Marshall Auerback: Beware German Trojan Horses – More “Europe” Might Mean More Fiscal Austerity

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By Marshall Auerback, a portfolio strategist and hedge fund manager

As several newspapers have recently highlighted, Germany is slowly but surely moving toward a plan to combine much of Europe’s bad debt into a single fund with the idea of paying it off over 25 years. The latter proviso is key, as the bonds are temporary, and therefore compliant with recent decisions by Germany’s Constitutional Court, which has ruled against permanently surrendering Germany’s budget-making power to another entity.

The worsening crisis has led to a sweeping effort to chart a new path forward for the union, one that encompasses fiscal integration, Europe-wide banking supervision, and tighter coordination of economic policies.

German leaders have not provided details of a potential deal — and not every country may be eager to sign on — but it would be likely to mean an expansion of executive power in Brussels over fiscal targets in member states and supervision of their banks, along with Europewide deposit insurance. It would go far beyond what was contemplated for Europe even six months ago.

That’s the good news, right? To be sure, some form of a banking union is necessary, and it probably has to come sooner, rather than later. Given the magnitude of euro deposits which have already flooded into Germany’s banks, a euro area FDIC on its own could well be too little, too late, given the mounting deposit run. We could be looking at trillions of euros of bank deposits in the periphery countries now residing in German banks. Why would these depositors move their money back to, say, Spanish banks at this juncture? Nothing short of a commitment to infinite liquidity provision to banks will do. The Target 2 balances understate the extent of the run, as the ECB somehow finances ELA claims on periphery banks and ECB repos have to some degree financed deposit runs from these banks as well.

Ironically, for all of Germany’s complaints about “bailing out” Europe, if they insist on extracting more pounds of flesh from the already emaciated periphery, the euro zone itself could collapse, and Berlin would be on the hook in more than one way for these lenders of last resort claims as well. More importantly, these claims would be largely unenforceable for Germany if the entire system collapses.

So you need something bigger. Unfortunately, for the most part, Germany is constitutionally incapable of thinking in ‘infinite’ terms. Moreover, a banking union faces another form of resistance from German banks: they are horrified that a real EBA will discover the truth about the black holes within them, notably their Landesbanken.

And there is the question of time. The banking run is still accelerating. We must be getting close to the point where the banks are going to run out of collateral required for Target 2 and ELA loans. Then what happens? Then does the ECB waive all collateral requirements and break the rules or does it act bureaucratically and stick to them? I suspect they’ll do what they are doing for Greece right now and effectively take anything as collateral. But if you get a big “NEIN” all of a sudden, then some big PIIGS bank will not be able to get funding for deposit runs and has to suspend deposit withdrawals. What happens then?

As for the proposal from Germany’s “wise men”, which is now gaining political momentum amongst Berlin’s governing elites, the devil is in the details. If a new “fiscal compact” is part of the deal, it will enshrine an economic impossibility. Leaving aside the point that virtually no country today is compliant with the EU’s Stability and Growth Pact, budget deficits are largely “endogenous” phenomena, which is to say that they are non-discretionary. Slower growth inexorably reduces tax receipts and increases social welfare expenditures (the so-called “automatic stabilisers”). And, as Yanis Varoufakis has noted:

If Spain, Italy, Portugal, Ireland, France, Greece, Germany etc. (i.e. countries with debt well above 60% of GDP) were to reduce their debt by the specified 5% per annum, this would mean that all these nations should turn an average 2.8% primary deficit to something akin to 6% primary surplus. Suppose we could do it (which, of course, we cannot). Were we to succeed in this endeavour, the result would be a very deep recession equal to at least -4.5% in terms of average Eurozone-wide ‘growth’. In a period when a banking crisis is in full swing, the Periphery is in free fall, US growth is tittering of the verge, China is slowing down etc., engineering such a recession via this piece of ‘legislation’ is the macroeconomic equivalent of committing suicide.

