In the mean time in South America ...

Quiet Success in South America

The underappreciated economic achievements of Uruguay and Paraguay.

By JAIME DAREMBLUM

With a combined population of only 10 million, and a combined GDP roughly equivalent to that of Ecuador, Uruguay and Paraguay don’t get much attention from foreign journalists or policymakers. Yet the two South American countries, though dwarfed in size and influence by their two massive neighbors (Brazil and Argentina), have quietly been growing at very fast rates, improving their economic stability, and boosting their credit ratings.

A year ago, Financial Times correspondent Jude Webber dubbed them “Latin America’s impressive little guys,” noting that both were “punching above their weight.” Uruguay is by far the richer and more developed nation. Its economy expanded by 8.5 percent last year, and it received 29 percent more foreign direct investment (FDI) in 2010 than in 2009, with total FDI surging to $1.6 billion. In January, a joint Chilean-Finnish venture announced that it would be constructing a $1.9 billion pulp mill in Uruguay, the single biggest private investment project in the country’s history. Unemployment has fallen to historic lows, and Uruguay is also experiencing a real-estate boom.

“Uruguay is likely to be viewed as one of the best-run countries in Latin America,” investment strategist Jim Barrineau toldReuters this past summer. “What debt it does have is not very actively traded because the fundamentals are so good that most managers buy and hold.” Within the last year, each of the Big Three credit-rating agencies — Moody’s, Fitch, andStandard & Poor’s — upgraded Uruguay’s status. “Uruguay’s external and fiscal vulnerabilities have reduced owing to improvements in its external and fiscal solvency ratios, strengthened external liquidity as well as better currency composition and maturity structure of government debt,” Fitch declared in July. “High GDP per capita income, strong social indicators, and a solid institutional framework underpin Uruguay’s creditworthiness.” As Bloomberg News recentlyreported, investors believe that Uruguay “is heading toward its first investment-grade rating since 2002.”

The Uruguayan economy depends heavily on exports — which grew by nearly 24 percent between 2009 and 2010 — particularly beef, grain, and soybean exports. Back in May, the U.S. agribusiness giant Archer Daniels Midland announcedthat it was building a new facility in the South American country: a massive grain export terminal with a storage capacity of 180,000 tons and an initial loading capacity of 2.8 million tons. Uruguay may also become one of the Western Hemisphere’s biggest gas exporters: The U.S. Energy Information Administration has projected that it is sitting on 20,580 billion cubic feet of natural-gas reserves.

Yet booming commodity exports explain only part of Uruguay’s economic success. Its chief advantages are strong economic fundamentals, political stability, a relatively large middle class, and a relatively good education system. The 2011Wall Street Journal/Heritage Foundation Index of Economic Freedom gives Uruguay the third-highest score in Latin America and the Caribbean. For that matter, Uruguay boasts the top ranking in the first-ever Latin Education Indexproduced by the Latin Business Chronicle, and it is also the highest-ranked Latin American country in the 2011 Legatum Prosperity Index.

Whereas Uruguay is a middle-class nation that ranks 48th out of 187 countries and territories in the 2011 United Nations Human Development Index, Paraguay is a much poorer nation that ranks 107th. Last year, however, it posted the second-fastest economic growth rate in the entire world (15 percent), behind only oil-rich Qatar, thanks to a record soybean crop. According to the World Bank, Paraguayan exports increased by 43 percent between 2009 and 2010, with soybean exports jumping by a remarkable 102 percent and meat exports growing by 59 percent. But as with Uruguay, farm exports aren’t the sole explanation of its recent economic achievements: The International Monetary Fund has determined that Paraguay’s 2010 growth “was driven by a broad-based economic expansion and not only by the historically large agricultural sector boom.” Standard & Poor’s upgraded its credit status a few months ago, following the completion of a key bilateral energy deal with Brazil. (It received a rating boost from Moody’s in late 2010.) The U.S. Agency for International Development affirms that Paraguay “has improved the management of the economy, reduced the domestic debt, strengthened the customs service, and improved the tax system.”

To be sure, the country still suffers from rampant corruption, fragile public institutions, and severe social inequalities, and its southern border region near Argentina and Brazil (part of the the so-called Triple Frontier) is a lawless, Wild West–type area that serves as a magnet for terrorists and other criminal organizations. As the WikiLeaks cables showed, Washington is worried that Islamic militants and Iranian agents are operating in Paraguay. Meanwhile, on the economic front, there are concerns that both Paraguay and Uruguay are overheating. Policymakers will have to address rising inflation before it becomes a serious problem.

