The European Central Bank taking Steps to make the Eurozone Crisis Worse

Posted by PITHOCRATES - September 22nd, 2012

Week in Review

To increase the money supply central banks can do a few different things.  To stimulate economic activity.  They can lower reserve requirements to stimulate money creation via fractional reserve banking.  They can print money.  And they can buy bonds with money they create that they inject into the economy with their bond purchases.  These actions will put more money into the economy.  In hopes people will use it to generate economic activity.  Of course there is a tradeoff.  Increasing the money supply can also create inflation.  And often does.  Unless the economy is so far into the toilet that no one spends any money even with all of this new money in the economy (see ECB in ‘panic’, say former chief economist Juergen Stark posted 9/22/2002 on The Telegraph).

“The break came in 2010. Until then everything went well,” Juergen Stark, the German who resigned from the ECB in late 2011 after criticising its earlier round of buying up of sovereign debt, told Austrian daily Die Presse in an interview.

“Then the ECB began to take on a new role, to fall into panic. It gave in to outside pressure … pressure from outside Europe.”

Mr Stark said the ECB’s new plan to buy up unlimited amounts of eurozone states’ bonds, announced on September 6, on the secondary market to bring down their borrowing rates was misguided.

“Together with other central banks, the ECB is flooding the market, posing the question not only about how the ECB will get its money back, but also how the excess liquidity created can be absorbed globally,” Mr Stark said.

“It can’t be solved by pressing a button. If the global economy stabilises, the potential for inflation has grown enormously.”

The European Central Bank (ECB) wasn’t trying to stimulate economic activity with these bond purchases.  What they were trying to do was throw a lifeline to those nations in the Eurozone about to go belly up because no one will buy their bonds.  Because the chances of them ever repaying their enormous debts are slim to none.  Because of this these indebted countries have to offer very high interest rates to entice anyone to take a chance buying their risky bonds.  These high interest rates, though, were hurting these countries.  Increasing their financial woes.  And pushing them ever closer to bankruptcy.  So the ECB caved.  And bought their worthless bonds.  By doing something only a central bank can do.  Create money out of thin air.

These additional Euros thrown into the money supply could very well end up depreciating the Euro.  And sparking off inflation.  Which monetary expansion ultimately does.  Unless an economy is so far into the toilet that no one will spend this additional money.  And it just sits in the bank.  But if the economy does turn around there will be a lot more money available to borrow.  At exceptionally low interest rates.  So low that some will borrow it because of those low interest rates.  Which could spark off inflation.  Helping the Eurozone to settle back into recession.

This is not going to help anyone in the Eurozone.  Especially those staring down bankruptcy.  Because this won’t cut spending.  This won’t reduce any deficits.  And this won’t lower any debt.  All of the old problems that caused their problems will still be there.  Along with a new problem.  Inflation.  Guaranteeing that things will get worse in the Eurozone before they get better.

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China has no Pension or Health Care Benefits for their Rapidly Aging Population unlike in the West

Posted by PITHOCRATES - September 22nd, 2012

Week in Review

The Chinese economy is cooling off.  Worse, they have some even more bad news in their future (see Ageing China: Changes and challenges by Damian Grammaticas posted 9/20/2012 on BBC News China).

Life expectancy in China today rivals that in the West – it is one of this country’s impressive advances. Except China has not yet built a social safety net to provide pensions, affordable healthcare or homes for all its elderly.

Yet another reason why the Chinese economy is outpacing those in the West.  While Europe and the United States have suffered from the effects of an aging population China hasn’t.  At least, not yet.  While those in the West keep raising taxes and selling sovereign debt to pay for pensions and health care for the elderly and retired China has been growing their economy and using its proceeds to buy the sovereign debt of those Western nations.

So what is it like living in a nation without a social safety net?

“We don’t get a government pension because I never paid taxes. We don’t have any savings,” he says.

Because he has children and a wife, he does not qualify for a place in a care home – only those without relatives are eligible.

Of Henan’s 8.5 million elderly, just 2% are cared for in nursing homes. So Niu Yubiao and his wife fend for themselves.

The couple have seven grown-up children. But like other young people in the area, they have left home to look for work. Niu Yubiao has no idea where they are.

The reason why they don’t have any savings is not because they are greedy and materialistic.  It’s because they live in abject poverty.  And barely earn enough to survive.  This is what it’s like in China once you leave the modern cities on the coast.  The economic miracle of China has not reached the impoverished masses in their interior.

