Let’s go through the salient points:

1. Write-down of Greek debt to 50%

“Private-sector involvement,” aptly abbreviated PIS, is one of those dreadful phrases that conceals more than it explains. The private sector here means, of course, the banks that were stupid enough to give billions of euros to Greek politicians.

We all know what happens under capitalism to lenders who give money to borrowers, who end up being unable to pay: They lose their money. That is how it should be. That’ll teach them and, hopefully, make them more prudent lenders in the future.

Alas, this is Europe, so there is no capitalism. You can negotiate your losses with the political class and agree on the “appropriate” haircut. In July, a 20% write-off was agreed, now this was upped to 50. Either number is entirely arbitrary.

The positively Orwellian phrase “private-sector involvement” makes it sound as if these poor banks were just innocent bystanders — and respectable members of the private sector, for that matter — who got dragged into this unfortunate business at no fault of their own.

For how much should the “private” sector be “involved”? Well, I would say for exactly as much as it chose to involve itself in the first place, by voluntarily lending money to the Greek government. I mean, have the risk managers and credit analysts at the likes of Credit Agricole and Societe Generale ever been to Athens and inspected the bottomless pit in which their loans were dumped? Or have they, from the start, assumed that the German taxpayer or the ECB would cover their losses?

Of course, a haircut of 50%, as now agreed in Brussels, is better than the ridiculous 20% or so “agreed” in July. But looking at Greece’s dire financial situation, the haircut should be at least 60%, or maybe 90 or 100. There is no reason for the Greek citizens of this and future generations to suffer endlessly because of the corruption of their past governments and the stupidity of their bankers. Embrace default! Just stop paying, go bankrupt, shrink your government, role up your sleeves and start from scratch.

After a complete and proper default, the state will not get loans easily again. This, coincidentally, is an additional bonus of a complete government default. It keeps your future politicians honest. That would be the free-market solution. But again, we are in Europe.

An even bigger haircut, one decided not by political horse-trading but by the market and Greece’s true ability to pay, would be more helpful for the Greeks and would, conveniently, discipline the bankers. Why is it not considered?

Well, the politicians don’t like it, because it would shut much of the government bond market down and make it difficult or impossible for them to keep running deficits of their own, and also, because the banks have skillfully booby-trapped the entire financial system with explosive CDS (credit default swaps) that get triggered if the “private-sector involvement” gets too big. The bankers, increasingly, resemble financial terrorists, effectively declaring, “If you don’t bail us out, we blow the whole place up!”

The bottom line: A haircut of 50% is better than 20, but it is still too little for Greece, and the whole idea that the “private” sector negotiates losses with the politicians doesn’t bode well for the future.

2. Fiscal coordination

Nothing specific was agreed at the summit, but this is where we are going, and the mainstream economists are cheering for it.

For years now, we have heard this in endless macroeconomic research pamphlets and newspaper editorials: There can be no monetary union without a fiscal union. This is, of course, utter nonsense. Complete rubbish. And it doesn’t get any more right by repeating it at nauseam.

The money of capitalism, of the free market and global trade, has always been gold (or silver, but I will refer to gold here). A gold standard is the oldest and best currency union imaginable, and I would argue, the only one workable. Under a gold standard, various countries and their governments use the same currency, gold. There is no central bank and no printing press. Governments have to make do with the income they generate from taxing their local population.

In such a system, the state has to live, just like any other entity in society, within its means. Apparently, this is a truly fantastical notion for today’s politicians and mainstream economists. Under a gold standard, the state may also borrow from the market, but it is clear to the lenders that they assume full risk of default. There is no lender of last resort. This is a powerful constraint on government largesse.

The Greek crisis was a good test to see how closely the European fiat money union could resemble the workings of a proper gold standard. In theory at least, and as intended by the original designs for EMU, there should have been no bailout, and the whole mess should have been a local affair between the Greek government and its lenders, just as it would be under a gold standard.

All this nonsense about the falling apart of the euro was, of course, needless but politically motivated scaremongering. When a government defaults under a gold standard, there is no reason why any other government should give up gold as a currency. Had the no-bailout provision been adhered to, there would equally have been no reason why a Greek default should have affected the acceptance and the usability of the euro in any of the other countries, nor for the Greeks themselves. A currency union does not require a fiscal union.

