Yves here. Europe is looking wobbly and Brexit looms…
By Marshall Auerback, a market analyst and commentator. Produced by Economy for All, a project of the Independent Media Institute
We now know that there will be a changing of the guard at the European Central Bank (ECB) in October. The current head of the International Monetary Fund (IMF), Christine Lagarde, will succeed current ECB President Mario Draghi at that time.
A known quantity among the political and investor class of Europe, Lagarde seems like a safe choice: she is a lawyer by training, not an economist. Hence, she is unlikely to usher in any dramatic changes, in contrast to current European Central Bank president Mario Draghi, who significantly expanded the ECB’s remit in the aftermath of his pledge to do “whatever it takes”to save the single currency union (Draghi did this by underwriting the solvency of the Eurozone member states through substantially expanded sovereign bond-buying operations). Instead, Lagarde will likely stick to her brief, as any good lawyer does. There’s no doubt that her years of operating as head of the IMF will also reinforce her inclination not to disrupt the prevailing austerity-based ECB ideology.
Unfortunately, the Eurozone needs something more now, especially given the increasingly frail state of the European economies. The Eurozone still doesn’t have a treasury of its own, and there’s no comprehensively insured banking union. Those limitations are likely to become far more glaring in any larger kind of recession, especially if accompanied by a banking crisis. That is why the mooted candidacy of Jens Weidmann may have been the riskier bet for the top job at the ECB, but ultimately a choice with more political upside. An old-line German central banker might have been able to lay the groundwork for the requisite paradigmatic shift more successfully than a French lawyer, especially now that Germany itself is in the eye of the mounting economic storm.
It’s summertime, but the living is certainly not easy in the Eurozone. The Mediterranean economies—notably Greece and Italy—have never really achieved sustainable growth over the last decade, and to the extent that either country ran deficits, or received bailout assistance, it was largely used to pay off debts to a range of bank creditors, rather than generate higher employment.
However, the Eurozone’s weakness is now rapidly spreading to the North, notably in Germany, where the Ifo Institute’s manufacturing business climate index is “in freefall,” reports the Financial Times. The Ifo indicator—a good coincident gauge of overall economic health in the Eurozone’s main manufacturing hub—registered its worst reading in nine years, precipitously declining to minus 4.3 in July vs. a gain of plus 1.3 in June. Furthermore, Germany’s Purchasing Managers Index (PMI) has plunged to the mid-40s over the last few months. Fifty is the demarcation separating expansion from contraction, suggesting an imminent recession.
On top of that, Germany’s leading bank, Deutsche Bank (DB), is steadily being revealed to be the greatest repository of corporate corruption since BCCI. Whether it be money laundering for Russian oligarchs (or, allegedly, the Trump family); involvement in interest rate scams such as LIBOR manipulation; violations of U.S. economic sanctions on Iran, Syria, Libya and Sudan (among others); or the sale of toxic securities in the run-up to the 2008 financial crisis, DB has played a leading role, and is now paying the price. Berlin has repeatedly sought to find a buyer for the bank, but both Commerzbank and UniCredit have had a closer look under the hood and ran for the hills accordingly. The share price performance suggests that Deutsche Bank is an imminent candidate for a bailout, if not outright nationalization.
This comes during a historically unprecedented situation in global bond markets, particularly in the Eurozone where negative yields are now pervasive—in other words, investors are now willing to pay certain governments to safeguard their money, whether this be Germany, Denmark, Switzerland, or the Netherlands. This is a foolhardy risk to incur, given that all Eurozone governments are currency users, not issuers (only the ECB creates euros), and therefore carry the same kind of theoretical solvency risk as, say, an American state or municipality.
As the economist Frances Coppola notes, “Every Danish government bond currently circulating in the market is trading at a negative yield. And the inverted curve tells us that markets are pricing in further interest rate cuts, most likely to hold the ERM II peg when the ECB cuts rates and re-starts QE.” Which means yields can become even more negative. Such is the desperation for perceived “safe assets” that Austria, Belgium and Ireland have all sold 100-year securities (the yield on Austria’s 2117 bond has dropped nearly 100 basis points since it was launched two years ago with what was then considered a derisory 2.1 percent coupon, and recall that Ireland’s banking crisis placed the country close to national insolvency 11 years ago). It’s virtually impossible to make sensible economic forecasts a few months out, let alone a century, so this does suggest a certain kind of collective madness (or desperation) now taking over the bond markets.