Today, there are 180 million Chinese aged over 60, just over 13% of the population. That will double to 360 million in fewer than 20 years, when China will have more retirees than the entire population of the US.

By the middle of the century, their ranks will soar again to 480 million.

China is ageing so fast that a process that took up to a century in the West will happen in the coming 30 years here. And as the ranks of the elderly swells, the working-age population is starting to shrink…

China’s incredible economic growth has been built on its vast, cheap labour supply. But the numbers entering the workforce have started falling. China’s birthrate has collapsed – at its peak in the mid-1980s 25 million babies were born every year. Now there are about 15 million births a year. The dramatic drop is the result of a richer, developing society and of the one-child policy…

Currently, China funds only meagre pensions, and there are six workers paying taxes for each retiree – in 20 years’ time, there will be just two workers for every pensioner.

This is the current problem in the advanced economies in the West.  A declining population growth rate following the post-World War II baby boom is bankrupting their nations.  For those social safety net programs the Chinese don’t have were implemented in these Western countries before the baby boom turned into a baby bust.  Now the elderly generations in these nations grow faster than the younger generations.  More seniors are retiring and consuming government-provided pensions and health care while fewer are entering the workforce to replace them and pay the taxes to fund these programs.  So they have increasing government expenditures at a time of declining government revenue.  Thanks to a lower population growth rate.  Which has overwhelmed governments.  Causing greater budget deficits and soaring levels of debt.

As bad as things are in the Western countries what’s waiting for China is of such a massive scale that one shudders to think what will happen.  For even if China continues to enjoy high economic growth their aging population will bankrupt them.  Either by caring for the elderly.  Or by driving up labor costs and/or labor unrest as their baby bust fails to replace those leaving the workforce.  Bringing that economic juggernaut to a crashing halt.

But the scenario is even bleaker.   For they have driven much of their economy with artificial economic growth.  Fueled by Keynesian policies.  Artificially low interest rates.  And government interference into the private sector.  Much like what gave the U.S. the subprime mortgage crisis and the Great Recession.  And much like what gave the Japanese their asset bubble and their Lost Decade.  For all demand-side stimulative growth (i.e., Keynesian growth) ends in Great Recessions or Lost Decades.  Because this kind of growth is inflationary.  And when you inflate asset values you make asset bubbles.  Which ultimately burst.  And when they do they bring down those inflated values to market prices.  The longer those inflationary policies were in place the higher those asset values soared and the more painful the deflationary fall.  Just ask anyone in Japan.  Or in the U.S. with an underwater mortgage.

So China has some unpleasantness in their future.  Perhaps a deflationary spiral.  Along with an accelerated aging population.  Either one by itself is bad.  But together it could be more than the Chinese economy can handle.  And the fallout of any Chinese crash will ripple through every other nation’s economy.  Where we all will feel it.  And suffer the consequences.  Because we are all Keynesians, too.  At least, the economic policies of our governments are.  And when China can no longer buy U.S. sovereign debt there will be no more deficit spending.  Just massive spending cuts.  Or, if they choose to simply print money, massive post World War I Germany inflation.  Where it will take a wheelbarrow full of money to buy a loaf of bread.  Like in post World War I Germany.

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After the Fed says they will Print More Money (QE3) Egan-Jones downgrades U.S. Sovereign Debt

Posted by PITHOCRATES - September 16th, 2012

Week in Review

Back when the Congress and the White House were battling it out to raise the debt limit the final compromise to raise the limit caused Standard and Poor’s to lower the U.S. sovereign debt rating for the first time in history.  The Left blamed the Republicans for refusing to raise taxes.  As if the excessive spending had nothing to do with it.  Well, another credit agency is downgrading the U.S. sovereign debt rating.  And this happened after the Fed announced QE3.  And nothing else (see Egan-Jones downgrades U.S. rating on QE3 move by Wallace Witkowski posted 9/14/2012 on Market Watch).

Egan-Jones Ratings Co. said Friday it downgraded its U.S. sovereign rating to AA- from AA on concerns that the Fed’s new round of quantitative easing, or QE3, will hurt the U.S. economy. The ratings agency said the Fed’s plan of buying $40 billion in mortgage-backed securities a month and keeping interest rates near zero does little to raise GDP, reduces the value of the dollar, and raises the price of commodities.

