The Economic Downturn Worsens

The effective manufacturing PMI data on the euro area as a whole and several individual member nations confirmed this week that the 'flash estimates' were by and large correct: the entire euro area is now falling into a deepening recession, including the so-called 'core' nations. The time when Germany was the sole holdout is  finally over (those who believe in a 'US decoupling' should better reconsider their stance as well we think).

Here are links to the PMI reports released by Markit this week:


1.    the overall euro area manufaturing PMI which fell to a 34 month low of 45.9



Euro area manufacturing PMI: the downturn gets worse.


2.    Germany's manufacturing PMI, which clocked in at a 33-month low of 46.2, was undoubtedly the biggest 'shocker' in the European data released this week – click chart for better resolution.












Germany's PMI: the 'core' is getting hit badly now.


3.    Spain's manufacturing PMI – to no-one's surprise – also hit a new low for the move at 43.5, the worst reading since June of 2009. According the the Markit press release,  every single measure of the PMI recorded a sharp deterioration (new orders, output, employment, backlogs, and so forth).



Spain's manufacturing PMI: worst reading since June of 2009.



Now, this worsening in the data is no surprise, as the ECB's LTRO's have this time failed to lead to an increase in the euro area's money supply. In fact, in February (the most recent data available at the moment), euro area TMS contracted by 7.2% annualized, as private sector deleveraging continued apace. Note that the UK's 'double-dip' recession was also preceded by a contraction in true money supply growth (minus 9.3% annualized in February). Several governments are beginning to tighten their belts as well and the banks are trying to  achieve the more stringent core tier one capital ratios that have been prescribed by the EBA (European Banking Authority) and Basel III. Thus, although indirect monetization of government debt is indeed taking place – mainly via the banking systems of Italy and Spain – no growth in the overall true money supply was achieved.

This is actually a salutary development. Although the economic pain dished out by the collapse of the artificial credit boom is great, there is no other way to reorganize the misaligned and distorted capital structure the bubble has left behind. Malinvested capital needs to be liquidated and/or transferred to better uses where possible, and labor also needs to adapt to the new reality (or rather, the unmasking of reality that the end of the credit inflation has brought about).

This is of course much easier said than done, but keeping the boom-time capital structure on artificial life support would only lead to an even bigger bust down the road. In fact, the current bust is very likely the inevitable end result of the post 2008 crisis liquidity injections and the decision to bail out the banks and allow this army of the financial walking dead to continue to blight the economic landscape.


ECB Worries About the Lack of Credit Growth – How Long Before Credit Dirigisme Is Considered?

The ECB has in the meantime recognized that its LTROs have achieved nothing  except keeping insolvent banks in business and giving them the wherewithal to dig an even deeper hole for themselves.

The 'ECB had hoped that liquidity would reach the real economy faster', so Mario Draghi told the EU parliament:


“ The European Central Bank expressed disappointment Wednesday that the liquidity it has pumped into the banking system in recent months has not fed through into the real economy more quickly.

"We had hoped the LTRO money would go faster into the real economy," ECB president Mario Draghi told the European Parliament's Committee for Economic and Monetary Affairs.

In two separate long-term refinancing operations, or LTROs, in December and February, the ECB pumped more than one trillion euros ($1.3 trillion) into eurozone banks in a bid to avert a dangerous credit crunch. The money was made available to banks at rock-bottom interest rates in the hope they would lend it on to households and businesses, thereby keeping the eurozone economy up and running. But available data so far appear to suggest that lending activity remains low and banks are tending to park the cash on deposit at the central bank rather than loaning it out.

Draghi insisted the process would take some time.

"We are confident that central bank liquidity has come very close to the real economy. Of course, this does not mean that this will by itself boost lending to firms and households," he said in a regular hearing.

"It is encouraging to observe that a very large number of small banks have participated in the two LTROs. Small banks are best placed to refinance the real economy, in particular small- and medium-sized firms which are the biggest generator of employment in the economy," he said.

There is also evidence to suggest that banks may have used the money to buy up the sovereign debt of debt-wracked countries, a practice the ECB would strictly speaking be opposed to, since it would be an indirect form of so-called "monetary financing", or central bank financing of governments, which is banned under the ECB's statutes.

"This has to be overcome," Draghi said, while noting that the situation on the bond markets had nevertheless "markedly improved".

"In the first three months of this year, we had bond issuance equal to the whole of last year" and that was "positive," he said.


(emphasis added)

We will comment on all the points emphasized above. Firstly, the idea that the 'money provided by the ECB should reach the real economy' indicates that the central bank believes that what is needed to support economic activity and create wealth is 'more money'. However, as we have often pointed out, this is based on a misconception.

Production is not funded by 'money' – it is funded by the pool of real savings. What adding new money from thin air to the economy achieves is a misdirection of scarce resources to economic activities that would be considered unprofitable if not for the artificially suppressed interest rate. Moreover, additional fiduciary media allow those who have first dibs on them to buy goods before the price effects of this addition to the money supply has fully percolated through the economy – effectively a redistribution of wealth. 'Nothing' (money from thin air) will be exchanged for 'something' (real goods and services), without any production having taken place preceding these exchanges. On the surface, these activities may lead to an improvement in economic data (such as e.g. GDP), but in reality they will weaken the economy further on a structural level and delay the  necessary adjustment process. Note here that it is impossible to avoid the adjustment process in the long run. It can only be delayed, and hence made worse. The sooner it takes place, the better.

