in particular, to face up to the ramifications of monetary union. The principal architects of the euro – Jacques Delors, Helmut Kohl and Fran├žois Mitterrand – presumably knew what they were doing.

They wanted political union and saw a common currency as a way to achieve it, just as Margaret Thatcher predicted at the Rome summit in 1990 that precipitated her downfall. Twenty years on, Germany, as Europe’s powerhouse economy, is now confronted with the logic of what it agreed to then.

Either it can go for full integration, with EU control over budgets and taxes, allowing for fiscal transfers around the eurozone and thereby removing the sovereign debt uncertainty surrounding the weakest members; or it can pull out of the euro, which is clearly not something it wants to do, since this would wreck the political project; or it can wait for further crises to hit, each one worse than the last.

In the end, this is not really about Greece or Italy or Ireland. It is, as it has always been, about Germany.

As the twin pillars of international monetary system threaten to come tumbling down in unison, gold has reclaimed its ancient status as the anchor of stability. The spot price surged to an all-time high of $1,594 an ounce in London, lifting silver to $39 in its train.

On one side of the Atlantic, the eurozone debt crisis has spread to the countries that may be too big to save - Spain and Italy - though RBS thinks a €3.5 trillion rescue fund would ensure survival of Europe's currency union.

On the other side, the recovery has sputtered out and the printing presses are being oiled again. Brinkmanship between the Congress and the White House over the US debt ceiling has compelled Moody's to warn of a "very small but rising risk" that the world's paramount power may default within two weeks. "The unthinkable is now thinkable," said Ross Norman, director of

Fed chair Ben Bernanke confessed to Congress that growth has failed to gain traction. "Deflationary risks might re-emerge, implying a need for additional policy support," he said.

The bar to QE3 - yet more bond purchases - is even lower than markets had thought. The new intake of hard-money men on the voting committee has not shifted Fed thinking, despite global anger at dollar debasement under QE2.

Fuelling the blaze, the emerging powers of Asia are almost all running uber-loose monetary policies. Most have negative real interest rates that push citizens out of bank accounts and into gold, or property. China is an arch-inflater. Prices are rising at 6.4pc, yet the one-year deposit rate is just 3.5pc. India's central bank is far behind the curve.

"It is very scary: the flight to gold is accelerating at a faster and faster speed," said Peter Hambro, chairman of Britain's biggest pure gold listing Petropavlovsk.

"One of the big US banks texted me today to say that if QE3 actually happens, we could see gold at $5,000 and silver at $1,000. I feel terribly sorry for anybody on fixed incomes tied to a fiat currency because they are not going to be able to buy things with that paper money."

China, Russia, Brazil, India, the Mid-East petro-powers have diversified their $7 trillion reserves into euros over the last decade to limit dollar exposure. As Europe's monetary union itself faces an existential crisis, there is no other safe-haven currency able to absorb the flows. The Swiss franc, Canada's loonie, the Aussie, and Korea's won are too small.

"There is no depth of market in these other currencies, so gold is the obvious play," said Neil Mellor from BNY Mellon. Western central banks (though not the US, Germany, or Italy) sold much of their gold at the depths of the bear market a decade ago. The Bank of England wins the booby prize for selling into the bottom at €254 an ounce on Gordon Brown's orders in 1999. But Russia, China, India, the Gulf states, the Philippines, and Kazakhstan have been buying.

China is coy, revealing purchases with a long delay. It has admitted to doubling its gold reserves to 1,054 tonnes or $54bn. This is just a tiny sliver of its $3.2 trillion reserves. China's Chamber of Commerce said this should be raised eightfold to 8,000 tonnes.

Xia Bin, an adviser to China's central bank, said in June that the country's reserve strategy needs an "urgent" overhaul. Instead of buying paper IOU's from a prostrate West, China should invest in strategic assets and accumulate gold by "buying the dips".

Step by step, the world is edging towards a revived Gold Standard as it becomes clearer that Japan and the West have reached debt saturation. World Bank chief Robert Zoellick said it was time to "consider employing gold as an international reference point." The Swiss parliament is to hold hearings on a parallel "Gold Franc". Utah has recognised gold as legal tender for tax payments.

A new Gold Standard would probably be based on a variant of the 'Bancor' proposed by Keynes in the late 1940s. This was a basket of 30 commodities intended to be less deflationary than pure gold, which had compounded in the Great Depression. The idea was revived by China's central bank chief Zhou Xiaochuan two years ago as a way of curbing the "credit-based" excess.

