David Apgar: Could Germany Be Right about the Euro?

By David Apgar, co-founder of GoalScreen, a web app still in trials that lets investors test alternative price drivers of specific securities (free though the end of the year at www.goalscreen.com. He has been a manager at the Corporate Executive Board, McKinsey, the Office of the Comptroller of the Currency, and Lehman, and writes at www.goalscreen.com/blog.

What if there are good reasons for the preternatural calm of German Chancellor Merkel’s inner circle as the English-language media (based, after all, in the investor capitals of London and New York) light their collective hair on fire about the euro’s imminent immolation? Surprisingly, you can make a decent argument that the euro zone is at no risk of breakup – unless someone secretly switches its purpose from facilitating European trade to providing investors an implicit guarantee against losses.

The working assumption is that German calm reflects a pious belief in the power of crises to sober up borrowing governments and motivate a little austerity. It was on display Tuesday night at the French Embassy when luminaries as diverse as former ambassador Jean-David Levitte, former UNDP head Kemal Derviş, and former Treasury secretary Larry Summers all quickly agreed on it.

Suppose, however, the feasibility of Mediterranean austerity – austerity at a scale big enough to impress the bond markets – is not what Merkel’s team is counting on. Suppose instead the Germans are really counting on the feasibility of a series of orderly partial defaults.

Not that Merkel thinks austerity is a bad thing. She wants EU treaty changes like the 2%-of-GDP borrowing limit that European Central Bank (ECB) President Draghi hinted today might tempt him to buy more government bonds. But how much stock can she possibly put in a treaty change after her predecessor busted the current 3% limit every year he was in office from 2002 to 2005? (Merkel has busted it only twice – so far.)

There are limits to how good a thing austerity is and German history of the last, say, 80 years provides several arresting examples of them. The big unasked question is not whether austerity might be tolerable but whether defaults would be as intolerable as the bond media insist. Here’s why Merkel’s team could have quietly concluded that the costs of a series of partial defaults are unavoidable even without any defaults, that some of those supposed costs may in fact be disguised benefits, and that the alternatives to selective debt relief are probably unsustainable.

As far as costs go, massive European bank restructuring comes to mind, especially following a cool €300 billion or so of losses on government bond holdings. It’s hard to say anything nice about bank restructuring, but at least we know how to do it. We know, for example, how to split good banks from bad banks. (Hint: rank balance sheet assets by quality and liabilities by seniority and draw a line across the balance sheet after the last asset of reasonably determinate value.) That’s handy when you need banks with systems in place ready to restart lending. And we know these transactions work when free from political interference as they were in Sweden in 1992. We also have institutions like the ECB ready to fix broken banks – unlike broken governments.

Less widely discussed, massive European bank restructuring may be unavoidable even if Europe somehow enlisted enough ECB printing presses, enough future earnings of all those carefree northern European taxpayers, and enough future benefits of all those docile southerners to plaster a smile on the face of every bond portfolio manager at BNP Paribas and Commerzbank. The scale of the bailout needed to avoid further investor losses as of today – much less tomorrow or next week – would entail cross-border consolidation or de facto nationalization of a significant portion of the euro banking sector.

In one way, a bailout followed by cross-border consolidation and a lot of de facto nationalization could be worse than explicit restructuring. The bailout would cut interest rates on euro government debt enough that banks could keep a lot of it on their books at par. But that would delay recognition of true credit impairments. Delayed recognition of losses has not worked so well for Japan over the past two decades. An unflinching restructuring of banks with big losses on their books has the benefit of at least trying a different approach.
How about the dark threat of a loss of access to the bond market that hangs over every idle head contemplating partial default? For three years from 1986 to 1989 countless financial CEOs, spokespersons, commentators, regulators, lobbyists, journalists, consultants, and hacks warned Mexico would never sell another bond in our natural lives if anything like the structured default of the Brady bond were to occur. Once it occurred, Mexico was back in the market within about nine months.

Argentina’s (latest) default, by contrast, was a mess. But that’s the point. The markets readily distinguish defaults that are alternatives to large-scale riots from defaults reflecting political cynicism. It’s the market’s appraisal of the quality of its politics, not its macroeconomics, that accounts for the harsh treatment of Italy’s debt even as most financial analysts argued Spain was in worse shape.

Won’t unemployment be high in countries that restructure? Yes, rather like unemployment in countries that do not. With its own central bank, a country such as Italy could devalue its currency to soften the impact of austerity on jobs but austerity is what we’re questioning. It’s hard to find costs of partial defaults that aren’t also costs of pretending every euro government but Greece can pay par.

As serious as these costs are, moreover, none forces a breakup of the euro – not even the circumstances of hapless Greece, with its 50% debt-relief package. Countries can run distinct interest rates, inflation, budget policy, and growth rates within a currency union just as easily as US states can within the dollar zone. And investors can and probably do understand the distinctive risks those countries pose just as clearly as they understand the credit differences among the 50 states. Germany has good reason to protect the euro – but it may also have good reason to think it’s not under threat.

The alternatives to partial defaults by countries that can’t afford to pay rising interest rates, furthermore, may be unsustainable. The most popular alternative has the ECB stepping in to buy bonds every time investors try to cut their exposure. At first blush, it looks clean – no forced austerity, no messy investor losses and bank restructurings, no burden on taxpayers in creditor countries like Germany. The only problem is that it would be inflationary.

And that inflation turns out to be quite a problem. With such ECB generosity on offer – and with euro zone inflation looming – why would any bond trader with a pulse stop after dumping her Greek, Portuguese, Irish, Italian, and Spanish exposure? Why not get rid of the French and German paper in the vaults, as well? Get rid of it all. Well, maybe not the Estonian bonds. But the ECB would be buried.

If turning the ECB into a purchaser of last (and first) resort is not the fix it seems, how about replacing today’s dubious debt guaranteed only by issuing governments with euro bonds jointly guaranteed by, well, Germans? Surely this would have the enormous benefit of pacifying the markets and so at least take the past year’s panics out of the picture.

Euro bonds are such a good idea, in fact, that it’s hard to understand why US state and local governments, with their longer history of crises in a currency union, haven’t got around to using it. The image of a Texas legislator explaining an upcoming state tax hike at the barbecue to pay for the latest California bond issue does, however, help clarify the problem. Any promise by California not to borrow too much that would calm down our Texas legislator’s constituents around the grill would be enough to pacify California bond investors without a guarantee. Joint euro zone guarantees ultimately accomplish nothing more than the fiscal promises of individual euro zone states can accomplish without them.

Ironically, the ECB purchaser-of-last-resort and eurobond alternatives probably would break up the euro zone. The inflationary strains of the former, and the accountability problems of the latter, would never survive the next referendum in a euro zone state. The purpose of the euro is to facilitate trade and commerce – not facilitate government borrowing.

This, then, is the impasse euro zone bond investors have reached. To avoid losses, they clamor for alternatives that could disrupt the currency itself – one of the few things that might actually make them worse off in real terms than they are right now. A brave debtor country or two, backed against the wall, could save them from themselves. As Norman Bailey memorably said of the debt crisis of the 1980s, though, the bankers have no brains and the debtors have no balls.

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  1. psychohistorian

    If,”the bankers have no brains and the debtors have no balls” what do all those folks holding derivatives have or not have?

    I consider all this austerity kabuki just a cover for a Shock Doctrine event by the global inherited rich to undermine the social safety nets of the EU and then the US.

    1. Mattski

      I’m with psycho, and find the pov of this post decidedly. . . aherm. . . problematic, ambiguous in its allegiances. . . maybe wearing a little more heavily the contradiction embedded in this assumptions of this site itself.

      Personally, I’m here to bury the ruling class, not praise it.

  2. LRT

    I am really having trouble understanding where people are coming from with this ‘austerity’ stuff. Is austerity when you spend no more, as a government, than you raise from taxes? Or when you spend no less than 2% more?

    Would it still be austerity if you declined to bail out the banks but had a balanced budget?

    Or is austerity when you spend less than the speaker would like spent on some project he/she favors?