That the banks are not lending any money out may be an indication that there is literally 'nothing left to lend'. There may be money, but it is possible that the pool of real funding is in such bad shape that it is simply no longer possible to divert resources to new bubble activities.

The idea that the excess reserves the banks are parking with the ECB are somehow an obstacle to monetary inflation is erroneous. In a fractionally reserved system, excess reserves do not represent a constraint on more inflationary credit creation – on the contrary. Consider that the central bank bought nearly € 1 trillion in assets. These are now on the asset side of its balance sheet. There has to be an offsetting entry on the liabilities side. Apart from its minuscule capital and the valuation adjustment on its assets which are a separate line item, the main liabilities of the central bank consist of the currency it issues (bank notes), as well as required reserves and excess reserves deposited by commercial banks. If the banks were to use their excess reserves to pyramid more inflationary credit on them, all that would happen would be that a small portion of these reserves would be reclassified as 'required reserves'. Currently the ECB's reserve requirement is a mere 1%, so in theory the banks could lever their excess reserves by a factor of 100:1.

That they are not doing so has several reasons: for one thing, they all fear a continuing funding crunch and are eager to deleverage.

Secondly, there is little credit demand from the private sector anyway – what demand there is often comes from putative borrowers that are currently not considered creditworthy enough.

Thirdly, the banks that are depositing funds with the ECB are a select group that holds more cash reserves than it currently needs to support its liabilities. The other banks needed the ECB to fund their shortfall, a demand that would normally have been satisfied in the interbank market by the banks in possession of excess reserves. So essentially the ECB functions here as a 'risk buffer'. The banks with excess reserves don't need to worry about the ECB as a counterparty, while the banks that require funding are receiving it directly from the ECB regardless of their dubious creditworthiness. 

As to the idea that some banks 'may have bought sovereign bonds', there's no 'maybe' about it at all. It is an ironclad fact that they have done so. This is the reason why Italian and Spanish bond yields declined. We're not sure what Draghi means when he says 'this has to be overcome'. We believe that there are in fact sub rosa agreements between big commercial banks and the governments in the nations concerned: a quid pro quo.

Governments extended 'guarantees' to certain bank assets so that they could be pawned off with the ECB in spite of their shoddy quality. In return they probably asked the banks to engage in what has become known as the 'Sarkozy trade', i.e., they told the banks to show up as bidders at their bond auctions and play the carry trade. The EBA also dispensed a broad hint to the banks when it said that lower sovereign bond interest rates would cause it to consider lowering the associated capital requirements that are supposed to  account for the risk of holding such bonds. So this is a 'win-win' for all concerned, as the banks would not survive the insolvency of their sovereigns anyway. As a result they have now tied their fate even closer to that of their governments.

One question that the above raises is the following: how long will it be before some of the euro area nations resort to credit dirigisme?

As Hugh Hendry mentioned at a recent conference, he is greatly worried that 'asset confiscation' may come next in Europe.


“The thing that I fear is confiscation. Confiscation of my assets, confiscation of my clients' assets. I fear that this thing could get out of [control]. I think we're a year away from the French fully nationalizing their banking system…”


Given that the assets of France's banks amount to over 400% of the nation's GDP, this is definitely in the realm of the possible. We have already noted in the past that the sequestration of ever more bank assets with the ECB already amounts to a kind of 'stealth nationalization' of the banks, as the pool of bank assets that private creditors of banks can lay claim to in the case of insolvency is shrinking ever more.

Now consider the socialist contender for France's presidency, Francois Hollande. This is the man who wants to create 'economic growth' by increasing deficit spending, raising taxes and raising the minimum wage. He certainly sounds like someone who would not shy away from nationalizing the banks, or failing that, at least attempt to take control over their credit policies in exchange for supporting them. We think Hendry is right – something of this sort is probably coming.

Hendry made one more remark that is well worth repeating:


We have reached a profound point in economic history where the truth is unpalatable to the political class – and that truth is that the scale and magnitude of the problem is larger than their ability to respond – and it terrifies them.”




Addendum: Juncker Quits

J.C. 'we lie when we have to' Juncker is quitting as head of the euro-group. The reason? He doesn't like that France and Germany are butting in all the time.  Bloomberg reports:


“Luxembourg Prime Minister Jean- Claude Juncker said he’s stepping down as head of the group of euro-area finance ministers because he’s tired of Franco-German interference in managing the region’s debt crisis.

“They act as if they are the only members of the group,” Juncker said today at a podium discussion in Hamburg. At the same time, Juncker said he’d “fully support” a potential candidacy of German Finance Minister Wolfgang Schaeuble to succeed him at the helm of the Eurogroup.

Schaeuble has “superb qualifications” for the job, Juncker said. As a fundamental requirement, the job needs a “personal capacity” to listen to others, he said.

