Euro Area Recession Worsens

It is not too surprising that the latest PMI data from the euro area show continued deterioration. Let us not forget that money supply growth in the euro area as a whole has slowed to a crawl since about early 2010.

Prior to 2010 euro area money supply growth has been brisk indeed (most of the time, anyway – there was a mid-cycle slowdown, see also further below) – in the first decade of the euro's existence, the true money supply increased by roughly 130% – a massive inflation that was attended by commensurately massive booms in many countries, often centered on the real estate sector. The conclusion must therefore be that the slowdown in money supply growth has unmasked a great deal of malinvested capital for what it is and that the liquidation of these malinvestments is since then proceeding in fits and starts.

Note here that the ECB's first batch of interventionist measures as the crisis of 2007-2009 took place was quite effective in boosting money supply growth initially. This was the main reason for the brief bounce in the 'data' after the conclusion of phase one of the GFC ('great financial crisis').

Why was the ECB successful in pushing money supply growth up in this initial phase but not (at least, not yet) in the second phase of the crisis? We believe this can be explained by how perceptions about deficit spending and public debt have changed in the euro area. Since the ECB is not allowed to directly finance government spending, the only way large growth in the money supply can be expected to come about in the face of private sector deleveraging is if the banks redirect their lending toward governments and governments in turn increase their deficit spending concurrently. At first the banks and market participants treated the effect of the GFC on government debt with equanimity: everybody already knew that the Maastricht treaty limits would be broken again, just as had happened in the 2000-2002 recession.


Therefore, the ECB's initial foray into extraordinary inflationary measures did more than just boost bank reserves – it boosted money supply growth as well, quite dramatically in fact. As one would expect, banks loaded up on sovereign debt, and the sovereigns in turn increased their fiscal deficits just as Keynesians said they should.

Modern-day 'counter-cyclical' economic policy in essence follows both the monetarist and Keynesian prescriptions: it is always a combination of money printing and fiscal 'stimulus' spending.

We suspect that this is not only due to the manner in which these policies are intertwined in a monetary system that uses government debt as an asset that so to speak 'backs' the money the central banks issue, it has also to do with the fact that the economic orthodoxy of today admits both schools of thought as 'acceptable' for establishment figures like economic policy advisers and central bankers. Both theories are advocating interventionism and assert that positivist methodologies are an appropriate approach in economics – in other words that economic theory requires 'testing' by means of empirical verification.

It should be quite obvious that this can never work if one is confronted with being unable to set up controlled experiments, but today's economists insist that economic science must be like physics or other natural sciences, otherwise, how can it be a science? It seems not to have occurred to them that  human beings are fundamentally different form inanimate objects.

Now, we are also quite often referring to empirical data here – even in this article. We are not saying that one should simply ignore such data. What we are saying is that the data as such can only be properly explained by employing a correct economic theory, whereas no theory can be fashioned from studying the data.

This also explains our approach to the ongoing recession in the euro area: we show you the data, as they confirm that yes, there is a recession, one that will quite possibly become quite severe.

However, in explaining the recession, we look toward what theory is telling us: an artificial credit-expansion induced boom has turned into a bust when money supply growth began to initially slow down in 2004-2007. It then was briefly revived when money supply growth once again accelerated; now it is falling apart again as money supply growth has stagnated for about two years.

Also, we do not think it would be appropriate to fight the recession by printing more money or by increasing deficit spending (the latter has thankfully become nigh impossible in most of the euro area, so there is something good that has come from the  adoption of the euro).

How can these views – the explanation and the recommendation – be reconciled? That is quite simple: in our view, money printing would only serve to continue to mask the false economic activities that have already consumed untold amounts of scarce capital and would allow them to consume even more. The bust is the economy's attempt to heal itself; inciting another boomlet would only add to the structural damage that has already been inflicted by the 'Great Moderation' boom.

Of course all of this is beside the point that the current path of policy in the euro area remains terribly misguided, as it consists of 'austerity for everyone except governments', while there continues to be a conspicuous lack of pro-free market economic reform that would be required to spawn a genuine and sustainable recovery.

