Triple shocks threaten Europe's sickly and deformed recovery

Europe has not recovered. It has begun to stabilise, but only just, amid mass unemployment, with debt trajectories still spiralling out of control in Italy, Portugal, Spain and once again in Greece.

By Ambrose Evans-Pritchard

7:27PM BST 04 Sep 2013

 Closeup of the map of Europe seen  on the face of a 10 Euro Cent coin in Paris

The debt spiral cannot be checked until Euroland embarks on full-blown reflation Photo: Reuters

The complacency of those dictating Euroland's policies - though not its victims - is breathtaking.

"Europe, it seems, has become anaesthetised to bad news," says Simon Tilford from the Centre for European Reform. Tentative signs of life after six quarters of contraction are deemed a vindication of shock therapy, even as the underlying crisis gets worse in almost every key respect.
"The reality is that the Spanish and Italian economies will shrink by a further 2pc in 2013. Greece is on course to contract by an additional 5pc to 7pc and Portugal by 3pc to 4pc. Far from being on the mend, the economic crisis across the South is deepening. Real interest rates are increasing from already high levels," he said.
An end to the slump - hardly assured - is not enough to reverse a compound interest trap across Club Med as debt loads rise faster than nominal GDP, or enough to render Italy and Spain viable within EMU. Such is the "denominator effect".
Mr Tilford says the elephant in the room is the rise in the debts of Portugal and Spain by 15 percentage points (pp) of GDP over the past year, by 18pp in Ireland and by 24pp in Greece. Italy's ratio rose 7pp to 130pc of GDP, already at or near the point of no return. 

This is the fruit of "naked" austerity, conducted without offsetting monetary stimulus. Debt ratios are rising even faster. The hairshirt strategy has been self-defeating, even on its own terms.

The debt spiral cannot be checked until Euroland embarks on full-blown reflation, yet EMU creditors shun such a course. The Club Med states in turn have yet to throw up a leader of stature, willing to forge a debtors' cartel, and bargain from strength. They let themselves be picked off one by one.

Much was made of a slight fall in Spain's registered unemployed in August. The more relevant detail is that a net 99,000 people left the workforce in a single month. Some are coming to Britain. We now know that 45,530 Spaniards signed up for UK National Insurance last year.

The EMU refugees are still arriving daily at Victoria Station, where the Telegraph is based. They make a bee-line for a currency shop nearby known for low fees. Three Andalucians in their 20s were in the queue ahead of me the other day, chatting about their prospects. Each changed a thick wad of euros into pounds, starting new lives in London.

Bienvenidos. They are Britain's gain; and Spain's loss. They no longer pay Spanish taxes or contribute to Spain's Social Security system, sliding towards bankruptcy as the reserve fund is depleted at an exponential pace. The ratio of workers to those receiving benefits has already fallen to 1:7 in Aragon.
Not that the exodus from Southern Europe has made a dent in youth unemployment rates: 62.9pc in Greece, 56.1pc in Spain, 39.5pc in Italy, 37.9pc in Cyprus and 37.4pc in Portugal. It is surely the greatest policy failure of modern times.

Unemployment over the past five years

Whether you think Europe's recovery is reaching "escape velocity" depends on what you look at. Optimists cite PMI manufacturing indices, punching back above the boom-bust line of 50, though these are the same PMI surveys that gave no forwarning of EMU disasters of 2012.

Money data are a different story. Growth of "broad" M3 money has stalled, slowing to a 1.5pc rate (annualised) over the past three months, a harbinger of economic stagnation over the winter. Credit to business fell at an accelerating rate of 1.9pc in July as banks continue to retrench too fast, compelled by overzealous pro-cyclical regulators. If that is the launch-pad for a new cycle of growth, I will eat my monetarist hat.

Euroland has been hit by three shocks, none life-threatening but serious when combined, which are likely to bite with a delay. The euro has risen 30pc against the Japanese yen over the past year, 25pc against the Indian rupee and 20pc against the Brazilian real. It is has even risen against the resurgent US dollar, an odd state of affairs for the world's slowest growing economic bloc.
To make matters worse, borrowing costs have jumped by 70 basis points across Europe since the US Federal Reserve began to talk tough in May, the difference between life and death for small firms in Spain, Italy and Portugal clinging on by their fingertips.

