The Polish letters: That beautiful collateral

In a now long ago forgotten week of June 2006, yours truly was participating in a week-long workshop organized by the ECB in Frankfurt-am-Main, to show off to the world the wonders of its carefully crafted monetary policy process. As I recall with amazement to this day, ECB officers spent a whole afternoon discussing just the thoughtful approach they applied to the evaluation of collateral for repo-operations. What a wonder! What a marvellous display of human ingenuity and rigor!! This was vastly superior to anything that those rustic cowboys on the other side of the Atlantic ever will come up with, not to mention the apes in the rest of the Americas or the brutish despots and their bureaucrat-henchmen in Asia.

And so it was... beautiful... Until Reality rang the doorbell, and against the best judgment of the Teutonic crew, Club Med people imposed their Board majority (and Axel went... and Jürgen went...), and now we are here, with this awful wound open... and rotting... The system was just too beautiful to resist the ugliness of humanity and life (like that, in lower-case...)

Anyway, I sympathize with the private creditors though. After all, it is true that the ECB got quite a discount on its purchases, so why isn't it taking a little cut to help the boys? Otherwise, Portugal's, Ireland's, Spain's, Belgium's, Italy's remaining private bond investors will confirm what they have known all along: they are now holding junior debt, junior to the identical toilet paper held by the ECB. You know, not all toilet papers are created equal, either...

But I sympathize with the ECB also, mainly because Jens is still involved with that motley crew... And also because they did attempt to perform an operation that restored the transmission mechanism of monetary policy, and besides, by not taking a hit they can still pretend that the system is young and beautiful and wholesome... That beauty is worth the self-delusion...

The only honorable thing to do now, is for one of the Ponzi-scheme funds out there (the ESM, EFSF, FBI, IUD, whatever) to purchase the rubbish out of the ECB balance sheet and take the hit... But hey, there are French involved here, so... Not to mention Angela Merkel, who with typical Weimar politician spirit, is again failing her constituents...

Now, you want something really funny? Listen to another Frenchman talking:

European Central Bank Executive Board member Benoit Coeure on Tuesday called for emerging countries to put their monetary reserves to use through the International Monetary Fund to help stabilise the global financial system.
In a thinly veiled reference mainly to China, Coeure said emerging countries hold around $2.1 trillion in U.S. government debt and have overall reserves of $6.5 trillion, adding that those levels are not justified for precautionary motives.
"The unused resources of the international monetary system need to be mobilised," Coeure said in the text of a speech to be given at a BIS/ECB workshop.
"It would be advisable, therefore, to utilise some of these excess reserves to stabilise the international monetary system, while Europe is enhancing its firewall. One obvious way to do this would be via the IMF," Coeure said.
"The IMF could borrow global excess reserves and use them to support programme countries that are suffering from liquidity shortages, under strict conditionality."
European governments have pushed other countries to help them increase the IMF's resources in order to build stronger defences against the euro zone sovereign debt crisis.

Is this the French way of begging? Is there no limit to arrogance? I know this whole rant of mine reeks of Schadenfreude, but truly, it is not. It is just looking at things the way they were looked upon in the past, when the roles were the opposite...

I presume that at this point you might be asking yourself (among many other more important things like "did I buy milk?") whether I think the German people can do no wrong. As a matter of fact they can. They are not asking for the devolution of Prussia yet...

Tschüss

The Polish letters: a long digression from the Euro discussion

Morning!

Back in the saddle here in B-city, and boy, is it cold or what?

By all means, I hope you actually got to sleep a bit over the weekend, the ECB certainly needs all its brightest minds alert and ready! But right off the bat, you bring up a crucial point: the French did fail to run monetary policy their way… But I think that was mainly because they never knew what monetary policy was in the first place!! The Bundesbank always did it for them... Now there lies the tragedy of the world right now: we (the world) no longer have a real Bundesbank, but a powerless rump and a bunch of bozos on both sides of the Atlantic worrying about expectations, output gaps, sticky prices and money-less monetary policy…

I am sorry that your foray into Verblendung (isn't Deutsch beautiful? We don't have such a precise word for that kind of "blindness" in Spanish, or in English for that matter) was so disappointing, that will teach me to be more prudent in the future when endorsing stuff, at my age I should have known that already. Further to your discussion, I should say that most movies draw endings from a well established set of clichés, so being surprised about a movie ending should not be a deliberate purpose of the wise movie viewer. I think the last time I have been mildly surprised by a movie ending was "The Sixth Sense" and even for that one, you could tell Willis was toast a good 30 minutes before the credits. So in my view, movies are pretty similar to life: you should enjoy the trip, not the destination. On that score, I would say Verblendung has got a lock on the upper half of the distribution… On a related point, I have recently seen some quite ingenious pornos, with totally unpredictable endings (for the genre). I hesitate to recommend you specific titles, after my botched attempt with Verblendung.