    What’s the alternative to austerity that people have in mind? A deficit of what %?

    1. F. Beard

      A deficit of what %? LRT

      That’s like asking how much gold should be mined under a gold standard. Who knows? Some deficit is undoubtedly good; too much is undoubtedly bad.

      However, deficits need not (and should not) be financed with borrowed money. Sovereign governments should simply create, spend and tax as necessary their own inexpensive fiat.

    2. Praedor

      “Austerity” means gutting/cutting any and all spending that helps the “little people” (the drones) including education, any and all social safety net programs, infrastructure, etc, and it also means gutting worker pay (but not touching executive pay!). It means increasing taxes on the poor/middle class and cutting them for the rich.

      In short, it is pure Ayn Randianism forced upon the populace whether they want it or not (so much for “democracy”).

      1. F. Beard

        A shorter definition of austerity is:

        Cutting government spending so that usury can be paid for what government need not and should not borrow in the first place – its own money.

  3. Cathryn Mataga

    You know, maybe it’s Corzine that pushed the Euro over the edge. That without the MF Global bankruptcy, Italy might have turned around and managed impress the bond markets enough to get back in. But, because MF Global imploded based on investments in European bonds, now for every US Bank, well, European bonds are now poison. Whatever the Germany or anyone does in Europe, MF Global is still going to be bankrupt. The bar for regaining the trust of the bond markets is hugely higher, because of one big fatality — even if it was just extreme stupid, investors are going be suspicious of anyone putting a lot of money into Europe now.

    1. scraping_by

      And also, perhaps MFG will become the scarecrow that the Globalists use to stampede the governments of Europe into a bailout that bankrupts the lot of them. Noun, verb, Lehman Brothers. Noun, verb, MFG.

      Deficits justify austerity, austerity justifies repression, repression and austerity create deficits, and so the spiral goes.

      When a private group goes down, the current Administration has given us the choice between compensation and prosecution. The Madoff case shows there can be both, but never mind. The bondholders for Europe might be just as corrupt, but we won’t know until they collapse and we see what’s scurries out.

      An orderly resolution is long term ideal, but gores too many well-connected oxen.

  4. Tyresias

    Or has Germany declared The Great War Part III without telling anyone?

    After all, the US won the cold war when the USSR could no longer afford to play.

    A German financial hegemony (hedge-money?) of Europe while simultaneously crashing the Anglo-American financial systems would achieve what they failed to do in Parts I and II.

    He who laughs last…..

    1. Fiver

      If the outcome is the destruction of the American/Angloshpere fraud-based, predatory financial system, I’m all for it.

  5. Paul Tioxon

    Everything dies baby that’s a fact
    But maybe everything that dies someday comes back
    Put your makeup on fix your hair up pretty and meet me tonight in Atlantic City

    Well I got a job and tried to put my money away
    But I got debts that no honest man can pay
    So I drew what I had from the Central Trust
    And I bought us two tickets on that Coast City bus

    Everything dies baby that’s a fact
    But maybe everything that dies someday comes back

    Bruce Springsteen, “ATLANTIC CITY”

    The problem that no amount of tinkering can fix, or even face up to is exactly the same as someone that has debts that no honest man can pay. The creation of more debt than there is the capacity to service. And, the underlying problem of capitalism, the endless pursuit of profits, keeps producing more and more surplus capital that keeps finding a way to create more and more debt vehicles, in order to make more and more profits off of the interest.

    And no matter how much debt is racked up, no matter how much is written off as toxic, non-performing and never will perform as intended, there is still more money sitting on the sidelines, just waiting to come into the game. The liquidity preference is in the trillions and growing. So much money, that bank like BNY-Mellon wanted to charge a fee for holding the money, not paying any interest, but re-couping federal insurance fees for deposits. Yes, it is a matter of time before lenders will lend to Greece, Italy, Ireland. It is after all business, in its cycle, not excommunication for all of time for heresy from the church.

    Capitalism endlessly pursues profits and will invest again, will lend again, to the very people that can not repay them now. Where else and what else is the alternative? Eventually the money has to be put back to work, even if the unemployed are not.

    But also, what of the nations that sell off all assets worth having? What of destroying their citizenry’s capacity to be taxed by wage suppression, structural unemployment, contraction of pubic services such as education, health care and pensions, which contract demand? If the state is destroyed as a place to do profitable business, to have a healthy economy that can conduct public borrowing for capital projects of nation building and infrastructure maintenance, where will the surplus profits go in the next round after the recovery? There is a minimum of the capital that must be distributed to the public, to the citizenry to maintain ratables to allow bond issues to go forward.

    Market based, debt issuing capitalism can not be unbound with no upper limits on profit making and surplus capital accumulation, without bleeding dry the social order upon which it profits. It must reinvest in nation building, in recreating a healthy, educated, respected citizenry from one generation to the next. And you do not show your care for people by plunging them into debt peonage and suppressing their political dissent when they identify the problem and begin to move to correct it. The correction is that the debts have to go, and the market has to be placed into service for the people and not dominate and loot them.

    Already the economic calculus has to factor in the revolt of people in the streets, which is worldwide and only going to grow in complexity and successful political gains.

    1. mansoor h. khan

      Paul Tioxon,

      “debt issuing capitalism can not be unbound with no upper limits on profit making”

      But capitalism need not be debt issuing (debt based money issuing). It is also possible for the government to issue currency and hand it over to the capitalist in exchange for produced output. This scheme was worked out by economist Clifford H. Douglas in the 1920s in his book Social Credit. In fact, Keynes ideas are very much consistent with Social Credit Ideas. Even MMT is consistent with both Keynesian economics and Social Credit idea.

      Given deposit insurance and lender of last resort currency even today is very much like equity since it is backed up by the future labor of the “entire population” ultimately.

      Currency Supply = Deposit Balances = Loans Outstanding

      The “= Loans Outstanding” part is not even necessary. We don’t need bankers to create deposits. Government can do it just fine.

      Proof: Just remove deposit insurance protection and lender of last resort protection and the current system will crumble. This proves that the system is totally dependent on the “promise” (an equity claim) of the entire population and not just the “borrower” as bankers claim.

      Money reform as outlined by F. Beard is the first giant step in fixing capitalism. The next step I think should be for the government to remove all impediments to other money (currency) alternatives (like legal tender laws).

      This will decentralize money creation and distribute power (I would expect metal based currencies, city/county gov based currencies, state gov based currencies and other “creative ideas” to come from the marketplace).

      Yes. Social credit based money will have other issues. The government will have to manage inflation (deflation is easy to manage). We need to teach humanity that money ultimately is an equity claim. This equity claim (of fiat currency) needs to be managed (adjudicated) by the currency issuer (the government). The adjudicating is determining who to tax and how much to tax to control inflation (when inflation ensues).

      Mansoor H. Khan

      1. Susan the other

        I like what you just said Mansoor. It gets close to a definition of money that I can almost grasp. Money is a symbol of equity. There is only equity and future equity. And to turn it on its head, to claim that it is the opposite of what it is, and make debt out of it, is the underlying corruption of the system. But I think I know there will always be a needy borrower and a willing lender in some capacity. Social Credit between individuals probably won’t exist. In an ideal world it should. In a truly productive world.

        1. Susan the other

          …because debt obligations create a double jeopardy. It is not enough to pay off a transaction for financing with the social good the money will create. The interest on the debt and the debt itself must be repaid in addition to the social good. So who in their right mind would work to create the social good unless they could rlp some poor citizens blind in the process in order to make enough net profit?

          1. mansoor h. khan

            Susan the other,

            You are giving up on humanity far too easily like most people on this blog. Don’t get me wrong I do not thing UTOPIA (on earth) is possible.

            But it IS possible to greatly improve our condition from what it is now. It is just matter of right knowledge and understanding of how the economy and currency (which is a social arrangement) really work.

