Europe on the verge of another financial crisis?

(9 am. – promoted by ek hornbeck)

  The IMF has been making a lot of noise recently, but their biggest move almost managed to slip through completely unnoticed.

 The Executive Board of the International Monetary Fund (IMF) today approved a ten-fold expansion of the Fund’s New Arrangements to Borrow (NAB) and the transformation of the Fund’s premier standing credit arrangement into a more flexible and effective tool of crisis management. The NAB will be increased by SDR 333.5 billion (about US$500 billion) to SDR 367.5 billion (about US$550 billion), representing a major increase in the resources available for the Fund’s lending to its members.

 This IMF program didn’t even exist until a year ago, when the IMF began issuing SDRs for the first time since the 1970’s. The IMF has only sold SDRs in times of global financial stress.

  It makes a person wonder “Why now?” Why is the IMF suddenly tripling its lending facilities? What do they know that we don’t?

 To answer that, let’s look at the announcements of the past few weeks.

  The IMF has been busy issuing warnings over the past couple weeks. If this massive expansion of lending resources is a direct reaction to their recent statements, then we are looking at a severe financial shock in the near future.

  Two weeks ago the monetary fund’s chief, Dominique Strauss-Kahn, said that Europe needed a “Fire Brigade” to deal with any potential banking crisis.

 “What I think is needed is a European Resolution Authority, armed with the mandate and the tools to deal cost-effectively with failing cross-border banks,” the monetary fund’s chief, Dominique Strauss-Kahn, said in the text of a speech delivered to a conference on banking supervision in Brussels.

 The weakness of the European banking sector is not a secret. German banks are unable to lend. High unemployment in Spain is threatening their banking system. Sweden’s banks were overextended in the Baltics. Britain’s banks came within just three hours of total collapse. Ireland’s banks require another round of bailouts. Austrian banks are overexposed to eastern Europe.

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  The list goes on and on.

In fact, Europe’s financial system weakness is so well-known that American fund managers consider Europe to be a ‘No-Go Zone’.

 Of course Greece is getting the lion’s share of the blame for this condition. The on-again off-again bailout from the EU/IMF has been the gossip of the markets for months.

  The term PIIGS even has its own wikipedia page.

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  Yet, even while the political and financial leaders talk about the need to prepare for more bank bailouts, they criticize the governments for taking on too much debt. As if the two linked concepts aren’t directly related.

 It’s an amazing level of gall. These are the same guys who fully supported the deregulation of the financial industry. They back the public bailing out private banks for taking stupid risks while paying themselves obscene bonuses, and justify it as a “necessary evil”. They then lecture the governments about spending too much on social services, as if much of those deficits didn’t come about because bank bailouts, tax cuts for the rich, and useless wars, none of which they ever seemed to find a problem with.

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 To put it another way, our political and financial leaders have a problem with deficit spending in ways that benefit taxpayers. They don’t have a problem with deficit spending in ways that benefits banks and large corporations because its “necessary”.

  Savings the multi-million dollar bonus of a Wall Street bank executive is necessary, but helping out the 107,000 homeless veterans on any given night is a luxury we can do without.

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 And speaking of bailing out banks, there are indications that something dramatic is going on behind the scenes. $421.8 Billion in a single week requires some sort of explanation, an explanation that I haven’t seen anywhere.

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 The problem is that the bankers and politicians are right about one thing: we are too heavily in debt. The levels of deficit spending are totally out of control and unsustainable.

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  A few days ago Dominique Strauss-Kahn warned about public debt levels. However, that wasn’t the announcement that needed attention. The really scary report came from the Bank of International Settlements a week ago.

 “The aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to the boiling point“, said the Swiss-based bank for central bankers — the oldest and most venerable of the world’s financial watchdogs. Drastic austerity measures will be needed to head off a compound interest spiral, if it is not already too late for some.

 Official debt figures in the West are “very misleading” since they fail to take in account the contingent liabilities and pension debts that have mushroomed over recent years. “Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody’s guess,” said the report. The BIS lamented the lack of any systematic data on the scale of unfunded IOUs that care-free politicians have handed out like confetti.

   Britain emerges in the BIS paper as an arch-sinner. The country may have entered the crisis with a low public debt but this shock absorber has already been used up, exposing the underlying rot in the UK’s public accounts.

