Last week in Europe

Some thoughts on the ongoing crisis

by DETLEV SCHLICHTER

Last week was supposed to be a major week for Europe. We had the ECB meeting on Thursday and then another EU summit to ‘solve’ the eurozone debt crisis on Thursday and Friday. Of course, nothing has changed, nothing has been solved, and quite frankly, I do not see any reasons whatsoever for changing my analysis of what is going on and how all of this is likely to end – badly, that is. If anything, the events of last week confirm that authorities are adamant to continue travelling further on the road to complete currency destruction – not only in the eurozone but equally in the U.S. and the UK, although the latter two are managing to escape closer scrutiny by markets for the time being. As usual, I felt that most of the commentary in the media was missing the main points.

The problems around the world are essentially the same. After decades of ongoing and generous expansion of the fiat money supply, of artificially low interest rates and cheap credit, banks are hopelessly overextended, asset markets are distorted, and sovereign states are bust. I sometimes get pushback on the last point. Are they really bust? – Yes, most of them are. They have acquired debt loads and spending habits – now very deep-rooted and practically impossible to eradicate – that require constant new borrowing at fairly low interest rates – cheap credit forever. Obviously, that is not going to happen. The end of the forty-year credit boom has arrived. The private sector is no longer playing ball.

What needs to happen? The overextended credit edifice needs to be cut back to a size that is commensurate with the underlying pool of real voluntary savings and with underlying real income streams. Money printing and the constant attempt to manipulate lending rates down have to stop. The market has to finally be allowed to set interest rates that reflect the true cost of available savings, and to liquidate what is not sustainable. Deleveraging, default, and debt deflation are necessary to bring the economic structure back into balance. Is this painful? – You bet. It is also unavoidable. There is no other solution. Yet, the solution is deemed politically unacceptable and it is thus being fought tooth and nail. Not only in the US and the UK, also in Europe.

The entities that are most under stress in this scenario are the banks and the debt-addicted states. You know my forecast: the central banks will be asked to underwrite the states and the banks directly with the help of the printing press on an ever-larger scale, and this will ultimately lead to higher inflation and finally to paper money collapse: the end of our present fiat money system, the latest experiment in the sad history of unlimited and fully elastic state money systems.

While this is broadly a global story, many people question whether it really applies to Europe. Isn’t the ECB more conservative, more Bundesbank-like, and thus less prone to debt monetization than the other central banks? Is there not some real effort being made in Europe to sort out the fiscal problems? – No. Most of it is simply theatre that has no or little implication for the final outcome. Let me explain.

The EasyB.

Like the other major central banks around the world, the ECB played its role in setting the world up for the credit bust by providing the cheap credit for the preceding credit boom. The ECB’s balance sheet – or rather the consolidated statement of the Eurosystem as it is correctly termed – started out at less than €690 billion in 1999. On the eve of the present credit crunch, in the summer of 2007, the balance sheet had reached a size of €1.2 trillion. In fact, over this period the ECB’s balance sheet had grown faster than that of the Fed. Like all other central banks, the ECB has, since the crisis began, become the lender-of-last resort to ever more banks and also to state institutions. At the end of 2011, the ECB’s balance sheet will be more than €2.4 trillion – its largest size ever, and also more than 20% larger than at the start of the year!

And as Mr. Draghi, the ECB’s top central banker, told us on Thursday, the growth of the central bank’s balance sheet will continue. More than four years after the crisis started and more than three years after Lehman collapsed, none of the problems in the European banking community are fixed. This is evidently the case as the European banking sector is still in desperate need of ongoing and, this is important, growing central bank support. In fact, the ECB announced more ‘liquidity’ measures to prop up the banking system this week. It also stated that it would lend money against an even wider range of collateral than previously. These measures are similar to the ones announced a week earlier by the major central banks around the world, which were also designed to lessen funding pressures among the banks. We can only conclude that the state of the banking sector must be extremely precarious.

Can all these banks ultimately be ‘eased’ back into lasting health and operational independence by the central banks? Of course, not. A reduction in banking capacity via a shrinking of balance sheets and potentially via defaults is ultimately unavoidable. Again, the banking sector overdosed on years of cheap credit. The boom will not be extended forever. Rehab is inevitable. So are the present measures of the central banks aimed at slowing this process, at postponing it, at sabotaging it or even completely avoiding it? I fear that the key decision-makers don’t even know the answer themselves. They simply want to buy some time, I guess.

The ECB had by Thursday night also fully reversed its timid and tentative rate hikes from spring and summer and was thus back to record-low policy rates. Developments last week thus confirmed my outlook: None of these central banks have an exit strategy. If you believe that these so-called unconventional and extreme measures are temporary, and that policy will be normalized at some stage, you are mistaken, in my view. The biggest direct beneficiaries of cheap money from the central banks are now the ‘private’ banks and the sovereigns, and as the shrinkage and/or failure of these entities is deemed politically unacceptable, and as the states in particular cannot cut back their expenditures and thus their deficits meaningfully, the central banks will continue to print money.

It is somewhat astonishing that in financial market debate and in large parts of the media coverage of ECB policy, the idea is conveyed that the ECB was being particularly stringent. This is due to the fact that many now demand that the ECB provides not only ‘unlimited’ direct support to the banks but that it should also manipulate directly the prices of certain financial assets, in particular the prices of governments bonds of weaker eurozone states, to an unlimited degree, because many banks hold huge quantities of them and they struggle with the lower and, I would suggest, more appropriate market prices for these securities. ‘Unlimited’ bond buying, however, is something that the ECB struggles with, at least officially, and that hits some raw nerves in Germany. Draghi’s negative assessment of large-scale bond buying in the press conference made all the headlines last week, and this is what helped to give the impression of conservatism and policy tightness.

