December 28, 2011 8:03 pm

Grim lessons from the 30 years war



The financial crisis has given rise to several historical comparisons, not least the Great Depression. I would like to invoke another for the eurozone crisis – the 30 years war, which ravaged central Europe from 1618 to 1648.


Both the eurozone crisis and that terrible war occurred amid sudden power shifts; they were triggered by seemly trivial events; and they became incredibly complicated. They are also marked by sudden regional power shifts.


Before 1618, the Holy Roman Empire was almost equally divided into Catholic and Protestant electorates. The truce ended when the balance of power shifted with the ascension in 1617 of the Catholic Ferdinand as king of Bohemia, who was one of the seven electors of the emperor.


The actual war started a year later when rebels threw some of the king’s advisers out of a window. The famous defenestration of Prague triggered the first battles of a war between Protestants and Catholics, which went completely out of control. The war had four phases, and drew in outside nations – the Danes, the Swedes and finally the French.


The eurozone, too, has been subject to an internal power shift in the past five years, with the relative rise of German economic power. The eurozone crisis also had a comparatively trivial trigger, a fiscal meltdown of a small country at its outer perimeter. This too unleashed a wider economic conflict between a largely Protestant north and a Catholic/Orthodox south. When the eurozone’s modern rulers assembled in Brussels this month to sign the modern equivalent of a peace treaty, they were interrupted by the cross-current of a much older conflict – a UK-versus-the-rest dispute. So instead of one peace treaty, they ended up with two overlapping and interacting conflicts. Europe is once again getting absurdly complicated.


I do not wish go overboard with the parallels. The German regions lost between 20 and 45 per cent of the population between 1618 and 1648, as a direct and indirect consequence of the war. What is happening in the eurozone today is not war, nor likely to lead to one. And, no, I am not predicting that the crisis will last 30 years. It might, however, end in an economic devastation of a similar scale, especially if the German-imposed austerity policies are implemented everywhere and in full.


There are other obvious differences. Nobody is fighting over land any longer. One of the undoubted achievements of the European integration process has been the transformation of conflicts into theatrical late-night summit disputes that are so much at the heart of political life in Brussels. We have of course progressed.


But what remains unchanged from those times are the underlying cultural conflicts between Protestants and Catholics, north and south, Britain versus the Continent. The many decades of European integration have not ended this fundamental mistrust. This is also one the reasons why the Europeans have created such an irrationally unbalanced monetary union. Its rules were not the result of a rational economic argument, but designed to allay very old German suspicions.


I see the most disturbing parallels between the way the 30 years war has ended and the way Europe’s political leaders are setting about to resolve the current crisis. In 1648, the Spanish and the Dutch ended their bilateral 80-year war. The Netherlands became independent. In the subsequent peace treaties, the German Protestants regained their influence. In return, Bavaria and Brandenburg became independent states, the latter giving rise to the kingdom of Prussia half a century later. The Holy Roman Empire continued as an empty shell until it was formally dissolved some 150 years later. The war brought about the fragmentation of continental Europe, followed by 300 years of utter carnage.


The crisis management in the eurozone may also end in fragmentation. I see the three following scenarios as the most plausible outcomes: a political union with a joint debt instrument; the status quo enforced by eternal austerity; or a break-up.


No matter which is chosen, it may also lead to an unstable equilibrium. A political union would solve the narrow crisis, for sure, but may weaken democratic legitimacy, and may thus become unstable. German-imposed austerity is the solution most likely to trigger political extremism and violence. It is also inherently unstable because it imposes the economic doctrine of one country on another. A break-up of the eurozone will, at worst, destroy the European Union itself or, at best, return us to the situation of the early 1970s.


The treaty of Westphalia ended the 30 years war in 1648. It was the early modern period equivalent of what Herman Van Rompuy, the president of the European Council, would nowadays call a comprehensive resolution.


Neither addresses the underlying conflicts. The 30 years war shows that we Europeans have been delaying making the necessary hard decisions for a long time.

Copyright The Financial Times Limited 2011.

Two Models for Europe

Hans-Werner Sinn

2011-12-29



MUNICH – Interest rates for public debt within the eurozone have spread once again, just as they did before the introduction of the euro. Balance-of-payment disparities are steadily increasing. The sovereign-debt crisis is eating its way from the periphery to the core, and the exodus of capital is accelerating. Since the summer, €300 billion, in net terms, may well have fled from Italy and France.