But EMU is no gold standard, and it already failed its first test of whether it could even be a currency union of some discipline. The gold standard was abandoned globally, precisely so that governments would not have to live within their means. The euro is political paper money, fiat money. It is issued to allow persistent fiscal irresponsibility, as is any other paper currency. Central banks have always been created to fund the state and the banks. The ECB is no different.

This is the global picture in 2011: After 40 years of complete paper money, public debt around the world has reached such momentous dimensions that the major central banks are now increasingly funding the state directly. This is what is happening in the U.S., the U.K. and increasingly, the eurozone. It is either accepted with suspicious equanimity or enthusiastically supported by bank economists and the inflationistas in the mainstream media. The trend is the same pretty much everywhere. It is only that, within the eurozone, it is less clear which government has first call on the printing press. In other paper money economies, this can be done more straightforwardly.

To assume that some form of institutional framework for fiscal coordination will discipline the European governments and reduce the desire for ongoing central bank debt monetization is at least naive. Maybe outright stupid. All governments in Europe are fiscally irresponsible, even the German one.

In the run-up to EMU, Germany imposed the Maastricht criteria on her European partners. Anyone remember the 60% debt-to-GDP limit? Laughable. Today, Germany is at 83% and rising, which may look relatively prudent if compared with Belgium or Greece, but if Germany has to pay up on its already-agreed-upon commitments under the European Financial Stability Fund, she will go above 90% in one giant leap, roughly where Ireland was when her creditors said, “No mas!” Germany may have the lowest unemployment rate in 20 years and, last year, had the highest GDP growth in 20 years, but she is still running deficits, accumulating debt every year, just like anybody else in Europe.

On a long-enough timeline, everywhere is Greece!

The bottom line: We will see a plethora of treaty changes, top-level EU summits and other pointless boondoggles. All to no avail. To assume that governments will not collectively resort to the printing press and that they will, instead, discipline one another, when all of them are long-standing, habitual and incorrigible fiscal offenders, is beyond ridiculous! If you believe it, call me, I may have something I want to sell you!

3. “Unlimited firepower” courtesy of the central bank

I guess you might argue that it could have been worse. Merkel could have given in to demands by Sarkozy to use the ECB straight away to leverage the €440 billion bailout fund. Seems like she didn’t, and Sarkozy will have to go, hat in hand, to the Chinese and see if they have some change to spare. However, this is not a long-term solution, and once Italy and Spain are in trouble, the bailout fund will be depleted.

One of the most shocking aspects of this crisis is how acceptable it has become for the mainstream economists and the pundits in the media to point toward the “unlimited resources” of the ECB. True, a fiat money central bank can print unlimited amounts of paper and electronic money to bail out everybody, the government, the banks, the pension funds, etc. It is just that such a policy used to be advocated only by suicidal cranks. That’s likely because it is a sure recipe for complete currency annihilation.

Today, established and supposedly highly regarded economists point out the importance of “keeping the ECB engaged,” because only the ECB has the “unlimited” resources to underwrite the boundless fiscal profligacy of modern democratic governments and their vote-buying political elites, and to underwrite the gargantuan debt pile.

As the hysterical calls by the inflationistas for a bold ECB policy get ever shriller, Mario Draghi, the new money-printer-in-chief for Europe, has already signaled his support for the ECB’s debt monetization policy, that is, ongoing buying of depressed and ultimately worthless government bonds with the help of the euro printing press.

Anyone who has any savings stored in the euro-area should be extremely concerned about what is going on here, and in particular, about the tone of the debate. When the mainstream speaks of “unlimited” resources of the ECB, they do in fact mean unlimited. The creation of new euro-currency units will be without ANY LIMIT. And the remaining inflation will also be without limit.

The bottom-line…On the face of it, the German position has won: deeper haircuts and no use of the ECB for leveraging the EFSF for now. But from where is the money for the larger EFSF going to come? Italy and Spain will remain under pressure. Nobody has the money to save them or to recapitalize the banks again when the big deficit countries lose access to the market and fail.

