Early Retirement for the Eurozone?
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Nouriel Roubini
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15 August 2012
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NEW YORKWhether the eurozone is viable or not remains an open question. But what if a breakup can only be postponed, not avoided? If so, delaying the inevitable would merely make the endgame worsemuch worse.



Germany increasingly recognizes that if the adjustment needed to restore growth, competitiveness, and debt sustainability in the eurozone’s periphery comes through austerity and internal devaluation rather than debt restructuring and exit (leading to the reintroduction of sharply depreciated national currencies), the cost will most likely be trillions of euros. Indeed, sufficient official financing will be needed to allow cross-border and even domestic investors to exit. As investors reduce their exposure to the eurozone periphery’s sovereigns, banks, and corporations, both flow and stock imbalances will need to be financed. The adjustment process will take many years, and, until policy credibility is fully restored, capital flight will continue, requiring massive amounts of official finance.



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Until recently, such official finance came from fiscal authorities (the European Financial Stability Facility, soon to be the European Stability Mechanism) and the International Monetary Fund. But, increasingly, official financing is coming from the European Central Bank first with bond purchases, and then with liquidity support to banks and the resulting buildup of balances within the eurozone’s Target2 payment system. With political constraints in Germany and elsewhere preventing further strengthening of fiscally-based firewalls, the ECB now plans to provide another round of large-scale financing to Spain and Italy (with more bond purchases).




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Thus, Germany and the eurozone core have increasingly outsourced official financing of the eurozone’s distressed members to the ECB. If Italy and Spain are illiquid but solvent, and large-scale financing provides enough time for austerity and economic reforms to restore debt sustainability, competitiveness, and growth, the current strategy will work and the eurozone will survive.



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In the process, some form of fiscal and banking union may also emerge, together with some progress on political integration. But, however important the fiscal and banking union elements of this process may be, the key is whether large-scale financing and gradual adjustments can restore sustainable growth in time. This will require considerable patience from governments and publics in the core and periphery alike – in the former to maintain large-scale financing, and in the latter to avoid a social and political backlash against years of painful contraction and loss of welfare.



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Is this scenario plausible? Just consider what must be overcome: economic divergence and deepening recessions; irreversible balkanization of the banking system and financial markets; unsustainable debt burdens for public and private agents; daunting growth and balance-sheet costs in countries that pursue internal devaluation and deflation to restore competitiveness; asymmetrical adjustment, with moral-hazard risks in the core and insufficient financing in the periphery fueling incompatible political dynamics; fickle and impatient markets and investors; austerity fatigue in the periphery and bailout fatigue in the core; the absence of conditions for an optimal currency area; and serious difficulties in achieving full fiscal, banking, economic, and political union.




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If a gradual process of disintegration eventually makes a eurozone breakup unavoidable, the path chosen by Germany and the ECB – large-scale financing for the eurozone periphery – would destroy the core central banks’ balance sheets. Worse still, massive losses resulting from the materialization of credit risk might jeopardize core eurozone economies’ debt sustainability, placing the survival of the European Union itself in question. In that case, surely an “orderly divorcenow is preferable to a messy split down the line.



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Of course, a breakup now would be very costly, requiring an international debt conference to restructure the periphery’s debts and the core’s claims. But breaking up earlier could allow the survival of the single market and of the EU. A futile attempt to avoid a breakup for a year or two – after wasting trillions of euros in additional official financing by the core – would mean a disorderly end, including the destruction of the single market, owing to the introduction of protectionist policies on a massive scale. So, if a breakup is unavoidable, delaying it implies much higher costs.



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But politics in the eurozone does not permit consideration of an early breakup. Germany and the ECB are relying on large-scale liquidity to buy time to allow the adjustments necessary to restore growth and debt sustainability.



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And, despite the huge risk implied if a breakup eventually occurs, this remains the strategy to which most of the players in the eurozone are committed. Only time will tell whether betting the house to save the garage was the right move.


