Marshall Auerback and Warren Mosler: Core Europe Sitting Pretty in their PIIGS Drawn Chariot

By Marshall Auerback, a portfolio strategist and hedge fund manager, and Warren Mosler, an investment manager and creator of the mortgage swap and the current Eurofutures swap contract. Cross posted from New Economic Perspectives

The refusal to countenance a Greek default is now said to be dragging the euro zone toward even greater crisis. Implicit in this view, of course, is the idea that the current “bailout” proposals are operationally unsustainable and will lead to a broader contagion which will ultimately afflict the pristine credit ratings of core countries such as Germany and France.

Well, we see a very different view emerging: The “solution” currently on offer – i.e. the talk surrounding the European Financial Stability Fund (EFSF) now includes suggestions of ECB backing. This makes eminent sense. Let’s be honest: the EFSF is a political fig-leaf. If 440 billion euros proves insufficient, as many now contend, the fund would have to be expanded and the money ultimately has to come from the ECB — the only entity that can create new net financial euro denominated assets — which means that Germany need no longer fret about being asked for ongoing lump sums to fund the EFSF in a way that would ultimately damage its triple AAA credit rating.

Despite public protestations to the contrary, it is beginning to look like the elders of the euro zone have begun to embrace the reality that, when push comes to shove, it is the ECB that must write the check, and that it can continue to do so indefinitely.

That means, for example, the ECB can buy sufficient quantities of Greek bonds in the secondary markets to allow Greece to fund itself in the short term markets at reasonable interest rates. And it gets even better than that for the ECB, as the ECB also substantially enhances its profitability by continuing to buy deeply discounted Greek bonds and using Greece’s income stream to build the ECB’s stated capital. As long as it continues to buy Greek debt, Greece remains solvent, and the ECB continues to increase its accrual of profits that flow to capital.

The logical conclusion of all of this is ECB ownership of most of Greece’s debt, with austerity measures imposed by the ECB steering the Greek budget to a primary surplus, along with sufficient taxation to keep the ECB’s capital on the rise, and help fund the ECB’s operating budget as well. Now add to that similar arrangements with Ireland, Portugal, Spain and Italy and it’s Mission Accomplished!

Mission Accomplished? Are we daring to suggest that the Fathers of the euro zone had exactly this in mind when they signed the Treaty of Maastricht?

Or, put it another way: it’s all so obvious, so how could they not have this mind?

So let’s take a quick look at the central bank accounting to see if this seemingly outrageous thesis has merit.

Here is what is actually happening. By design from inception, when the ECB undertakes its bond buying operation, the ECB debt purchases merely shift net financial assets held by the ‘economy’ from Greek government liabilities to ECB liabilities in the form of clearing balances at the ECB. While the Greek government liabilities shift from ‘the economy’ to the ECB. Note: this process does not alter any ‘flows’ or ‘net stocks of euros’ in the real economy.

And so as long as the ECB imposes austerian terms and conditions, their bond buying will not be inflationary. Inflation from this channel comes from spending. However, in this case the ECB support comes only with reduced spending via its imposition of fiscal austerity. And reduced spending means reduced aggregate demand, which therefore means reduced inflation and a stronger currency. All stated objectives of the ECB.

We would stress that this is NOT our PROPOSED solution to the euro zone crisis (see here and here for our proposals), but it is clearly operationally sustainable, it addresses the solvency issues, and puts the PIIGS before the cart, which at least has the appearance of putting them right where the core nations of the euro zone want them to be.

Additionally, the ECB now officially has stated it will provide unlimited euro liquidity to its banks. This, too, is now widely recognized as non-inflationary. Nor is it expansionary, as bank assets remain constrained by regulation including capital adequacy and asset eligibility, which is required for them to receive ECB support in the first place.

To reiterate, it is becoming increasingly clear, crisis by crisis, that with ECB support, the current state of affairs can be operationally sustained.

The problem, then, shifts to political sustainability, which is a horse of a different color. And here is where the Greeks (and the other PIIGS) paradoxically have the whip hand. So long as the Greeks continue to accept the austerity, they wind up being burdened by virtue of their funding of the ECB. The ECB takes in their income payments from the bonds, and the ECB alone ensures that Greece remains solvent. It’s a great deal for the ECB and the core countries, such as Germany, France and the Netherlands, as it costs the core’s national taxpayers nothing. And, as least so far, Greece thinks the ECB is doing them a favor by keeping them out of default. The question remains as to whether the Greeks will continue to suffer from this odd variant of Stockholm (Berlin?) Syndrome.