Finally, the view that Europe's banks and their bondholders are simply too precious to be allowed to fail needs to be discarded. We could be persuaded to support protection of the claims of depositors to the extent that shareholder equity and bondholder capital prove insufficient to do so, but at the same time it is necessary to thereafter completely alter the monetary and banking dispensation if one wants to lay the foundations for a sustainable and bubble-free economic resurgence.

Lastly, we should point out that the euro area's true money supply is calculated as roughly equivalent to narrow money M1, i.e., the sum of currency and demand deposits (we are using Michael Pollaro's data), although a case can be made – depending on the country one looks at –  that other components of the euro area money supply could be included to create an equivalent to the US TMS-2 'broad' true money supply measure. The main reason why this isn't done is that it is debatable what exactly should be included and that it would greatly complicate the data gathering process (in fact, such data would probably be only available with a big delay considering the tardy reporting habits of some euro system NCB's).  We only mention this in order to point out that there has probably been even greater money supply growth in the euro area's first decade than indicated by the narrow true money supply measure.

Now, briefly to the data; these are preliminary data, the official data will be published soon however and per experience the 'flash' PMI data gathered by Markit are pretty reliably precursors. The euro area as a whole has seen a fall in composite PMI to 45.9, a 35 month low. Once again the periphery has fallen to even worse levels, but the 'core' is catching up quickly. The recession is already almost as bad as the 2000-2002 recession was at its nadir, with the big difference that the current backdrop suggests it will get still worse.



Euro area flash PMI and GDP, via Markit – click chart for better resolution.



Euro area PMI, core versus periphery – click chart for better resolution.



Markit's chief economist Chris Williamson commented as follows:


The flash PMI indicated that the Eurozone downturn gathered further momentum in May, with business activity and new orders both falling at the fastest rates for just under three years.

“The survey is broadly consistent with gross domestic product falling by at least 0.5% across the region in the second quarter, as an increasingly steep downturn in the periphery infects both France and Germany.

“France is seeing a the steepest deterioration in business conditions for three years, with the survey pointing to a marked fall in GDP in the second quarter of at least 0.5%. However, even Germany is at risk of GDP falling slightly in the second quarter if the situation continues to deteriorate in June.

“Inflationary pressures eased during the month, but this largely reflected price discounting due to the weakness of demand. Company profits are therefore coming under increased pressure. Companies consequently continued to focus on cutting staff levels. Although slightly weaker than in April, the rate of job losses is still running at the highest levels since early-2010.


(emphasis added)

For readers interested in more report details here are the links to the 'Eurozone Flash PMI' (pdf), the  German Flash PMI (pdf) and the  French  Flash PMI (pdf). All of them make for sober reading.

As an aside, China's flash PMI (pdf) also showed that the manufacturing contraction is continuing for the 7th month in a row, which has spawned yet another flood of calls for 'more stimulus'. We strongly suspect stimulus won't be forthcoming in the amounts that would satisfy this misguided herd of would-be bulls, who have retreated to basing their optimism on the idea that one must remains bullish on China even if the economy turns down sharply, because then there will be 'more stimulus'. The conclusion from this train of thought would be that everything is bullish and that no negative outcome is conceivable at all. That hardly jibes with the confluence of problems China's economy is facing after credit and money supply expansion went basically amuck in 2009-2010.

As Junheng Li reports, 'China is a box of misinformation' to boot, while Robert Wenzel reports that new bank loans in China have contracted by 33% last month from March.


Greece – Will It Be Pushed Out?

We have talked about the 'catch 22' situation the ECB finds itself with regards to Greece in earlier this week.  A recent Global Data Watch report published by JPM essentially repeats what we have relayed about how ELA funding and the TARGET-2 payment system are currently keeping Greece's banking system afloat in the face of a run on bank deposits. Below is a passage from the report that talks about how exactly Greece could therefore be pushed out of the euro area, i.e., it explains the technicalities involved:


„The Greek central bank creates euro reserves when it grants loans to Greek banks via either repos or the ELA. In the first instance, these show up as reserve holdings of the

Greek banks at the central bank when the euros are credited to their account. But, with euros leaving the Greek banking system, Greek banks lose reserves as transactions are settled through the payments system. As Greek banks’ reserves fall, they are replaced by a liability to the TARGET2 payments system for the Greek central bank.

