Another Greek Panic Recedes Once More

Yet another Greek Crisis has been averted, another kicking of the proverbial can. Syriza has seemingly sold out its election pledges to keep the status quo intact. Should it be a surprise? What were the options?

Greece's largest creditors are members of the EU and the European Central Bank. Greece is broke. They have two options, to stick or to twist. Stick involves keeping on the side of their EU creditors. The twist option would be one of even more potential disaster. One only has to look at Venezuela for what happens when a country goes broke. Empty Shelves, rampant inflation, crime waves, brain drain emigration and no foreign investment. Greece could have decided to break from the EU but this would have involved the whole countries banking system becoming insolvent. Capital would be wiring instantly out of the country. A National currency would have been established to replace the Euro. Only the Government is broke. No foreign capital would come forth and with little genuine domestic capital would have resulted in the inevitable currency devaluation accompanied with crippling inflation. Syriza, now in power, realise this reality. They had to get a deal.

The real question how many crisis will we get? France, Belguim, Spain, Italy - you could name any of the EU countries, they all have terrible fundamentals. There will be other issues elsewhere, but all will be papered over, kick that can - thats what I can be sure will happen. How long can that "can" be kicked for? As I've said until the centralised central policy makers - IMF, Central Banks, Governments - can't fix the problem. In other words events go beyond their control. Currently they have the illusion of control. But in time they won't. We are in the midst of a super bubble, the bond bubble. I knew it would go bad but I didn't think it be this bad. 

It may sound like a doom rant but it was the same back in 2006 when I said similar (housing, Government Deficits etc). People not only didn't want to know, they think you to be some sort of loon. Then 2008/09 hit with everything going into a tailspin. Its going to be the same once more, only this time worse. I still believe we have some years to go. Interest Rates will go lower. Stocks will go higher. All this will fool everyone to believe all is well. But don't be fooled. The bond bubble will burst with catastrophic consequences. Currencies will be decimated. Chaos will ensue in financial markets once more, worse than in 2008/09. Governments and Central Banks will be helpless. It will be an economic event that we will all remember and tell our Children and Grandchildren about. 

Growth vs Austerity

The battle between Growth and Austerity continues as economies have become stagnant with no end in sight for the current crisis. In one camp the solution is to grow our way out of trouble by increasing public spending, therefore trying to shrink the debt as the economies size increases. The other school states, we need to reduce spending and remodel the economy away from the old borrow and spend mentality. It's hard to know who to believe. On the one hand economies got into this mess because they spent beyond their means, increasing their GDPs to artificial levels therefore one could conclude that the logical outcome is to reduce spending, to set right these imbalances. However many nations have adopted Austerity, growth has flatlinned, even gone into reverse, and created higher unemployment with incomes being continually squeezed. 

Do our main political parties really offer options? In the UK the pro growth Labour Party claims we need to increase spending, while the Conservatives, the pro austerity party, claim we need to cut spending. Despite all the rhetoric the difference between cuts actually implemented by the Government and the cuts that would have been proposed by the opposition under Alistair Darling results in only a £9B difference, small in comparison with an economy estimated to be in that value of £1.5T.

The problem with both camps is that neither really offer solutions to the problems at hand. Greece has attempted to implement austerity but has not really addressed the core issue. That core issue is the fact that the country is bankrupt, and when something is bankrupt it needs to default and restructure. Without a default and restructure the debate on growth or austerity is irrelevant, Greece will never be able to get out of its current mess. The same goes for many nations facing similar issues, primarily spiralling Government spending with income from taxation not keeping pace.

The schools of thought can be summarised as follows.

Austerity

In order to solve deficits austerity proponents state that spending has got out of control, therefore Government spending must be cut. A lot of the cuts are half measures, cuts made on the fringes of the welfare system that don't amount to much and don't affect the majority of the people. 

Interest rates are still held exceptionally low, printing money is still deemed as austere and emergency loans from the ECB/IMF are considered to be tackling the spending crisis.

With the above, austerity is not really being implemented instead many countries are just postponing spending into the future.

Growth

The followers of pro-growth believe the false Socialist Keynesian fallacy that we need to increase Government spending in order to haul our economies out of this mess. They believe that Growth can come from the Government and this will alleviate the debt crisis. Its a simple solution, although fatally flawed and over the long term would have the complete opposite effect. The level of bankruptcy within the country would intensify over time, with peoples living standards eroded further.

As spending increases, so do deficits. Governments over the long term can never create growth by arbitrary spending. Over time, taxes are raised to try and cover the gap caused by increased spending, undermining potential future growth further. Genuine capital for investment begins fleeing along with income from taxation as individuals stop paying taxes. The Government is put under further pressure and prints money to cover the shortfall. Inflation rises, living standards decrease, Entrepreneurship dwindles. In other words it becomes a vicious cycle where the Government finds themselves back at square one, however now in a more dire state of affairs. The Growth camp can only intensify the crisis further.

Default and Roll back of state

The other camp that remains out of the debate is one of default along with a roll back of what functions the state should perform. As Governments can not pay on the majority of their spending commitments they need to default on bond holders. If Greek debt stands at over 100% of GDP then the best way to reduce this is to default on much of it and liquidate capital, similar to private entities and companies. Billions of Dollars are liquidated all the time, either through share price falls or outright bankruptcy, yet the system is incredibly efficient and re-mobilises economic resources producing genuine long term future economic growth. 

The solution also involves rolling back the state and allowing free enterprise further reign in society to improve productivity and reduce costs. Healthcare, Schools, Government Pensions - the costs continue to rise while productivity falls. Private capital would solve many of these issues.