The whole affair is complete theatre, of course. The ECB has indeed been engaged in sizable price-fixing operations in the government bond market for quite some time and is still conducting these operations today. Every week, the ECB buys bonds of weaker eurozone states in an attempt to lift their prices above normal market-clearing levels. Such indirect funding of state spending via the printing press is against ECB-rules, as Mr. Draghi confirmed again in his press conference. However, it is being done continuously by the ECB and defended with the ridiculous excuse that these operations are needed to allow a proper transmission of ECB policy. This is a blatant lie, of course, but apparently all this money-printing, market manipulation and rule-breaking still doesn’t go far enough for many in the financial industry who now demand even more money printing and more market manipulation. Please remember that the ECB presently limits its bond buying to €20 billion per week. If it only continues at this pace, which I expect it to do until it will give up its faint resistance and accelerate bond buying, the present procedures will add up to more than another €1trillion by next Christmas, and thus mean that the ECB’s balance sheet has expanded by another 42% in a single year! But, according to financial market economists, that is not enough!

None of this is a solution but all that market participants (and politicians) want is apparently some peace and quiet, a little pause in this unfolding disaster. Of course, it is only a question of time and the ECB will accommodate the wishes for even more aggressive money-printing. Again, I consider most of the debate theater.

Inflation will rise

What will all this money-printing mean for the purchasing power of money? – The answer is clear in my view: it will mean rising inflation, then accelerating inflation when confidence in paper money erodes and when central banks will find it impossible to restore such confidence through tighter policy.

It is truly remarkable that four years into a major credit correction, none of the major economies has registered any deflation. Of course, those who have an irrational fear of deflation and declare it an evil to be avoided at all cost will consider this a success. The truth is, a deflationary correction would be the natural response at the end of an extended inflationary boom based on artificially cheap money. Deflation would be part of a necessary, if in many ways painful adjustment process. This process is aborted via aggressive money printing from the central banks. We can clearly see that nothing has been solved and that the channels through which money debasement occurs have simply changed but that it is still ongoing.

Inflation in the eurozone may not be very high at present but it is above target and it will, in my view, continue to rise. The idea that all this money printing is not only harmless but also positive because it avoids deflation is nonsense. In the case of Britain, we are told every month that the Bank of England needs to keep rates low and its balance sheet expanding to avoid deflation and economic contraction when inflation has continuously been above target and in fact rising. Something similar is now unfolding in Europe. Easy money is supposed to help the banks and the states but enough of it is leaking into the wider economy to continually debase the monetary unit, while failing to initiate another artificial boom in the wider economy. I consider what we are seeing in Britain a good blueprint of what will unfold elsewhere in coming quarters: rising inflation (now above 5 percent in the UK), ongoing central bank balance sheet expansion (whether labelled officially ‘quantitative easing’ or something else), an overall weak economy with rising unemployment, failure to reign in budget deficits.

Fiscal consolidation and fiscal integration

It can only be a sign of desperation that grown and otherwise intelligent people believe that the solution to Europe’s debt problem is fiscal integration or policy coordination. This is at a minimum naïve. Debt levels and budget deficits are not where they are today because of a lack of coordination or integration among the member states. They are where they are because NONE of the states can live within their means.

Fact is that all members of the club have been shown to be habitual over-spenders and fiscal-rule breakers for years. The risk that in a fiat-money union some members may run excessive deficits and then expect to get bailed out by the other states or via the printing press, thus being rescued by a process that involves taking from the tax-payers in other countries (via fiscal transfers) or by taking from their own savers and savers in other countries (via higher inflation), was understood and clearly seen from the start of EMU. That is why certain rules were implemented: budget deficits shouldn’t exceed 3 percent, overall debt levels not 60 percent, there was a no-bail-out provision, and the ECB was banned from bailing out states with the printing press. ALL of these rules have now been broken. Germany insisted on the Maastricht criteria which restricted overall state debt to 60 percent of GDP. Germany herself is now at 83 percent – and happily signing up to new commitments in bail-out-funds that should not be possible under EU rules to begin with.

All fiscal rules have by now been broken. Bail-outs have been implemented and the ECB is funding member states to the tune of €20 billion per week!

But now, these politicians tell us, now we can finally trust them. Because all these cheaters and fraudsters will now check on one another very thoroughly as part of ‘fiscal integration’ under a new set of self-imposed restrictions and with a new treaty, and this will turn a club of rogues and rascals into a group of prudent and trustworthy guardians of the public purse.

This whole idea only deserves ridicule. It is completely laughable. Of course, it will not work. Sadly, it is also presented to the public with that specifically distasteful ingredient of bureaucratic micro-management. Obviously, the member states only trust one another to obey the rules if all decision-making is minutely coordinated and policy-setting on everything from corporate tax laws to bank regulation carefully centralized under a new European super-state. We will get more state-interference, more centralization, more meddling in markets, more and higher taxes and more capital misallocation. What we will not get is less government spending. All power to the bureaucracy!

The endgame does not change because of any of this. The only question is this: Will this impress the markets and restore some stability for a while? I doubt it.

In the meantime, the debasement of paper money continues.

Rome is burning while fiddlers are playing

Ludwig von Mises on Economic Growth, Denial, and Truth in Europe

By John Chapman

Recent data from Europe suggest the economy there is already in recession with, regrettably, the political class seemingly in denial over its potential severity.  Depending on the fate of bank recapitalizations there, a Eurozone recession may or may not pull the U.S. down with it in 2012, but it will bear close watch.  In any case, brief highlights of causes and consequences of this are discussed below, but we start our analysis of the present global economy by recalling the similar-seeming gloom and denial of the early 1970s here.

When the great Austrian economist Ludwig von Mises died in New York on October 10, 1973, he was a broken man.  Mises had devoted his life to the cause of unrestricted laissez faire — or as he called it, the unhampered market economy.  He understood better than any man who lived in the 20th century what redistributive interventionism would generate: for the individual, lower living standards that bred frustration and broken dreams. And, at a macro level, slower growth, a breakdown in social cooperation due to declining investment, and in the extreme, the unraveling of civilization itself are the inevitable results of socialist policies. 