The Greek central bank’s liability to the rest of the Eurosystem via TARGET2 is currently just over €100 billion. As we move toward the Greek election next month, that is likely to climb further given deposit flight. But, we expect the ECB to do everything within its power to keep the Greek banking system afloat until the election on June 17, even if some of the loans to Greek banks are redirected via the ELA. The terms of the ELA can be stretched so that Greek banks do not run out of collateral, while banks can issue bonds to themselves backed by a government guarantee to create more collateral.


How Greece could be cut off from TARGET2

But a much more challenging question is what happens after the election. Let’s imagine Syriza is able to form a government. It then antagonizes the rest of the region by rejecting the Troika program in its entirety and declares a debt moratorium. Even with no further disbursements of official loans, the region’s loans to Greece via the TARGET2 system will continue to grow. Loans from the Greek central bank to Greek banks would be almost completely forced into the ELA.

The ECB can limit the TARGET2 loans if it exercises its veto over the ELA loans (requiring a two-thirds majority on the ECB Governing Council), and if the Greek central bank respects that veto. But, the Greek central bank would likely be faced with the need to impose very restrictive controls on euro deposits to limit outflows if ELA loans to Greek banks could not be made. If the Greek central bank is faced with the prospect of either imposing capital controls, or watching a collapse of the Greek banking system, or defying the ECB’s veto on ELA loans, which route would it take? If it chose the latter, the only way for the ECB to “shut off” the TARGET2 loans would be to prevent Greek access to the payments system itself, refusing to accept payments of euros to and from Greek banks. At that point, reserves created by the Greek central bank would no longer be euros. That decision would not be made by the ECB alone, but would likely be deferred to the European heads of state.


(emphasis added)

A few comments: as noted in our previous missive on this topic, the 'current' Greek TARGET-2 balance mentioned above is from March – it is therefore actually not 'current'. We would estimate – based on the balance sheet of the GCB from January and the increase in the ELA ceiling since then, that it sits already at something like €135 to €140 billion. 

As long as the ECB is giving its nod to more ELA – which it can only do under the assumption that the planned recapitalization of the Greek banking system per the second bailout agreement will actually take place – Greece's banks won't run out of funds to pay depositors withdrawing their money. As we already noted, the banks simply create their own IOUs as 'collateral' for ELA funding, garnished by 'government guarantees' – this is to say, an insolvent government is 'guaranteeing' the debt of its equally insolvent banks. Neat, and this can of course only be done in a fiat money system.

The 'catch 22' comes from the fact that as long as the election result is not known, the bank run will likely continue and push Greece's TARGET-2 liabilities ever higher. After the election result becomes known, we could – in the event of a SYRIZA win – literally see queues forming in front of the banks as the people who waited until the last moment desperately try to save their money from annihilation.

As JPM notes above, to simply tell the Greek National Bank that there won't be any more ELA approved by the governing council isn't going to be enough – the ECB would have to actually kick the Greeks out of the TARGET-2 payments system if they decided to ignore a 'no more ELA' directive. And that, as JPM rightly notes, is not a decision the ECB is likely to make on its own. It will require the backing of the euro area's heads of state, which is also the main reason not to expect a cessation of ELA prior to the election.

As things stand, there are now various polls out that say that Antonis Samaris stands a chance of winning again and actually piucking up a bigger proportion of the vote on June 17th, but other polls are actually giving SYRIZA the win by a huge margin. However, as polls also reveal that 85% of Greek citizens want to keep the euro, the SYRIZA win is still very much up in the air. It will largely depend on whether Alexis Tsipras can actually convince people that he will be able to square the circle.



About a week ago, poll numbers saw ND surpass SYRIZA, but more recent polls suggest otherwise again (chart via the WSJ). All three major parties seem to be drawing support away from the smaller fringe parties – click chart for better resolution.



Meanwhile, the German magazine 'Deutsche Wirtschaftsnachrichten' reports that Greece's exit is according to its sources already a 'done deal' and that the only reason this has not been made public yet is to avoid naked panic in Greece (and in the financial markets, one presumes). The report states that a Greek exit from the euro has been decided regardless of the election outcome on June 17, for the simple reason that Greece has so far still failed to hew to any of the agreed commitments and 'will never be able to do so'. According to the report, Lusas Papademos was an 'EU plant' on a 'recon mission' in Greece in order to deliver a verdict on the probability that Greece would ever be able to implement the agreed upon plans. Allegedly he reported back that this is simply not possible (we would actually agree with him if he really did say that. Greece's administrative structures are hopelessly corrupt and utterly paralyzed). Allegedly all that is now still debated is how to do it and how to apportion the costs.