Default is politically unpopular and a banishment of the state is a banishment of politics. Many people still believe that state systems are "free" and that they benefit from them i.e. they take more from them then what they put into such systems, convincing many members of public that we need welfare. To default on loans is a political parties nightmare as this tarnishes the incumbent Government, despite helping to solve the spending problems by freeing up wasted lines of production. It is important to distinguish that a default will not solve the issue on its own, the Government has to take the correct action after the event, that's why a roll back of the state needs to occur with moves towards greater individual freedom and a smaller state.

In our current system only until market forces deem the situation so dire does bankruptcy come about. Currently the market is lenient as it realises debt can be monetised by Governments and inflation is historically low. It also realises that Governments control the rules and consequently can lend to itself or other Governments (as its been doing). Without the recent QE and low interest rates the market would have already started forcing bankruptcy upon many nations, fixing the ills we see. When Governments have such extraordinary control economic problems get out of hand, in comparison private companies go bust very quickly if they can't control expenditure versus income. Governments merely take or adjust the rules in play to avoid this scenario, thus continuing to put economic resources to bad use.

Default comes about when inflation gets out of control or Governments struggle to monetise the debts, then the markets deliver the killer blow  instigating a default. Britain went Bankrupt in 1976 because inflation was out of control meaning printing money would have been unacceptable to the public and markets refused to lend to a Government who couldn't control spending. The IMF bailed the UK out but it didn't fix anything, it just pushed the problems into the future. We should have just defaulted and rolled back the state. Of course the Government can still ignore these signals under a dictatorship and just print more money et al Robert Mugabe, leading to a world of misery. 

From a global point of view, the current fractional reserve system can deal with the odd small country defaulting, say Iceland, but when it comes to larger entities such as Italy, Spain, France, UK and so forth, then the true naked state of the system is shown. The interconnectedness of the current fractional reserve banking system comes down like a house of cards, calling into the question its very existence. People would then ask questions such as why do Governments have free reign on interest rates, money and permit fractional reserve banking? Why do we need Central Banks? Why do we need Governments? The ultimate solution is to remove all central powers, instead  empowering individuals with the freedom to run their own lives, free from third party interference.

Current state of affairs

So we find ourselves in the current predicament, no one really wants to do the right thing therefore the crisis is prolonged. Governments have great power through the monopoly they have in money so rather than accepting the situation they opt instead to push problems into the future. Bankruptcy and failure is nothing to fear or to avoid, it happens all the time in the free market and is an outcome of discovering prosperity. Until people are educated and aware in such matters then we will always have Government debt crisis throughout history on a regular basis. Austerity or Growth, both solutions do not fundamental solve the problems baked into the system. 

We have no Solutions Yet

"Don't be fooled. Don't fall into the government's trap. Lenders and debtors will sit at the same table, having agreed to skin the people alive."

Aleka Papariga, Greek Communist Party Leader

The ECB and IMF have yet again decided to lend Greece more money in order to 'avoid' contagion which would lead to a tsunami of defaults across the financial world. The Greeks can't pay but who cares, I don't think any Western Government can. 

'Tough talking' British Prime Minister Cameron told Ed Milliband during this weeks PMQ's Punch and Judy show that if Labour were in power, then we would have a Greek crisis. Yet what is the current Governments approach? Inflation is rising. The BoE have now admitted they don't give a monkeys about Inflation. Despite it being more than double their official target they have stated that more QE (money printing) may be 'required'. The rate of inflation is now predicted to stay above target for the next two years. Of course, what they don't say is they plan for it to stay around for the whole decade.

David Cameron is a showman, all talk and no action, a modern day Ted Heath, as I previously said before he came to power. He has been in power for over a year, yet the Government continues to spend more money, 

"During April and May, the first two months of this fiscal year, the Government borrowed £27.4bn according to figures released last week, up from £25.9bn during the same months in 2010."

The majority of people are wrong that Cameron will solve our problems. A valuable lesson in life is that people are not able to see trends. They see the current time-frame, and extrapolate. When Cameron talks of 'austerity' and 'cuts' the public believes we will be back to boom times again soon. Cameron is no Thatcher. The Governments loose monetary policy may inflate tax receipts, but spending will rise as costs always catch up. Thatcher raised rates, lowered spending and let business go to the wall. Until this happens, then the current rhetoric is all fluff.

History is repeating itself again. Britain in the 1970's had some of the highest inflation in the developed world. Fast forward 40 years and its the same again, we are world leaders in the Western inflation league table. Germany meanwhile has less than half our inflation rate, and their earnings, unlike ours, are rising in real terms,

"Real earnings, that is, the price-adjusted gross monthly earnings of full-time employees, rose by an average 2.0% in the first quarter of 2011 on the same quarter of 2010. As also reported by the Federal Statistical Office (Destatis), nominal earnings increased by 4.1% in the first quarter of 2011 compared with the first quarter of 2010. Consumer prices were up 2.1% in the same period. The increase in real earnings was the second highest since the beginning of the time series in 2008, while that in nominal earnings was stronger than ever before in the given period."

Yet Germany imports every drop of oil, and the majority of food, just like the UK. UK wages in real terms continue to decline,

"Average pay rose at an annual rate of just 1.8% a year in April, according to the Office for National Statistics (ONS), while the consumer prices index was running at 4.5%."

Inflation is a monetary phenomenon. Keynesian's will point to the symptoms of Inflation and tell the public that these are the causes, for example increases in workers wages. Government friendly economists state that if wages do not rise, then inflation should be subdued. It doesn't take an economist to work out this is just plain illogical thinking. The above clearly disproves the theory. German wages are rising twice as fast, but the inflation rate is half as much. By any scientific measure this Keynesian law wouldn't even hold at primary level education. 