Here is perhaps the most interesting aspect of the story: For their entire modern history, Uruguay and Paraguay were ruled by either non-leftist democratic governments or right-wing military dictatorships, yet their recent economic success has come under social democrats. Uruguay has had a social-democratic president since 2005, and Paraguay has had one since 2008. These leaders — Tabaré Vázquez and José Mujica in Uruguay, and Fernando Lugo in Paraguay — have demonstrated that there is more than one brand of leftist in Latin America. Presidents Vázquez, Mujica, and Lugo have all governed in a moderate, pragmatic manner, without any of the radicalism we have seen in Venezuela. They provide firm evidence that, as I have written elsewhere (here and here, for example), Hugo Chávez is losing the ideological war in the Western Hemisphere.

Outside, looking in

How a Financial Pro Lost His House

By CARL RICHARDS

ONE night a few years ago, when the value of our home had collapsed, our debt was out of control and my financial planning business was shaky, I went to take out the trash.

There was this enormous window that looked right in on the kitchen table, and through it I could see my wife, Cori, and our four children eating dinner. It was dark outside, so they couldn’t see me, and I just stood there looking at them.

After a while, I pulled up a bucket and I sat on it, just watching my children eat. I found myself wishing that I could get back there, connected to the simple ordinary stuff of my family’s life. And as I sat and watched, filled with longing and guilt, two questions kept arising:

How did I get here?

And how am I going to get out of this?

There are many stories these days of people who lost their financial bearings during the housing boom and the crisis that followed, but my story is a bit different from most.

I’m a financial adviser. I get paid to help people make smart financial choices, and I speak and write about personal finance issues for this publication and others. My first book comes out in January, “The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money” (Portfolio, a Penguin imprint).

The thing that few people know, though, is that I learned a lot of this from experience. I made a bunch of mistakes, the very same ones that I now go around warning people to avoid.

So this is the story of how I lost my home, the profound ethical questions that arose along the way, and what my wife and I learned from the mistakes that led us to that point. It made me better at what I do, but it wasn’t much fun getting there.

Like most financial stories, this one is personal. It starts with me getting into the financial services industry more or less by accident. I answered an ad in 1995 that I thought was for a job related to “security” (as in security guard) but was in fact related to “securities.” That’s how little I knew about the stock market. A few months later I found myself working a phone at a Fidelity Investments call center.

Things went well, and by 1999 I was a Merrill Lynch financial adviser and a certified financial planner. By then, we also owned a house in Salt Lake City. We’d bought it two years earlier, with a $25,000 down payment.

A few years later, an opportunity arose to form a partnership with a successful Merrill adviser in Las Vegas. The place was on our top 10 list of never-move-to cities because we had always associated it with the Strip. But Cori and I were looking for an opportunity to have an experience somewhere else, and we met some great people when we visited the city. I took the job, and we moved down there.

That was May 2003. Housing prices were already crazy, so we rented. But our neighborhood had zero character and lots of cookie-cutter houses. Within a few weeks, we were looking for a place to buy.

I felt we could afford around $350,000. We called a real estate agent named Mitch, who had signs on all the bus stops: Talk to Mitch! He picked us up in a gold Jaguar, and suddenly we were looking at houses that listed at $500,000 or more.

It felt a little crazy to be shopping for houses that cost half a million dollars, but my income was growing rapidly. Everywhere I looked, people were being rewarded for buying as much house as they could possibly afford, and then some. There was this excitement in the air, almost like static. I started to think that if I didn’t buy a house right then, I would never be able to afford one.

At moments during our house hunt, I felt in my gut that something wasn’t right. We’d go to open houses for $400,000 homes and see lines of couples in their late 20s — younger than we were — waiting to get inside. I kept wondering where all the money was coming from. How did all these people make so much?

But prices just kept rising, and when people kept buying, that made it seem safer. I knew from my work as a financial adviser that following the crowd could be costly. But like everyone else, I felt safer in a crowd.

Bulldoze the current system and start over

The Public-Union Albatross

 What it means when 90% of an agency's workers retire with  disability benefits.

By P. Howard

The indictment of seven Long Island Rail Road workers for disability fraud last week cast a spotlight on a troubled government agency. Until recently, over 90% of LIRR workers retired with a disability—even those who worked desk jobs—adding about $36,000 to their annual pensions. The cost to New York taxpayers over the past decade was $300 million.

As one investigator put it, fraud of this kind "became a culture of sorts among the LIRR workers, who took to gathering in doctor's waiting rooms bragging to each [other] about their disabilities while simultaneously talking about their golf game." How could almost every employee think fraud was the right thing to do?

