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貴
社
ま                                   Freudenstadt Konferenz 2-4 July 2010
す
ま
す
ご
盛
栄
の
こ                   The Banking €risis and the Euro
と
と
お
慶
び
申
し
上
げ
ま
す
。
平
素
は




                    DAS BOOT
格
別
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ご
高                                euro
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賜
り
、
厚

                     € Krise: Banking, Trade & Growth?
く
御   τὸ Α καὶ τὸ Ω
礼
申
し                             Robert McDowell
上
げ                   Banking Expert & Macroeconomist (Edinburgh)
ま
す
。
DAS euro BOOT Krise ?
                          Airlock panic


•   EA sub stuck in ocean mud: who can escape via the airlock?
•   Or, who or what can be jettisoned out the torpedo tubes?
•   Break-up of Euro: stories start flooding in January 2010
•   March: „Die Griechen sollten den Euro verlassen?“
•   FT: Greece‟s best option: default & leave ?
•   May-July: FT posits Germany leaving EA !
•   Soros: rät Deutschland zu einem Austritt aus der Euro-Zone
•   Sarkozy: a menacé de sortir la France de l’euro pour sauver la Grèce,
    selon Zapatero, cité par El Pais
•   Jean-Claude Trichet: “world faces a second Lehman” hours before EU
    leaders launched their €720bn (£612bn) defence fund. If ECB President is
    correct, we are in trouble (Daily Telegraph).
•   “EU-IMF package unraveling. What will West do next?”
•   June: Die Welt: “Deutschland sollte die Währungsunion verlassen „?
•   Panic ? = safety within borders? „every man (state) for himself“!
                                                                        I
LOGGED IN THE WARD ROOM




                                        1. EU/EA Stabilisation fond?

•    Haiku van Rompuy*/ plus heads of state 7th May/ meet a new deal to agree
•    President Rompuy/ & 3 Spanish econ grads/ PR 2 am, 10th May
•    Announce fund set up/ €720 billions/ for state-aid loan grant bail-outs
•    SPV format/ Bankruptcy Remote concept?/ to assure wolfpack markets?
•    Big as an IMF if/ but no board, bank account, or…/ vaunting Barroso** power?
•    Normally takes years/ e.g. EIB – EBRD / guile sans skill: amateur hour!
•    Sub-rosa: it‟s TARP again/ will MEPs play Congress/ vote a slice plus oversight?

____________________________________________________________
* Van Rompuy Presidency 2009-2012
    Invented “asymmetrical translation” e.g. European Council = "le gouvernement économique“ / "economic governance"

** Barroso Commission 2004 -2014 incompetently desperate to get hold of a major reserve fund

                                                                                                               II
Wolf pack v. euroConvoy
                      Atlantic War new game version?




•   Market Speculators „Wolf Pack“
•   $tens billions of profit plays
•   Players choose save or destroy € euro-system
•   Investors briefings on € /EA break-up:
    –   Sell Belgium, Spain, Greece, Portugal stocks
    –   Buy Bunds, sell Dax (DM?      Exports )
    –   Buy Italian stocks (Lira? Exports )
    –   France neutral (hold, subject to downward revision)
    –   Buy $, £ (safe havens) &
    –   leverage & arbitrage derivatives & shorting Euro & banks: big money
        gains for hedge funds?
                                                                       III
EU/EA crisis

                        a crisis of mixed metaphors


•   EU 3 P‟s: Prejudice, Prudence, or Profligacy?
•   EU 3 C‟s: Capital, Credit, or Competitiveness?
•   EU 3 B‟s: Budget, Balance, or Bankruptcy?
•   not about moral virtues (that‟s callous political spin)
•   it‟s EU jigsaw of trade, payments & bank lending
•   each member finds its own efficient growth path
•   they cannot all follow export-led or credit boom or a mix
•   EU = different economies united, not a single economy!
•   EU/EA system has to embrace economic risk diversity!
•   EU/EA is world economy scaled 1/3; it is not a single economy state

                                                                          IV
Eine Reise ans Ende des Verständnis




                              6
Provocations 1



                    POLITICAL-ECONOMICS IS A SCIENCE… OF
                 PROPAGANDA OTHERWISE IT IS A SOCIAL SCIENCE
                       SYSTEM OF ECONOMIC ACCOUNTING




• Public finances are not “in a mess” !
• …unless private finances are a Greek Tragedy?
• Countries perforce have different growth strategies
• Export-led growth forces others into credit-boom                   & vice versa
   – New fashion ignored external accounts & their financing for „money supply‟
     (so-called „new paradigm‟ for growth = „credit-boom‟ growth?)
   – Extreme imbalances in world trade: credit-boom / export-led economies = net
      financial assets = payments deficit/surplus = pay for trade deficits & finance
      credit boom = asset bubbles & growing banks‟ funding gaps
   – High bank funding cost wiped out net interest income = Credit Crunch
     = trigger of Anglo-Saxon recession & temporary global shock
                                                                      1a
Provocations 2
• Bank lending patterns dictate GDP growth strategies
• Economies not made safe merely by balanced budgets!
• Crowding Out theory = myth of public/private competition
• Other „crowding out‟ = real problems in composition of bank
  lending: earnings v. property as borrower collateral
• Lower public deficits = lower private surpluses
• Micro-model theories = macro-stupid!
• Savings, growth, competitiveness, productivity, & zero-sum
  ideas are entirely different at
    – macro & micro levels
    – domestic & international levels