Perhaps not if some of the more recent proposals make headway. As an example of what might be in store for Greece, consider the “Eureca Project”, publicly mooted in the French press last week. In essence, it aims to reduce “Greek debt from 145% to 88% of GDP in one step” without default (so protecting all northern European banks); reduce ECB exposure to Greek debt (that is, force Greece to pay the ECB for the bonds it has purchased in secondary bond markets) and it claims that it will “kick-start the Greek economy and revive growth and job creation” and promote “structural reform.”

So how is it going to do all of that? Simple: engage in the biggest asset strip in history. The proposal in essence calls for a non-sovereign entity to take all the public assets – hand them over to a holding company funded by the EU which pays Greece who then pay off all it debtors. End of process – except that if it is implemented, the Greeks could well say “Stuff it. Let’s default and take our chances. At least we get to keep our national assets.” That’s the risk that is being run if the ECB and the economic moralists in Germany take this too far. If this proposal were accepted, the eurocrats would in fact have a failed nation state on their hands in 3 months time — in the eurozone, not the Mideast or Africa.

By contrast, the current arrangements seem tame in comparison. They obviate the solvency issue, but even here one wonders how much more can be inflicted on countries such as Greece. We stress that the current arrangements have OPERATIONAL sustainability, not necessarily POLITICAL sustainability. The near universally accepted austerity theme is likely to result in continuously elevated unemployment, and a large output gap in general characterized by a lagging standard of living and high personal stress in general. This creates huge systemic risk insofar as it might well make sense for Greece (and others) ultimately to reject this harsh imposition of austerity. But, so far so good for the core nations, as there appears to be no movement in that directions (except on the streets of Athens, rather than in the Greek Parliament).

By the ECB continuing to fund Greece, and not allowing Greece to default, but instead to continue to service its debt, the whole dynamic has changed from doing Greece a favor by not allowing Athens to default to disciplining Greece by not allowing the country to default. And while that’s what the Germans SEEMINGLY haven’t yet figured out, if one is to judge from the current debate, particularly in Germany itself, at the same time they have approved the latest package and are quickly moving in the direction we are suggesting. Note that Angela Merkel has been most adamant on the particular question of allowing Greece to default or allowing an “orderly restructuring.” It’s also worth noting that when the ECB funds Greece, that funding facilitates Greek purchases of German goods and services, including military, at no cost to the German taxpayer. In fact, Germany gets to run larger trade surpluses, which means by accounting identity it is able to run lower government budget deficits, which allows it to feel virtuous and continue its incessant economic moralizing.

So what’s in it for Germany? That should be obvious by now: Germany gets to export to Greece, and to control/impose austerity on Greece, which keeps the euro strong, interest rates in Germany low, and FUNDS the ECB. All in the name of punishing the Greeks for past sins. It doesn’t get any better than that for the core nations. It’s time for the Germans to stop pushing their luck. Rather, they should embrace the genius of one of the so-called southern profligates, Italy, as they have surely created an operationally sustainable doomsday machine of which Machiavelli himself would be proud. How could this not be the Founding Fathers’ dream come true?

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  1. Hugh

    This isn’t working operationally because things are falling apart even as I write. Nor does it make much sense to separate the politics from the economics since the two are inextricably intertwined. And how exactly does Germany keep exports up to a country like Greece in depression?

    As always this is about the looting. Countries like Greece are being looted not only by their local kleptocratic elites but by those of the core as well. The reason the current Greek government won’t default is because it is filled with puppets of the kleptocrats. This is not just a Greek problem. Kleptocracy has become the world’s dominant political/economic model. What the peoples of the world are slowly coming to the realization of is that kleptocracy can not be reformed or defanged. It can only be overthrown.

    1. Ralph Musgrave

      It is not really accurate to describe Greece as a kleptocracy. The latter word implies that the elite are far more corrupt than the population at large. In Greece, EVERYONE is into the tax evasion business: shopkeepers, doctors, the whole lot. Hence the expression “Beware of Greeks bearing gifts”.