This time, it’s not the Greeks, but the Germans, who could well be introducing Trojan Horses into European economic policy. It’s bad economics, stupid politics and unlike the original Greek Trojan horse, might well not bring “victory” to Berlin. So everybody should beware Germans bearing economic “gifts” of this sort, including Mrs. Merkel’s own electorate.

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  1. F. Beard

    To be sure, some form of a banking union is necessary, Marshall Auerback

    To be sure, banking itself is not necessary. Governments can simply spend their money into existence and tax SOME of it out of existence – no need for banks there. In fact, the reverse is true – banks need government.

    As for the private sector, why should some – the so-called “credit worthy”- be allowed to steal purchasing power from everyone else? Surely between honest usury for existing government money (generously spent into existence for infrastructure and social needs) and alternative private monies the need for money in the private sector can be well met?

    1. Paul Tioxon

      Mr Beard, I applaud your elegant yet simple description for the operational need for banking. The government, as the issuer of currency, has a ready made bricks and mortar branch system: The US Postal Service. It has been in the financial service business for over a century, as the carrier for mortgage checks, rent checks, car payments, utility bills etc. America’s middle class never saw such prosperity as they did when they paid their bills by mail and banks never had it so good as when US government made sure they got their checks no matter what.

      Today, the government needs to initiate a internet strategy to conduct the simple, yet necessary banking needs of the 99% who have deposits to make and bills to pay and some place safe to keep their spare cash, yea! Government geeks writing apps for smart phones and tablets, like a voter registration app that kicks in with yr birth certificate! How hare can it be? If the NYSE and NASDAQ and the Fed etc can do business over the internet, why not the registration of voters, at the post office of course.

      1. F. Beard

        The government, as the issuer of currency, has a ready made bricks and mortar branch system: The US Postal Service. Paul Tioxon

        Yes and once the public has a free* risk-free fiat storage and transaction service that makes no loans and pays no interest then ALL government privileges for the banks should be abolished including and especially deposit insurance.

        *For non-commercial use up to limits that include 99% (?) of the population.

    2. Joe Rebholz

      “…why should some – the so-called “credit worthy”- be allowed to steal purchasing power from everyone else?”

      I think I understand the stealing of purchasing power, but I’m not sure. Could you explain this please?

      1. F. Beard

        It follows from “loans create deposits.” That new money dilutes the existing supply of credit and money and thus steals purchasing power.

        This is not to say that money creation is bad (it isn’t) but that money creation must be done ethically.

        1. Kiste

          Please describe a practical mechanism for the “ethical creation of money”. But not before you define what “ethical” even means in this context.

          1. F. Beard

            That’s a big request but here’s a few principles:

            1) We should have coexisting government and private money supplies per Matthew 22:16-22 (“Render to Caesar …”).

            2) Banking should be an entirely private business.

            3) Non-usury based private money forms such as common stock should be encouraged.

            4) Monetarily sovereign governments should never borrow.

            5) The existing money system has cheated everyone so everyone is entitled to a bailout.

            6) Government money should ONLY be inexpensive fiat.

          2. Kunst

            2) Banking should be an entirely private business.

            Why should banking be an entirely private business? Not disagreeing, just asking. For example, most savings in Japan are held by the government through the postal system.

          3. Andrew

            This is the F. Beard I like…..Sounds like you should be a big fan of Islamic banking which forbids interest on loans and forbids investment in unethical businesses. I believe the spirit of the Islamic system is that debtors and creditors share the risk and share the profits in any joint venture.

            Of course the City of London spivs and Wall Street hucksters have found technical loopholes in the paperwork. They offer Islamic loans which are functionally the same as interest bearing loans but use different terminology. E.g. Instead of providing an interest bearing loan to procure a car. They buy the car and sell it to you at market price plus [their] profit. Which is equal to 7 years compounded interest… Payable over….. Wait for it……7 years. They even have a twist on an interest “free” lease that caters for variable [interest] rates.

            I suppose a good Muslim can happily pretend he is not paying interest. I hope Allah sees it all in the same light.

          4. F. Beard

            Why should banking be an entirely private business? Kunst

            Why shouldn’t it be? Banking is gambling. Why should gambling be subsidized by government?

