No Wonder the Eurozone is Imploding

→ Washington’s Blog

You might assume that the reason for the implosion in the Eurozone is a mystery.

But it's not.

There Wouldn't Be a Crisis Among Nations If Banks' Toxic Gambling Debts Hadn't Been Assumed by the World's Central Banks

There wouldn't be a crisis among nations if banks' toxic gambling debts hadn't been assumed by the world's central banks.

As I pointed out in December 2008:

The
Bank for International Settlements (BIS) is often called the "central
banks' central bank", as it coordinates transactions between central
banks.

BIS points out in a new report
that the bank rescue packages have transferred significant risks onto
government balance sheets, which is reflected in the corresponding
widening of sovereign credit default swaps:

The
scope and magnitude of the bank rescue packages also meant that
significant risks had been transferred onto government balance sheets.
This was particularly apparent in the market for CDS referencing
sovereigns involved either in large individual bank rescues or in
broad-based support packages for the financial sector, including the
United States. While such CDS were thinly traded prior to the announced
rescue packages, spreads widened suddenly on increased demand for
credit protection, while corresponding financial sector spreads
tightened.

In other words, by assuming huge portions of
the risk from banks trading in toxic derivatives, and by spending
trillions that they don't have, central banks have put their countries
at risk from default.

No wonder Greece, Portugal, Spain and many other European countries - as well as the U.S. and Japan - are facing serious debt crises.

But They Had No Choice ... Did They?

But nations had no choice but to bail out their banks, did they?

Well, actually, they did.

The leading monetary economist told the Wall Street Journal that this was not a liquidity crisis, but an insolvency crisis. She said that Bernanke is fighting the last war, and is taking the wrong approach (as are other central bankers).

Nobel economist Paul Krugman and leading economist James Galbraith agree. They say that the government's attempts to prop up the price of toxic assets no one wants is not helpful.

BIS slammed
the easy credit policy of the Fed and other central banks, the failure
to regulate the shadow banking system, "the use of gimmicks and
palliatives", and said that anything other than (1) letting asset
prices fall to their true market value, (2) increasing savings rates,
and (3) forcing companies to write off bad debts "will only make things
worse".

Remember, America wasn't the only country with a housing bubble. The world's central bankers let a global housing bubble development. As I noted in December 2008:

The price of Southern California homes is already down 41%, Southern California hasn't fallen as fast as some other areas, and we're nowhere near the bottom of the market.

Moreover, the bubble was not confined to the U.S. There was a worldwide bubble in real estate.

Indeed, the Economist magazine wrote in 2005 that the worldwide boom in residential real estate prices in this decade was "the biggest bubble in history". The Economist noted that - at that time - the
total value of residential property in developed countries rose by more
than $30 trillion, to $70 trillion, over the past five years – an
increase equal to the combined GDPs of those nations.

Housing bubbles are now bursting in China, France, Spain, Ireland, the United Kingdom, Eastern Europe, and many other regions.

And the bubble in commercial real estate is also bursting world-wide. See this.

***

Moreover,
the real estate bubble formed the base upon which a series of bubbles
in derivatives were built. Specifically, mortgages were packaged in "collateralized debt obligations"
(CDOs), which were sold in enormous volumes all over the world.

Credit
default swaps were then bet against the companies which bought and sold
the CDOs.

Now, with housing prices crashing, the CDO bubble is crashing, as is the CDS bubble.

A series of other derivatives bubbles are also crashing. For example, the "collateralized fund obligations"
- sort of like CDOs, but where the assets of a hedge fund are the asset
being bet on - are getting creamed as hedge funds are forced to sell
off many hundreds of billions in assets to cover margin calls.

As
everyone knows, the size of the global derivatives bubble was almost 10
times the size of the world economy. And many areas of derivatives are
still hidden and murky.

So the bust of the derivatives bubble could even be bigger than the bust of the housing bubble.

BIS also cautioned that bailouts could harm the economy (as did the former head of the Fed's open market operations). Indeed, the bailouts create a climate of moral hazard which encourages more risky behavior. Nobel prize winning economist George Akerlof predicted in 1993 that credit default swaps would lead to a major crash, and that future crashes were guaranteed unless
the government stopped letting big financial players loot by placing
bets they could never pay off when things started to go wrong, and by
continuing to bail out the gamblers.