A decision on replacing Juncker has been postponed until after the second round of France’s presidential election. Juncker has repeatedly stated that he won’t seek to remain in the job. On March 2, he cited “time constraints” as his reason for stepping aside.”


(emphasis added)

So in other words, are we to understand that in typical Juncker fashion, he lied at first? Or is his good-bye barb not entirely truthful? After all, to criticize Germany for butting in and concurrently recommending Wolfgang Schäuble for the  job is seemingly a contradiction.

Here's our guess: the reason why he wants Schäuble to take the job is revenge. He  wants him to be in the hot seat.

The Germans meanwhile didn't want to comment.




Charts by: Markit, BME, Bundesbank



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23 Responses to “Euro – Area – Worsening Contraction amid Faltering Credit Growth – is Credit Dirigisme on the Way?”

  • Texian:

    I find it extrordinary, that anyone would consider a Radical change to; or a suspension of, The Constitution in order to placate or “cut a deal” with corrupt parasitic creditors. Would this not enslave like chattel the citizens of the country to a pack of self seeking Economic bumblers of Very dubious morality? Shall we rebuild work houses or debtors prisons? There are those who would probably try to sieze and sell the body organs on the Global market of someone in order to settle or discharge their debts if they could get away with it. It is the Constitution that keeps these “people” from getting away with it. Liquidate the banks and strip the “personhood” from corporations before tearing up the Constitution. For if you tear THAT document up, you have nothing more than a Corporate Dictatorship, where the individual person and human dignity means nothing. Save us from that tyranny, please.

  • Andrew Judd:

    Rodney and Amun1

    Thanks for the replies. Blog software makes a conversation like this very difficult. There is no ‘reply’ link to reply to Rodneys comment.

    Firstly i think it is worth pointing out that this topic is enormously complicated. Part of the issue I am having with the Misesian explanation is definitions. even simple things like inflation become impossible to understand when each person decides their version is the correct language to use. I can agree to use whatever language you want but for the purposes of *other people* in the future it is not very helpful even if i am myself totally converted to the Von Mises economic realities.

    We seem to agree that if use my credit card, real production savings exist before i use the card and by using the card i ‘borrow the use of the production’, spend less in future and repay my debt (hopefully).

    We then have the producer holding claims which you do not want to call savings, or at least do not want to call *real* savings.

    The terms funding, real funding, and capital seem to me to be a bit muddled because one of you said the bank needs access to capital. But you have already made it clear that funding, real funding and capital are physical production goods/food/items. In fact all a bank needs is money savings in the form of national currency/bonds/various legal claims.

    The central banks are also not absolutely printing but are mainly swapping claims. It is true that if we consider the reality the central bank and the government are one organisation or a conglomerate of organisations in the case of the ECB set up, that permanent asset purchases can be likened to printing but huge private bank owned deposits at the central bank are not actually part of the banks ‘regulation capital’ and are not allowed to be part of their spendable speculative money and therefore most of this so called money is not in fact able to be used as a means of exchange for any allowable purpose. It is essentially dead money unless the bank itself owned bonds. But even if the bank owned bonds purchased by the CB the bank no longer owns these bonds. The private banks position is not much changed. I know you talk about the TMS. I cannot understand what meaning you wish to convey with the term. And you emphasise “printing”. Printing is happening since paper notes in circulation has increased but it is fairly small compared to most of the QE CB deposit amounts held by the private banks.

    You have also emphasised ‘consumers’ living beyond their means, but the real savers who produced glass for my house have also lived beyond their means. Most of the real production in the economy can be considered to be ‘mal investment’ from a certain point of view. What actual use is a BMW when a cycle or walking will suffice?

    One thing seems clear to me, because of the cost of production today, where almost nothing made to day is produced with basic technology in a simple workshop, if we begin a deflation that is allowed to proceed without a coordinated response the deflation will likely destroy most of us.

    But obviously things could be organised differently to they way they are proceeding today

  • Andrew Judd:

    As I said before there appears to be a bug in the Misean logic to me.

    If BMW has produced a car and I am given a credit card to buy the car then clearly production occured *before* I bought the car with my out of thin air credit card. BMW get out of nothing savings. I get a car.

    • Andrew Judd:

      Just to emphasise what I cannot understand:

      “‘Nothing’ (money from thin air) will be exchanged for ‘something’ (real goods and services), without any production having taken place preceding these exchanges.”

      When my out of thin air credit card or my HELOC is used, in my case anyway, production has always *already* taken place.

      Seems to me that the more production that takes place and therefore the more created money savings that are generated then the more you need to generate more money.

      It seems to me that Miseans are somehow giving special importance to money as if money was a real object which you call real savings? Any item valueable to humans can be monetized to enable a person to have valueable savings, providing a ****genuine**** effort is made to avoid unsustainable asset price bubbles.

      • IvoZ:

        Andrew, it is really simple: Using your credit card creates money out of thin air, so you exchange nothing for something real. Without your money out of nothing BMW would sell one BMW less. One day when credit cannot expand, the artificial demand created by credit disappears and you have a depression. People think that this depression is an anomaly, something like an earthquake, while in truth the artificial BMW demand is the anomaly.

      • rodney:


        The correct term is Misesian.