The LIRR disability epidemic is hardly unique—82% of senior California state troopers are "disabled" in their last year before retirement. Pension abuses are so common—for example, "spiking" pensions with excess overtime in the last year of employment—that they're taken for granted.

Governors in Wisconsin and Ohio this year have led well-publicized showdowns with public unions. Union leaders argue they are "decimat[ing] the collective bargaining rights of public employees." What are these so-called "rights"? The dispute has focused on rich benefit packages that are drowning public budgets. Far more important is the lack of productivity.

"I've never seen anyone terminated for incompetence," observed a long-time human relations official in New York City. In Cincinnati, police personnel records must be expunged every few years—making periodic misconduct essentially unaccountable. Over the past decade, Los Angeles succeeded in firing five teachers (out of 33,000), at a cost of $3.5 million.

Collective-bargaining rights have made government virtually unmanageable. Promotions, reassignments and layoffs are dictated by rigid rules, without any opportunity for managerial judgment. In 2010, shortly after receiving an award as best first-year teacher in Wisconsin, Megan Sampson had to be let go under "last in, first out" provisions of the union contract.

Even what task someone should do on a given day is subject to detailed rules. Last year, when a virus disabled two computers in a shared federal office in Washington, D.C., the IT technician fixed one but said he was unable to fix the other because it wasn't listed on his form.

Making things work better is an affront to union prerogatives. The refuse-collection union in Toledo sued when the city proposed consolidating garbage collection with the surrounding county. (Toledo ended up making a cash settlement.) In Wisconsin, when budget cuts eliminated funding to mow the grass along the roads, the union sued to stop the county executive from giving the job to inmates.

No decision is too small for union micromanagement. Under the New York City union contract, when new equipment is installed the city must reopen collective bargaining "for the sole purpose of negotiating with the union on the practical impact, if any, such equipment has on the affected employees." Trying to get ideas from public employees can be illegal. A deputy mayor of New York City was "warned not to talk with employees in order to get suggestions" because it might violate the "direct dealing law."

How inefficient is this system? Ten percent? Thirty percent? Pause on the math here. Over 20 million people work for federal, state and local government, or one in seven workers in America. Their salaries and benefits total roughly $1.5 trillion of taxpayer funds each year (about 10% of GDP). They spend another $2 trillion. If government could be run more efficiently by 30%, that would result in annual savings worth $1 trillion.

What's amazing is that anything gets done in government. This is a tribute to countless public employees who render public service, against all odds, by their personal pride and willpower, despite having to wrestle daily choices through a slimy bureaucracy.

One huge hurdle stands in the way of making government manageable: public unions. The head of the American Federation of State, County and Municipal Employees recently bragged that the union had contributed $90 million in the 2010 off-year election alone. Where did the unions get all that money? The power is imbedded in an artificial legal construct—a "collective-bargaining right" that deducts union dues from all public employees, whether or not they want to belong to the union.

Some states, such as Indiana, have succeeded in eliminating this requirement. I would go further: America should ban political contributions by public unions, by constitutional amendment if necessary. Government is supposed to serve the public, not public employees.

America must bulldoze the current system and start over. Only then can we balance budgets and restore competence, dignity and purpose to public service.

A modern day tragedy

Hip, Hip, Hooray, It's Rhodesia Independence Day!

 

Ian Smith lived to see all his worst predictions come true.

By H. W. CROCKER, III 

On 11 November 1965, Ian Smith, prime minister of the British colony of Rhodesia, signed his country's unilateral declaration of independence, giving birth to a new nation that would, rather heroically, seek to maintain its way of life for the next fifteen years. That way of life was not -- as critics will be quick to allege -- based on racism, but on freedom, the freedom that was vouchsafed Rhodesia by the British Empire. It was the freedom that was lost by Rhodesia's transformation into Robert Mugabe's Zimbabwe. It's a transformation from which even we, as American, have something to learn.

The Rhodesians, in fact, based their declaration of independence on our own, though they charmingly reaffirmed their allegiance to the queen. Thinking themselves "more British than the British," they announced their independence on Remembrance Day, marking the end of World War I (what we mark as Veterans' Day), to remind Britain that when she fought at great cost to defend freedom, the rule of law, and the rights of small nations, Rhodesia had been at her side. In the Second World War, indeed, Ian Smith himself had flown Hawker Hurricanes and Spitfires for the RAF. A flight accident had smashed up his face (which required extensive plastic surgery) and left him with numerous serious injuries that took months to heal. He returned to duty, was shot down over Italy, and eventually made his escape back to Allied lines.

