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Email From 'An Irate German' Over the Transfer Union; German Bank Exposure by Country...

Harvard Economist Seeks 'Transfer Union' and US Inflation

An "Irate German" sent an Email this morning about the European Nanny State and more specifically about the EuroZone "transfer union" that will strip Germany of wealth to bailout the rest of Europe.

Before we get to the Email, let's first take a look at the size of German bank exposure to the rest of Europe and a call from an economics professor just today for exactly the kind of "transfer union" my reader opposes.

Risks to German Banks

Der Spiegel has interesting graphs and commentary in a German-to-English translation Merkel's rescue experts reject Italy

According to SPIEGEL, experts doubt whether Italy could be rescued by the European EFSF rescue - even if the fund tripled. There are currently 440 billion euros in the fund, after deduction of the Greek aid, and that is insufficient to support possible future shaky candidates.

That is my modified translation. Here are a couple of charts.

Image 1

Image 2

'Some European Countries Are Fundamentally Bankrupt'

In an interview on Der Spiegel, Kenneth Rogoff, a professor of economics at Harvard University, makes the case 'Some European Countries Are Fundamentally Bankrupt'.

My comments are embedded inline.

SPIEGEL: With the turmoil on the global stock markets, is the world staring into a new financial abyss?

Rogoff: Mainly, the markets are simply adjusting to the reality of a continuing slow and halting recovery. They realize there will be no boom anytime soon. Wall Street forecasters, and many central banks, had been starting to think that there was going to be a sharp uptick in the recovery. But they have got this wrong again and again because they keep wanting to use normal postwar recessions as a frame of reference. But this is a post-financial-crisis recovery, a rarer and very different animal.

Mish: So far so good. In fact it is perfect.

SPIEGEL: What effect has that perception had?

Rogoff: The mentality that this is just a big recession, "the Great Recession," has led to wrong policy decisions, such as the premature end of quantitative easing by the US, and the belief in Europe that there is a brisk recovery around the corner that will save the day and enable policymakers to avoid tough decisions on periphery country debt. In reality, this was a different kind of downturn, which would have been better termed the "Second Great Contraction," because it involved a prolonged shrinking of overextended global balance sheets and a tightening of the credit system. Right now, the recovery from this needs more monetary stimulus, especially in the US.

Mish: The idea we need more monetary stimulus is patently absurd. There is $2 trillion in excess reserves parked at the Fed and banks simply are not lending. Increase base money supply by another $2 trillion and they will not lend that either. Banks are capital constrained not reserve constrained. Moreover, credit-worthy businesses do not want to borrow in the first place.

SPIEGEL: Is that likely? The current debate in the US is focusing on cutting back government expenses and reducing debt. Would higher inflation be a way out?

Rogoff: If you happen to be on the board of a central bank, you have to be willing and able to stand up to popular opinion. Many people even consider moderate inflation heresy. But we are in a perfect storm here. I am not saying we should have hyperinflation or double-digit inflation, but I believe that central banks should accept somewhat elevated core inflation for several years, higher than the normal 2 percent. Whereas I believe monetary stimulus is coming, I am worried that it will not be forceful enough to have any material effect on balance sheets.

Mish: Monetary stimulus will not do anything good for reasons noted above. However, it will make the Fed's exit problem far bigger down the road.

SPIEGEL: Does the US also need another stimulus program? Larry Summers, a former top adviser to President Barack Obama, says that cutting back on government spending in the middle of a downturn will kill economic growth and employment.

Rogoff: People asking for a fiscal stimulus are looking at the wrong model. They think this is just a big, but typical, recession. But it is not. Policymakers need to focus on relieving overextended private balance sheets in the short run, and stabilizing public debt in the long run. A fiscal stimulus cannot be the main solution. It may provide temporary relief, but there will be no traction without some normalization of private debt levels. In Europe, of course, government debt itself needs to be sharply written down in some countries. The US will eventually come to the realization that something similar has to happen to some mortgages. Homeowners who accept this relief will have to make some significant concession, perhaps giving away some future appreciation if home prices go up.

Mish: Fiscal stimulus will not work, nor will monetary stimulus. Has anyone learned anything from Japan? The idea of homeowners giving up future appreciation is complete silliness. The best thing for deeply underwater homeowners to do is walk away. Many have. More will. Why give up future gains when you do not have to? It's better to walk. Moreover, there are numerous problems with even attempting such a program. For starters, securitization gets in the way.

SPIEGEL: What have politicians done wrong on both sides of the Atlantic during the latest financial crisis?

Rogoff: I just cannot understand how President Obama made so many concessions in the latest negotiations over the debt ceiling. He was holding all the cards and he was still stared down by the Tea Party. He should have said: "I do not negotiate with terrorists. If you want to bring down financial markets, it will be on your head. I am going to behave normally and responsibly." Instead, he got gamed into making giant concessions, and this has weakened the presidency. Perhaps the damage will not be lasting, but then next time the president may have to prove him or herself willing to accept a short technical default rather than give in.

Mish: Contrary to popular belief no cuts were made, rather nonbinding promises to make future cuts were made. Obama got exactly what he initially asked for: a debt ceiling hike with no strings attached. Thus, one can easily argue Republicans caved in, not Obama.