As a captain in the field artillery of the Austro-Hungarian army in the Carpathian Mountains during World War I, he had witnessed the destruction of a century of peace and progress in Europe in a war that could only have happened in collectivist madness.  Then came the interwar disintegration in Germany.  Later, with the rise of Hitler, he felt compelled to leave Vienna for the relative safety of Geneva in 1934, and eventually hurried across France in a bus bound for Lisbon — his gateway to America — just ahead of advancing German armies in 1940, having left behind and lost everything.

For Mises the repeated denial of reality by the major powers both throughout World War I and then about Germany during the interwar period, were a depressing commentary on the inability of the political class to act in ways that benefited the populace.  But this was not to be the worst of it: following the post-war rise of collectivism, in 1971 he was horrified to see the final and total decoupling of the world’s currencies from gold, the first time in at least 2,700 years that the yellow metal was not money anywhere in the world. 

Mises knew — and predicted — that a regime of fiat currencies everywhere in the world would not end well.  He asserted at the time that this would lead to an era of unprecedented monetary instability, fiscal profligacy that guaranteed retrograde government policies, depressions, and inevitably, social conflict.  Without a sound monetary system to facilitate trade and harmonious cooperation between countries, peaceful and progressive economic order disintegrates.  And ultimately, Mises knew, this leads to the kind of catastrophe we lived through in 2008, and whose reverberations will now long be felt, even as we may yet live through it all again.

Mises’ heroic life and vision — and the depth of despair he felt at the end over the Orwellian denial all round him alongside retrograde policies — were recalled to us this week for two reasons: first, the fairly unprecedented intervention by the Federal Reserve and other central banks’ easing to support initiatives undertaken by the European Central Bank (ECB) to prop up asset values and maintain interbank credit flows in the Eurozone.

And secondly, the calendar has turned inside one month until the first votes are cast in the 2012 election for the U.S. Presidency.  This election, like those of 1896, 1932, and 1980 before it, is dominated by the lingering effects of a recessionary downturn borne of monetary instability.  And like those others, it is an inflection point that will either ratify existing policies put into place in the wake of the recession, or bring someone new in to change the direction of policy (as an aside, in all three of those prior inflection point elections, the candidate from the challenging party beat the incumbent or his party; in 1896 the Republican challenger McKinley defended the incumbent Democrat Cleveland’s monetary policy against radical change sought by William Jennings Bryan, but in 1932 and 1980 the White House switched party hands and policy regimes). 

The United States thus has two very different futures in store based on competing visions that will be discussed next year — one in which government-run health care and 25% federal spending-to-GDP levels are permanently cemented into America’s welfare state apparatus, or the other in which much policy in recent years is dismantled and the U.S. economy retreats back toward <20% spending-to-GDP.

Mises had long recognized the inescapability of such a clash to the death of the competing ideologies – between socialism and the market economy – that is now in store for us in 2012.  And as such, he would understand the primal importance of vigorous engagement with the other side in the months prior to the vote.  As he wrote in 1922,

Everyone carries a part of society on his shoulders; no one is relieved of his share of responsibility by others. And no one can find a safe way out for himself if society is sweeping toward destruction. Therefore everyone, in his own interest, must thrust himself vigorously into the intellectual battle. None can stand aside with unconcern; the interest of everyone hangs on the result. Whether he chooses or not, every man is drawn into the great historical struggle, the decisive battle into which our epoch has plunged us.

This sentiment resonates as one reviews the situation in the Eurozone this week in the run-up to the meeting that may yield greater fiscal coordination there in exchange for German acquiescence to a quasi-bailout of periphery debtors.  And indeed this is a great historical struggle, though too many on both sides of the Atlantic seem not to realize it.  The wrangling over first Belgian, then more acutely Greek, and now Italian, debt has consumed the better part of two years, with little resolution alongside growing investor risk and pervasive gloom about the Eurozone’s prospects.  And here in the United States, concerns about the Eurozone have taken on an outsized proportion, with wild stock market swings on every bought rumor and sold fact.  As gloomy as Mises was at his end, he nonetheless also never failed to think clearly.

And so the first thing to note is that indeed, Europe is likely headed into recession in 2012.  Data on Eurozone manufacturing out this week were stark in their universal trend in the last four months (>50 = expansion; <50 signals contraction):

These data are alarming for their trend uniformity; while the manufacturing sector is now down to roughly 20% of the total Eurozone economy, like everywhere else in the world, it correlates very closely with changes in GDP growth.  Capital goods equipment production is tailing off at an alarming 2% rate on a quarterly basis, partly due to rising rates in Europe, but mainly due to perceived drop in primary demand.  The Eurozone PMI Index was in fact down to a 28-month low, and there were job layoffs in every country except Austria and Germany. New orders have fallen for the fifth month in a row, and at the steepest rate in 30 months, due to both the lack of demand in Europe and for exports.

An empty chair resolves nothing

Britain opts for the empty chair

FT Editorial

For the past 30 years, going back well before the Maastricht treaty, successive British governments have sought to maintain influence in Brussels while steering clear of some of the European Union’s signature projects, notably the single currency.

The crisis in the eurozone has laid bare the contradictions in this policy. As the single currency’s woes have deepened, British ministers have found themselves pulled in two directions. Terrified by the consequences of the euro’s failure, they have urged fiscal union on the eurozone as a means of shoring up the currency. George Osborne, the chancellor of the exchequer, has even talked about the “remorseless logic” of tighter integration. But those same ministers have deprecated the idea that this would have consequences for Britain. The message has been: “do what you must but leave us out”.

Public disenchantment with the EU has spurred the British government to ratchet up its demands. Not only has opposition on the Tory benches hardened against any further transfer of powers, but calls have intensified to claw some back. In recent weeks, David Cameron has been egged on to demand a price – in repatriated powers – for nodding through any change in the EU treaties that a eurozone rescue might require.