On Argentina and its education system, age comes into play again: this was then (when I was a boy), now the education system has been rubished by teachers' unions, so I don't even know whether they still have history anymore, except, perhaps, of the history of soccer. Beckenbauer (google him) will fill the role that Bismarck once had, and Maradona (ditto) is probably the new Argie "liberator" (in place of some José de San Martín, don't bother to google him). In any case, the Argie educational system was originally set up in the late 19th century by two presidents, Domingo Sarmiento (1868-1874) and Julio Roca (1880-1886, and again 1898-1904). It was quite a work, bringing down illiteracy from 90% to less than 10% in about 50 years…

So I shouldn't trust The Economist? Shouldn't I believe 100% their self-serving coverage? Oh my God!!! This thing you are telling me is terrible!!! I have lost the compass of my life!!! Somehow, in the future, I will have to read their notes with skepticism, treading carefully among the pile of angle and rubbish to try and sift through a few facts… and please don't swallow the crap!!! Specially not wholly!!! Thank you K., you just saved my life and career, although it will be tough for me to adjust to this new reality...


At some point next week I will go over the relevance of the Euro currency for the European project: I think they are very different things, and to me it is obvious that the Euro has become detrimental to the larger and more important European project. But that is what happens when you let the French inferiority complex run amok. Is it too intrusive of me, lowly South American, to say that the Euro contraption (i.e. the attempted neutering of the Bundesbank) was the price that Mitterrand and Delors exacted on Germany to approve the reunification? If so, la France has very well deserved the things that are coming its way…

The Polish letters: The Euro, that unnecessary mistake

At 8pm in the evening, I am in no position to deeply debate many of the subtle economic points you raised in your email (actually, I might not even be able to do that at 9am!). But some of the philosophical ones I want to tackle.

First of all, I actually don't like anybody or any country forcefully exporting his/her/its view of anything to anywhere, being the exporters Germans, Japanese, Americans, gypsies or PhD trained economists. Diversity is the great wealth of the world in general, and Europe in particular. But people have to live up to the consequences of their actions. And the reality (I hesitated to write "the truth") seem to be (I hesitated to write "is") that for the euro to survive, Europe has to die. Or in other, less dramatic terms, Europe has to become a big Germany (meaning competitive). Which would be a terrible tragedy. Now, there are different ways in which that could be achieved, that would involve fiscal restraint in most cases, but would not simply mean pasting additional German institutions on Greek or Italian societies and polities. And, as a matter of fact, I think M. recognized this, his position was that Italy was in trouble because Italians did not make any structural reform, while the Germans did, not that Italy failed to implement a Germanic reform agenda (as some commentators in the financial press are fond of suggesting). Incidentally, in the good ol' times (before the Euro), these situations could easily and relatively painlessly be dealt with a blow-up in some segment of the ERM. A few weeks of adrenalin, a couple of parliamentary governments went down, FT and WSJ had better sales for a few days, Soros pocketed some capital gains, and that was it, everybody back to work.  Now, it seems that the "adjustment" will certainly mean either long periods of wage deflation and possibly social unrest in Club Med Europe, or relatively high inflation (and social unrest?) in mein geliebtes Deutschland.

In regards to the role of Chinese imports on Germany's trade balance (the ultimate reason of my initial email), it seemed to me that you were surprised about my statement, which is the only reason why I brought this up again, otherwise I guess I would have forgotten about the whole thing. Your mild surprise made an impression on me (I obviously see you incapable of ignorance, if not mistake...).

