America Makes a Good Start

Even the punditocracy is starting to see the folly of denying the Credit Bubble's losses...

SO AS THE Eurocrisis staggers onward to what surely must be its grand climacteric, one of these fine weekends, the same old hair-of-the-dog quacks have been baying ever louder at the heels of Frau Merkel that she should finally submit and open her – or, rather, her fellow citizens' – chequebook, writes Sean Corrigan of Diapason Commodities at the Cobden Centre.

Berling should place the full faith and credit of Germany at the disposal of its hapless southern neighbours, they urge. But whether it is Eurobonds, ECB debt monetization, or a toleration for higher German inflation levels, it goes without saying that all of these so-called 'solutions' will come at a great cost to the creditor nations in true tall-poppy culling, egalitarian, redistributionist fashion.

What is more dubious is whether they can actually do anything to give a leg up to those who have spent the first decade of the single currency frittering away their shadily-acquired club privileges in an orgy of both state and private-sector indebtedness.

So far, the fatal step has not been taken, despite all the braggadocio of the new incumbent of the Elysée Palace. Indeed, Chancellor Merkel delivered herself of the opinion that it was disingenuous to talk of 'austerity' when all that was really being suggested was that people live henceforth within their means. As for the sharing of fiscal burdens across borders – in truth, a thoroughly undemocratic measure – one of Angela's CDU fellows, Michael Meister tartly called the Latins' bluff by pointing out to M. Hollande that there was nothing preventing him from issuing bonds jointly with his counterpart Signor Monti, if he was convinced that such was the mechanism which would resolve all the Continent's woes.

In this, the Germans have found support from the forthright Austrian Finance Minister Maria Fekter, who dismissed the new-old French approach in a comment to a local newspaper. "Growth financed by debt!" she exclaimed.

"Those are the recipes from the day before yesterday. The arguments that France's new president...is putting forward again are nonsense and got us into this whole mess in the first place!"

As for the creeping inflation ruse, the ever provocative Thilo Sarrazin told the FAZ that it was a sad testament to the morality of the political elite that Wolfgang Schaeuble – the Man Who Would Be King of the Euro Group, at least – could endorse a rate of price depreciation of 3% or more a year at the very moment his own Ministry was raising long-term money from people saving towards their retirement at the rate of 1.5%.

Turning to the idea of the ECB buying all the paper no-one else wants so that member states could continue in their ways of profligacy, Sarrazin went one better even than Helmut Schlesinger in his condemnation. The latter, august gentleman has disparaged the scheme as 'war finance', but our Thilo was characteristically much more blunt, dubbing it nothing less than 'financial pornography'.

However, on the other side of the debate, there have emerged the first signs that it might be better for all concerned to make at last a full acknowledgement of the unpalatable truth that since enormous losses have been made by means of cooking the books, it is nothing more than a cheap palliative to go on falsifying them in order to postpone the realisation of those losses, however hard the penance which might be the result of such a confessional.

It is indeed not hard to find this somewhat amusing – in a grimly ironic sort of way – for the fact is that I and my fellow Austrian economists, for the whole of the past four years, have never ceased to emphasise that the losses had already been irrevocably incurred DURING THE BOOM, and that the proper response amid the Bust was for both debtors and creditors to recognise this as soon as possible, to take their lumps, to roll up their sleeves, and to get on with rebuilding their wealth, aided by the removal of as many microeconomic impediments to growth as possible and absent ANY and ALL macroeconomic fiscal/monetary conjuring tricks, designed as they were merely to camouflage the bitter truth and so perpetuate the illusion that all was not as bad as feared.

The dominant, Keynes-influenced mindset among the Nomenklatura (yes, Mr Krugman, this means you), of course found this to be utterly unpalatable – principally, one suspects, because it did not leave its preening, Davos Man proponents with much of a role in explaining or enacting a grown-up policy of admitting one's mistakes and trying to restore the requisite degree of functionality to markets so that goods, capital, and labour might once more clear and so regain useful employment.

Having seen our no-nonsense approach initially parodied as being crudely 'Austerian' – and having endured the insinuation that we were the new Brünings, all set to usher in the next incarnation of the German Reich by our point-blank refusal to implement instead what are, in fact, palpably Hitlerian (or, at least, Schachtian) economic policies – we see that the truth is at last beginning to percolate slowly through the semi-permeable mental well-springs of the punditocracy.