These truths are as
applicable in Europe as in America. The central bankers have done the
wrong things. They haven't fixed anything, but simply transferred the
cancerous toxic derivatives and other financial bombs from the giant
banks to the nations themselves.

Are Debt-Based Economies Sustainable?

Of
course, Eurozone countries like Greece and Italy have been living
beyond their means and masking their real debt levels for years (with a little help from Goldman Sachs, JP Morgan and the boys) - just like the U.S.

And of course, Eurozone central banks - like America's Federal Reserve - create fiat money out of thin air. As I argued in March, one or the primary problems is that Europe and America have debt-based economies, and the debt-based ponzi scheme has reached it's maximum limit:

Private banks don't make loans because they have extra deposits lying around. The process is the exact opposite:

(1)
Each private bank "creates" loans out of thin air by entering into
binding loan commitments with borrowers (of course, corresponding
liabilities are created on their books at the same time. But see
below); then

(2) If the bank doesn't have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It's
not just Bernanke ... the central banks and their owners - the private
commercial banks - have been running the printing presses for hundreds
of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve
requirements in the U.S. If Bernanke has his way, American banks won't
even have to borrow from the Fed or other banks after the fact to have
reserves. Instead, they can just enter into as many loans as they want
and create endless money out of thin air (within Basel I and Basel II's
capital requirements - but since governments are backstopping their
giant banks by overtly and covertly throwing bailout money, guarantees
and various insider opportunities at them, capital requirements are
somewhat meaningless).

The system is no longer based on assets (and remember that the giant banks have repeatedly become insolvent) It is based on creating new debts, and then backfilling from there.

It
is - in fact - a monopoly system. Specifically, only private banks and
their wholly-owned central banks can run printing presses. Governments
and people do not have access to the printing presses (with some
limited exceptions, like North Dakota), and thus have to pay the monopolists to run them (in the form of interest on the loans).

See this and this.

At
the very least, the system must be changed so that it is not - by
definition - perched atop a mountain of debt, and the monetary base
must be maintained by an authority that is accountable to the people.

Comments

[Panafrican Funk...]

"And that is exactly the reason why gold or other PMs are the only real money, it is self regulating because it is objective in its valuing unlike fiat currencies."

I would contend that the value of precious metals is far less objective than is typically assumed.  In a barter economy, what exactly would I do with a gold coin?  Melt it down and make a really shitty hammer?  To extend the example, would you trade a steel hammer for a gold coin?  What would you do with the gold coin?  Trade it for food?  Why would someone give you their food for a gold coin?

[akak]

You need to learn some monetary history before asking such naive and ignorant questions.  The"why" has been answered countless times throughout the last, oh, five or six thousand years.

And who says that we, or anyone else, are going to revert to a purely barter economy?  Are you predicting the imminent and complete collapse of civilization?  I am not.  And in the event that we do see a collapse of our monetary system (a given), WITHOUT a full-blown "Mad Max" scenario, then you will get to see firsthand the value of having held gold, silver, or other tangible and tradeable assets.  Gold merely has been found throughout history to be the most acceptable and convenient such tradeable asset.

[Panafrican Funk...]

I'm really more just playing devil's advocate here, I understand the historical precedent and have non-trivial physical gold holdings myself, but I do question to a certain extent whether we are in a monetary policy area, from a world history standpoint, that does not have precedent, and that the normal rules may not necessarily apply here.

Some things that concern me:

1.  Government "emergency reclaimation" that may result in a forced trade for a replacement fiat currency of questionable value.

2.  In the event of soveriegn debt default, simply hitting the "reset" button and assigning a bunch of bullshit values to the various currencies.

3.  General manipulation by private players of both the physical and "paper gold" markets. 

4.  Uncertainty as to whether investing in physical assets of practical value might be a better option.   

I'm also unsure as to whether there might just be a flight to the dollar, sort of a "last man standing deal" similar to what we saw earlier.  We all know the dollar is a piece of shit, but our public and private players seem to do a pretty convincing job of packaging shit in pretty boxes.