                                                       1b
In the Conning tower
•   PRIMITIVE visual GUIDANCE CONTROL SYSTEM
•   Authorities* have no macro-economic models for analysing Finance in detail!
•   Basel II tasked banks to build such systems; they didn‟t, couldn‟t, wouldn‟t!
•   For factors
     –   Dictating the Credit Crunch or
     –   Measuring interventions or
     –   Understanding banks in economies, or
     –   Income, trade, payments in growth!
• & not now (despite G20 tasks that assume such models exist!)
• Most effort is in behavioural games theory models!
• Economics as double-entry accounting standards was lost to politics
• Econ teaching is empirically poor, math-algorithmic absurd bubble!
• Mythos of “hard choices”: but can refinancing & recovery be self-financing?
• Governments cannot agree a self-financing painless path?
_________________________________________________________
                                                                                   2
* Central banks, government finance ministries, regulators, major banks, NGO banks
EURO SYSTEM-KRISE


                                 Maastricht SGP too crude



Multi-national sovereign
      EURO SYSTEM DESIGNED TO BE PROOF AGAINST MARKETS
NOW DEPTH CHARGED by markets & gunslinger politicians

Causes
- Not GOVERNMENT DEBTS (political not technical problems)
- OPPOSING (complementary) INTRA-EU external accounts
- CREDIT BOOM v. EXPORT-LED v. MIXED MODERATE states

Effects
- PIGS‟ external deficits cannot be funded without fiscal austerity?
- Bond markets impose higher margins on CB deficit states &
- countervailing v.low margins on external EL surplus states
- Credit-Crunch scandal effectively replayed at Governments            3
- hits banks again & other sectors but now per sovereign borders.
ENGINE ROOM



                BLIND OR BLINKERED??
                         BLINKERED?


Traditional economists’ view:
    financial sector should not have macro-
             economic significance
Is this
- MAD, LAZY, FOOLISH, DANGEROUS and/or

Irresponsible
- BANKS DIDN‟T KNOW OR CARE EITHER WAY !

Regulation
- BASEL II brilliantly DESIGNED TO CURE THIS, BUT PILLAR II
of it NOT COMPLETED BY ANY BANKS!
                                                              4
WHO SETS
                         COURSE HEADINGS?


Composition of bank lending reflects, causes & amplifies a
country‟s growth choice (export-led EL, credit-boom, CB or a mix?)
(Not discussed in debates among economists, regulators, governments, or media. )

Export-led Germany & others (also China): 60% lending to business,
capital investment & trade = low consumer & mortgage lending.
High deficit credit-boomers: UK, Greece and Spain, banks‟
customer lending is 60-70% to mortgages & property (also USA).
Bank lending in both EL & CB states is risky because banks do not
diversify across whole economy.
Bank balance sheets are as fragile in EL as in CB countries!
                                                                                   5
UK & De bank lending

              „crowding out’ in bank lending?

UK customer loans    = 165% /GDP ratio (€2.5tn, $3.5tn)
De customer loans    = 78% /GDP ratio (€2.3tn, $3.2tn)

UK mortgages ($2.1tn) = 58% of loans, > 75% residential
De mortgages = ($1.53tn) = 44% of loans, < 50% residential

UK h‟hold loans ($1.95tn) = 55% of loans        (87% / GDP)
De h‟hold loans ($1.39tn) = 55% of loans        (43% / GDP)


                                                              4
Bank credit support



                                               or not
                                                for
                           INDUSTRY           & TRADE?

UK loans businesses = 45% customer loans (but 50% = com. mortgages & property)
UK non-property loans = 23% of cust. loans or 37% /GDP.
De loans to industry = 56% or 44% / GDP of which 25% is mortgages/property.
UK tradable goods industry sectors get bank credit  = 5% /GDP
De industry loans = 33% /GDP, of which tradable goods = 30% /GDP
UK (non-financial) business output = £590bn
(£300bn services, £290bn industry, of which manufacturing £240bn).
nf all business incl. services bank borrowing = £900bn = 152% /sector GDP,
or 76% ratio (excluding commercial mortgages )
De domestic bank credit excl. mortgages to German industry = 163% of sector GDP
UK figure is 76% of industry sector GDP.
UK banks extend $100bn of credit to support $350bn exports = 28% ratio
De banks extend $620bn credit supporting $1.5tn exports    = 41% ratio
                                                                                  5
Debt burden
                               on De industry
                                  & banks

                                                       LOGIC BEHIND MERKEL‟S
                                                       TOUGH-LOVE STANCE IN
                                                         EA SOVEREIGN DEBT
                                                              DISPUTE?




High exposure by De banks to industry (business loans are lowest margins) =
De sovereign debt spreads v. critical to banks‟ net interest income = in EA sovereign debt crisis
De priority = De sovereign debt needs far lower risk margin than other EU sovereigns!
Or, banks & corporates risk insolvency losses.
                                                                                                6
Die Heimat gefährdet ?