        Seems to me that the more production that takes place and therefore the more created money savings that are generated then the more you need to generate more money.

        The size of the money supply does not matter. As long as you are using a market chosen medium of exchange, i.e. a commodity, the purchasing power of that commodity will adjust accordingly. If you need more details, it is very well explained in “What Has Government done to our money?”, by Murray Rothbard.

        It seems to me that Miseans are somehow giving special importance to money as if money was a real object which you call real savings?

        Real savings is not money, but rather production of real goods and services that are not consumed. Money is only a medium of exchange.

        Any item valueable to humans can be monetized to enable a person to have valueable savings, providing a ****genuine**** effort is made to avoid unsustainable asset price bubbles.

        Provided it cannot be inflated at will, otherwise it will lose it’s purchasing power over time and some day it will cease to be valuable.

        • Andrew Judd:


          >>Real savings is not money, but rather production of real goods and services that are not consumed.

          When you say consumed, do you mean destroyed, eaten, worn away or no longer existing? For example I do consider the value of my house to be part of my savings. Without expensive upkeep a house or a car is consumed over time.

          • rodney:


            I am sorry that my replies have been too dry. I appreciate you are making a genuine effort to understand these articles by PT.

            I use the term consumed to mean ‘used up’. Following the example of your house, think of the glass in your windows. That had to be produced and stored before it was used up in the construction of your house. It was available for the production of your house because it had been ‘saved’ after it was produced, i.e. it was not used up in anything else.

            One of the best explanations of savings as real ‘things’ rather than money, and also of the importance of the size of the economy’s pool of these real ‘things’ (PT’s term is the ‘pool of real funding’) is in this article:

   (The Errors and Dangers of the Price Stability Policy)

            It’s best if you read all of it, but check this out:

            If we consider economic activity and what funds it, it should be clear that money is not funding anything as such. All economic activities are funded by unconsumed final goods. Consider the hypothetical case of embarking on a long range investment project that requires ten workers to be realized. In the time that passes between its initiation and the point when the contribution of this long range project to the production of consumer goods reaches fruition, the lives of these workers must be sustained. In short, present (i.e. consumer) goods must be made available to them for consumption. Obviously, if the pool of such saved present goods is not sufficiently large to achieve this, then it matters little how much money someone at the central bank prints. The project will never come to fruition. More generally we can state, the size of the pool of real funding and the scarcity of capital set the limits of what is possible in terms of economic activities (it should be noted that goods of the lowest order, i.e., consumption goods, become from the point of view of the entrepreneur/capitalist, higher order goods when they are employed in production processes).

            Let us now say that an economic actor in a free market economy by the name of Fritz wishes to exercise a demand for money. To do so, he must first sell his own previously produced products or services in the marketplace. In this type of transaction, Fritz contributes to the pool of goods and services, while receiving money with which he can subsequently exercise a claim on whatever other goods and service he wants to acquire from the pool.

            Consider now the case of Tony Soprano, who has in his cellar a machine with which to counterfeit money. He can use this money to divert real goods to himself, but he won’t contribute anything to the pool of funding in return. Total spending in the economy would increase, but there would be no increase in wealth. On the contrary, those producing wealth, such as Fritz, would find that when they want to exercise their claims on goods, fewer goods are available to them than there would be if Tony had not introduced counterfeit money (what Tony has diverted to himself and consumed has literally gone missing, since he has not contributed anything in its place).

            To the extent that Tony’s banknotes are well made counterfeits that remain undiscovered, his actions are in principle no different from those of a central bank creating money from thin air or a commercial bank creating fractionally reserved deposits from thin air. The only difference would be that Tony’s money would likely enter the economy at different points.

            Think about the implications of this: If printing money is such a good thing, then why not give a printing machine to every one of us? Why is the privilege restricted to the Central Bank and the fractionally reserved banking system? Proponents of inflationism will ignore a question like this because they have no answer to it, and the question exposes the unfairness of the system (it leads to ever growing wealth inequalities precisely because only a selected few have first access to the new money), so it’s better to pretend it is not being asked, e.g. Krugman.

            Your house is indeed part of your savings. You raise an excellent point when you mention the necessary ‘expensive upkeep’. Indeed, savings are crucial not only for the production of new goods, but in the upkeep and maintenance of the existing stock of capital. If you need to paint your house, a certain supply of paint must be readily available, and if you choose to contract the work, sufficient hours of skilled labor to finish the job must be ready for employment.

            Check amun1’s answer right below, I couldn’t have said it better.

    • mc:

      In a legitimate credit transaction, one cannot create money, but instead the savings of other are exchanged for future claims. When Alice uses credit to buy the BMW, she is being extended a loan of the savings of Bob. Before Alice can buy that car, Bob has to have produced and saved so that the money exists to provide the loan. The money goes to BMW, which is able to draw on the pool of savings to which Bob contributed, and Bob receives a claim on Alice’s future earnings – the circle is complete. Production by Bob has to occur first, otherwise there will be nothing for BMW to exchange its money for.

    • amun1:

      “If BMW has produced a car and I am given a credit card to buy the car then clearly production occured *before* I bought the car with my out of thin air credit card. BMW get out of nothing savings. I get a car.”