      Thus overthrowing the Greek elite would just be a repetition of George Orwell’s “Animal Farm”: replacing one lot of sleazebags with another lot.

      1. KFritz

        Is this supposed to imply that the Cherman ueber-Capitalists and (comparatively) well-paid orderly citizens all smell as sweet as Bundkuchen? They don’t.
        Whatever the Greeks’ failings, they’re the fall guys in a rigged game. Enumerating their failings in this context diverts attention from the main issue–the rigged game.

      2. YankeeFrank

        That’s actually bullshit. Perhaps the petit bourgeios merchants and professional class are able to cheat the government but the common folk pay the vast bulk of the taxes, and now are going to be getting a tax added to their electricity bills for “ease of collection”. Yours is just a variant of the crap spewed in the US after the housing bubble popped that “everyone was doing it” and so no one is responsible. Actually no, the vast majority of the people losing their jobs and houses didn’t do anything wrong at all, and yet they are bearing the brunt of the collapse, while the banksters who committed the control fraud and the bubble have walked away with huge taxpayer-funded bonuses. Please spew that line on some tea-party freeper site next time.

        1. Ralph Musgrave

          Putting words into other peoples’ mouths is not a desperately intelligent argument. If I was going to compare the US to Greece, my comparison would be a lot more nuanced than you suggest. Re the US, I’d put most of the blame on banksters, a fair amount of blame on the fractional reserve system which gives rise to asset bubbles, a lot of blame on the loosening of lending standards in the 1990s thanks to do-gooders on the political left (strengthening of the Community Reinvestment Act), and small amount of blame on the innocents who took out NINJA mortgages.

          1. liberal

            “…a lot of blame on the loosening of lending standards in the 1990s thanks to do-gooders on the political left (strengthening of the Community Reinvestment Act)…”

            Except that this right-wing shibboleth has been debunked numerous times with empirical evidence.

            But thanks for playing.

          2. chris

            The baloney that the Community Reinvestment Act is to blame is pure fantasy. Banks did not securitize theses assets as they could not. Wall Street’s securitizing everything they could for fees destroyed the housing market as well as the asset-backed commercial paper market.

            Additionally, the CRA had nothing to do with triple A ratings on subprime auto loans which were issued by auto finance companies and banks.

            Check the history around the issue of ABCP in 2006.

        2. Eric

          Greece has been a very solid democracy for the last couple of decades. There was not any large-scale corruption on the spending of national funds, including borrowed funds. Those funds were spent on the priorities of legitimate Greek governments. I don’t think that austerity is a sensible program to help Greece through these hard times, but I also feel that austerity is not some kind of cruel injustice being foisted upon the Greek populace by banks or their European Union partners. No, Greek governments responding quite directly to what the Greek electorate asked of them, borrowed all that money and spent it in line with what the electorate wanted.

      3. Ming

        What kind of rascist bullshit is this? Ralph you wrote:
        ‘ In Greece, EVERYONE is into the tax evasion business: shopkeepers, doctors, the whole lot. Hence the expression “Beware of Greeks bearing gifts”. Like a typical banker apologist you fail to distinguish the difference between the Greek factory/shipyard/government worker, who does pay tax, the little shopkeeper who pays some tax but does perhaps avoid tax on a few thousand euros ( but provides decent products and services to his customers), to the Greek banker or politician or big businessmen, who embezzled millions of Euros a year and hides the money off shore, and then sticks the Greek workers and small entrpreneurs with the bill. And now those same politicians/bankers/big businessmen are conspiring with the euro-craps to privatize all the public assets of Greece, in essence to convert the ordinary Greek citizens into mere tenants on their own homeland.

        Someone who does not pay tax on a small amount if money is an annoyance to the state. But any group of persons who acts to embezzle billions, and seek to bankrupt the state in order to capture the assets for themselves and their foreign allies, they are represent the worst type of corruption; they are traitors.

        1. Ralph Musgrave

          It’s blindingly obvious that the average shopkeeper fiddles a smaller amount of tax than members of the Greek elite. Same goes in EVERY COUNTRY. My point is that the standards of honesty in the Greek elite are not much different to standards of honesty of the WHOLE SOCIETY – unlike the US where my hunch is that standards amongst banksters and politicians have taken a turn for the worse over the last ten years RELATIVE TO standards for the US as a whole, which I don’t think have changed for decades.