The ECB is not off the hook. Resorting to the printing press has become a global policy theme for the past three years, and sadly, such thinking is now part of the mainstream. The balance sheet of the ECB will not shrink; it will grow. There is no exit strategy. Pressure for further and accelerated monetization of debt, of budget deficits and bank balance sheets, will continue and intensify. The endgame will be inflation.

Regards,

Detlev Schlichter

Europe’s Future Comes Into Focus: Hyperinflation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In the first place, we may ask, “public sector” of what? Of something called the “national product.” But note the hidden assumptions: that the national product is something like a pie, consisting of several “sectors,” and that these sectors, public and private alike, are added to make the product of the economy as a whole. In this way, the assumption is smuggled into the analysis that the public and private sectors are equally productive, equally important and on an equal footing altogether, and that “our” deciding on the proportions of public to private sector is about as innocuous as any individual’s decision on whether to eat cake or ice cream. The State is considered to be an amiable service agency, somewhat akin to the corner grocer, or rather, to the neighborhood lodge, in which “we” get together to decide how much “our government” should do for (or to) us. Even those neoclassical economists who tend to favor the free market and free society often regard the State as a generally inefficient, but still amiable, organ of social service, mechanically registering “our” values and decisions.

One would not think it difficult for scholars and laymen alike to grasp the fact that government is not like the Rotarians or the Elks, that it differs profoundly from all other organs and institutions in society, namely, that it lives and acquires its revenues by coercion and not by voluntary payment. The late Joseph Schumpeter was never more astute than when he wrote, “The theory which construes taxes on the analogy of club dues or of the purchase of the services of, say, a doctor only proves how far removed this part of the social sciences is from scientific habits of mind.”

Apart from the public sector, what constitutes the productivity of the “private sector” of the economy? The productivity of the private sector does not stem from the fact that people are rushing around doing “something,” anything, with their resources; it consists in the fact that they are using these resources to satisfy the needs and desires of the consumers. Businessmen and other producers direct their energies, on the free market, to producing those products that will be most rewarded by the consumers, and the sale of these products may, therefore, roughly “measure” the importance that the consumers place upon them. If millions of people bend their energies to producing horses-and-buggies, they will, in this day and age, not be able to sell them, and hence, the productivity of their output will be virtually zero. On the other hand, if a few million dollars are spent in a given year on Product X, then statisticians may well judge that these millions constitute the productive output of the X-part of the “private sector” of the economy.

One of the most important features of our economic resources is their scarcity: land, labor and capital-goods factors are all scarce, and may all be put to various possible uses. The free market uses them “productively” because the producers are guided, on the market, to produce what the consumers most need: automobiles, for example, rather than buggies. Therefore, while the statistics of the total output of the private sector seem to be a mere adding of numbers, or counting units of output, the measures of output actually involve the important qualitative decision of considering as “product” what the consumers are willing to buy. A million automobiles, sold on the market, are productive because the consumers so considered them; a million buggies, remaining unsold, would not have been “product” because the consumers would have passed them by.

Suppose now that into this idyll of free exchange enters the long arm of government. The government, for some reasons of its own, decides to ban automobiles altogether (perhaps because the many tailfins offend the aesthetic sensibilities of the rulers) and to compel the auto companies to produce the equivalent in buggies instead. Under such a strict regimen, the consumers would be, in a sense, compelled to purchase buggies, because no cars would be permitted. However, in this case, the statistician would surely be purblind if he blithely and simply recorded the buggies as being just as “productive” as the previous automobiles. To call them equally productive would be a mockery; in fact, given plausible conditions, the “national product” totals might not even show a statistical decline, when they had actually fallen drastically.