It may well be, as several astute commentators have argued, that the prevailing political orthodoxy is such that its practitioners have had to exhaust all other courses before beginning to countenance this, the only choice to offer any real hope of relief. But, if we are to limit the cost to no more than the already appalling, post-Lehman reckoning of trillions of wasted Dollars and hundreds of millions of blighted lives and livelihoods, we can at least move from its belated contemplation to its rapid and resolute implementation with as little further delay as possible!

It is therefore time to recognise that both lenders and borrowers have been misled or unlucky or negligent or devious (take your pick) and to move on. Moralizing about this does nether side any good. Lenders from the north – if not fully satisfied by whatever debt:equity swaps and open renegotiation of terms that can be undertaken – must put it down to experience and remember to exact more rigorous conditions when they again extend credit – as they surely will – in the future, just as they should have been doing all these years, had they not been hoodwinked by false EMU optimism and ludicrously low, Bundesbank-sanctioned official interest rates at the launch of the joint currency.

As for the southerners, it is time to realise that scaremongering about the possible consequences of an repudiation and/or an exit by one or more countries is just that: a blatant attempt to suppress debate on the part of those whose blinkered orthodoxy has been progressively worsening the plight of all involved, ever since the Chuck Prince Charleston suddenly ceased its syncopations four – indeed, five – long years ago.

Yes, if the Greeks were to do something – how shall we put it? – a little discontinuous, would it not threaten the whole house of cards? Well, yes, 'contagion' would certainly be a possibility, but why not take this risk and turn it into something positive?

Why not seize the moment to announce a sweeping, Euro-wide solution at one and the same time? Why not launch a swift and transparent process of full debt renegotiation? Execute genuinely rigorous banking (and insurance) stress tests across the board and immediately enact a re-capitalization of all those firms still deemed viable after their portfolios have finally been properly revalued – having been pitiless in barring and shuttering the rest, in wiping out the shareholders and in inflicting their deserved losses on such numbers of unsecured creditors as is thereafter necessary, excepting perhaps only personal and SME liabilities from this act of triage.

Then, manage the new entities via arms-length taxpayer trusts, supervised under the aegis of representatives of the creditor nations who at least get something back this way for both their previous good faith (sadly ill-advised) and their current forbearance – if only in instalments, as the business for the survivors improves and the value of their new equity stakes are realized.

(Incidentally, unlike the sorry example set in the UK and the US, the rescuers should actually vote their shares, and thus exert control over the executive board, thereby limiting all insider pay-outs until the providers of this emergency capital are satisfied they have first received sufficient recompense for their investment.)

Further measures could include the insistence that the PIIGS drastically shrink the scope of their overlarge and ill-run sway in the life of their put-upon citizens by an immediate auction of all public properties and stakeholdings – or perhaps by undertaking a privatisation by means of vouchers issued to existing debt holders as a means of redeeming no less than, say, 50% of all outstanding bonds.

Greece – and whoever else felt it necessary to restore competitiveness at one stroke – could then step temporarily out of the Euro, devalue to some agreed extent, THEN STEP STRAIGHT BACK IN at the new parity, with all remaining debt principal and interest adjusted pro rata. This would best ensure that such nations maintained their discipline and did not fritter away their windfall in a further riot of governmental excess and personal irresponsibility.

Additionally, it would spare them all possible assault by the market and hence remove the danger of a drastic and debilitating overshoot of their depreciation. It would also maintain their access to the single market (perhaps the only compelling argument for an institution which Bernard Connolly used to witheringly describe as the 'New Soviet Union'). There might also be some sort of provision made – by due constitutional-parliamentary accord, not technocratic fiat – that nothing other than the most trifling and accidental of deficits would henceforth be permissible.

A bias to cutting spending, rather than raising taxes to achieve this would be greatly preferable, while such revenues as are deemed absolutely necessary to raise should be focused on consumption, not production or employment, or, worse, on entrepreneurial returns to capital or rewards to thrift.