QE3 is Keynesian stimulus.  Printing money.  Which according to Egan-Jones won’t help the economy.  Apparently the people at Egan-Jones aren’t Keynesians.  Like in the Obama administration.  And at the Fed.  QE3 will devalue the dollar and raise prices.  While it may cause some short-term stimulus it will only make things worse in the long run.  Because of that inflation.  And it doesn’t address the real drag on the economy.  The anti-business policies of the Obama administration.  The biggest one being Obamacare.  With Taxmageddon right up there with it.  It’s the high taxes and costly regulatory policies that are holding back economic growth.  And devaluing the dollar doesn’t help these problems.  It only compounds them.  By raising prices.

QE3 will take a bad economy and make it worse.  Making the recession longer.  And the eventual recovery more painful.  Just like every recovery after a long period of inflation.  Just like after the Seventies.  Just like after the Nineties after the dot-com bubble burst.  Just like now after the subprime mortgage crisis.  There is a pattern here.  Easy money leads to irrational exuberance.  (Reckless spending encouraged by cheap money.)  And very unpleasant recoveries.  We got out of the early Eighties recession by cutting taxes.  Not with inflationary monetary policies.  We got out of the early 2000s recession by cutting taxes.  Along with some inflationary monetary policy.  The recovery wasn’t as long lasting as it was following the Eighties.  Now they are only proposing inflationary monetary policy without any tax cuts.  Which is why the Great Recession lingers still.  Proving tax cuts stimulate.  Not inflationary monetary policy.

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Revolutionary War, Sovereign Debt, Report on Public Credit, Hamilton, Jefferson, Madison, Assumption and Residency Act

Posted by PITHOCRATES - August 16th, 2012

Politics 101

In 1792 the Outstanding Debt at all Levels of Government was 45% of GDP

Wars aren’t cheap.  Especially if they last awhile.  The American Revolutionary War lasted some 8 years until the British and Americans signed the Treaty of Paris (1782) officially ending all hostilities.  So the Revolutionary War was a very costly war.  The ‘national’ government (the Continental Congress) owed about $70 million.  The states owed another $25 million or so.  And the Continental Army had issued about $7 million in IOUs during the war.  Added up that comes to $102 million the new nation owed.  About 45% of GDP.  (Or about 35% without the state debt added in.)

To put that in perspective consider that the Civil War raised the debt to about 32% of GDP.  World War I raised it to about 35%.  World War II raised it to about 122%.  Following the war the debt fell to about 32% at its lowest point until it started rising again.  And quickly.  In large part due to the cost of the Vietnam War and LBJ’s Great Society.  Government spending being so great Nixon turned to printing money.  Depreciating the dollar’s purchasing power in every commodity but one.  Gold.  Which was pegged at $35/ounce.  Losing faith in our currency foreign governments traded their U.S. dollars for gold.  Until Nixon decoupled the dollar from gold in 1971.  Ushering in the era of Keynesian economics, deficit spending and growing national debts.  Because of increased spending for social programs governments everywhere now have debts approaching 100% of GDP.  And higher.  But I digress.

So 45% of GDP was huge in 1792.  And it continued to be huge.  Taking a devastating civil war and a devastating world war to even approach it.  It took an even more devastating world war to exceed it.  And now we’ve blown by that debt level in the era of Keynesian economics.  Without the devastation of another World War II.  This debt level has grown so great that for the first time ever in U.S. history Standard and Poor’s recently lowered the United States’ impeccable sovereign debt rating.  And restoring that debt rating at today’s spending levels will be a daunting task.  But imagine trying to establish a sovereign debt rating after just becoming a nation.  Already with a massive debt of 45% of GDP.

In Hamilton’s Report on Public Credit the New Government would Assume Outstanding Debt at all Levels of Government

There was only one choice for America’s first president.  The indispensible one.  George Washington.  Some delegates at the Philadelphia Convention in 1787 who were skeptical of the new Constitution only supported it because they had someone they could trust to be America’s first president.  George Washington.  Benjamin Franklin, John Adams, Thomas Jefferson and James Madison were indispensible at times.  But not as indispensible as Washington.  For without him the Continental Army would have ceased to exist after that winter at Valley Forge.  That same army would have mutinied (for back pay and promised pensions) after the war if he didn’t step in.  Our experiment in self-government would have ended if he did not relinquish his power after the war.  We wouldn’t have ratified the Constitution without having Washington to be America’s first president.  And our experiment in self-government would have ended if he did not relinquish his power.  Again.  After his second term as president.