Events at the European summit this week have spectacularly unseated Mr Cameron’s attempt to ride these two diverging horses. In pursuit of safeguards designed principally to protect the City of London, the prime minister has vetoed a treaty whose ostensible purpose is to secure a rescue of the eurozone. His determination not to see such a treaty enacted at the level of the 27 existing members has forced its authors – France and Germany – to pursue an inter-governmental agreement.

The consequences are still reverberating around Europe. It is too soon to know whether the breach is permanent. A purely inter-governmental arrangement could be legally tiresome for the eurozone, denying it access to EU institutions and forcing it to design a whole parallel structure for its deal. Conceivably, after a further round of horse-trading, a compromise might be reached.

But this cannot soften the impact of the British veto. Mr Cameron may describe himself as “relaxed” about a decision which allows him to sidestep a referendum he was desperate to avoid, and which would almost certainly have smashed his coalition government. But the price has been to ditch past UK policy, which stressed opposition to anything leading to the entrenchment of a “two-tier Europe”. That such a Europe now exists may be a logical conclusion, and one can argue that the prime minister had no choice but to accept such an outcome. But while Mr Cameron is enjoying his newfound bulldog role at Westminster, his stand in Europe makes for disastrous politics. No other member state has backed Britain. The impression is that Mr Cameron has hindered a euro rescue. While the Financial Times does not believe any price is worth paying to be in the room, Britain in this instance has wielded a veto and gained nothing in return.

The prime minister chose to take a stand on protecting the City. The government has long worried about the incoming tide of EU regulation, some of which could damage the financial services industry, a vital national interest. In a more integrated eurozone, the government fears there could be moves to tighten and centralise financial supervision in ways that harm the UK. It is not unreasonable for a British government to seek to nip such a risk in the bud.

However, forcing the eurozone to set up its own parallel union will not protect the City. The new club’s 17 members could still force through big changes to the single market if they acted as a bloc. While this may not be an immediate risk – they remain divided on many issues – things may change as they move closer and cut deals among themselves. France and Germany have already indicated a wish for the eurozone to encroach on areas hitherto reserved for all 27. These include labour market regulation and a common corporate tax base.

By precipitately wielding his veto, Mr Cameron may well have hastened the formation of such a bloc, to the detriment of British interests. Moreover, forcing the eurozone to pursue its own treaty has put his own goal of repatriating powers beyond reach.

Mr Cameron must now find a way to restore the UK’s influence over the single market. This will require resourcefulness and political courage. One thing is clear: an empty chair resolves nothing.

A vicious Spring

Libya betrayed

The Hindu Times Editorial

Libya's interim government, the National Transitional Council (NTC), is getting no international help over the enormous problems it faces. To start with, the NTC has failed to restrain the militias that hold several areas and have killed thousands of people in attacks on alleged or real former supporters of Muammar al-Qadhafi. Reliable Libyan observers have likened the arbitrary killings, arrests, and torture to the former regime's brutalities. There have also been racist lynchings of African migrant labourers mistaken for mercenaries. A recent United Nations report characterises the militias as a major challenge to the NTC; it points out that women whom they detain are at particular risk. The NTC also faces political problems with Libya's severely divided society; five Amazigh or Berber leaders boycotted the November 24 swearing-in of the cabinet, saying that their ethnic group had not got enough posts. Nato, which deployed U.N. Security Council Resolution 1973 ostensibly to protect civilians but in reality to cause violent regime change, is making no attempt to intervene. The U.N. mandate ended on October 27, and the Atlantic alliance has rejected Tripoli's request that it protect Libyan frontiers against possible re-entry by Qadhafi loyalists who fled the country as the regime disintegrated.

Furthermore, the U.N. states that both rebel and government forces committed atrocities during the uprising. Serious issues, however, have arisen over the trials of office-holders in the old regime, with some western officials calling for them to be tried in Libyan courts rather than the International Criminal Court (ICC). That would be consistent with the ICC's statute, but would also conceal key problems. First, Libya's judicial system is not currently fit for such trials. Secondly, ICC trials would enable defendants to reveal evidence of western collusion with the Qadhafi regime over many years. As it is, the British security service MI6 faces a possible criminal investigation following the discovery of documents in a Libyan government office that show U.K. cooperation with Mr. Qadhafi over the forced deportation of a Libyan dissident, Sami al-Saadi, and his family, from Hong Kong in 2004. The whole family was imprisoned; Mr. al-Saadi was held for six years, and tortured. During that period, British Prime Minister Tony Blair visited Tripoli and announced counter-terrorism cooperation, and the Shell company signed a £550-million deal with Libya. Interim Prime Minister Abdurrahim El Keib could well conclude that all Libyans have been betrayed by their so-called friends and helpers in Nato.

On doing the right thing

Great Britain Saves Itself by Rejecting the EU

The French and Germans may howl with outrage, but David Cameron did the right thing in pulling up the drawbridge to a continent on the verge of collapse, says Niall Ferguson.

by Niall Ferguson

To listen to some conservative commentary in London on Friday, you would think the British Prime Minister David Cameron just morphed into Winston Churchill, valiantly upholding England’s ancient liberties against German aggression. In fact, what happened in Europe this week was nothing so grandiose. 

David Cameron’s refusal to back a Franco-German plan to revise the European Union treaty was the culmination of a consistent Conservative policy, dating back to Margaret Thatcher and continued under John Major. That policy has been to resist any steps taken in the name of European integration that would in practice lead to Britain’s becoming a member of a federal Europe.

Cameron is not—despite the opprobrium that has been heaped on his head by everyone from the French President Nicolas Sarkozy to the shadow foreign secretary Douglas Alexander—a pathologically insular Little Englander. Like Margaret Thatcher, he believes in the single European market. Like John Major, he opposes British membership of the European monetary union. As over the Schengen Agreements on passport-free travel, as over the euro, Britain has once again reserved its right to retain sovereignty over key areas of policy.