More than that, though, the Rhodesians had done what is the measure of a man -- they had gone into the wilderness and been able to re-create their civilization. While they had a reputation as outdoorsy, beer-swilling hearties, the great Rhodesian writer (and liberal) Peter Godwin and Ian Hancock estimated in their classic study of Rhodesia, 'Rhodesians Never Die,' "that probably no other transplanted English-speakers had done more -- with similar resources -- to reproduce and practice the parent culture."

It is a question worth asking ourselves: how many of us could hack our way into the jungle and re-create the United States? The more culturally pessimistic, or multiculturally inclined, might even wonder whether that would be a good thing anyway.

The Rhodesians had no doubts -- or few. They were so confident in their civilization that they were willing to endure international ostracism. They were so certain they were on the right side of history, and certain of their martial valor, that they volunteered to send troops to Vietnam (an offer that the embarrassed Lyndon Johnson administration declined to accept). They were so certain that they stood athwart tyranny, that they sacrificed their sons and fortified their farms in an African bush war that thrilled the armchair adventurers among the readers of Soldier of Fortune magazine, which sold "Be A Man Among Men, Rhodesian Army" t-shirts, based on a Rhodesian recruiting poster.  

Smith believed that one-man, one-vote in Africa meant free elections once. He was loath to submit his country to the chaos, socialism, violence, and dictatorship that he was certain would follow elections based on a universal franchise (which, as he pointed out, had difficulties that Western critics were not likely to consider: for instance, how to accurately register voters when most rural-born black Africans had no birth certificates). Smith was careful to gain the support of the country's tribal chiefs, he stated that his goal was evolution not revolution on the way to expanding the franchise (which was tied to income and property qualifications), and he affirmed that he would not risk Rhodesia's multi-party elections, free press, independent judiciary, and free economy with a mass electorate that might be inclined to do away with them.

In the end, of course, the British brokered a deal. Lord Carrington and almost all the other delegates to the so-called Lancaster House Agreement of 1979 were convinced that Robert Mugabe, regarded as the most radical of the Communist-backed insurgents, would be defeated in the elections arranged for 1980. Ian Smith thought otherwise. He was certain Mugabe would win because he belonged to the Shona tribe, which represented eighty percent of Rhodesia's population, and because Mugabe would be the most effective at voter intimidation. Smith was proved right, as he usually was -- though he got no credit for it.

Smith lived to see all his worst predictions come true; had he been able to read his obituaries he would have seen that liberal opinion blamed him for it. Smith's solace in his declining years was the popularity he had among black Zimbabweans who saw him as a symbol of unbreakable resistance to Mugabe. If you want to see the Rhodesia Smith defended, you can watch a video or two on YouTube and see black soldiers (most of the Rhodesian army was black) marching on parade past mostly white civilians, including an official dressed like an 18th-century town crier; you can see the sons of productive farmers and businessmen, who made Rhodesia an economic success, shouldering rifles to defend their homes and their liberties.

And if you want to see the tribute that vice pays to virtue -- or that Zimbabwe pays to Rhodesia and the British Empire -- just note how Zimbabwe's judges still wear white wigs, how Mugabe's henchmen make a show of owning farms (taken from white farmers who once produced plenty, and whose fields now lie barren while Zimbabweans starve), and how Mugabe still goes thorough the formality of having elections (as long as his goons ensure that he wins). Zimbabweans think of British institutions as having legitimacy, even if they are deployed as part of Robert Mugabe's charades. 

So what can America learn from gallant Rhodesia? For one thing, we can learn to judge nations by the values they uphold, not the electoral processes they observe. We can see why Western "colonialism" was oftentimes better than the alternative. And most of all, perhaps, we might learn not to take our own liberties for granted. In every generation, they are only a demagogue away from being taken from us.

Sleight of Hand

And the Big Time Banksters Come Marching In

by Robert Wenzel

Here's what you need to know about the current crisis in the Eurozone. The big time banksters are getting direct hands on control:

Mario Drgahi has become president of the European Central Bank as of November 1. He was vice chairman and managing director of Goldman Sachs International and a member of the firm-wide management committee. He was the Italian Executive Director at the World Bank. He has been a Fellow of the Institute of Politics at the John F. Kennedy School of Government, Harvard University.

Lucas Papademos takes over today as Prime Miinster of Greece. He was an economist at the Federal Reserve Bank of Boston. He was a visiting professor of public policy at the Kennedy School of Government at Harvard University. And, he was previously a vice president of the European Central Bank. He has been a member of the Trilateral Commission since 1998.