The printing presses at the Banque de France and the Banca d’Italia are working overtime to make up for the outflow of money. But this only furthers the exodus, because creating more money prevents interest rates from rising to a point at which capital would find it attractive to stay.


If Europe had the same rules as the United States, where the Federal Reserve’s regional banks have to pay the Fed for any special money creation with securities collateralized in gold, they would not create this much supplementary money, and capital flight would be limited. Instead, local printing of money is essentially aiding and abetting the exodus.


If the eurozone does not want to embrace capital controls, it has only two alternatives: make the local printing of money more difficult, or offer investment guarantees in countries that markets view as insecure.


The first option is the American way, which also demands that the buyers bear the risks inherent in public or private securities. The taxpayer is not called upon, even in extreme cases, and states can go bankrupt.


The second option is the socialist way. Investment guarantees will lead, via issuance of Eurobonds, to socialization of the risks inherent in public debt. Because all the member states provide one another with free credit guarantees, interest rates for government securities can no longer differ in accordance with creditworthiness or likelihood of repayment. The less sound a country is, the lower its effective expected interest rate.


The socialist way follows necessarily from the free access to the printing press that has so far characterized the eurozone. As long as banks – and thus governments, which sell their debt to the banks – can draw cheap credit up to any amount from the European System of Central Banks, Europe will remain volatile. The exodus of capital will continue, and enormous compensation claims of the European core’s central banks, particularly the German Bundesbank and the Dutch central bank, will pile up.


In Germany, these compensation claims amount to half of the country’s entire net foreign wealth, or €500 billion ($653 billion). Since these claims would probably be lost should the euro collapse, the political pressure to give way finally to Eurobonds is becoming overwhelming.


But German acquiescence would be a disastrous result for Europe. The European Financial Stability Facility in Luxemburg would become a socialist planning agency, organizing flows of public capital in Europe and thwarting markets’ allocative function. The consequence would be reduced growth, owing to a misallocation of scarce capital, and economic stagnation in the core areas.


Matters are made no better by controlling credit flows via a fiscal government, which is what the eurozone countries have now decided they want. As long as the debtors co-determine the rules, more capital will flow under such an arrangement than markets would permit.


That distortion will become apparent even within the countries that benefit from the additional credit, because Eurobonds will, for the time being, provide security only for government debt. Private debtors will continue to have difficulties finding capital, so the state will expand relative to the private sector. The ECB’s founding chief economist, Otmar Issing, has referred to this as a road to serfdom.


But it is not a smooth road, because it threatens resistance by the capital-exporting countries’ taxpayers and trade unions against the outflow of capital. In Germany, in particular, enormous resistance will build up if the country – via the introduction of Eurobonds – is driven back into the crisis that it underwent as a result of the interest-rate convergence that followed the introduction of the euro.


Only the American alternative is viable. Short- and long-term interest-rate spreads are determined by the economy’s creditworthiness, and whoever wants low interest rates has to provide real collateral.


The American route does not necessarily imply a heavy-handed approach vis-à-vis the crisis countries. It can be combined with a system of measured, limited help in the sense of partial coverage of investors against a country’s insolvency.


This model, contemplated by the European Economic Advisory Group at CESifo, would retain the disciplinary effects of interest-rate spreads while capping them in order to limit panicked extremes in the capital markets. It offers the last chance to avoid debt socialism.

Hans-Werner Sinn is Professor of Economics and Public Finance, University of Munich, and President of the Ifo Institute.



Gold Near-Term Outlook 2012

by: Peter Grant

December 29, 2011



Gold is consolidating below $1600 as we enter the last week of the year. The last London gold fix of 2010 was $1405, so barring any dramatic price changes in the last week of the year, the yellow metal is on-track for yet another double-digit gain of about 14%.

That's pretty impressive given the dramatic delveraging sell-off from the 1920.50 record high we saw in September, which prompted all manner of commentary proclaiming the end of gold's decade-long rally. More recently — amid another bout of deleveraging associated with rising uncertainty about the fate of European Union — the yellow metal retested the September low at 1534.06 along with important channel support. While much was made of the technical damage done by the recent move below the 200-day moving average, gold continues to display good resilience, underpinned by solid fundamentals.


