This crisis is NOT the result of government overspending and austerity WONT solve it

jasonc5432 · 01-12-2011 10:33AM #1

David McWilliams: Small savers will pay price if euro goes into meltdown

Wednesday November 30 2011

This crisis is likely to culminate with capital controls re-imposed in Ireland, following a Europe-wide run on the banks. This bank run will be an accelerated and panicked version of what is already happening right now. Money is likely to leave all the major banks of the eurozone with the exception of German banks.

This is because savers fear the breakup of the euro will leave them with "cheapened" savings in their own countries. Obviously, the corollary of this should be a wall of money flooding into Germany because -- whatever happens -- the currency that Germany will eventually trade in will rise against all others.

And so we are likely to see a massive credit crunch all over Europe because without funding, lending will dry up.

As lending dries up, growth will plummet and the already fragile bond markets of the non-German members of the eurozone will close down. This means that the enormous redemptions which are necessary next year to roll over the huge national debts of Italy and Spain, together with France will not be financed. These countries will have to renegotiate their debts.

Yesterday, for example, Italy raised money but paid more for three-year money than for 10-year money. The three-year yield was 7.89pc while the 10-year yield was 7.56pc . This is abnormal because you should always pay more for money that you borrow over the longer term, not least because -- based on the bird in the hand notion -- the risk to the lender rises as the amount of time the lender has to wait to get his money back is extended. But in Italy, the risks are now accumulating in the near term as money leaves the country and the expected crisis comes closer.

The rest of Europe is now imploring the ECB to act and save the day. Who else will buy these bonds if the ECB does not? But it is quite likely that the European Central Bank will sit on its hands, hiding behind its limited mandate, which prevents it from financing governments. Maybe the reason the ECB is not acting is that it has misdiagnosed what is going on.

I speak now as a former central bank economist when I talk about the type of thinking that has taken over in the heads of ECB economists. In the 1990s, there was an obsession with government spending inside the heads of economists at the various European central banks.

This line of thinking saw "evil" governments everywhere and if the central banks financed these free-spending governments, it would lead to fiscal incontinence everywhere.

Possibly as a result of this thinking, the German faction in the ECB believes two evidently false propositions and because it has not diagnosed the problem correctly, it lurches to the wrong conclusion.

The first misdiagnosis is that the eurozone crisis is the result of too much government spending. This is patently not true. Ireland and Spain entered the crisis with budget surpluses and Italy has been running a primary surplus for years. Only Greece fits neatly into the "too much government spending" model. We all know that the main problem is excessive lending by private banks to the private sector.

The second canard held dear by the ECB economists is that austerity leads to growth. This idea is so silly that it is amazing time is still devoted to it. But here goes. Some economists believe that if a government cuts spending, the average citizen will conclude that his taxes in the future will be lower, which makes him feel richer today. As a consequence of this extraordinary insight, he will bring forward spending that he was going to make in two years' time to today.

Can you think of anything more ludicrous?

This thinking leads to what I would call "policy vindictiveness". The ECB sees the crisis now as an opportunity to teach governments a lesson and to drive home the point that the ECB has been right all along. Therefore, we get an element of vindictiveness in its overall approach.

But it fails to realise that it is maturity and wisdom and not small mindedness that is called for now. The ECB's job is not to use the crisis to prove a point but to stop a dire situation becoming worse. However, while rhetoric is cheap, wisdom is -- unfortunately -- in short supply.

As a result, the central bank does nothing as the commercial banks experience a run on deposits. Bank runs happen quickly; that is why they are called bank runs, rather than bank ambles.

Here in Ireland, as savers' money floods out of the country, the State will be faced with a choice. Does it allow this to happen or does it impose currency and capital controls to "lock in" money? We will not be the only country faced with this choice -- all peripheral eurozone countries will be faced with the same dilemma as the citizens move to protect their savings.

Remember the citizens will be the last to "doubt" the banks. Shareholders have already sold, so too have bondholders, the final sources of bank funds are small deposits and, as always, they are the last to move.The big deposits moved a long time ago as evidenced by Siemens moving €6bn out of Soc Gen a few weeks back. This is a recurring pattern in financial history -- the little guy always pays.