And yet the highly touted “public sector” is in even worse straits than the buggies of our hypothetical example. For most of the resources consumed by the maw of government have not even been seen, much less used, by the consumers, who were at least allowed to ride in their buggies. In the private sector, a firm’s productivity is gauged by how much the consumers voluntarily spend on its product. But in the public sector, the government’s “productivity” is measured — mirabile dictu — by how much it spends! Early in their construction of national-product statistics, the statisticians were confronted with the fact that the government, unique among individuals and firms, could not have its activities gauged by the voluntary payments of the public — because there were little or none of such payments. Assuming, without any proof, that government must be as productive as anything else, they then settled upon its expenditures as a gauge of its productivity. In this way, not only are government expenditures just as useful as private, but all the government needs to do in order to increase its “productivity” is to add a large chunk to its bureaucracy. Hire more bureaucrats and see the productivity of the public sector rise! Here, indeed, is an easy and happy form of social magic for our bemused citizens.

The truth is exactly the reverse of the common assumptions. Far from adding cozily to the private sector, the public sector can only feed off the private sector; it necessarily lives parasitically upon the private economy. But this means that the productive resources of society — far from satisfying the wants of consumers — are now directed, by compulsion, away from these wants and needs. The consumers are deliberately thwarted, and the resources of the economy diverted from them to those activities desired by the parasitic bureaucracy and politicians. In many cases, the private consumers obtain nothing at all, except perhaps propaganda beamed to them at their own expense. In other cases, the consumers receive something far down on their list of priorities — like the buggies of our example. In either case, it becomes evident that the “public sector” is actually anti-productive — that it subtracts from, rather than adds to, the private sector of the economy. For the public sector lives by continuous attack on the very criterion that is used to gauge productivity: the voluntary purchases of consumers.

We may gauge the fiscal impact of government on the private sector by subtracting government expenditures from the national product. For government payments to its own bureaucracy are hardly additions to production; and government absorption of economic resources takes them out of the productive sphere. This gauge, of course, is only fiscal; it does not begin to measure the anti-productive impact of various government regulations, which cripple production and exchange in other ways than absorbing resources. It also does not dispose of numerous other fallacies of the national product statistics. But at least it removes such common myths as the idea that the productive output of the American economy increased during World War II. Subtract the government deficit instead of add it, and we see that the real productivity of the economy declined, as we would rationally expect during a war.

But how is it that only government agencies clamor for more money and denounce the citizens for reluctance to supply more? Why do we never have the private-enterprise equivalents of traffic jams (which occur on government streets), mismanaged schools, water shortages and so on? The reason is that private firms acquire the money that they deserve from two sources: voluntary payment for the services by consumers, and voluntary investment by investors in expectation of consumer demand.

If there is an increased demand for a privately owned good, consumers pay more for the product, and investors invest more in its supply, thus, “clearing the market” to everyone’s satisfaction. If there is an increased demand for a publicly owned good (water, streets, subway and so on), all we hear is annoyance at the consumer for wasting precious resources, coupled with annoyance at the taxpayer for balking at a higher tax load.

Enterprise makes it its business to court the consumer and to satisfy his most urgent demands; government agencies denounce the consumer as a troublesome user of their resources. Only a government, for example, would look fondly upon the prohibition of private cars as a “solution” for the problem of congested streets. Government’s numerous “free” services, moreover, create permanent excess demand over supply and therefore permanent “shortages” of the product. Government, in short, acquiring its revenue by coerced confiscation rather than by voluntary investment and consumption, is not and cannot be run like a business. Its inherent gross inefficiencies, the impossibility for it to clear the market, will insure its being a mare’s nest of trouble on the economic scene.

In former times, the inherent mismanagement of government was generally considered a good argument for keeping as many things as possible out of government hands. After all, when one has invested in a losing proposition, one tries to refrain from pouring good money after bad.

Most economists have two basic arguments on behalf of the public sector, which we may only consider very briefly here. One is the problem of “external benefits.” A and B often benefit, it is held, if they can force C into doing something. Much can be said in criticism of this doctrine, but suffice it to say here that any argument proclaiming the right and goodness of, say, three neighbors, who yearn to form a string quartet, forcing a fourth neighbor at bayonet point to learn and play the viola, is hardly deserving of sober comment.