Although we think the election will probably represent the decisive cesura, the report does not sound entirely implausible. The only thing that makes it a bit suspect is that we don't believe this little known magazine has better contacts than everybody else – and no-one else has reported this 'the exit is a done deal' version of events yet.

We do however continue to believe that the remaining euro-group members are fully prepared to call Tsipras' bluff if he wins the election and goes through with his threat of repudiating Greece's obligation – even though the effect on markets and economies in the rest of the euro area can not be gauged with any certainty in advance (the markets may well be relieved, but the range of possible reactions is great; after all, Greece itself would likely experience a period of chaos).


Financial Markets

Interestingly, European stock markets finally bounced on Thursday after the terrible flash PMI data were released. The reason? Everybody expects the ECB to open the spigots fairly soon.

For instance, the chief economist of Germany's Commerzbank opined:


„The prospect of a Greek exit from the euro zone, rising losses at Spanish banks, and a failure of labor reform in Italy will force the European Central Bank to inject more liquidity into the banking system through a long-term refinancing operation, according to the chief economist at German banking giant Commerzbank.

“If the crisis threatens to escalate again, like in the autumn of last year, the ECB will probably follow up with more three-year tenders even if it rejects this at present,” Dr. Jörg Krämer, the chief economist at Commerzbank, said in a research note as EU leaders met in Brussels.

Such a move could take some time, according to Krämer and his team at Commerzbank, but is likely if things continue to deteriorate. “The growing uncertainty is poison for the economy,” he said.


The 'failure of labor reform in Italy' is by the way a highly significant event. As reported at Bloomberg a year ago:


„[Italy's] labour laws are some of the stiffest in the developed world. Article 18 of the Labour Code states that after a short probationary period, an employee fired from a company with 15 or more employees can bring a lawsuit against their former employer. Although they have no right to reinstatement, they would be entitled to compensation ranging from 2.5x to 6x monthly pay. That explains the low unemployment rate, since firms can’t fire inefficient or sub-par workers without a hefty cost.“


However, Italy's unemployment rate is no longer 'low', as the downturn has  overcome the reluctance to fire people – not least because many firms have gone bankrupt. However, since firms can not easily fire people, they will now refuse to hire them – institutionalized unemployment is here to stay. One really shudders at the utter absurdity of the above mentioned regulation. It should be clear though that such nonsense cannot be altered by more money printing.


Italy's unemployment rate – no longer anywhere near 'low' – click chart for better resolution.



The Euro-Stoxx 50 bounces after yet another set of atrocious PMI data is released – click chart for better resolution.



Meanwhile, most CDS spreads rebounded, in other words, credit markets deteriorated somewhat in spite of the bounce in stock markets (bond yields were mixed and the moves were generally small). Below are a few examples – as always, prices and price scales are color coded and readers should keep the different scales in mind when assessing 4-in-1 charts.



5 year CDS on Portugal, Italy, Spain and Greece – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – click chart for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns – click chart for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – click chart for better resolution.



Meanwhile, Nomura is calling for outright 'QE' ('quantitative easing') from the ECB:


Jens Nordvig, Nomura's Head of Fixed Income Research in the Americas and Global Head of G10 FX Strategy explained that all signs from investors point to an escalation of the crisis.

"Over the last two months, we've seen a new face of deterioration," Nordvig told analysts. "The most important element is what euro investors themselves are doing…It is very, very rare to see investors accumulate foreign assets in a bear market, so this tells me that we are essentially entering a new, even more dangerous point in the crisis." "We are reaching a point over this time period—which may be accelerated by Greece—which requires a proportional policy response," Supple concluded.

This policy response, analysts believed, would be nothing less than full-scale quantitative easing, a policy which the ECB has so far resisted because it would monetize sovereign debt.