After the imposition of capital controls, the existence of the eurozone will come into question because it is hard to sustain the idea of a monetary union with capital controls. At this point, its strikes me that the most likely next move will be that the core countries, including France, will execute the plan they have been hatching for some time now, which is to move forward with a two-speed euro.

In fact, a move to a two-speed euro can only happen if capital controls are imposed. As these events tend to happen quickly, many citizens will not realise what is happening until it is over and done with.

The whole debate in Ireland about the next phase of the euro is reminiscent of the boom years where those of us who called the boom correctly as nothing more than a "vacuous confidence trick" and a "scam" were labelled unpatriotic, while those who ripped off the people with greed backed up by "quack economics" peddled by fully paid-for "quack economists" were treated as national heroes.

Again the temptation here with the euro will be to shoot the messenger. But that would be wrong.

Europe is headed towards a major policy shift, the most likely outcome is some type of two-speed euro but before that happens, the people will panic. And all the while the ECB, which could do something, does nothing because it wants to prove a point.

www.davidmcwilliams.ie

Irish Independent

I'm sure most forum members will be interested in this article, given its implications for many of us.

Eliot Rosewater · 01-12-2011 10:55AM

jasonc5432 wrote: »

The first misdiagnosis is that the eurozone crisis is the result of too much government spending. This is patently not true. Ireland and Spain entered the crisis with budget surpluses and Italy has been running a primary surplus for years.

I think this is a silly statement on two counts.

Firstly, that before the crisis Ireland had a budget surplus doesn't say anything about the crisis itself. Before the crisis, banks were lending to people. Therefore banks not lending to people now is not a problem. The logic here is clearly flawed.

Secondly, while Ireland may have had a budget surplus in the year before the crisis (I don't know) it still had high levels of debt. In 2009, public debt was 65% of GDP, or 113 billion dollars, according to the CIA Factbook. This is the problem - not the specific figures from one or two budgets selected by Mr. McWiliams to supported his point.

The equations behind the budget surplus are very simple. You add tax revenue and subtract spending. If there's a budget deficit those two things need to be looked at. In Ireland's case both are to blame. The boom-years tax base was highly unstable, being based so much around the property sector, so when the housing crisis started tax taking declined. Additionally, government spending increased during the boom-years to unsustainable levels, in the current context. Job seeker's allowance increased by over 100%. And yet now people protest if a cut of even 5% is proposed.

And the point of the EU/IMF bailout is that Ireland could no longer pay its way. This was because, as above, fall in tax taking and increases in spending during the boom.

jasonc5432 · 01-12-2011 11:00AM

Eliot Rosewater wrote: »

I think this is a silly statement on two counts.

Firstly, that before the crisis Ireland had a budget surplus doesn't say anything about the crisis itself. Before the crisis, banks were lending to people. Therefore banks not lending to people now is not a problem. The logic here is clearly flawed.

Secondly, while Ireland may have had a budget surplus in the year before the crisis (I don't know) it still had high levels of debt. In 2009, public debt was 65% of GDP, or 113 billion dollars, according to the CIA Factbook. This is the problem - not the specific figures from one or two budgets selected by Mr. McWiliams to supported his point.

The equations behind the budget surplus are very simple. You add tax revenue and subtract spending. If there's a budget deficit those two things need to be looked at. In Ireland's case both are to blame. The boom-years tax base was highly unstable, being based so much around the property sector, so when the housing crisis started tax taking declined. Additionally, government spending increased during the boom-years to unsustainable levels, in the current context. Job seeker's allowance increased by over 100%. And yet now people protest if a cut of even 5% is proposed.

And the point of the EU/IMF bailout is that Ireland could no longer pay its way. This was because, as above, fall in tax taking and increases in spending during the boom.

Its not budget deficits that are causing lack of bank lending --- it's the fact that private banks have over-lent to a fantastic degree.

Banks are the cause. If you have not noticed that in the past four years, I can supply you with plenty of academic literature, popular literature, newspaper articles, top economists' blogs/interviews/editorials/journal articles.