Nor is this an exclusively Conservative policy tradition. Gordon Brown, too, resisted the siren calls of the Europhiles in his own party to take Britain into the EMU. I don’t think he did this out of high principle, mind you. I suspect it was partly to spite Tony Blair, partly to maximize the economic power he retained as chancellor of the Exchequer and partly to please his friends in the City, many of whom were rather put off of monetary union by the trauma of Britain’s brief membership of the Exchange Rate Mechanism. Nevertheless, Brown’s preservation of the pound was his single greatest achievement. Had he yielded, the British economy would now be suffering a far more agonizing economic contraction, because we would have lacked the monetary flexibility that was so successfully used by Sir Mervyn King to mitigate the impact of the 2008-9 financial crisis.

So it is not that British policy has dramatically changed. The real historical turn is the one now being taken by the 17 euro zone members and the six non-euro states that have chosen to follow them. For there should be no doubt in anyone’s mind that what they have just agreed to do is to create a federal fiscal union. Moreover, it is a fundamentally flawed one. The only surprising thing is that so few other non-euro countries—Sweden, maybe the Czechs and Hungarians—have joined Britain in expressing reservations. I quite see why countries with the euro are prepared to give up their fiscal independence to avert a currency collapse. But what on earth is in this for the others?

Nicolas Sarkozy, as usual, bad-mouthed the British prime minister in the hope of maximizing his own personal glory at the expense of la perfide Albion. “Very simply,” declared the French president, “in order to accept the reform of the treaty at 27, David Cameron asked for what we thought was unacceptable: a protocol to exonerate the U.K. from financial-services regulation. We could not accept this as at least part of the problems [Europe is facing] came from this sector.” This is claptrap of the lowest order.

To see why, you need to read the “international agreement” announced in the early hours of Friday. The stated aim of the agreement—which would have been the aim of EU treaty revision had Cameron rolled over—is to establish and enforce “a new fiscal compact and strengthened economic policy coordination” in the euro area. The phrase “fiscal stability union” is explicitly used. It is to be based on “common, ambitious rules” and “a new legal framework.”

How will this work? The answer is that there will be a “new fiscal rule”: “General government budgets shall be balanced or in surplus; this principle shall be deemed respected if, as a rule, the annual structural deficit does not exceed 0.5 percent of nominal GDP.” This balanced budget rule is to be adopted in the national constitutions of euro zone members. But there will also be an “automatic correction mechanism,” enforceable by the core EU institutions—the commission, the council, and the court—if member states violate their own constitutions.

Moreover, the document states that there will henceforth be “a procedure … to ensure that all major economic policy reforms planned by euro area Member States will be discussed and coordinated at the level of the euro area” with regular euro zone summits to be held at least twice a year. The French and Germans leaders have made it clear that they envisage harmonizing labor law, taxation, and financial regulation on this basis.

This, in sum, is the founding charter of the United States of Europe. Notice two problems however. First, it is not clear how the European Commission, Council, and Court can act in this way, policing a 23-member fiscal union that is not covered by any treaty. Second, the balanced-budget rule is nuts. As it stands, it’s a recipe for excessive rigidity in fiscal policy—unless you think the rest of the Brussels Agreement implies a significant centralization of fiscal policy. Because you cannot have a balanced budget rule for member states if you don’t also have a federal government with flexible fiscal rules (as in the U.S.).

So where is the clause describing the new USE Treasury, with the right to issue bonds as well as to transfer resources from the more productive to the less productive member states? The answer is there isn’t one because the German voter refuses to countenance such a thing. That means one of two things. Either it’s going to be created by stealth—or this is a federal union that will be dead on arrival. I think it’s supposed to be the former, but I am not sure.

Remember, none of this would be happening if it wasn’t for a disastrous crisis of the Eurocrats’ own making. Twelve years ago, I was one of a small band of commentators who warned correctly that a monetary union without some fiscal component would fall apart after about 10 years. Four years ago, I was also one of a handful of people who pointed out that the German banks were in worse shape than the American banks and needed urgent attention. Europe’s leaders ignored these arguments. The result has been an entirely predictable combination of fiscal crisis and banking collapse.

There is now a depression on the other side of the English Channel, and it is the continent that is cutting itself off—from sane economic policies.

In the past few months, incompetent leadership has brought the euro-zone economy, and with it the world economy, to the edge of a precipice strongly reminiscent of 1931. Then, as now, it proved impossible to arrive at sane debt restructurings for overburdened sovereigns. Then, as now, bank failures threatened to bring about a complete economic collapse. Then, as now, an excessively rigid monetary system (then the gold standard, now the euro) served to worsen the situation.

For some time it has been quite obvious that the only way to save the monetary union is to avoid the mistakes of the 1930s. That means, first, massive quantitative easing (bond purchases) by the European Central Bank to bring down the interest rates (yields) currently being paid by the Mediterranean governments; second, restructuring to reduce the absolute debt burdens of these governments; third, the creation of a new fiscal mechanism that transfers resources on a regular basis from the core to the periphery; and finally the recapitalization of the ailing banks of the euro zone.

The problem is that the Brussels Agreement only does these things in the most half-hearted way. Aside from new borrowing, euro-area governments have to repay more than €1.1 trillion euros of long- and short-term debt in 2012, with about €519 billion of Italian, French, and German debt maturing in the first half alone. Meanwhile, the European banks need, we are now told, €115 billion of new capital—of which €13 billion is required by German banks.

Yet the European Financial Stability Fund has been capped at €500 billion, of which more than half has already been committed. The International Monetary Fund is to be given (by whom?) just €200 billion to recycle back (to whom?). And the ECB has committed itself to spend no more than €20 billion a week on bond purchases in the secondary market.

It is all, quite simply, too little. And the result is that the euro zone is about to repeat history. In the absence of sufficient resources for the new federal model, the new rules about budgets (and bank capital) are going to lead to pro-cyclical fiscal and monetary policies, deepening rather than alleviating the economic contraction we are witnessing.