          Have a look at this BBC report on the corruption that pervades Greek society. Unlike in the US, Greek doctors don’t like being paid with credit cards because the tax authorities can spot credit card payments.

  2. Ralph Musgrave

    Mosler & Auerback claim that ECB funding of Greece costs the German taxpayer nothing.

    So when A buys IOUs issued by B at face value, when the market regards the IOUs as being near worthless, that’s not a subsidy of B by A? Pull the other one.

  3. VerySerious Sam

    “Germany gets to export to Greece”

    Are you kidding? Greece accounts for about 0,5% of the German exports. No problem whatsoever for Germany if this would be reduced to, say, 0,2%.

    Plus, there is no mentioning of the fact that Germany is on the hook for ~27% of the losses the ECB will create with its irresponsible GIPSIs junk-bond buying, or, as the authors put it, the checks the ECB should write.

    The whole article is boringly stupid in his German-bashing and the underlying aim to continue limitless to transfer taxpayer’s money to the finance industry.

    BTW, the suggestions the authors have posted elsewhere for a ‘solution’ are shrill: have the ECB distribute trillions of €, apply a per capita rule. What?

    1. KFritz

      Closer to 1%, but that’s a quibble. Exports to Greece aren’t very significant for Germany. Germany (and Italy) are Greece’s most important trade partners, over 10% of both exports and imports for each.

  4. Hilary Barnes

    Sounds remarkably like Anglo-Saxon colonialism, by which high productivity European businesses, often working in tandem with European governments, supplied Asian countries with highly desirable goods on most profitable terms and in so doing destroyed the relatively prosperous but low productivity domestic economies of the countries concerned. The governments of the said countries remained responsible for running the country, but were in fact rendered powerless. Looks as if Europe’s Economic Destruction Mechanism could put the PIIGS into a similar condition of permanent poverty. Surely not what the Founding Fathers had in mind.

  5. Thodoris

    So the good news is that we aren’t worth more dead than alive. The bad news is that we are worth more in a permanent coma, or as zombies. The economy is there, but with no vital signs. Dawn of the debt?

  6. craazyman

    This sounds pretty good.

    I will start my own country (I’ll call it “Magonia”), join the euro, borrow from the ECB and buy German exports, loading up on BMWs, beer and sausages.

    Magonia will run a massive trade deficit. What would I export? That’s hard to say, considering I’m not competitive in any way. The Germans could come as tourists if they wanted to, but they’d probably never find the place on a map.

    Anyway, I’d start a few companies to buy German exports, financing the companies with German loans and staffing them with Magonians (who are notoriously flaky). Our companies may not make much in the way of profits, but if those loans keep coming, what difference does it make? An asset is an asset, as long as it’s an asset.

    Actually, if I really think about this, we’re helping the Germans make a profit to such an extent that we’re nearly good German employees. To hell with it, forget Magonia. It’s too complicated and it would be impossible to explain to most people where it is. Let’s just become Germans, if they’ll let us. And if they won’t let us, well, they better keep those loans coming! We know what to do with the money! ha hahaha haahahah

  7. yo

    greece and germany have the same currency and exchange rate

    germany is not getting a “free ride”

    they are more productive

    you can’t say that that greece can’t compete because the exchange rate is so gosh awful high and then turn around and say that germany is only prosperous because of the low exchange rate of the euro.

    germany doesn’t pay their gov’t workers fourteen monthly paychecks per year.


  8. Jim Haygood

    Auerback and Mosler say:

    The ECB can buy sufficient quantities of Greek bonds in the secondary markets to allow Greece to fund itself in the short term markets at reasonable interest rates. And it gets even better than that for the ECB, as the ECB also substantially enhances its profitability by continuing to buy deeply discounted Greek bonds and using Greece’s income stream to build the ECB’s stated capital. As long as it continues to buy Greek debt, Greece remains solvent, and the ECB continues to increase its accrual of profits that flow to capital.

    It’s a great deal for the ECB and the core countries, such as Germany, France and the Netherlands, as it costs the core’s national taxpayers nothing.

    This is exactly what we heard during the TARP LooterFest: sticking the taxpayers and the Fed with trillions worth of insolvent debt is a “great deal.”