                                                       De BANKS VULNERABLE TO CREDIT
Sovereign debt prices directly influence banks‟ &
                                                     DEFAULTS AS TRADE & MARGINS FALL &
corporates‟ credit status & debt costs, not just
                                                     BANKS TO REFINANCE €0.5tn IF CANNOT
government borrowing cost!                                   GET LOWEST RATES!?

                                                    De industry's debts= 160% /industry’s
                                                    gross output
                    Sovereign bonds
                                                    De industry debt servicing =10% / gross
                    spreads & yields                operating surplus
                    for years 2007 –                GDP forecasts are 1/3 lower than UK
                     2010 /German
                          Bund
                                                    UK industry debt servicing = 4% / gross
                                                    operating surplus,
                                                    Debt servicing for all UK business = 13%
                                                    /profit in ‟08 & 9% in ‟09
                                                    GDP forecasts are sharply higher than De

                                                    In „04-‟08 EL‟s GDP grew fastest
                                                    now endogenous CB‟s GDP higher
                                                    in medium term… except EA‟s PIIGS!         7
De in EU/EA
                                      EU/EA




De trade & surplus = same size as China‟s
60% is intra-EU but De ex-EU trade surplus halves EU external deficit
De in EA
nf private sector lending = 22% of EA total
Lending to business = 25% of EA total
nf customer lending = 21% of EA total
                         despite nf private customer lending in EA = 107%/GDP
                                                  compared to De = 78% /GDP
De economy in EA is like USA % in world
USA in the world is an extreme credit boom economy
De in Europe is an extreme export-led economy
____________________________________________________
nf = non-finance sector (business excluding banks etc.)
                                                                          9
Greece
                                                                 extreme credit boomer


             Greek Banks' Loans by Sector as % ratios to GDP                                                                 GREECE FOLLOWED
30                                                                                                                           OTHERS „ MODELS -
                                                                                                                             IRELAND, UK, USA,
25                                                                                                                           SPAIN & PRAISED IN EU
                                                                                                                             FOR HIGH GROWTH
20
                                                                                                                             CONTRIBUTION TO EU
                                                                                                                             FOR YEARS!
15

                                                                                                                             RECESSION WIPED OUT
10
                                                                                                                             90% OF GREEK BANK
                                                                                                                             CAPITAL. BUT THAT IS ON
5
                                                                                                                             A PAR WITH UK, USA,
                                                                                                                             OTHERS‟ BANK CAPITAL
0
                                                                                                                             IMPACTS.
                                                                                                               2005
      1990

             1991

                    1992

                           1993

                                  1994

                                         1995

                                                1996

                                                       1997

                                                              1998

                                                                     1999

                                                                            2000

                                                                                   2001

                                                                                          2002

                                                                                                 2003

                                                                                                        2004



                                                                                                                      2006



     Tourism                      Services                           Industry                       Shipping
     Consumer                     Other Personal                     Res.Housing                    Finance                                          10
Competitiveness: reality & illusion
300                                      275
                          EU Trade                               EU Balance
                                         250
275                       Balances                               of Payments
                          $ billions     225                      $ billions
250
                                         200
225                                                                 GERMANY
                           GERMANY
                                         175                        FRANCE
200                        FRANCE
                                         150                        UK
                           UK
175
                                                                    ITALY
                           ITALY         125
150                                                                 SPAIN
                           SPAIN
                                         100                        NETHERLANDS
                           NETHERLANDS
125
                           POLAND         75                        POLAND
100                        AUSTRIA                                  AUSTRIA
                                          50
                           DENMARK                                  DENMARK
 75
                                          25                        GREECE
                           GREECE
 50                                                                 PORTUGAL
                           PORTUGAL        0
                           FINLAND                                  FINLAND
 25
                                          -25
                           IRELAND                                  IRELAND
  0
                           CZECH          -50                       CZECH

 -25                       SLOVAKIA                                 SLOVAKIA
                                          -75
                           LUXEMBOURG                               LUXEMBOURG
 -50                                     -100

 -75                                     -125

-100                                     -150
                                                                               11
   2007     2008   2009                     2007   2008   2009
Credit boom V. export led
                                                             GDP of 6 Credit Boom CB economies incl. USA and UK v. GDP of 10
                                                $ billions            Export Led EL economies incl. Japan, Germany &China.
                                                20000

                                                19000
credit-boom: USA, UK, Spain,
others                                          18000
export-led: China, Germany, Saudi
Arabia, Netherlands, Russia, S.Korea,           17000                                                                CB
others                                                                                                               EL
                                                16000
modest mix: France, Italy, Belgium,
Switzerland, RSA, Mexico, others                15000
strong mix: India, Brazil, others
                                                14000
                                                              2005           2006                2007     2008            2009


