Geithner on Europe: “Subprime is Contained” Redux?

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Most of the major figures in the financial crisis have had an “insert foot in mouth and chew” moment, although none have yet proven as memorable as Irving Fisher’s “Stock prices have reached what looks like a permanently high plateau.” less than a week before the Great Crash of 1929 commenced.

Bernanke’s was his March 2007 Congressional testimony, in which he argued that the subprime crisis was contained. He further estimates losses at $50 to $100 billion. I recall gasping out loud when I read that; loss forecasts from private sector analysts at that juncture were $150 billion or more. Similarly, Hank Paulson contended when he asked for authority to rescue the GSEs that it was more powerful if it was substantial: “If you’ve got a squirt gun in your pocket you may have to take it out … If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” As we have seen again and again, the markets have a nasty way of calling bluffs. Paulson put Fannie and Freddie into conservatorship less than two months after his comment.

Geithner’s moment may have arrived. In a Bloomberg TV interview (to be aired), the Treasury Secretary maintained that Europe could surmount any sovereign debt related challenges and the US economy would be unscathed:

“Europe has the capacity to manage through this,” Geithner said in an interview today on Bloomberg Television’s “Political Capital With Al Hunt,” airing this weekend. “And I think they will.”

Geithner, 48, said he doesn’t think the European turmoil will hurt U.S. growth because “our economy is getting stronger. We’re seeing a lot of strength, improvement and confidence.”

Yves here. Geithner is cautious enough that this (sadly) does not contain a crisp quote that could come back to haunt him, but the message is unambiguous: l’affare Euro is strictly local, of no serious import to the US.

Let’s see how credible this whistling in the dark is. From the EU Trade Commission:

The EU and the US economies account together for about half the entire world economy. The two economies are interdependent to a high degree. Close to a quarter of all EU-US trade consists of transactions within firms based on their investments on either side of the Atlantic.

The transatlantic relationship also defines the shape of the global economy as a whole as either the EU or the US is also the largest trade and investment partner for almost all other countries in the global economy. In 2008, total FDI stocks held in each others countries reach approximately €2.1 trillion. The overall “transatlantic workforce” is estimated at 12 to 14 million people, of which roughly half are Americans who owe their jobs directly or indirectly to EU companies.

The European Union and the United States have the largest bilateral trade relationship in the world.

Trade in goods

* EU good exports to the US in 2009: €204.4 billion
* EU goods imports from the US in 2009: €159.8 billion

Trade in services

* EU services exports to the US 2009: €119.4 billion
* EU services imports from the US in 2009: €127.0 billion

Foreign Direct Investment

* EU investment flows to the US in 2008: €121.4 billion
* US investment flows to the EU in 2008: €50.5 billion

Yves here. Geithner’s optimism might be warranted if one believed the Eurozone upheaval was on its way to a happy resolution. But what is happening instead is:

1. Rather than take measures to allow for an internal rebalancing (such as more promoting more demand from Germany and the northern states, restructuring Greek debt), the EU has put itself on a deflationary path.

2. Given the fiscal straitjackets on member states, the only way to offset deflationary pressures is via currency depreciation, so that strengthening exports will buffer the impact of austerity measures. That is happening, with a vengeance.

3. Even with a sharp fall in the euro, deflation may still take hold, so sovereign defaults (realistically, restructurings) beyond Greece (which seems hopeless) are quite possible

4. A decline in the euro could set off competitive devaluations (at a minimum, my contacts in the UK expect the pound to need to keep pace with the euro, whether by happenstance or design). At a minimum, it will put a major crimp in US exports, dampening the US recovery (such that it is) and put pressure on China. If the loss of export-related jobs is great enough, it could lead to protectionist measures

5. A disorderly fall in the euro has and will continue to lead investors to shun risky assets. The shift in investor sentiment will stress a less than healthy financial system. We know what that movie looks like

And despite the attempt to convince his audience that the EU can go it alone, Geithner was awfully quick to defend IMF involvement:

Geithner also said a Republican proposal to bar U.S. support for IMF loans to European countries is “absolutely not” reasonable. “We have a big stake in helping Europe manage through these things,” he said. “We’re going to do it in a way that’s sensible for the American economy, the American taxpayer.” The U.S. holds a 17 percent stake in the IMF.