Your point on Ireland's reliance on property related taxation is very valid however. No problems with that.

whatstherush · 01-12-2011 11:01AM

jasonc5432 wrote: »

Can you think of anything more ludicrous?

Yep, advising a Minister of Finance to guarantee every bank in the land. How did that one work out Dave?

Permabear · 01-12-2011 11:04AM

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jasonc5432 · 01-12-2011 11:13AM

whatstherush wrote: »

Yep, advising a Minister of Finance to guarantee every bank in the land. How did that one work out Dave?

By David McWilliams:

Morning,

There have been a number of recent comments about the Bank Guarantee. I would like to take the opportunity to get something straight about the Bank Guarantee, not in my words but in the words of Brian Lenihan.

It is true that when he called out to my house – at his instigation not mine – I told him that in my opinion (opinion, not advice – advice is given by paid advisors, civil servants, paid consultants, paid central bankers etc) he should copy the Swedish banking policy of 1992. This would stop the bank run that was happening in Ireland at the time.

That was it. I assumed that they would do their homework – that is after all what these guys are paid to do. Remember the politicians had teams of civil servants, central bankers and personal economic advisors.

In contrast, I have never been inside the Department of Finance in my life to advise on anything. I was never asked to clarify the parametres of anything – re timing, scope etc.

Very soon it became shockingly apparent to me that the Swedish approach was not being followed. In fact, the opposite was occuring with devastating consequences. By early 2009, I thought it best – even at that stage – to rescind the guarantee and call the creditors into a room and tell them the game was up. I wrote articles to this effect.

In response to this stance, Brian Lenihan in April 2009, personally wrote a op-ed page for the Irish Independent. I am sure this is one of the first times such a thing has happened where a Minsiter of Finance writes a personal attack on an individual commentator.

I would like you to read it as it clarifies what my position was by early 2009 and the fact that the Guarantee as implemented since Oct 2008 was nothing like what I had suggested. Within three months, I had realised it was a diasater because it had been hijacked by the very bankers who had brought the country to ruin in the first place.

It might also reveal the level of establishment smearing and undermining that goes on in this country when the entire appartus of the State is used to blacken someone’s reputation.

http://www.independent.ie/opinion/analysis/states-priority-is-helping-economy-not-the-developers-1716678.html

Best,

David

http://www.davidmcwilliams.ie/2011/11/15/recent-inaccuracies-re-the-bank-guarantee

Wibbs · 01-12-2011 11:15AM

I agree with Eliot Rosewater. I'd also agree with McWilliams on a couple of points. The small guy will get screwed in any shakeup. Though this is hardly groundbreaking insightful stuff. There has been a bank run by those entities with lots of money. Again hardly insightful. I would certainly agree with him re "austerity leads to growth" BS.

whatstherush · 01-12-2011 11:29AM

jasonc5432 wrote: »

It is true that when he called out to my house – at his instigation not mine – I told him that in my opinion (opinion, not advice – advice is given by paid advisors, civil servants, paid consultants, paid central bankers etc) he should copy the Swedish banking policy of 1992. This would stop the bank run that was happening in Ireland at the time.

September 2008 Article

The only option is to guarantee 100 per cent of all depositors/creditors in the Irish banking system. This guarantee does not extend to shareholders who will have to live with the losses they have suffered. However, it applies to everyone else. If the minister does this, he will not only staunch any funds outflow, he will show leadership and be seen as someone who is coming up with a solution that can be copied all over the world.

Given this was his view in Sep 08 and he met Lenihan in Sep 08, Do you think his opinion, not advice mind, had any affect on the course of history.

PRAF · 01-12-2011 11:30AM

whatstherush wrote: »

Yep, advising a Minister of Finance to guarantee every bank in the land. How did that one work out Dave?

Very easy to make a statement like this and suggest that Dave McW is the bogeyman we've all been looking for. Faced with the imminent collapes of liquidity in the Irish banking sector (i.e. no cash in the ATMs), DmcW informally advised BL to go down the Swedish route of issuing a blanket guarantee (this advise was also offerred officially by a US investment bank who were paid millions for their advice). This was a confidence trick, i.e. to tell everyone everything was ok, buy us some time to fix the problems, and avoid economic armageddon.