Indications are that Mario Monti will succeed Silvio Berlusconi as prime minister of Italy, within in days. Monti completed graduate studies at Yale University, where he studied under James Tobin (see the Tobin Tax). He is a member of the European Commission. He is European Chairman of the Trilateral Commission and and member of the Bilderberg Group.

If you get the sense that the elitist banksters are going to take this financial crisis and push it in whatever direction they want, you are probably very right.

The ever expanding financial bubble

Why Is There a Euro Crisis?

by Philipp Bagus

On Thursday, October 28, 2011, prices of European stocks soared. Big banks like Société Générale (+22.54%), BNP Paribas (+19.92%), Commerzbank (+16.49%) or Deutsche Bank (+15.35%) experienced fantastic one-day gains. What happened?

Today's banks are not free-market institutions. They live in a symbiosis with governments that they are financing. The banks' survival depends on privileges and government interventions. Such an intervention explains the unusual stock gains. On Wednesday night, an EU summit had limited the losses that European banks will take for financing the irresponsible Greek government to 50 percent. Moreover, the summit showed that the European political elite is willing to keep the game going and continue to bail out the government of Greece and other peripheral countries. Everyone who receives money from the Greek government benefits from the bailout: Greek public employees, pensioners, unemployed, subsidized sectors, Greek banks — but also French and German banks.

Europeans politicians want the euro to survive. For it to do so, they think that they have to rescue irresponsible governments with public money. Banks are the main creditors of such governments. Thus, bank stocks soared.

The spending mess goes in a circle. Banks have financed irresponsible governments such as that of Greece. Now the Greek government partially defaults. As a consequence, European governments rescue banks by bailing them out directly or by giving loans to the Greek government. Banks can then continue to finance governments (the loans to the Greek government and others). But who, in the end, is really paying for this whole mess? That is the end of our story. Let us begin with the origin that coincides with beneficiaries of the last EU summit: the banking system.

The Origin of the Calamity: Credit Expansion

When fractional-reserve banks expand credit, malinvestments result. Entrepreneurs induced by artificially low interest rates engage in new investment projects that the lower interest rates suddenly make look profitable. Many of these investments are not financed by real savings but just by money created out of thin air by the banking system. The new investments absorb important resources from other sectors that are not affected so much by the inflow of the new money. There results a real distortion in the productive structure of the economy. In the last cycle, malinvestments in the booming housing markets contrasted with important bottlenecks such as in the commodity sector.

The Real Distortions Trigger a Financial Crisis

In 2008, the crisis of the real economy triggered a banking or financial crisis. Artificially low interest rates had facilitated excessive debt accumulation to finance bubble activities. When the malinvestments became apparent, the market value of these investments dropped sharply. Part of these assets (malinvestments) was property of the banking system or financed by it.

As malinvestments got liquidated, companies went bust and people lost their bubble jobs. Individuals started to default on their mortgage and other credit payments. Bankrupt companies stopped paying their loans to banks. Asset prices such as stock prices collapsed. As a consequence, the value of bank assets evaporated, reducing their equity. Bank liquidity was affected negatively too as borrowers defaulted on their bank loans.

As a consequence of the reduced bank solvency, a problem originating from the distortions in the real economy, financial institutions almost stopped lending to each other in the autumn of 2008. Interbank liquidity dried up. Add to this the fact that fractional-reserve banks are inherently illiquid, and it is not surprising that a financial meltdown was only stopped by massive interventions by central banks and governments worldwide. The real crisis had caused a financial crisis.

Conditions for Economic Recovery

Economic recovery requires that the structure of production adapt to consumer wishes. Malinvestments must be liquidated to free up resources for new, more urgently demanded projects. This process requires several adjustments.

First, relative prices must adjust. For instances, housing prices had to fall, which made other projects look relatively more profitable. If relative housing prices do not fall, ever more houses will be built, adding to existing distortions.

Second, savings must be available to finance investments in the hitherto neglected sectors, such as the commodity sector. Additional savings hasten the process as the new processes need savings.

Lastly, factor markets must be flexible to allow the factors of production to shift from the bubble sectors to the more urgently demanded projects. Workers must stop building additional houses and instead engage in more-urgent projects, such as the production of oil.

Bankruptcies are an institution that can speed up the process of relative price adjustments, transferring savings and factors of production. They favor a rapid sale of malinvestments, setting free savings and factors of production. Bankruptcies are thus essential for a fast recovery.