            But here is how social credit could work. Let us say we started with $500 per month per citizen. This is not enough to live on but for a family of four on average income it helps tremendously. It also helps businesses of all kinds in a deflationary environment. People will still want to work because $500 per month is not enough to kill the “look for work incentive”. Because I will still want my iphone and go on a ski trip.

            It also help super producers (Capitalists). One thing a super producer craves for (besides power) is “fame”. Well if we encourage super producers to produce as much as they can and give them government issued money and also encourage (inspire) them to not consume (spend) much of what they produce then their bank account (which I would not even tax) will act like a “score” and give them “fame”.

            The gov then can print and give social credit without touching the “super producer’s” score (bank account).

            Look around you. Take Newtonian physics which says an object will keep moving forever unless something is done to stop it. This understanding totally contradicted everyday experience (at the time of Newton) yet here we are in 2011 and most our technology is built on Newtonian physics and even quantum physics and Relativistic physics is built on top of Newtonian physics (adjusted Newtonian physics).

            mansoor h. khan

          2. Susan the other

            I promise you Mansoor I am not giving up on us. And I am also not anti-corporation. I have faith in the basic human desire to create good.

          3. mansoor h. khan

            Susan the other,

            Good. I know we can do better because my faith tells me that there will be far more people in heaven than in hell. And it also tells me that hell will be destroyed after a certain amount of time (as mercy to those who end up in hell) but heaven is for infinity.

            mansoor h. khan

    2. rotter

      “Market based, debt issuing capitalism can not be unbound with no upper limits on profit making and surplus capital accumulation, without bleeding dry the social order upon which it profits. It must reinvest in nation building, in recreating a healthy, educated, respected citizenry from one generation to the next. And you do not show your care for people by plunging them into debt peonage and suppressing their political dissent when they identify the problem and begin to move to correct it.”

      But this is what capitalism is today. Some predicted that it would end this way. I think they are going to kill and maim a lot more people before it finally burns.

    3. WorldisMorphing

      Good nicely written post.

      To these lines:
      [“Market based, debt issuing capitalism can not be unbound with no upper limits on profit making and surplus capital accumulation, without bleeding dry the social order upon which it profits.”]

      …I would simply add that we have not heard what is the “Grand Design” mechanism that our “Great & Wise Wizards” thought of to tackle the very immovable issue of the unsustainability of perpetual growth…
      …and I’m not really an Eco-Fluff club member mind you…

      Here’s an interesting video on the subject. It’s a Geoffrey West conference on Fora TV’s channel. Like you would expect(on fora tv), the guy is an avowed right wing republican, but being a scientist(physicist), he is forced to a disconcerting conclusion…


      1. Paul Tioxon

        Many scientists, regardless of politics, have been beating on this conclusion for quite some time. In “DESIGN WITH NATURE” BY IAN MCHARG, a landscape architect, the principles of urban social pathologies were stacked up one upon the other, from incidences of alcoholism, lung diseases, etc all commensurate with industrial urban manufacturing complexes which included nearby barracks style rowhomes to house labor, and provide an easy walk to the factory. His thoughts and methods took into account the land, the physical space where all things happen, regardless of you politics (Navies not withstanding). As the saying goes, real estate, they aren’t making anymore of it.


        These problems were well known and the moderate conservatives promoted and nurtured the environmental movement, to point the of establishing the EPA under Nixon. You can not poison the well from which you draw your profits. It is not so much a triumph of the bold, lone hippie protesters agitating for clean air and water on earth day as the absence of organized political opposition from more moderate conservatives, in coalition with liberal and radical environmentalists.

        Not only can we not all live like kings, we can not all live like to the standards soccer moms and nascar dads.

  6. Diego Méndez

    I cannot decide on whether the author is an idiot or just a hypocrite.

    The US has eurobonds. They’re called US bonds, aka, T-bills.

    The problem in Europe is not fiscal. There is no evidence whatsoever suggesting it is a fiscal problem. Spain has less public debt than Germany. Public debt in the euro periphery declined every single year until 2007.

    The problem is *private* debt. Net external debt (most of which is private) amounts to 90% GDP in Spain, far over the 40% limit usually considered to signal a significant risk of an Argentinian-like devaluation-cum-hyperinflation crisis.

    The answer is debt relief, aka, letting banks go down. But, under that scenario, Germany would have to deal with massive losses in its banking system, since Spanish banks would go bankrupt and wouldn’t repay what they owe to the German banks.

    Now, if Germany accepts it has to deal with massive losses in the banking system, why not force the euro periphery to exit the euro and gain absolute hegemony in the reduced euro block? I think that’s the plan.

    1. Philip Pilkington

      I don’t think that the entire problem is external private debt at all. But for the private sector debt problem that is there the easiest thing to do would be to promote economic growth by taking the hand off the austerity brake.

    2. Pat

      “Now, if Germany accepts it has to deal with massive losses in the banking system, why not force the euro periphery to exit the euro and gain absolute hegemony in the reduced euro block? I think that’s the plan.”

      I think so too. This is in the best interests of Germany, given the alternatives, and that’s the only thing that matters.
      – All the PIIGS will drop out, since the planned austerity proposals will be unachievable
      – The PIIGS will go back to native currencies, and effectively be devalued by 30-50%.
      – PIIGS will either default on foreign debts, or redenominate in native currency, or keep paying out but face an absolute crushing foreign debt load (above 120-150% of GDP)
      – PIIGS will not have access to bond markets
      – PIIGS will be total basket cases economically. They will be crushed. They will default on foreign loans, impose some austerity and suffer high inflation and unemployment. And on top of that the PIIGS will have to deal with black markets, capital flight and second economies in Euros.
      – Germany will face large bank losses that need to be recapitalized. However, German banks will be stuffed with deposits as Euros from the PIIGS flee to Germany. Or else Germany can sell more bonds easily since they have good credit.
      – German economy will be somewhat depressed since their export market to PIIGS will disappear. However, they will make up for this by selling more to South America, Asia and China. There will be some austerity and higher unemployment in Germany but the burden will mostly fall on the German working class.
      – Germany will avoid the problems of conversion to New Deutsche Marks.
      – The new arrangement will be acceptable to Germans, since the hardship to Germans will minimal compare to the alternatives. German politicians will be able to blame the PIIGS for not complying with austerity conditions.
      – The Euro will be effectively a Super DM, share by Germany, Austria, Finland, Holland, Czech/Slovakia, Lux, and maybe France.
      – France will try to stay in and face difficult austerity measures, whose burden will fall mostly on the working class. France will be a week servant to Germany.
      – The only real difficulty with changing to this new reality will be overcoming the legal obstacle of expelling the PIIGS, but I imagine Germany can figure this out and impose its will

      1. Antifa

        France may need convincing . . .

        but even now we have secretly amassed twenty divisions of technocrats and bankers, all wearing Goldman Sachs armbands. They are hiding in the Ardennes forest.

        When the time is right we will sweep in behind their defenses . . . Alsace vill be ours!

      2. Diego Méndez

        Pat, I agree with most of what you wrote. However, I’d say Germany would experience a huge depression in the short term. And expect lots of political instability (including political murder, possibly worse) both on the periphery and the core countries.

      3. Jim

        Pat argues, “PIIGS will be total basket cases economically”.

        I reply, like Argentina after it paid creditors 35 cents on the dollar?

        I ask David Apgar, who praised the Mexico debt restructuring while implicitly denigrating the Argentine one, which country had a higher CAGR (GDP/Capita) ten years after debt restructuring, Argentina or Mexico?

    3. David Apgar

      “The US has eurobonds. They’re called…T-bills.”

      No, that’s wrong. The US does not guarantee bonds issued by the state of Texas, Orange County, or the Chicago Transit Authority. It’s bad enough that FNMA and FHLMC were able to convince Congress that it had to backstop their borrowing. Imagine what would happen if states, counties, other local governments, and local-agency issuers were able to do the same.

      You may want to explain what you think Germany would gain through “absolute hegemony in the euro block”. I don’t see it. German banks could still lose money on investments in peripheral European countries — albeit in non-euro denominations. Germany would probably enjoy the same low borrowing rates it enjoys today.