Moreover, I did not say that you personally were supporting the idea of Germany's as an unfair trader, but the table's discussion was slightly drifting in that direction, something that I, a consummate germanophile, could not allow. Now I must say I totally share your three favourite eurocrat's ideas, maybe only swapping 1 and 2.  On the other hand, even though it is probably true that Germany is benefitting from some heavy degree of flight to quality, the fiscal impact of that effect is marginal (kicking in through the rollover of maturing debt, peanuts), compared with the massive size of the support that Germany might need to provide to her European buddies to "buy" time. So, it is not yet, but it could become a case in which to a large extent frugal Germans end up paying the bill for sinful Southerners (though their main sin was getting into a poorly designed monetary union with Germany… remember Hayek: to each people their money...).

Now, to cap it all, if your Polishness was somehow offended by the capricious projections of my incomplete European history knowledge, here's a tip, were you in the mood for petty revenge: you can really piss off an Argentinian if you ask him/her whether the capital of Argentina is Rio de Janeiro. A final dangerous remark: almost everything in life is relative. So if the benchmarks are the Kievan Rus' or the Grand Duchy, Ukrainians and Lithuanians have "some reason" to felt occupied…

Schön Wochenende!!!

PS: since Argentina was almost a desert before the XV century, we used to fill up the time gap in primary (and even secondary) school with long European history lessons  -- the Chinese were too far away, and Aztecs and Mayans were Mexicans, whereas we Argentinians thought of ourselves as Europeans in exile :). (Alas, the lavish display of European stupidity in the current juncture does nothing to prove countless generations of Argies wrong...)  Anyway, Kievan Rus', Grand Duchy of Lithuania, the old kingdom of Poland, Golden Horde, needless to say the Holy Roman Empire, are all entities with which I was quite familiar way before Wikipedia. Though I won't lie to you: I keep building up thanks to it!!

The Polish letters: Kick-off

A good friend of mine is an economist at the ECB... and Polish. The current tragicomical developments in Europe have motivated, recently, quite an exchange of ideas between us. While our editorial policy prevents me of using other people´s comments and publish them here without their consent, I will quote some of the statements that triggered my own responses, that I will reproduce here. So, without further ado, the first letter follows...
It all started at lunch in sunny (and humid) Cartagena. Four Europeans (non-German) and the Gorilla discussing whether or not and how Germany got unfairly benefitted by the new currency. The Gorilla, a consummate germanophile, was disputing the notion that Germany´s exported the Club Med bums to death. At some point, he comes up with the, till then unproved, assertion that Germany´s recent export success owes much more to the Chinese nouveau riches than to the lazy and spoiled Mediterranean deadbeats. Upon return to his base in B-town, he easily found evidence backing up his assertion. Moreover, he finds this in his Inbox (the actual "letter" follows, now for sure):

China takes over France as Germany’s biggest trading partner

As Angela Merkel starts her visit to China today, Les Echos explains on its front page that China will this year take over France’s long held position as Germany’s most important trading partner. Also the presence of German companies in China bears no resemblance to that of French companies and of any other European country. There are roughly 5000 German companies doing business in China compared to 900 French firms. More than two thirds of all luxury cars sold in China are German and the country’s manufacturers of chemical products and industrial machines are also leading. The paper also points out the support organisations German interest groups of small and medium sized enterprises have put into place in Beijing to help SME’s get started in China.

 I guess the gist of that conversation at lunch with P., your roommate M. and F. was whether or not the Germans have unfairly (?) benefitted from the euro contraption, by exporting too much (??) to the rest of Europe. I just brought to the fore the fact that over the last 10 years, about 50% of German exports have gone to emerging markets, especially China. And in fact, imports from Europe have grown much faster than exports to them deadbeats (sorry for the gangsta grammar). So what else the Europeans want from Germany in terms of rebalancing?

As a libertarian, I must say the German Leviathan seems to be one of the least harmful on the Western hemisphere. I understand that you, as a Polish, will be hard pressed to recognize any merit on the Germans, but I think you should try to overcome those ancient tribal rivalries. They seem to be blurring your judgment. And after all, you guys ended up snatching most of Prussia anyway :)

A minimalist roadmap to leaving the Euro

This article was originally written in November 2011. I thought of adapting it, because many things happen between then and now. And then I got lazy. Besides, the main message did not change.