The ECB has not done much about this, beyond waffle on about "forward guidance". It has allowed imported tightening to run its course, while plans for direct lending to small businesses in the South have withered on the vine. The ECB's Mario Draghi pledged last year to do "whatever it takes" to save monetary union. He is not in fact doing so.

His masterplan to backstop Italy and Spain has averted an immediate chain of sovereign defaults, and kudos to him for that, but has not averted the slow slide towards insolvency. If the ECB targeted 5pc growth of M3, or even better 5pc growth of nominal GDP, this would lift Club Med off the reefs. It could do this easily. It chooses not to do so.

Europe will now have a third shock to contend with, and perhaps a fourth if the emerging market rout continues. Brent crude has jumped by $15 a barrel since June, nearing the economic inflexion point around $120 even before Tomahawk missiles rain on Damascus. This will tighten the deflationary vice yet further by draining spending power from the economy, like a tax.

It was a Princeton professor called Ben Bernanke who wrote the last word on this in "Systematic Monetary Policy and the Effects of oil Price Shocks". Central banks themselves cause most damage from oil shocks because they panic, over-reacting to short-term inflationary noise.

Yet the mystics at Bundesbank still seem to think that oil spikes are inflationary. They have largely succeeded in imposing their 1970s views on the ECB's Governing Council. They raised rates to counter the pre-Lehman oil shock in July 2008, even though half of Europe was already in recession, the worst monetary policy blunder since the Second World War. They repeated the mistake in 2011, causing Europe's double-dip. Third time lucky, perhaps?

Euro trade-weighted exchange rate

Even if eurozone growth does indeed gather speed, this will bring forward the day when Germany demands rate rises to head off overheating in its own misaligned economy. This will change the contours of the crisis, not solve it. The 20pc gap in labour competitiveness between North and South - the fundamental cancer of the EMU Project - will remain.

And no, the North-South current account chasm has not closed in any meaningful sense. It has been masked by crushing internal demand and investment in the Latin bloc.

Germany's surplus actually grew to 7pc of GDP last year. The misalignment is so extreme that even a full depression in the South cannot bring intra-EMU trade into balance. Should they be even trying to hold the currency together given sheer scale of the task, you might ask.

How this gap in incompetitiveness was allowed to evolve over the first 15 years of the EMU experiment is by now ancient history. It no longer matters whether it was caused by Germany's beggar-thy-neighbour wage squeeze, or by Italy's "scala mobile" wage escalator, or by a flood of cheap foreign capital into Spain. The damage from this joint venture is now done. All EMU states are in it together.

Forcing all the burden of adjustment on the debtors repeats the cardinal sin of the Gold Standard. It cannot succeed since deflation poisons debt dynamics, and mass joblessness poisons democracy. There comes a point when leaders have a moral obligation to default.

Yet to stoke EMU-wide inflation deliberately to lift the South off the reefs would destroy political consent for monetary union in Germany. It would require statesmanship of the first order in Berlin to marshall civic support for such an imperative. No such statemanship is on offer. We have an impasse.