Simultaneously, all temptation should be resisted to make credit artificially cheap and too-readily available as some sort of 'offset' to this new, more sober regime. As Wilhelm Roepke long ago pointed out, sometimes a region can be so far out of kilter with its peers that it has no choice butto devalue – when, to change the framework of Axel Leijonhufvud's economic corridor argument to make it a political one, the system has wandered so far from equilibrium after years of soft budgets and unproductive borrowing that laissez-faire alone would involve too painfully protracted a process of naturally re-coordinating prices and costs, returns to labour and capital, and relations between debtor and creditor. In that extreme, in order to circumscribe the time spent wandering in the wilderness of dispersed information and you-first logjams, shock therapy may be the only alternative if the people are quickly to regain the Promised Land.

But, as Roepke also insisted, it is vital that no further distortions are then introduced in the form of a renewed credit expansion as a way of 'lessening the pain' while the restorative effects of the devaluation are filtering through the economic organism and a new balance is being found.

Nor would this supposed sweetener do much to compensate the northerners for the loss of their assets and the reduced profitability of their export markets. All a greater supply of money and credit there would achieve would be to compound the current misery of having unrealizable non-monetary claims on the south with the malign consequences of having equally unrealizable monetary claims on goods and services which do not yet exist, i.e., to condemn them to inflation and hence to foredoom them to further losses – and losses of the most inequitable, arbitrary, and socially corrosive kind, at that.

Lest you think this last is a fantasy in a world of straitened finance and anaemic aggregate money growth, be aware that already there are signs of a growing land and property boom, north of the Alps and east of the Rhine. Are we really to continue this weary, Keynesian aggregate-obsessed game of pass-the-parcel by despoiling the last batch of relatively unimpaired balance sheets to be found anywhere in the world, all in the vain attempt to mitigate the losses accruing to the currently ruined set possessed by their neighbours? Have we learned nothing in the headlong career from Asian Contagion/LTCM to Tech Bubble to Housing/CDO bust to Euro Bank/Sovereign collapse? Must we now drag the Germans, the Finns and others down into the mire, or can we cry a resounding 'Genug!' and quit here, short of the final conflagration of values?

If so, then, on that fateful weekend when the present charade finally comes to an end, if it were not just the Greek government, not only the beleaguered Spanish banks which were so cauterized, but all the strugglers everywhere, together in one fell swoop, there could be no bank runs to fear once the markets re-opened. Indeed, with less Euros residing in those accounts after devaluation, money might well be scarce enough to stick there. Further, if the reset Euro parities were sufficiently low – i.e., if the adjustments were seen to be realistic enough – there would be so many ostensible bargains to be had by both those who have already exploited the TARGET2 system to flee the wreck and those northerners currently suffering an embarrassment of liquidity at home that the run might even operate in reverse.

After all, why pay the German government to sell you a bond if you can buy a Portuguese light manufacturing company now likely to enjoy wider operating margins? Why earn less than inflation on your Dutch deposit account if you can acquire a stake in a Spanish bio-medical concern now that the threat to its well-being posed by a desperate state, eager to devour its wealth in order to prolong its own death agonies has been removed as part of our sweeping fiscal jubilee?

Besides, once we insist that all TARGET2 balances (plus or minus) – beyond some small fraction of normal transactional flows (i.e. beyond those consonant with the system acting as a clearinghouse with some residual float, not a backdoor 'firewall') – are henceforth subject to penal rates of interest, northern bankers would have to recycle whatever monies they did receive.

And with their southern counterparties – somewhat reduced in number, no doubt – now boasting pristine, rigorously marked-to-market balance sheets and adequate capital backing, why would they, or anyone else, not wish to do so, in any case?

All we would need then is to remove the appalling regulatory bias in favour of state obligations which exists under the Basel framework, Solvency-II, local pension laws, and the various other positivist intrusions into the free market and – here your author is, Mea Culpa,  guilty of his own act of reverse-interventionism – simultaneously decree that they are no longer eligible as repo collateral, we would thus ensure that any future borrowing is properly funded out of voluntary saving and not either flattered by financial repression or monetized at one remove by the banking system.

If we are to restore prosperity we need to keep the ravening beast of the Versorgungsstaat on a very tight leash, indeed, from now on, and this is just the sort of measure that would help achieve that aim.

Another justification for this imperative is to be found in the need to damp down the current clamour for growth 'initiatives' to take the form of massive, state-sponsored infrastructure projects. Britain's floundering coalition government is supposed to be considering the administration of this fabled panacea, while the more respectable end of Euro-stimulus proposes a similar programme, perhaps involving the agency of the ERBD. Finally, the panicking Chinese regime has just sent out a diktat to its sprawling regions, bidding them rush their wild-eyed and typically corrupted spending and construction plans – for both this year and possibly the next – to Beijing for immediate implementation as a way to counter the implosion of the previous, centrally-ordained bubble of activity which is presently shaking the Party to its core.

