Tag Archives: eu

The EU Needs a Bill Seidman to Save It from Itself: Cyprus and the “Reverse Toaster Theory”

Posted on March 18, 2013 by | 11 Comments

By William K. Black
(Cross posted at Benzinga.com)

Everyone involved in financial regulation in modern times with any broad knowledge of the field will know of Bill Seidman, Chairman of the FDIC and the RTC.  In 1989, the newly elected President Bush (the First) had a very good idea that became the Financial Institution Reform, Recovery and Enforcement Act of 1989 (FIRREA).  FIRREA was one of the very unusual cases of enhancing financial regulation.  It was prompted by the lessons we had learned in containing the Savings and Loan (S&L) Debacle.  The original administration bill, however, had a very bad idea associated with the President’s chief of staff, John H. Sununu.  Sununu is a brilliant guy – who wants you to know how much smarter he is than everybody else.  His wiki biography page informs the reader that: Continue reading →

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EU austerians rely on US stimulus to bail them out of recession

Posted on January 8, 2013 by | 21 Comments

By William K. Black

The New York Times’ web version ran a story this morning (January 8, 2013) entitled “Unemployment Continues to Climb in Euro Zone.”

Eurostat reports that Eurozone unemployment has reached the record rate of 11.7%, with 18.8 million unemployed (an increase of two million in a year).  “[Y]outh unemployment continues to grow, with 5.8 million people under 25 classified as jobless in November, up 420,000 from a year earlier.”  As youth unemployment surges it becomes common for college graduates in the periphery to emigrate.  The article shows that Berlin’s insistence on inflicting austerity on Spain and Greece has forced them into Great Depression levels of unemployment.  Italy’s level of youth unemployment is also at Great Depression levels.   
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The Elephant in the Room is Spain, Not Italy

Posted on February 6, 2012 by | Leave a comment

By Marshall Auerback


Another day andthe markets remain fixated on whether Greece comes to a “voluntary” arrangementwith its creditors.  The key word is“voluntary” because the myth of “voluntary compliance has to be sustained sothat those deadly credit default swaps avoid being triggered. 
But let’s faceit:  Greece is a pimple.  If the rest of the euro zone could cut itlose with a minimum of systemic risk, Athens would have long gone the way ofTroy.  The real issue is whether thecredit default swaps trigger such a huge mess with the counterparties that itcreates renewed systemic stress which more than offsets the benefits to theholders of the CDSs. 
The moreinteresting question is:  suppose Greece finally does get a deal?  Irealize everybody says it is a “one-off”, but do you really think theIrish, Portuguese, or even the Spanish and Italians will go along with that,particularly if (as is likely) they continue to experience double digitunemployment and minimal growth?
Now you could argue thatPortugal and Ireland, like Greece, are but small components of the EuropeanUnion and could well be covered in one form or another via the existingbackstops established over the last several months, notably the EuropeanFinancial Stability Fund (EFSF) and the European Stability Mechanism(ESM). 
But you can’t say this aboutSpain, which remains the real elephant in the room – not Italy – even thoughSpain’s borrowing costs remain lower than Italy’s. This is perverse. 
Though Italy has a highsovereign debt, it has a low private debt (the product of years of high budgetdeficits, but that’s the story for another blog). Italy has a fiscal deficitthat is low relative to most economies today. It already has a primary surplus.The greater than expected past expansion of the ESCB and the current ongoingLTROs are likely to absorb panic and forced selling of Italian debt. TheItalian 10-year yield could fall back below 5% (having already fallen from the 7%plus levels, pertaining a mere 6 weeks ago).

In theory, this rally in bond yields should lead to a reassessment of thegravity of the Italian problem and therefore the European sovereign debt andbanking problem. That could be positive for equity markets and, indeed, hasbeen so since the start of the year. 