"We need QE to happen. Our core view is you will need QE," Supple said, explaining that it "will be focused on taking [sovereign debt] assets away from the banks" in order to cleanse their exposures to troubled sovereigns. That said, "it won't happen until things get a whole lot worse."

Nomura analysts on the call believed that other suggestions—another LTRO or eurobonds—are doomed to fail. "LTRO3…would have a very limited effect in contrast to the old LTROs" because investors are more concerned about solvency than liquidity.

Eurobonds, too, would be ineffective because current plans would require countries to issue separate national sovereign debt in addition to joint euro-wide debt. While they would pay less on joint debt, the issuance of a more reliable centralized European debt would drive investors away from riskier debt issued by individual sovereigns.”


(emphasis added)

So the naïve belief that all it takes to fix an economic crisis is a good dose of money printing remains alive and well. We believe that it will in the end fail so badly that it will end up utterly discredited (again) for many generations.


Pleasure Pressure in Germany

Meanwhile, scientists believe they have found out why Mrs. Merkel is such a big fan of austerity. Germans allegedly lack for a 'joy gene':


“With low unemployment and solid economic growth, things are going better than ever for Germans. But a new study shows they're practically incapable of enjoying it. Not only do they find it difficult to cut loose and experience pleasure, but their "joy gene" is broken, researchers say.”


Apparently the reason for this is German 'perfectionism' – even enjoying oneself is seen as an obligation that forces one to cut a good figure while one is at it. This is known as 'pleasure pressure'.

Still, something tells us the Germans wouldn't want to trade places with the usually rather more joyful Greeks.



Scene from 'Die Freudlose Gasse' ('The Joyless Street'), Germany 1925

(Image via



Addendum: Old Nazi Laws Revived – in the US

Germany is still finding imitators it appears – only, they have a tendency to imitate the worst German culture has ever had to offer. After the US Congress modeled the misnamed 'PATRIOT' Act and its appendages (the military commissions and NDAA acts – the latter has by the way just suffered a judicial setback) after Hitler's 'Enabling Law', Senator Schumer recently modeled his equally misnamed 'Ex-PATRIOT Act' after the Nazi 'Reichsfluchtsteuer' (literally 'the tax for fleeing the Reich'), which was used by the Nazis to dispossess Jews who tried to save their lives by fleeing Germany. Note that the law was not introduced by the Nazis but by the cash-strapped Brüning government shortly before the Nazi takeover. The Nazis were merely the ones using it to the fullest extent in order to entrap the fortunes of those unfortunate enough to be on their sh*t list.

Reason magazine has published an article on this entitled 'Eduardo Saverin and Echoes of the Reichsfluchtsteuer'. Apparently Schumer's proposal is all but a word-by-word translation of the Nazi law – the main difference is that he chose an even higher tax rate! The Atlantic also finds the law 'creepy'. Well, Schumer is creepy, so he proposes creepy laws. We would note as an aside that Eduardo Saverin has already paid more tax in the US than 99% of American citizens will in their lifetimes – and he wasn't even born in the US.

By contrast, Mr. Schumer is a great burden on the US tax payer. In fact, he costs altogether too much,  not only in monetary terms, but also in terms of the economic and reputational damage he regularly inflicts. We would reiterate here that 'politician' should not even be a profession. It would suffice entirely if civic minded people holding real jobs were to meet a few times per year to make whatever really important decisions need to be made. Moreover, as is custom on the Isle of Man, they should be forced to appear before the public in open air once a year, in both sunshine and rain, and read aloud every single new law they have put into place. That would cut down beautifully on law production.


We leave you with a photograph that unambiguously proves that Europe is now in extremely capable hands:



Francois Hollande on a personal expedition to find out what time it is.

(Photo via



Post Scriptum: 

We wanted to point out to our readers that the May Financial Forecast from Elliott Wave International (EWI) can be downloaded for free (it only requires registration with the 'Club EWI'). This is a fairly comprehensive report by the two biggest long term bears and deflationists in the EWI camp beside Bob Prechter himself, Steve Hochberg and Pete Kendall  (their long term target for the DJIA: below 400 points, believe it or not). 
Disclosure: we have an affiliate relationship with EWI . However, this report doesn't cost anything and is quite interesting regardless of whether one agrees with its conclusions or not, so we recommend taking a look at it.