The second argument is more substantial: Stripped of technical jargon, it states that some essential services simply cannot be supplied by the private sphere, and that, therefore, government supply of these services is necessary. And yet every single one of the services supplied by government has been, in the past, successfully furnished by private enterprise. The bland assertion that private citizens cannot possibly supply these goods is never bolstered, in the works of these economists, by any proof whatsoever. How is it, for example, that economists, so often given to pragmatic or utilitarian solutions, do not call for social “experiments” in this direction? Why must political experiments always be in the direction of more government? Why not give the free market a county or even a state or two, and see what it can accomplish?

Regards,

Murray N. Rothbard

The Fallacy of the Public Sector was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Those of us concerned about the ever-increasing level of government debt gasped at the astonishing $787 billion cost estimates for this bill. True to form it has actually cost 10 percent more at $862 billion. We heard over and over that government could not sit around and do nothing while people lost their jobs and houses. The administration claimed that unemployment would not go above 8 percent if the stimulus bill passed. Now, a year later, the government estimates that unemployment is over 10 percent. The real number is closer to 20 percent. It appears that those promises were total fabrications in order to close the deal.

In any case, the American people know that more government spending obviously equals more government. If the goal was to strengthen the private sector, Congress would have allowed businesses and individuals to keep more of their own money through meaningful tax cuts. Outrageously, the administration claims that they did “cut taxes” by reducing withholding, and that they have stimulated the private economy by increasing the amount of money in every worker’s paycheck. What they fail to mention is they did not change the total amount of taxes due. This means that all that money not withheld from paychecks will add up to a big unpleasant surprise when returns are filed this year. Many tax preparers are already seeing shocked taxpayers having to come up with big checks to the government when they normally expect a refund. Stimulus, indeed!

The administration also claims that thousands of jobs have been created or saved by this massive spending bill, but these are just more government jobs, and counterproductive in the long run. Funding for the public sector necessarily comes at the expense of an overtaxed private economy. But, it makes sense that government would seek to expand its payroll since every new bureaucrat becomes a likely advocate for big government, when an increasing number of Americans are demanding the opposite. But the more the burden, the closer the government parasite comes to killing its host.

Rather than learning the lessons of the past year, the administration is moving full-speed ahead to do even more economic damage. With the stimulus bill set as a precedent and victory declared, another “jobs” bill is in the works. And, in order to address the unavoidable issues of our massive deficit, the administration has named a bi-partisan commission to find ways to decrease it. Tax increases on the middle class are notoriously back “on the table,” exposing that campaign promise as another instance of merely saying what the people wanted to hear. If the obvious solution to our spending problems was seriously put forth, that is, getting back to the constitutional limitations of government, I would be shocked. More likely, this will be a tactic to increase taxes and spending in a way that passes the political buck.

Regards,
Ron Paul, LewRockwell.com
for Whiskey & Gunpowder

March 1, 2010

One Year After the Government Stimulus was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Complicating matters is the fact that both adversaries have powerful allies. The Fed has the Treasury and the government, as well as the Wall Street elite, as allies. The government could implement massive tax cuts in order to stimulate economic activity; the Treasury could bail out financial institutions, which in reality should be punished by bankruptcy; and the moneyed Wall Street elite will ensure that politicians and the Fed make it possible for them to continue their con game.

The private sector has allies in the form of inflation, a weak dollar, and a dissatisfied public (declining consumer confidence and lack of trust in government, which is reflected in the strong showing of Ron Paul), all of which form a powerful phalanx when battling the Fed’s reflation attacks. Inflation is a powerful ally for the private sector, because it squeezes corporate profits and curbs personal consumption.

The war between the Fed and the private sector will, in my opinion, be very protracted. The Fed will win some battles, which — along with much brouhaha in the media — will see Pyrrhic victories such as the stock market rally of August-early October, which led in dollar terms to new highs, but failed to do so in euro and gold terms, and was followed in euro terms by renewed severe weakness.

Other battles will be won by the private sector, which through its contraction (recession) amid inflation will lead to sharp downward movements in equity prices. I am well aware that the Bureau of Labor Statistics and the Bureau of Economic Analysis will continue to use bogus figures when reporting inflation, and hence real GDP growth, but they won’t be able to hide the squeeze on corporate profits and the consumer from rising prices.