As the weeks go by, the unavoidable nature of the impending default and collapse of the Greek economy is becoming obvious to everyone. To everyone, that is, except the obtuse European technocrats and politicians, who have too much of their own careers and reputations invested on the success of this monetary Frankenstein. In this circumstance, it is however remarkable that no serious economist or practitioner seem to be trying to think carefully and hard about the details of how to implement an orderly exit from the Euro for Greece (and probably a few more countries later). Most economists, especially those in the sell side (which have a lot to lose in the event of a Greek/Portuguese/Italian/French default) keep fretting about the horrible cost (for whom I wonder? For the Greeks or for them?) of an Euro exit, refusing to elaborate at all in the best of cases, or pulling numbers out of thin air in the worst. We are constantly reminded about the terrible (but vague) consequences of bank runs, run on financial assets, economic depression, and overall financial markets collapse. Some economists I used to respect are telling us that “the prospect of Greece exiting the euro area is seldom viewed with the proper degree of fear and trepidation.”[1] Oh really? And what about the prospect of living in a depressed economy for an indefinite number of years while the internal devaluation that Greece needs occur? The most astonishing feature of the current debate about the Greek Problem is that nobody discusses it. What we are discussing day in and day out, is how to save the necks of the gullible bankers that lent to Greece (and Portugal, and Italy, and Spain, and France) on terms comparable with those of Germany.[2] Nobody discusses how Greece will become a competitive and viable economy again, which is the crux of the real Greek Problem. The debt level stopped being an issue for Greece months ago. It cannot be paid, and that is the end of it. And the real Greek Problem is not discussed mainly because we all know that solving it would require a nominal devaluation (which is not possible within the Euro) or years of economic depression and deflation, which is too painful to contemplate carefully now, while Eurocrats are busy covering their behinds and pretending they can be part of a solution.

Last Friday I read for the first time in the WSJ online a “recipe” or to-do list of the things the Greek government should do in case it wants to leave the Euro. It goes like this:

·         Prepare for a run on banks through bank holidays, limits to deposit withdrawals.

·         Prepare for capital flight by introducing temporary capital controls, travel curbs.

·         Change the law to re-denominate wages, incomes in new national currency.

·         Re-denominate mortgages and other debts in new currency.

·         Prepare plan to recapitalize banks.

·         Plan to balance budget because government would lose ability to borrow.

·         Set fiscal and monetary framework to rebuild policy credibility.

·         Prepare new notes and coins for distribution.

·         Reprogram computers, change vending and payment machines

Allow me to give you some perspective on this… I am Argentine. I lived through the hyperinflation of 1989-1990, and followed closely the depression and default of 2000-2002. Any economist with a minimal of common sense should know that most of that list is not only wrong, but also dangerous. It is close to what Argentina did in 2002, and it is a recipe for disaster.[3] The right state of mind that a civil servant should have before beginning a forced process of monetary reform is one of humility. Hubris will not achieve anything good. Bureaucrats should not pretend to understand better than the affected people what their problems would be as a result of the monetary reform, and therefore they should not try to solve those problems for the people. Because the truth is that they have no clue, in general (otherwise a forced monetary reform would not be happening), and in particular, they don’t know anything about the personal tragedies that the reform will trigger. Therefore, they should NOT overregulate and/or attempt to overcontrol the process. And above all, they do NOT have to meddle with private contracts or attempt to separate people from their savings. They must take a minimalist approach, to disturb markets and society as little as possible (they have caused them enough damage already). They must set up a short number of simple rules that create the correct incentives for the markets (who are the people after all) to take the best decisions for themselves. They must explain clearly to the people the short and simple set of new rules. And then they just need to trust the people (i.e. the markets), which by now is completely clear are infinitely wiser than the idiotic and arrogant Euro-technocrats that got them in this mess in the first place.

With that said, let me enumerate the 10 measures I humbly believe Greece (and later Portugal, Italy, Spain, even France) could take to leave the Euro with minimum (though not small) cost:

1.      Stop paying the debt immediately, and began planning for a restructuring which should include a large nominal haircut across the board, including the ECB, the EFSF and other bilateral and/or multilateral official lenders, in addition to the private sector. Be ready to wait a few years before the restructuring is finalized, because it will take a while to figure out what debt level is sustainable for Greece.