      It’s helpful to think about the definition of “savings”. Savings is anything of use or value that we produce in excess of the bare essentials to sustain life, i.e., enough food and water for today, a primitive shelter from the elements. Our capital base (stored food, buildings, equipment, materials, intellectual property, etc.) is our savings accumulated over time. If a stable form of money exists, then capital savings can be stored as money, with the knowledge that in the future the money can be freely converted back into true capital without loss of value. That is only the case if the supply of money is constrained so that it does not grow faster than the capital base of real savings.

      In your example, someone in the past produced enough excess goods to allow the manufacture of a BMW automobile; their savings (prior production in excess of consumption) permitted that endeavor. The car could never have been built without mining the steel, producing the rubber, etc, and none of that could have been done without savings of food and shelter in excess of immediate consumption so that someone could do the work. Once completed, the car is also a form of savings; it can do work and is a useful tool. So, “savings” preceded production of the car, just not your savings.

      You, on the other hand, did not “save” (produce in excess of your past consumption) when you bought the car on credit. What you did is borrow proceeds from your future production and spend them today. You have acquired someone else’s savings, with a promise to pay them back with your future savings. You must consume less in the future to pay those savings back. If you default on that loan, then you have damaged the savings of the lender, which decrements the available pool of savings for future production. By using credit to buy the car, someone has to produce more or consume less in the future to maintain our pool of true capital savings, either borrower or lender, or…., and that’s where we come to Ben Bernanke and his friends.

      Our central bankers have re-discovered an old trick. Collectively, people have funded their consumption with too much borrowing. The banking system of the world is stuffed to the gills with bad debt. Now the banks are about to pay the price of bad lending. Their access to true capital savings is at risk, because they’re about to go bankrupt. But wait, Captain America, Ben Bernanke is here to save the day! He’ll just summon new dollars from the ether and our problem is solved. Both borrower and lender can be made whole without damaging their savings or their future ability to produce and consume.

      The glitch, of course, as PT points out, is that Ben Bernanke didn’t generate “savings” when he punched his keyboard. He didn’t produce a rubber tire, or a headlight, or a transmission, or even a single ounce of steel or grain of wheat. When the Fed “stimulates” consumption by creating new money, there is no savings that precedes the new consumption. Our collective savings are unchanged, but by diluting the money supply, Mr. Bernanke has simply altered the equilibrium between money supply and “savings” of true capital. He has passed the cost of bad borrowing and lending to those people who trusted the currency and stored their savings in the form of dollars. He has damaged their future ability to produce from their dollar savings because their money will purchase less true capital. And, of course, he has preserved the banks’ access to true capital, which was the goal all along.

      Global central banks are facilitating the greatest weath transfer in history. They are NOT enhancing future production, or consumption, because they have NOT contributed anything to our pool of savings. What they are doing is damaging the ability to save using fiat money, distorting price signals in the economy and encouraging bad investment by borrowers and lenders who feel immune to their bad decisions. The cumulative effect of decades central bank interventions is dry tinder for a bonfire and right now they are pouring on the gasoline.

      • Andrew Judd:


        Most people who have dollar savings today have those savings because of the economic activity that happened during an unsustainable boom. It is not clear to me why you want this particular group to be singled out to be particularly protected. For example we could just let the banks fail and wipe out this group of dollar savers. Instead governments have bent over backwards to protect this group of people.

        In turn the governments have also bent over backwards to protect the senior bond ‘savers’ who stood behind the banks ability to enable the creation of savings that you are wanting to particularly protect.

        Which then nicely describes todays problem where nobody wants to get a haircut. Even the Norwegians are taking Greece to court for receiving Greek haircuts. You would have imagined the Norwegians would agree they were foolish. But if your group of dollar savers gets particular protection then why not the Norwegians?

        Look at the French ‘savers’. They have lent something like 600B to Italy spain and co, and those nice Italians now have very little private debt and a pretty good life from many points of view.

        The French will probably elect whoever is most likely to protect their savings, where it appears that France needs a massive haircut.

        Germany too does not want a haircut. They enjoyed it when the greeks and co were buying those BMWs and now want to keep all of the benefits.

        Are we really talking about a massive wealth transfer by the CB’s or instead a massive maintenance of the illusion of wealth?

        • amun1:

          Andrew, you seem to be making the case that people who save via currency holdings deserve no special consideration vs those who invest in new production, lending, etc. I would argue that is completely wrong and a recipe for disaster.

          Money has two functions; it is a store of value and a unit of exchange that allows economies to operate more efficiently than they can under a barter system. Some people try to separate those two functions and suggest that the latter function (unit of exchange) takes precedence over the former (store of value). There is just one problem with that line of thought; despite money’s utility as grease for the economic engine (unit of exchange), money cannot exist without the first function (store of value). The holders of money must retain confidence that their money (“savings”) are an effective placeholder for true capital. If they lose that confidence, then true capital rapidly gains ascendance over money. That loss of confidence in money will quickly impact its other function as the unit of exchange, which in turn makes the entire economic system less efficient. When people, companies, states, begin to hoard true capital and abandon money, then you have a real problem and that confidence in money, once lost, is very difficult to regain. Our central banks have already compromised their balance sheets beyond historical precedent. The average person may not understand that, but governments do, wealthy individuals do. Any further evidence that the risk of holding money is rising will trigger accelerating inflation as confidence in money fails.