But does Spain truly deserve theborrowing advantage it now has in relation to Italy?  Its 10-year bonds are yielding some 60 basispoints lower. True, its sovereign debt to GDP ratio is low at about 75%, but partof its enormous private debt will almost certainly have to be “socialized.”  Moreover, Spain has virtually the highestnon-financial private debt-to-GDP ratio of all the major economies.  Its ratio is almost twice that of Italy’s. Itsfiscal deficit last year was probably higher than the official estimates, closeto 9% of GDP (the previous Socialist government routinely lied about itsfigures – in fact, no country, not even the US, has lied more extensively aboutthe condition of its banks.  Spain, relative to GDP, has the largestshadow real estate inventory in the world, with the possible exception ofChina, which probably doesn’t even have a reliable second or third set ofbooks).

Let’s be clear about onething:  this is not a tale of Mediterranean“profligacy”, as least as far as public spending was concerned.  Anybody looking at Spain through a sensiblefinancial balances framework in the mid-2000s would have observed that theprivate sector was being squeezed badly by the fiscal drag. The externalposition was in deficit (current account) which means the public and externalbalances were draining growth from the economy. Yet it still boomed up into theonset of the crisis. How did that happen?

The profligates were all in theprivate sector, although you could readily argue that the government’s“responsible” fiscal policy created the conditions for a private sector debtbinge.  Prior to 2008, the Spanisheconomy was held out as the darling of Europe however the reality was quitedifferent. The country was running budget surpluses by 2005 and foreigninvestment was booming. Most of this investment went into construction whichwas stimulated by a massive real estate boom.

A few years ago, using data fromData from the Banco de España (central bank) Bill Mitchell graphed the nationalbudget deficit as a percentage of GDP for Spain and the EMU overall from 1989to 2008 (data for the EMU clearly didn’t start until 1995). As Mitchell notes,one can observe the tightening of fiscal positions as the Growth and StabilityPact provisions were forced on the EMU nations:


EMU and Spain: Budget deficit % of GDP,1989 to 2008

Consistent with a tighteningfiscal position leading to surpluses in 2005, the only way that this boom couldcontinue was for the private sector to go increasingly into debt.That is exactly what happened and because the property boom was so large thedebt levels were also very high – average household debt tripled. And that, incontrast to Italy, is the core problem with which Spain is dealing today to asubstantially greater degree than Italy. So it’s wrong to lump the two together interchangeably as the marketshave been doing.  Paella and pasta don’tmix well together.

Okay, but that was the previousZapatero Administration.  Now we supposedly have a new “responsible” conservativegovernment that promises to carry out the same policies even moreresolutely.  And look how successfulthey’ve been:  Spain’s joblessclaims shot up a further 4% in January from December to 4.59 million, a signthat the euro zone’s fourth-largest economy is still shedding jobs at a recordrate. All sectors posted more claims but the rise was sharpest for services at5.1%. In construction, weighed down by a four-year property slump, the numberof residents registered as job seekers rose 2.1%. Compared with the same perioda year ago, overall claims rose 8%.  GDPcontracted 0.3%.  

Okay,“give them time”, argue the defenders of the new government.  And, if the Rajoy Administration was trulyembarking on a new policy course, that would be a fair comment.  Unfortunately, this government has signed onto even tighter fiscal policy rules. Somehowthey are expected to suck demand out of their economies through tax increasesand spending cuts, but when the slower growth that results in means the targetfor deficit reduction is not met, the Spanish, like their Greek, Irish,Portuguese and Italian counterparts, will be punished for it.

Eventhe Rajoy Administration implicitly appears to recognize this danger, as it isalready moving the goalposts in regard to its spending cuts targets as apercentage of GDP.  Unfortunately, theyblame this on external circumstances beyond their control. To the extent thatthey agree to submit themselves to rules which were routinely disobeyed by theGermans and French during the EMU’s inception, that is true, although theSpanish government refuses to acknowledge that their resolute tightening fiscalpolicy ex ante might well have something to do with the fact that Spain’seconomy continues to deflate into the ground ex post.  Remember, thehistory of the Stability and Growth Pact has long demonstrated that thesenonsensical rules are already impossible to keep within during a significantdownturn. And now the new Spanish government wants to tighten them even furtherand invoke pro-cyclical fiscal reactions earlier.
This, at a time when the nationalunemployment rate is approaching 23%, and the youth unemployment rate (25 yearsor younger) is at 49%, according to the latest Eurostat data.