And Mr. Market does not agree with Geithner. I’ve pinged the author to see if I can reproduce the key charts here (please check back if you see “Updated” in the headline) from a report on Friday’s market action by the anonymous analyst who prepared a detailed report on the May 6 meltdown. Bottom line: through the early PM, the selling pressure on Friday was WORSE than on May 6. As long at the Eurodollar rate is elevated, investors are going to be cautious about taking on risky assets.

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  1. Mogden

    I really do not get how the utterly broke and bust Federal Government of the United States feels like it has the wherewithall to send fifty billion dollars to Greece. But then, I couldn’t follow the rationale for the bailout of AIG, GM, Goldman Sachs, et al, so I must be painfully behind the curve.

    1. Robin

      Maybe because it is just another Bank Bailout, Eurpean-style?

      It worked well in the U.S. Why not pull off another government-supported bank heist in Europe as well?

    2. Jeff65


      I’m not agreeing with the bail out policy, but the Federal Govt can take this action because it is NOT broke. And it will never be broke as long as it can enforce taxation and does not enter into debt in a currency it does not control.

      The game is that the Federal Govt can do and does (check the news) whatever it’s masters want (no matter the cost) but for things the masters don’t want, it cries “we’re broke”. And most people fall for it every time because they don’t understand how the monetary part of the economy works. They think it works exactly like their business or household budget, but it does not.

    3. DanAllen

      What 50 billion to Greece? Maybe I’ve missed something, but the total IMF package to Greece is 30 billion euros, and of that, 17% comes from the USA.

  2. a

    “At a minimum, it will put a major crimp in US exports, dampening the US recovery (such that it is) and putting pressure on China. If the loss of export-related jobs is great enough, it could lead to protectionist measures.”

    Repeat after me: The US is not the center of the world, the US is not the center of the world. According to this paragraph, one might think that the causal link between Europe and China is: euro down, US exports down, US recovery down, China exports less to the US, pressure on Chinese economy. Yeah, well, that will happen, but it’s not the important link. The important causal link is more direct: euro down, Chinese exports to Europe down, pressure on Chinese economy. That’s because the euro down against the dollar means the euro is also down against the Chinese currency.

    “5. A disorderly fall in the euro has and will continue to lead investors to shun risky assets. The shift in investor sentiment will stress a less than healthy financial system.” Wait a minute… Now which country just had a day in which the equity market fell 10% intraday? Oh the US! Seems to me like *that* will lead investors to shun risky assets as much as the Euro going down.

    1. Yves Smith Post author


      With all due respect, you have a rather large axe to grind, and have engaged in quite a lot of misinterpretation to make your argument.

      1. Reread point 4. The sentences parse that the fall in Chinese exports is the result of the fall in the euro.

      2. Look at equity averages since the Greece and the euro started getting wobbly. Overseas market have taken much more of a beating than US markets. Not sayin’ that properly reflects fundamentals, but overseas markets were already off more than the US before the May 6 downdraft, and that pattern continued this week.

      So you seem out to accuse me of some sort of bias, and have gone so far as to make distorted readings to prove your point. So who has a bias here?

      1. a

        “1. Reread point 4. The sentences parse that the fall in Chinese exports is the result of the fall in the euro.”

        Your point 4 did not explicitly mention a fall in Chinese exports. You said, “At a minimum, it will put a major crimp in US exports, dampening the US recovery (such that it is) and put pressure on China. If the loss of export-related jobs is great enough, it could lead to protectionist measures”. All those references to exports refer to US exports, not Chinese exports. Or, if you somehow meant Chinese exports, you need to rewrite to make this clear.

        I’m just taking you to task for your *argument* in point 4, as it’s written, that the fall in the euro (event A) would put pressure on the Chinese economy (event B). Event A will cause event B – we agree on that. I’m just amused that in that lovely Americo-centric way of yours (and so many American commentators), you’ve put the US in the center by running the causal chain through the US. You’re argument, as written, seems to be:

        Fall in euro ==> US exports to Europe fall ==> US economy suffers ==> China suffers.

        All it needs to be is:

        Fall in Europe ==> China exports to Europe fall ==> China suffers

        No US needed!

