America Should Bet on Berlin, Not the Basket Cases
Rarely has the establishment been so unified, and misguided, in its ever-more-frantic efforts to promote a Euro bailout. Today's Daily News Brief from the Council on Foreign Relations writes:
G20 leaders, meeting in Los Cabos, Mexico yesterday, urged European members to jumpstart growth in the beleaguered eurozone (al-Jazeera) by easing austerity measures and allowing the European Central Bank to play a more active role. A draft of the G20's official statement, to be finalized and published later today, called on members to "take the necessary actions to strengthen global growth, amid increased concern that the eurozone sovereign debt crisis could plunge the global economy back into recession."
The CFR highlights the following items:
"Since the euro crisis has escalated, the chancellor [Angela Merkel] has been more isolated than ever before. Everyone, from U.S. President Barack Obama to French President François Hollande, British Prime Minister David Cameron to Italian Prime Minister Mario Monti, together with an army of international economists, financial experts and journalists, is demanding that the Germans take on a greater financial burden," notes Der Spiegel.
"But a eurozone collapse would be a disaster that might define our era. Its prospect must focus the minds of all at the G20 summit on action. Non-Europeans must persuade Europeans that the rules change when the stakes rise. The ECB's credibility will mean little if there is no longer a common currency," writes Lawrence Summers for the Financial Times.
"With the global economy again weakening, we need a strong G-20 now more than ever. The leaders of the world should take the opportunity of their meeting in Los Cabos to put aside political incentives and do what is best to ignite the global economy. By setting real membership standards, world leaders could build a better G-20, one capable of facing the challenges ahead," Alex M. Brill and James K. Glassman for the Wall Street Journal.
"Growth" according to the G-20 and the foreign policy establishment means a massive bailout of bankrupt debtor nations, mainly at the expense of the German and Dutch taxpayers. It sounds sort of reasonable until you look at the numbers: it's a hoax, a goof, a scam. Spain, the crisis du jour, is a Ponzi scheme, a property market bubble that dwarfs America's subprime problem.
Spain just asked for a Euro 100 billion bailout for its banks, whose bad loans reportedly are just under 9% of their total book. That's bad enough, but the real number is two or three times as bad, as we infer from the fact that Spanish banks tripled their lending volume since 2008, lending money to zombie borrowers to pay interest on their old loans. Spain's official response has been to delay a promised audit of the banks and go on vacation. No joke: the Wall Street Journal reports this morning:
The deadline for a group of auditors to present full reports on the capital needs of Spain's financial sector has been delayed to September from July 31, a Spanish central bank source said Tuesday. The move has been agreed with Spain's government, the International Monetary Fund and the European Central Bank, as well as the auditing firms -- Deloitte, KPMG, PwC and Ernst & Young -- themselves, this person added. The delay seeks to provide the auditors with more time to complete their evaluation of the banks' books and also responds to the fact that many Spanish companies and government institutions are only thinly staffed in August, a traditional holiday month when the cabinet and parliament rarely meet, this person said.
All the pious pronouncements from the policy elite amount to a plea for more money to keep scams going that should have been shut down a long time ago. Americans, after all, lost $6 trillion in net worth (a 40% decline for the average family) between 2007 and 2010, and municipal workers are taking pension clawbacks. The problem is not monetary, but political.
As I wrote in an Asia Times essay June 18:
Europe's nominal wealth is embodied disproportionately in national debt and in the banking system, especially in the debt of the banking system. To reduce the paper value of wealth would be an overtly political act, rather than a quasi-market phenomenon as in the United States. All of Europe's politics now revolves around the question of whose wealth gets taxed. If Spanish pensioners are told that their pensions will be reduced by a big margin because the Spanish banks made too many bad loans to construction companies while the government looked on, they rightly will blame the government. This may destroy the delicate fabric of Spanish political life. That is unfortunate, and it may be unavoidable.