      True, a narrower ECB would target monetary policy to complement German fiscal policy — but that’s not far from what the broader ECB does today (and that may be part of the problem).

      1. Diego Méndez

        The US does not guarantee bonds issued by Texas because the US does emit its own bonds: US bonds, aka T-bills.

        In the eurozone, there would be no need for Germany to guarantee Spanish bonds provided that both Germany and Spain agreed on having a eurozone government emit common bonds in sufficient quantity. That’s what many eurobond proposals are about.

    4. Ross Thomas

      “The problem is *private* debt. Net external debt (most of which is private) amounts to 90% GDP in Spain, far over the 40% limit usually considered to signal a significant risk …”

      All debt in the Eurozone is external, in a sense, because the euro is effectively a foreign currency for every member state. Better plans have been hatched.

      1. Diego Méndez

        Ross, you are right to some extent, but please consider that Spain is a large external net debtor, while most eurozone core countries are balanced regarding external debt. On the other end of the spectrum, Germany is a large external net creditor.

        In other words: the euro is the deutsche mark.

    5. Jake


      Might wish to take a look at the Autonomas, see Castilla-La Mancha for example, when it comes to Spanish public debt. A proposito, como anda el Duque de Palma y su dinerito en Belice?

      1. Diego Méndez


        Spain’s public debt, including that of its regions, is not higher than Germany’s, and is far lower than US public debt or Japan’s public debt.

        So where is the evidence that this is public debt problem? I can not see it. The countries with debt problems today are not the ones with high public debt, but those which:

        1) are inside the euro, AND

        2) have high net external debt levels

        So tackling public debt only or as the main cause for the crisis is like quien tiene tos y se rasca los cojones, or scratching your balls to solve your cough.

  7. rafael bolero

    “market’s appraisal of the quality of its politics” What arrogance. What Hubris. If this is style, it’s prologue to tragedy.

  8. Gast01

    Well – by observing the crisis management of my beloved chairwoman an old W.S.Burroughs quote came to my mind:

    Never give anything away for nothing. Never give more than you have to give (always catch the buyer hungry and always make him wait). Always take everything back if you possibly can.

    …in that case, eurobonds would be like methadone-program.

  9. Philip Pilkington

    “The most popular alternative has the ECB stepping in to buy bonds every time investors try to cut their exposure. At first blush, it looks clean – no forced austerity, no messy investor losses and bank restructurings, no burden on taxpayers in creditor countries like Germany. The only problem is that it would be inflationary.”

    That’s a complete myth — and even Trichet knows this. The bond purchases are no more inflationary than QE and even then they’re less inflationary because the purchases are sterilised by using interest earning accounts.

    1. Philip Pilkington

      Here’s a former Dallas central banker who knows what he’s talking about:


      “The ECB should not be overly concerned that bond purchases would lead to inflation if they are not sterilized. The massive bond purchases by the Fed did not lead to massive inflation; indeed, until recently, their impact on the money supply was muted by the desire of U.S. banks to hold excess reserves, just as they did in the 1930s. The same is likely to be true of distressed European banks. During a financial crisis, central bank asset purchases are much less likely to create inflation, and the factors that make that so are the same factors that make the absence of asset purchases so destructive. So, I’m not only advocating bond purchases in volume by the ECB; I’m also advocating allowing them to expand the ECB’s balance sheet and, hopefully, the money supply, at least during the current crisis. Purity is obscurity.”

      1. mansoor h. khan

        Philip Pilkington,

        Private bankers would rather have us (USA and Europe) go through a depression (to reset the system and re-create lending capacity).

        A depression (ultimately) is more profitable and gives private bankers more power.

        mansoor. h. khan

        1. Philip Pilkington

          “A depression (ultimately) is more profitable and gives private bankers more power.”

          It might give them more power, but it will not be more profitable.

          1. Hugh

            In a broad downturn initially the banksters are less profitable or even lose money, but relatively speaking their share of the pie increases and, as we saw in 2008 and after, they are first in line for any bailouts and first to return to profitability. So in the mid to longer term, they are richer and more profitable.

          2. mansoor h. khan


            Thanks for pointing this out. I keep telling Rodger Mitchell Malcolm via comments on his blog that “Incentives are all wrong”. The design of our money and banking system sets up a very strong incentive for private bankers to “reset” the monetary system via a deflationary depression rather than do something more reasonable to keep the economy from getting wrecked.

            mansoor h. khan

          3. Praedor

            Depression could/can produce unpredicted or uncontrolled results. Thus, I would love to see a depression that causes enough social unrest that the bankers (all seeking more power) are instead strung from light posts.

            That is where they belong.

            All US states should follow the N. Dakota State Bank model and cut the private banks out entirely.

      2. Susan the other

        If debt default panic is the problem and liquidity is the answer why don’t we just go with liquidity to begin with? It gets paid back just like debt but it doesn’t destroy the economy.

        1. Philip Pilkington

          Because people like distracting themselves about things by looking at minutiae instead of the big picture? Because people are irrational? Because people have an emotional need for doomsday narratives in times of economic uncertainty when rational policy is needed? Because people are scared of undertaking policy actions that are not sanctioned by those undertaken in the immediate past? Because humans are fearful and anxious creatures that cannot bear the thought of doing something new?

          All of the above, probably. Something about human nature, I guess. As Jim Morrison once sung — and Stina Nordenstam then improved upon: “People are strange”.


    2. David Apgar

      “[ECB] bond purchases are no more inflationary than QE [quantitative easing] and even then they’re less inflationary because the purchases are sterilized by using interest earning accounts.”

      It’s true that a one-time ECB purchase of euro government bonds from distressed banks need not be inflationary and probably would not be so in a credit collapse. It depends on whether the increased supply of cash from the ECB in exchange for those bonds outstrips the increased private demand for cash (or near-cash) as credit drains from the system.

      The trouble is that a one-time purchase solves little. As soon as some of that debt matures and the government that issued that debt needs to issue new bonds to roll it over, the banks buying those bonds would immediately test the ECB’s willingness to backstop the new issue. This would continue in good times and bad. And when it happened in good times — in times where there is no precipitous increase in demand for cash — it would of course be inflationary.

      In sum, the arrangement turns over control of euro monetary policy from the ECB to European banks. Pure corporatism.

      But what about your other suggestion of sterilizing those purchases? (Better yet, the ECB could purchase government bonds from distressed banks without sterilizing the purchase now and undertake sterilized purchasing as needed in the future.) The ECB could do this, as you suggest, by asking banks to hold the cash they receive in exchange for the euro zone debt they sell.

      Over time, the ECB’s balance sheet would fill up with these euro zone government bond issues and bank balance sheets would fill up with cash accounts (or excess central bank reserves) that they could not use. The arrangement would be materially the same as jointly-guaranteed eurobonds discussed elsewhere in the blog. But while such a back-door approach to joint guarantees of euro zone government debt issuance might sneak past the press, it would do so only at the cost of greatly distorting the euro zone’s credit and monetary system.

      That, and transparency, make me think it would be better to adopt the explicit idea of jointly guaranteed euro government bonds than to ask the ECB to make an ongoing commitment (because it would have to be ongoing to do any good) to sterilized purchases of government debt that European banks do not want to hold.

      But then Europe would face all of the problems with jointly guaranteed euro government debt. Again, ask yourself what would happen if the US government backstopped bond issues of every state and local government in the country.

      1. Ross Thomas

        “The trouble is that a one-time purchase solves little. As soon as some of that debt matures and the government that issued that debt needs to issue new bonds to roll it over, the banks buying those bonds would immediately test the ECB’s willingness to backstop the new issue.”

        Who said one-time? If the ECB made it known it was capping Eurozone interest rates at, say, 5% then only a moron would “test” such an intention. The problem is that the ECB and most other central banks have been targeting quantity rather than price. Only the SNB has so far had the cajones to use the word “unlimited”.

        1. Sy Krass

          Ultimately, this is the question, if they start targeting a rate does this mean that once they start purchasing bonds they can’t ever stop without cuasing interest rates to spike. This experiment hasn’t completly played out here yet either, what happens when the FED stops? How high do interest rates go?