Monthly Gold Chart
click to enlarge


Daily Gold Chart



Those supporting fundamentals are unlikely to change any time soon as the world continues to seek solutions for an overwhelming level of debt and anemic growth prospects. Thus far, the focus remains on creating more of what is arguably to primary source of the problem: debt.


Of course, someone needs to buy that debt, so we have also witnessed unprecedented — and in some instances "unlimited" — liquidity pumps to perpetuate the now institutionalized game of "hide the debt." I don't think that anyone really believes that more debt is really the answer to our global debt crisis, but in staving off a complete economic catastrophe several years ago with massive deficit spending and liquidity schemes, the United States effectively set the tone.


Actually, the US was simply following the example set by Japan more than 20-years ago: drive interest rates to zero and hold them there by printing currency and buying bonds with it.


In fact, Japanese debt is fast approaching ¥1 quadrillion! That rather ominous benchmark is expected to be surpassed by the end of Japan's fiscal year in March. The BoJ's balance sheet is a startling ¥138 trillion.


Meanwhile, the Fed's balance sheet has contracted in recent months, but is still in excess of $2.7 trillion. But perhaps most troubling is the expansion of the ECB's balance sheet. Despite their persistent assurances that quantitative measures simply aren't an option, the ECB's balance sheet has grown by nearly a third, approaching €2.5 trillion. Hey Mr. Draghi, if you're not engaged in QE, explain that exploding balance sheet.


There are policymakers in Europe, including ECB board member Lorenzo Bini Smaghi, that favor true — or at least un-obscuredquantitative easing by the ECB to prevent another recession in Europe. Imagine the implications for the central bank's balance sheet if the objections are ultimately circumvented.


Late in December, the ECB unleashed a wall of money, €489 billion ($638 billion) in 3-year LTROs to 523 eurozone banks. The positive reaction to all this new liquidity was very short-lived. The euro remains under pressure and eurozone spreads have widened back out.


As the FT's Gillian Tett pointed out in a recent column, the hope was that the banks would use this abundance of cheap ECB money to buy European sovereign debt, much in the same way that US banks plowed the proceeds from mortgage backed securities sales to the Fed into US Treasuries.


Basically, the private sector ends up financing the government with funds provided by the government. Being in the middle of this financing cycle results in a potential profit bonanza for the banks.


ZIRP and liquidity. Liquidity and ZIRP. From here to eternity.


There are growing rumblings that the Fed is about to extend their ZIRP guidance from mid-2013 out to 2014 and potentially beyond. I'm sure when the BoJ launched their quantitative measures they were expected to last maybe a couple of years. Here it is 20 some years later and Japan still has 0% interest rates. Do you suppose this is our fate as well?


Some of the major financial firms are predicting lofty average gold prices for the coming year: Goldman Sachs $1810, Barclay's $2000 and UBS $2050 to name just a few. We maintain that the long-term uptrend in gold is protected as long as we remain in a negative real interest rate environment.


This in fact seems all but assured for quite some time. On top of that, the ongoing expansions of debt, monetary bases and central bank balance sheets, along with broadly positive supply/demand dynamics highlighted by robust investment and central bank demandconspire to underpin gold as well in the new year.



It’s time for the IMF to stand up to the European bullies

Mohamed El-Erian

December 29, 2011



Sovereign risk was a principal theme in 2011most visibly in Europe and, to a lesser extent, in America’s loss of its triple A rating. Along with poor growth and rising inequality, it will continue to raise serious questions next year about the functioning of the global economy. As this occurs, one institution – the International Monetary Fund – will attract special attention. The key question is whether it can finally step up to the role of global conductor, rather than suffering yet more erosion of its credibility.


The sovereign risk crisis has not been kind to the IMF, especially when it comes to Europe. There is no denying that too many of the adjustment programmes it has overseen have fallen short of their objectives. Whether it jumped or was pushed, the institution sacrificed some of its own rules, including those previously deemed sacrosanct.


For two years, the IMF agreed to a series of programmes that were partially designed, inadequately funded and, in some cases, even threatened its preferred creditor status. In each case, the IMF ended up supporting a weak attempt to muddle through, rather than a plan sustainable in the medium term.


This shortfall has accentuated prior concerns about the IMF’s governance, representation and legitimacy. The damage has been material, though fortunately not irreversible.


Don’t get me wrong. This is not about the IMF’s ability to be an agent of good for the global economy. After all, it is endowed with considerable influence, global standing and talented staff. Rather, it is due to political pressures from Europe.