Now is a time to reign in loose monetary policy, but not for the UK, its time to print more. If history is a guide the UK will have negative wage growth and high inflation for a long time, just like in the seventies. Worse still, we will accept it. Its a culture thing. Similar to the Greeks, as the quote at the top of this article reads, believing their problems are inflicted by others, when in reality it is all their own reckless doing. They wasted money for years.

The rise of union strikes have also become more prominent. So rather than lacing up our boots to go work, like the Germans, we decide not to turn up to work, compounding inflationary pressures, eroding our global market competitiveness and lowering real term wage growth. Marvelous! I believe people are free to do as they please. Strikes however are always a waste of time and do not raise peoples living standards. It seems to me that their living standards are already quite cushy compared with many,

"The calculations show that a mid-ranking teacher on £32,000 a year will receive a final salary pension that is the equivalent of having built up a £500,000 pension pot. This is 20 times higher than the average private sector scheme, according to figures from the Office for National Statistics."

Rather than sulk, how about they spare a thought for future generations. State pensions will be non existent, despite the fact we pay National Insurance, the greatest ponzi scheme in existence and the new pension standard is to be put on a private contributory scheme (if you are lucky) that is no where near as previous non-defined schemes. 

Previous generations fought a war, underwent rationing during the 1940's and 1950's, left school at 15, worked for 40-50 years and got a paltry state pension, if they lived that long. Meanwhile many boomer's were the first generation that got a free University education, gained greatly from credit booms from substantial asset inflation in items such as houses and to top it off were given gold plated pensions. A generalisation, of course, my mum left school at 15, never went to University and won't have a gold plated pension, but for many of her generation this was not the case. However this is how economies should work, the next generation has it better.

Subsequent generations now have to pay for their University education. They will never see their state pension as it keeps riding on further into the sunset. Private pensions are minimal in comparison. This is not how the next generation should have to live. But hey, that's governments, they take money from the future to buy off present day votes.

Circumstances will improve, the free market will see to that. As the Government creates more problems the only way to solve them will be to expand the price system and allow free markets further reign over the economy. It always happens. The end of this current age of stagflation will result in further moves towards free markets. Just like the last stagflation. In the current climate I see no solutions yet, just more compounding of our current problems. The solutions will come, just not quite yet.

It's not a Greek Crisis

"There is no money. There is no one else’s pocket left to pick. You can’t borrow anymore, you can’t print anymore, and you can’t steal anymore from anyone else....You object to the bond market, but the bond market is just the voice of reality calling. It’s telling you that 2 plus 2 is still 4, no matter what your union bosses would have you believe. Your bosses tell you that ‘the people’ didn’t spend the money, but it’s not true. That’s exactly who has wasted the money, and now the bill is coming due....You’ve thrown your bottles, burned your flags, waved your signs and had your fun. Now it’s time for you to learn the lessons of history and abandon this idiocy before we finally lose our patience with you. Grow up – and get back to work."
Daily rant directed towards the recent Greek Protesters

It may be all Greek to you, but the effects of the bond bubble is here for all to view (already a wiki page has formed). As soon as the so called economic professors proclaimed the financial crisis to be over (the very same individuals who said 'What housing bubble?') another one has begun to erupt and its only just begun. The location or nation doesn't matter, the important point is no politician, government official or prominent academic has a clue what to do next. A 'bailout' is required to avoid financial contagion, horror stories of Lehman are retold. It doesn't matter that no one in the West can cope with their own domestic liabilities never mind take on others, instead a short term fix is proposed as the solution. In reality it can only exacerbate the problems down the line.

Euro bashing has taken center stage. All the Euro sceptics have suddenly come out of the closet. They never knew in the first place why the UK shouldn't join the Euro but recent events have given them the confidence to speak out once more. Is the Euro doomed? Wrong question. All fiat money is doomed. Despite what has been said regarding the Euro, the Germans hold the key to it. Their Deutschtum regarding sound monetary policy does not bode well for future bailouts towards the more irresponsible European nations. Germany should have got rid of Greece and let them fail. But politicians prefer short term fixes rather than the tough long term ones - they won't be around when they break again. Our old PM Tony Blair can attest to that.

Many falsely believe that Greece is the Canary down the coal mine. Put it this way, did we expect better of the Southern Mediterranean nations? We could list the historical facts, the Inquisition, Catholicism focus on the collective rather than the individual, corruption, even the hot weather but that's what history teaches you - what to expect. Greece isn't the canary down the coal mine, the drachma when it existed was very weak, and the Greeks vigilance at the printing press had a terrible history. Britain, as I have mentioned, is the canary down the coal mine from what I can gather. It is a member of the monetary core - nations such as Germany, Switzerland, the Scandinavian countries, the US - these countries have historically had relative sound money (a few periods of exception can be noted) and have respected individual liberties as early leaders of free markets. When the crisis spreads to the core then we will see real problems. Who will bailout the last resort? There is only one tool. A printing press, others such as China wait to see what destruction we can inflict on ourselves. They gave us cheep goods, gave us their savings to buy more of their goods and saturated us with consumption based debt as we have already struggled to grow our economies over the past decade. If you can't beat them militarily then use economics as a weapon, as Sun Tzu said, '...one hundred victories in one hundred battles is not the most skillful. Seizing the enemy without fighting is the most skillful'.

Portugal and Spain are showing signs of stress also, how long it takes to spread northwards remains to be seen. Eastwards Dr Faber says bubbles are forming in China, nothing I haven't observed but good to hear from the doom prophet whose practically called every bearish situation before it happened for the past 25 years. Where can an investor turn in times like these? The answer should now become obvious to anyone who is following such events closely.

Tonight we have the election here in the UK. Will we have a hung parliament? I hope it lives up to its promises as the most exciting election in a generation. The last two were very boring for a neutral like me, I was too young for the elections previous to these. On that note its time to go watch what Government will 'solve' our domestic crisis. Unfortunately as the quote hints at the start, no politician or bailout offers a cure. Only ourselves as individuals can put things right. Politicians will just keep putting our problems back for the next guy to solve.