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Nouriel Roubini, a professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was one of the few economists to predict the recent global financial crisis. One of the world’s most sought-after voices on its causes and consequences, he previously served in the Clinton administration as Senior Economist for the President’s Council of Economic Advisers, and has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.



08/15/2012 06:05 PM

Greece Before the Abyss

Only Bankruptcy Can Help Now

A Commentary by Stefan Kaiser

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Greece has disappointed its creditors yet again. Now its government plans to ask for more time -- and needs billions more in aid. But Greece's euro-zone partners are unwilling to provide any more help, meaning that the only hope now is to admit defeat and let the country make a fresh start.




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Officially, at least, everything is going according to plan. In September, officials with the troika -- made up of the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) -- are planning to travel to Athens to check on the progress that Greece has made with its cost-cutting program. Then, according to the plan, they could disburse billions more in aid out of the second bailout package for Greece, which the euro-zone countries and the IMF agreed on in February.




But, in reality, it is rather unlikely that all of the €130 billion ($160 billion) in the bailout package will ever be paid out. And what is even more unlikely is that the money would keep Greece from going bankrupt.



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The assumptions on which the current program was based in February are no longer valid. At that time, it was thought that the Greek economy would only contract by 4.5 percent this year, but now it appears that this figure will be closer to 7 percent. This would mean even fewer tax receipts and even more social expenditures.



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What's more, given these circumstances, it's almost irrelevant that the Greek government is expected to ask for a two-year extension, to 2016, of the agreed austerity plan.



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One thing is clear: In addition to more time, Greece also needs more money. And those who have been financing it thus far -- primarily the major euro-zone countries and the IMF -- are either unwilling or unable to give the country any more. In political terms, that is completely understandable: One can only imagine the earful that German Chancellor Angela Merkel would get if she were to present a third aid package for Greece before the Bundestag, Germany's parliament. In fact, the members of her own conservative coalition would probably chase her out of the building.



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Truth be told, Merkel only has herself to blame for the fact that she is stuck in this pickle. She dug in her heels too much in insisting that the problems of Southern European countries could only be solved by drastic belt-tightening, and that what the Greeks were really lacking was the will to do what was necessary. Now she can hardly abandon this way of interpreting the crisis.



.Delaying the Inevitable and Necessary



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If it was ever the goal of Merkel and her allies to rescue Greece from bankruptcy, then they have failed. The only thing the drastic austerity measures have done is to exacerbate the economic crisis and push Greece's debts even higher. Nevertheless, the creditors have insisted on moving forward with their plan -- even though it already became clear long ago where it was heading.



.The end of this approach now appears to have been reached. Neither euro-zone countries nor the IMF can provide Greece with more aid without sacrificing their own credibility. Given these circumstances, there is only one option left: Greece must go broke.



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European politicians have balked from taking this step -- probably also because the new permanent bailout fund, the European Stability Mechanism (ESM), which is supposed to cushion the economic impacts of a Greek bankruptcy, has yet to enter into force.



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Instead, they have tried to buy time with the help of a dangerous interim arrangement: The Greek government is supposed to borrow the money it needs from the ailing Greek banks. In return, the banks receive sovereign bonds that they can, in turn, provide as securities for new loans from Greece's central bank. In this way, Greece's central bank is financing the Greek state in what is really just a kind of shell game that gets riskier the longer it is played. In any case, all euro-zone countries will in the end be jointly on the hook for these liabilities.



A Greek bankruptcy would already be costly enough at the moment. Estimates say that it would cost Germany alone some €80 billion. Lest this figure climb any higher, the right thing to do would be to finally make that one fateful step.




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No matter how unpredictable the consequences of a Greek bankruptcy might be, it appears to offer the only chance to resolve the messy situation. In this way, Greece would be free of its debts and would have a chance to make a fresh start -- either as part of the euro zone or not. And the creditors in Berlin and Brussels could finally free themselves from the spiral of threats and rescue actions that they have gotten themselves into.