The Failure of Free-Market Finance

Adair Turner

04 September 2013

This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.LONDON – Five years after the collapse of the US investment bank Lehman Brothers, the world has still not addressed the fundamental cause of the subsequent financial crisis – an excess of debt. And that is why economic recovery has progressed much more slowly than anyone expected (in some countries, it has not come at all).
Most economists, central bankers, and regulators not only failed to foresee the crisis, but also believed that financial stability was assured so long as inflation was low and stable. And, once the immediate crisis had been contained, we failed to foresee how painful its consequences would be.
Official forecasts in the spring of 2009 anticipated neither a slow recovery nor that the initial crisis, which was essentially confined to the United States and the United Kingdom, would soon fuel a knock-on crisis in the eurozone. And market forces did not come close to predicting near-zero interest rates for five years (and counting).
One reason for this lack of foresight was uncritical admiration of financial innovation; another was the inherently flawed structure of the eurozone. But the fundamental reason was the failure to understand that high debt burdens, relentlessly rising for several decades – in the private sector even more than in the public sector – were a major threat to economic stability.
In 1960, UK household debt amounted to less than 15% of GDP; by 2008, the ratio was over 90%. In the US, total private credit grew from around 70% of GDP in 1945 to well over 200% in 2008. As long as the debt was in the private sector, most policymakers assumed that its impact was either neutral or benign. Indeed, as former Bank of England Governor Mervyn King has noted, “money, credit, and banks play no meaningful role” in much of modern macroeconomics.
That assumption was dangerous, because debt contracts have important implications for economic stability. They are often created in excess, because in the upswing of economic cycles, risky loans look risk-free. And, once created, they introduce the rigidities of default and bankruptcy processes, with their potential for fire sales and business disruptions.
Moreover, debt can drive cycles of over-investment, as described by Friedrich von Hayek. The Irish and Spanish property booms are prime examples of this. And debt can drive booms and busts in the price of existing assets: the UK housing market over the past few decades is a case in point.
When times are good, rising leverage can make underlying problems seem to disappear. Indeed, subprime mortgage lending delivered illusory wealth increases to Americans at a time when they were suffering from stagnant or falling real wages.
But in the post-crisis downswing, accumulated debts have a powerful depressive effect, because over-leveraged businesses and consumers cut investment and consumption in an attempt to pay down their debts. Japan’s lost decades after 1990 were the direct and inevitable consequence of the excessive leverage built up in the 1980’s.
Faced with depressed private investment and consumption, rising fiscal deficits can play a useful role, offsetting the deflationary effects. But that simply shifts leverage to the public sector, with any reduction in the ratio of private debt to GDP more than matched by an increase in the public-debt ratio: witness the Irish and Spanish governments’ high and rising debt burdens.
Private leverage levels, as much as the public-debt burden, must therefore be treated as crucial economic variables. Ignoring them before the crisis was a profound failure of economic science and policy, one for which many countries’ citizens have suffered dearly.
Two questions follow. The first is how to navigate out of the current overhang of both private and public debt. There are no easy options. Paying down private and public debt simultaneously depresses growth. Rapid fiscal consolidation thus can be self-defeating. But offsetting fiscal austerity with ultra-easy monetary policies risks fueling a resurgence of private leverage in advanced economies and already has produced the dangerous spillover of rising leverage in emerging economies.
Both realism and imaginative policy are required. It is obvious that Greece cannot pay back all of its debt. But it should also be obvious that Japan will never be able to generate a primary fiscal surplus large enough to repay its government debt in the normal sense of the wordrepay.” Some combination of debt restructuring and permanent debt monetization (quantitative easing that is never reversed) will in some countries be unavoidable and appropriate.
The second question is how to constrain leveraged growth in the future. Achieving this goal requires reforms with a different focus from those pursued so far.

Fixing the “too big to failproblem is certainly important, but the direct taxpayer costs of bank rescues were small change compared to the damage wreaked by the financial crisis. And a banking system that never received a taxpayer subsidy could still support excessive private-sector leverage.
What is required is a wide-ranging policy response that combines more powerful countercyclical capital tools than currently planned under Basel 3, the restoration of quantitative reserve requirements to advanced-country central banks’ policy toolkits, and direct borrower constraints, such as máximum loan-to-income or loan-to-value limits, in residential and commercial real-estate lending.
These policies would amount to a rejection of the pre-crisis orthodoxy that free markets are as valuable in finance as they are in other economic sectors. That orthodoxy failed. If we do not address the fundamental fact that free financial markets can generate harmful levels of private-sector leverage, we will not have learned the most important lesson of the 2008 crisis.
Adair Turner, former Chairman of the United Kingdom's Financial Services Authority, is a member of the UK's Financial Policy Committee and the House of Lords.

How Fed Policy Has Devastated Three Generations of Retirees

John Mauldin

Sep 03, 2013

Retirement can be an unpleasant prospect if you’re not ready for it. This week’s Outside the Box is in in-depth report on Americans' retirement prospects, which comes to us from Dennis Miller, a columnist for CBS Market Watch, and editor of Miller’s Money Forever. It's not just the Boomers who are trying (often in vain) to retire this decade; it's also Gen-Xers, who are the most indebted generation (and the one that saw their assets depreciate the most in the Great Recession). The Millennials haven't been spared, either; in fact, over time they may be the hardest-hit, since near-zero interest rates are keeping them from compounding their savings in the early years of their careers, when the power of compounding is greatest. In addition, the difficult post-college job market and sky-high levels of student loans have kept most Millennials out of the stock market, and they are far less likely than previous generations to open a retirement savings account.