        “Look at equity averages since the Greece and the euro started getting wobbly. Overseas market have taken much more of a beating than US markets.” *European* markets, certainly, which is normal, since the origin of the problem is in Europe. But your point, to which I was commenting, was that a disorderly fall in the euro would cause a shunning of risk. While that’s true, I think an intraday fall of 10% in an equity market also causes a fair shunning of risk. Also (a point I didn’t make but I’ll make it now) I find it amusing that observers are worried about “disorderly” movements in the exchange rate only when their exchange rate is going up. Europeans complained when the euro was going up vs the dollar about exchange-rate “volatility”. In fact it wasn’t so volatile, it was just going up slowly but surely. No Americans piped up then. And now the shoe’s on the other foot, and the Americans begin to be worried about forex disorder, when in fact it’s not disorder, but the upward movement of their currency that perturbs. And of course, the Europeans are now silent…

        “So you seem out to accuse me of some sort of bias, and have gone so far as to make distorted readings to prove your point. So who has a bias here?”

        The only bias I would accuse you of is of being an American writing with a too-American perspective. Surely you realize you have that bias, and you don’t need me to tell you. Or if you do need me, then it’s worse than I thought! It’s not so much an axe to grind as something which I find amusing.

        1. Yves Smith Post author


          Can you read? Seriously. You keep insisting the piece made the impact on China a derivative of a US slowdown. While that will happen too, this is absolutely NOWHERE in what I wrote and is your pet obsession.

          The effect on China is via the DOLLAR peg. Euro falls, sterling falls, other perceived to be risky currencies fall, dollar and pegged RMB stay aloft.

          Read the SENTENCES I wrote in 4, as in PLURAL.

          They parse:

          Decline in euro (cause) produces effect A (fall in US exports) and B (pressure on China).

          A and B are INDEPENDENT effects of the cause. You keep asserting I wrote them as dependent. That is YOUR PROJECTION and YOUR BIASED READING.

        2. Yearning to Learn

          Europeans complained when the euro was going up vs the dollar about exchange-rate “volatility”. In fact it wasn’t so volatile, it was just going up slowly but surely. No Americans piped up then.

          This is very wrong. People in the US were very concerned about the destruction of the value of the dollar, heralded by none other than Larry Kudlow himself. Every day he lambasted our political leaders and called for “King Dollar”. So you know American investors cared if even the buffoons on CNBC were squawking about it.

          Hank Paulson et al went out many times and talked about the need for “strong dollar policy” due to the worry by US investors. (of course they were lying through their teeth… talking about a strong dollar policy while clearly pursuing a weak dollar policy). However, the fact that they needed to get up there and lie about their strong dollar policy shows that there was worry about it.

          There were big news stories when Euro/$ hit around 1.55, and when Can$/US$ went near par. there was pressure on China to revalue due to their peg (and still is)

          on a side note: I read Yves point the way she claims to have written it, not the way you interpreted it.
          I think this post talks so much about the US, because the point of the post is contradicting Mr. Geithner’s claim that Euro problems won’t affect US economy…

          however, clearly there is a US bias on almost all US sites, including this one.

    2. Smells Like Chapter 11

      For better or worse, the US will remain the center of the world for awhile (how long is anyone’s guess) the center of the world becuase the USD is the reserve currency and no one currency is backed by gold.

      Do you see the RMB or the Euro taking its place?

      Maybe a currency combo? But what a mess?

      The old adage, adjusted for inflation, still obtains: if you owe me $1.0 billion and you can’t pay, you are in trouble; but if you owe me a $1.0 trillion and you can’y pay, i am in trouble.

      China is not prepared to take the 40% hit now on its USD holdings by letting the RMB float, it is still running huge current account surpluses with the US and almost everyone else and the Euro is collapsing.

      Like it or not, this why the USD will remain the reserve currency and thus the center of the world for a long time.

      Frankly, for a lot of reasons, i would like the USD not to occupy its central position, but it would take a very long time to unwind them, a lot longer than i expect to be around.

  3. alex black

    “Europe has the capacity to manage this.” – Geithner

    Well, the word “manage” can cover a wide spectrum, so he gave himself a lot of wiggle room. I mean after all, Europe DID somehow manage both WWI and WWII. The land survived. Some people did too….

    1. Glen

      I may not know what “manage” means, but I sure want some of what Timmeh’s smoking (and I’ll bet he had his fingers AND his toes crossed.)

      It’s a whole new quantum leap in what we call dope (pronounced d’hope!)

  4. /L

    Europe has the capacity to manage through this

    Of course, but is it going to break up, the EU/euro has already entered the stage of dead man walking.