 Of course Britain’s “shock absorber” was used up bailing out its banks, not by spending it on public pensions and health care. The reports never seem to mention things like that.

  On the other hand, it’s a matter of math. The deficit spending cannot continue. You can’t make 2 + 2 equal 5. The savings and capital simply aren’t there.

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 “Current fiscal policy is unsustainable in every country (in its study). Drastic improvements in the structural primary balance will be necessary to prevent debt ratios from exploding.”

  …Historical data shows that once public debts near 100pc of GDP they act as a ball and chain on wealth creation.

  If countries do not retrench quickly, they will create a market fear of “monetization” that becomes self-fulfilling. “Monetary policy may ultimately become impotent to control inflation, regardless of the fighting credentials of the central bank” it said.

 Which brings us back to the IMF’s new lending capabilities. Debtor nations being forced to monetize en mass because they can no longer support their spending habits causes price inflation, which hurts almost everyone.

  But it hurts the people who hold that nation’s debt the most.

 The reason why the IMF dusted off the SDR program in 2009 was because of pressure from the world’s lenders – namely China.

 China’s central bank chief on Monday proposed a sweeping overhaul of the global monetary system, outlining how the dollar could eventually be replaced as the world’s main reserve currency by the Special Drawing Right (SDR).

  “The role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system,” Zhou said.

 “The price is becoming increasingly high, not only for the users, but also for the issuers of the reserve currencies. Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws,” Zhou said.

 The Asian creditors of the world are getting nervous holding dollars, and recently Euros. They can see that another downleg to this Great Recession could be catastrophic. They want to diversify, but they can’t start selling without crushing the value of their remaining holdings.

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  That’s where the SDR comes it. They simply swap out their dollar-based debt for SDRs.

It should be noted that SDR is merely a ledger entry. Its is a composite of major reserve currencies, rather than a new currency by itself, but it does help diversify.

 The reason for the IMF rolling this out now might be two-fold: 1) an approaching financial crisis that the IMF needs to build up its reserves to prepare for, and b) the demands of Asian creditors to diversify their holdings in order to help avoid the impact of that coming financial crisis.

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 When you look at this chart above, and see the projections of debt/GDP ratios of 200%, 300%, and 400% by 2040, remember the quote above: “Historical data shows that once public debts near 100pc of GDP they act as a ball and chain on wealth creation.”

  So if 100% public debt to GDP is a ball and chain, then what do you think 300% debt/GDP does to an economy and its ability to pay its debts?


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    • gjohnsit on April 14, 2010 at 1:42 am
    • Edger on April 14, 2010 at 2:37 am

    on the brink too, apparently…

    Financial experts are cautioning Japanese officials that their economy may go bankrupt as early as next year because of their high public debt figure.

    Tokyo, Japan – As global financial markets watch Greece very closely, economic analysts are warning that Japan’s economy may go bankrupt because of its astronomical public debt figure, according to AFP.

    Dai-ichi Life Research Institute sounded the alarm this week when they said a Japanese bankruptcy could occur as early as 2011 when the public debt is expected to hit 20 per cent of the gross domestic product.

    It is estimated, reports Press TV, that the public debt of Japan will surge to 950 trillion Yen ($10.2 trillion) next year and experts are cautioning the government that the only way they can avoid bankruptcy is if they issue more government bonds.

    “Japan’s revenue is roughly 37 trillion yen and debt is 44 trillion yen in fiscal 2010.  Without issuing more government bonds, Japan would go bankrupt by 2011,” said Hideo Kumano, chief economist at Dai-ichi Life Research Institute, reports the Manila Times.

  1. Abba Lerner developed this concept:

    The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound and what is unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science opposed to scholasticism. The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance …

       Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability …

    A couple of things about the deficit, government spending and debt: 1) what makes the deficit “bad”, IMO, is how it has been wasted on things you mentioned and has been used to redirect income upward to high income and corporations; 2) consider what would happen if the Treasury Dept. tomorrow decided to not issue any more debt – what would happen?  Nothing would happen but maybe prices of Treasury Securities may increase because of supply (interest rates would go down).  Treasury would continue to spend by crediting accounts.  