      2. john

        Maybe I’m misinterpreting, but as I understand it you’re suggesting that Merkel’s strategy may be to re-introduce Capitalism into the European banking system by making real the possibility that investor can suffer losses.

        Personally I love the idea but wonder how the Ur corporatists in the Obama administration will view it: if Euro investors can take losses what’s up with dollar investors permanent guarantee? And after all it is our nuclear umbrella.

        A split at this scale between the US and Germany could really turn the whole thing geo-political rather than economic. Of course a massive re-armament of Germany to get itself out of an economic jam is not unprecedented.

      3. Philip Pilkington

        “It’s true that a one-time ECB purchase of euro government bonds from distressed banks need not be inflationary and probably would not be so in a credit collapse. It depends on whether the increased supply of cash from the ECB in exchange for those bonds outstrips the increased private demand for cash (or near-cash) as credit drains from the system.”

        No it doesn’t. It’s quite simple:

        The ECB swap a bond — which is a private sector agent’s savings instrument — for an account that earns interest. This is not inflationary. If the private sector agent had wished to spend their money they could have sold the bond — just the same, if they wish to spend their money they can remove it from the interest earning account.

        Inflationary pressures ares caused in these circumstances by the private sector agents discontinuing their savings and engaging in spending.

        The fact that this discussion is even taking place in the present economic conditions shows just how far most commentators have strayed off any rational course.

        1. Susan the other

          “Savings” should have a broader capacity. It should include social good (my term of the day) and equity in a functioning commonwealth. Things like a jobs program to clean up the environment should more than offset inflation.

        2. David Apgar

          “The fact that this discussion is even taking place in the present economic conditions shows just how far most commentators have strayed off any rational course.”

          In general, that’s true. It’s crazy for people to worry about euro inflation right now. But if it’s also true that ECB purchaser-of-last-resort and jointly-guaranteed eurobond proposals require ongoing commitments then we need to look at what they do to money supply or fiscal accountability once we’re past the immediate crisis, as well.

      4. Philip Pilkington

        “Over time, the ECB’s balance sheet would fill up with these euro zone government bond issues and bank balance sheets would fill up with cash accounts (or excess central bank reserves) that they could not use.”

        Right. Just like in QE. This would cause downward pressure on interest rates which would fall to zero. However, the ECB’s sterilisation program ensures this doesn’t happen. They maintain control on the interest rate through stepping up OMOs and opening interest earning accounts for previous bondholders.

        “The arrangement would be materially the same as jointly-guaranteed eurobonds discussed elsewhere in the blog. But while such a back-door approach to joint guarantees of euro zone government debt issuance might sneak past the press, it would do so only at the cost of greatly distorting the euro zone’s credit and monetary system.”

        No it wouldn’t. No more so than the QE program did. As above it would put downward pressure on interest rates. Now, you may consider that a ‘distortion’ of the credit system if you’re a diehard Austrian, but its not really. And this downward pressure can be countered by sterilisation and OMOs.

        Anyway, even if interest rates fell to 0% there would be no inflation. The problems at the moment are with aggregate demand and, as the US, the UK and Japan have shown, in these conditions 0% rates do nothing to the inflation rate.

        Once again, the fact that we’re even having this discussion ignores ALL the lessons that CBs have learned during credit crunches.

        1. David Apgar

          There are two equivalent proposals here and both would prove politically unsustainable, in my view. First I’ll repeat the proposals and then I’ll review why I think they are unsustainable.

          One is the proposal to commit the ECB on an ongoing basis to purchase euro government bonds that banks do not want to hold — and to sterilize those purchases by exchanging other assets held by the ECB for those government bonds or by issuing in exchange for those government bonds an ECB liability like an account that retains its value by paying interest. No one argues this is inflationary. It has other problems.

          The other proposal — equivalent, in my view — is to issue jointly guaranteed eurobonds on behalf of euro zone governments that need to borrow. This is not inflationary, either.

          Either proposal would nevertheless unravel at the first opportunity voters in a euro zone country had to express their views, I believe, if not before. Since interest rates on government debt would reflect the credit of the entire euro zone and not that of the borrowing government, each government would have more of an incentive to raise taxes and cut spending than it has now (interest rates would not rise as much for the heaviest borrowers). Such borrowing, however, would impose more of a cost on the entire zone than it does now.

          Depending on what was going on in other economies, that borrowing might raise interest rates a little and start to crowd out non-government borrowers throughout the euro zone. It might lead the euro to appreciate, cutting off export opportunities and increasing imports at the expense of workers in traded sectors throughout the zone. Or it might lead to a combination of the two.

          As a result, euro zone citizens outside of a borrowing country would resent the country doing the borrowing. They would insist on having some control over it. But then they, too, would have to let other countries sign off on their own borrowing.

          Nothing less than full fiscal union would make this sustainable. But full fiscal union will take years if not decades to accomplish. So it provides no solution to the current crisis.

          Incidentally, there would be one kind of cost to borrowing borne disproportionately by the borrowers. They would eventually experience higher inflation under either of these proposals. But it would be due to their rising aggregate demand and not changes in their monetary base. That kind of adjustment takes a long time to show itself and is unpredictable, however, so it’s unlikely to calm down voters who feel they are losing control over their economic lives.

          1. Philip Pilkington

            “One is the proposal to commit the ECB on an ongoing basis to purchase euro government bonds that banks do not want to hold — and to sterilize those purchases by exchanging other assets held by the ECB for those government bonds or by issuing in exchange for those government bonds an ECB liability like an account that retains its value by paying interest. No one argues this is inflationary. It has other problems.”

            Not to nitpick, but you did actually say that this was inflationary. That’s what I was arguing about. First you said that purchases were inflationary — they’re not. Then you said that while one-off purchases are not inflationary during a credit crunch, long-term purchases are inflationary — but they’re not either. (I think you also said something about inflation in the EZ ‘looming’ which is another investment myth).

            Inflation has to do with how lax EU government budgets are. And as I said, even thinking about this at the moment is just a giant distraction from the matter at hand.

            As far as politics go, of course this isn’t politically sustainable. In Europe at the moment nothing is politically sustainable because our leaders are incompetent, power-hungry troll-creatures. But circumstance has pushed them quite far along the path. (I remember well a few months back when people would laugh at me and others for suggesting an ECB bond purchase system). I think there’s every chance that they’ll bumble through. And if they do, it will be austerity, recession and stagnation that will be the problem — NOT inflation.

            I spoke with a hedge-fund manager the other day and asked him why he was buying gold — knowing that he doesn’t see inflation risk. He reminded me about Keynes’ beauty contest. (http://en.wikipedia.org/wiki/Keynesian_beauty_contest). I smiled.

            My take on this: let the banking baby obsess over its financial-spreadsheet bottle and let’s the rest of us serious folk focus on the austerity programs. They will be the death of us.

          2. F. Beard

            They will be the death of us. Philip P

            Yep. They’ve done it before:

            The main causes of World War II were nationalistic tensions, unresolved issues, and resentments resulting from the World War I and the interwar period in Europe, plus the effects of the Great Depression in the 1930s. from Major causes of WW II [bold added]

        2. Fiver

          Why are you so keen on asset inflation, the inflation Bernanke et al so successfully ignored for so long?

          And why so insistent that QE2 had no distortive effects when it’s absolutely evident that aside from equity markets, it drove commodity prices far higher in the space of 6 months post-Jackson Hole, creating enough “real” inflation in the US to have the fall in that inflation SPECIFICALLY cited numerous times by the Fed as a factor in favor of “better growth” in H2 2011, and in OTHER countries with very serious deleterious affects including rebellions?

      5. Philip Pilkington

        “Again, ask yourself what would happen if the US government backstopped bond issues of every state and local government in the country.”

        All depends what states did in such a circumstance and the state of unemployment/output gap in said states.

        In Europe austerity will be continued. And if it weren’t and governments hiked spending output would increase, not inflation.