A Budget to Forget

"If we subtract spending on welfare and debt interest then we estimate that the rest of public spending would be cut in real terms by an average of 1.4% a year compared to an average increase of 0.7% in the Thatcher era."
Institute of Fiscal Studies

It was a budget we all expected just before a General Election, a budget aimed at claiming maximum votes. It was quite simply a farce. No real change anywhere, savings cancelled by further spending promises, it felt like a budget for an era gone by where the economy was once perceived to be humming along. Mentions of cuts were detailed after the actual event, with yet more 'efficiency savings'. Call me sceptical but surely if it was that easy to cut billions in Government spending, then why aren't they doing this already? Never in history have I seen a Government be able to bring down a budget deficit like ours with 'efficiency savings', only real cuts can carry out the required correction. Of course the truth eventually came out. The press picked up on the fact that Chief secretary to the Treasury Liam Byrne confirmed that the Labour Government would have to make larger cuts than Thatcher did back in the 80's. However I still don't believe Labour would do this. It stinks of Jim Callaghan who took over the mess Harold Wilson left him, talked tough, but never had the conviction to administer the cure.

What's amusing in all this is people's shock to it all, 'Tougher cuts than Thatcher, well I didn't think it was that bad', well think again, you won't get common sense from the media. Thatcher never had a deficit like this. She came in when interest rates had peaked. She came in when Unions were Striking everywhere, North Sea Oil production was on its way up and private debt was no where near what is today. Thatcher had it easy! We have everything in reverse at this current point in time. Still it will work itself out, won't it?

Growth is what we need or what we are told. We need to ensure a return to growth and this will solve everything, right? Communist Russia grew for years during Stalin's reign of terror, but it wasn't the paradise that the propaganda portrayed. Governments can grow an economy like now by borrowing from future generations but the bill has to be paid at some point. Communist economic systems recorded growth but this growth included people never having goods they wanted. Governments made Steel, Cement, machines that no one used but at the same time people in these countries couldn't get basics such as bread or clothes, items we now take for granted. They couldn't get homes. Russia has historically been one of the largest Oil producers in the world but its people couldn't even buy the stuff as it was rationed during Communism. The state needed the oil to to pay for imports as natural resources were the only exports the central planned system could sell to the West. They had growth but people weren't satisfied, peoples lives didn't get better. Governments can grow economies but they can't meet peoples individual needs, innovate and create like a free market can.

When you hear a politician saying we need 'to lock in growth' its just political engineering, telling people we need growth rather than letting people, as individuals, determine what they want to do, what they want to consume and produce. It's time to let our economy shrink if need be and put it on a more sustainable long term path.

IMF Greek Bailout

Well not quite a bailout, but it stinks of another 'Greenspan put'. If the market won't lend to you, we will. The market now knows there will always be a lender of last resort, again another moral hazard. I'm sure the Greeks will now be able to sell their bonds, in fact rates may even come down again as the market can rely on the IMF to buy if Greece gets in real trouble. A further inflationary wave among the existing ocean of expansive monetary policy. Problem is, the plaster doesn't cure the Cancer patient. They can get lazy once more. Why train as hard as the other sprinter to compete when they keep making the race shorter for you.

The Eurozone should have let the Greek Government fail. People may look at this stance as uncompromising but this is how free markets work. No one objects to small companies failing, indeed it frees up societies resources, labour, land and capital for others to use in a more productive manor that satisfies peoples needs. When it comes to Governments, people rationalise that they should print, get bailed out etc, but if Greece was allowed to fail this would be beneficial to the Euro and also for the Greek people.

It would have sent a signal that the EU is serious in maintaining discipline on Governments. Either Greece's Government would have been forced to shrink by market forces and the Greek people would have got more competitive or what I feel would happen is the Greek people would have just left the Euro, thus leaving the nations that are serious about trying to have a sound economy under the Euro.

Greece should have left. I can't see their culture getting real. They blame international 'speculators', the Germans, the Euro anyone but never themselves. They are not man enough to admit to the error of their ways and if you can't do this then you can never learn from your mistakes and improve. Let them have their drachma, they would probably encounter a short term inflationary bounce as they regained monetary autonomy once more. So called economic commentators would use this as evidence to support their theory that the Euro is a straitjacket. The bounce wouldn't last and their economy would tailspin into a basket case state once more over the long term.

Franc Fort

Back in the 50's, 60's and 70's the French Franc was like the British Pound - a basket case. For years the French had used the currency to try and solve the problems of the day but on all occasions it never worked. When the ERM was introduced throughout Europe its aim was to achieve currency stability between nations after Bretton Woods collapsed. It meant all Governments had to peg their currency to the German D-Mark, the cornerstone of the scheme in effect 'borrowing' anti-inflation credibility from the Bundesbank. The problem was other countries would always keep revaluing as they couldn't keep pace with the Germans uber-hard monetary stance. Ironically it was France's Socialist leader Mitterand who decided to get France serious and a policy known as the 'Franc Fort' was implemented. He liberalised markets, allowed unemployment to go where it had to, cut government spending and so forth. They didn't use the currency and allowed people to get competitive once more and in turn won the respect of the Germans who in effect exported their harder monetary stance to France. I'm not saying France is a free market utopia (far, far from it) but they are in a better shape now thanks to such policies. I also don't agree with currency pegs, but the peg meant the French had a commitment to track the Germans on monetary policy. The Euro of course removes the peg factor completely.