August 15, 2012 7:26 pm

China’s very different election show

©Ingram Pinn







On November 6 or 7, two American men in suits will appear on television. Even with the sound off you will be able to tell, by the expression on their faces, which of them has been elected president and which has not.




And, on an unspecified date between now and the end of the year, an unspecified number of Chinese men in dark matching suits will applaud themselves on to the stage of the Great Hall of the People. From the order in which they appear, experienced onlookers will be able to tell who is president, who is premier and who has which of the other jobs on the Politburo’s standing committee, China’s pre-eminent ruling body. My colleague Richard McGregor, in his enthralling book The Party, says the spectacle providessomething rare in modern China, a live and public moment of genuine political drama”.



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If the Communist party keeps to its present 10-year cycle (and manages to hold on to power), the next time the two most powerful countries in the world elect their leaders at roughly the same time will be in 2032. This year, then, will witness the psephologist’s equivalent of a total solar eclipse.



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In the US, we know practically everything there is to know about the candidates, if you leave aside Mitt Romney’s missing tax returns. In China, we know almost nothing substantive about them, save that Bo Xilai need not apply.





This week the Communist party picked the 2,270 delegates who will attend the 18th party congress at which the new standing committee members will be anointed. Party officials sought to present the process as the mostdemocratic” in its history. It emphasised the humble origins of some of the delegates, who include miners, factory workers, bus drivers and 22-year-old Jiao Liuyang, who won the 200m women’s butterfly gold medal at the London Olympics. The official China Daily newspaper pointed out triumphantly that the selection entailed “an unprecedented choice, with every 100 delegates elected from a field of more than 115 candidates”. In Communist party terms, this evidently counted as near-anarchy.




Deng Shengming, deputy head of the powerful organisation department, said: “It’s a very open, transparent electoral system, all out under the sunshine.” One must assume he was talking about the view of sunshine one often gets in Beijing, through the pea-soup haze of coal dust and assorted particulates.




So open is the transition process that the date of the party congress itself is still a state secret. Hong Kong newspaper Ming Pao this week speculated that it would be moved forward to September as a signal of party unity following the Bo Xilai scandal. Party officials would only repeat the mantra that the national congress would take place sometime in the second half of 2012. Even the number of people who will sit on the standing committee is unclear. Currently nine, it may be cut to seven. Or then again, it may not.





The result of the election will not be left to chance. It will be decided well in advance. While Delegate Jiao was breaking an Olympic record in London, senior party hacks were getting down to real business. They gathered in Beidaihe, the seaside resort favoured by Communist party leaders and – in the doubtless open and democratic atmosphere of their walled compound – they set about finalising the selection process.





The transition was blown badly off course by the detention of Mr Bo, the disgraced former party secretary of Chongqing who had openly campaigned for a slot on the standing committee. It is ironic that the only man who publicly sought office should be the one barred from seeking it.



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With Mr Bo purged and his wife, Gu Kailai, convicted of murder in last week’s one-day trial, there are signs that the transition is back on track. Beijing is stepping up security and cracking down on any sign of disgruntled citizens. The silencing of the powerless is a sure sign that China’s democratic process is in full swing.




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If everything goes according to plan, the Communist party will accomplish only its second smooth transition since it came to power in 1949. Deng Xiaoping took over from Mao Zedong after a protracted tussle with Mao’s chosen successor, Hua Guofeng. Jiang Zemin succeeded Deng in the chaotic time after Tiananmen Square. Before the Bo scandal, the party had gone to considerable trouble to telegraph its next two top leaders. Xi Jinping, almost certain to succeed Mr Hu as president, and Li Keqiang, who will take over from Wen Jiabao as premier, have been paraded at home and rolled out on symbolic visits to the US and Europe. So organised is everything, the new leaders won’t even have to worry about coming up with their own policies. Those were laid out for them in the five-year plan for 2011-2015 approved last year.





The murkiness of the transition process is in direct proportion to its importance. In spite of the shift towards collective decision-making, it matters greatly who runs China even if, as Mr McGregor writes, “any fundamental political differences between them had been purged on their ascent through the ranks”.