Also:

http://www.goldprice.org/spot-gold.html

Check the 30 year timeline.  Sorry, that just looks like a bubble to me, and pretending that paper gold doesn't affect the physical gold market is, well, not being very truthful.  I just get this sense that, when the time comes, attempting to redeem the physical gold I do have is going to end up being a painful and disappointing experience. 

[dcb]

letter I sent our today:

Sir, by avoiding the complete story regarding goldman's ethics you paint the firm in a very favorable manner 1) goldman sells loans they know are full of crap to clients 2) goldman (not even holding the loans bets against them with AIG 3) knowing that aig has insured so many crappy loans goldman takes out positions against aig           - goldman is sophisticated so they should know aig won't be able to pay and shouldn't have made these policies with them to that extent anyway 4) as the loans go sour goldman demands collateral, further weakening aig and therefore their bets against aig make even more money 5) aig goes bankrupt, and the tax payer bails them out 6) the bailout money goes to pay off the insurance policies that were written against loans goldman knew were "shitty" ( I CALL WHAT THEY SOLD AND GOT INSURANCE AGAINST AN ACT OF FRAUD. IF I PLAN ON BURNING DOWN MY HOUSE AND TAKE EXCESS INSURANCE AGAINS IT IT IS FRAUD. HELL IF i BURN DOWN MY HOUSE FOR THE INSURANCE IT IS AGAINST THE LAW. BUT GOLDMAN DID THIS. IT BURNED DOWN THE PRODUCT IT SOLD FOR THE MONEY.  AND IT BURNED DOWN AIG FOR THE MONEY             but using goldman's arguments they should have known aig could not have paid off the loss goldma is in fact the definition of a sophisticated investor. Hell maybe goldman stick aig with so much crap on purpose so they knew their short positions on them would pay off.              therefore, using goldman's internal logic they should not receive any money form the aig insurance policies. they are in fact sophisticated. 7) now lets add what goldman can do with their prop desk, their role as supplemental liquidity provider, and their role as market maker.  YOU THINK THEY MAY HAVE DONE SOME ILLEGAL NAKED SHORTING. CONSIDERING THE INCENTIVES OF THOSE INVOLVED. HELL WHAT THEY CAN DO LEGALLY IN THIS SCENARIO IS VERY DISTURBING. NOW ADD THAT I KNOW AT TIMES FROM JAN TO MARCH 2009 THEY WERE TRADING 40% OF NYSE VOLUME. i HAVE SENT THIS INFO TO YOU BEFORE   so the people who bought the fraud filled loans loose out, but the people who wrote them get paid off by the tax payer via a bankrupt company. ( Via the NY Fed, which is currently being investigated for a "cover up" regarding this whole episode. )   You make Goldman out to be a saint compared to what really happened.   Let me add, you know about Greece. Does anyone doubt that perhaps goldman at points took heavy bets against the fraud loans to greece as well. maybe they are also taking positions against the people they know they sold the loans too, or the people who wrote insurance on them. Once more the IMF/ central bankers run to the rescue and reward the criminals.   This is the system of international finance you support. to say it hasn't happened before isn't realistic. while I don't know the nature of bets against other debt crisis. we can say latin america, russia, etc. Each and every time the tax payers pay for the mistake the banks make and those who made the mistakes make billions. Call it what you will, but to me this is clearly a criminal enterprise designed to transfer wealth. This is legal mafia.   now goldman is burning down the euro zone!!!!

Imf now running to the rescue of the criminals "our own good"

[Mitchman]

To whom did this letter go?

[dcb]

this went around a lot, but in specific it was intended to address the ft editorial commnent of today 4/29/10 "goldman's ethics" pg 8

[RockyRacoon]

You are to be congratulated for taking the initiative to voice your concerns.  A suggestion might be to have someone proof your message before sending it.  You know, spruce up the spelling, punctuation, capitalization, syntax, a quick spell-check... that sort of thing.  Otherwise, I tip my hat to you.

[anony]

No one on this board assumes that implosions are a mystery. 

Maybe on CNBC's but here, even the least astute know that there is no mystery in the machivellian machinations of people who use alchemy to change one zero to 9 of them.