            For example, most savings in Japan are held by the government through the postal system. Kunst

            You’re confusing saving with banking. The government should provide a risk-free fiat storage and transaction service but it should pay no interest and make no loans.

          5. F. Beard

            Sounds like you should be a big fan of Islamic banking which forbids interest on loans and forbids investment in unethical businesses. Andrew

            Well, there you are wrong.

            Go figure. Hint: Common stock as a private money form. Hint: Government money spent into existence without borrowing.

          6. F. Beard

            I believe the spirit of the Islamic system is that debtors and creditors share the risk and share the profits in any joint venture. Andrew

            Yes, but that is still not Biblical since the Bible also condemns “profit taking” (but not profits!) which rules out dividends as well as interest.

            A solution is common stock as private money:

            1) Common stock as money requires no borrowing or lending. Assets and labor would simply be bought with new stock issue. Thus no PMs, usury, or fractional reserves are required. This is a huge benefit since PMs, usury (see Deuteronomy 23:19-20) and fractional reserves are all problematic.
            2) All price inflation is born by the owners of the corporation since every receiver of the new common stock money is by definition a part owner of the corporation. This is an important moral consideration.
            3) Since all money receivers/holders are part owners of the corporation then they could vote on how much new money is issued and for what purposes. Thus price inflation is under the control of only those affected by it.
            4) The assets of a corporation are typically performing assets though PMs could easily be accommodated too.
            5) Common stock as money shares wealth at the same times as it consolidates it for purposes of economies of scale. Labor problems should be non-existent since the workers would be paid in common stock and thus be part owners. The number of those with a stake in capitalism would increase. The need and desire for socialism should decrease.

          7. Andrew

            There are many similarities between the Koran and the bible, there are many contradictory verses in the Bible.

            PRO 26:4 Answer not a fool according to his folly, lest thou also be like unto him.

            PRO 26:5 Answer a fool according to his folly, lest he be wise in his own conceit.

            Common stock as private money.. Hmmm, not an entirely bad Idea, but unless you solve the problems of corrupt governance, gross inequality of wealth and inequality of opportunity it will not be a major improvement to society.

            How do you prevent leaders giving themselves stock awards far in excess of their contribution and abusing their powers? Crony capitalism, nepotism, elitism, cheating, corruption etc etc. It happens every day in the real world.

            Why would these corporations be any different to any other of our utterly corrupt and useless large organizations?

            All capitalist enterprises degenerate into monopolies over time. How do you control and limit monopolies. Owners of monopoly stocks will still enjoy pricing power and wealth in excess of their physical contribution. Other honest hardworking enterprises engaged with active competition will get diminished rewards.

            People won’t desire socialism????? Socialism is a manifestation of what people desire and are not getting! MOST PEOPLE desire to work and contribute to their family and society, they desire reward in proportion to their efforts and ability, they desire autonomy, they desire to master a skill, they desire a safe clean, healthy, sustainable environment, they desire an equal opportunity to succeed regardless of birth right, they desire access to effective health care, they desire income security when they are too feeble, too old or sick to work, MOST people desire to help those less capable or fortunate than themselves.

            The fight is against the human instincts of selfishness, envy, greed and the corruption of power. Stock as money will make not a jot of difference unless you take the fight to the enemy within us all.

            Like many old men You are obsessed with the concept of money as a store of wealth. Admit it…..your hearts desire is to accumulate a pile of forever valuable treasure upon which you can curl up in contentment and security.

            Mathew 6:24

          8. F. Beard

            … there are many contradictory verses in the Bible.

            PRO 26:4 Answer not a fool according to his folly, lest thou also be like unto him.

            PRO 26:5 Answer a fool according to his folly, lest he be wise in his own conceit. Andrew

            You’re joking right? So the guy who wrote Proverbs was so dumb he contradicts himself in two adjacent sentences?! What if the first verse means to ignore a single foolish comment and the second verse means to refute an additional foolish comment?