    I’m becoming increasingly convinced that ‘Marshall Auerback’ is just a nom de plume for Hank Paulson, who’s still singing the same old Bushco/Goldman Sachs tune.

    Plutocrats who want to rip off the public with simplistic monetary frauds are one-note Johnnies …

  9. Barbyrah

    “Greece thinks the ECB is doing them a favor by keeping them out of default.”

    Correction: “Greece’s [frantic] plutocrats think the ECB is doing them a favor by keeping them out of default; the citizens of Greece know better.”

  10. Skutch

    I agree with the assertion that the ESFS is a political fig leaf, and I suspect that people who are promoting it are hoping that nobody bothers to look at the budget numbers for the countries involved. The current figure of 440 billion euros might have to be increased by a factor of four or five to about 2 trillion euros if all of the PIIGS need help. There are 17 countries that now use the euro. If you take out the 5 PIIGS, there are 12 left. Of them, six are small countries whose collective economic activity is about as big as Portugal’s (Estonia, Slovakia, Slovenia, Luxembourg, Cyprus, and Malta). Belgium is not in any political or economic condition to help. That leaves five countries: Finland, Austria, the Netherlands, France, and Germany. In 2009, these countries collectively had budget revenues of about 2.5 trillion euros, but they also collectively ran a deficit of about 300 billion euros. The additional amount that is being suggested for the ESFS is larger than the revenues of Finland, Austria, the Netherlands, and France combined. As such, the only solutions that have any possibility of occurring would involve action by the ECB. Whether any ECB plan would be politically viable is the most important question that needs to be addressed.

    1. kevin

      This article is disingenuous, to say the least. ECB buying of Greek debt for as long as it takes, even if accompanied by an austerity program, is monetization of debt. Monetization of debt will weaken the euro. A weaker euro means inflation. Inflation means devaluation of debt. Devaluation of debt = implicit default over time.

      1. Jim Haygood

        Correct. As well as a savage inflation tax on little people, the ones who end up getting screwed silly by the Aeurback/Mosler ‘print till it hurts’ lunacy.

        Bankster tools …

        1. Yves Smith Post author

          Get informed before you go into knee jerk reactions.

          Martin Wolf has discussed that the only way for the needed wage adjustment to take place is at a higher rate of inflation. You need a higher rate of inflation in Germany so that you can achieve the needed wage adjustment (at 0% increases) in Greece. At a lower interest rate, you get deflation in Greece which makes it impossible to service the debt (debt to GDP ratio gets worse).

          And inflation is a tax on capital much more than workers, so you have that backwards too.

          Australia has long had a 4+% inflation rate and it has had the best growth record in the last decade in the OECD among advanced economies. And it had the best growth rate in the period preceding commodities boom too.

          1. chris

            While I do not doubt the resilience of the Germans (they did take the economic pain of re-incorporating East Germany) it might be wise to hedge accordingly when making an assumption that they will follow along with the demands that the Eurocrats (and it would seem, economic theorists) think they should go along with.

          2. Ralph Musgrave

            Higher inflation in core countries than in PIGs would certainly be a solution, but it would take years to work. Another solution would be 20% or so instant cut in nominal wages for PIGs. That would equal a devaluation of their currency and would NOT of course mean anywhere near a 20% cut in living standards. That would be a horrendously difficult solution to effect and sell to the PIG population, but then the costs of the current “solution” is horrendous as well.

          3. Septimus

            I’m with Jim on this.

            This proposal IS a form of “printing money”. I’m not going to argue whether or not is inflationary, I’m not well enough versed in economics to argue one way or the other. But it doesn’t change the core point.

            And yes, Martin Wolf has argued that the best way for the Western world to pull itself out of the mire is to fire up the printing presses. But if that is what we are going to do, lets recognize that openly.

  11. chris

    While the MMT pushers do sound like they are living in denial of the possibility of currency debasement and spurring uncontrolled inflation (which would be keynesian of them) they may actually believe that papering over non-repayable paper is better than austerity.

    I seem to recall that Marshall had (at one time) a relationship with a precious metals/bullion dealer. And there is nothing wrong with hedging an inflation concern with a little barbarous relic that has about as much edibility as full faith and fecklessness paper investments, right?

    1. Anonymous Jones

      It’s very important what things “sound” like to you, huh?