Mr Bernanke himself was grilled by Congress this week on the role of gold. Why do people by gold? "As protection against of what we call tail risks: really, really bad outcomes," he replied.


A €3.5 trillion rescue fund to ensure the survival of Europe's currency union .... yeah right .... I have trouble seeing countries like Germany willing to sacrifice even more in order to give a break to the dead-beats in Greece and elsewhere. In the end ... maintaining all of debt is not sustainable .... hence everyone is now looking for safe havens and gold (for the moment) is providing it.

This is the part where the ratings agencies start destroying the economy.

Debt ceiling: financial world warns Washington to hurry up.

The Ideological Crisis of Western Capitalism....

NEW YORK – Just a few years ago, a powerful ideology – the belief in free and unfettered markets – brought the world to the brink of ruin. Even in its hey-day, from the early 1980’s until 2007, American-style deregulated capitalism brought greater material well-being only to the very richest in the richest country of the world. Indeed, over the course of this ideology’s 30-year ascendance, most Americans saw their incomes decline or stagnate year after year.

Moreover, output growth in the United States was not economically sustainable. With so much of US national income going to so few, growth could continue only through consumption financed by a mounting pile of debt.

I was among those who hoped that, somehow, the financial crisis would teach Americans (and others) a lesson about the need for greater equality, stronger regulation, and a better balance between the market and government. Alas, that has not been the case. On the contrary, a resurgence of right-wing economics, driven, as always, by ideology and special interests, once again threatens the global economy – or at least the economies of Europe and America, where these ideas continue to flourish.

In the US, this right-wing resurgence, whose adherents evidently seek to repeal the basic laws of math and economics, is threatening to force a default on the national debt. If Congress mandates expenditures that exceed revenues, there will be a deficit, and that deficit has to be financed. Rather than carefully balancing the benefits of each government expenditure program with the costs of raising taxes to finance those benefits, the right seeks to use a sledgehammer – not allowing the national debt to increase forces expenditures to be limited to taxes.

This leaves open the question of which expenditures get priority – and if expenditures to pay interest on the national debt do not, a default is inevitable. Moreover, to cut back expenditures now, in the midst of an ongoing crisis brought on by free-market ideology, would inevitably simply prolong the downturn.

A decade ago, in the midst of an economic boom, the US faced a surplus so large that it threatened to eliminate the national debt. Unaffordable tax cuts and wars, a major recession, and soaring health-care costs – fueled in part by the commitment of George W. Bush’s administration to giving drug companies free rein in setting prices, even with government money at stake – quickly transformed a huge surplus into record peacetime deficits.

The remedies to the US deficit follow immediately from this diagnosis: put America back to work by stimulating the economy; end the mindless wars; rein in military and drug costs; and raise taxes, at least on the very rich. But the right will have none of this, and instead is pushing for even more tax cuts for corporations and the wealthy, together with expenditure cuts in investments and social protection that put the future of the US economy in peril and that shred what remains of the social contract. Meanwhile, the US financial sector has been lobbying hard to free itself of regulations, so that it can return to its previous, disastrously carefree, ways.

But matters are little better in Europe. As Greece and others face crises, the medicine du jour is simply timeworn austerity packages and privatization, which will merely leave the countries that embrace them poorer and more vulnerable. This medicine failed in East Asia, Latin America, and elsewhere, and it will fail in Europe this time around, too. Indeed, it has already failed in Ireland, Latvia, and Greece.

There is an alternative: an economic-growth strategy supported by the European Union and the International Monetary Fund. Growth would restore confidence that Greece could repay its debts, causing interest rates to fall and leaving more fiscal room for further growth-enhancing investments. Growth itself increases tax revenues and reduces the need for social expenditures, such as unemployment benefits. And the confidence that this engenders leads to still further growth.

Regrettably, the financial markets and right-wing economists have gotten the problem exactly backwards: they believe that austerity produces confidence, and that confidence will produce growth. But austerity undermines growth, worsening the government’s fiscal position, or at least yielding less improvement than austerity’s advocates promise. On both counts, confidence is undermined, and a downward spiral is set in motion.

Do we really need another costly experiment with ideas that have failed repeatedly? We shouldn’t, but increasingly it appears that we will have to endure another one nonetheless. A failure of either Europe or the US to return to robust growth would be bad for the global economy. A failure in both would be disastrous – even if the major emerging-market countries have attained self-sustaining growth. Unfortunately, unless wiser heads prevail, that is the way the world is heading.

Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy...

Europe lost in the desert....
By Reuven Brenner

Spending the past few weeks in Europe, my strong impression is that the present crisis will not end up with it becoming more unified by planting the seeds of a European Ministry of Finance, issuing "European" bonds, and coordinating actions with the European Central Bank.

Rather, the European governments will use a variety of short-term bandages and somehow muddle through, for a while. And then, facing an even bigger crisis, the present EU experiment will go up in a puff of smoke. What seems to be utterly missing in Europe at present is any sense of purpose. No politicians in any country are able to convey a vision of a model of a successful and prosperous society.

Paradoxically though, the euro could survive, if eventually anchored in gold, while the now member states of the European Community will each go their own way to find their fiscal solutions. This would not be too surprising as Europe had historically embraced variations of the gold standard, though far from any notion of a "community".

Mark Twain's "History does not repeat itself, but it rhymes" is an aphorism that is constantly in the back of my mind. Unless one finds a point of reference, there are an infinite number of lines along which to extrapolate. So bear with me, because some of the rhymes that lead me to reach the above conclusions are truly from distant pasts.

The first thing that strikes me in Europe is the constant whining and the expectation that the government must find solutions to everything. Never mind that governments' coffers are empty and their access to credit limited. Of course we have plenty of whining on this side of the Atlantic too.

One difference though is that on this side of the pond there is a sense of hope and purpose that is hard to detect in Europe. Google, Apple, Facebook, Yahoo and Amazon, the entrepreneurial drive behind them, the access to capital to grow and execute, finding solutions to tough problems, are symbols of that difference in drive. In France, by contrast, the blah-blah debate is about "de-globalization" and Martine Aubry, the leading socialist party candidate, the architect of the 35-hour work-week.

The "kvetching" about the good, old times when Western employees did not have to compete with hundreds of millions of Asians and Latin Americans, when students could spend years at universities disposing of their time in frivolous and idle ways and adopting just about any opinion and obscure jargon thrown to them by equally sheltered academics, when Keynesian money seemed to be growing on trees, reminded me of nothing more than the Jewish people, who, about to enter the Promised Land, did not stop complaining: "Who will feed us the meat? Remember the fish we ate in Egypt for free, cucumbers, watermelons, leeks, onions and garlic?" (Numbers 11:4, 5).

To a fed-up Moses' surprise, God tells him that the solution would come by choosing 70 men from the elders. I am not suggesting that this would rhyme with Christine Lagarde descending with 70 IMF bureaucrats on poor Europe. Heavens, no. The rhyme is elsewhere.

Moses led the Jews out from Egyptian slavery and presented them with the option of freedom and responsibility. Not an easy task. First, he wandered around for 40 years to get rid of the generation brought up with the "being a slave" mentality. Then he found himself with a new generation who no longer had the slave mentality, but had lost their work ethic having received constant manna from heaven.

Just as with Mao Zedong's uniforms, having this limited menu must have bored them to death too, even if, apparently, manna could have a variety of tastes. To wit: there are no free lunches in this world, even if physically the manna seemed so. Slave mentality was lost, but whining laziness replaced it.

The Western Europeans had it pretty good until 20 years ago. Capital, financial and human, was escaping from the rest of the world to them, the US, and Australia. This allowed even the laziest and less skilled to get paid far more than their efforts and competence were worth because they had increased negotiated powers relative to the skilled and ambitious, who had no other places to move. This situation provided the "manna." And, with communist threats and memories of World War II at their doorstep, the Western Europeans kept some sense of purpose. These are the parallels of memories of slavery.

And then, all this was gone with the winds of history. Greater freedoms came, but to what purpose?

What the 70 men had to achieve was just that: show the new generation that the elusive notion of national freedom will be compatible with individual perspective and achievement. Somehow they managed to do this.

That is how Joshua could then lead the Jews from boring manna to the Promised Land of milk and honey. Note: not oil and gold. And this promise is for good reasons too. Milk and honey are returns on capital. One must groom the hive of bees, the herd of cows, and use one's brains to sustain them in arid lands. In other words, you must be entrepreneurial and you must execute.

The European tribes, given greater freedoms the last 20 years, failed to use their gifts. They had it too easy. Now, in this or the next crisis, they will have to find their own arrangements, relying on their particular culture and institutions. If they are lucky, they will stumble upon leaders who can reinvigorate their soul.

Future weeks' columns will be about finding the far narrower parallels for helping solve monetary and financial affairs.

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