A Fast Liquidation Is Inhibited at High Costs

All three aforementioned adjustments (relative prices changes, increase in private savings, and factor-market flexibility) were inhibited. Many bankruptcies that should have happened were not allowed to occur. Both in the real economy and the financial sector, governments intervened. They support struggling companies via subsidized loans, programs such as cash for clunkers, or via public works.

Governments also supported and rescued banks by buying problematic assets or injecting capital into them. As bankruptcies are not allowed to happen, the liquidation of malinvestments was slowed down.

Governments also inhibited factor markets from being flexible and subsidized unemployment by paying unemployment benefits. Bubble prices were not allowed to adjust quickly but were to some extent propped up by government interventions. Government sucked up private savings by taxes and squandered them maintaining an obsolete structure of production. Banks financed the government spending by buying government bonds. By putting money into the public sector, banks had fewer funds available to lend to the private sector.

Factors of production were not shifted quickly into new projects because the old ones were not liquidated. They remained stuck in what essentially were malinvestments, especially in an overblown financial sector. Factor mobility was slowed down by unemployment benefits, union privileges, and other labor market regulations.

Real and Financial Crisis Trigger a Sovereign-Debt Crisis

All these efforts to prevent a fast restructuring implied an enormous increase in public spending. Government spending had already increased in the years previous to the crisis thanks to the artificial boom. The credit-induced boom had caused bubble profits in several sectors, such as housing or the stock market. Tax revenues had soared and had been readily spent by governments' introducing new spending programs. These revenues now just disappeared. Government revenue from income taxes and social security also dropped.

With government expenditures that prolong the crisis soaring and revenues plummeting, public debts and deficits skyrocketed.[1] The crisis of the real and financial economy led to a sovereign-debt crisis. Malinvestment had not been restructured, and losses had not disappeared, because government intervention inhibited their liquidation. The ownership of malinvestments and the losses resulting from them were to a great part socialized.

Sovereign-Debt Crisis Triggers Currency Crisis

The next step in the logic of monetary interventionism is a currency crisis. The value of fiat currencies is ultimately supported by their governments and central banks. The balance sheets of central banks deteriorated considerably during the crisis and with them the banks' capacity to defend the value of the currencies they issue. During the crisis, central banks accumulated bad assets: loans to zombie banks, overvalued asset-backed securities, bonds of troubled governments, etc.

In order to support the banking system during the crisis and to limit the number of bankruptcies, central banks had to keep interest rates at historically low levels. They thereby facilitated the accumulation of government debts. Consequently, the pressure on central banks to print the governments' way out of their debt crisis is building up. Indeed, we have already seen quantitative easing I and quantitative easing II enacted by the Fed. The European Central Bank also started buying government bonds and accepting collateral of low quality (such as Greek government bonds) as did the Bank of England.

Central banks are producing more base money and reducing the quality of their assets.

Governments, in turn, are in bad shape to recapitalize them. They need further money production to stay afloat. Due to their overindebtedness, there are several ways out for governments negatively affecting the value of the currencies they issue.

Governments may default on debts directly by ceasing to pay their bonds. Alternatively, they can do so indirectly through high inflation (another form of default). Here we face a possible feedback loop to the banking crisis. If governments default on their debts, banks holding these debts are affected negatively. Then another government's bailout may be necessary to save the banks. This rescue would likely be financed by even more debts calling for more money production and dilution. All this reduces the confidence in fiat currencies.

Conclusion

After crises of the real economy, the financial sector and government debts, the logic of interventionism leads us to a currency crisis. The currency crisis is just unfolding before our eyes. The crisis has been partially concealed as the euro and the dollar are depreciating almost at the same pace. The currency crisis manifests itself, however, in the exchange rate to the Swiss franc or the price of gold.

When currencies collapse, price inflation usually picks up. More units of the currency must be offered to acquire goods and services. What had started with credit expansion and distortions in the real economy, then, may well end up with high price inflation rates and currency reform.

It is now easy to answer our initial question: Who is paying for the mutual bailouts of governments and banks in the eurozone?  All holders of euros, via a loss of purchasing power.

Instead of allowing the market to react to credit expansion, governments increased their debts and sacrificed the value of the currencies we are using. The remedy to the distortions caused by credit expansion would have been the fast liquidation of malinvestments, banks, and governments. As the innocent users of the currencies are paying for the bailouts, it is difficult not to be a liquidationist.