Sonearly 50 per cent of willing workers under the age of 25 in Spain are withoutwork and will remain like that for years to come. That will damage productivitygrowth for the next decade or more. It is an indication that the monetarysystem has failed and attempting to reinforce those failures with moreausterity will only make matters worse.  The new government’s proposed fiscal policy “reforms” areparticularly toxic policy mixture for Spain.

Of course, the ongoing threat ofa disorderly default in Greece also remains a potentially dangerous areaif it is not contained by the ECB’s actions. But it’s more interesting to see what happens as the magnitude ofSpain’s problems become more apparent.  Will the troika tell Spain that a Greek style70% haircut is not in the cards?  Willthey try to suggest that the government is rife with corruption, that thecountry is chock-a-block full of scoff-laws and tax evaders, and that theefficient Germans would do a much better job of collecting taxes?

Spain is still a relatively youngdemocracy.  The transition began a mere37 years ago when Francisco Franco died in 1975, but there was an attemptedcoup by Antonio Tejero as recently as 1981. This is worth pondering whilst observing the implosion of Spain’seconomy. The decision for Europe’s bosses is this: they must ultimately confront theconsequences of their policy choices. They can destroy the eurozone by continuing with the same failed mix ofpolicies or by salvaging it by adding what has been missing from the outset: amechanism for shifting surpluses to the deficit regions in the form ofproductive investments(as opposed to handouts or loans). Turning stateslike Spain into sundrenched economic wastelands within the eurozone, andforcing the rest of the currency area into a debt-deflationary spiral, is amost efficient way of blowing up the whole system and possibly threatening thevery existence of Spanish liberal democracy itself.

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Germany puts the EU through the Wood Chipper – and Theocrats Cheer

Posted on November 21, 2011 by | Leave a comment

By William K. Black


Those of you who have seen the film Fargo have the wood chipper scene indelibly seared into yourmemory.  (If you have not seen Fargo please remedy this deficiencypromptly.)  I return to the scene at theend of this piece. 

Walter Russell Mead, a recovering liberal, has crafted acrude ode to purported German national character and insult to purported Frenchnational character.  The defectivepurported national character of the French is leavened with equally crudestereotypes of the purported superior religious character of Huguenots andJews.  It is all set within a broader,cruder attack on purported ethnic “Latin” character.  Mead’s piece ran in opinion pages of the Wall Street Journal, which embracesthese prejudices and considers them the height of intellect.  

Mead’s cultural thesis is that Germans are good.  They exemplify superior “northern”values.  The French are a “Club Med”people with minimal northern features. The northern features are attributable to France’s Huguenots and Jews “out of which communities many of its mostsuccessful business leaders have come.” France’s business leaders aresuccessful because they are not Catholics. But wait, Mead has forgotten that two paragraphs earlier he dissed theseFrench business leaders: “Worse, the French corporate elite decided in itssleek official way that this was the right time to go long on Italy, buyingbanks, companies, stocks and bonds ….”  So, the French Huguenots and the Jews, who exemplify “northern” valuesare actually the problem?  Mead cannot gotwo sentences without launching a snide stereotype at the French.  He can’t pass up the chance even when itcontradicts his analytics.  Mead knowsthat there are few easier ways to make the WSJ’sopinion pages than bashing the French.      