        2. Joe Rebholz

          So those who get the credit can buy more stuff now whereas those who can’t get the credit can’t purchase stuff now. So less purchasing power. Thank you.

          1. F. Beard

            who can’t get the credit can’t purchase stuff now.

            Not just now – potentially forever! Because credit drives up prices faster than the interest on people’s saving then non-borrowers can be permanently left behind.

          2. Kunst

            You don’t mean we have a system that favors the rich and connected, while holding down the poor and disunited, do you? Why that would be unfair, illegitimate even. Thus are revolutions born.

  2. Proud German

    More Germany bashing from our beloved snake-oil salesman !!

    “By Marshall Auerback, a portfolio strategist and hedge fund manager”

    For better credibility, would you please post track record of your hedge fund so that we know what kind of ‘hedge fund manager’ you are.

    1. Yves Smith Post author

      Shorter: “I don’t like what you are saying, but I can’t refute it.”

      1. Proud German

        Even the dumbest numbskull can see that those southern European countries partied wildly on credit and now reached credit limit. The excuse they are making about collapse in German export is really lame. It is like saying – “Look Yves Smith, I bought booze for you and other young girls on my credit card, and now hit my credit limit. If you do not pay off all my credit card bills using your blog income, you will not be able to get any more booze and there won’t be any more wild parties.”

        Sob, sob, sob.

        1. Proud German

          The other excuse made by these southern countries is that the credit card companies are responsible for my having wild parties and blowing up my credit. So, they should eat all the losses. I agree that the credit card companies (German banks in this context) were stupid and should eat the losses. They should also stop issuing credit to those parasites. Doing that brings back the same ‘austerity’ for the parasites.

          1. paul

            Ironically, when these “profligate spenders” are cut off, so will be Germany’s export market.

            Hope you guys can afford to buy your own stuff. Oh, wait…

          2. Jim

            Paul, by that line of thinking, Cisco should never have cut off any of its many customers one decade ago, when the company was valued at over 550B, more than Apple is today. Those customers were able to buy Cisco equipment ONLY b/c Cisco fronted them vendor financing.

            Imagine what would have happened if Cisco kept “selling” those co’s equipment until 2004.

            Similarly, if Germany assumes peripheral debts, its 10-year will go from 1.21% to 4.50%. Corpartes will have to pay higher rates as well.

            Perhaps Mercedes and Siemens don’t care. I don’t know.

          3. Lune

            Proud German-

            You’re mixing morality with policy. Not that you never should, just that you should determine if your primary goal is to punish countries for their bad behavior, or look for the best way to solve this mess with the least pain possible for everyone, including Germans.

            You may be right about the morality of Greece’s past behavior. They didn’t successfully use the one-time gift of a reduction in their interest rate (when joining the euro) to improve the competitiveness of their economy. To be fair, in exchange for that reduction in interest rates, they agreed to a fixed exchange rate, so it wasn’t a completely free “gift” from Germany.

            And if the Germans used the fixed exchange rate to create an economic and export powerhouse, that’s good for them. Kudos.

            But the question now is given the circumstances we’re in, what’s the best way forward? Is your desire for moral punishment of Greece strong enough to stomach a major suckerpunch to the German economy as well? Perhaps it is. After all plenty of people cut off their nose to spite their face. If that’s the case, by all means, “punish” Greece for its past profligate ways. And when it rebounds into a massive banking disaster within Germany, along with a major recession as Germany’s exports shrivel up and the entire EU economy contracts, then see whether your moral satisfaction was worth the price.

          4. reslez

            You brand entire nations of people “parasites” and accuse them of throwing wild parties. This is frankly disturbing rhetoric. The only people partying it up are the obscene elites who count stacks of money while you and other Europeans pay.

            Watch them unleash their idiot outrage, convenient dupes of the 1%. “Proud German” should be ashamed.

          5. Hugh

            Remind us again what wise German bankers made all of these bad loans, and having made them, still expect them to be paid back.