    The role models of Europe are the Baltic economic miracles, something Greeks and others is mandated to imitate. Estonia the European poster boy of responsibility did merely so far have had a real GDP decline of nearly 20%, the other praised model to emulate Latvia did also engaged in a minor economic contraction of more than 25%. The bad boy Iceland did only have 14% contraction, the bosses of Iceland are not satisfied with that and want to join EU to make some real progress. Last year Latvia’s retail sales dropped 30,2%, this year its “only” expected to drop 10%.

    Latvia have done tremendous progress in its export-import balance but the trade in large have gone sourer.
    Export (billion) 2008_$9.63, 2009, 2008_$6.72_-30.2%, Import 2009 _$15.65, 2009_$8.85_-45.7%. That is a huge improvement on the balance entirely achieved by less import due to crushing the domestic economy. Latvias 3 largest export countries is Lithuania, Russia and Estonia that account for 43%. Latvia and Estonia does only have around 20% official unemployment that is probably much higher in real terms. That is depression numbers.

    However, their precious money is sound.

    Every document and speech in these days political environment is riddled with the phrase “sustainable” to the extent that it have became a nuisance, how can anyone in his right mind believe that this kind of unemployment can be a sustainable and sound path.

    Albeit the socialist leader in Spain have take a hair cut of 15% on his salary it’s an exception, recently there was an hacker in Latvia that revealed how lavishly the Latvia politicians rewarded them self while closing down the economy for the people. No less is true about EU-bosses and administrators in Brussels who have lavishly generous wages, benefits and pensions. So far, I have not heard anything about some austerity and hair cuts on Brussels.

    Is the dogma of export-orientated growth the solution? In large the core of EU is highly advanced industrially, advanced industry have had and have tremendous productivity growth, more and more is produced with less and less labor. It’s simply not viable to remedy unemployment with export growth in developed countries like EU. The core EU policies are to hamper domestic growth in the idea that it will favor export, it’s the basic idea of German “thriftiness”. The two elements in this is wage pressure and hamper import too achieve that eagerly wanted export surplus. The wage pressure argument is weak then wages is not a dominant part in export industries cost structure, the overall crippling of the domestic economy might do it’s part to keep the currency exchange rate at an favorable level.

    They who thought the princes and bosses of Europe who did throw Europe and the world in to the firebrand of WWI and then relentlessly continued with the second half that was WWII was weak minded idiots do have real challengers of idiocy record in the present European leadership.

    Taxidriver in Estonia:
    They [the Estonian political elite] speak to us just like they did under Communism , Back then, they said ‘make sacrifices now and everything will be wonderful when the harvest comes’. Now, they say the same things about joining the euro.

  5. anon

    Maybe ‘Whistling past the graveyard’ too. But definitely not “whistle while we work”.

    This is going to be Subprime meltdown redux at hyperspeed.

  6. Siggy

    As to Greece, the resolve of its dilemma is the repudiation of that of its debt that it cannot service. However much the EMU may arrange thru the IMF some form of rescure, that rescue will be, effectively, a repudiation of some level of debt. The sooner that happens the better. Delay will make the ultimate cost only greater and more widespread.

    The required repudiation will lead to reduced economic activity in Greece and thereby in each and every nation that trades with Greece. From that there will flow reduced activity globally in the sense that the reduced activity will be much less than might have otherwise occurred.

    The selloff in Euros, the flight to gold and the selloff in the securities markets concurrent with strength in the dollar all reflect a movement to reliable liquidity. It’s not that the dollar is such a good store of purchasing power, its that it currently is a reserve currency and for financial institutions reserves are what they need just now.

    Geithner’s blathering that the problems of Greece and the EMU are limited to that corner of the world are sufficient to occasion his removal for cause.

    Subprime was/is merely a symptom of a much more profound disease that is tipping the patient to the point of being terminal. It’s the dammed fiat dollar that lies at the root of this cancer. Add to that the assinine belief that we can borrow our way to stability and prosperity. Add to that fractional reserves of nothing for a fiat dollar is after all nothing.

    A crisis has been wasted on evading the necessity of restructuring the currency itself. We have eschewed the requisite depression that could have been the basis of underwriting a sustainable recovery and a prosperous ongoing economy.

  7. E L

    I have been living with the fear that September 15, 2008 was just the overture to Götterdämmerung.

  8. MyLessThanPrimeBeef

    ‘Stock prices have reached what looks like a permanently high plateau.’

    ‘Subprime is contained.’