          Beyond that, you make several points that are confusing to me. Bailing out bondholders/shareholders is, and should always be, distinct from preserving the value of money savings. Remember, money is a proxy for true savings, our accumulated capital base. Bonds and stocks are investment capital. Our economic system should incentivize that the deployment of savings into risk capital, aka investment, be prudent. Otherwise, bad investment will destroy savings and waste resources that we need for continued prosperity. Thus, the principles of risk and return are paramount to efficient economic function, because capital can be consumed or destroyed by undue risk and bad investment.

          Think of all assets as a value pyramid. Savings is at the very bottom, low risk low return, but a very stable base of value. This is important because savings is the basis of future production and “rainy day” flexibility. If we want the “unit of exchange” advantages of money, then money savings (currency first and demand deposits second) must accompany true capital savings at the base of the pyramid, a low risk, low return asset base upon which all future investment is dependent. Further up the pyramid, higher risk and return are debt assets, and finally equity assets at the top with highest risk, highest return. This pyramid ensures that our savings are deployed over time in the most efficient manner, regulating risk, preserving our ability to respond to changing events and guiding investment to projects that maximize prosperity. Any other arrangement will lead to increasing misallocation of capital, economic inefficiency and poverty.

          Regarding bank deposits, you can make the case that federal deposit insurance was a mistake, and I wouldn’t necessarily disagree because it gave banks and their depositors too much leeway to ignore risk. Nevertheless, if losses must occur now, they must first occur further up the risk/return pyramid, because sacrificing money (the base) puts the entire structure at risk. By monetizing debt, the federal reserve is turning the US dollar into a high risk, low return asset. Loss of confidence will inevitably follow if this doesn’t stop.

          In other words, the price of our preceding artificial boom must be borne by risk capital first and foremost, whether you define it as a share of Apple, a factory in Detroit, or a 10 year Spanish bond. If we continue to destroy savings capital, the base of our pyramid, the entire structure will topple. Unfortunately, we have severely misallocated our savings because of a very long debt/easy money boom, and the when the destruction is finally unmasked the precarious state of our economy will be evident. I am not optimistic.

          • JasonEmery:

            amun1–I pretty much follow you, and agree. Since things are so screwed up, why can’t we just throw all the play monopoly money back in the box and start over? Isn’t that what a currency collapse is anyway? If so, why do we have to wait for it to happen?

            I realize this would punish savers and benefit risk takers, but if the new game had a few actual rules, wouldn’t we be better off than where we are now?

            • amun1:

              Jason, your idea sounds simple and straightforward, but an abrupt transition to a new form of money would (will?) be incredibly dangerous. You are talking about a sudden loss of confidence, in money, in government, in the virtues of good behavior. The stress of that sudden rift will test the limits of civilization.

              Loss of confidence is coming either way, but I believe that it is preferable to incentivize people to hoard dollars rather than food or gasoline. Better to try to save the US dollar and and weather an extreme slowdown than throw it all away and start from scratch, in my opinion.

              • JasonEmery:

                amun1-I don’t think that[save the USA dollar] can be done without scrapping the constitution, Congress, Supreme court, etc. The reason for that is that Social Security, Medicare, and Medicaid alone are too much to overcome. And with retirees becoming an increasingly large percentage of the electorate going forward, they will first have to do away with elections to make any headway.

                Theoretically, we could hold a 2nd constitutional convention, and cut a deal with our creditors, domestic (including ss and medicare beneficiaries) and foreign. But part of the restructuring would almost certainly involve a dismantling of over half of our military. I don’t see them giving up control. It would be worth a try, I suppose.

                I read that John Williams of Shadowstats thinks we are running an ANNUAL budget deficit of $5 to $7 Trillion, using GAAP accounting. How can a deficit of that magnitude possibly be closed? If we try to do it very slowly, so as to minimize the deflationary disruption, then think how much more debt and unfunded liabilities will be piled on over the next decade or two!!

                I just think we are starting in too deep a hole to save the dollar. The time to do it was when G. W. Bush took office. We had a balanced budget. If he had made his first priority to partially privatize social security, I think they could have pulled it off. The ss fund was still collecting a couple hundred billion above and beyond benefit payments at that time. That ‘extra’ money could have been used as seed money to help start private accounts. However, once he cut taxes and started to pour money into Iraq and Afghanistan, it had no chance.

                • amun1:

                  Jason, you may be right. Under a sound money scenario, defaults would obviously occur, both in outstanding debt and future obligations. Voter outrage would be unprecedented. Our media has spent decades convincing people, both rich and poor, that government funded consumption can drive the economy, and it will be difficult to convince the electorate otherwise.

                  One simple step would suffice, if it could be accomplished with no possibility of undoing. Take away the Fed’s printing press and we would be unable to borrow on acceptable terms. We could still tax our way into oblivion in an attempt to support government bloat, but that would be a very short exercise in futility.

                  But, consider that either scenario, deflation or hyperinflation, will threaten the constitution. Voters aren’t likely to hold an ancient piece of parchment in high regard when they are offered an alternative and a promise to fix poverty.