"As the chancellor made crystal clear, there is going to be no devaluation, no realignment...The soft option, the devaluer's option, the inflationary option would be a betrayal of our future, and it is not the government's policy."
John Major, days before the pound exited the ERM

Well the Conservatives tried but failed. The UK couldn't stand the heat or rather we are still stuck in a bygone age where we believe the pound to be still the best currency in the world, hence not for the first time we valued the pound way above market rates, in this case we overvalued it against the Mark. What a bunch of pansies we are! Speculators made great gains from the event at the time, many are critical of the money men for profiteering at a nations expense.

However what about the speculators that bet against the Franc at the time? No one tells that side of the story, where those speculators lost a bundle. Ten years prior the French wouldn't have stood the heat, their culture would have been too weak, but the Mitterand 'Franc Fort' meant they could maintain the peg, admittedly with great difficulty. The market still didn't believe the French, thats why they bet on a similar devaluation that had happened in Italy and the UK, but they underestimated the shift in French culture that had occured during the past decade and the determination of the Government not to bow to short term outlooks.

'Sound as a pound' is still a popular saying but its lost all meaning these days, referring to a time when the pound used to be sound compared with the worlds other currencies. A more fitting title going forward may be to replace the 'sound' with 'unsound'.

Market Prices need to be allowed to do their Job

Market Prices are there for a reason. Profit, Loss, Bond Yields, Currency Exchange rates - prices all directing economic activity in an uncertain world where we all have infinite desires and wants but limits in our productivity to meet them. Don't use a currency to solve your problems, it will just embed the rot further. Let prices do their job.

Keynes and Hayek (Accompanied by General Ramblings)

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
John Maynard Keynes
The General Theory of Employment, Interest and Money


“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
F A Hayek
The Fatal Conceit

Both quotes above are taken from the recent econstories rap video that has been showing up all around the Internet which can be viewed here. A very lucid video crammed with factual information, so don't be put off by it's format as a rap song. As we start a new decade, more people will see the ill's of our economic system and formats such as this will help inform people on all levels, as I realise many people find history and economics a very dry and boring subject.

The video contains many subtle messages. The receptionist not recognising Hayek, Keynes book in place of the bible in the hotel room, a party at the FED - the old alcoholic analogy along with "Tim" and "Ben" as the bar tenders. It compares our current solutions to nothing more than the 'hair of the dog', painting a clear picture of what needs to be done. The video is not biased either, with a fair representation of Keynesian economics.

Back in the real world Greece finds itself on the ropes once more, the bond vigilante's are turning up the heat sending rates upwards meaning rollover default is becoming a real danger. As quick as the pansy states will be able to cut their budgets, the rates on their bonds will rise over the long term negating all of the spending cuts. Portugal was thrown in the same gladiatorial arena, as the med club cousin found it couldn't find buyers for some of its bonds. Who's next - Spain, Italy, Japan, the UK, the landscapes getting ugly as distress in the bond bubble is on display for all to see. The Euro fell, but the Germans seem to be having no Southern Shenanigans. Staunchly opposed to any bailouts instead demanding nations begin to get their house in order as their Bunds still look as solid as any other government debt instrument out there. Could the Chinese bail the Greeks out? Yu Yongding doesn't believe so declaring the assets as unsafe.

What seems to have surprised many is the speed of events and how the Greek economy has fallen into the abyss. Well this is what happens when a government runs out of bullets, the market always catches up with you. It took near 80 years for it to catch up with Communist Russia but when it did, it fell in spectacular fashion. The decades of decay are still there for all to see.

Pimcos Bill Gross has given a big no, no on UK Government Gilts as he sees not only real rates of return as an issue but the devaluation dilemma. When the UK politicians still have access to devalue, investors wisen up and realise its not just the interest rate you need to worry about, its a question of will the currency still be worth the same 10 years down the line? Italians used to perform this form of default when the basket case lira was around, nonetheless international money gets smart and knew not to trust an Italian Government. Similar to their driving, reckless.

In Britain it goes from bad to quite simply awful. Over in America Obama has felt the peoples backlash of late, with all the Wall Street bailouts and excessive government intervention coming back to bite him. Meanwhile the 'Great' British public reward Gordon Brown, increasing his bounce in the polls, even though the current Labour government are doing all they can to make the fundamentals worse. That's the British for you, we believe in the free lunch and that Government can solve the issues of the day. We like illusions, inflation, governments and think there's not enough spending on public services despite our gigantic deficit. Americans talk of dollar death, they should think about coming over to Europe and see how to really mess things up! Sorry Peter Schiff, its not just America that's the 'Caboose', its pretty much the whole of the West.

Japan has been in the news a fair amount lately, with many commentators declaring default could occur there first. While Japan is a basket case, their savings rate is not what it was and they are all getting a lot older, they still have a lot of currency reserves, second only to China. They will sell these first to pay for the latest Government who are following Keynes advice just like the previous Government did for the past 20 years. They will also stop buying US Treasuries at some point, which they still seem to have an appetite for, instead buying their domestic bonds. Of course they will go pop at some point. You don't build up 200% of government debt and not pay for it. Any slight move in rates would be fatal, therefore expect the above actions to be taken first.

Switching gears, Shells profits collapsed forcing the sale of its assets and job losses for the oil giant due to oils lower price. You always hear about price rises in the media, but never hear about the falls. When oil was around $148 a barrel, it was the 'evil' oil companies that was causing the price to rise, profiteering at the expense of the public. When it collapsed, the same reasoning didn't add up as the same companies were scrambling to mend their books. 'Why didn't the price of oil fall at the pump substantially when its price fell from $148 to $40' - simple its hedged. The free market insulates consumers from the volatility in the commodities markets by using futures contracts to hedge against price spikes and dips. Hence the price at the pump stays fairly stable in comparison. The only reason the price rises over the long term is from Government Monetary mismanagement. Of course the government likes to blame speculators, oil companies, Arabs and the public generally buys the lies. Against gold of course oils price doesn't really move anywhere over the long term, but enough on minor details such as these.