    ‘Dewey defeats Truman!’

    A few masterpieces from Homo Not-So-Sapiens Not-So-Sapiens.

  9. /L

    It might all look like a technical economic and monetary issue but it is an ideological failure of neo-liberalism, all what is happening now is 100% political. There are no real things that cause misery, no war (yet), no natural disasters, no lack of real resources and so on that force people in to unemployment and misery. All it takes to get out of the mess is political will, politicians with the intellectual ability to do the right thing and break out of a defunct ideological prison they them self have built.

    It is now only 4 years to go until it is the 100 years anniversary of the break out of the European idiocy of WWI. Before the war started many believed another big war was not possible, the world where just so interconnected with trade, gold standard and so on that another foolish bloodbath where not rational.

    The Balkan conflict yet is not solved, it is a clash on hold.

    1. Smells Like Chapter 11

      You are so right that the issue is primarily political.

      The question is how much pain can be inflicted on those who are not particpants in the predator class of bankers, lawyers (like me) and others who largely live off sucking value out of the system without returning much in return.

      Unfortunately, the recent US, Iceland & Greece experience tells us that a lot of pain can be inflicted on advanced socieities before there is much in the way of push real back.

  10. Gary Anderson

    Well, with Geithner’s statements I have some questions and thoughts. Either this weakness and debt burden is a conspiracy to form a united Europe, or Geithner and the central banks no longer have control.

    While the latter may be true, this crisis could be a play by central bankers to create a Europe that has a true reserve currency. It appears that the ponzi housing scheme was a nearly worldwide scheme to inflate real estate. The crash seemed to be somewhat orchestrated in that banks in the Us were bailed out.

    So, the question that remains is whether the prize of central bankers everywhere, the Euro, is destined for success or doomed to failure. Any takers?

  11. MarcoPolo

    6. Triggers a boat load of fx vanilla swaps. Though I have no idea what that means.

  12. kares jhangiani

    Unduly alarmist write-up by Yves Smith. In 2002, the Euro was at 87 cents to the dollar, I purchased Euro in Italy at that time. The U.S. was not in a recession then (an election year) and went on toward the largest boom in housing construction and prices in 2004. In 2006, the Euro started climbing alarmingly; I had to buy it for about $1.37/Euro. Yet, the Europeans did alright. It is a mistake to think that people can’t tighten their belts and live on 10%-15% less. They will consume less which is good and reduce the burden upon this besotted planet. I suppose, it will increase some unemployment in Euroland, but, employment should be based upon personal creativity. The Europeans are smart: they might give people grants to start small enterprises and small farms. Don’t short change them. Reduced consumption should create a little more unemployment in China and perhaps direct that economy toward internal balance than upon cheap exports. What is wrong with that?

    You people have become so afraid of “bad times,” that is incomprehensible. How much better off would the Democrats and this country have been if they had nominated and elected a progressive person like Ralph Nader than this awful, ignorant, historically uniformed man, who barely gives a damn about the greatest environmental crisis and the rip-off future generations by the Goldman Sachs and its likes.

    1. psychohistorian

      Don’t lose hope entirely yet. The fat lady hasn’t sung yet. It is kind of about who can’t recover from that last sneeze.

      There is an opinion that relatively speaking the the US and UK have the most adjusting to do in their level of consumption/debt relative to the rest of the world. If US consumption continues to decline and there is no CETA type jobs program forthcoming from Congress then spending will stop.

      It does seem like we are getting closer to the edge of something happening for Mr Jones…..

    2. Yves Smith Post author


      Spoken like someone who presumably has a job. I suggest you get out and talk to the un and underemployed.

      You also forget that the euro rose when the world, including the EU, was awash in a global debt bubble and growth was humming along nicely. I suggest you read posts here and elsewhere on how pretty much every country in the world, including the US, is looking to exports as their way out of this mess. That is a zero sum game. A cheaper euro is good for eurozone members and a negative for the US, China, and Japan.

      And the evidence of the last few weeks is that the rapid fall in the euro IS financially destabilizing, or did you manage to miss what happened to bank bond spreads and short term funding rates in the EU?

  13. tz

    Somehow this post reminds me that there exists a real product:

    Bazooka Bubble Gum.

    Tastes better and easier to chew than a foot.

    They probably didn’t mean that kind of Bazooka, but the actions did tend to gum up the works.

    And although you can blow bubbles, it is equally messy when they pop.

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