Thursday, September 6, 2012

Circling the fiscal drain

I'm getting tired of linking to all the many blog posts I've written about the ongoing financial crisis, so I won't even bother any more.  Instead, here are a couple of links to recent articles that illustrate the approaching collapse (which becomes less and less avoidable the longer governments refuse to take decisive action, instead 'kicking the can down the road', leaving it for their successors to deal with).

First, Spain appears to be 'playing both ends against the middle' in its game of financial brinkmanship with European Union authorities and the national governments of the states involved.  The Telegraph reports:

Spain has issued a veiled warning that it will not accept a full bail-out from Europe if the terms are too harsh, a move that would paralyse the European Central Bank and call the euro’s survival into question.

In an escalating game of brinkmanship, Spanish finance minister Luis de Guindos said his country is not yet willing to sign a Memorandum giving up fiscal sovereignty to EU inspectors. “First of all, one must clarify the conditions,” he told German newspaper Handelsblatt.

Mr de Guindos said the crisis engulfing the region is larger than any one country and warned north Europe not to scapegoat Spain.

“My colleagues are aware that the battle for the euro will be fought in Spain. Spain is right now the breakwater for the eurozone,” he said, adding that “solidarity” would be well-advised.

The warning comes as German Chancellor Angela Merkel leaves for Madrid for talks with premier Mariano Rajoy to thrash out the conditions of a full sovereign rescue of up €300bn [about US $379 billion], beyond the €100bn [about US $126 billion] bank rescue already agreed.

. . .

There is little doubt that Spain will need a rescue as it struggles to raise €40bn [about US $50.5 billion] over the next two months. The country’s finances are unravelling on every front, with internal rescues for Catalonia, Valencia, Murcia, and Andalucia fast depleting the €18bn [about US $22.7 billion] fund set aside for the regions.

It emerged today that Spain’s social security system has raided a rainy-day fund to cover state pensions for the first time as deepening recession erodes contributions.

Tomas Burgos, social security minster, said the government had drained €4.4bn [about US $5.5 billion] from the Fondo de Prevencion – financed from workers’ illness insurance – to the meet the shortfall in July, reducing the account to just €400m [about US $505 million].

Mr Burgos said Madrid may have to use “all mechanisms at our disposal” to meet payments, revealing that the next step may be a raid on the pension system’s €67bn [about US $84.5 billion] Reserve Fund. The pension system has been losing contributors as unemployment soars to 25pc. It shed a further 137,000 jobs in August.

Meanwhile, official data shows that the toxic property loans of Spain’s four nationalised banks have reached €75bn [about US $94.7 billion] and are rising faster than feared. Bankia’s “potentially problematic” loans are €42bn [about US $53 billion]. The biggest surprise is a 50pc surge in bad debts to €9bn [about US $11.4 billion] at Cataluyna Caixa since January. Non-payments on mortgages have doubled.

Nomura’s Jens Nordvig said Spain’s crisis has entered a “more dangerous phase”, resembling the sort of currency dramas once confined to emerging markets.

Capital flight has been running at an annual rate of 50pc of GDP, more than twice the rate in Indonesia during the Asian meltdown in the 1990s.

Foreigners have sold Spanish securities worth 19pc of GDP over the past quarter. Spanish residents have shipped funds worth 16.7pc of GDP into foreign bank accounts.

There's more at the link.  As I pointed out a few days ago concerning the Spanish bank run, "if your country's banks see the equivalent of seven per cent of gross domestic product withdrawn in the space of a single month, you may as well stick a fork in that economy.  It's done."

Greece is also playing brinkmanship with the EU over its already-agreed bailout package.  Its new proposals for further economic cuts are so swingeing that its own people are threatening revolution if they are implemented.  Greek politicians are doubtless hoping that the ECB and the politicians behind it will back down, rather than see the hundreds of billions of Euros they've invested in the Greek bailout being repudiated altogether by a new and more hardline administration.  However, that may not happen - in fact, a leading German economist has come out flat-footed and said that the country needs to "leave the euro and reintroduce its own currency if it wants to get back on its feet and return to growth".

(Both Spain and Greece may have the power of numbers on their side in their respective games of fiscal brinkmanship with the ECB.  As J. Paul Getty famously put it, "If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem.")