Reports again come out detailing inequality is larger than it was thirty years ago. As Milton Friedman once said "We all start the race from the same point, but each one of us has a different finishing line". Markets enable us all to prosper and follow our own goals, using our available talents. Governments are the ones who ensure further inequality. The monopoly on money ensures the currency is inflated, enriching the asset rich at the expense of the asset poor. Lower incomes are also crushed further as a larger chunk of money is used to buy everyday goods, food, energy and so forth. The Government welfare state has meant the 'why work?' culture further expands creating an increased disillusioned underclass stuck in a vicious circle. Charity starts at home and the only way to help people is to allow them to help themselves. Who says the free market can't run a social welfare system? They already exist in the form of voluntary organisations who gain donations or Church organisations. People are more reluctant to claim if they can see the people providing the handouts, rather than some faceless factory system, where the government churns out the public's money. Of course we only get widespread unemployment when the free market tries to correct the governments wrong doings. Otherwise shocks to the whole system wouldn't occur, outside of a natural disaster of course.

Coming full circle back to Hayek and Keynes, I always find history is full of interesting stories. One such story is before Keynes wrote his famous book in 1936 becoming the de-facto textbook in economics, Hayek had critiqued Keynes previous works. In Keynes previous work, Hayek had done such a good job that Keynes declared to him that he no longer believed in what he wrote and had gone back to the drawing board to write his famous general theories. When this later book was released Hayek decided not to critique it as he didn't wish to waste his time again and felt everyone would see it to be as flawed as his previous works. The rest, they say, is history.

The Euro, the Pseudo Gold Standard

The Euros showing signs of stress lately. The Dollar climbed to $1.43, its highest in three months as the fiat race to the bottom continues. Greece's sovereign debt was downgraded with the third generation of a Papandreou residing at the helm in what looks to be another Greek catastrophe. Spain somehow continues to mask the mess it finds itself in. At some point the poison will inevitably seep through. Meanwhile with regards to the other PIIGS (yes thats two i's, Ireland and Italy) we find Ireland have launched their second cost cutting budget in an attempt to appease the other 'sounder' Euro states. According to the governments figures they have come out of recession unlike here in the UK. Italy's leader Berlusconi took a beating, literally. Although the attack was appalling, its more disturbing to see such popular support for Massimo Tartaglia, the person who carried out the senseless assault. Austria's Government followed the new global trend by effectively nationalising the countries 6th largest bank, Carinthian Hypo Alpe Adria Bank AG, with the taxpayer now becoming it's largest shareholder. It's not the only bank in trouble with the countries 4th largest, Oesterreichische Volksbanken AG, also under the governments watch. Exposure in the Balkans and Eastern Europe, Austria's banking system is looking more insolvent as time goes on. Despite what Americans say about their banking losses at least their banks are declaring them. Europe's financial system is one monstrous black box, with everyone trying to call each others bluff. Even Germany seems to be throwing out the rule book announcing tax breaks despite a widening budget deficit, however compared with many other countries double digit percentage horror shows it won't sound an alarm with the bond vigilantes.

There's been many commentaries written in relation to the Euro the single currency that's used by 16 separate nations, usually critical toward the faceless bureaucrats who reside in Brussels. However its important to understand how the Euro came about. During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. There was an obvious issue from the start. Two distinct tribes existed within the union, the North dominated by Germans who had previously presided over the Mark, a currency as hard as any other in its day. The other faction, the Southern Mediterranean nations a historic bunch of pansies that would use their currency at the first instance of economic trouble to try and solve their problems. During its first 10 years all seemed well but when disorder came, the Mediterranean nations suddenly found themselves in a bind. They couldn't devalue or print as they had in the past, instead they were told by the Northern circle that they must cut their deficits along with reckless spending. Don't get me wrong, the ECB have dabbled in QE however in comparison to the Drachma, Lira, Escudo or Peseta if they still existed and were in the hands of the irresolute Southern Europeans, then things would be getting a whole lot worse for such countries as we tread into unknown waters.

The Euro is in effect a Pseudo Gold Standard for some. Similar to when the majority of nations had a fully convertible Gold Standard, there are checks on Government spending such that they can not rob the public through inflation, or sidestep genuine long term fixes with short term devaluations. This is not to say the rules can't be bent, the rules are always for bending when the government is solely in charge. For example the deficit limit for states that were to join the Euro was originally set at no more than 3% of GDP. Problem being that nations such as Portugal just moved some of their deficit from the official figures to assist in their entry into the Euro to meet the criteria. After the financial crisis fiscal restraint has been put on the back burner, another crisis will need to occur before anyone gets serious again.

Like a Gold Standard, the old bundesbanks dominance on the ECB acts as a check against others that are more willing to deploy looser monetary policy. It depends if you have the stomach for such medicine as to whether you believe it is beneficial.

Many commentators state that the Euro is the problem facing countries like Greece, the reasons given are usually the very same policies that got them in the hole in the first place, in this case excessive government involvement and monetary inflation. They are usually correct on one point, that it was the Euro that exacerbated the credit boom for many such nations. Generous subsidies to promote the Euro's launch created undeserved prosperity, accompanied with negative real interest rates in such countries, meant loose lending was endemic.

Ideas that increased inflation and spending can alleviate the problems we face are wrong. They instead increase the states control and crowd out private enterprise and initiative. Not only does it fail, but it becomes an immoral path as genuine savings are stolen from the people.

One of the questions people ask is what will become of the Euro? Will it survive? Will its members fragment? Will it gain in numbers and strengthen? I don't think we can arrive at a conclusive decision on any of the above as they are all legitimate possibilities.