With the state of the government’s finances after the war there was another Founding Father that was indispensible.  Not as indispensible as Washington.  But close.  For without him the Washington presidency may have failed.  As well as the new nation.  Because of that convoluted financial mess.  The Continental Congress borrowed money.  The states borrowed money.  Some of which went to the Continental Congress.  The army took stuff they needed to survive in exchange for IOUs.  There were bonds, loans and IOUs at every level of government in every state.  Complicating the matter is that most of the instruments they sold ended up in the hands of speculators who bought them for pennies on the dollar.  As the original holders of these instruments needed money.  And did not believe the Continental Congress would honor any of these obligations.  For before the Constitution the government was weak and had no taxing authority.  And no way to raise the funds to redeem these debt obligations.

A few tried to get their arms around this financial mess.  But couldn’t.  It was too great a task.  Until America’s first secretary of the treasury came along.  Alexander Hamilton.  Who could bring order to the chaos.  As well as fund the new federal government.  He submitted his plan in his Report on Public Credit (January 1790).  And the big thing in it was assumption.  The federal government would assume outstanding debt at all levels of government.  Including those IOUs.  At face value.  One hundred pennies on the dollar.  To whoever held these instruments.  Regardless of who bought them first.  “Unfair!” some said.  But what else could they do?  This was the 1700s.  There weren’t detailed computer records of bondholders.  Besides, this was a nation that, like the British, protected property rights.  These speculators took a risk buying these instruments.  Even if at pennies on the dollar.  They bought them for a price the seller thought was fair or else they wouldn’t have sold them.  So these bonds were now the property of the speculators.

Jefferson and Madison traded Hamilton’s Assumption for the Nation’s Capital

Of course to do this you needed money.  Which Hamilton wanted to raise by issuing new bonds.  To retire the old.  And to service the new.  Thus establishing good credit.  In fact, he wanted a permanent national debt.  For he said, “A national debt, if not excessive, is a national blessing.”  Because good credit would allow a nation to borrow money for economic expansion.  And it would tie the people with the money to the government.  Where the risk of a government default would harm both the nation and their creditors.  Making their interests one and the same.

That’s not how Thomas Jefferson saw it, though.  He had just returned from France where he witnessed the beginning of the French Revolution.  Brought upon by a crushing national debt.  And he didn’t want to tie the people with the money to the government.  For when they do they tend to exert influence over the government.  But Hamilton said debt was a blessing if not excessive.  He did not believe in excessive government debt.  And he wanted to pay that debt off.  As his plan called for a sinking fund to retire that debt.  Still, the Jefferson and Hamilton feud began here.  For Hamilton’s vision of the new federal government was just too big.  And too British.  Madison would join Jefferson to lead an opposition party.  Primarily in opposition to anything Hamilton.  Who used the Constitution to support his other plan.  A national bank.  Just like the British had.  Based on the “necessary and proper” clause in Article I, Section 8.  Setting a precedent that government would use again and again to expand its powers.

At the time the nation’s capital was temporarily in New York.  A final home for it, though, was a contentious issue.  Everyone wanted it in their state so they could greatly influence the national government.  Hamilton’s struggle for assumption was getting nowhere.  Until the horse-trading at the Jefferson dinner party with Hamilton and Madison.  To get the nation’s capital close to Virginia (where it is now) Jefferson offered a deal to Hamilton.  Jefferson and Madison were Virginians.  Give them the capital and they would help pass assumption.  They all agreed to the deal (though Jefferson would later regret it).  Congress passed the Residency Act putting the capital on the Potomac.  And all the good that Hamilton promised happened.  America established good credit.  Allowing it to borrow money at home and abroad.  And a decade of prosperity followed.  Hamilton even paid down the federal debt to about 17.5% of GDP near the end of America’s second president’s (John Adams) term in office (1800).  Making Hamilton indispensible in sustaining this experiment in self-government.  Keeping government small even though it was more powerful than it was ever before.  Of course his using that “necessary and proper” argument really came back to bite him in the ass.  Figuratively, of course.  As government used it time and again to expand its role into areas even Hamilton would have fought to prevent.  While Jefferson no doubt would have said with haughty contempt, “I told you so.  This is what happens when you bring money and government together.  But would you listen to me?  No.  How I hate you, Mr. Hamilton.”