60,000
                $ Bn US banks flow                                                                      Note dependence of inter-
                 of funds by sector                                                                     bank lending in USA to
50,000
                                                                                                        household mortgage and
                                                                               Households
40,000                                                                                                  consumer lending.
                                                                               Non-financial business   The opposite prevails in
30,000                                                                                                  export-led where inter-
                                                                               All public sector        bank lending is tied to
20,000                                                                                                  business lending.
                                                                               Financial firms
10,000
                                                                               Rest of the world
    0
                                                                                                                                    12
         2000     2002    2003    2004   2005      2006      2007    2008
COMPARING BANK LENDING
     USA      &    prCHINA
   $ trillion rounded                                                                                                       %
                                         Dec.’09          % GDP     $ trillion rounded                   Dec.’09         Increase
                                                                                                                          in ‘09
  Bank & other lending                  21.3               150
                          Financial                 4.0                 Bank Deposits                9                   27.7
         Enterprises                          4.8                   Of which: By enterprises               3.3              36.5
                 Loans & corp. bonds                3.2                          By households             3.9              19.5
              Commercial mortgages                  1.6                             Of which: Rmb
                                                                                          Deposits                 3.8          19.7
         Real estate                       2.6
         Households                       14.0             102                  By Government                            Foreign
                 Of which mortgages                                                                        1.8
                                                10.8                                                                     currency
      Consumer credit & lease finance               3.2                  Bank Lending                6.3                 33.0
 Bank & Other Liabilities                 21.3             150      Of which: Short-term                   2.2              17.7
           Non-financial Deposits       7.3                50                    longer-term
                                                                                                           3.5              43.5
             Money Market depos         3.0
                            Trading     0.8
                                                                  FC Reserve loaned to banks                     2.4 600
                      Central bank                                               Other                     0.6
                                        2.3
                              Other     2.6                                     Enterprises
                                                                    Of which:                              4.8
   Banks reserve capital                            1.1                          Households                1.2
             Equity                                 1.5
                                                                                 Other                     0.3
     Inter-bank debt                          3.7
USA economy 5-7 times bigger than PR China (depending on whose adjusted GDP figures)
USA bank lending = 150%/GDP, China = 2-300%/GDP. China lending to industry (half of which is funded by loans of
all of China‟s foreign reserves) matches the total for the USA i.e. China‟s industry is severely over-borrowed and the
economy is vulnerable to downturn in world trade and fall in net exports (& commercial property collapse?).            13
USA
65% of credit to households,                   Some more comparisons
22% to medium & large Enterprises
10% to small firms incl. self-employed.
70% of total exposure is property-related,
This chimes with UK, Spain, Greece, Ireland.   UK banks lend too much to h‟holds for property
                                               (70% /total customer loans)
                                               Manufacturing (17%/GDP export 13%/GDP)
PR CHINA                                       =3.5% business loans (1.5%/GDP)
75% loans to business                          Construction (5%/GDP) = 4.5% /business loans
19% to households                              (=2%/GDP)
nf firms debt =173% /total output              Small firms & self employed get 1.5% of all loans
Net debt of enterprises =114% /output!         yet employ 50% priv. sector jobs!
Households borrow 30% of h‟hold deposits.
                                               German banks loan too much to industry at
UK & USA lending to h‟holds = 100%/GDP         56% / total customer lending
of which 70% = residential mortgages           29% /business loans are to small firms &
                                               self-employed =10 x UK %.
China h‟hold loans =25%/GDP
mortgage & consumer finance are small.
                                                                                              14
Back to port
                          sovereign debt &
                           Euro system 1

Banks & EU states need government borrowing to
- boost private sector assets & reflate economies
- improve quality & quantity of banks‟ capital reserves
- finance trade deficits

Fiscal & Monetary measures
- are clutch & accelerator pedals, not steering wheel
- do not restructure, or
- change type of economic growth direction
- we leave steering to banks & free market
- who do not navigate on basis of national macro economics   15
Back to port
                            sovereign debt &
                             Euro system II

Maastricht Criteria /EU’s Growth & Stability Pact
- Ceilings & hurdles to cap member states‟ borrowing
     in reference only to GDP ratios !
- Other factors ignored incl. bal. of payments
    (anomaly Ireland: economy far smaller than its GDP?)
- Only gross not net National Debt
- Deficit & debt ratios scaled to GDP (not GNP) &
    don‟t take account of ext. trade & payments
    (supposed benign intra-EA & EU but Greece shows not so)
- Ignores currency of debt & private debt levels, &
    domestic versus foreign ownership of debt (EA=domestic?)   15
Back to port
                           sovereign debt &
                            Euro system III



Solving EU/EA Sovereign Debt Crisis requires system to:
- Recognise differing/opposing growth stances e.g. CB & EL, &
- Intra-EU/EA imbalances, on & off government budgets
- Regulatory supervision to compel banks to rebalance lending.
- Does not directly require aligning tax or fiscal stances.



                                                                 15
Concludings A-E
         (time permitting?)




unsere Krise riskiert eine riesige
    Sicherheitskatastrophe


                                     26
A
• De was in heart of EU „generous’ to secure Europe.
                     EU,
• De is the protagonist in Euro Krise, bringing integration
  into a crunching of gears.
• € incomplete : monetary union sans political union, ECB
  sans central treasury (not insoluble).
• EA states are alone on sovereign debt weakened sans
  treasury money market flexibility.
• ECB accepts sovereign debt of all EA equally, same interest
  rate as Germany, but not a solution.
• Banks loaded up with PIIGS debt until 2010.
                         PIIGS‟


                                                       A
B
• After Sept. „08, EU Council guarantee no big banks will
  default. De insists each state to care for its own.
• Capital moves with guarantees, interest-rate differences in
  EA stay small.
• Hungary & Baltic states rescued.
• As markets cage-rattle sovereign debt, interest-rate
  differentials widen.
• Greece the battleground.
• EU authorities slow. EA members hold opposing views.
• De insists on S&G Pact‟s “no bail-outs”.
• Greek crisis festers, contagion spreads.