[The Alarmist]

I live in another european country where they actually started to roll back government spending (just a little ... didn't want to go overboard) and actually rolled back some of the excessively high marginal taxes.  Since it is a net exporter, the pronounced global downturn took its toll on new output. I still see quite a bit of consuming going on, but since it was not significantly credit driven, it didn't seem to fall off as severely as what I see when I go to the US. The big problem seems to be that its idiot bankers are patsies for the likes of Goldman and Greece.

Until recently I did not feel like my personal wealth was in as much danger as that little that I continue to keep in the US, but our "serious and wise leaders" seem intent on supporting the drivel about not letting the Euro fall apart.  Solidarity now, for the future! Ostensibly because we might need them some day ... yeah, that's the ticket. 

It is now clear that the leech-states of Europe have an unconstrained call on my wallet.  How can that be, they were supposed to be like us and delay gratification for the greater good once we granted them access to the inner sanctorum of the EU?

People protest in Athens and the my local government opens my checkbook to buy them off.  The correct answer is to grant them leave from the EU and to let our local bankers take the haircut for their stupidity and, if need be, to backstop the savings and demand deposits while letting stupid investments implode. Instead, my local bankers had a good bonus round and no doubt will live to have another as my pocket is picked to stop them from failing.

I read a paper in 2007 that said something along the lines of "deviation from normality might lead to inadequate value at risk estimations."  Duh!

Clearly the answer is to assume normality and assume the problems will go away ... So lend my money to Greece, then lend them some more.  Then lend my money to Spain, Italy, Portugal, Ireland and who knows where else.  And then wonder why I am no longer buying anything in here or have moved to Singapore.

Failure is an option when the alternative is a connected, foreseeable and even greater failure later.

[THE DORK OF CORK]

I live in a European country of sorts where there has been a 25% drop in GNP , there is now as far as I can see almost zero credit in this economy(not zero credit growth zero credit).

The government deficit is consistently north of 10% and even at these high levels it is unable to stop the bleeding in consumption.

The only safety valve for the economy is migration of both the domestic workforce and more newly arrived European workers. This adds to the consumption drop.

Our exports have held up pretty well considering and with the huge drop in imports our trade surplus per capita is higher then even Germany.

Yet the financial outflows from this country is enormous and is continuing to savage the remaining wealth.

There is allot of blame to go around in this little island but few people are looking towards the ECB which allowed obscene levels of credit creation while obsessing about fiscal deficits which were secondary to the real money creation mechanism.

[kaiserhoff]

Good points.  Many of us laughed at monetarists when they couldn't really define money supply, much less measure it.  Turns out you can screw up money supply if you work hard enough and rig everything.

The recurring themes are that markets are not allowed to clear, no one wants to tell the truth, and none of this is sustainable.

[Tic tock]

The essential quality for a currency seems to be in convincing whosoever that despite printing, the purchasing power remains unchanged. The larger an individual's income, the easier that is to do. The collary of that is equality in the distribution of income; the more equal is income distribution, the easier it is to convince. Europe pays much more lip-service at least, to income-equality- see health-care, welfare entitlements. ..but as for the balance-sheet fundamentals of the various nations.. or their ability to repay their bonds.. that, presently depends quite significantly on their formenting economic growth. Which requires an attractive business climate.

GS made a reference to the current sustainability of indebtness of the USGovt., possibly they felt that in a period of economic growth the US would be well positioned to force something like economic reparations from the rest of the world. I expect that should an economic recovery take place, the non-capital goods-making nations will continue to be disadvantaged, in terms of capital flows, for some time.        

[Tic tock]

Yes..and no, increasing the money supply has to happen in some form. I think the problem is that we have a conflict between two sets of idealogists, one of whom sits at the Federal Reserve and them what sits in Europe. 

Pretend for a second that it can be summed up as: In Europe they believe that the Rich should pay for the poor, and at the Fed, the opposite. So when as situation like this occurs there is an inbuilt expectation that Europe will enact 'populist' measures; and somehow pay for it..wherein lies the rub. But contrast that with the Fed system. The US (and UK) consumer is fairly confident that it is going to get shafted right and proper. Salaries, wages, food, energy and rent - there's every expectation that they will trend adversely. ..the US system is rational in the way that a simple bunch of cogs is rational, but it isn't designed to breakdown, the EU is. Hence the hymn, the EU won't split over budgetary complications. 