Just why is it that everyone assumes that, having got ourselves into a slump by spending oodles of money on what turn out to be largely non-remunerative, highly inflexible, price inflating, budget-busting undertakings, we can mitigate its effects by spending oodles more money on yet further non-remunerative (or doubtfully remunerative) projects, of the kind which no right-thinking entrepreneur would have taken on, absent the irresistibly juicy rents offered him from the deep pockets of his fellow citizens via the agency of the State?

Why do we imagine that this does anything other than to add more debt to the load under which we are already groaning, without any greater prospect of an associated return with which to service or redeem it? Except in the few, rare cases where the infrastructure earns the requisite income from commercial (rather than political) rents, tolls, landing fees, etc., or – more nebulously – except when it enables its users to enjoy its fruits (e.g., faster rail transport, greater port capacity) and so to expand their particular activity to the point they can somehow be construed to be helping defray the cost to the general taxpayer out of their own, specific earnings stream (this is still an exercise in unfairness, of course), is this not just the sort of 'two railways from London to York' that even Keynes derided – for its stultifying effect on future investment as duplicated capacity progressively erodes the returns attainable – as being worse even than a second 'mass for the dead'?

Ye gods! If, despite all our protestations to the contrary, you must follow the cockamamie prescriptions of the Bloomsbury Beelzebub at least do what the man tells you to do – and do not ignore the crushing weight of empirical evidence regarding the folly of plastering the countryside with 'bridges to nowhere' and of erecting enduring monuments to ephemeral political vanity in the form of otiose, one-shot Olympic stadia!

As for China itself, we have expatiated at length on this topic of late, so it only suffices to note that recent reports suggest the Big 4 banks only managed to lend CNY34 billion in the first three weeks of May, implying that the overall total for the month could rival the immediate aftermath of the Lehman bankruptcy for the paucity of new loans extended. Moreover, Japanese trade numbers, Hong Kong export data, Taiwanese industrial production estimates, and the advance PMI activity indicators for China itself all confirm the picture of economies struggling under the weight of their burdens. Relief is not yet to be found on that side of the Pacific.

On the other side of that vast divide, however, we have to point to a tentative ray of cheer, namely, that the US does look as though it is at last beginning its own act of 'rebalancing' – in this case, of course, one which must take the opposite trajectory to that desired in China, viz., away from over-consumption and back to good, old-fashioned production. Although there are fears being expressed that the scheduled raft of fiscal changes at year end will – if not rejigged in the interim as part of some cynical 'bipartisan' deal-making – push the economy over a 'cliff' as Washington crashes down the gearbox in mid-corner.

Here we have to point again to the simple-minded attitude which makes a fetish of the absolute size of the GDP number without paying any heed to its composition. On the tax hike side of the equation we can certainly share some of the anxieties of the commentariat – when the Sheriff of Nottingham becomes more rapacious, it does Much the Miller nothing but harm in the conduct of his affairs, of course. On the side of diminished spending, however, we have to depart from the consensus: this is decidedly a Good Thing.

One might also be cheeky here and point out that the US has, all unnoticed, already undergone $218 billion of 'fiscal tightening' as a climb in Federal revenues of 4.7% year-on-year in the rolling twelve-month total have combined with a 3.1% decline in outlays (this last the fastest retrenchment since the end of the Korean War) to reduce the still yawning budgetary gap by said amount in the past year, having been trimmed a further $112 billion in the year prior to that.

This has all contributed to a substantial improvement  in the ratio between non-government and government GDP, taking it from the quarter-century nadir of $3.74:$1 it registered in mid-2009 to a four-year high of $4.11:$1 which would, in truth be one of the best readings in two whole generations were we to exclude the exceptional expansion from 1993 to 1998, its subsequent three-year plateau, and its gradual relapse after 2001. This latter development marked the decisive juncture – one lying somewhere between the cheapening of Asia as a productive base after the region's deep crisis of the late-1990s, the disillusioned exhaustion of the West after the madness of the TMT Bubble, and the extension of WTO membership to China – which saw a preponderance of investment shift away from a tired Old World lying either side of the Atlantic and into the dynamic emerging one situated on the far side of the Pacific, with all the consequences for real income and capital provision this entailed for each.