                                                        B
C
• EU forced into bigger rescue package than if it‟d reacted
  quicker.
• Markets see terms as punitive, fiscal consolidation harder, can‟t
  see how PIIGS can fly:
• Close trade deficits & revive growth sans currency
  depreciation? (Euro system break-up) or risk deflation.
• Can push EU into long stagnation (late „90s early „00s) = social
  unrest (at worst, xenophobic extremism).
• De has major responsibility as biggest trade surplus, most
  creditworthy country (externally, not internally)




                                                         C
D
• De unwittingly imposes deflation on EA (itself included &
  next recession imminent).
• De public cannot see the harm because of how the €
  works. Soros says, “deflation will serve to make Germany
  more competitive on world markets, while pushing the
  weaker countries further into depression and increasing
  the burden of their debt”.
• No, this is a two-sided coin; De will also fall.




                                                    D
E
• If De left €, Dm would soar, € & De exports plummet.
• Rest of Europe more competitive to grow its way out but
  Germany crucified by overvalued currency (like Japan).
• De trade balance evaporates, businesses default &
  unemployment soars (extreme political crisis).
• De Banks require v.large injections of gov. funds.
• Hypothetical - if De left €, consequences are immense,
  unthinkable beyond making sure this cannot happen!




                                                  E
€ötterdämmerung darf nicht wahr sein




schon am Ende vom €uro BOOT?

                               32

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Das Euro Boot Take Away Copy