The need for a common currency. Gold

The Euro Crackup

By Jeffrey Tucker |

Watching the euro melt has been like watching a train wreck in slow motion. You knew it was coming. You know which cars on the train are next line to be mashed. There is nothing you can do to stop it. You can only watch as it happens, with one car after another compressing like a tin can, and all you can do is say, “I told you so,” the entire time.

The whole European currency scheme was both brilliant and crazy. It was brilliant because Europe should have a united currency. In fact, the whole world should have a united currency. Once upon a time, it did. It was called the gold standard. National currencies were just another name for the same core thing — a nationalist spin on a global consensus. If some country had waved around an unbacked piece of paper and called it money, no one would have taken it seriously.

And the gold standard was internally policing. If one country debauched the currency, gold would flow out, the thing would lose credibility and capital would flee to places that took sound finance seriously. Governments were restrained, the hands of politicians were tied (they could only spend what they could overtly steal) and markets ruled the day. The politicians hated it, but markets were free, stable and growing.

So yes, there is a case for single currencies in regions, or even the entire world. Truly, why should people and multinational commercial institutions have to go through the ridiculous headache of changing currencies at the border? This is just pointless. Imagine if an inch meant something different in every country, and you had to come to a new understanding of its meaning in order to build on this, versus on that side of the border? Markets don’t like this kind of pointless exercise. The natural market tendency is toward unity in what matters (money) and disunity where it matters (competition and entrepreneurship).

So the European elites who cobbled together the euro after many decades of planning played to that sense, and developed a reasonable expectation of a wonderful Europe united with peace and free trade, all with a single currency. It seemed like a recreation of an older, freer, more-wonderful world. So why not?

Here’s why not: The gold standard no longer exists. It hasn’t existed since the politicians destroyed the last remnants of it in the early 1970s. And it was in 1970 that the idea of a single currency for Europe went from the dream stage to the planning stage. At the end of the gold standard, the idea should have been dropped, but it was not. The planning elites had it in their heads that this was the only way forward, and nothing would stop them.

A single currency seemed like a great idea to the relatively weak economies of Europe. The lira, peseta, escudo, franc and drachma would no longer suffer at the hands of traders who seemed to forever cling to the German mark. They could inflate without consequence. Knowing this to be a problem, the pro-euro planners cobbled together certain safeguards. There would be a single central bank, and sovereign countries would have to give up autonomous control over monetary policy. The same would apply to national finance: no more endless running of deficits, and no more free-spending legislatures.

As a condition of entering the currency union, countries would have to agree to all these terms and more, including harmonized regulatory systems. Governments would have to confess their prior sins and swear on a holy copy of the EU Constitution that they would be good from now on. Well, that didn’t happen, but the planners were so dead set on the notion of a single currency that they decided to look the other way. All these entered the union with debt and broken banking systems, all in a sort of collective hope that the whole could cover the sins of the parts.

Sure enough, the southern countries experienced a wonderful boon following the introduction of the euro. Interest rates on government bonds fell dramatically — not because their citizens were suddenly saving, and the banks were flush with capital. The reason was the new perception that the European Central Bank would operate as a guarantor of the debt of all eurozone countries. In other words, rates fell in Europe for the same reason they fell in the United States: The centralization was creating a moral hazard.

This set off a lovely economic boom that later led to bust, there just as here. The central bank, however, had already promised that it would not be involved in any bailout schemes, that it would only fight inflation. This was a strange repeat of history because this is precisely what the Fed had claimed when it was created too. Central banks always say this at the outset: We will sleep with the money, but we won’t actually do anything. We will resist every temptation!

The problems here are incredibly obvious. Countries had not actually given up all their fiscal authority. Most importantly, their banking systems still had control and, thanks to fractional reserve banking, they still could create money, and in a way that the central bank could not control. This too is a consequence of not being on a gold standard that automatically regulates and restrains the banking systems.

Now, each national banking system, and even each bank, ran its own discretionary policy, with the implicit (but never stated) guarantee from the central bank that it would never let the system fail. Worse, every country in Europe had to accept this money.

Economist Philipp Bagus of Juan Carlos in Madrid observes that the whole system embedded a kind of monetary imperialism from unsound economies to sound economies, dragging down economic structure and poisoning the whole system with the viruses of the worst states. If this story sounds familiar to Americans, it should. This is the same problem that gave rise to the crazy real estate boom in the U.S. and the subsequent meltdown. It’s our old friend Mr. Moral Hazard, but operating across the entire eurozone.

Hans-Hermann Hoppe, the economist who predicted this whole scenario in the early 1990s, observes that this centralization is the inevitable path of paper money regimes, as governments constantly seek higher and higher authorities to expiate their sins. With each step, the money gets qualitatively worse and the imposition of economic controls becomes ever more tyrannical.