The probably more relevant second half is that the chief US xport could just as well be financial instruments, priced in dollars, so, if you're a bank, the last currncy you want left standing..is the dollar. There's the match made in Hell. This is about financial instruments vs. employment. One of whom is going to have to learn how to roll over and beg. 

[AnAnonymous]

I see no differences between the EU and the US. Both think that their 'poor' should help the rich to transfer as wealth as it is possible to their areas, this from the poorest areas in the world.

The Euro is failing because as a currency, it lacks some features which are more and more revealed as essential.

Not because of pseudo-differences in ideologies.

[anony]

It's not the rich that 'wealth' is transferred from. 99% will come from the rungs on the prosperity ladder to the next rungs in succession above the poor:  to wit, The Middle Classes.

If you think the rich are going to experience one one millionth of the burden of supporting the welfare state, think again.

[AnAnonymous]

Did I write something else?

Rich are people to whom  wealth is transfer to.

What did you misunderstand?

[Escapeclaws]

George, I wasn't assuming that the reason for the implosion in Europe was a mystery. Rather, I thought it was because the big European banks had bought a lot of toxic debt and these banks need to be bailed out by the state just like the big American banks. In fact, we even bailed out Société Générale ourselves to the tune of $11 billion.

The mystery is rather who benefits from the dissolution of the European Union. Recall how many right wing pundits gloated during the Iraq war when the Eastern Europeans were in favor of the war and even sent soldiers (Poland, for example), much to the consternation of the Western European countries. It looked like there was real dissension in the EU, and many Europhobes were delighted with that. Now once again, the same people are gloating with the EU once again threatened. This points to groups having an interest in spreading this anti-European progaganda and it would be interesting to know who would benefit the most from the collapse or near-death of the EU. What are the geopolitical strategic consequences of such a collapse?

Given that the Europeans have been making efforts to beef up and rationalize their military and that they have been making efforts to give Europe a single voice in foreign policy as well, the objective being to gain a voice in world affairs that corresponds more with their economic weight, all of these efforts would be for nought if the union can't hold together. Cui bono?

[AnAnonymous]

Benefits?

Troubles are to support the ongoing consumption level.

EU is a consumption sink.

What is best to ease the consumption worries? Kicking out a large consumption sink like the EU or focusing on people who are already out of the consumption trend in hope they can yield what they no longer have?

Rhetorical question of course.

The boat is sinking. Claiming it is sinking because of people who are no longer on the boat appeases and helps to provide a feeling of security as the targets are weak and the usual suspects but it does not solve the issue.

As soon as the EU is dissolved, this will remove pressure on consumption of the Earth as every former member country will no longer deliver an aggregated demand power through a common currency.

[Anton LaVey]

EU is a consumption sink.

And the USA are not, perhaps?

If Europe is in trouble for being a "consuption sink" (whatever that means), I fully expect the crash of the USA to be 10 times worse. I can't remember the exact number, but the average European consumes around half the raw material of the average American.

As soon as the EU is dissolved, this will remove pressure on consumption of the Earth as every former member country will no longer deliver an aggregated demand power through a common currency.

In your dreams. By that same token, I fully expect the breakup of the United States will remove an even bigger pressure on the Earth's resources... Third-world standard of living, here we come!

Short history lesson: the EU existed before the Euro, and it will probably exist -in one form of another - after the Euro. If the Euro ever disappears, that is, and I am not convinced it will.

Another possible scenario is that the EU will restructure the debts of the "Club med" countries, impose austerity measures on everyone, and refuse to reimburse whatever debt and CDO/CDS it has incurred... especially if the banks demanding repayment are outside of the Eurozone. Yes, J.P. Morgan and Goldman Sachs, I am looking at you. Net result? Painful restructuring and economic massacre in Europe, but a real bloodbath in the USA.

Of course, that's just me. Make of that what you will.

[AnAnonymous]

Huh? Yes...

The US is as well a consumption sink.

So is Japan.

Present times troubles are that some areas of the world are dying for air. They want to maintain/extend their consumption without the carrying possibility of it.

When big eaters are at a table and that the food amount brought to the table is no longer enough to satisfy their hunger, they can live in the illusion that searching the pockets of starving people will help them to collect the missing food or they can hope that one of the big eaters will die from a heart attack. Once removed from the picture, the other big eaters will indeed enjoy a temporary satisfaction of their ever growing appetite. 