“Eurozone Deal Leaves Britain Isolated” trumpets the Financial Times, for many years an ardent proponent of monetary union. But if David Cameron can succeed in isolating Britain from the disaster that is unfolding on the continent, he deserves only our praise. For once the old joke—“Fog in the Channel: Continent Cut Off”—seems applicable. There is now a Depression on the other side of the channel, and it is indeed the continent that is cutting itself off—from sane economic policies.

Last month I warned that the disintegration of the European Union was more likely than the death of the euro. You now see what I meant. The course on which the continent has now embarked means not just the creation of a federal Europe, but a chronically depressed federal Europe. The Eurocrats have exchanged a Stability and Growth Pact—which was honored only in the breach—for an Austerity and Contraction Pact they intend to stick to. The United Kingdom has no option but to dissociate itself from this collective suicide pact, even if it strongly increases the probability that we shall end up outside the EU altogether.

Many more brickbats will rain down on David Cameron in the days to come. But he has done the right thing. And he will swiftly be vindicated by events on the cut-off continent.

Good luck with that

Statist Delusions 

The bill for cradle-to-grave welfare has come due.

By Mark Steyn

The president of the United States came to Osawatomie, Kan., last week to deliver a speech of such fascinating awfulness archeologists of the future sifting through the rubble of our civilization will surely doubt whether it could really have been delivered by the chief executive of the global superpower in the year 2011.

“This isn’t about class warfare,” declared President Obama. Really? As his fellow Democrat Dale Bumpers testified at the Clinton impeachment trial, “When you hear somebody say, ‘This is not about sex,’ it’s about sex.” The president understands that “Wall Street,” “banks,” “fat cats,” etc. remain the most inviting target and he figures that he can ride the twin steeds of Resentment and Envy to reelection and four more years of even bigger Big Government. His opponents, he told us, “want to return to the same practices that got us into this mess . . . . And their philosophy is simple: We are better off when everybody is left to fend for themselves and play by their own rules . . . . It doesn’t work. It has never worked.” He blamed our present fix on “this brand of ‘you’re on your own’ economics.”

This is a deliciously perverse analysis of the situation confronting America and a fin de civilisation West. In what area of life are Americans now “on their own”? By 2008, Fannie and Freddie had a piece of over half the mortgages in this country; the “subprime” mortgage was an invention of government. America’s collective trillion dollars of college debt has been ramped up by government distortion of the student-loan market. Likewise, health care, where Americans labor under the misapprehension that they have a “private” system rather than one whose inflationary pressures and byzantine bureaucracy are both driven largely by remorseless incremental government annexation. Americans are ever less “on their own” in housing, education, health, and most other areas of life — and the present moribund slough is the direct consequence.

It would be truer to say that the present situation reflects the total failure of “you’re not on your own” economics — the delusion of statists that government can insulate millions of people from the vicissitudes of life. Europeans have assured their citizens of cradle-to-grave welfare since the end of the Second World War. This may or may not be an admirable notion, but, both economically and demographically, the bill has come due. Greece is being bailed out by Germany in order to save the eurozone but to do so requires the help of the IMF, which is principally funded by the United States. The entire Western world resembles the English parlor game “Pass the Parcel,” in which a gift wrapped in multiple layers of gaudy paper is passed around until the music stops and a lucky child removes the final wrapping from the shrunken gift to discover his small gift. Except that, in this case, underneath all the bulky layers, there is no gift there: Broke nations are being bailed out by a broke transnational organization bankrolled by a broke superpower in order to save a broke currency. Good luck with that.

The political class looted the future to bribe the present, confident that tomorrow could be endlessly postponed. Hey, why not? “Tomorrow, and tomorrow, and tomorrow, creeps in this petty pace from day to day,” says Macbeth. “To borrow, and to borrow, and to borrow,” said the political class, like Macbeth with a heavy cold (to reprise a rare joke from Mrs. Thatcher). And they failed to anticipate that the petty pace would accelerate and overwhelm them. On Thursday, Jon Corzine, former United States senator, former governor of New Jersey, former Goldman Sachs golden boy, and the man who embodies the malign nexus between Big Government and a financial-services sector tap-dancing on derivatives of derivatives, came to Congress to try to explain how the now-bankrupt entity he ran, MF Global, had managed to misplace $1.2 billion. The man once tipped to be Obama’s Treasury secretary and whom Vice President Biden described as the fellow who’s always “the smartest guy in the room” explained his affairs thus: “I simply do not know where the money is.” Does that apply only to his private business or to his years in the Senate, too?

When Corzine took over the two-and-a-quarter-century-old firm, he moved it big-time into sovereign debt — because you can’t lose with sovereign debt, right? Because a nation, even one that is in any objective sense bankrupt as Mediterranean Europe basically is, is not bankrupt in the sense that a homeowner or small business is: Corzine figured, reasonably enough, that no matter the balance sheets of Portugal, Spain, Italy, and the rest, they’d somehow be propped up unto the end of time. As their credit ratings hit the express elevator to Sub-Basement Level Four, Corzine was taken down with them. The smart guy made a bet on government and lost. That’s where the rest of us are headed: The “you’re not on your own” societal model of Western Europe has run out of people to stick it to.

In Kansas, in his latest reincarnation, the president channeled Theodore Roosevelt in trust-busting mode. “He busted up monopolies,” cooed Obama approvingly, “forcing those companies to compete for consumers with better services and better prices.” But who wields monopoly power today? Washington dominates ever more areas of life, from government-backed mortgages to the government takeover of education loans to Obamacare’s governmentalization of one-sixth of the U.S. economy. In my most recent book, which makes an attractive and thoughtful Christmas gift for the apocalyptically minded loved one in your family, I quote an old joke about the British equivalent of the U.S. antitrust division: “Why is there only one Monopolies Commission?” This is a profound insight into the nature of statism: By definition, there can only be one government — which is why, when it’s “monopolizing,” it should do so only in very limited areas.