        People need a reality check on the European situation. The words of the wise man at the beginning of the Wu-Tang Clan song come to mind:

        “It’s like a finger pointing away to the moon.
        Do not concentrate on the finger or you will miss all of the heavenly glory!”


        Catch up, guys… come on…

        1. David Apgar

          “Not to nitpick, but you did actually say that this was inflationary.” (This is in the post preceding the one just above. For some reason it has no reply option.)

          No, you’re not nitpicking, but rather objecting to widespread errors that neither I nor, I think, others on this thread have embraced. It’s worth going over what is and is not inflationary because there are some excellent posts at the end of the thread (as of 2000 GMT) that require clarity on these macroeconomic effects.

          A one-time central-bank bond purchase that is not sterilized increases the money supply. It may or may not be inflationary depending on the demand for money at the time. Under Europe’s present conditions that demand is high (credit is tight) so one-off central-bank bond purchases pose no inflationary threat.

          Ongoing central-bank bond purchases that are nor sterilized may be inflationary in the future if credit conditions return to normal. Perhaps we disagree about that. The increase in US inflation up to 1980 would be an example.

          Ongoing central-bank bond purchases that are sterilized are not inflationary. Here they are essentially equivalent to proposals for jointly-guaranteed eurobonds. They’re not inflationary, either, but involve the accountability and political problems others on the thread are discussing.

          “Inflation has to do with how lax EU government budgets are.” (Later in the post preceding the one above.)

          Inflation may “have to do” with laxity but it depends on other factors as well. If a central bank tightens money to offset government borrowing then there need not be any inflation. It’s also possible that inflation will rise in a country whose government is not borrowing anything — perhaps because of a rising current account surplus, a consumption boom, a fall in the private sector’s demand for cash, or supply-side changes in the global labor market or in prices of inputs.

          1. Philip Pilkington

            “Ongoing central-bank bond purchases that are nor sterilized may be inflationary in the future if credit conditions return to normal. Perhaps we disagree about that.”

            We do.


            “The increase in US inflation up to 1980 would be an example.”

            Those were driven by rising oil prices and institutional factors (i.e. unions pegging their wages to the CPI which caused a wage-price spiral). They were NOT demand pull. And they were certainly NOT caused by loose fiscal policy.


    3. rotter

      Why do Europeans want to preserve the Eurozone? Who (truly, honestly) derives a net benefit from it? And any answer to that question along the lines of, – well “job producers” like banks and international corporations are the largest direct beneficiary because they make jobs and money – is pre-emptively Invalid. So who in real non-“tecnocrat” speak. WHY, save the Eurozone?

      1. Anon

        Some Europeans such as me view the EU, and the €, as a bulwark against the mighty $, and hence a safety mechanism against some of the more egregious tenets of the neoliberal ideology that flows from the US these days.

        The benefits of a unipolar world, with the greenback as the reserve currency for all, based on the denomination of OPEC production in $, are not necessarily apparent here, particularly in the wake of the invasions/occupations of Afghanistan, Iraq, and the current repressions across the oil-rich Middle East and North Africa.

        For some of us, the US has a somewhat psychopathic taint at present – think Abu Ghraib, Gitmo – so the € appears in part to announce a distinctive political European identity that helps preserve values we do not share with the US – right to free healthcare at point of use, subsidised/free education, social safety net, pensions, living wage, paid holidays, need for serious effort to tackle climate change, and so forth.

        In addition, the € is a late arrival to the European project, since the structure of the EU is already deeply embedded in all EU member countries, after more or less 60 years of continuous evolution the from older, partial post-WW2 economic unions among Eurostates such as the EEC.

        I suspect many US commentators underestimate the costs and dislocation that countries that use the € having to leave the EU would cause, and why, in the midst of the serious economic problems we already face, these would not be desirable.

        Even dyed-in-the-wool rightists such as the British prime minister David Cameron support EU membership. Politically, it is unthinkable that the project would be allowed to fail, despite the line of blogs such as ZeroHedge, where Nigel Faragist-type eurobollocks tends to get some traction.

        1. different clue

          The Canadians do all that with their mono-national currency the Canadian Dollar. You Europeans did all that with your separate single-national currencies. Is the Euro helping you do all that any better? Or even as well? If not, then how does the Euro protect you from Dollar political-economic culture any more than your separate national currencies did?

      2. richard in norway

        Price transparency especially in border regiens, no need for currency hedging in a pan European buisness, no need to change money on short trips which saves on commissions, big currency is less volatile makes long term planning easier and then there is the biggie …. A chance of surplanting the $ as reserve currency and be able to get free oil in the same way the US has since the 70s

    4. Jim

      Why does everyone discount the constitutional implications of ECB monetization? The German voter was EXPLICITLY promised that the ECB would not monetize debt. Do we not care about German sovereignty or the German constitution.

      Do we believe, as do many Eurocrats in Brussels, that the German voter is simply too ignorant to realize what’s good for him?

      And if we do, would we also support a Republican president, by decree, converting the Medicare defined benefit program into a defined contribution program? The reason? Gingrich would argue that the American voter (who overwhelmingly supports Medicare as is) is too ignorant to realize what’s good for him, and that he’s simply ensuring the long-term viability of the program.

      Frankly, I’m shocked that so many NK readers who support the OWS movement in the US also support the violation of the German constitution and sovereignty in Europe.

      Democracy in the US, but not in Europe?

      Cognitive Dissonance is strong.

      1. Fiver

        The depth of hostility to Germany just stuns me. Sterotypical prejudices of older generations were so quickly reanimated in media I view it as part of what to me is a financial attack on Europe as a whole – the aim is to essentially duplicate the coup that began with Paulson/Bush/Geithner/Bernanke and has been strongly consolidated under Obama – with almost all of the same players, public and private in good or better position and financial standing). Concentration, centralization is power. Real democracy and independent action are always the enemies. Central power makes it a million times easier for global financial predators to savage everyone. How better to hamstring Germany for decades, using it to ensure some sort of lucrative payment stream and also leave them to take all the hate? These are great times for elite technocrats and kleptocrats on both sides of the Atlantic.

        1. Foppe

          German politicians or the German people? It seems to me that they’ve got the same representational problem the Greeks do — the politicians act, the people are blamed.
          That said, I do think that ‘Germany’ does deserve a large portion of the blame. But this not so much because their politicians are in bed with big finance (and, presumably, industry, but my knowledge of the German political scene is woefully inadequate), because that seems to be true pretty much anywhere. Rather, because they already had to deal with this problem once before (and, annoyingly, during the period in which Maastricht was written), in their attempt to reintegrate eastern Germany. That failure should’ve told anyone that forced integration of 12-17 economies in a decade and a half is impossible to pull off — yet nobody with access did, while those who did criticize the reunification efforts were no doubt vilified. (I mean, I do not mean to suggest that it is in any way surprising that it went this way, but just that the German people were in a fantastic position to see how a rushed implementation of a single currency area, and rushed ‘opening’ of an economy, could go wrong.)

          1. Fiver

            Reunification was by choice, and, though fraught with great difficulties, clearly a better fate than that of other Eastern bloc entities. Polls since 2004 in both East and West show less than full enthusiasm, though they tend to track the overall sense of economic performance (polls in 2009 much worse than 2010 for instance). In any case, I’d bet the farm that East would not vote to leave, nor West vote to force departure. That said, there was and is much room for improvement.

            You are quite right that Germany was/is in a position to know how tough integration can be. But where we part ways is that you believe that’s their first choice, whereas I believe they are doing what the Western elite consensus view, and those who own that view, tells them they must do, or else “markets” will ensure failure.

            How many times here on NC, which is more democracy-friendly than, say the Economist, or FT or any US mainstream media have you seen pieces or opinions presented with precisely that view: fiscal union is essential in order to secure what’s really desired, which is unlimited ECB backstopping to bail wholly parasitic banksters and their husk host governments in Europe and in time, America.