What is the way out? Everyone is now talking about the restoration of national currencies, and while that is a better approach than standing by as the entire system collapses and the contagion spreads around the world, it is not as easy as it seems. Every country that wants to reassert its national currency will have to give up its debt addictions and clean up its fiscal house. The banking system will have to be deleveraged. Industries sustained by the euro subsidy will have to go belly up.

If this fantasy actually became true, it would be entirely possible for any one country (hint: Germany) to adopt an authentic gold standard, perhaps inspiring others to do the same. The end result — we are talking about a decade-long process here — could, in fact, be another single European currency, a sound currency rooted in reality and not the hallucinations of politicians and financial elites.

How much tolerance is there in the world today for such pain? You need only look at the U.S. situation to get an idea. The technocrats in charge today are completely unlike those of yesteryear. They will not permit wholesale deleveraging. They believe that they have the tools to prevent all pain, and the political systems of the world are structured to punish anyone who thinks about long-term gains over short-term pain. If you doubt that, take off an evening and watch the Republican presidential debates.

All booms bust. The only question is when

The Truth About China

By Tim Staermose 

There’s a key concept in economics called the law of diminishing returns. It sounds complex, but it’s actually very easy to understand.

Imagine for a moment that there are two towns cut off from each other by a vast river. Communications and trade are infrequent at best. But if you build a bridge, you’ll get a tremendous boost to the possibilities for trade and commerce.  Economic activity rises dramatically. 

Build another bridge a half-mile from the first one and you’ll ease congestion, speed up travel times, and create some further improvement in the region’s economy.  But the additional returns on investment for the second bridge pale in comparison with the first. 

So on and so forth for the third, fourth, fifth bridge that you build. Each successive bridge provides less and less of a boost to the regional economy.

What China has been doing for years now, is the equivalent of having built thousands of bridges, each one providing diminishing returns to its economy. Even more concerning, China has been building these economic bridges, so to speak, even though when they weren’t necessary.

Consider that the share of fixed asset investment in China, at more than 65%, is the highest for any major economy in modern history. What’s more, China’s own electricity authority recently reported that there are 64.5 million dwellings in China where absolutely no electricity is being used. The investments they’re making are producing little return.

When I was back in Wuhan this summer, I saw exactly this phenomenon.  You may never have heard of it, but Wuhan is an important commercial city of more than 10 million.

Barreling along one side of an 8-lane highway towards the airport with hardly another vehicle in sight, we passed apartment block after apartment block, sitting empty like a construction graveyard.

Eventually we crossed a gigantic new bridge over the Yangtze River.  Barely half a mile downstream, another equally vast and expansive bridge was nearing completion… and others further down the river.

I was astounded. There was no traffic. No commercial activity. No people. No tolls. Just empty space and a lot of ridiculously expensive bridges. It was something out of a bizarre zombie flick. 

There are thousands of similar projects all over China, many funded by debt.  And, with no direct cash flows earned back and the ongoing maintenance required, these infrastructure projects have become huge liabilities on the Chinese government’s balance sheet.

The conventional wisdom is that China’s economy will continue to grow 8% or 9% per year indefinitely. And a lot of people are drinking this Kool-Aid. It sounds a lot to me like the other old songs that we’ve heard over the past few years, like “real estate always goes up in value.” Famous last words.

I live by another rule:  “All booms bust.  The only question is when.”  And China has had one of the biggest economic booms in history over the past decades. In fact, per capita consumption of cement in China is at the same levels as Taiwan and Japan right before those infrastructure-boom economies hit a brick wall.

Absurd hysteria

Kindergartner Suspended Over Toy Gun

A gun in private hands represents the empowerment of the individual. This is why the Second Amendment was considered so crucial by the Founding Fathers — and why collectivist moonbats hate handguns with an unholy passion, causing them to once again give way to absurd hysteria:

A kindergartner has been suspended from Cheviot Elementary [in Cincinnati] after it was discovered he brought a toy gun to school.

Liam Adams, 5, was sent home Wednesday with a letter stating that he would be suspended for three days for possessing a “dangerous weapon or object.”

Dangerous? Gasps Liam’s mom,“[H]e’s a baby … and a little tiny toy gun not even the size of my hand, it’s just ridiculous.”

Actually, it makes total sense. Condition people from the age of 5 to regard firearms with horror and shame, and they will be less likely to grow up to understand or even deserve American liberty, much less be willing or able to fight for it.