However rational its beginnings, this movement became horribly over-extended in the ensuing decade, principally due to the long era of over-easy money imposed by Mssrs. Greenspan, George, and Duisenberg, together with the systematic currency intervention to prop up the Dollar (as well as the more radical one to eliminate the Escudo, the Peseta, the Drachma, et al). This served to bleed the productive heart out of much of the West while fostering the illusion it could get rich by borrowing money to buy imports, to speculate in real estate, and to enjoy lavish welfare entitlements, while employing a swollen hive of expensive public sector drones to oversee this dole. Replicated in part by a similar trend in the infant Eurozone, vis-à-vis Germany and the Olive Belt, much of our current woe finds its origins therein, so any signs that the reaction is setting in, that we are finally beginning to cook more of what we eat, can only be an occasion for cautious optimism.

In more concrete terms, the official stats show that, since Feb 2010's overall employment low, US government payrolls have fallen by 502,000 (a mere 2.2% reduction, but good enough as a start) while those for manufacturing have expanded by 485,000 or 4.2% – a gross shift from grasshoppers to ants of almost 1 million souls. Given that manufacturing jobs are tested not just in the domestic, but increasingly in the world market for their potential to add value – in stark contradistinction to those of the jobsworths, PC-sensitivity commissars, and garbage-snoopers whom Leviathan is wont to hire – it is difficult to avoid the suspicion that this must be good news all round, as is the fact that, however sickly some portray the recovery to be, this is the first three year period in 3 ½ decades when the proportion of manufacturing hours worked in the (rising) count of total private hours has actually grown.

In this – as well as in the creditable rebound in non-structures fixed investment – we see a certain corroboration for the drumbeat of one-off commentary and industry survey responses suggesting that America, Inc, is starting to look to create wealth at home, once more, instead of concentrating on increasing it abroad. No wonder US equities are threatening to break trendlines in their relation to both ROW major market equities and their supposed EM challengers.

Here, however, we must emphasize that if we talk about a possible renaissance of American productive vigour, these are still early days and the results – even assuming nothing acts to stunt this putative regeneration in the meanwhile – will not be seen overnight. New Rome will not be rebuilt in a day. Moreover, we potentially have a few near-term obstacles to overcome in the shape of a supply of money, in an overly stimulus-dependent system, which has refused to grow at all so far this year. The sort of disappointment we should expect over the next few months if this is not rapidly rectified should not blind us to the fact that there may indeed be a faint glimmer of light at the end of this longest and darkest of tunnels.

As for markets themselves, what is there to say? We had always envisaged this quarter as being a difficult one, but the pell-mell entry into Donald Rumsfeld territory – a land of terrifyingly unknown unknowns – in both Europe and China has only made a reversal into something of a rout. 'La Garde recule,' indeed!

All we can add is that while real economy activity remains subdued and monetary trends unsupportive – and with trend lines either breached or creaking ominously under the weight of selling in all manner of risk assets – the main hope for a reversal is simply the fact that everything has been sold so hard, for so long.

Beyond the often dangerous confusion of any such short-covering bounce, however, it is hard to resist the conclusion that we are again reduced to second guessing our political masters and to hoping – despite or better instincts – that one of them will boost the market value of the things we focus on at the wider social cost of further postponing the lancing of the suppurating boil of over-indebtedness and fatally-conceited central planning which is poisoning us all.

The only thing that does seem certain is that the current level of uncertainty can surely not persist indefinitely; that we shall wake up one of these summer Sunday mornings to find a very different world being delivered to us to than the one we left when we stopped trading on the preceding Friday evening.

All we can hope – without overmuch conviction of that hope being realised – is that whatever changes are effected during our routine weekly hiatus might actually do something to speed the patient's recovery, rather than condemning him to a further, vitality-sapping spell in a sick-house full of quack doctors where he has already languished far too long.

In the meanwhile, we must look for somewhere else to shelter other than in that dangerously over-crowded lifeboat which is the 'risk-free' bond market, lest we drown with our peers on the day we all awaken to the capital dangers entailed by its perilously compressed real and nominal yields and its fabulously extended durations and rush, all at once, to quit it.

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