  • 1. 貴 社 ま Freudenstadt Konferenz 2-4 July 2010 す ま す ご 盛 栄 の こ The Banking €risis and the Euro と と お 慶 び 申 し 上 げ ま す 。 平 素 は DAS BOOT 格 別 の ご 高 euro 配 を 賜 り 、 厚 € Krise: Banking, Trade & Growth? く 御 τὸ Α καὶ τὸ Ω 礼 申 し Robert McDowell 上 げ Banking Expert & Macroeconomist (Edinburgh) ま す 。
  • 2. DAS euro BOOT Krise ? Airlock panic • EA sub stuck in ocean mud: who can escape via the airlock? • Or, who or what can be jettisoned out the torpedo tubes? • Break-up of Euro: stories start flooding in January 2010 • March: „Die Griechen sollten den Euro verlassen?“ • FT: Greece‟s best option: default & leave ? • May-July: FT posits Germany leaving EA ! • Soros: rät Deutschland zu einem Austritt aus der Euro-Zone • Sarkozy: a menacé de sortir la France de l’euro pour sauver la Grèce, selon Zapatero, cité par El Pais • Jean-Claude Trichet: “world faces a second Lehman” hours before EU leaders launched their €720bn (£612bn) defence fund. If ECB President is correct, we are in trouble (Daily Telegraph). • “EU-IMF package unraveling. What will West do next?” • June: Die Welt: “Deutschland sollte die Währungsunion verlassen „? • Panic ? = safety within borders? „every man (state) for himself“! I
  • 3. LOGGED IN THE WARD ROOM 1. EU/EA Stabilisation fond? • Haiku van Rompuy*/ plus heads of state 7th May/ meet a new deal to agree • President Rompuy/ & 3 Spanish econ grads/ PR 2 am, 10th May • Announce fund set up/ €720 billions/ for state-aid loan grant bail-outs • SPV format/ Bankruptcy Remote concept?/ to assure wolfpack markets? • Big as an IMF if/ but no board, bank account, or…/ vaunting Barroso** power? • Normally takes years/ e.g. EIB – EBRD / guile sans skill: amateur hour! • Sub-rosa: it‟s TARP again/ will MEPs play Congress/ vote a slice plus oversight? ____________________________________________________________ * Van Rompuy Presidency 2009-2012 Invented “asymmetrical translation” e.g. European Council = "le gouvernement économique“ / "economic governance" ** Barroso Commission 2004 -2014 incompetently desperate to get hold of a major reserve fund II
  • 4. Wolf pack v. euroConvoy Atlantic War new game version? • Market Speculators „Wolf Pack“ • $tens billions of profit plays • Players choose save or destroy € euro-system • Investors briefings on € /EA break-up: – Sell Belgium, Spain, Greece, Portugal stocks – Buy Bunds, sell Dax (DM? Exports ) – Buy Italian stocks (Lira? Exports ) – France neutral (hold, subject to downward revision) – Buy $, £ (safe havens) & – leverage & arbitrage derivatives & shorting Euro & banks: big money gains for hedge funds? III
  • 5. EU/EA crisis a crisis of mixed metaphors • EU 3 P‟s: Prejudice, Prudence, or Profligacy? • EU 3 C‟s: Capital, Credit, or Competitiveness? • EU 3 B‟s: Budget, Balance, or Bankruptcy? • not about moral virtues (that‟s callous political spin) • it‟s EU jigsaw of trade, payments & bank lending • each member finds its own efficient growth path • they cannot all follow export-led or credit boom or a mix • EU = different economies united, not a single economy! • EU/EA system has to embrace economic risk diversity! • EU/EA is world economy scaled 1/3; it is not a single economy state IV
  • 6. Eine Reise ans Ende des Verständnis 6
  • 7. Provocations 1 POLITICAL-ECONOMICS IS A SCIENCE… OF PROPAGANDA OTHERWISE IT IS A SOCIAL SCIENCE SYSTEM OF ECONOMIC ACCOUNTING • Public finances are not “in a mess” ! • …unless private finances are a Greek Tragedy? • Countries perforce have different growth strategies • Export-led growth forces others into credit-boom & vice versa – New fashion ignored external accounts & their financing for „money supply‟ (so-called „new paradigm‟ for growth = „credit-boom‟ growth?) – Extreme imbalances in world trade: credit-boom / export-led economies = net financial assets = payments deficit/surplus = pay for trade deficits & finance credit boom = asset bubbles & growing banks‟ funding gaps – High bank funding cost wiped out net interest income = Credit Crunch = trigger of Anglo-Saxon recession & temporary global shock 1a
  • 8. Provocations 2 • Bank lending patterns dictate GDP growth strategies • Economies not made safe merely by balanced budgets! • Crowding Out theory = myth of public/private competition • Other „crowding out‟ = real problems in composition of bank lending: earnings v. property as borrower collateral • Lower public deficits = lower private surpluses • Micro-model theories = macro-stupid! • Savings, growth, competitiveness, productivity, & zero-sum ideas are entirely different at – macro & micro levels – domestic & international levels 1b
  • 9. In the Conning tower • PRIMITIVE visual GUIDANCE CONTROL SYSTEM • Authorities* have no macro-economic models for analysing Finance in detail! • Basel II tasked banks to build such systems; they didn‟t, couldn‟t, wouldn‟t! • For factors – Dictating the Credit Crunch or – Measuring interventions or – Understanding banks in economies, or – Income, trade, payments in growth! • & not now (despite G20 tasks that assume such models exist!) • Most effort is in behavioural games theory models! • Economics as double-entry accounting standards was lost to politics • Econ teaching is empirically poor, math-algorithmic absurd bubble! • Mythos of “hard choices”: but can refinancing & recovery be self-financing? • Governments cannot agree a self-financing painless path? _________________________________________________________ 2 * Central banks, government finance ministries, regulators, major banks, NGO banks
  • 10. EURO SYSTEM-KRISE Maastricht SGP too crude Multi-national sovereign EURO SYSTEM DESIGNED TO BE PROOF AGAINST MARKETS NOW DEPTH CHARGED by markets & gunslinger politicians Causes - Not GOVERNMENT DEBTS (political not technical problems) - OPPOSING (complementary) INTRA-EU external accounts - CREDIT BOOM v. EXPORT-LED v. MIXED MODERATE states Effects - PIGS‟ external deficits cannot be funded without fiscal austerity? - Bond markets impose higher margins on CB deficit states & - countervailing v.low margins on external EL surplus states - Credit-Crunch scandal effectively replayed at Governments 3 - hits banks again & other sectors but now per sovereign borders.