          • Andrew Judd:


            For the purposes of simplification my view can be narrowed down to me observing:

            1. You want money savers to have extra special protection where not only are they are guaranteed to get whole dollars as promised by the numbers in their accounts but also those dollars are not reduced in value by price inflation – where currently an effort to create 2% annual devaluation of the savings is part of policy that you object to.

            2. Money savers have gained and become richer because of the increase in the money supply.

            3. Dissatisfied money savers can at any point in time buy an alternative ‘currency’

            Ultimately there is no magic fix for this mess. Your desire is that savers who gained from monetary expansion should be able to somehow profit by price deflation. But price deflation will destroy the banks and can only mean other members of society have to be further burdoned to protect the money savers who gained in the lead up to the mess we wish to resolve.

            Fundamentally many of the money savers are richer people. Poorer people can be protected but why should richer people be protected?

            It is also worth pointing out that about 900 US banks have failed so far since 2007 and no doubt more will fail.

            This does not mean that I do not see a huge number of things that seem very unfair or that I feel optimistic.

            • amun1:

              Andrew, what you are describing is the actual policy that has been tried over several decades now. It has created a world in which there is never an incentive to save, at least not in the form of money. In good times, money savings lose value relative to risk assets. In bad times, loose monetary policy causes money savings lose value relative to food and energy, which are the most basic forms of hard asset savings necessary for survival. When the general population finally understands that saving money has no reward, hoarding of basic goods will ensue, then our monetary system will collapse and our economy will cease to function.

              As for your second point, money savers don’t profit from the increase in the money supply, certainly not when money supply grows faster than the base of true capital. Real interest have steadily declined since 1982 or thereabouts, to the point of being negative today. This has clearly not been beneficial to savers and has brought us to the current crisis. You believe that price deflation will be a reward for savers. That’s true, but only to the extent that caution is always rewarded when risk proves excessive. If savings are in short supply, then savers have the upper hand and they should. An attempt to invert those relationships (risk/reward, supply/demand) violates the fundamental tenets of economics, or nature if you prefer. It hasn’t worked and it won’t work.

              Finally, inflation is not a boon for the poor, actually it’s just the opposite. Inflation favors those who already own the real assets. The poor who are earning a paycheck will find their purchasing power constantly eroded and be unable to save. That’s why the lower economic cohort is struggling to pay for essentials, thus the sharp rise in government transfer payments, even as the stock market soars with every new “quantitative easing”. The result is loss of social mobility and despair.

              Our current situation does not have a “solution” in the sense we’ve come to expect. There is no way to “stimulate” real economic growth in this situation. We consumed resources using borrowed money and repayment is due. Growth must take a back seat while we repay the debt. Debasing the value of the currency will simply convince lenders that lending is unwise and raise the future cost of borrowing, which is why we no longer have a private mortgage market at these artificially low interest rates. Further monetary inflation will lead to extreme price inflation, well beyond the 2% number the Fed has endorsed, and the 4% Mr. Krugman prefers. Historical evidence, empirical data, the laws of supply and demand, even common sense all support that conclusion.

              So, yes, we’re headed for trouble. Your sense of foreboding is warranted. Banks are going to fail, in large numbers, whether we inflate or deflate. Unemployment is going to rise and people are going to suffer, rich, poor, middle class. The only “solution” is to re-establish a set of incentives that will presage future growth, on the other side of a serious economic downturn. That requires re-establishing the proper relationship between risk and reward, instead of bailing out failed risk and punishing caution. It requires encouraging people to live within their means and saving for their future at the individual level, instead of encouraging dependency. Any other path will be even more destructive than the depression we already face.

              • Andrew Judd:


                The current boom has probably been running for most of our lives and I am 56. Pretty well every single one of us has benefitted from government spending where even at a time of enormous debt unsustainability a person who holds their savings in the form of an IOU is still regarded as being wealthy.

                You have again now said that the debt has to be repaid. Repaying all of the debt is a guaranteed way to find out which group of people are the richest and most powerful. You and I, will have long spent all of various savings by the time the richest person gets their final debt repayment.

                Fundamentally these rich people have been foolish. And one way or another they need to share the problem we are all faced with.

                • amun1:

                  I try not to think in terms of rich vs poor, because a forced transfer of wealth, in either direction is the road to tyranny. I’m more interested in market efficiency, because that is the key to maximizing prosperity for everyone. If markets had been allowed to function over the last four years, many wealth people who took ill advised risk would have been bankrupted. Of course, many middle class and poor people would also have been impacted. It’s not just the rich who have been foolish, we’ve all been foolish to believe that debt based consumption was a free lunch and that big government could centrally plan economic output. We will all pay the cost of that and some already are paying the cost.

                  I should specify exactly what I mean when I say that debt must be repaid. Using debt for consumption means that consumption is pulled forward. Consumption must be less by that amount in the future, not in nominal terms, but in real terms equivalent to what was consumed when the loan was incurred. If the borrower repays the full amount in real terms, then their future consumption declines. Anything less than full repayment, via default, means the lender’s future consumption will decline. Inflation passes the cost to a third party, the saver. We may quibble over whose future consumption should be impacted, lender vs borrower vs saver, but that debt will be repaid by someone and someone’s future consumption will decline by the real amount of the original debt. That is the repayment I refer to, and it manifests as a decline in real growth. All debt gets repaid.