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The US and UK are pressuring Germany to print Euros and guarantee Greek Debt

Posted by PITHOCRATES - May 20th, 2012

Week in Review

Greece is in a world of hurt.  Their government spends too much money.  And their people answer calls for austerity with riots.  They simply refuse to address the problem that got them where they are.  Too much spending.  If they continue to reject austerity measures to bring their spending in line with their ability to pay for it they’re going to be cut off from future loans.  And broomed out of the Eurozone.  That won’t be pretty.  Because if others don’t prop them up they simply won’t be able to service their debt.  They will default on their sovereign debt obligations.  And the banks who have loaned large sums of Euros to them will struggle to recover from these losses.  Many of them simply won’t be able to.  Once the banks start failing the contagion will spread throughout Europe.  And the world.  Bringing on a worldwide recession.  That could easily slide into a depression.  And all of this because of excessive government spending.  There’s a lesson to learn here.  STOP SPENDING SO MUCH.  But no one ever learns this lesson.  Especially when Keynesians are running the government.

They’re talking about your typical Keynesian solutions.  More of the same that got Greece into the trouble they’re in.  Quantitative easing.  Printing money.  To stimulate these troubled economies with…wait for it…more government spending.  As if they can fix their debt troubles with higher consumer prices.  Which is what you get when you print more money.  Especially when the supply of money grows at a rate greater than its economy grows.  So prices will rise while the value of the Euro will fall.  It’ll make their exports cheaper.  But it’ll also make the value of all those outstanding sovereign Euro bonds worth less.  Those bonds all those banks are holding.  Giving them a negative return on their investment.  Pushing these banks closer to insolvency.

And it doesn’t end there.  The strongest economy in the Eurozone is Germany.  They know a thing or two about inflation thanks to the hyperinflation in Weimar Germany that gave the world Adolf Hitler.  So the Germans have governed responsibly.  By living within their means.  And their people have been paying a lot of taxes to pay for all of those Eurozone bailouts.  A nation that has truly gone above and beyond.  Their reward for responsible governing and selfless sacrifice?  They’re asking the German taxpayer to assume the Greek debt (see David Cameron and Barack Obama lead charge to save the eurozone by James Kirkup posted 5/19/2012 on The Telegraph).

Angela Merkel of Germany came under intense pressure to do more to support the struggling currency by putting German economic credibility behind the debts of weaker economies like Greece…

There is growing agreement among G8 leaders that the answer to the eurozone crisis is for members of the single currency to “mutualise” their debts, meaning strong members like Germany partly guarantee the debts of weaker ones like Greece.

Mrs Merkel has resisted any such plans, reluctant to ask German taxpayers – who already resent the bill for helping other eurozone countries – to underwrite the budgets of indebted southern Europeans…

That’s fair.  Except to the Germans, of course.  The problem is if the Greeks don’t reduce their government spending the underlying problem will remain.  Excessive spending.  Which means they will need bailout after bailout.  One or two or three just won’t do it.  And it will delay the inevitable.  And take more people with them when this Keynesian house of cards implodes.

Giving people benefits is easy.  People love you for your generosity.  Taking benefits away is very, very difficult.  People will hate you.  The longer you wait to start the more difficult it will be to cut these benefits.  And the more the people will hate you.  Which is why it is so difficult to govern responsibly.  Because politicians find it is easier to buy votes with generous benefits than it is win votes with good ideology.  This is why governments everywhere embrace the failed policies of Keynesian economics.  Because it gives legitimacy for the easy way of winning elections.  Buying votes with excessive government spending.

And this is the ultimate problem in the Eurozone.  Keynesian economics.  For if governments did not deficit spend or ‘stimulate’ their economies with monetary policy there would be no Eurozone sovereign debt crisis.  Being debt free makes everything easier.  Because you don’t have to borrow.  Service your debt.  Or roll it over.  You have none of those headaches when you live within your means.  Just look at the Germans.

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Government Bonds, Deficits, Debt, Interest and Inflation

Posted by PITHOCRATES - January 16th, 2012

Economics 101

Unlike Corporate Borrowing, Government Borrowing does not Translate into Consumer Goods and Services

When corporations need large sums of money to finance their businesses they issue stocks and bonds.  Investors respond by buying their stocks and bonds.  By loaning the business their money they are investing into these businesses.  Giving them capital to create more things to sell.  Thus stimulating the economy.  Because this investment translates into more consumer goods and services.  That consumers will ultimately buy.

When they offer these goods and services at prices consumers will pay the business does well.  As do the consumers.  Who are able to use their money to buy stuff they want.  So consumers do well.  Corporations do well.  And the investors do well.  For a corporation doing well maintains the value of their investments.  Everyone wins.  Unlike when the government enters the bond market.  For when they do there are some winners and, unfortunately, some losers.