This is not a problem the government is going to be able to fix. One way and another, Social Security will do less for people in coming years, not more. We are all going to be more dependent upon our own resources if we want to have anything that resembles what we have come to think of as a secure and comfortable retirement.

Miller, along with my partner David Galland, former US Comptroller General David Walker, Jeff White of American Financial, and John Stossel of Fox Business, will be discussing retirement strategies for individual investors during a broadcast set for Thursday, September 5. You can learn more here.

Have a great week and to my friends of the Jewish persuasion let me wish you Shanah Tova.
You’re not even thinking about retiring analyst,

John Mauldin, Editor
Outside the Box

How Fed Policy Has Devastated Three Generations of Retirees

By Dennis Miller

One aspect of the American Dream has always been the prospect of enjoying one's golden years in retired bliss. And while everyone knows that the rules of the game have been subject to change over the years, the recent, unprecedented changes in fiscal policy have proved to be a virtual wrecking ball to Americans' retirement dreams.

Over the past few years, the Federal Reserve has moved from simple interest rate manipulation to wholesale market interference with the goal of maintaining bank solvency and equity prices. This steamroller-style interference in the markets has had massive consequences. And not just for the Baby Boomers who are now hitting retirement age, but also for their children and children's childrenthree American generations whose retirement hopes have been left to swing in the wind on a string of broken promises.

Baby Boomers Get Their Risk On

The Baby Boomer generation (born 1946 – 1964) is quite used to adjusting to ever-changing conditions when it comes to retirement.

For decades, receiving a pension was what one looked forward to for their old age. But as you can see in the chart below, at least in the private sector that idea has become as extinct as a T-rex.

Its replacement became the 401(k) and the IRA—tax-deferred vehicles that let savers take control of their own retirement, for better or worse.

Granted, Americans have built up a sizable nest egg in these defined-contribution retirement accountsmore than $5.4 trillion in IRAs alone—but the cumulative savings fail to tell the larger story. The dire truth is that Baby Boomers are caught in a trap, simultaneously trying to preserve capital and generate yield through wild market swings like 2000's massive crash, 2008's 30% correction, and 2010's flash crash.

The market's frequent large "corrections" have had a sobering effect on Boomers' investment behavior. In an attempt to avoid the swings while still making money to live off, Boomers have flooded the bond market with money and significantly reduced their stock market exposure.

As you can see in the right-most bars on the graph above, Boomers who are in their sixties today have significantly reduced the weighting of equities in their portfolios over the last decademuch more so than their peers of just 10 years earlier.

It's true that since the bursting of the housing bubble in 2007, major indexes have recovered to a point where anyone who stayed put after the crash should have been made whole again. Yet the actual market participation by the Boomers has been considerably lowerthrice bitten, twice shymeaning many missed out on the equity market's recovery.

Instead, hundreds of billions of dollars flowed into the bond markets over the past five years, as evidenced by the $50 billion upswing in bond ETF assets in 2012, and the $125 billion in bond-based mutual fund net inflows over the same period.

Following a protective instinct, conservative investors shifted their money from stocks to bonds… at exactly the time interest rates were rapidly falling for most classes of income investments.
Boomers have suffered more losses and settled for lower income than ever before. The double whammy took a serious toll on the retirement dreams of many. But that was OK, because there was always Social Security as a backstop.

It's become increasingly obvious, though, that Social Security is not keeping up with the times.
By tying its payouts to the Consumer Price Index (CPI)—a measure as flawed at predicting actual consumer prices as a groundhog at predicting the weather (a consumer price that doesn't include fuel or food?)—as a net effect, the real value of Social Security payouts has shrunk dramatically.

Here's a chart of official consumer inflation vs. the real numbers calculated by economist John Williams of ShadowStats (he uses the US government's unadulterated accounting methods of the 1980s). While the official number is 2%, real inflation is in the 9% range.

Washington has been cutting Social Security payments for years, just in a way that wasn't obvious to most newscasters and taxpayersat least not until it was time to collect, as increasing numbers of Boomers now are.