                  For free markets to function efficiently, it is always preferable to tether risk and reward as tightly as possible. In the case of private debt, the parties are easily identifiable and should work out terms of repayment between them. We have already violated that arrangement by allowing Ben Bernanke to buy mortgage debt, by bailing out corporations, by nationalizing the GSE’s, etc. This interference in free markets will haunt us for decades.

                  Government debt is a trickier issue, because it’s not clear who exactly the borrower is, at least not on the level of the individual. You believe savers should pick up part of the tab through inflation, on the premise that they benefitted from the overall climate of debt fueled consumption. I believe that inflation is a very poor choice for several reasons. It corrupts the incentive structure that encourages proper risk. It leads to malinvestment and misallocation of resources, as we’ve seen from multiple inflationary asset bubbles. It is a secret tax, levied in retrospect and without accountability for those who made the decision, or who reaps the benefit of the new money. It is the most regressive form of taxation, hitting the poor hardest, those who are vulnerable because they don’t understand the process of inflation and they save in the simplest manner available. In extreme cases, and I believe we’re close to that, inflation risks the unit of exchange for all financial transactions.

                  I believe that some other combination of taxation or direct default are more accountable than inflation, more applicable to the principles of free markets, and more likely to clearly identify (for the general population) the risks and rewards of debt. Those incentives and discincentives must be as clear as possible, so that society can make informed decisions for how to invest our resources. I believe currency debasement is a slippery slope, and eventually a free fall, into economic disfunction and autocracy.

                  • Andrew Judd:

                    In todays circumstances when the damage is already done, if we had free markets, we would have no effective government, and we would get deflation and we would all get ruined unless we were part of the winning group of war lords. Few people are really up to the business required to keep assets without some measure of the rule of law.

                    The idea the government could in the circumstances stand back and allow free markets to resolve a crisis of this magnitude seems fanciful to me. But a big problem for societies today is the huge amount of crony capitalism where there does not appear to be any true democratic process. So either way it will be ugly for some.

                    I am not really saying that savers should suffer as a particular group. I was just wondering why you particularly feel they should not suffer. In a depression opportunistic savers as speculators on cheaper prices are a major problem. If they are rewarded problems are created by the lack of spending.

                    Just for the record, as you know, debt default means the debt is *not* repaid (and the lender has reduced future consumption). Without government interference in the market I would guess very little of the debt would be repaid. Most of the debt repayment relies on the rule of law over mob rule or even democracy.

                    On the topic of the GSE’s they were government sponsored enterprises:-) Successive governments had endorsed their behaviour going back decades. Had the US defaulted on those obligations we would be looking at a very different bond market situation than we have today where against many expectations US government debt is still regarded by the market as the safest place to put money.

                    I am not an inflationist. For that reason i did not buy gold. I just think that a small amount of price inflation is better than a bigger amount of deflation. Even today the expectation of price inflation is struggling (at least it is in my mind)

  • What a mess. I think the ECB is concerned with how they get their money back after 3 years. Ponzi finance always comes to an end and the banks financing the governments so the governments can bail out the banks has to be one of the greatest ponzi’s of all time.

    Pater, you and I know why the banks are keeping the money instead of loaning it out. It is because they have already loaned it out. The funds were for the TBTF banks that were already well beyond their statutory capital to make loans in the first place and were liable for the funds to other banks. The smaller banks aren’t about to blaze a trail and become liable in an insolvent system for these funds. But, they do have the liabilities on their books, the deposits that resulted in the transfer of funds in the first place. I doubt the inter-bank lending system would work in Europe at this time, as those banks that have cash have better sense than to lend to a bankrupt. I have my doubts they are going to be able to resurrect this important function of banking any time soon.

    I believe it was Rothbard that said that banking worked as long as all banks expanded credit in a roughly equal pace. As I had noted in my reading in 2007, Citi and BAC were hundreds of billions short in Fed funds. It wasn’t a secret that when CNBS claimed banks were afraid to lend to each other they were primarily talking about these 2 big banks. They were the pair that had what amounted to roughly the entire Fed balance sheet owed to the system, due to their excessive money creation. Had the Fed replaced that money at the time, the banks would have still been liable to their customers and quite possibly been subject to even more liabilities as deposits moved to other safer banks.

    Europe not only hasn’t solved anything, but it appears that with every attempted solution, they have created another problem. There isn’t anyone who could tell either of us how the ECB is going to end LTRO, is there? They can’t bail this out with the proceeds from bonds issued by insolvents, which appears to be the only solution being employed. The truthful way is haircuts on both sides of the ledger. Credit banking has created a mess, but that mess has been amplified by the actions and guarantees of governments meant to ensure confidence in the ponzi. How can you actually have deposit insurance when the only money to pay the claims is in the accounts insured? That is besides the insurance funds themselves, which through fancy accounting can function without directly touching the cash. What has happened to a plain old bankruptcy reorganization?

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