  • 11. ENGINE ROOM BLIND OR BLINKERED?? BLINKERED? Traditional economists’ view: financial sector should not have macro- economic significance Is this - MAD, LAZY, FOOLISH, DANGEROUS and/or Irresponsible - BANKS DIDN‟T KNOW OR CARE EITHER WAY ! Regulation - BASEL II brilliantly DESIGNED TO CURE THIS, BUT PILLAR II of it NOT COMPLETED BY ANY BANKS! 4
  • 12. WHO SETS COURSE HEADINGS? Composition of bank lending reflects, causes & amplifies a country‟s growth choice (export-led EL, credit-boom, CB or a mix?) (Not discussed in debates among economists, regulators, governments, or media. ) Export-led Germany & others (also China): 60% lending to business, capital investment & trade = low consumer & mortgage lending. High deficit credit-boomers: UK, Greece and Spain, banks‟ customer lending is 60-70% to mortgages & property (also USA). Bank lending in both EL & CB states is risky because banks do not diversify across whole economy. Bank balance sheets are as fragile in EL as in CB countries! 5
  • 13. UK & De bank lending „crowding out’ in bank lending? UK customer loans = 165% /GDP ratio (€2.5tn, $3.5tn) De customer loans = 78% /GDP ratio (€2.3tn, $3.2tn) UK mortgages ($2.1tn) = 58% of loans, > 75% residential De mortgages = ($1.53tn) = 44% of loans, < 50% residential UK h‟hold loans ($1.95tn) = 55% of loans (87% / GDP) De h‟hold loans ($1.39tn) = 55% of loans (43% / GDP) 4
  • 14. Bank credit support or not for INDUSTRY & TRADE? UK loans businesses = 45% customer loans (but 50% = com. mortgages & property) UK non-property loans = 23% of cust. loans or 37% /GDP. De loans to industry = 56% or 44% / GDP of which 25% is mortgages/property. UK tradable goods industry sectors get bank credit = 5% /GDP De industry loans = 33% /GDP, of which tradable goods = 30% /GDP UK (non-financial) business output = £590bn (£300bn services, £290bn industry, of which manufacturing £240bn). nf all business incl. services bank borrowing = £900bn = 152% /sector GDP, or 76% ratio (excluding commercial mortgages ) De domestic bank credit excl. mortgages to German industry = 163% of sector GDP UK figure is 76% of industry sector GDP. UK banks extend $100bn of credit to support $350bn exports = 28% ratio De banks extend $620bn credit supporting $1.5tn exports = 41% ratio 5
  • 15. Debt burden on De industry & banks LOGIC BEHIND MERKEL‟S TOUGH-LOVE STANCE IN EA SOVEREIGN DEBT DISPUTE? High exposure by De banks to industry (business loans are lowest margins) = De sovereign debt spreads v. critical to banks‟ net interest income = in EA sovereign debt crisis De priority = De sovereign debt needs far lower risk margin than other EU sovereigns! Or, banks & corporates risk insolvency losses. 6
  • 16. Die Heimat gefährdet ? De BANKS VULNERABLE TO CREDIT Sovereign debt prices directly influence banks‟ & DEFAULTS AS TRADE & MARGINS FALL & corporates‟ credit status & debt costs, not just BANKS TO REFINANCE €0.5tn IF CANNOT government borrowing cost! GET LOWEST RATES!? De industry's debts= 160% /industry’s gross output Sovereign bonds De industry debt servicing =10% / gross spreads & yields operating surplus for years 2007 – GDP forecasts are 1/3 lower than UK 2010 /German Bund UK industry debt servicing = 4% / gross operating surplus, Debt servicing for all UK business = 13% /profit in ‟08 & 9% in ‟09 GDP forecasts are sharply higher than De In „04-‟08 EL‟s GDP grew fastest now endogenous CB‟s GDP higher in medium term… except EA‟s PIIGS! 7
  • 17. De in EU/EA EU/EA De trade & surplus = same size as China‟s 60% is intra-EU but De ex-EU trade surplus halves EU external deficit De in EA nf private sector lending = 22% of EA total Lending to business = 25% of EA total nf customer lending = 21% of EA total despite nf private customer lending in EA = 107%/GDP compared to De = 78% /GDP De economy in EA is like USA % in world USA in the world is an extreme credit boom economy De in Europe is an extreme export-led economy ____________________________________________________ nf = non-finance sector (business excluding banks etc.) 9
  • 18. Greece extreme credit boomer Greek Banks' Loans by Sector as % ratios to GDP GREECE FOLLOWED 30 OTHERS „ MODELS - IRELAND, UK, USA, 25 SPAIN & PRAISED IN EU FOR HIGH GROWTH 20 CONTRIBUTION TO EU FOR YEARS! 15 RECESSION WIPED OUT 10 90% OF GREEK BANK CAPITAL. BUT THAT IS ON 5 A PAR WITH UK, USA, OTHERS‟ BANK CAPITAL 0 IMPACTS. 2005 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2006 Tourism Services Industry Shipping Consumer Other Personal Res.Housing Finance 10
  • 19. Competitiveness: reality & illusion 300 275 EU Trade EU Balance 250 275 Balances of Payments $ billions 225 $ billions 250 200 225 GERMANY GERMANY 175 FRANCE 200 FRANCE 150 UK UK 175 ITALY ITALY 125 150 SPAIN SPAIN 100 NETHERLANDS NETHERLANDS 125 POLAND 75 POLAND 100 AUSTRIA AUSTRIA 50 DENMARK DENMARK 75 25 GREECE GREECE 50 PORTUGAL PORTUGAL 0 FINLAND FINLAND 25 -25 IRELAND IRELAND 0 CZECH -50 CZECH -25 SLOVAKIA SLOVAKIA -75 LUXEMBOURG LUXEMBOURG -50 -100 -75 -125 -100 -150 11 2007 2008 2009 2007 2008 2009
  • 20. Credit boom V. export led GDP of 6 Credit Boom CB economies incl. USA and UK v. GDP of 10 $ billions Export Led EL economies incl. Japan, Germany &China. 20000 19000 credit-boom: USA, UK, Spain, others 18000 export-led: China, Germany, Saudi Arabia, Netherlands, Russia, S.Korea, 17000 CB others EL 16000 modest mix: France, Italy, Belgium, Switzerland, RSA, Mexico, others 15000 strong mix: India, Brazil, others 14000 2005 2006 2007 2008 2009 60,000 $ Bn US banks flow Note dependence of inter- of funds by sector bank lending in USA to 50,000 household mortgage and Households 40,000 consumer lending. Non-financial business The opposite prevails in 30,000 export-led where inter- All public sector bank lending is tied to 20,000 business lending. Financial firms 10,000 Rest of the world 0 12 2000 2002 2003 2004 2005 2006 2007 2008