            I think fiscal union is a disaster all around, not least because it’s being foisted on Europe only in order to accomplish the even dumber goal of using the ECB to save banks that ought to have all the debt taken back onto THEIR balance sheets and destroyed.

  10. steve jennings

    @Diego Méndez

    I think hypocrite. He obviously has an axe of some kind or other to grind, no one can be a dumb as all that.

  11. Mike Sax

    Interesting David! I had assumed that the lender of last resort or Eurobond scenarios were the way to go. It seems to me though that if the ECB is not the lender of last resort though, then the EU mmeber countries really have a lose-lose on their hands and a country like Britain really dodged a bullet-or Switzerland for that matter.

    For what the EU countries are of course are no differnt now than the state of Texas or California. Why would you move from being a sovereign nation to a state?

    On the MMT question:

    While I find some of this MMT stuff intriguing as a wholly different way to coneptulize the world, talking to some of these MMTers individually is harldy a meeting of the minds.


  12. Don

    Does it make any difference to anyone that European banks are 3x as leveraged as American ones, and have [very] approximately $36 trillion in assets vs. $13+ trillion is European GNP? And relative to the above, Germany has only a $3.5 trillion GNP, vs. over $9 trillion for the rest of Europe. Can Germany, with its own debt to GNP ratio of 80% really save the rest of Europe? The analogy of a larger West Germany saving a smaller East Germany 20 years ago does not seem to be realistic in these circumstances. If Germany guarantees the debts of Europe, its interest rates will be as high as Italy’s, or worse.

  13. Jackrabbit

    The Stick: Germany wants the ability to leave if the other countries do not choose a closer fiscal union. (Its almost funny seeing commentators think that this “option” is meant for the weaker states.)

    The carrot: “Voluntary” debt forgiveness and restructuring.

    So, IMO no “defaults” via political and market manipulation. This current period of market turmoil and angst is just setting the stage for the grand bargain.

      1. Jackrabbit

        Well lots of ppl (like Diego Mendez and Pat above) seem to think that a break up and defaults are inevitable, either because the debts are just too much to handle or because European leaders are out of touch and/or powerless (due to the EU structures).

    1. Fiver

      “Markets” don’t want defaults. “Markets” are the tools used to force the most lucrative conditions for looting. Defaults and their “catastrophic” consequences are the Bogeymen.

  14. Ignim Brites

    “What if there are good reasons for the preternatural calm of German Chancellor Merkel’s inner circle as the English-language media (based, after all, in the investor capitals of London and New York) light their collective hair on fire about the euro’s imminent immolation?”

    My guess is that the US and London banks are being forced to post collateral on all the CDS contracts they have written. Judging by the stock market action, Morgan Stanley and JPM are most at risk in the US. So why should Germany care? London and New York are financing the French and German banks. If this is the case, then it is most important that there be no solution. Any solution would require the French and German banks to quickly return all the collateral they have received. And that might cause their collapse. So France and Germany are just going to string this crisis out as long until their banks can be properly recapitalized.

    People talk about a Lehman event. But it was the AIG event which really drove the 2008 crisis.
    Everyone is wasting their time even thinking about a solution. The crisis is the solution from a Franco-German perspective.
    Welcome to the age of pyroclastic secularity.

    1. Susan the other

      Pyroclastic secularity. You lost me there. But everything else sounds totally true: “The crisis is the solution.”

  15. aeolius

    Way up on top psychohistorian calls this Kabuki. I would rather see it as a sit-com
    I believe that the story is about a couple who has been living together for many years because relatives object to a marriage. So the couple (fittingly played by Merkel and Sarkozy)connive (in a plot Lucy and Ethel would be proud of)
    to get everyone to agree to the marriage.
    It has been clear that the present EU system is outdated and unworkable. The structure which was designed to be temporary confidence moves on the road to a closer union has instead become bogged down on the problem of giving up some if not most national soveignity in favor of a true united states of Europe.
    Confining the union to the Euro states gets ride of the large UK problem. Within the Eurozone the most nationalistic-Greece, Spain Italy are in no position to complain.
    In fact it is the nation state which is outdated.

  16. pebird

    A common currency without a common bond leads to transferring FX speculation to national bond speculation, where default is the alternative to FX losses. Whoever designed this system needs their head examined.

    Since there must be a risk free financal alternative in order to price risk and EZ national government debt isn’t an option, then the risk free alternative is mediated through the bailout process, which makes price discovery difficult if not impossible.

    The EZ should issue Eurobonds only up to whatever cumulative stability pact metrics they wish to enforce, and individual countries could still issue their own debt in the markets if they wanted to spend more than their allotment of Eurobonds. Eurobonds backed by ECB, individual bonds backed by individual nation’s ability to pay. Just like the US. Clean and clear to the markets.

    For those countries issuing their own debt, there would be a price to pay for “excessive” spending in higher rates, but the majority of their debt would be lower interest Eurobonds. And northern Europeans could sleep at night knowing that the southern Europeans couldn’t borrow more in Eurobonds than any other EZ member as a % of GDP. And when Germany or France exceeded the debt limits, there would be a clear marker for all to see in the form of their own nation’s bonds.

    But instead I believe that we are going to see the development of a fiscal union in Europe analogous to Texas telling New Mexico how much they are allowed to spend in their own state.

    1. F. Beard

      Sovereign governments should NEVER borrow in the first place. The ability to service debt is the ability to not borrow in the first pace when it comes to monetarily sovereign governments.

      But now we have the absurd spectacle of sovereign governments needing to borrow from the private sector the very money that the governments (through taxation) give value to!

      1. Ignim Brites

        Well if taxation is what gives value to fiat money, then those with the highest taxation will compete the hardest for the currency. Therefore to cure inequality and poverty, lower taxes on the rich and raise taxes on the poor. Effing brilliant!

        1. F. Beard

          Therefore to cure inequality and poverty, lower taxes on the rich and raise taxes on the poor. Ignim Brites

          He who oppresses the poor to make more for himself or who gives to the rich, will only come to poverty. Proverbs 22:16

          I imagine that applies to nations too.

          Further the rich, being the chief beneficiaries of the government enforced money monopoly, should pay for it, no?

      2. pebird

        Sovereign governments don’t borrow, they issue interest bearing financial instruments equivalent to the amount they spend. We just call it debt.

        1. F. Beard

          they issue interest bearing financial instruments equivalent to the amount they spend. pebird

          Whatever for? To regulate what should only be a private business, banking? To give the rich a risk-free return at the expense of everyone else? To make government a usury collecting agent? To waste taxpayer’s purchasing power on needless interest payments?

        2. Calgacus

          We call it debt because it is debt. Currency & bonds are both debt, practically the same thing. (Monetarily sovereign) government borrowing is not borrowing because that financial transaction is simply not at all the same as private borrowing, borrowing properly speaking.

          Government spending can be considered borrowing – when it spends, it gets a cup of sugar from you in exchange for its currency, its IOU, whose implicit promise is that it can be exchanged for (roughly) another cup of sugar in the future. So in this correct sense, sovereign governments can be considered to borrow, not in their own currency, but with their own currency.

          1. mansoor h. khan


            Yes. But true nature of transaction is not debt (i will get back 1 cup of sugar). It is more like equity.

            Fiat management requires open market operations and/or taxation to maintain the value of the monetary units which was exchanged for a cup of sugar to a cup of sugar.

            In other words inflation (and deflation) must be dealt with by the government. Deflation is easy to deal with (just spend money and create inflation) until the same number of monetary units buys one cup of sugar.

            Ok. How about inflation. Some inflation can be dealt with open market operations to attract investors to forgo current consumption in return for interest income.

            I don’t think open market operations will always work to bring inflation under control. At least not without causing social instability. In some cases taxation may be required if baby boomers start spending in golden years and labor productivity and savings rate is not sufficient to balance supply vs. demand for real goods and services. In this case the government will have to tax away some of the spending power of earners to control inflation (even a consumption tax may be required).

            This means while same number of monetary units buys one cup of sugar but I will have fewer number of monetary units in total because the gov taxed some away. Effectively, I don’t get same number of cups of sugar for my pot of money even though each singular cup cost the same number of monetary units.