One would like to think it matters, for instance, whether Wang Yang, the (possibly) liberal-leaning party secretary of Guangdong province, is on the standing committee. It should matter too who is in charge of domestic security, a portfolio whose budget has been ramped up to surpass that of national defence under the hardline incumbent Zhou Yongkang. It ought to matter how committed the new leadership is to rebalancing the economy towards domestic demand, how tightly it wants to control interest rates and bank lending, and what sort of tone it hopes to set in foreign policy. It is almost enough to make you want a televised debate.



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Copyright The Financial Times Limited 2012



CRICKETS FOR STOCK MARKET

August 15, 2012



 
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It’s hard to imagine markets being this quietly determined to move higher without any dissent. Bears are in hibernation consistently put-off by fear of QE3 and HAL 9000s. (Rosengrens & Fisher duel over QE.) Economic data remains mixed with some better housing data but much worse manufacturing data given today’s poor Empire State Mfg Survey (-5.85 vs 7 expected & prior 7). Within that data was very poor employment trends and much higher prices paid data.





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The CPI came in flat which was strange given the 20% rise in most energy prices. The Homebuilders Sentiment rose to 37 from 35 which is the highest since February 2007 but we know what happened after that. Industrial Production was slightly higher (.6%) and energy inventories dropped substantially allowing for more price gains.



A chart from the Fed showscompletednew homes and presents a rather different picture.
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Meanwhile eurozone bulls remain enthusiastic there will be a “fix” even as Germans continue to shoutnein, nein, nein.” I guess bulls just don’t believe German rhetoric.


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Little noticed in headlines are higher energy costs stimulated by more war talk with Iran and much lower inventory data. Saudi Arabia, Qatar and the UAE just ordered all their citizens to leave Lebanon immediately as the Syrian conflict escalates and headlines shout Israel is preparing an attack on Iran.



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Given such a publicized headline might mean it’s not going to happen, at least not right away. If Obama is successful in securing a second term I doubt he’ll be attacking anyone other than RNC headquarters.



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Beneath the surface are some disturbing preparations the government is engaging in. The Fed and Treasury have asked the TBTF banks to prepare an emergency plan should there be an economic collapse. Homeland Security has been practicing for civil disorder on a massive scale. Over the past two days several articles have appeared suggesting various government agencies are ordering massive amounts of deadly hollow point bullets as noted. This is all quite disturbing and not denied by the government. I sound paranoid.



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As noted stocks continued their stealth rally led mostly by tech (XLK), bonds continued to sell-off during current auction, commodity prices (DBC) were higher, and the dollar (UUP) was slightly stronger putting gold (GLD) back on the defensive.




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Trading volume is the lowest since 2007 as the summer wears on and most investors must be awaiting Jackson Hole results. Breadth per the WSJ was positive overall.



The Death Of Paper Money And The Reemergence Of A Global Gold Standard

August 14, 2012

by: Ben Mountifield
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In the years ahead, we will witness the death of paper money and the reemergence of a global gold standard. This article examines why this transition is inevitable, how it might occur, and how to protect yourself from it.



Why A Return To Some Form Of Global Gold Standard Is Inevitable




In the coming months and years, governments around the world will do everything in their power to prevent a global depression. They will do this by printing massive amounts of new money and pushing it out into the global economy - something which will result in a collapse in the value of paper money.




Eventually, as their actions fail to produce lasting economic growth, people will lose faith in governments' ability to resolve the crisis. Crucially they will also begin to lose faith in the paper money these governments issue, and ultimately it is this loss of faith in what is essentially worthless money that will necessitate our return to a gold standard.




This is the first time in history that no currency on the planet is backed by anything tangible; they are all fiat. History teaches us that fiat (paper) currencies do not stand the test of time. They have been tried many times before but every fiat currency since the time of the Romans has ended in devaluation, hyperinflation and, eventually, collapse. In fact, there have been 34 instances of hyperinflation in the last 100 years alone, the majority of which took place in the 20th century with fiat currencies.