Yet, after hymning the virtues of “better services and better prices,” the president went on to issue the latest brain-dead call for increased “investment” in education. America “invests” more per student than any other nation except Switzerland, and it has nothing to show for it other than a vast swamp of mediocrity presided over by a hideous educrat monopoly. Might this fetid maw not benefit from exposure to “better services and better prices”? Perish the thought! Instead, Obama is demanding increased “investment” in “education” in order to “give people the chance to get new skills and training at community colleges so they can learn how to make wind turbines and semiconductors.”

I am not a trained economist, but it is not obvious to me that the United States of America is crying out for more wind turbines, and, if it is, I’m sure many of those colleges’ tenured Race and Social Justice Studies professors could be redeployed to serve as such. In Europe, the political class is beginning to understand that the social-democratic state created to guarantee permanent stability risks plunging the Continent into the worst instability since those happy-go-lucky days of the 1930s. By contrast, in Kansas, the president of the United States is still riding the tie-dyed wind turbine and promising to waft you to Oz. These are dangerous times — and, as many will discover, whatever assurances the statists give, in the end you’ll be on your own.

Monetary and social chaos accelerates globally

Liars Led By Junkies

By Tim Price

In my several decades as a financial and economics commentator – covering banking crises dating back to the early 1970s and the Latin American debt catastrophes of the early 1980s – I have never heard a sitting [Bank of England] governor talk in such apocalyptic terms about the parlous state of the global financial system.— Alex Brummer, The Daily Mail.

So what precisely did our inflation-fighter-in-chief actually say? Well, that euro zone instability had created

an exceptionally threatening environment

as falling government debt prices, softening confidence, and distressed asset sales threaten to

spiral

into a systemic financial crisis. Also, the UK financial system was encouraged to continue building up capital to bolster against an

extraordinarily serious

situation not of its own making and which it could not resolve. Also,

The crisis in the euro area is one of solvency not liquidity. And the interconnectedness of major banks means the banking systems and economies around the world are all affected. Only the governments directly involved can find a way out of this crisis.

And,

If debt is not to [continue] exploding to ever more unsustainable levels, transfers will be required together with the plan to restore the competitiveness within the euro area. There comes a point where the creditors need to realise that the scale of the debt owed to them is so large that they may have to be part of the solution.

Strong stuff from a fellow who looks like the hamster in “Danger Mouse”. It is all a waste of time, of course, more than a day late and more than a trillion short in whichever currency you care to proffer.

Perhaps things are not quite as bad as they seem. Last week in London we had the pleasure of hearing Gordon Corrigan speaking at Owen James’ always stimulating “Meeting of Minds” investment seminar. The intention of his speech was to put to rest a few myths about Britain”s role in the Great War. There was undeniable tragedy during those dreadful four years, but could there be a chance, asked the ex-Gurkha Major, that the Brits have tended to mythologise the whole World War One experience, magnify the national role, and accentuate the negative – a process that hardens with every passing year? 

The late Alan Clark once quoted a conversation between a German general and one of his men that has not just entered the national psyche but become firmly embedded there. These British fight like lions, observed the soldier. Yes they do, replied the general: lions led by donkeys. But apparently Alan Clark made it up. No such conversation ever took place.

And there are evidently plenty of other established “facts” about the Great War that turn out to be somewhat detached from the actualité:

The popular British view of the Great War is of a useless slaughter of hundreds of thousands of patriotic volunteers, flung against barbed wire and machine guns by stupid generals who never went anywhere near the front line. When these young men could do no more, they were hauled before kangaroo courts, given no opportunity to defend themselves, and then taken out and shot at dawn. The facts are that over 200 British generals were killed, wounded or captured in the war, and that of the five million men who passed through the British Army 2,300 were sentenced to death by military courts, of whom ninety per cent were pardoned.

The popular conception is that nearly every family in Britain had somebody killed in it. But according to the official census reports, there were approximately 9,800,000 households in Britain in 1914. The British lost 704,208 dead in the Great War. So statistically, only one family in 14 lost a member. Although there were undoubtedly certain parts of the country where fatalities were concentrated due to the way in which British infantry were recruited back then, there were large swathes of the country from where no one was killed. Corrigan has spoken of his own family, and his own black-clad Great Aunt, who never married – perhaps because all of her boyfriends and potential boyfriends met their end at the front? “Nonsense,” suggests an uncle – his Great Aunt never married because she was “simply too damned ugly”.

By Gordon Corrigan’s account, British soldiers actually spent more time playing football than facing the enemy. By regularly rotating the soldiery and never keeping men in maximum danger for more than relatively short periods of time, the British army was alone among the major forces on the Western Front in never suffering a collapse of morale leading to mutiny.  

One in 65 of the British population was killed in the war; for the French, the figure was one in 28. One in every 12 men mobilised in Britain was killed; for the French, one in six. For the Germans, one in 31 of the population was killed, one in every seven mobilised, as shown in the table below:

France, with a population six and a half million less than that of the UK, mobilised more men and suffered nearly twice as many deaths. Unlike in the UK, the demographic effect on France was enormous. 

The perception of soldiering in the Great War has the young patriot enlisting in 1914 to do his bit and then being shipped off to France.

Arriving at one of the Channel Ports he marches all the way up the front, singing “Tipperary” and smoking his pipe, forage cap on the back of his head. Reaching the firing line, he is put into a filthy hole in the ground and stays there until 1918. If he survives, he is fed a tasteless and meagre diet of bully beef and biscuits. Most days, if he is not being shelled or bombed, he goes “over the top” and attacks a German in a similar position a few yards away across no man’s land. He never sees a general and rarely changes his lice-infested clothes, while rats gnaw the dead bodies of his comrades.

Just on the topic of transportation, many soldiers were moved by train until a few miles from the front, and as the war went on, motor lorries and even London buses were used as troop carriers.  And as Corrigan has already pointed out, the rotation of troops alone ensured that conditions were altogether more bearable than the popular conception would have it. 