The virtuous Germans are beset with “bad news from Spain and Portugal, wheredespite the most-solemn promises to undertake the most-sweeping reforms, andthe blessings of Brussels, the economies are somehow failing to grow.  Add disappointing news on Italian bond yields,and Europe has resumed its grim slide.” “Somehow?”  Understanding whySpain and Portugal are “failing to grow” is hardly a mystery.  The ECB and IMF (paragons of northern values)have forced austerity and “labor reforms” designed to make it far easier tofire workers on Spain and Portugal.  Thegoal of the “reforms” is to drive down their working class’ wages.  The ECB and IMF are demanding similar actionsin Greece and Ireland and the Irish government’s plan for responding to thecrisis is to cut working class wages to make Ireland more competitive withPortugal.  At UMKC, we call this race tothe bottom dynamic the “Road to Bangladesh” strategy.  Reducing wages and public spending during aserious recession are pro-cyclical policies that make the recession moresevere.  Private sector demand isseverely deficient in nations suffering from the Great Recession.  Reducing wages reduces income, which furtherreduces private sector demand.  Reducingpublic sector spending makes total demand even more inadequate and increasesunemployment (further reducing private sector demand).  Modern nations have known for roughly 70years that fiscal policies should be structured so that they function as“automatic stabilizers.”  Austerity andaggressive efforts to cut wages function as self-inflicted destabilizers.  These “northern” policies are soself-destructive that only economists who are total ideologues fail to opposethem.    

But return to Mead’s ode to German values, and examine thecontent of those values and Mead’s multiple fictions about the causes of theeuro crisis.  Mead claims the Frenchcrisis was caused by:

Clueless European regulators … pushed many banks toinvest in soon-to-be-worthless sovereign debt from soft euro countries likeSpain, Italy and Greece.  So French banksin particular are loaded to the gunwales with bonds that won’t float.
Worse, the French corporate elite decided in its sleek official way thatthis was the right time to go long on Italy, buying banks, companies, stocksand bonds….

I have already discussed one of the logical inconsistenciesin Mead’s argument that arises from the juxtaposition of this passage and hisode to France’s “most successful business leaders” (because they aredisproportionately Huguenots and Jews). The second logical inconsistency arises from two consecutivesentences.  French banks are “loaded tothe gunwales” with underwater bonds from “Italy” because French regulators“pushed many banks to invest in” Italian bonds. The French bankers were the unwilling victims of this regulatory“push[ing].”  In the next sentence,however, Mead tells us that “the French corporate elite decided that this wasthe right time to go long on Italy, buying … bonds….”  Are French bankers not part of “the Frenchcorporate elite?  How exactly didFrance’s regulators (who had the most “northern” of anti-regulatory values) (a)decide to actually start regulating by pushing French banks to purchase Italy’sbonds, (b) how exactly did they “push” French banks to buy Italy’s bonds, and(c) and why, if they thought it was unwise, did French banks accede to such a“push?”  Mead made it up.  The officers that control French banks maketheir own bad investment decisions for the same reason other banks make badinvestments – the officers love what the extra (nominal) yield does to theirincome in the near term.    

Assume forpurposes of discussion that Mead is correct about the condition of Frenchbanks: “The French bottom line is that Germany must help raise the carcass ofthe French banking system from the dead.” If that is true, then France’s banking regulators retain their“northern” anti-regulatory ideologies for they are failing to act against thefailed banks.  It also means that the eurois dead and that France and the EU desperately need aggressive monetary andfiscal policies.  I’m quite willing tobelieve that French banks are “carcass[es],” but what about German banks?  German banks took the lead in making most ofthe foreign bank loans to the EU periphery (I call it “German banks gonewild”).  It is Germany that is demandinga ten year phase-in to the increased bank capital requirements proposed inBasel III because it believes its banks are so grossly deficient in capitalthat it will take a decade of subsidies, bailouts, and accounting gimmicks tobring them into nominal compliance with the new rules.  German banks are among the largestbeneficiaries of the Irish and Greek “bailouts.”  It was “northern” banks’ values that drove theglobal financial crisis.  Banks with“northern” values (U.S., German, Irish, and Icelandic) were the mostnotoriously fraudulent and imprudent lenders in the Western world.  What all these failed banking systems mean isthat there is an urgent need to remove the (“northern”) theoclassical policiesthat create the criminogenic environments that produce our recurrent,intensifying financial crises. “Northern” values and policies are the problem, not the solution in financein the U.S. and the EU.  