Governments issue bonds when they spend more money than they collect in taxes.  They borrow instead of raising taxes because they know raising taxes reduces economic activity.  Which they want to avoid.  Because less economic activity means less tax revenue.  Which would make the original problem worse.  So like a corporation they have a financing need.  Unlike a corporation, though, the money they borrow will not translate into more consumer goods and services.  They will spend it inefficiently.  Reward political friends.  But mostly they will just pay for past spending.  In mature countries deficits and debt have grown so large that some governments are even borrowing to pay the interest on their debt.

Investors like Government Bonds because Government has the Power to Tax

When the government sells bonds it raises the borrowing costs for businesses.  Because their corporate bonds have to compete with these government bonds.  Corporations, then, pay a higher interest rate on their bonds to attract investors away from the government bonds.  Interest is a cost of business.  Which they add to the sales price of their goods and services.  Meaning the consumer ultimately pays these higher interest costs.  Worse, if a corporation can’t get financing at a reasonable interest rate they may not borrow.  Which means they won’t grow their business.  Or create new jobs.

As government debt grows they sell more and more bonds.  Normally not a problem for investors.  Because investors like government bonds.  (What we call sovereign debt.  Because it is the debt of sovereign states.)  Because government has the power to tax.  So investors feel confident that they will get their interest payments.  And that they will get back their principal.  Because the government can always raise taxes to service this debt.  And raise further funds to redeem their bonds.

But there is a downside for investors.  Too much government debt makes them nervous.  Because there is something governments can do that businesses can’t.  Governments can print money.  And there is the fear that if a government’s debt is so great and they have to pay higher and higher interest rates on their sovereign debt to attract investors that they may just start printing money.  Inflate the money supply.  By printing money to pay investors.  Sounds good if you don’t understand the consequences of printing money.  But ‘inflating the money supply’ is another way of saying inflation.  Where you have more dollars chasing the same amount of goods and services.

When Corporations Fail and go Bankrupt they don’t Increase Consumer Prices or Cause Inflation

Think of it this way.  The existing value of all available goods and services equals the amount of money in circulation.  When you increase the money supply it doesn’t change the amount of goods and services in the economy.  But it still must equal the amount of money in circulation.  So the dollar must now be worth less.  Because more of them still add up to the same value of goods and services.  That is, by printing more money they depreciate the dollar.  Make it worth less.  And if the dollar is worth less it will take more of them to buy the same things.  Causing consumer prices to rise.

Worse, inflation reduces the value of bonds.  When they depreciate the dollar the money locked into these long-term investments shrink in value.  And when people get their money back they can’t buy as much with it as they could before they bought these long-term investments.  Meaning they lost purchasing power while the government had their money.  Which gives investors a negative return on their investment.  And if a person invested their retirement into these bonds they will have less purchasing power in their retirement.  Because a depreciated dollar shrinks their savings.  And increases consumer prices.  So retirees are especially hard hit by inflation.

So excessive government borrowing raises consumer prices.  By making corporations compete for investment capital.  And by causing inflation.  Whereas excessive corporate borrowing does not.  They either provide goods and services at prices consumers willingly pay.  Or they fail and go bankrupt.  Hurting no one but their private investors.  And their employees who lose their jobs.  Sad, but at least their failure does not increase consumer prices.  Or cause inflation.

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The European Central Bank Acts to add Liquidity to European Banks

Posted by PITHOCRATES - January 7th, 2012

Week in Review

The European Central Bank (ECB) offers up some cheap loans to add some liquidity to the Eurozone economy.  A liquidity problem caused by the Eurozone debt crisis.  Which was caused by excessive government deficit spending.  So the ECB’s solution to this problem is to throw more cheap money into the economy.  Problem solved (see Europe banks gobble up cheap loans offered by Central Bank by Henry Chu posted 12/21/2011 on The Los Angeles Times).

Faced with the threat of another regional recession, the European Central Bank said Wednesday that it was doling out more than half a trillion dollars in special long-term loans to hundreds of financial institutions in a bid to keep credit flowing…

The money, lent at the low interest rate of 1%, proved attractive to many financial institutions that are highly exposed to government debt and that have therefore found it hard to borrow commercially.

“It provides some stability to the funding of banks which have more or less completely lost market access,” said Sony Kapoor of the think tank Re-Define.