Four Scenarios For Returning To A Gold Standard




In his excellent new book, The Golden Revolution: How to Prepare for the Coming Global Gold Standard, John Butler states that:


A currency can only function as such if there is a general consensus that it provides a stable store of value. Without this trust, money, no matter what form it takes, will be abandoned - either suddenly in a crisis, or gradually over time - in favour of something else.


Mr Butler also makes the case that:



the world is rapidly moving toward some form of global metallic standard, in which money, at least in official, international transactions, is linked directly to gold, silver, or both.


In his book, Mr Butler, who was a Managing Director at Lehman Brothers, Deutsche Bank (DB) and Dresdner Bank, lays out four scenarios for returning to a gold standard.
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Scenario 1




In the first scenario Russia suddenly announces its intention to return to a gold-back currency. This was a scenario which was originally put forward by Jim Rickards, author of Currency Wars: The Making of the Next Global Crisis, during a war-game exercise at the US Department of Defense.




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In this scenario Russia's return to a gold standard is motivated by the desire to improve its global economic position, as well as the desire to inflict economic harm on the United States due to a disagreement over its foreign policy.




A gold-backed ruble would become a threat to the US dollar, since for the first time in over 40 years investors around the world would have the choice between holding unbacked US dollars issued by a country with almost $16 trillion in public debt, a $1.3 trillion annual budget deficit, and a massive looming entitlement problem, or holding a currency backed by gold.



Even if investors were only to diversify a small percentage of their capital out of US dollars, it would cause serious problems for the United States, which brings us to the next scenario.



Scenario 2




In the second scenario the United States preempts such a move by Russia, or some other country, and takes steps to return to a gold-backed dollar. This move would require a massive change in fiscal and monetary policy, as well as a considerable adjustment in the political process. It would also require a program of education so that American citizens understood why it was necessary.




Scenario 3




In the third scenario the BRIC countries club together and form a new currency block that is backed by gold. This scenario is similar to the first one; however, this time Russia gets together with Brazil, India and China to form a new currency bloc backed by gold from all four countries.




Again, this scenario might not be as far fetched as it seems, since all four countries have recently expressed their concern about US foreign policy, and their combined gold reserves would be the fourth largest in the world behind the US, Germany and the IMF.
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Scenario 4



In the fourth scenario, the financial markets, in particular the gold vigilantes, force one or more governments to back their currencies with gold. In this scenario investors continue to do what they have been doing for the past 12 years, only on a much larger scale., i.e. rather than holding rapidly devaluing paper currencies, they instead opt to hold (and transact in) gold.




The behavior of these investors is not dissimilar to that of the bond investors during the 1970s. These so-called bond vigilantes forced the US government to reign in its profligate spending (and hence inflation) by demanding higher returns for holding US debt.



The gold vigilantes may eventually force the US, or some other country, to return to a currency backed by gold. This would mean that the currency could not be issued without limit - something which would help restore faith in it.




No one should underestimate the impact a return to a gold standard will have. As Mr. Butler puts it,


The practical reality of the transition to the coming global gold (or bimetallic) standard is going to be substantially different from the global fiat monetary and financial regime of today. It is not just money that is going to change. The nature and business of banking will also be affected, as will finance in general.



The Bottom Line




Those that stand to lose the most from the coming paper money collapse, are those that don't see it coming and therefore remain holding paper currencies even as rising inflation eats into their value.



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Anecdotal evidence from inflationary episodes in countries such as Argentina and Brazil suggests that most people don't take steps to protect their wealth until inflation reaches as high as 50%.




The big winners in this transition from faith-based money to gold-backed money will be the early adopters, i.e., those that make the transition before a large part of their wealth has been eroded by inflation.



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Investors should consider moving a portion of their wealth out of paper assets, such as cash and bonds, into physical gold bullion. Other hard assets that are likely to help investors preserve their wealth during these turbulent times, include, silver, prime residential property, land, fine art, and natural resources such as oil and diamonds.