Fragmentation could be possible. A number of nations could drown in their own debt but we have to realise governments always bend the rules. The ECB may show a tough hand for the moment but could ease if events got out of hand. If a nation did wish to exit then imagine the stigma attached to the politician in office at the time. It would take a brave politician to declare an exit from the Euro while others in the Balkan's, Baltic's and the East are clamouring for such prestige.

Would others join the Euro as a refuge? Possibly, however if the above were to occur we could see the emergence of a new strengthened Euro. Nations such as Norway or Switzerland could join, forming what would be one of the soundest currencies in the world. They didn't join in the beginning with the current members therefore , if the weakest were weeded out they could have a change of heart. This would be the only reason I could see them joining.

Survival? I'm bearish on all fiat money. Even the Euro. There are many problems contained in Europe. It could however emerge as a genuine contender to the Dollar if the harder money circles have their way.

So is the Euro a good or bad thing? Well I'd prefer the ECB administering my nations currency rather than the current set of inept individuals who are running riot with the UK's monetary policy. German jokes aside, you have to wonder how they do it. After a crippling war they arose as the dominant power of Europe once more, a dynamic economy that produced quality products, while other Western nations industries went into decline. It dealt with unification as Communism collapsed thus inheriting a nation with years of decay that required to be rectified. She then became one of the key participants to unify Europe under the single currency opting to bin their sound Mark. Subsidies were provided to Ireland and Spain to promote the Euro, subsidies paid for by the German taxpayer. She wasn't even resource rich, importing many commodities. There was however a culture of hard work, along with the abstinence of partaking in speculative activities such as Real Estate even as the 'Anglo-Saxon' economic models mocked the Germans for relative stagnant growth in comparison. Since the arrival of the crisis the jokes have stopped and once more the Germans hold the key to Europe, to the pseudo fiat Gold Standard known as the Euro. History leads me to the opinion that I'd prefer the Germans to manage my sovereign currency. Its the same story for many others who are current members of the Euro, it just depends if their culture can adapt to a different monetary way of thinking.

Strike!

"The banks are fucked, we're fucked, the country's fucked."
Anonymous Cabinet Minister speaking in regards to the UK

"The last time we built up this much debt was when we were fighting ... half of Europe. This time we've done it on our own. It's quite a chilling thought. This is my worry is that it's like the man in the casino has lost it all on red and you know ... what's to stop Gordon putting it all on red all over again?"
William Buiter ex MPC member on recent events

The first UK Gilt tremors were felt this week. It was the first failure to sell non-inflation linked (regular) government bonds since 1995, with only 93% coverage. Back in 1995 it was 99%, which shows the significance of this event. Comments made earlier in the week by Mervyn King, the Bank of England's Governor in regards to worrying levels of government debt and how he may not wish to print as much money as first anticipated spooked the market. So how significant is this event and what does it mean for Britain in general? Is this a sign of things to come for many Western Governments? Many commentators may dismiss what happened as a one off or just a fact of bond auctions, however this would be very naive. It would be correct to state that this is only one failed auction, however context is key. This is not 1995.

Estimates for the following years budget deficit has come in at around £150bn - £200bn, which for a small nation such as Britain is a huge amount of money that the government needs to raise. Along with the shrinking economy, with last quarters contraction revised to -1.6% GDP, giving an annualised figure greater than -6% GDP, these billions listed above could turn out to be even worse, as Britain begins the path towards bankruptcy. The fact that a Gilt auction has already failed this early on, and by such a large margin, should be of great worry. As mentioned before on the blog, the governments bond markets are a classic bubble as market forces are being tampered with, along with irrational investment behaviour. Will the Government let market forces burst the bubble now? I doubt it. Like all bubbles it will continue to grow, going against all market fundamentals.

The other day, bond yields went up as the government struggled to sell them. This is market pricing in supply and demand where there was a lack of demand, therefore the government has to raise its returns for potential investors in order to attract buyers. The market forces where yields go up should be allowed to happen. In the Euro zone recently there is now a large divergence on the returns given to hold say German bonds, to say Greek bonds. Greek bonds are now having to offer far higher returns to compensate for the fact that there is more risk in the country, specifically default. Despite what the Greeks may say regarding the Euro, or their wish to have control over monetary policy the current situation is actually beneficial to the Greek public. It ensures the Greek government can not print money to buy government debt, thus artificially reducing short term rates on government debts. This of course encourages the Government to take on more debt as they can print money, thus holds the rate of interest artificially low over the short term so they can increase spending thus piling up more debt. However there is a cost to all this. Specifically this is how massive inflation begins, by the governments spending getting out of control thus printing money to pay for it. If the Greeks still had the Drachma, this is what would happen leading to high inflation and in Greece's case probably currency destruction.

As they are on the Euro, they consequently don't have this control, rather it seems to be the more traditional hard money countries such as France and Germany that have greater control. German officials and the Bundesbank understand the problem, and they know printing money can not help along with huge government spending in the long run. These ECB hawks know we have to take the medicine now allowing market forces to work and ensure real capital is used for government debt, not this 'new' money. This is the problem Britain finds itself in now, however Britain has the pound so it can do what it likes unlike Greece. It still has full autonomy over the printing press. The recent lack of buyers now casts doubts over the governments ability to raise the £200bn or so in money over the next 12 months. And not only the next 12 months as Government deficits are going to be a feature for a very long time, even with huge spending cuts all the other governments debts that are yet to be felt will be coming into play over the next 5 - 10 years. So where does this leave the Government?