The initial application of the guarantee worked. Economic armageddon was avoided.

However, the next bit of the recommended Swedish solution was not implemented. During the next two years, the govt should have tried to fix the problem, burned the bondholders, implemented some targeted debt forgiveness for mortgage holders etc. That didn't happen. Blaming Dave McWilliams for this is unfair.

The reasons the govt didn't do this has a lot to do with own their laziness, ineptitude, political cowardice, self interest, and also the bad advice they were given. However, the biggest reason was that they were totally shafted by the ECB who threatened to shirk their responsibility as lender of last resort to the Irish Banks if even 1 euro of senior bondholder debt was burned.

So, in hindsight, had he known that Ireland would not be able to fully apply the Swedish solution to our banking problems, would Dave had recommended the guarantee? Who knows? I think he would have and he would have also recommended that the Irish Govt call the ECB's bluff and insist on burning the bondholders.

What was your solution by the way? If all 6 key banks had knocked on your door and told you there would be no money in the ATMs the next morning and you had to issue a guarantee, what would you have done? Very difficult to fix a problem that was 10 years in the making in one night.

nesf · 01-12-2011 11:34AM

I don't think we can escape the austerity, we can't function with a deficit as big as we have as no one with any sense will fund it without us going into austerity to reduce it.

It's la la land stuff to think that we can get away with ignoring the deficit and somehow magically come up with funding for it.

PRAF · 01-12-2011 11:43AM

nesf wrote: »

I don't think we can escape the austerity, we can't function with a deficit as big as we have as no one with any sense will fund it without us going into austerity to reduce it.

It's la la land stuff to think that we can get away with ignoring the deficit and somehow magically come up with funding for it.

There is absolutely no doubt that some drastic reduction in spending is required. The appalling thing though is that it is the middle class that will likely pay most here (increased taxes, reduced services etc.). If 'austerity' continues to focus on this sector, our growth prospects will be severly limited and we will have a zombie domestic economy on our hands.

I'm not currently in negative equity (not too much anyway), however, I do feel we need some form of national purging of the most unsustainable of our private debts in order to get people spending again. Never again should we waste so much money on a property bubble. However, we should be encouraged to spend money in the domestic economy.

nesf · 01-12-2011 11:45AM

PRAF wrote: »

There is absolutely no doubt that some drastic reduction in spending is required. The appalling thing though is that it is the middle class that will likely pay most here (increased taxes, reduced services etc.). If 'austerity' continues to focus on this sector, our growth prospects will be severly limited and we will have a zombie domestic economy on our hands.

I'm not currently in negative equity (not too much anyway), however, I do feel we need some form of national purging of the most unsustainable of our private debts in order to get people spending again. Never again should we waste so much money on a property bubble. However, we should be encouraged to spend money in the domestic economy.

Rock and a hard place. Any debt forgiveness will mean losses for the banks which means the taxpayer picking up the bill which means everyone ends up paying more which depresses the economy anyway.

No easy solutions here I'm afraid, despite what a politician might tell you.

jasonc5432 · 01-12-2011 11:47AM

nesf wrote: »

I don't think we can escape the austerity, we can't function with a deficit as big as we have as no one with any sense will fund it without us going into austerity to reduce it.

It's la la land stuff to think that we can get away with ignoring the deficit and somehow magically come up with funding for it.

The point is -- austerity is not the solution.

A complete restructuring of the financial system is.

With the recent concentration on private interests replaced with public interests -- e.g. pension funds should benefit pensioners, not pension fund managers. Pension fund managers should be paid well for doing a good job, but not millions/billions.

Banks are supposedly societally systemic.. thus they should benefit the surrounding societal system -- our current banks are doing the EXACT opposite. Short term profit, much of which is often bogus and includes over valuation of assets, and often inclusion of incredibly sketchy amounts.