But back to the present. The war then may have been ultimately much less bleak for the British, for example, than the media and propaganda have portrayed. That does not mean that the peace now is any less bad for any of us than Mervyn King suggests. As investors we remain trapped in a surreal nightmare in which clueless politicians and desperate central bankers can see nothing other than money printing as a way out of the gloom. In the euro zone the problem is worse to the extent that the currency crisis is not merely severe but existential. Tragically, former voices of sanity such as The Telegraph’s Ambrose Evans-Pritchard seem to have now taken leave of their senses and joined with the inflationists, as this recent mad piece indicates.   

This crisis can be stopped very easily by monetary policy … to expand the quantity of money.

Oh, really?  I am indebted to Tony Deden for the following quotation, from Alasdair Macleod in excerpts from a speech given to the Committee for Monetary Research and Education, given in New York on 20 October 2011: 

I support sound money for two very good reasons. Firstly, it is a basic human right to choose to save, without our savings being debased by the tax of monetary inflation. Those who are worst affected by this inflation tax are not the rich, they benefit; but the poor and the barely well-off, which is why monetary inflation undermines society and why the right to sound money should be respected. If government gives itself a monopoly over money, it has a duty to protect the property rights vested in it.  

Secondly, it is a basic right for us to own our own money rather than have it owned by the banks. For them to take our money and expand credit on the back of it debases it. It is an abuse of an individual’s property rights and a banking licence is a government licence to do so. If anyone else was to do this, they would be guilty of fraud. Banks should be custodians of our money, and it should not appear in their balance sheets as their property.

Sound money guarantees a stable yet progressive economy where people are truly equal. It allows people to save properly for their retirement so that they will not become a burden on the state. It leads to democracy voting for small governments. It encourages peaceful trade and discourages war. It is the only path, after this mess, that leads us to long-lasting and peaceful prosperity. We really need everyone to understand this for the sake of our future.

Are you listening in the chancellories of Europe? Here in Britain we may not have had lions led by donkeys, but we now have liars throughout finance being led by junkies addicted to the printing of money. As democracies throughout the continent now topple to be replaced by technocrat stooges, and as the monetary and social chaos accelerates, we must hope that we at least manage to avoid the devastating political mistakes our forebears throughout Europe committed almost a century ago.

Quote of the Day

Talking about the Middle Class

"The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation."

                                                        By Vladimir Ilyich Lenin

The Road to Serfdom

Government of The Elites, By The Elites and For The Elites

By Monty Pelerin

In the short span of a century and a half, the US went from a government famously described by Abraham Lincoln as "of the people, by the people, for the people" to one "of the Elites, by the Elites, for the Elites."

Albert J. Nock referenced Lincoln's phrase as "probably the most effective single stroke of propaganda ever made in behalf of republican State prestige." Perhaps, but when Lincoln said it our country had at least some resemblance to Lincoln's description.

This country, founded on personal liberty, freedom and limited government, has morphed into a massive Social Welfare State rivaling the paragons of Socialism in Europe.  The concept of government serving the people no longer applies. The people now serve their government and its cronies.

The Founding Fathers would not recognize what has transpired in this country. Their creation and ideals have been savagely distorted if not destroyed forever. In its place stands the detested evil that results from increasingly unbridled power. The image of Leviathan ruthlessly ruling over its citizens is faintly visible.  Each violation of The Constitution and The Rule of Law only strengthens the growing monster.

Two Views of Government

Two diametrically opposed views of government played a role in our metamorphosis:

• 1. Government as Passive, Unbiased Referee
• 2. Government as Active Player

Government as Passive, Unbiased Referee

The concept of government as an honest broker used to be acceptable to many (although probably not the Founding Fathers). Fifty or sixty years ago this view was reflected in statements like: "If you can't trust your government, who can you trust?" Today, few make such statements outside of comedy club routines.

Even the libertarian Milton Friedman believed, for a time, that government could be an unbiased referee. When asked late in life about his biggest mistake, he replied that some early policy recommendations he made were based on this erroneous assumption.

If government were honest and unbiased, it would be reasonable to grant it a larger role than if it were not.  However, even this unrealistic assumption cannot justify the excessive government of today.

Government as Active Player

Public Choice Theorists, like Nobel Laureate James Buchanan and Gordon Tullock, provided an alternative view of government that was consistent with that of the Founders. They saw government as just another institution in the sense that it is populated by self-interested individuals. As such, it would be an active player in the economy and society to the extent possible.

So long as these individuals could benefit from outcomes, government could not be an honest broker. In their view, those who "serve" are no different from the "greedy" businessman who politicians regularly condemn.

This view of human nature drove the Founders to develop The Constitution, The Bill of Rights and the separation of powers in an attempt to contain misbehavior by government. Public Choice theory is merely a  modern intellectual affirmation of what our educated Founders knew two and one-half centuries ago.

Government is necessarily run by self-interested individuals until we discover a way to breed and elect angels.  Friedrich Hayek, among others, argued that a biased process attracts and enables the "worst" to succeed in government. (See "The Road to Serfdom" for his reasoning).

Passive and unbiased government is not impossible, merely highly improbable. Noble phrases like "public service" are should be seen as modern day examples of what Nock saw as self-serving propaganda.

What Does This Mean?

Public Choice theorists deal with the difficulties of providing the proper incentives and disincentives to prevent self-interest from exploiting positions in government.  Charles R. Anderson recently used a taxonomy that is consistent with Public Choice and history. He described two orientation of government --  principled versus pragmatic. 

Mr. Anderson's description of the two follows:

1) A government which is highly limited by principle in power and scope to the purpose of protecting the equal, sovereign rights to the individual to life, liberty, property, the ownership of one's own mind and body, and the pursuit of personal happiness. This is the legitimate government envisioned by the Declaration of Independence and the Constitution.

2) A so-called pragmatic government not restricted by principle to a limited scope and with few powers which is inclined to bestow special privileges on special interests. Such a government may be a democracy, an oligarchy, a one-party state, or a dictatorship and it must of necessity trample the rights of the individual because our personal interests are too diverse for government to foster all of our interests. It must pick which interests it will favor and which it will suppress.  It violates the principle that government should do no harm.