Charts by: Bigcharts, WSJ, Bloomberg, Tradingeconomics, Markit



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18 Responses to “Catch 22 Revisited”

  • Outlaw:

    Perhaps more important than the “conversion” of economics into a “science” by modern economists (Keynesians, Neo-Keynesians and Monetarists), is the divorce of economics from morality and justice.

    It was the substitution of moral considerations with scientific mumbo-jumbo that really screwed up economic thought.

    As you say, one must start with a sound theory in order to coherently and consistently explain economic data. However, in order to obtain the sound theory one must apply a mixture of reason and morality, both fundamentally human elements which defy rigid scientific analysis. This is what prominent Austrian theorists have done (Mises, Hayek, Rothbard, and others), although this is not commonly emphasized.

    Starting from the right to life, liberty and property, economic justice in the sense that consequences of mistakes must be borne by those who commit them, the inviolability of contracts, the rejection of sovereign immunity and moral superiority in relation to the citizenry, the understanding that every economic transaction has a basis in trust….this framework must figure prominently in the mind in order to derive and comprehend sound economic theory, and in turn to explain economic outcomes.

    Perhaps it is our moral decline that underlies our economic decline, and the stark insanity surrounding it.

    • worldend666:

      Interesting post for a reader with an “outlaw” handle :)

    • JasonEmery:

      Outlaw-“As you say, one must start with a sound theory in order to coherently and consistently explain economic data.”

      Even more important, one must start with good data. For example, the media reports the ‘cash’ federal deficit, as being about $1.3 trillion the last 4 years. That is awfully high, at 9% of GDP, but they seem to get funding for it, so it has the appearance of being manageable.

      But using GAAP accounting it is at least $5 trillion, possibly more. Call it $5 trillion. That’s a third of GDP, which is itself over 1/3 government spending, much of it borrowed. Not so manageable.

  • Floyd:

    EW is sufficiently complex to describe any price action.
    Sometime I wonder if one could describe a circle using EW principle. (just kidding).

    EWI has a poor track record.
    So poor, imo, that they are not credible wrt dow 400.
    This is not to say it certainly won’t hit 400. Only, that EWI projecting 400 is meaningles.

    • I don’t disagree, but their reports always contain a number of interesting data and observations. Personally I think they vastly overstate the case for deflation, as there is a meaningful difference between money and credit which they do not acknowledge (even though the two are undoubtedly interlinked in the fiat money system, they are not simply the same, as I’ve hopefully demonstrated convincingly here: ).

      • JasonEmery:

        ‘Conquer the Crash’ is my favorite economics/monetary type book of all time, so no one can say I’m a Pretcher basher. However, I just don’t see the deflation case.

        The post Bretton Woods system has been breaking down since 2008, and I’m pretty sure the final trajectory will be very high inflation, if not hyperinflation, and eventually the scrapping of the dollar.

        With both China and Japan, our largest creditors, on the ropes, I think they are going to try to cash in some of their chips within a year or two. The result of that will be very high inflation if we accept their chips with QE-X funds in return. If we repudiate our debts, like Greece is about to do, the dollar takes a 50% haircut in buying power overnight. I just don’t see where deflation fits in.

        As the world slips into a severe recession, the pressure on Japan and China to cash those chips gets greater, not less, I believe.

  • amun1:

    PT, your output of economic data, observations and thoughts is incredibly prolific. I don’t know how you do it, but it is certainly appreciated.

    You said the following above: “Modern-day ‘counter-cyclical’ economic policy in essence follows both the monetarist and Keynesian prescriptions: it is always a combination of money printing and fiscal ‘stimulus’ spending. ” It’s a minor syntactical point, but technically the combination of fiscal and monetary stimulus is the Keynesian prescription. Keynes suggested that if money was difficult to borrow, the central bank should increase the money supply to lower borrowing costs for the government. We tend to associate his theory with countercyclical deficit spending, but he also advocated loose monetary policy in conjunction with the deficits. If I understand it correctly, Milton Friedman’s brand of “monetarism” advocated a slow and steady increase in the money supply, which would be more akin to a gold standard than it would be to the Keynesian policy.