All of which tells us that something is indeed rotten in the state of Denmark (and elsewhere), as Lagarde takes over as president of the ECB. The constellation of soft economic data in Europe has investors clamoring for the ECB to act, but negative yields suggest that there is little more that interest rate manipulation can do to generate an economic upturn. Indeed, economists Markus Brunnermeier and Yann Koby have persuasively argued that negative yields represent the juncture “at which accommodative monetary policy ‘reverses’ its effect and becomes contractionary for output.” In other words, monetary policy has reached the point where further attempts to cut rates might actually hinder economic growth, rather than promote it.
As Rob Burnett, a fund manager at Lightman Investment Management, has suggested, “What is required is demand-based stimulus and spending must be directed into the real economy”—in other words, fiscal expansion, which unfortunately is not the purview of the ECB. Furthermore, the central bank’s “quantitative easing” purchases of sovereign bonds have hitherto been conditionally predicated on the national finance ministries’ continuing to practice fiscal austerity, which in turn produces the exact opposite economic outcome that Burnett has proposed. The unfinished architecture of the Eurozone makes this problem particularly awkward, given that there is no “United States of Europe” treasury equivalent—a gaping institutional lacuna in the Maastricht Treaty—which in itself creates unstable dynamics that constrain national policy fiscal space. Politically, the ECB represents the awkward focal point in regard to increasing global market integration on the one hand with growing demands for reclaiming national political sovereignty on the other. Such challenges become more acute in the context of a global economy that, outside of the United States, is teetering toward recession (or worse).
It’s also a terrible environment for banking in particular, especially as any attempts to reduce deposit rates below zero (in effect charging depositors for the privilege of having banks store their money) would almost certainly trigger bank runs. Nor are the banks inclined to generate profits via lending activity when there is a steadily decreasing supply of creditworthy borrowers on the other side.
The other problem also relates to the Eurozone’s faulty half-finished architecture: free intra-Eurozone capital flows are promoted within the Eurozone (via the Trans-European Automated Real-time Gross Settlement Express Transfer system, aka the “TARGET2 system”), despite the absence of a unified supranational banking system or common, Eurozone-wide deposit insurance (such as the American FDIC). This creates ample scope for bank runs from one country to another (as the economist Peter Garber predicted back in 1998), and which were occurring in earnest back in 2012, as investor George Soros observed, and specifically tied to TARGET2.
Across the Eurozone, bank assets generally exceed GDP. They also do in non-Eurozone countries, such as Norway, Switzerland, and the UK. But the difference in the non-Eurozone countries is that they are all sovereign currency issuing countries, which means that all have unlimited capacity to provide deposit insurance in the event of a bank run. Paradoxically, it is precisely because of this unlimited currency issuing power that such bank runs seldom go very far in these countries. The public intuitively understands that the insurance can be made good.
This is why the United Kingdom and Switzerland were able to handle their respective banking crises in 2008 without threatening national insolvency. Retaining sterling as the national currency, the UK had unlimited fiscal capacity to offer credible deposit insurance instantaneously during its crisis. To cite one example, in 2007 a regional bank, Northern Rock, applied to the Bank of England (BOE) for emergency support to help it through a liquidity crisis triggered by the subprime mortgage slump in the U.S. and temporarily incurred substantial deposit runs as a result. The BOE’s prompt actions (made easier by the fact that they did not need to secure the collective approval of 19 other countries, as occurs in the single currency union) put a halt to the withdrawals. Likewise, Switzerland was able to recapitalize its own major banks relatively quickly after the 2008 crisis began in earnest and avoided the prolonged banking crises that characterized the Eurozone countries.
Ireland is a good example of the latter. An economy structurally similar to the UK, Ireland experienced a banking crisis with far more longstanding deleterious effects (including an unemployment rate almost double that of the UK at its peak). The crisis was far more serious than in non-Eurozone countries because the markets intuitively understood that the country did not have the fiscal capacity to adequately safeguard the banks’ deposit base (despite pledges to do so on the part of Dublin’s policymakers).