It has already embarked on the policy of QE, printing money to buy government Gilts with an initial figure of £150bn mentioned by Mervyn King to buy this debt, with statements when this policy was implemented that this figure could rise. So this is where we come onto how the Government always distorts the markets. The statement that they made sent a signal out to the market, "If there are no genuine buyers of government debt, then we will buy it". Hence the first market bond sale after this statement was made saw huge amounts of buyers with the auction being oversubscribed. The market is now playing the governments game, a game of the last one to hold the debt will get burned, and the market is thinking that will be the Government. In the future all Bonds will be bought by the Government, with all other sellers rushing to sell. It's a classic Ponzi scheme, where the whole pyramid exists on the premise of selling to the bigger fool.

Many nations are embarking on this path, America, Japan even the traditional hard money country Switzerland has followed this route. QE will just blow this bubble up further causing more damage in the long term, as this will become a vicious cycle if it is not stopped soon.

At the moment inflation is not a concern so the bond investor does not demand huge returns. With the Stock market in the tank, other assets falling in value and deflation on many peoples minds Government Bonds look like a good bet, a steady income stream 'sheltered' from the financial dislocations. Therefore people have piled into Gilts. However as government debts have been growing in certain nations, contracting economies and huge economic imbalances in these countries, market forces are trying to set higher returns, specifically for nations with these risks. However with the new intention for expanding the money supply to "combat" deflation, QE is now monetising many of these bonds, in effect creating artificial buyers. Similar to the recent housing bubble, real demand was never there, it was just people flipping houses to one another with artificial cheap money as the driver. The market anticipates this new QE artificial demand, by lowing rates as there is less risk on default as more buyers have entered the market - seemingly increased demand, limited supply. This is where the real trouble begins, the point we find ourselves in now. The UK money supply has actually been expanding over the past few months even more than during the credit boom, which is highly inflationary under an environment such as this. This will eventually feed through to the economy into consumer prices. With the currency devaluing (inflation) there is a decrease in the demand for bonds that are not inflation linked as the future becomes more uncertain. Usually under this environment yields would rise to attract buyers, however with the Government becoming increasingly strained just paying the interest payments (and with the fear of no buyers thus in effect bankrupting the government) they wish to try and keep these yields down. This in turn means the government has to buy more, creating more artificial demand. This in turn feeds back and increases the money supply, thus creating more inflation with investors demanding even higher returns of compensation. With the monetary base getting ever more out of control it leads to investors fleeing Gilts even more, thus eventually leading to no genuine buyers, with the only buyer being the Government. Such a cycle feeds back on itself, creating an even more desperate state of affairs, and worse economic conditions.

We are only in the early stages of the above. In theory, this could be stopped now with the Government abandoning QE, but I doubt it. Not with the huge deficits to come and the lack of Global Capital. The above describes the very process of how the Central Banks believe they can beat the market. However they can't, as the above details, they can only make it worse and the longer they try to 'beat' the market the worse they make the situation. In the event that things go to far they will destroy the currency, the lifeblood of the economy, thus impoverishing us all. Prices are there for a reason. Economists will tell you that when yields come down, that the Central Banks have saved us and proclaim that QE has worked. It can never work and is doomed to failure. The longer they try and hold the short term price down, the higher it will shoot up eventually and the longer it will stay there. Just like any market price, it's there for a reason - basic supply and demand. Kings new hard line will not stay for long. He will keep the QE program on track, with the initial £150bn just a foot in the door. There seems no political will to scale back Government spending or accept the terms of an IMF loan just yet.

The basic process described above is how all governments go broke. It begins with a little, but eventually takes over the whole market similar to Zimbabwe. With statements continually made that they will be able to "turn off the tap" or "mop up the excess", this is simply not true and misleading for many members of the public. Countries like Ireland, Italy, Greece etc may complain with the hard line the Germans have took, but they are doing them a favour in the long run, some tough love. We may well see the EU take exactly the same route described above, I do not discount that. However at least we have witnessed some rational opinions expressed again by the Germans, many whose Great Grandparents and Grandparents lived during the Hyper-inflationary Weimar period. The UK should let their Gilt Prices rise. This puts a check on excessive government spending by the market rationalising on who is solvent and which countries are sound. If there are no buyers, let there be no buyers. This will either stop government spending altogether or let the country go bankrupt. The short term pain would be far better than bankruptcy by the printing press, drawing out the process and leading to a much worse collapse.

The Currency Wars

A new world currency? Russia and China have expressed their recent concern over the Dollar monopoly of reserve status and have mentioned the possibility of an alternative, not associated with any nation - a new world currency. The Austrian School of economics predicted this back in the 1960's, along with the creation of a European Common currency that would supersede this step. We saw the Euros creation back in 1999, are we about to witness the early stages of the Global Currency? The Austrians said this would be the ultimate desire of Governments, the ability to inflate with no apparent currency fluctuations occurring masking the debasement. Timothy Geitner put his foot in it, and contradicted Obama by saying it would be a good idea. The Euro will probably fragment at some point in the future. Nations such as Greece may opt out, thus regaining their autonomy over their currency with the ability to inflate once more. We will have to see. Back around six months ago I said currencies will disappear or merge, with the Icelandic Krona the first victim, there will no doubt be many other interesting twists and turns over the coming decade.

More Carry trades will continue unwinding over the year. The Yen carry trade that we witnessed unwind last year, causing the collapse of the Icelandic Krona, the fall in the British Pound and the spectacular rise of the Yen, should still unwind some more this year, as more of these currencies come under pressure along with the increasing scramble for cash. The Eastern European Debts have been unwinding too, with these debts bought in Euros, Yen or Swiss Francs beginning to undo as the hryvnya, Forint or Zloty have devalued. There will be lots of civil unrest to come in these countries, Latvia and the Ukraine will not be the last to succumb to protests. We will continue to see more gyrations of the worlds currencies, as "beggar thy neighbour" policies continue and carry trades continue to unwind.