But the record response to the ECB’s offer is a sign of how dire the situation has become, Kapoor said. He warned that the new loans failed to address the heart of the euro crisis: the loss of faith in Europe’s banks and in the heavily indebted governments that stand behind them, especially in peripheral countries of the Eurozone…

Meanwhile, European government bond yields rose on fear that banks might back away from buying more sovereign debt amid pressure to reduce risk on their balance sheets.

Perhaps not.

This is why there is no easy solution to the Eurozone debt crisis.  European banks aren’t buying sovereign debt.  Because their balance sheets are full of risky sovereign debt.  So much that these banks have lost market access.  They can’t borrow because they are now risky, too.  Much like the countries of the Eurozone who are having trouble selling bonds.

All of this bad debt has resulted in a liquidity crisis.  And weakened European banks.  So the European Central Bank stepped in to relieve this liquidity crisis.  By providing low interest loans.  In hopes that these banks will use that cheap money to buy more of that risky sovereign debt.  That has caused the liquidity crisis.  And weakened European banks.

So either the banks will sit on that money to improve their balance sheets.  Or they will further weaken their balance sheets by buying more of that risky sovereign debt.  Neither which will fix the underlying problem.  Too much debt.  These countries with too much debt need more austerity.  To reduce their borrowing needs.  Before the European banks start failing.

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Big Trouble for the Euro as Massive Greek Debt may be too much for the German People to Endure

Posted by PITHOCRATES - September 11th, 2011

Loans aren’t Gifts, you have to Pay them Back

Tax. Borrow. Print. And spend. The social democracies of Europe have been doing it for years. Thanks to central banking. And fiat money. And a little of John Maynard Keynes. You can keep interest rates artificially low. Deficit spend at will. Sell bonds forever and ever. And even print money. That’s Keynesian economics. Liberal Democrats in America were so enamored with the Europeans that they followed their example. And with government having the power to monetize debt, what could go wrong?

Apparently, a lot. Standard and Poor’s just downgraded U.S. sovereign debt. Citing high debt. And growing deficits. Leading them to believe that the U.S. may have trouble paying back what they’ve borrowed. Saying the U.S. government was living beyond their means. Just because they were spending more money than they had.

You mean we can’t do whatever we want? That’s right. You can’t. Because debt has consequences. You can’t keep borrowing more every year. Because people loan money (i.e., buy bonds) expecting you to pay back that loan. Yeah, I know. Crazy talk. But true nevertheless. Loans aren’t gifts. You have to pay them back.

The Root Problem within the Eurozone is Excessive Government Spending, Deficits and Debt

The U.S. has some financial problems. Record deficits. And record debt. Used to finance ever growing government spending. Yes, things may be bad in America, but they pale in comparison to the problems they have in the Eurozone (see German Dissent Magnifies Uncertainty in Europe by Liz Alderman posted 9/11/2011 on The New York Times).

Despite repeated pledges by Chancellor Angela Merkel to keep Europe together, the cacophony of dissent within her country is becoming almost deafening. That is casting fresh doubt — whether justified or not — over the nation’s commitment to the euro.

“The German electorate is not in the mind-set to undertake actions it sees as subsidizing less worthy nations,” said Carl Weinberg, the chief economist of High Frequency Economics in Valhalla, N.Y. “As a result, the government is moving in a very isolationist way to try to establish a fortress Germany that’s economically secure despite the risks in its European Union partners.”

This weekend, Der Spiegel reported that the German government was starting to prepare for a Greek insolvency and was devising various responses to handle a potential default, including allowing Greece to abandon the euro and return to the drachma. The government in Berlin would not comment, but such reports only add to the doubts bedeviling the euro monetary union.

The root problem within the Eurozone is excessive government spending, deficits and debt. Especially in Greece. Where they’ve borrowed heavily to pay for a very generous public sector. And state benefits.

There were strict requirements to join the monetary union. To change their currency to the Euro. The Euro Convergence Criteria required an annual government deficit of 3% of GDP. Or less. And total debt of 60% of GDP. Or less. Deficit and debt above these limits endangered a nation’s financial stability. And the common currency. The Euro. Which would spread one country’s irresponsible ways to the other countries in the Eurozone.

And that’s exactly what happened. Greece ‘fudged’ their numbers. So while they passed themselves off as fiscally responsible they were anything but. Their deficit and debt far exceeded the Euro Convergence Criteria. And when the global financial crisis of 2008 hit, it hit Greece hard. A couple of years later, with their economy depressed, S&P downgraded their sovereign debt. Increasing their borrowing costs. Which they couldn’t afford. So they had to turn to the international community for help. And it came. With a price. Austerity. Which the Greek people didn’t like.