The current auditing profession, and ratings professions are a joke. Their BEST rated institutions are proving to be often the WORST ones in reality. Their measures are clearly flawed at best, useless and incredibly damaging at worst.

etc etc etc

etc etc etc

Raskolnikov · 01-12-2011 11:48AM

Eliot Rosewater wrote: »

And the point of the EU/IMF bailout is that Ireland could no longer pay its way. This was because, as above, fall in tax taking and increases in spending during the boom.

You're wrong.

Our structural deficit is certainly a problem, but it is nothing compared to the sheer size of the banking bailout. Saving the Irish banks and bondholders has cost taxpayers 43% of GDP, an astronomical figure and hasn't been matched by any country in the Western world. The austerity that has brought about increased taxation has also generated a reverse multiplier effect (money ordinarily being circulated in the economy is now leaving the country to pay interest). This itself has fed back on GDP, creating a loop.

Our natural structural deficit is about 5%, a figure that isn't far off the likes of Holland (6%), Germany (4%), etc.

nesf · 01-12-2011 11:51AM

jasonc5432 wrote: »

The point is -- austerity is not the solution.

Whoever said that it was the solution? It's just a key element of the solution and by far the most painful for the people of the country so that's why it's bigged up so much.

jasonc5432 · 01-12-2011 11:56AM

nesf wrote: »

Whoever said that it was the solution? It's just a key element of the solution and by far the most painful for the people of the country so that's why it's bigged up so much.

Wrong -- austerity on low income earners has a direct effect on the local economy.

Low income earners spend almost ALL their income, because it is so low. Thus, they have a huge role to play in the economy locally, and nationally.

Cutting lowest income earners takes money out of the economy. Cutting high income earners puts money back into the economy.

So austerity at the top, yes. At the bottom, no. It stalls an economy.

Ireland is in a depression. Cutting lowest incomes, from ANY source, takes billions from the economy. Everytime a low income earner spends a euro, that euro serves as more lifeblood to the economy and financial system.

High earners tend to hoard, because they simply cannot spend what they earn. They are the place where austerity should start.

PRAF · 01-12-2011 12:00PM

nesf wrote: »

Rock and a hard place. Any debt forgiveness will mean losses for the banks which means the taxpayer picking up the bill which means everyone ends up paying more which depresses the economy anyway.

No easy solutions here I'm afraid, despite what a politician might tell you.

Rock and a hard place is right! I'm halfway through Matt Coopers book and so far it seems the biggest villain of the piece is the ECB. Surely the solution (albeit not an easy one) is that the ECB massively ramps up its bond buying program (effectively printing money). The only potentially easy soloution here is that the ECB cops itself on and saves the European economy.

My other villains are FF (for ruining Ireland), the Banks (for fueling the property bubble), the civil service and the regulators (for incompetence, laziness, self serving attitude and a total lack of balls) and the social partners (for encouraging FF to ramp up unsustainable spending). Have I forgotten anyone?

David McW is so far down my list, he's not even on my list!

Permabear · 01-12-2011 12:09PM

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nesf · 01-12-2011 12:10PM

jasonc5432 wrote: »

Wrong -- austerity on low income earners has a direct effect on the local economy.

Low income earners spend almost ALL their income, because it is so low. Thus, they have a huge role to play in the economy locally, and nationally.

Cutting lowest income earners takes money out of the economy. Cutting high income earners puts money back into the economy.

So austerity at the top, yes. At the bottom, no. It stalls an economy.

Ireland is in a depression. Cutting lowest incomes, from ANY source, takes billions from the economy. Everytime a low income earner spends a euro, that euro serves as more lifeblood to the economy and financial system.

High earners tend to hoard, because they simply cannot spend what they earn. They are the place where austerity should start.

Um, you do realise that we have to solve the deficit yes and that we can't do this without in some way affecting low income workers?

Permabear · 01-12-2011 12:11PM

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nesf · 01-12-2011 12:13PM

PRAF wrote: »

Rock and a hard place is right! I'm halfway through Matt Coopers book and so far it seems the biggest villain of the piece is the ECB. Surely the solution (albeit not an easy one) is that the ECB massively ramps up its bond buying program (effectively printing money). The only potentially easy soloution here is that the ECB cops itself on and saves the European economy.