Within the Eurozone, the Emerald Isle’s problems were by no means unique. As is now well appreciated, all Eurozone member states operate under the same constraints with no national currency. In regard to coping with a potential banking crisis, however, the currency issuer, the ECB, does not have the regulatory or political authority to close a bank, regardless of what country the bank claims as its home (in the same way that, say, the American FDIC can operate to shut down a bank, no matter which state, and credibly restart it quickly, by virtue of the backstop of the U.S. Treasury). So far the member states within the single currency union have managed to dodge this particular bullet, but given the mounting strains now intensifying in the Eurozone, a credible banking union of some sort must ultimately be on the table. Wolfgang Münchau, columnist for the Financial Times, outlined the four key “centralised components” required to make such a union workable and durable: “a resolution and recapitalisation fund; a fund for joint deposit insurance; a central regulator; and a central supervising power.”
Even a central banker as powerful as Mario Draghi has yet been unable to persuade the major Eurozone powers, especially Germany, to accede to such a proposal, which Berlin still regards as a covert means of putting German taxpayers on the hook for billions of euros’ worth of other countries’ banking liabilities. In light of the current travails of Deutsche Bank (and the longstanding financial difficulties of Germany’s regional lenders, the so-called “Landesbanken”), however, attitudes might change in Berlin.
In any case, this represents one of the more formidable challenges Christine Lagarde is likely to face in her new job going forward. Given the existing institutional limitations of a monetary union without a supranational treasury backstop, no Eurozone FDIC can be credibly established absent institutional ties to the ECB. National banking interests cannot interfere with the deposit insurance fund because this would immediately destroy the credibility of the banking union. But absent broad multinational consensus, no such supranational FDIC can come into being.
The glue holding the Eurozone’s institutionally fragile structure together has always been the European Central Bank. As the sole issuer of the euro, the ECB is operationally free to provide as many euros as needed to keep the funding system in place. It cannot go broke. But politically, it is an orphan. The problem is that calls for international cooperation to improve its supranational governance structures to address these cross-country dynamics reinforces the impression of eroding national control, which in turn heightens populist backlash across the continent. Mario Draghi’s monetary gymnastics helped preserve the Eurozone, but the battle is not yet won.
One wonders whether someone with Christine Lagarde’s comparatively limited economic and financial expertise has the ability to confront these challenges with the same aplomb her predecessor. We shall find out soon enough.
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I’m european and EU should do fiscal expansion, however none of this should be done before EU’s Stability and Growth Pack (SGP) is significantly changed or dismantled. The current agreement enables austerity policies and even if coordinated fiscal expansion is done now, the main problem of Stability and Growth Pact is not going away, it’s just ignored for this specific instance and will most likely raise it’s ugly head again in the future.
A problem here is that a lot of Germans (and northern Europeans in general, Dutch, Austrians.. ) genuinely believe that debt is bad, saving is good, and you’d tighten your belts first and foremost. It’s a cultural thing, and takes a lot to change, but has significant impact on politics.
This is definitely true in The Netherlands. During the Greek crisis, propaganda was vicious in portraying Greece and Mediterranean countries generally as lazy squanderers, receiving free money from hard-working, prudent, Calvinist Dutch citizens. This was across the political spectrum, including left parties, and across the media.
During the late 1990s, Dutch public finances were very much focused on balancing the budget and reducing the national debt. The analogy to a household budget was universally accepted and unchallenged. This was under a Labour/Liberal coalition (PvdA/VVD/D66)
I’m half Austrian so i can concur with that. Partly it’s been influenced by the great depression and hyper inflation that hit Gemany & Austria hard. For example; my great grandmother life savings were spent on a pair of snow shoes.
For the Germans, the underlying Protestant (work ethic) cultural values that originally constituted the foundation for ordoliberalism formed and still forms much of thinking of the German electorate.
And of course by the fact, that no politician wants to talk about the fact, that the Nazis were very good at attacking the real cause of the depression and managed an extremely successful turnaround of the economy with the economy shrinking about 7% both in 1931 and 1932 and growing almost 8% on average each year from 1933 to 1935.