            This means what my savings/earnings buy (when I try to spend in the future) will change based on how the gov will maintain the aggregate supply and demand balance (i.e., control inflation).

            If peak oil is true and effective energy output is constricted in the future this will be even more true. A consumption tax may be required on spenders to control inflation.

            Mansoor Khan

      3. Jackrabbit

        I agree with the sentiment but in actuality deficit spending makes sense:
        * in wartime;
        * economic downturns (especially when severe); and
        * when the government wants to finance the acquisitions like aircraft carriers and fund long-term projects.
        In addition, an active market in government-issued “risk free” securities has proven to be useful to the capital markets.

        However, when a deficit becomes structural – where, for political and other reasons, new debt is increasingly used to pay interest on old debt – then the debt has become excessive and the ship of state starts to leak sovereignty (so to speak).

        Couple that with privately funded elections and winner-take-all capitalism. Mix well and stir. Yum! (if you can afford it.)

        1. F. Beard

          actuality deficit spending makes sense: Jackrabbit

          It almost always does. However deficit spending DOES NOT require borrowing. The government should simply create the difference between spending and revenues from thin air.

          The bankers have gulled us into believing that borrowing must finance deficits. It does not.

  17. Klaus Kastner

    National Banking Supervisions in each country, in coordination with the ECB, should send a directive to their member banks stating the following: “You are required to establish loan loss provisions (note: not a haircut! BSAs cannot mandate haircuts but they certainly can mandate loan loss provisions) on all sovereign debt of PIIGS-countries within 30 days. The percentages are: 50% of nominal for Greece; x% for Italy; y% for Spain; z% for Portugal and zz% for Ireland”.

    This would trigger losses in the area of 1-2 trillion EUR, wiping out the capital & reserves of most banks. Banks have to ask for bail-outs and governments say: “We will recapitalize you. The capital of existing shareholders will be subordinated to our new capital. When, in some years, all the dust has settled, we will sell our shares and calculate a decent return for our risk. If more than that is generated through the sale, it goes back to present shareholders. If not, present shareholders have lucked out”.

    If banks object, governments respond: “Ok with us. You declare bankruptcy tomorrow morning. The successor companies which we have in place already will take over the operating business of your bank and it will be up and running again by afternoon. No depositor will be hurt; in fact, we will guarantee all deposits”.

    In and by itself, this would do nothing to the debt of the PIIGS-countries because their debt would still be in place. But then governments, as owners of the lending banks, can steer meaningful solutions for those debts directly (reschedulings, lower interest rates, even haircuts, etc.) instead of having to accept bankers’ games like cutting the debt in half and doubling the interest rate. The losses would already be booked and when losses are already booked, banks have a lot more freedom to act.

    How to finance the recapitalizations? Have the ECB sell bonds. How much will it cost tax payers? That part of the 1-2 trillion EUR loan loss provisions which turn out to become real losses over time. Is it worth it? By all means, because one can start all over again with a clean slate! Another alternative is in the link below.


    1. Ignim Brites

      Why bother with the recapitalization scheme? Just take them over and be done with it. They’ve already had there chance.

  18. ron

    “preternatural calm of German Chancellor Merkel’”

    The Central Banks have had her back so the reality is that she and others had no immediate crisis other then PR. The reality of the situation is clouded by the Central Banks and US determination to hold the Euro together for how long and at what cost. For Merkel its a matter of letting the U.S. financial sector smoother over these rough patches.

  19. craazyman

    I bet that preternatural calm is either Xanax or some variation of scientology, which seems to fit the Germanic mind. I have met a few totally insane Germans in bars in New York who got into Christian cult stuff and they were nice folks but the tribal mind dies hard.

    Or maybe they see this all as a big Y2K, knowing it’s all hysteria but feeling powerless in the throes of the big Pilot Wave that pushes forward daily.

    Nothing bad would really happen if the whole place fell apart. There’s a Zen term or when your world view disintegrates buut I don’t know what it is. But the world is still there it’s just your world view that collapses. And so the Master sees the fraudulence of any world view.

    Europe did great without the euro. The euro is only a mental phenomenon and they think without that mental phenomenon there’ll be back to the blood feuds. But the blood feuds don’t need a common blood currency to solve. Consider the wars where places have a common currency, and the peace where they don’t. Consider the blood feuds in families where even the blood itself is the same. The feud transcends the currency and the blood.

    I read this post once sober and sort of bounced off as my mind kept distracting me with images of related things, and then read it after several wines and xanax and sort of get it. I suspect the Germans are on Xanax and beer and that’s why they’re calm. Plus, they know they can figure it out if their exports have to go someplace else.

  20. A_reader

    Two types of bank shill´s:

    Hi Yves,

    thanks for posting this article. Besides Buiter´s Fund/good Bank proposal probably one of the more enlightend contributions to the current discussion.
    I used to read your blog on a regular basis and whilst your articles have changed only slightly, the general tone of the comments has become decidedly poisinous.
    I read a fair bit and try to cover the whole spectrum of opinions. Unfortunately compared to the situation of about 6-24 months ago, there´s a lot more employed commentators(shills) for the financial industry around and it seems to be more of a long-term strategy by now(maybe the price of becoming relevant?).
    Their strategy at all times seems to be to polarize; either the basic line is: it´s due to regulation/the market has been hindered by regulation/…(hence austerity, w/o losses for bondholders is the solution) or it´s along the lines of prettending that MMT/a perfect world/…(hence the solution is easy money) was the way the world works currently.
    The interesting thing point is that under current arrangements the financial sector(banks especially) would profit from either arrangement.
    It´s interesting to note that when you publish an article that has some interesting ideas, which however involve a certain amount of pain for the financial sector, that the second kind of bank shills(sorry, some of your [regular?] commentators) are up in arms against it, without even discussing the main point.

    1. F. Beard

      Name names, buddy.

      Are you calling me a banker shill? If I had my way, banking would be no more significant to the economy than pawn shops, if that much.

  21. Fiver

    Nice to see a view presented that attributes Germans with something other than demonic, supremacist or robotic qualities.

  22. Sceptic

    The outcome you suggest, that controlled defaults are compatible with the euro, is an interesting idea, however you seem to forget some problems:
    1) Your 300 billion number is very optimistic. If Italy with its 2 trillion of debt goes down, it won’t be 300 billion of losses. Especially, because one has to take the domino effect in account. After loosing at least 100 billion on Greece, the banks and funds would have to digest probably a loss of a third of the debt of Italy. And them all hell would break loose: Portugal, Ireland, Slovenia, Spain and Belgium. There would be pure panic across the world. Then France, Austria (their yields are already climbing) and, yes, even Holland and Germany (80% debt to GDP). American banks would be affected too, because CDS would have to be mobilized.
    2) Massive runs on European banks and flight of capital to safe haven currencies. One could say banks would recapitalize with the new facilities from the ECB (3 years loans). But on what collateral? On defaulted bonds? And wouldn’t they have to sell their other resources to face the massive runs on them?
    No, I’m afraid that if Italy goes down, it will take the Euro with it. Member States of the eurozone would have to leave it in order to print trillions to save their banks. That, of course, would create inflation, but the printing of a trillion now by the ECB wouldn’t create big inflation, as the QEs of the Fed confirmed.
    But I agree that the Eurobonds are unhelpful. However, not even the Germans believe in your outcome and they seem to live in a very different world (these are political correct words for “crazy”). They seem to want to build another general water pump system in the middle of an uncontrolled fire. They are going to destroy the Euro in order to save it from quixotic inflation.
    We needed something like the Fed printing another trillion and buying European debt to save us all. Since this move seem political impossible even to someone as competent as Bernanke has been, we are heading to disaster, leaded by a blind women and a “super” Mario (he is going to be lynched in Italy, after loosing his job with the close of the ECB).
    Anyway, only delusional people can have the pretension to write truths. To write things that help others see clear the future seems a good goal. Right or wrong, you did that.

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