Mead ignoresGermany’s banking crisis, but he is also blind to the fact that it is Germany’spolicies that have turned an EU financial crisis into a combined economic andpolitical crisis that has exposed the sham of European unity and revealed theeuro and ECB’s fatal design flaws. Indeed, Mead celebrates those design flaws and Germany’s perverse EUpolicies that are spreading ruin throughout much of Europe.   

[T]he Germans are supposed to capitulate, authorize theEuropean Central Bank (ECB) either directly or indirectly to print masses ofmoney, and the proceeds will go to save the French banking system and nationalelite—without anything so humiliating as a bailout ever being mentioned.

Mead accurately reflects the manner in which Prime MinisterMerkel frames the policy choices.  WhatMead fails to consider is that the Germans could be wrong.  Germany controlled the design of the euro,the ECB, and the Stability and Growth Pact. Germany insisted that the ECB have no mission to ensure full employmentand no lender of last resort function. Germany insisted that the Stability and Growth Pact be designed as adouble oxymoron that produces instability and destroys growth when there is asevere recession.  It is Germany that hasdemanded that the ECB follow a generally restrictive monetary policy. 

Because Germany insisted on defective designs ofinstitutions related to the euro, the EU periphery nations have been left withno effective means of escaping the Great Recession.  They cannot devalue their currency or adoptappropriately expansionary fiscal and monetary policies.  They are left with one option, a hydra-headedmonster – slash social services, slash working class wages, and suffer severeunemployment.  The “national elite” ofthe periphery are not the issue in this context.  German policies devastate EU working classcitizens.  The “national elite” of Greeceand Italy still largely evade their taxes and have exceptional wealth despitethe EU bailout “reforms.”  Merkel has nottaken any effective steps against any foreign or domestic “national elite” andhas never made doing so a priority. Germany’s austerity demands are aimed at the “Latin” working class andpoor and they are the victims of the German demands. 

The ECB could save the euro and produce the expansionarypolicies that would help, instead of hinder, EU recovery from the GreatRecession.  (This would also aid the U.S.recovery.)  Mead, however, heaps scornon this (supposedly) Gallic idea.  Ofcourse, Trichet was head of the ECB when it implemented its destructivepolicies that Merkel so strongly supported. Trichet is French and he is as theoclassical as any economist (Trichetis not an economist).  He is infamous forclaiming the ECB performed brilliantly by maintaining price stability – whichwe can all agree is a Herculean task during a Great Recession.  The fact that the EU has gone to financialhell on his watch must be ignored because his only mission was to preventinflation.  Except that his real missionwas to warn the EU that it had an urgent need to expand the ECB’s mission andchange the EU’s anti-stability and anti-growth pact.

Mead channels Merkel’s phobias that prevent thechanges in the ECB’s missions and policies and the stability and growth pactthat are essential to save the euro, end the crisis, and assist the EU toachieve a strong, broad financial recovery. The specter is hyper-inflation. The EU should be so lucky as to have modest inflation.  Creating over 20 percent unemployment inSpain to prevent the non-existent risk of hyper-inflation in the EU is aninsane policy.  It is alsoself-defeating.  The high unemploymentreduces governmental income and increases the deficit, which leads to ratingdowngrades, which raises the interest rate on sovereign debt, which increasesthe budget deficit.  Merkel thinks thatpolicies that are certain to drive this destructive cycle makes sense.  Thinking that insanity is sane is one of thesymptoms of insanity. 