Contrary to public proclamations it was deflation, which finally finished the Weimar Republic, not inflation.
Actually, by the time Nazi’s took over, the world economy was starting to recover (ex France, which still stuck to the gold standard), and it’s very likely that German economy would have recovered w/o them. The large army stuff didn’t start until mid 30s (1936 IIRC).
If you look at any economic graphs of GD, you’ll notice that it bottomed out in 1932/33 – even for the US.
Well, you almost say it:
The deflation policy of Brüning was essentially the same as sticking to the gold standard. That some, but not all, other countries as well abandoned the gold standard is neither in conflict with the fact, that in Germany it were the Nazis doing it and that the insane austerity policy of Brüning is seen as the right thing to do. See as well the comment of Rev Kev.
And while the explicitly military stuff might have come later, the Nazis did end austerity immediately and started to deficit spend. Actually, my argument gets even stronger: It is even possible to deficit spend on other things than military stuff to end deflation, but the narrative in Germany is “Nazis did deficit spending” –> “Deficit spending is evil”; “Defenders of Democracy (Brüning) did the responsible thing of belt tightening” –> “Austerity is morally superior”
I do agree that Bruning’s policy was idiotic.
But how much Nazi deficts helped is still a subject to a large debate, includjng the fact that it’s actually very hard to measure the deficits – the data was classified, destroyed, and money were moved a lot within budgets.
For example, see http://personal.lse.ac.uk/ritschl/pdf_files/ritschl_dec2000.pdf
That said, it does not rule out the narrative you mention, as narratives rarely have good grounding in reality.
I read that the German economy was starting to get a bit wobbly by the start of the war. There is an interesting article at https://en.wikipedia.org/wiki/Economy_of_Nazi_Germany which states that-
“Between 1933 and 1939 the total revenue of the German government amounted to 62 billion Reichsmarks, whereas government expenditure (up to 60% of which consisted of rearmament costs) exceeded 101 billion, thus causing a huge deficit and rising national debt (reaching 38 billion marks in 1939).’
This was causing the government all sorts of problems but I understand that the start of the war stopped some of the worse problems coming to a head prematurely.
There’s a fascinating read “Wages of Destruction” by Adam Tooze. It basically argues (and I believe marshalls good arguments for his thesis) that for Nazi Germany to win the war, it had to get resources pronto. When it failed to get the USSR, it was more or less economically doomed.
Would that explain the puzzle of them invading the Caucasus instead of capturing Moscow and pushing on through?
I don’t think it has ever been considered a puzzle as to why they went for the Caucasus – the oil fields there were a major prize and German economists saw controlling them as vital as a means of ensuring the captured territories were not an economic drain (the calculations were that the western territories of the Soviet Union had little or no economic value to Germany).
There was also a fear that the British would strike from Iraq to seize the oilfields for themselves in the event of a Soviet collapse.
It must be remembered of course that nobody expected the Soviets to put up such a good fight. US military assessments were that the Soviets would last 2 months at most against the Germans. It was known that the officer class had been decimated by Stalin and it was assumed from outcome of the Winter War in Finland that the Soviets were no match for a determined modern army.
Germany didn’t get the mineral resources from Chile either, largely due to US interference. This hampered its technical manufacturing.
As for the invasion of the USSR, I have thought it odd that Hitler didn’t learn from Napolean’s failure. He should have waited.
As the later deficit spending was into rather unproductive assets (military equipment) compared with the earlier spending (infrastructure like the Autobahn), it wouldn’t surprise me, if there would eventually have been problems. However, the passage you quote is very revealing: it takes a large government deficit and high gov’t debt (well, about 40% of GDP (38 billion debt to a GNP > 100 billion)) as self-evidently problematic. However, the figure in the wiki article shows, that even 1939 the growth rate was still about 7%. There is absolutely no sign of real economic trouble before the outbreak of the war in those numbers.
Btw. the relation between tax income and spending isn’t that much different to the general federal budget of the US today. In today Germany, there would be mass hysteria with ~5% deficit and the US isn’t even in a recession.