There are many ways to write off the nominal wealth to levels that correspond to economic reality. The simplest and best would be for Spain, Italy and so forth simply to impose a wealth tax. But wealthy southern Europeans have been hiding their wealth for generations precisely in order to avert such an eventuality. Another way to have a de facto wealth tax is to devalue the currency, which makes everyone (but especially people of modest means) much poorer, while reducing the real liability of debtors (mainly the government). And yet another way to tax wealth is to wipe out the value of assets.
Americans accepted the overall reduction in wealth because the housing bubble was a people's Ponzi scheme, as I wrote in this space (See The people's Ponzi scheme, Asia Times Online, August 16, 2011). Americans speculated on their own houses, and lost. So did the Irish, who glumly accepted the consequences.
Not so the Spanish: the massive misdirection of credit to the construction sector focused on corporate rather than household lending. Financial institutions issued debt in the astonishing volume of 109% of GDP (about three times the level in the United States). The construction sector ballooned to a size large than manufacturing (vs a fifth of the manufacturing sector in Germany and a quarter in the United States).
The massive issuance of financial institutions' securities constitutes a large portion of the wealth of Spaniards; they sit in pension funds and life insurance portfolios. Wipe out their value, and Spaniards will have to accept pension reductions. That is precisely what should be done: the banks are valueless, and their liabilities should be erased so that an external buyer can recapitalize them. The Spanish won't like it a bit. Nor will other Europeans.
The Spanish elite with the connivance of the Spanish government gambled with the retirement funds of the Spanish people and lost them speculating in property. If the nominal wealth of the Spanish people is written down to its fair value, a whole generation of Spaniards will suffer a penurious retirement. If the banks are put through a proper bankruptcy, new capital can be injected by foreign investors to restart the economy (as in Thailand after the 1997 real estate market crash). But the Spanish will be poorer. Will Spain's fragile social fabric hold together? Probably not; the Spanish are still fighting the terrible civil war of 1936-1939. Spain well might descend into political chaos. But I'm not going to write them a check to prevent that. I don't see why Chancellor Merkel should, either. With a fertility rate of just 1.4, Spain won't be around much longer in any case.
The alternative to letting the nominal wealth of Spain sink to its fair value is to make the Germans poorer. As I wrote June 18 in Asia Times:
The alternative is to place a de facto wealth tax on the frugal and industrious northern Europeans, by extending Germany's (and Holland's) balance sheet until the euro weakens drastically, raising the cost of imported goods for the Germans. It is unfair to tax German wealth in order to maintain the wealth of the rest of Europe, and the Germans won't like it.
Why should America want to prop up the fictitious wealth of the Spanish by making the Germans poorer? What possible purpose can that serve? America should be strengthening our alliance with Germany, rather than badgering the Germans to bail out the basket cases. We share a fundamental interest with the Germans -- containing Russian influence. The European community will shrink to a smaller and more prosperous core. We should be more concerned with strengthening NATO. Economics isn't always a positive sum game. The slow and terrible decline of Spain during the 16th and 17th centuries was good news for the Dutch, who opened their doors to talented immigrants from all over Europe (notably the Spanish and Portuguese Jews). There are plenty of smart Spaniards, and a lot of them (along with a lot of smart Greeks) will be working in Germany.
There just aren't enough Europeans to go around. Europe's working-age population will shrink by a third by mid-century. There are plenty of prospective immigrants from Africa and the Middle East, but few of them are educated and many of them are culturally unassimilable.
Exhibit 1: Europe's working age population (15-59) shrinks by a third while population over 65 doubles
Source: United Nations World Population Prospects (Constant Fertility Scenario)
Exhibit 2: America's working population grows but retired population grows faster
Source: United Nations World Population Prospects (Constant Fertility Scenario)
Germany's biggest economic problem is a shortage of skilled labor, and that likely will be solved the way it was solved in the 17th century after the Thirty Years War: through immigration. America should bet on the winners, provided that the winners share our democratic values and our strategic interests.