2.      DO NOT LEAVE the Euro overnight. Just re-introduce the Drachma and let Greece be a bi-monetary economy. The idea is that the stock of pre-existing contracts should not be overruled or redenominated (by the Government), but the flow of new economic activity will be denominated in Drachmae from the point of monetary reform on. Over time, by Gresham’s Law, the bad money (Drachma) will take over the good money (Euro) in exchanges, and the economy will be naturally Drachma-tized slowly over time. The Euro will naturally fade and become at best a unit of account. The Government should take care of renegotiating its own contracts, with its suppliers (including workers).

3.      Impose capital controls to avoid a massive run of hard currency out of the country. However, do not impose restrictions in local foreign exchange markets, and let the new Drachma float freely. It will be a wild ride at the beginning, but with the capital account effectively closed, the initial volatility should abate quickly.

4.      Remove the Euro’s legal tender: even though outstanding contracts (and even new contracts, this will be a bi-monetary economy) can be denominated in Euro, actual payments could not be requested in physical Euros. All payments in the economy should be redeemable in physical on notional Drachmae, converted at the exchange rate of the day for Euro-denominated payments. However, note that the fact the Euro loses legal tender means only that payments cannot be requested in Euros, but anybody can voluntary choose, if his counterparty agrees, to cancel his payments using Euros (for instance in his bank account). That would avoid a massive contraction of means of payment at the beginning of the transition, before Drachmae get broadly distributed in the economy once again.

5.      DO NOT REDENOMINATE private contracts from Euro to Drachma, including loans, rentals, insurance policies, private labor contracts, BANK DEPOSITS. The private sector should take care of renegotiating its own contracts.

6.      Nationalize bank deposits, NOT the banks themselves. Moreover, the Government should offer a 100% guarantee on all deposits it takes (more on this later). Therefore, the government will be in effect wiping out the liability side of the banks’ balance sheet, “recapitalizing” them. In so doing, it will give the banks enormous flexibility to renegotiate their loan contracts (including commercial loans and mortgages) with their customers in the best possible ways for all the parties, without the government picking winners and losers. And trust the bankers: they cannot profit from a bankrupt client, and they really hate to repossess real estate, so with the flexibility of a clean balance sheet, they will surely offer their customers (and the voters that politicians care about) fair terms.

7.      Keep people and businesses’ full access to bank deposits (now on government’s hands). Under NO circumstance limit bank withdrawals. That is a recipe for rioting, spike in suicides and overall unrest. But remember: Euro has not legal tender. Make sure to explain clearly that people can always access their deposits, and even withdraw them if so they want, but they will be receiving the Drachma equivalent of their deposits in Euros, at the prevailing free-market exchange rate. As long as they keep their money in their bank accounts (now managed by the Government), it will be indexed to the Euro, and it will NOT be converted, re-denominated or confiscated, and they can use that money to make payments in Euro or in even in Drachmae (CRUCIAL), at the prevailing free-market exchange rate. On the other hand, as soon as they withdraw their money from the bank, presumably to buy Euros in the exchange rate market, they will be subject to exchange rate risk.

8.      Keep interest rates, exchange rates, prices, unregulated and un-restricted. No price controls, no exchange rate bands, no interest rates ceilings. Let the private sector do its work. Based on the outstanding evidence, it is unlikely to do a worst job than regulators and bureaucrats already did over the last 12 years.

9.      Set clear rules for a central bank concerned with price stability above anything else. However, allow for a transitional period (with an explicit, realistic and credible ending date) during which the central bank will be allowed to finance the government by monetizing its debt. Needless to say, that period should be as short as possible. A credible plan leading to a balanced fiscal result within that period would be quite convenient.

10.  A (short) banking holiday might be needed to get the government’s logistics ready to deliver the new Drachmae to the market in case it is necessary. Explain the measures carefully. Sit back… and pray.

And yes, don´t forget to re-program those vending machines.

---

[1]  “Exit would be a mess for Athens”, WSJ online, November 4^th 2011.

[2]  And don’t forget the regulators that encouraged that lending through preposterous capital regulations, which subsidized government borrowing. Simply explained, the regulations in place during most of the previous decade allowed the banks to lend to governments, all of them, from Germany to Greece, without having to put aside any capital reserves to cover for potential defaults. That arrogance (or bad faith) is one of the causes that brought ruin to Europe.