Many countries interpret the IMF’s actions in Europe as confirmation that they are members of an institution that speaks about uniformity of treatment but makes large exceptions for its historic masters. As the institution’s credibility and balance sheet suffer, its programmes are less effective in attracting co-financing from the private sector.


The world needs a strong and legitimate multilateral institution if it is to avoid costly fragmentation; and Europe needs a credible IMF to help it overcome a deepening crisis. This will only be achieved if there is a change next year in the overly cosy relationship between Europe and the IMF.


What is required goes beyond enlightened restraint on the part of European leaders. The IMF must find the courage to resist European bullying; and the rest of the world must help by making a collective effort to accelerate reform of the institution’s governance and representation. Only then would an enhanced IMF be able to help the global economy back to growth and jobs.


The writer is the chief executive and co-chief investment officer of Pimco.


When China Rules

Ivan Krastev

2011-12-28




VIENNA – For a European these days, thinking about the future is disturbing. America is militarily overstretched, politically polarized, and financially indebted. The European Union seems on the brink of collapse, and many non-Europeans view the old continent as a retired power that can still impress the world with its good manners, but not with nerve or ambition.


Global opinion surveys over the last three years consistently indicate that many are turning their backs on the West and – with hope, fear, or bothsee China as moving to center stage. As the old joke goes, optimists are learning to speak Chinese; pessimists are learning to use a Kalashnikov.


While a small army of experts argues that China’s rise to power should not be assumed, and that its economic, political, and demographic foundations are fragile, the conventional wisdom is that China’s power is growing. Many wonder what a global Pax Sinica might look like: How would China’s global influence manifest itself? How would Chinese hegemony differ from the American variety?


Generally, questions of ideology, economics, history, and military power dominate today’s China debate. But, when comparing today’s American world with a possible Chinese world of tomorrow, the most striking contrast consists in how Americans and Chinese experience the world beyond their borders.


America is a nation of immigrants, but it is also a nation of people who never emigrate. Notably, Americans living outside the United States are not called emigrants, but “expats.” America gave the world the notion of the melting pot – an alchemical cooking device wherein diverse ethnic and religious groups voluntarily mix together, producing a new, American identity. And while critics may argue that the melting pot is a national myth, it has tenaciously informed the America’s collective imagination.


Since the first Europeans settled there in the seventeenth century, people from around the world have been drawn to the American dream of a better future; America’s allure is partly its ability to transform others into Americans. As one Russian, now an Oxford University don, put it, “You can become an American, but you can never become an Englishman.” It is, therefore, not surprising that America’s global agenda is transformative; it is a rule-maker.


The Chinese, on the other hand, have not tried to change the world, but rather to adjust to it. China’s relationships with other countries are channeled through its diaspora, and the Chinese perceive the world via their experience as immigrants.


Today, more Chinese live outside China than French people live in France, and these overseas Chinese account for the largest number of investors in China. In fact, only 20 years ago, Chinese living abroad produced approximately as much wealth as China’s entire internal population. First the Chinese diaspora succeeded, then China itself.


Chinatownsoften insular communities located in large cities around the world – are the Chinese diaspora’s core. As the political scientist Lucien Pye once observed, “the Chinese see such an absolute difference between themselves and others that they unconsciously find it natural to refer to those in whose homeland they are living as “foreigners.”

While the American melting pot transforms others, Chinatowns teach their inhabitants to adjust – to profit from their hosts’ rules and business while remaining separate. While Americans carry their flag high, Chinese work hard to be invisible. Chinese communities worldwide have managed to become influential in their new homelands without being threatening; to be closed and non-transparent without provoking anger; to be a bridge to China without appearing to be a fifth column.


As China is about adaptation, not transformation, it is unlikely to change the world dramatically should it ever assume the global driver’s seat. But this does not mean that China won’t exploit that world for its own purposes.


America, at least in theory, prefers that other countries share its values and act like Americans. China can only fear a world where everybody acts like the Chinese. So, in a future dominated by China, the Chinese will not set the rules; rather, they will seek to extract the greatest possible benefit from the rules that already exist.


Ivan Krastev is Chairman of the Center for Liberal Strategies in Sofia and a Permanent Fellow of the Institute for Human Sciences, Vienna.

Copyright: Project Syndicate/IWM, 2011