Or that could be as well the scenario you depict: a big eater is compelled to cut down his eating habits, freeing food for his glutonous neighbours.

Still the best is death.

[Greyzone]

Look, central banks (including the Fed) always get established for one basic reason - to allow the private bankers to play fraud games then offload the losses onto the public's back by claiming the crisis is "systemic". In earlier eras different terms were used but the intent has always been the same.

So it was never a matter of choice for the politicians. The politicians did exactly what their programmed role said they had to do. Just like politicians bailed out bad bank bets on foreign countries in the 1970s, etc.

As soon as people get fooled into allowing a central bank to exist, that becomes to primary purpose of the central bank. You can even read the actual words of the private bankers who basically wrote the Federal Reserve act. They knew exactly what they were doing and what the result would be. The great financial panic of 1907, deliberately caused by bankers ended up with those same exact bankers being the authors behind the Federal Reserve Act.

It is no coincidence that Wall Street financiers are consistently named to high political financial posts. It is no coincidence that the language around each financial crisis focuses on systemic instability, implying that the problem is not the fault fo any particular banker. Until people learn these things, learn the lessons right there in our own history and apply these lessons, these same hucksters will play the same game over and over and over again, in slightly different forms, all with the aim of enriching themselves by stealing from you.

[AnAnonymous]

A global housing bubble? I'd say located housing bubbles. But you can always state that the places hosting housing bubbles are the world, the rest being something else.

[Escapeclaws]

Hang on, the lavish entitlements in the US (the military, the cost of the wars in Iraq and Afganistan--entitlements for military contractors--and the payoffs to the big banks) were going to bankrupt this country eventually. At least the Europeans got something for their money, whereas Americans got less than nothing.

[akak]

"...the monetary base must be maintained by an authority that is accountable to the people."

Why not go all the way, and separate the issuance of money from ANY authority altogether?  In other words, free market money!  Just as it is critically important for a free society that there exist a wall between the church and state, so is it important for a free, honest and prosperous economy that there be a wall between money creation and the state.

Until the people themselves, through the market, take control of their own money and its issuance, nothing financially and monetarily significant will change for the better.

[Burnbright]

And that is exactly the reason why gold or other PMs are the only real money, it is self regulating because it is objective in its valuing unlike fiat currencies.

[Sudden Debt]

There are still a lot of real estate bubbels in Europe that haven't blown up yet. Here it's actually commercial real estate that got the hit first.

A house which you could buy for 200.000 euro in 2000 is now still priced at 700.000 euro and prices actually even got up another 7% this year.

[The Alarmist]

That is the asking price.  That does not mean that house is going to sell at that price.  I've been looking at houses in europe that have consistently been listed at the same asking price for over a year now.  I made offers on a couple of them, but the owners would not budge because they have a specific price in mind.  Fine, if you don't need to move.  I don't need to buy. That's not a bubble ... that is a lack of a market, and it does nobody any good.

[Auroch]

Irish property market : a few funny graphs

http://daftwatch.thepropertypin.com/

[NERVEAGENTVX]

What's that strange scraping sound?    Could it be the feet on the deck chairs as they're getting dragged around?                                                                        

[BlackBeard]

No reserves...that's fucked up.  And this Bernanke character claims to be educated?

[RockyRacoon]

I guess it's like watching a train wreck, you just can't turn your eyes away even knowing it's going to be bloody.  Some sort of human trait at work here that CD can expand on some day.  Watched Kudlow this evening (another train wreck in process) and he came up with the brilliant notion that gold is becoming an alternative currency.  My, the guy is brilliant!   Somebody should go on the show and break the news that gold has always been a currency.  Gotta go now, I hear MB sneaking in -- he smells a gold discussion.  I'd rather not tangle.  That's one train wreck I can avert my eyes from.

[TBT or not TBT]

Hang on, the lavish entitlements in Europe coupled with deathbead demographics were going to bankrupt these countries' governements anyway, ineluctably.   If it happens a few years sooner than projected because of the current difficulties, think of it as the market just pricing in knowledge about the future today.    We're getting on with this mess now, and usually that's less painful than waiting it out and dealing with it when it has become truly bestial.