Between the downfall of the pension, Boomers' eschewing of the stock market, and the government's zero interest rate policy, for many Americans retiring in their sixties has become little more than wishful thinking—and a financially comfortable retirement now requires taking significantly more risk than most are willing or able to handle.

Generation X Strikes Out

Traditionally, the 45-55 age group has been the most fervent retirement savers, but that has changed drastically in the last 25 years. As you can see in this chart, the most rapid declines in participation rate for the black line (age 45-54) coincide with major dips in the market, such as in 2001 and 2007.

To make matters worse, Gen-Xers (born 1965 – 1980) are also the most debt-ridden generation of the past century.

According to the Pew Research Center, Gen-Xers and Baby Boomers alike have much lower asset-to-debt ratios than older groups. Whereas War and Depression babies got rid of debt over the past 20 years, Boomers and Gen-Xers were adding to their load:

War babies: 27x more assets than debt

Late Boomers: 4x more assets than debt

Gen-Xers: 2x more assets than debt

That situation deteriorated further in the last six years; while all groups lost money in the Great Recession, the Gen-Xers were the hardest-hit.

As Early and Late Boomers struggled with asset depreciation of 28% and 25%, respectively, Gen-Xers lost almost half (45%) of their already smaller wealth. They also lost 27% of home equity during the crisis, the largest percentage loss of the groups studied by Pew.

Millennials: Down a Well and Refusing the Rope

The effects of a prolonged period of low interest rates on current and near-term retirees are obvious. But the long-term effects on those now in their early years of working and saving may be much greater.

We've all been taught about the power of compound interest. Put away $10,000 today, compounding at 7%, and in 20 years you have about $40,000 and in 30 years nearly $80,000.

As powerful a tool as long-term compounding is, though, nothing can cut the legs out from under it more than saving less early on or earning less in the first few years. Any small change to the input has a drastic effect on what comes out the far end.

The Millennials—those born between 1981 and 2000—are suffering from both right now. It's no secret that interest rates are low, and there is little that their generation, whose oldest members are now in their early thirties, can do about it.

Shrinking interest rates are wreaking real havoc on the Boomers' children, extending the time to retirement for that generation by nearly a decade.

Why would any politician pass legislation to change Social Security eligibility, a measure that usually doesn't bode well for reelection, if they can simply rely on fiscal policy to accomplish the same net effect?

To make matters worse, the years of financial turmoil, a tough post-college job market, high levels of student loans, and numerous other factors have kept most Millennials out of the stock markets.

Millennials are far less likely to open a retirement savings account than previous generations.

According to a recent Wells Fargo survey, "In companies that do not automatically enroll eligible employees, just 13.4% of Millennials participate in the plan."

This is worse even than the number EBRI collected in the graph presented earlier, which still pegged retirement plan participation rates at all-time lows for the 20-something set. Only a small percentage of Millennials are taking even the most basic step toward taking charge of their own retirement.

With their parents and grandparents showing them the failure of the pension system and Social Security first-hand, one would think the opposite might be true. But the numbers clearly show that Millennials are less interested in saving for their future retirement than their parents were.

Having seen it happen to their own grandparents, maybe they are just resigned to the idea that they'll have to work well into their golden years anyway. And who could blame their generation for not trusting the stock markets with their capital after seeing what happened to their parents’ nest eggs so many times during their own childhoods?

The youngest working generation is eschewing investment, at what might be a great cost down the road.

Adapt to Survive

Multiple years of shrinking interest rates, thanks to heavy bond buying by the Federal Reserve in its Quantitative Easing program, have taken an immense toll on generations of savers. The increased risk that current and future retirees have to take on to meet their income needs has left many shaken and financially insecure.

As a result, many are now looking to new strategies to make up for the shortfall the Fed's zero interest rate policy has createdshifting their focus from bonds to dividend-paying stocks and adapting as they go along.

Dennis Miller is a noted financial author and “retirement mentor,” a columnist for CBS Market Watch, and editor of Miller’s Money Forever (, an independent guide for investors of all ages on the ins and outs of retirement finance—from building an income portfolio to evaluating financial advisors, annuities, insurance options, and more. He also recently participated alongside John Stossel and David Walker in America’s Broken Promise, an online video event that premieres Thursday, September 5th.