  2. in a week?  Looking at the x-axis of the graph leads me to one question:  was that the week after March 15?  You know, the Form 1120 filing deadline?  Was stuff off the books for March 15 being loaded back in now?

  3. when governments around the world will be left with no choice but to declare all naked CDS contracts null and void as against public policy.

    There is simply no other realistic way to deal with this worldwide, multi-trillion dollar debt problem.

    Of course, the banks and the hedge funds won’t like it, but by the time the global economy has been ravaged enough to force the nullification, no one will care anymore what they think.

  4. on similar figures for the BRIC countries? Brazil, Russia, India, China…

    They have all been screwed over by the IMF and World Bank and are itching for revenge, I am sure. I am curious if they will throw a lifeboat or an anvil…

    Interesting times, indeed….

    And thanks for your always informative diaries/essays.

    • banger on April 14, 2010 at 4:33 pm

    We could be seeing the globalization of fiat currency, i.e., that SDR’s and other instruments with be the basis of a more solid financial system that systemizes the rigging of financial markets.

    The whole concept of fiat currency is that the state can determine the value of money by various enforcement mechanisms. With the rise of sophisticated financial software I believe we are heading into that era.

    The fundamentals stink yet the markets are stable and creeping upwards. I don’t see any basis for economic growth right now yet, I suspect it may well happen. All crises in recent history, from 9/11 onward have the stink of being contrived in some way. Perhaps this financial crisis was, in part, contrived to institute new financial arrangements and permanently rigged markets. In other words, debt may now be irrelevant since the systems are so hedged and interlocking and arranged by massive multi-state systems and sophisticated software. States acting through emergent and resurgent international institutions (mainly ad hoc and secret) may well be getting the power to run the entire financial system through central planning mechanisms.  

  5. Maybe exposing a bit of the contradiction here and there, but by and large assuming without question the “truth” of “proper” capitalist political economy: don’t assume too much debt, growth is good, and so on.  Nowhere in here do I see any questioning of the contradiction between an ever-growing capitalist economy and the finite resource base of planet Earth.  

    For thirty years, now, the existing system, which once made most profits contingent upon actual production, has been “switched over” to a financialized, neoliberal system, in which profit has been made by gaming the debt system.  Robert Brenner, in his 2002 classic “The Boom and the Bubble,” said it outright — economic prosperity today rests upon the ability of homeowners to borrow upon equity.  But why do you think they made this switchover in the first instance?  The answer, for anyone who’s read Brenner (and I expect gjohnsit to HAVE read Brenner) is obvious: they were producing goods that nobody who wanted them had the money to buy.  This is the classic crisis of overproduction.

    The way they got around the crisis of overproduction, back in the ’70s as today, was and is by generating huge quantities of debt.  Rein in debt levels you say?  Escalating debt is the modus operandi of the system today!  Let the debts escalate, and as long as capital is denied the power to force the system to a screeching halt, the debtors will continue to pretend to owe, and the creditors will continue to pretend to collect.  And everyone will eat breakfast.

    Except —

    Except, of course, that the capitalist mode of production is unsustainable for another reason, a reason not mentioned here.  Capitalist production is unsustainable because it’s ecologically destructive.  Burning 85 million bbls./day of crude oil (and a nearly equal carbon equivalent of coal) will result in a horrendous abrupt climate change effect.  Competitive fisheries have destroyed ocean ecosystems; wood “production” is destroying our forests, metals production has gotten to the point of vastly increased extraction costs for vastly reduced returns.  Production for mere financial profit, for the sake of separating people from their money, results (as we have seen above) in a crisis of overproduction, but in this paragraph I write of a different crisis of overproduction: the second contradiction of capitalism.  Capitalist production results in an ever-increasing “drag” upon ecosystems, which in its turn forces down the profit rate.

    There is really no solution to the problem mentioned above in gjohnsit’s diary.  Any revival of “prosperity” along capitalist lines will result in an oil “bottleneck” — the price of oil will go up to the point where the expense drags the whole economy back down.  It’s about time, too — planet Earth can’t afford a whole lot more “growth.”

    The global capitalist economy is doomed to increasing stagnation and crisis, then, and our best intellectual bet is to refocus upon the meeting of basic needs and the transition out of the capitalist system.

  6. crisis, when other Euro nations look to be in worse shape such as Italy, from the numbers I’ve seen.

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