SPIEGEL: And the Europeans? Chancellor Angela Merkel was very reluctant to agree to a bailout for Greece.

Rogoff: It is not easy for a politician to do what needs to be done if it is unpopular. Greece needs a massive restructuring plan, Portugal as well, probably Ireland, too. Ultimately, Germany has to guarantee all the central government debt in Spain and Italy, and that will be very painful. If Italy and Spain are to be kept in the euro area, then unfortunately the Germans will have to acknowledge that Europe is going to be a transfer union for some time to come.

SPIEGEL: Is there an alternative?

Rogoff: Clearly it was a mistake to accept some of the southern countries prematurely into the euro zone, but there is now no other way to pay for their debt than through transfers. I would like to say it is only a one-time payment, but I do not think anyone in Germany still believes that and they should not. This is a long-term problem. Of course, Germany should extract major political concessions on the way, like the installment of a powerful European president or a European finance minister.

Mish: There you have it. An insane call for German taxpayers to bailout Spain, Italy, Portugal, Greece, and Ireland. Clearly Rogoff has not done any thinking about costs to German taxpayers.

Let's now turn our attention to an email that got my attention.

Email From An "Irate German"

Dear Mish,

I read Your comments on the markets and the economy nearly every day. I appreciate your work.

Today I am very angry. Trichet wants to buy Italian debt. I don't have to tell you that Italy has nearly the same amount of debt as Germany, but you cannot compare the economies. Italy is nothing but "Dolce vita and amore" [Sweet Life and Love].

A big wealth transfer from Germany to southern Europe is now in the works.

From my perspective,

  • German citizens pay for an EU that few want
  • German citizens pay for a Euro that most now wish we did not have
  • German citizens pay for the politicians in Brüssels that nobody wants and we certainly do not need.

All is not all is well in Germany. Sure if you work for BMW or BASF, you are doing O.K. However, if you work for a small business company, without an export component, life is not so easy.

Regards Marco, An Irate German

Marco is irate, and in my opinion he has every right to be. How dare economist fools like Kenneth Rogoff propose German taxpayers bail out all the rest of Europe without even giving those taxpayers a vote.

Will Germany Leave the Euro?

Last Thursday I asked the question: Another Major Feud Between the German Central Bank and the ECB Over Resumption of Bond Purchases; Will Germany Leave the Euro?

Jean-Claude Trichet is Out, Mario Draghi is In

Greek bonds blew up in Trichet's face and complete fools are clamoring for more of the same.

Bear in mind that Trichet steps down in October. Mario Draghi, head of the central bank of Italy takes over.

Will Germany Leave the Euro?

Will Draghi rebuff Italy's Finance Minister? The answer to that question turns our focus to the major unresolved question:

"Does Germany accept the monetization of foreign bonds at German taxpayer expense or does Germany leave the Euro?"

Ball in Germany's Court

Let's finish with another look at what I said in ECB to Buy Italian Bonds; Italy Seeks Constitutional Amendment to Require Balanced Budget; Ball in Germany's Court

Questions Abound

  1. Will Mario Draghi, head of the central bank of Italy, carry as much influence over the board when he takes over from Jean-Claude Trichet in October?
  2. Can Italy really balance the budget?
  3. Will all the governments ratify the proposed changes to the Maastricht Treaty?
  4. What is the potential cost of this backstop?
  5. How many pledged has Trichet broken in the past 2 years? Does anyone have a count?

That is more questions than I have answers. Moreover, please note that changes to the Maastricht Treaty must be unanimous. Germany and Finland will be very reluctant at best. Germany's constitution may need modification first. This is far messier than it looks, and it looks quite messy.

German Taxpayers on the Hook

Zero Hedge does a good job at question 4 in his post Explaining How The Just Announced ECB Market Rescue Pledged 133% Of German GDP To Cover All Of Europe's Bad Debt

Basically what just happened an hour ago, is that the ECB gave a green light to use the SMP program to buy Italian and Spanish bonds. The problem is that the SMP's unsterilized purchasing capacity is de-minimis and it is merely a stopgap until the sterilized EFSF is enacted in its final form.

The question is precisely what this final form will be: will it be €1.5 or €3.5 trillion? Nobody knows yet which is why Rehn refused to answer the question twice already today.

And here is where Germans get angry, because explicitly they end up backstopping everyone in Europe! And the cost to them becomes 133% of their entire economy in a worst case scenario, which of course in this centrally planned world, is now guaranteed.

So the ball is now basically in Germany's court.

Ball in Germany's Court

Without saying so explicitly, ZeroHedge just asked the question I asked yesterday: "Does Germany accept the monetization of foreign bonds at German taxpayer expense or does Germany leave the Euro?"

If the alternative is a transfer union wherein Germany backstops the entire rest of Europe, then yes, Germany should consider leaving the Euro. Bear in mind, should that happen, the rest of Europe would then default on debt owed to German banks. Thus, German taxpayers are going to be screwed one way or another.

Yet, from my perspective, ceding sovereignty to a European Nanny State for the sake of the EU would not be a good choice.

However, that is not for me to decide, fools like Kenneth Rogoff to decide, or even politicians like Chancellor Angela Merkel to decide. German citizens should be involved in this decision. The citizens of Iceland chose wisely, I think German citizens would as well.


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