    You also said: “we do not think it would be appropriate to fight the recession by printing more money or by increasing deficit spending (the latter has thankfully become nigh impossible in most of the euro area, so there is something good that has come from the adoption of the euro).” I’m not so sure about that. Eurozone deficit spending has obviously increased over the last decade, although it may have moderated or slightly declined over the last couple of years. But it’s difficult to separate the impact of monetary expansion from deficit spending. If it wasn’t for money printing, it’s quite possible that deficits would be expanding apace as interest on these higher levels of debt began to rise. In other words, we won’t really know whether deficits have moderated until the ECB stops accumulating debt. Otherwise, they could theoretically make nominal interest rates negative and every country in Europe could run a balanced budget in no time.

    In the real world, highly levered companies reach a point of no return where they can’t borrow themselves back to growth, because every new unit of borrowing raises the cost of capital for the entire portfolio of accumulated debt, whether it’s new or rollover. They can’t find investment opportunities with a high enough return to service and pay down the debt, so they enter a vicious cycle that culminateds in default. Central banks have disguised the true cost of capital on a global basis by increasing the money supply, gradually over 30 years and now rapidly. It’s very possible, likely even, that the true cost of capital for global government borrowing now exceeds any plausible return on investment. The practical implication in our current system would be that deficits are actually accelerating higher, and the money printing can never stop, because if it does the true cost of capital will be unmasked and governments will default. But if the printing doesn’t stop, then the true cost of capital will be expressed as a rapidly accelerating decline in the value of fiat money.

    • I didn’t mean to imply that the Keynesians are not also inflationists. But as regards the alleged ‘cure for depressions’ most of the modern-day Keynesian sub-sects stress deficit spending rather than monetary stimulus, especially when the so-called ‘zero-bound’ has been reached and further monetary stimulus is regarded as ‘ineffective’. By contrast, the monetarists have always advocated aggressive monetary stimulus to counter depressions. It is true that the Friedmanites recommended a fixed percentage of money supply increases in ‘normal’ times, but they clearly advocated (and continue to do so) more heavy central bank interventions in times of economic contraction. In fact, Friedman himself, in an attempt to show that this was the better way, collected data that compared economic performance when one or the other method was employed, but not both.
      Of course imo such empirical methods prove nothing, as every historical economic period is marked by its very own, unique combination of complex market data that can not possibly yield any conclusive information. This is precisely why it is important to have a good economic theory first, which then can be applied toward an explanation of the observed phenomena. Such a theory can only be arrived at by rational, logical deduction starting from axioms that can not be disproved and require no testing (in trying to disprove such axioms, such as the action axiom, one must already presuppose their existence – hence one would run into logical contradictions when trying to disprove them).
      As to deficit spending and money printing, I acknowledge the connection between them and agree that Europe has shown little restraint in recent years. However, it could well be argued that due to the special circumstances – the existence of a supranational central bank that is forbidden by statute to directly finance governments – the point of no return that you describe in the case of highly levered companies has been reached for a number of euro area governments as well.
      The LTRO’s have given Italy and Spain some breathing space in that regard and have allowed the three card Monte between the central bank, commercial banks and the governments to continue for a while longer, but things are now getting really tight, especially in Spain’s case. Obviously neither Greece, Portugal nor Ireland are still free to spend as much as they like, and most other euro area governments are probably in mortal fear of losing market access as well. So in that sense, the deficit spending option has actually been severely curtailed. Of course it remains to be seen whether the statutory limitations of the ECB’s operations won’t be rescinded in the event of a deepening economic and financial crisis.
      Finally, regarding the Keynesian ‘liquidity trap’ concept (which invites the stress on deficit spending as a method to counter depressions), there are many ways in which this idea can be refuted. I was actually planning to write a post dedicated to that particular topic soon.

      • amun1:

        Thanks. I stand corrected on Friedman’s monetarism. As for the Eurozone, I cede to your point that at least they are having a debate about spending, and therefore are spending less than their politicians consider optimal for the purposes of re-election (much to the chagrin of Professor Krugman and the MMT crowd). Sharp contrast to the US where we don’t even present budgets anymore, and discussion of spending is mainly limited to pre-election sound bites and a week before hiking the debt ceiling by another trillion or two.

  • You would think with all the Jews in NY, they would spot a NAZI like Shumer in 10 seconds and get rid of him. I believe the governments of the western world are nothing but bank cartel members and we are being herded for the benefit of them and little else.