Because of the common currency, Greece’s problems were now Germany’s problems. Because they were the strongest economy in the union. And the German people are growing tired of picking up the tab for Greece. And they’re not alone.

Finland, the Netherlands and Austria have all spoken with dissonant voices on the Greek bailout, revealing deep divisions among Europe’s strongest countries about how far they should go to save their weaker neighbors.

Continued fears over the state of European banks, and French ones in particular, have also roiled financial markets, especially after Christine Lagarde, the managing director of the International Monetary Fund, warned that European banks needed substantial additional capital.

Meanwhile, fears over Greece are only likely to intensify this week, after Mrs. Merkel’s finance minister, Wolfgang Schäuble, warned that Germany, for one, would not approve new financial assistance to help Athens continue to pay its bills through Christmas unless the Greek government fulfilled the conditions of its first bailout.

Can you blame them? Would you want to loan more money to a family member that continues to spend beyond their means? People want to help others. But they don’t want to finance the irresponsible ways that caused their problems in the first place. Austerity isn’t fun. But others are doing it. As they try to adjust their budgets to live within their means.

Outside of Greece, some things have improved, if only haltingly. Italy’s lower house of Parliament is expected to approve a tough new fiscal package in coming days.

France, Portugal and Spain are adopting measures to make it easier to balance budgets, moves intended to reassure investors about their commitments to fiscal prudence.

Which is not helping Mrs. Merkel. For if she continues to try and save the Euro her party may lose power.

Still, Mrs. Merkel must contend with a stark divide between her support for European unity and a German public that sees no reason, in the majority’s view, to pour good money after bad into the indebted countries of southern Europe. Her Christian Democrat Party has now lost five local elections this year. Yet even as many Germans complain bitterly about their southern neighbors, few in business and politics are ready to let the euro zone fall apart.

After all, if the weakest countries were to revert to their original currencies, a German-dominated euro would soar as investors flocked to it as a haven, devastating the business of exporters who have relied on its stability and relatively affordable level against other major currencies.

Then again, if she doesn’t save the Euro, her export economy may tank. A weak Greece is helping to keep the Euro undervalued. And you know what an undervalued currency does. It makes your exports cheap.

Any American who vacationed in Canada understands this well. Back when the U.S. dollar was strong, it was nice crossing into Canada. When you exchanged your strong American dollars for Canadian dollars, you got a lot more Canadian dollars back. In other words, the American dollar bought more in Canada than in the U.S. So people took their vacations in Canada. Which made the Canadian tourism industry boom.

This is the value of a weak currency. When your currency is weak, goods and services in your country, or goods exported out of your country, are cheaper. And the weaker nations in the Eurozone are keeping the Euro undervalued. And German exports strong. But it comes with a price. The taxpayers are basically subsidizing the export industry. By subsidizing the Greece bailout.

In other words, the Germans are damned if they do. And damned if they don’t.

The More the Debt the More the Crisis, the Less the Debt the Less the Crisis

Governments embrace Keynesian economics because it gives them power. It facilities their deficit spending. Legitimizes it. They and their Keynesian economists will dismiss growing debts. Because they’re no big deal. You see, their policy of continuous inflation shrinks that debt in real terms. In other words, as you devalue the currency, old debts are worth less. And easier to repay years later.

But there’s a catch. You need a growing GDP for this to work. When the economy stagnates, tax revenues fall. And if those debts are too big you just may not be able to service those debts. And you know what can happen? Greece. So too much debt can be a bad thing.

And it’s a dangerous game to play. Because as that debt grows so must taxes to service that debt. So they increase tax rates. But higher tax rates work against growing GDP. Flat or falling GDP means less tax dollars. Which leads to more borrowing. So the solution to the problem is more of what caused the problem. Which makes the original problem bigger. It’s a vicious cycle. Until the cycle ends in a credit downgrade. And financial crisis.

Keynesians can say what they want. But one thing they can’t deny is this. If these countries had no debt then they would have no financial crisis. Some countries have less debt and are not in crisis. While the countries in crisis have excessive debt. See the pattern? The more the debt the more the crisis. The less the debt the less the crisis.

Even Keynesians can’t deny this. Then again, Keynesians could. For they do live in denial.

www.PITHOCRATES.com

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