Overall, as well given the GDP of West Germany alone in the early 50s, I’m not even sure, if the GDP would have been higher with deflation policy continued and no WW II than with deficit spending and WW II.
Autobahns were a PR victory, but not really important economically (say from employment perspective).
Economically no but militarily yes. The 19th century used railways to move troops to where they were needed and the calling up and transport of German troops at the beginning of WW1 is a study in itself. By the 20th century, solid roads were used in the same way which was the reason why the Germans built the autobahn system.
It is said that Eisenhower signed the Federal Aid Highway Act of 1956 for the same reason and he knew what he was about when deciding this. Back in 1919 he was part of a military convoy that went from Washington DC through to San Francisco so learned first hand what America’s transport grid was like-
https://en.wikipedia.org/wiki/1919_Motor_Transport_Corps_convoy
No.
Germany was starved for oil. Most of military transports within Reich were trains (which run on coal, which Germany had enough in the quality needed – although it suffered deficits of coking coal). Using A-Bahns for military transports was very fuel-inefficient. Moving tanks using their own engines was bad (wear on the roads and the tanks), and German army lacked specialised self-propelled equipment required to move heavy machinery until 1938 (Sd.Kfz. 9), and even those were really mostly recovery vehicles. Rail transport was essential.
Also, German army was way less motorised than most people believe (another big PR victory). Most of the transport was still good ole “one horsepower” (the most common figure is that only 20% of units were fully motorised).
Most of the Germany’s oil supplies went where they were absolutely necessary – airforce, navy (wasted a lot of resources here in building a surface navy initially), and Panzerwaffe/Panzergrenadier. Artillery and foot soldiers had to basically live with horses..
I knew that I worded that badly. I meant to say that those highways were to supplement the trains as that is how most troops and gear went. Agreed that the Wehrmacht depended mostly on horses as old war footage shows. People see the tanks but do not see the horse carts bringing up supplies. As it was, there is old footage of US armies rolling along the autobahn as they rode into Germany so at last they proved useful to one army.
Let us not forget the ‘people’s car’ and the purported ‘holiday camps’, which are now largely in ruins, most never finished. Hitler intended that they should run on the autobahn and used by ‘the people’.
A key problem with the economy of Germany in 1939 was that its army was huge, at mass mobilisation level. This obviously impacted on available labour and was very expensive to maintain. Some believe that the timing of the war was influenced by the impossibility of maintaining army at that level indefinitely. Had Hitler opted for partial demobilisation this could arguably have given the economy a further boost by releasing the pressure on labour supply.
Thank you, PK.
The issue of mobilisation and labour supply, especially at harvest time, was addressed in Sleepwalkers, how Europe went to war in 1914. The issue was acute in Austria-Hungary and Russia.
Hitler had the good sense to target the same people that Brüning did, when the latter’s first austerity step was a major cut in unemployment benefit.
As for the thrifty Northerners. I don’t suppose that NIRP with it’s negative effect on savings will endear them to the already wobbly banks who will through the same means suffer a hit in the profitability.
Perhaps the received job will turn out to be a poison chalice & I wonder whether she will actually pay income tax this time around.
Extend & pretend within an age of unaccountability.
One of the distorting factors I think is that Germany has a lot of sneaky Keynsianism built into its industrial policy. For example, automatic grants to small businesses to keep employees in place during downturns. So they talk austerity but in reality practice anything but. What we really need is an equivalent for the euro zone – i.e. a European job guarantee paid for on MMT principles. But that debate hasn’t even started.
It is correct of course to say that austerity talk is very deeply imbedded in northern European politics, sometimes even more so in countries like Finland or the Netherlands than in Germany.
The one hope is that some of the new board members – like Philip Lane – are more open minded. Lane I believe knows Lagarde well personally and hopefully can be a good influence on her – he is certainly someone well aware of the malign influence of German financial policy over the Eurozone.
This is mostly not true. The dimension of spending needed to right the economy according to Keynes’ theory is much larger than the money the automatic stabilizers provide. Actually, in a sense they are problematic. They prevent extreme economic hardship even in times of bad economic development. This reduces the pressure on doing something about the economy. In the US, there was always an understanding, that expansive fiscal policy in a downturn is needed, as unemployment on the level possible in Europe with its support for people out of luck would lead to a revolution.