            An important tactic in class warfare is to set the 99% against each other. Unless you are in the 1%, you are being had. The German and Greek 99%s are in the same boat. You are both being looted by your elites. German banksters thought they could make a killing while times were good financing bubbles in the South, Northern exports, and bankrolling Southern elites. Now times are bad and the banksters want their bad business decisions made good by looting Southern countries or by bailout programs whose purpose is to steal money from the German people and pass it through the peripheral countries (in a fake bailout) back to the Northern banks (for the real bailout).

            If you want to get angry and upset about what is happening, you have to look no further than your own banks and elites. You are being played.

          6. Nathanael

            “Proud German”, the borrowers hold all the cards. Remember the rule: if I owe the bank a hundred dollars, the bank controls me; if I owe the bank a billion dollars, I control the bank.

            The borrowers can repudiate the debt at any time and leave German bankers with nothing. They probably should. They have nothing to lose. If the borrower countries leave the euro, their exports get boosted immediately, and German industry discovers that its exports collapse.

            The “periphery” hold all the cards. Germany holds no cards. Germany hasn’t noticed yet, apparently.

          7. Andrew

            Let me rephrase for you.

            Only a brain dead numbskull would believe all the over moralizing, highly selective right wing propoganda that those southern European countries partied wildly on credit ….blah, blah, blah….

          8. Proud Spanish and not Parasite

            Dear German fellow. You are forgetting two important things here.

            All Europe suffered, specially Spain in the 30s the ambition of some Germans to make us all, the new reich. Thanks to England, USA and Russia, now we are not there… yet!

            BTW after the war we all paid for your mistakes and ambition.

            Secondly, you forgot that Germany and France have been the two countries that prior to the euro, were the countries with the worst deficit figures in the EU, not complying with your selfimposed 3% deficit rule.

            That being said, yes, we Spaniards, have been idiots in assuming that Europe was a federation and hoping that when thing were wrong we would find some kind of cooperation. It was not the case for the democratic second republic in 1926 and it’s neither the case now.

          9. Philip Pilkington

            By writing crap like this under the name ‘Proud German’ you’re not doing much for your fellow countrymen. Most of us would prefer to think that The Wonderful Exploding Merkel and her band of merry men only represent a slice of the German population. Asinine character assasinations and ranting about Greek pedophiles under the name ‘Proud German’ makes you think twice. Thank God I have some nice, sensible German friends, otherwise my prejudice may indeed grow.

        2. different clue

          reply to Nathaniel, actually . . .

          The strange thing, Nathaniel, is that the periphery countries (in particular Greece) don’t appear to have noticed it either. They ( or at least their governments) appear to believe that the Rich Core Countries hold all the cards, whips, chains, and tire irons.

          1. Eric

            Germany does not depend on the periphery for exports. Germany’s main export partners are France, United States, United Kingdom and Italy. Most export growth in recent years goes to countries outside EU. They couldn’t care less about countries like Greece.
            Secondly, Northern European countries have traditionally had an export model that goes hand in hand with a strong currency. They are used to it, so what you for example do is keep wage growth down, and a strong currency has advantages too: cheaper raw materials and it forces to innovate. Going back to their old currencies is not a major problem for them, for the others however it means a major blow to their living standard. Argentina is always mentioned as an example of a country that did so well after defaulting and devaluating. What I read about Argentina however in the news seems to suggest the country is in a real mess. Desperate governments take desperate measures like nationalizations and capital controls.

            Greece does not hold any cards, in fact I think most eurozone countries will be relieved if Greece would leave the euro as it has proven to be ungovernable.
            The only periphery country that holds any cards is Spain because of it’s size. But don’t think this is a problem for Germany only. I am sure Obama, Cameron and others are on the phone with Spain daily as they are scared shitless if Spain would start using their bargaining power. Do you think they let Spain blow up the world economy? So what power does the periphery have? None in my opinion.

          2. different clue


            I hope I am willing to learn despite my extreme lay-amateur disabilities. If you are correct and the periphery countries end up dropping out of the Euro and their own revived currencies devalue severely against the CoreEuro and German goods prices rise beyond the reach of periphery countries and people; then we will see if the Periphery Market was too small to matter to the German economy. It sounds like an interesting experiment which may well be run.