Mead embraces Merkel’s policy delusions and addsthis conspiracy theory:  “France wants to stick the Germans witha Latin currency and Latin rules for running it.”  In context, Mead appears to be saying thatthe French believe the euro is overvalued relative to trade competitors such asChina, Japan, and the United States. This makes it more difficult for EU nations to export, which canincrease unemployment throughout the EU. Mead appears to believe that a highly valued currency is virtuous.  It is unclear whether he believes that China,Japan, Switzerland, Brazil, and the United States (each nation has intervenedto drive down the value of its currency) are “Latin” nations or why he thinks“Latin currency” is deplorable.  It giveshim no pause that every major currency in the world, except the euro, is“Latin” under his rather bizarre dichotomy.
Mead describes the German policy for dealing with the crisis that iscausing immense human misery throughout the EU:

Germany, on the other hand, wants the Latin countries tolive by northern rules: Keep the currency sound, the budgets balanced and letthe chips fall where they may. There is zero, repeat, zero consensus in Germanyto go Latin and give the euro into the hands of slick French and Italianpoliticians. Technocrats bound by rules, the Germans can accept: That is why anItalian technocrat is following a Frenchman at the head of the ECB. But that isalso why the Germans are being such sticklers about ECB rules against bailoutsand unlimited ECB purchases of sovereign bonds.

Non-Germans can run the ECB as long as they are theoclassical economicsdevotees who have no power to take any of the actions essential to respondeffectively to the crisis because they are bound by German rules.  Mead calls these people “technocrats,” whichis how most media refer to them, but it is vital to understand that the term isa misnomer.  Trichet, Draghi, and the newleaders of Greece and Italy are theoclassical devotees.  They are the opposite of real technocrats.  They are intensely ideological and ignore theconsistent failures their policies cause. Merkel supports only the most fervent neoclassical ideologues.   

Mead makes no bones about his view that “northern rules” are the onlydesirable rules and that Germany is correct to insist on three policies: a“sound” currency, a “balanced” budget, and “let the chips fall where theymay.”  I have already explained why thefirst phrase is misleading rhetoric. Mead cannot seriously be claiming that Switzerland, China, Brazil,Japan, and the U.S. lack a “sound” currency because they have sought to expandexports by reducing the price of their currency relative to the EU.  Mead’s rhetoric is empty.  Germany’s insistence on keeping the eurooverpriced relative to other currencies harms the EU’s recovery from the GreatRecession.  Currency exchange rates are apractical issue of trade and employment policy, not a moral issue. 

Similarly, I have explained why insisting on a “balanced” budget, i.e., adeliberately pro-cyclical policy that makes it far harder to recover from aGreat Recession harms the EU and the U.S. Mead again relies on empty rhetoric. He seems to think that a “balanced” national budget self-evidentlyrepresents superior morality.  Nationalbudgets, however, are pragmatic, not moral, issues.  Nations like Ireland, Iceland, and Spain ranbudget surpluses during the run up to their crises.  Anyone with even a passing understanding ofU.S. history will find that our episodic efforts to dramatically reduce federalbudget deficits have repeatedly ended in depressions.  The United States became the reserve currencyfor the world not despite running budget deficits for the vast majority of ourexistence, but because we ran deficits.     

I end on the lead I’ve deliberately buried.  Germany’s policy is to cause exceptionallyhigh levels of unemployment, slash public services, and slash working classwages in the periphery nations.  None ofthis is necessary or desirable. (Merkel’s mantra is TINA: There is No Alternative, but there are farbetter alternatives if one escapes the theoclassical prison.)  Germany’s policies cause extraordinary humansuffering in many EU nations.  Mead captures Merkel’s response to that suffering: “let the chips fall where they may.” Like Mead, Merkel cannot be bothered to offer even a formulaicexpression of sympathy for the plight of the “Latins.” Mead’s metaphor isaccurate.  Germany’s policies are puttingmuch of the EU through a wood chipper, but people are not wood chips.  The idea that their suffering should betossed off with the line “let the chips fall where they may” indicates theinhumanity that is one of the hallmarks of theoclassical economics.  If this callousness represents “northern”“culture” then it is high time for “Latin” culture to save the EU in generaland Germany in particular from the kind of depraved kultur that runs people through a wood chipper and ignores or evenmocks their suffering.         

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