[3]  Do I have to remind people about the 16% contraction in private consumption over 3 quarters? Do I have to remind people of the loss of life and property? Do I have to remind people of the toddlers feeding off trash cans? That some shameless ideological bigots like Paul Krugman are currently exhibiting Argentina as an example would be funny, were it not so tragic and insulting.

Introduction (and mission statement)

I should start this note with a declaration: I am a Peronist. This might sound meaningless for those of you that are not Argentines. And for Argentines, at least for those that still got some electrical brain activity, this might sound baffling. Because, what is a Peronist nowadays? And if I am a Peronist, why do I look so much like a gorilla (in traditional Argie political argot, an anti-Peronist)? As a matter of fact, both questions are closely interrelated: the current Argie government, presumably Peronist, is so backward and obtuse, so unnecessarily centralized, and so opposed to what Peronism had become by the end of the XX century, that if this is the "new" and "real" Peronism, well, I am a Gorilla then...

I realized I was a Peronist when I finally understood that the Old Man (Perón) was not a progressive, but an old military man, rabidly anti-Communist, thoroughly conservative, whose main purpose was to save Argentina from the claws of Communism, towards which the country was arguably heading in the early 1940´s. To avoid that fate, the General (Perón) concluded that it was necessary to force Argentina´s myopic, stingy conservative elite  to "share" a tiny bit of their mammoth wealth in order to preserve order, and the rest of their piggily-hoarded riches. Now the idiotic conservative elite never understood this (to this day) and fought Perón with all they could. They never understood that Peronism was the big, massive, popular conservative party that Roque Sáenz Peña could only dreamt of forging in the early 1910´s, when he was developing his electoral reform. But they failed (that is what idiots like these do best) in getting Argentina rid of Peronism, and only achieved the leftist infiltration of the party, which is now definitely turning progressive, or something like that.

But parties, and political movements and ideologies change over time. Anglo-conservatism was not always market oriented: that is a relatively recent innovation in English-speaking countries, courtesy of Barry Goldwater and Maggie Thatcher. And Peronism was not always this shameful shell in which it has become under the Kirchners. So if Peronism can evolve (and regress), then gorillism can evolve as well, in this case from a visceral, mindless reaction of personal rejection towards Peron, devoid of any actual policy ideas, to the movement Peronism would have become were not for blind and corrupt elites. In  other words, the electoral tool of a popular, market oriented, law and order enforcing conservative movement. Advocating for this new Gorillism will be one of the driving forces of this space.

But I am also an economist. An old-fashioned one. Of the kind that think that governments are not all-powerful, and that sometimes, there are things they cannot achieve. And more importantly, there are things they should not even attempt. Specially with other people´s money! Sort of a XVIII century economist... Even though by history and education I should be (and to a large extent am) a mainstream economist, I am certainly not a new Keynesian (see my previous sentence) and crucially, I despise the intellectual arrogance of some of my colleagues. Especially those who think a doctorate entitles them to opine forcefully what is better for other people´s interests. They seem to believe that, because they came up with a couple of over-simplified, cleverly and even elegantly designed economic models, they can actually have a valid opinion on any subject even remotely connected with their model. And they even pretend to be able to anticipate the effect of policy changes, when their models scream Lucas´ critique all over (meaning that the model parameters are very likely to change when the policy regime is modified). And now that they have crashed the world, they still want to continue micro-managing markets, now they are gonna do better, now they understood: they are like compulsive gamblers, looking for a final lucky strike that will allow them to recover their huge losses. The important thing is: do not let them. If democracy is gonna be good for anything, it should be at least able to rid the policy circles of these arrogant pricks.

Anyway, now you know my basic philosophical starting point, and hopefully that will help you to understand better what I write or, at a minimum, to know which way I tilt... and then you can adjust and right size all the preposterous things (for the conventional wisdom at least) that I am gonna be writing here... My mission (that I have already decided to accept) is try to offer a different perspective than that offered by the financial press and some mainstream economists about the challenges and phenomena that mark our global (and sometimes regional, or national) economy. I will try to make the case of liberty and markets, over regulatory overstretch (and again, hubris), and calling the bureaucrats lies as they see them.

Have a good time and... enjoy the ride!!!

Lucas