My other villains are FF (for ruining Ireland), the Banks (for fueling the property bubble), the civil service and the regulators (for incompetence, laziness, self serving attitude and a total lack of balls) and the social partners (for encouraging FF to ramp up unsustainable spending). Have I forgotten anyone?

David McW is so far down my list, he's not even on my list!

You forgot the people for rewarding FF and FG/Lab/SF (who promised similar policies) with large amounts of votes. All politicians were promising largesse and we bought into it.

shaca · 01-12-2011 12:14PM

Give a man a gun and he can rob a bank...... give a man a bank and he can rob the world...:rolleyes:

jasonc5432 · 01-12-2011 12:28PM

Permabear wrote: »

This post had been deleted.

In vaults is becoming quite common.

I know of a safe/vault installer who says this EXACT sort of business (buried safes) are becoming very common.

The mattress one may be happening, but I doubt it

jasonc5432 · 01-12-2011 12:30PM

PRAF wrote: »

Rock and a hard place is right! I'm halfway through Matt Coopers book and so far it seems the biggest villain of the piece is the ECB. Surely the solution (albeit not an easy one) is that the ECB massively ramps up its bond buying program (effectively printing money). The only potentially easy soloution here is that the ECB cops itself on and saves the European economy.

My other villains are FF (for ruining Ireland), the Banks (for fueling the property bubble), the civil service and the regulators (for incompetence, laziness, self serving attitude and a total lack of balls) and the social partners (for encouraging FF to ramp up unsustainable spending). Have I forgotten anyone?

David McW is so far down my list, he's not even on my list!

Agree, agree agree!! ^^

And, when you say McW is down the list, if you mean not ON the list of ''people to blame for the crisis'' --- then again -- AGREE!!

Excellent post. Concise and to the point!

Permabear · 01-12-2011 12:30PM

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jasonc5432 · 01-12-2011 12:35PM

Permabear wrote: »

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There is evidence of such practice.

Many of the super wealthy store the money in various ways.
e.g. bank, hedge fund, pension fund, assets, gold, currencies, cars, paintings, etc

Do you think they keep it in their wallet or something?? The point is, there are people who are millionaires/billionaires and they keep their money somewhere.... they dont bloody spend it!! Otherwise... umm.. it'd be gone... of course!

The kinds of assets i list above (paintings, classic cars, gold,) do not drive the general economy -- they drive up the price of paintings, classic cars, and gold.... None of which creates any meaningful amount of jobs.

Car waxers, painting restorers, yes. Nothing meaningful figures-wise. Of course, it does have some nominal effect, but only when transactions occur

jasonc5432 · 01-12-2011 12:38PM

gnl92 wrote: »

I need sound advice, i have 70k in a 18 month saver account with the ebs which my mother left me when she died. I have a mortgage with the bailed out inbs of 2ook, what will happen to my money or life situation should the euro fail will i be ok as all my debts are in euros? Is there any way of getting out of my fixed saver account and if i cant what will happen to my savings- i have a young family and want to prioritise my family.

Find the safest thing you can. You should really take a lot of time to investigate this. The best solution will vary by each person and their circumstances.

I hope you find a solid solution and empathize with your plight as I know a few people in the same conundrum right now

View · 01-12-2011 12:41PM

As a matter of interest, how is that if we were in such good shape, as Mr McWilliams claims, that the government introduced an Emergency budget in July 2008 and in addition announced on September 3rd that it was bringing forward the December budget to October?

Those measures both took place before Lehman Brother's bankruptcy and the government decision to give the banks their guarantee at the tail-end of September.

Remember our deficit was -6.3% in 2008 - a figure that is really hard to square with us being in good shape...

Permabear · 01-12-2011 12:42PM

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jasonc5432 · 01-12-2011 12:47PM

Permabear wrote: »

This post had been deleted.

Permabear... try reading my POST... i said bonds, banks, funds etc.

Dont try to twist ive said.

I didnt do that to you.

Have some respect

Permabear · 01-12-2011 01:06PM

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This crisis is NOT the result of government overspending and austerity WONT solve it

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