The arguments I’ve read are that there are huge multipliers involved in keeping skilled workers in place, far more than providing fiscal boosts, which almost inevitably arrive after the main damage has been done to the economy. Keynes always emphasised the importance of multipliers over and above the direct impact of spending.
The one and only thing forcing big banks to shrink is that they are too big to bail-out. One, of many, bad consequence of the US handling of the financial cris is that the big banks got bigger and smaller more local banks disappeared. So the idea that we need a bigger back-stop so that big banks can grow even bigger is to me a strange and a very bad idea.
So no, currency issuers should not focus on helping banks get bigger and enabling banks to take bigger risks. There are even those in the US who might believe that the banking crisis was handled badly and anyone following the same model – which appears to be printing money so that nobody who mattered got into trouble – will get the same result also in the Euro-zone.
A shrinking economy with less consumption might even be good for the environment but hey, GDP is what counts so lets do whatever it takes to goose up the GDP and grow (or at least stop from shrinking) some banks even bigger…..
Thank you, Yves and the NC community.
The impact of the EZ slow down is felt further afield.
My parents and I have a small holding on the west coast of Mauritius, supplying local hotels and guest houses, and two houses on the northern tip for rent. Most of our their guests and ours are from the EU, mainly French. Takings have eased considerably since February. Apart from the festive season, the guest houses, ours and others, have few bookings for the next year or so.
Other farmers, big and small, and textile manufacturers report declines in exports, too.
I agree with PK about Philip Lane. That was most welcome appointment. Hopefully, he can work in tandem with Mario Centeno if Centeno does not get the IMF job.
Thanks CS, Lane has always impressed me, and I don’t often say that about Trinity College economists. He is in the news here at the moment because apparently he has expressed disquiet about the newly appointed Governor of the Irish Central Bank, a New Zealander. Lane seems to have suggested that there is more than meets the eye regarding the little scandal his successor was involved with.
Regarding a drop in vacationing, I heard it suggested that there has been a measurable impact on travel from northern Europe thanks to the Greta Thunberg phenomenon. Its been suggested that a large enough number of people in continental Europe are now opting for holidays in places they can access by train to have an impact – there has been a drop in Scandinavian visitors to Ireland this year. Although my guess is that the reason is more economic, there seem to be a lot of indicators of stress in the German economy.
As an aside, Denmark is still also a currency issuer. It’s in ERM2, pegged to EUR, but I believe it can break the beg. It would be a very non-trivial decision, but still orders of magnitude less than an EUR country dropping EUR.
If Germany is deindustrialilzing they’ll have to have something to replace it. If the whole problem revolves around keeping the old petro-industrial economy from imploding there will have to be an alternative to those profits. There’s no reason why deficit spending cannot do this until something like fusion comes on line. There is already a mega billion euro fusion plasma plant being built in France. They estimate another 10 years. But really it isn’t about the energy source at all. It is about the currency. The medium of exchange. If everyone just had an Ah-ha moment, took a deep breath, it (deficit spending) would prove itself to be just as effective as industrial production. And far more environmentally beneficial. It’s a mindset. I think Lagarde might have a little trouble with it. Too much “exorbitant privilege” for her taste.
I am 100% with Burnnet and with commenter statist above. Besides Weidmann would prove more pro-austerity than the all too conservative Lagarde.
I believe there is some internal war between expansionist and austere types and I wonder if the gauge could turn left when eurocentral countries feel the pinch no matter what they maintained during the financial crisis or how Calvinist they feel.
Don’t know if it was the intention, but it’s one of the best explanations for how the Brexit mess appeared. Makes more sense than the laughable explanation that politicians were scrambling to respond to the “left behind.”
Lagarde’s incompetence is one thing but Auerback forgets to mention her frivolity (rumor has it that she wanted the IMF nomination in order to get out of Europe and move back to the US) and weak character. She’s imminently corruptible and has already been convicted of corruption involving misuse of the public’s money. She wasn’t punished of course and expresses no remorse. Don’t look to her for leadership. She’s a puppet.
interesting, fairly believable