    Also, I believe Nomura Securities is where Richard Koo resides. Somehow, Koo believes QE and high deficit spending has worked in Japan. For one, there has been little private deleveraging in Japan and the government has spent itself broke, covering up the insolvency of its banks. They generally reserve spots in asylums for people this delusional.

    Note the move in US CDS rates. It has been steadily upward for some time. Obama fiddles while DC burns. Another totalitarian in office.

    Lastly, Germany is going to find out its trade surplus has been a gift all these years. I believe Says Law is significant in this area, in that financing trade over a period of time, in one direction, eventually leads to default in the other direction and the repudiation of all debts involved. A Bubble That Broke the World, by Garet Garrett, available for free on the site is a simple, but must read on this subject. If there is any basis for going back to gold, it is clearly in the field of international trade. But, the bankers couldn’t earn interest off the pile of debt that is currently involved.

    • The move in CDS on treasuries is quite curious – in fact, the same is true of CDS on JGBs. In theory, they are vastly overpriced relative to the yields of the bonds they are meant to insure. My unscientific guess is that this bifurcation, similar to the high price of gold, shows hat a critical mass of market participants thinks that the ‘safe haven’ bid for bonds of countries that can print their own money is flawed and that the risks to these bond markets are far higher than anyone now thinks – even though it is impossible to determine when exactly this risk will crystallize.

  • There must be more money-printing coming after the Greek election, regardless of the outcome. Not only the ECB, but the Fed’s new PCE “inflation” measure has also plummeted. More printing coming.

    On the Greek situation, it’s difficult to square their love for the Euro with voting intentions. Do they really believe the debt package can be repudiated with no political consequences? Do we have any Greek readers who care to comment? Surely, someone at EU HQ needs to let them know the situation. Perhaps they will do just that and tag-on a little growth-package to clinch the vote.

    • I think an attempt is being made to convince Greek voters that they cannot have both, and I agree the ultimate outcome will be more printing no matter what happens. In fact, a Greek exit would likely lead to an even bigger dose of money printing than is currently underway due to the constant expansion of ELA.

  • jimmyjames:

    This is a fairly comprehensive report by the two biggest long term bears and deflationists in the EWI camp beside Bob Prechter himself,

    Prechter has a good handle on economics but i have never been able to figure out why he’s so bearish on gold (money) in deflation-perhaps his mistake is that he measures everything in dollars or for that matter any paper currency which are nothing but floating abstractions and that he believes the general public holds a lot of gold which they will have to sell to survive-which as this site and a few others has proven to be BS-
    The “Automatic Earth” site touts Prechter a lot and to listen to them-we’ll all be eating the puddy out of the window sills before this is over-

    • See my comment above – it is not that one can not make a case for deflation -some arguments have been forwarded that are very thoughtful and worthy of consideration, such as e.g. Vijay Boyapati’s paper here:

      However, Precher & co. vastly overstate their case, due to a failure to differentiate between money and credit. Moreover, I personally believe after having read many of Bernanke’s papers and having listened to many of his speeches and finally seeing him in action, that the central banks (and that includes the ECB) are simply not going to allow a genuine money supply deflation to occur. On the contrary, I have become convinced that the threat of deflation that undoubtedly emanates from the unpayable debt-berg out there is sowing the seeds for an eventual inflationary overshoot, which is likely only going to be recognized with a considerable lag, by which time it may be impossible to put the genie back into the bottle.

      • Pater, at this point, all the CB’s can do is change the nature of the bank asset. It would take politicians and the markets to force more money onto the system. In “At the Crest of the Tidal Wave”, Prechter wrote something that I haven’t forgotten. He said, Credit is based on faith, faith of the lender they will get their money back and faith of the borrower they can pay. This is very important. There isn’t anything but credits circulation as money in today’s economy. There isn’t anything due on debts but credit. You see gold lose its lustre short term when the markets demand possession of these credits. I doubt these bankers are going to kill the golden goose to bail out anyone. When a country like Japan or even China blows, the world will take notice. In fact, they might wake up when Greece goes down.

  • Andrew Judd:

    QE is a certainty once Germany slides into deflation.

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