Despite that reality, Moody's has just lowered the EU's long-term issuer rating outlook to negative.

Moody's has lowered the European Union's long-term issuer rating outlook from stable to negative, saying the move reflected credit risks of the bloc's key budget contributors.

"It is reasonable to assume that the EU's creditworthiness should move in line with the creditworthiness of its strongest key member states," it said, citing negative outlooks for Britain, France, Germany and the Netherlands.

. . .

The agency said while there were "structural features in place that enhance the EU's creditworthiness", they were "not sufficient to delink the EU's ratings from the ratings of its strongest key member states".

"Additionally, a weakening of the commitment of the member states to the EU and changes to the EU's fiscal framework that led to less conservative budget management would be credit negative," it said.

Conversely, the bloc could regain a stable outlook for its ratings should the rating of the key triple-A budget contributors also return to stable, it added.

Moody's in July lowered the ratings outlook of Germany, Luxembourg and the Netherlands to negative, saying the "level of uncertainty about the outlook for the euro area" was no longer consistent with stable outlooks for the countries.

France and Austria have been under a negative ratings outlook since February, and Britain was assigned the same status in December.

Again, more at the link.

On this side of the Atlantic, the Fed looks to be doing more of the 'same old, same old'.  It doesn't realistically have any option, of course.  It's painted itself into a financial corner, and has no other way out.

Federal Reserve Chairman Ben Bernanke did not introduce a third round of quantitative easing (QE3) in his speech at Jackson Hole on Friday. But he did put forth the framework for what one analyst termed "QE forever" ... This entails the Federal Reserve having unlimited authority to buy U.S. treasury bonds. This is a de facto admission that all previous measures have failed -- the U.S. unemployment rate is still rising, economic growth is unsustainably weak, and the housing market has yet to bottom.

It also proves no other investors want to buy American treasury bonds at such low interest rates. This is a very unstable foundation for the U.S. dollar.

. . .

The Federal Reserve inflated its balance sheet by $700 billion to buy U.S. treasury bonds from November 2010 to June 2010 to underwrite the American budget deficit and provide liquidity to capital markets.

The creation of $700 billion in U.S. dollars with no economic growth behind it was inflationary because the U.S. dollar fell; basic supply and demand here, no surprise.  As a result of the dollar falling, oil and other commodities traded in U.S. dollars rose.

More at the link.  Bold print is my emphasis.

Our fiscal reality is simple.  The only thing underpinning the US economy right now is the Fed printing money hand-over-fist to buy US government bonds, thus funding the operations of the US government (which is borrowing more than 43c out of every dollar it spends).  Ever heard of Ourobouros, the serpent that consumes itself while endlessly renewing itself?  That's our financial system, right now.  Only trouble is, our fiscal Ourobouros will eventually consume itself entirely, because it can't renew itself.  It'll consume our individual financial security along with it.

Let me repeat what I've said several times in the past.  There are only three possible outcomes to our present financial predicament.

  1. The United States repudiates its national debt, thereby destroying its credit-worthiness.
  2. We print money to debase our currency through inflation, paying off debts incurred in (expensive) past and current dollars with (cheap) future dollars - but destroying the value of our savings and investments in the process.
  3. We 'bite the bullet' and savagely cut our expenditures, particularly on entitlement programs such as Social Security, Medicare, Medicaid, welfare and unemployment benefits.  That will allow us to pay off our massive debt over time - but it will also shrink our economy by at least 25%, dangerously weakening it and throwing even more millions of Americans out of work, this time without any federally-funded 'safety net' to help them.

Please note that those outcomes aren't optional at all.  One or more must and will come to pass - perhaps even a combination of all three.  There's no longer any way to avoid that.

Albert Einstein famously defined insanity as "doing the same thing over and over again and expecting different results".  One wonders whether Mr. Bernanke and his fellow governors of the Federal Reserve have ever bothered to ponder that . . .


1 comment:

perlhaqr said...

Option two should have ended with the phrase, "; And destroying our credit-worthiness."

Of course, given the use of the word "worthiness" in that context... I'm not sure we actually are "credit worthy". We certainly give no indication of being able to be trusted with it.