Cost of living increases vastly exceed the reported inflation figures and are squeezing the consumer, which leads to revenue pressure for the corporate sector. According to the Kaiser Family Foundation, health insurance premiums have risen 78% since 2001, while wages have gained only 19%. At the same time, corporations are faced with a squeeze on margins due to rising costs. Cost pressures contributed to the dismal performance of earnings in the third quarter of 2007.

For example, Starbucks increased coffee prices by an average of nine cents per cup in July. However, customer visits to U.S. stores fell 1% for the quarter ended Sept. 30. According to the CFO, “Unbeknownst to us, we saw economic head winds that, quite frankly, came up probably stronger than I thought.” Earlier, Starbucks’ CEO had remarked: “The consumer is being faced with rising costs in every sector of their lives, and so part of that is reflecting on us.” An informed friend of ours suggested that declining traffic at Starbucks stores in the U.S. is of particular concern, since Starbucks serves all income levels. Therefore, declining traffic is not just a “subprime problem”!

This rate of economic contraction would seem to be consistent with the impending slump in corporate profits, and with the observation that the U.S. economy is already in recession.

Investment Observations

On one side of the new inflation war, the Fed is pumping liquidity into the system via rate cuts and repurchase agreements. On the other, the financial sector is withdrawing liquidity from the system via huge write-offs and newly timid lending policies. This war should lead to increased volatility. Ten percent market moves will be the order of the day.

As was the case in the 1970s, we can expect the stock market to sell off by more than 20%. At the time, the two adversaries facing each other were “easy monetary policies by the Fed” and “consumer price inflation.”

Nobody won that war decisively, since stocks in 1982 were at about the same level they had been in 1964. However, since U.S. equities had declined in real terms by 70% from their real 1966 peak to their real August low, one can now assume that the Fed lost that war. Today, the adversaries are the private sector, which with its inflated asset values now wants to deflate, and the Fed, which under Bernanke and Greenspan, never quite understood that larger and larger injections of liquidity into the system, leading to excessive debt growth, brings about a gross misallocation of capital.

I have no doubt that the Fed will lose this war as well — if not in nominal terms, then in real terms, or adjusted for the sinking value of the U.S. dollar. More to the point, the Fed has already lost this war: U.S. equities fully recovered after October 2002 and made an all-time high in October 2007 in dollar terms, but even at their recent highs they were down by 37% in Euro terms (measured by the S&P 500) and by 60% in gold terms.

Still, we have to be mindful that even if the present economic and financial environment doesn’t look particularly enticing, as was the case between 1964 and 1982 when the market didn’t make any headway, plenty of investment opportunities will present themselves from time to time for the nimble trader and for the long-term investor who will be positioned in the few asset classes that will perform well.

Moreover, it would be wrong to simply assume that recession and slumping corporate profits will inevitably knock down equity prices. Other factors such as negative real deposit rates and negative real yields on Treasury bonds because of the Fed driving down the Fed Funds rate, a weak dollar, and “bubbly” emerging markets could make U.S. equities a relatively attractive proposition compared to other financial assets.

With Bernanke at the Fed and Paulson at the Treasury, and a Euro that could face some problems (a breakup, some believe) because of badly deteriorating economic conditions in Italy, Spain, Portugal, and Greece — precious metals are likely to outperform financial assets for some years to come, resulting in the persistent decline of the Dow/gold ratio.

As Michael Berry remarked, “Gold is no friend to the world’s central bankers. The printing press is their friend.” In fact, I would be very surprised if the Dow Jones Industrials/Gold Ratio didn’t decline to between 5 and 10 within the next three years. Therefore, I should like to reiterate my recommendation to accumulate gold.

Other commodities that could come to life this year are sugar, cotton, natural gas, and palladium. Moreover, uranium is unlikely to disappoint the longs. In general, some special situations aside, I am not positive on industrial commodities in a slow growth or recession type of environment.

Among commodities and currencies, my preferred asset remains physical gold held outside the U.S., for the simple reason that — depression or inflation — it is very likely to outperform financial assets. For gold, I believe the best is yet to come!

Best regards,
Marc Faber
March 4, 2008

The Struggle Between Inflation and Lending was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.