    2. Marley

      Oh, hush… ;-) What are you so proud about, hmmm?

      – your €2/hr “mini-jobs”?
      – your dodgy wage-dodging employment practices? Like hiring skilled tradesmen (carpenters, electricians etc) as “janitors” to skirt having to pay collectively negotiated wages
      – You flagging domestic demand? Yes, once you wring the GIIPS dry, see how many VW/Seat/Audi cars you’ll be selling them, and soon fewer at home will be buying them too
      – Your “cash for trash” scheme to keep bankers happy, but leave peripheral tax payers stuck with the bill?

      I could go on… but I think you get the point.

      And oh yeah… HUP ORANJE!!!!

      Euro 2012 …Bwwaaaahahahahaha! :)

  3. Kiste

    To be sure, some form of a banking union is necessary

    Oh, is it? So after the Germans have declined to guarantee Eurozone public debt, Auerback, Münchau and their ilk now come up with the brilliant idea of demanding that they guarantee banking liabilities several times as big.

    Yeah, that’s gonna fly.

    1. Jim

      Then they’ll demand that Germany send 7% of its GDP to peripheral countries every year in the form of transfer payments. They’ll argue that it’s the only way to ensure the viability of the Eurozone.

      1. Nathanael

        The only viable ways of continuing the eurozone are:
        (1) for Germany to transfer money to other countries every year as needed, until the other countries become bigger exporters than Germany
        (2) for the ECB to free money and distribute it to all countries as needed
        (3) for Germany to get the hell out of the Eurozone

        Take your pick, but Germany should stop demanding that everyone else follow its insane plans which won’t work. As long as Germany refuses to to (1), refuses to renegotiate the treaties to allow (2), it has to do (3). It is trying to demand something else, but there is nothing else.

        1. Kiste

          1) for Germany to transfer money to other countries every year as needed, until the other countries become bigger exporters than Germany

          Yes, because all it takes to become a successful exporter is an influx of foreign money.

          Jesus Christ, the comments section of NC is rapidly turning into a shithole.

        2. Andrew

          “Germany should stop demanding that everyone else follow its insane plans which won’t work.”


          The message is also repetetively delivered by a Droopy Dog lookalike, only without Droopy dogs dry wit and saving graces.

  4. G4st01

    as a German I say: no need for proud^^ Germans (aka nazis) here and else were…

    but maybe it is good to knew that ‘gift’ means ‘poison’ in deutsch

    friede den hütten – krieg den palestän

  5. Mark P.

    Spain has much, more more of an edge if it wants to play challenger than Germany (as defender of the status quo) has wished or now wishes to acknowledge, in game theory terms.

    If the leaders of Spain — then Italy and the rest — play their hands to their greatest advantage, Germany can’t really win this one.

    Germany’s best long-term move really seems to be a return to the deutsche mark.

    1. Nathanael

      Spain has all the cards. The only problem is that Spanish politicians do not represent the people and do not recognize that they hold all the cards.

  6. Ignacio

    I still can believe how we, europeans, have become such a stupid herd including supid germans, stupid spanish etc.

  7. Nathanael

    This is, indeed, an incredibly bad can-kicking proposal from the German government. Hopefully it will go nowhere.

    1. Maju

      2018 is the date considered… what is like neverland. I mean it’s further from our day than the crash of 2008… a lot of things can and will no doubt happen in between.

      Personally I’m all for the Basque Country leaving EU and joining the Bolivarian bloc before it’s too late and both Spaniards and Germans make us pay their debts at point of bayonet (another Basque invention incidentally).

  8. Werner

    The government of my country, under Chancellor Merkel, is brain dead. My countrymen are stultified by the “Bild” newspaper and neo-liberal radicals (FDP). They see (or are they blind?) that austerity exacerbated the crisis in the euro-zone and what is the medicine of the German government, European Commission, IMF and the ECB?

    More austerity! As a fiscal pact. And the demented Germans think it is good, as polls show. Even more braindead.

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