      To me, it kinda seems like you hear things but are not really listening, especially because the “MMT pushers” *almost always* acknowledge that inflation is a restraint on government expenditures.

      Cognitive dissonance. Read about it…

      1. chris

        “Almost always” would mean that there is the possibility that I am sometimes correct.

        I do not need to be 100% correct and if you are pandering theory you will never be correct 100% of the time.
        Being dissonant works for me.

  12. HS

    The purpose of austerity is that government revenues in Greece become high enough to cover government expenses, including debt servicing. So, if austerity works, Greece would have to fund their government functions and pay to service the debt. Default is a better deal. Greece would be unable to borrow and would have to cover government expenses out of government revenue. However, this allows their revenue to go farther as it doesn’t have to service the existing debt. Bad loans should be defaulted on or negotiated down. They should not be used as an excuse to make common Greeks pay for the excesses of their government in the past and provide profit for bankers who made bad loans.

    1. Eric

      Again, Greece clearly has been a well-functioning democracy for enough time that distinguishing between common Greeks and their government makes little sense. The excesses of Greek governments for the past couple of decades have been at the direction of common Greeks. PASOK promises, gets the votes, borrows money and delivers on their promises. And then ND has their shot at it. These borrowed funds got spent the way the common Greek expected them to be spent.

      1. Hugh

        This is disingenuous. Greek kleptocratic elites own the government. So contracts and wealth flow to them and they don’t pay taxes on them. It misses the mercantilist nature of the core exporters. It continues the canard of virtuous savers and profligate borrowers, missing why these lenders lent and the need of the exporting sectors of the core to recycle profits from countries like Greece to keep the export cycle going. It trots out the dodge that the elites aren’t to blame or are no more to blame than ordinary Greeks, i.e. they all were doing it. It has this contradiction that the Greek elites were just doing what ordinary Greeks wanted. Well, if that were true, how is it that even a socialist government turned so quickly and so easily into hardcore austerians, slashing budgets, laying off workers, and selling off the commons to rich investors (kleptocrats)? Greece’s best bet is exiting the euro, enacting capital controls, taxing the rich, and allowing both itself and the banks to default on their debts. But guess what, it’s not happening. And the reason it’s not happening is because the Greek political elites of which the current socialist government is a part are puppets of the kleptocrats.

        1. HS

          I’m with you on not letting the elites off the hook. They are kleptocrats. In addition, if they were serving the common people, they could have done something before the problem became a catastrophe. Instead, they collaborated with the setup of the common people. They made money while setting up the collapse, they will use it to buy what the government sells off, and they will use their connections to get a price break while doing it. That’s serving the public interest.

  13. Fiver

    Not sure how concentrating more power in an unelected elite body in order for it to openly ape the Fed in a coordinated round of global currency depreciation helps anyone but the very people of power in Europe (a shrinking number, duly humbled) and the US (BoA to be sure will be offered up as sacrificial lamb) who so completely balled this up to begin with. After all, tens of trillions of dollars were expended on bubble paper, bubble homes, mountains of consumer junk, all manner of waste – rather than the sort of productive investment then that produces a viable wealth stream for us NOW. That’s 20-odd years of effort right down the tubes in many respects. That’s gonna cost ya.

    How does this not end in currency emission into hands which, remaining as they do completely lacking lawful restraint, proceed to instantly take these monies to pursue the most rapacious game in town at all levels all over the globe assuring on-going, repeated top-down squeezings, a global market melt/transmuted debt tithe every third year or so? What Greek worker or German pensioner buys this BS is going to work?

    We still refuse to recognize how bad the damage of recent decades of stupidity really is. Some exceptionally important real world options are simply blown: we have neither any prospect of a good relationship with the world’s major oil producers, nor a tenable alternative energy plan and industrial strategy. Trillions spent, and no assurance whatever of a positive outcome. Same with banks. Stupendous amounts of public money looted, then the remainder taxed and wasted on banks. No real assurance the world is one bit safer from banks. Or jobs. Nope. Everybody is just fresh out of ideas for creating good jobs – because we got away with creating so many shitty ones. Now, we have no idea how to go about it profitably. That kind of thing.

    We’ve wasted the last 3 years, as well. You don’t usually get to be that dumb in the course of human affairs for that long without major consequences. They are surely coming if we don’t jettison this system, rather than feed it weak countries, nations, peoples.

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