  • 21. COMPARING BANK LENDING USA & prCHINA $ trillion rounded % Dec.’09 % GDP $ trillion rounded Dec.’09 Increase in ‘09 Bank & other lending 21.3 150 Financial 4.0 Bank Deposits 9 27.7 Enterprises 4.8 Of which: By enterprises 3.3 36.5 Loans & corp. bonds 3.2 By households 3.9 19.5 Commercial mortgages 1.6 Of which: Rmb Deposits 3.8 19.7 Real estate 2.6 Households 14.0 102 By Government Foreign Of which mortgages 1.8 10.8 currency Consumer credit & lease finance 3.2 Bank Lending 6.3 33.0 Bank & Other Liabilities 21.3 150 Of which: Short-term 2.2 17.7 Non-financial Deposits 7.3 50 longer-term 3.5 43.5 Money Market depos 3.0 Trading 0.8 FC Reserve loaned to banks 2.4 600 Central bank Other 0.6 2.3 Other 2.6 Enterprises Of which: 4.8 Banks reserve capital 1.1 Households 1.2 Equity 1.5 Other 0.3 Inter-bank debt 3.7 USA economy 5-7 times bigger than PR China (depending on whose adjusted GDP figures) USA bank lending = 150%/GDP, China = 2-300%/GDP. China lending to industry (half of which is funded by loans of all of China‟s foreign reserves) matches the total for the USA i.e. China‟s industry is severely over-borrowed and the economy is vulnerable to downturn in world trade and fall in net exports (& commercial property collapse?). 13
  • 22. USA 65% of credit to households, Some more comparisons 22% to medium & large Enterprises 10% to small firms incl. self-employed. 70% of total exposure is property-related, This chimes with UK, Spain, Greece, Ireland. UK banks lend too much to h‟holds for property (70% /total customer loans) Manufacturing (17%/GDP export 13%/GDP) PR CHINA =3.5% business loans (1.5%/GDP) 75% loans to business Construction (5%/GDP) = 4.5% /business loans 19% to households (=2%/GDP) nf firms debt =173% /total output Small firms & self employed get 1.5% of all loans Net debt of enterprises =114% /output! yet employ 50% priv. sector jobs! Households borrow 30% of h‟hold deposits. German banks loan too much to industry at UK & USA lending to h‟holds = 100%/GDP 56% / total customer lending of which 70% = residential mortgages 29% /business loans are to small firms & self-employed =10 x UK %. China h‟hold loans =25%/GDP mortgage & consumer finance are small. 14
  • 23. Back to port sovereign debt & Euro system 1 Banks & EU states need government borrowing to - boost private sector assets & reflate economies - improve quality & quantity of banks‟ capital reserves - finance trade deficits Fiscal & Monetary measures - are clutch & accelerator pedals, not steering wheel - do not restructure, or - change type of economic growth direction - we leave steering to banks & free market - who do not navigate on basis of national macro economics 15
  • 24. Back to port sovereign debt & Euro system II Maastricht Criteria /EU’s Growth & Stability Pact - Ceilings & hurdles to cap member states‟ borrowing in reference only to GDP ratios ! - Other factors ignored incl. bal. of payments (anomaly Ireland: economy far smaller than its GDP?) - Only gross not net National Debt - Deficit & debt ratios scaled to GDP (not GNP) & don‟t take account of ext. trade & payments (supposed benign intra-EA & EU but Greece shows not so) - Ignores currency of debt & private debt levels, & domestic versus foreign ownership of debt (EA=domestic?) 15
  • 25. Back to port sovereign debt & Euro system III Solving EU/EA Sovereign Debt Crisis requires system to: - Recognise differing/opposing growth stances e.g. CB & EL, & - Intra-EU/EA imbalances, on & off government budgets - Regulatory supervision to compel banks to rebalance lending. - Does not directly require aligning tax or fiscal stances. 15
  • 26. Concludings A-E (time permitting?) unsere Krise riskiert eine riesige Sicherheitskatastrophe 26
  • 27. A • De was in heart of EU „generous’ to secure Europe. EU, • De is the protagonist in Euro Krise, bringing integration into a crunching of gears. • € incomplete : monetary union sans political union, ECB sans central treasury (not insoluble). • EA states are alone on sovereign debt weakened sans treasury money market flexibility. • ECB accepts sovereign debt of all EA equally, same interest rate as Germany, but not a solution. • Banks loaded up with PIIGS debt until 2010. PIIGS‟ A
  • 28. B • After Sept. „08, EU Council guarantee no big banks will default. De insists each state to care for its own. • Capital moves with guarantees, interest-rate differences in EA stay small. • Hungary & Baltic states rescued. • As markets cage-rattle sovereign debt, interest-rate differentials widen. • Greece the battleground. • EU authorities slow. EA members hold opposing views. • De insists on S&G Pact‟s “no bail-outs”. • Greek crisis festers, contagion spreads. B
  • 29. C • EU forced into bigger rescue package than if it‟d reacted quicker. • Markets see terms as punitive, fiscal consolidation harder, can‟t see how PIIGS can fly: • Close trade deficits & revive growth sans currency depreciation? (Euro system break-up) or risk deflation. • Can push EU into long stagnation (late „90s early „00s) = social unrest (at worst, xenophobic extremism). • De has major responsibility as biggest trade surplus, most creditworthy country (externally, not internally) C
  • 30. D • De unwittingly imposes deflation on EA (itself included & next recession imminent). • De public cannot see the harm because of how the € works. Soros says, “deflation will serve to make Germany more competitive on world markets, while pushing the weaker countries further into depression and increasing the burden of their debt”. • No, this is a two-sided coin; De will also fall. D
  • 31. E • If De left €, Dm would soar, € & De exports plummet. • Rest of Europe more competitive to grow its way out but Germany crucified by overvalued currency (like Japan). • De trade balance evaporates, businesses default & unemployment soars (extreme political crisis). • De Banks require v.large injections of gov. funds. • Hypothetical - if De left €, consequences are immense, unthinkable beyond making sure this cannot happen! E
  • 32. €ötterdämmerung darf nicht wahr sein schon am Ende vom €uro BOOT? 32