The EU, dead man walking

The EU is dead, it just doesn’t know it yet. Chatting today to a friend who has been involved in the buying and selling of European banks. I asked him today about the situation of Deutsche Bank, he said it will be renamed DLB, (Deutsche Lehman Bank) Letting it fail would create a global financial meltdown. Germany will have to break every rule in the EU rulebook to keep Deutsche afloat. Then Italy will ask for the same treatment from the EU for its banking sector, which is also in crisis. There just won’t be enough money to go around and the result will be a political and financial fracture which will rip the EU apart.

Bank Espirito Santo. Holding company files for creditor protection

Espirito Santo International, the holding company of Portugal’s 2nd largest bank, filed for creditor protection late Friday evening after financial markets closed.

Not to say this will trigger part two of the financial crisis which began in 2007 but it does demonstrate the continued fragility of the global banking system. Saying this, it will be very interesting to see what happens as the threads of debt are unwound. When markets open on Monday I will be watching closely to see the reaction.

UPDATE 22/07/2014

Yesterday I was curious to see how markets would react to the news about Bank Espirito Santo’s holding company. The Portuguese stock market, the PS120, stayed flat, increasing by 0.05%. For now markets seems to be discounting the level of risk. Admittedly, Espirito Santo is not a big bank in relation to the likes of Credit Suisse, its market capitalization is $3.7 billion versus the $44.5 billion of Credit Suisse. The risk is in the fact that there are many banks in the periphery of the Euro-Zone which are equally fragile, when added together the figures will begin to become serious. I just checked the price of Credit Default Swaps for Euro-Zone banks, the cost of insuring against a debtor not being able to pay, and prices for insuring against a bank default in the Euro-Zone are starting to increase again.

This situation is a slow burner but it is inevitable that we are going to see another banking crisis in Europe. I will update this post as the situation develops.


Global GDP vs Global Debt. What is really going on?

I’m no economist but I am pretty good at understanding concepts. There are so many things about the global economy and all the talk about government debt that don’t make sense, well for me anyway and if anyone has any feedback I would like to hear it.

What it comes down to is this: In 2012 global GDP (Gross Domestic Product) that is the monetary value of all the finished goods and services including financial, produced in 2012 was about 70 Trillion Dollars. On the other hand the value of global debt (government, business and household) in 2012 was about 223.3 Trillion Dollars. That is a difference of 313% of global GDP. So my question is who are the creditors? Who is all the money owed to?

On the other hand, in theory, this level of global debt shouldn’t be a problem. For example, lets say you have an annual salary of $100k with no other debts and you take a mortgage to buy a house worth $300k, nobody would say that you can’t afford the house. The house could rise or fall in value but the debt itself remains the same. That is essentially the same situation with the ratio of global income to debt as exists now.

What is happening that is creating such a political storm in many countries, particularly in The USA and Europe, about government debt and spending? As I said before I’m not an economist but I am trying to find out for myself what is really happening. As part of trying to discover what is going on I want to look at the debt situations of two countries. The USA and Japan.

I have been looking at to get the raw facts and figures and it poses some interesting questions. In Japan the ratio of government debt to GDP is 211%. This is the same as the person with the $100k salary taking a mortgage to buy a home worth $211k. In The USA the ratio of government debt to GDP is 101.6 %.

What is going on here? It seems like The USA government is the person with a $100k salary taking a mortgage to buy a home worth $101.6k, yet politically it is creating a storm that doesn’t exist in Japan, which has more than twice the level of government debt. What is the fundamental difference between these two countries?

I am going to quote directly from I came across their website in my research for this post and they put into words what I want to say more concisely than I can. The original article, written in September 2012, is here

“Japan’s massive government debt conceals massive benefits for the Japanese people, with lessons for the U.S. debt “crisis.”

In an April 2012 article in Forbes titled “If Japan Is Broke, How Is It Bailing Out Europe?”, Eamonn Fingleton pointed out the Japanese government was by far the largest single non-eurozone contributor to the latest Euro rescue effort.  This, he said, is “the same government that has been going round pretending to be bankrupt (or at least offering no serious rebuttal when benighted American and British commentators portray Japanese public finances as a trainwreck).”  Noting that it was also Japan that rescued the IMF system virtually single-handedly at the height of the global panic in 2009, Fingleton asked:

How can a nation whose government is supposedly the most overborrowed in the advanced world afford such generosity? . . .

The betting is that Japan’s true public finances are far stronger than the Western press has been led to believe. What is undeniable is that the Japanese Ministry of Finance is one of the most opaque in the world . . . .

Fingleton acknowledged that the Japanese government’s liabilities are large, but said we also need to look at the asset side of the balance sheet:

[T]he Tokyo Finance Ministry is increasingly borrowing from the Japanese public not to finance out-of-control government spending at home but rather abroad. Besides stepping up to the plate to keep the IMF in business, Tokyo has long been the lender of last resort to both the U.S. and British governments. Meanwhile it borrows 10-year money at an interest rate of just 1.0 percent, the second lowest rate of any borrower in the world after the government of Switzerland.

It’s a good deal for the Japanese government: it can borrow 10-year money at 1 percent and lend it to the U.S. at 1.6 percent (the going rate on U.S. 10-year bonds), making a tidy spread.

Japan’s debt-to-GDP ratio is nearly 230%, the worst of any major country in the world.  Yet Japan remains the world’s largest creditor country, with net foreign assets of $3.19 trillion.  In 2010, its GDP per capita was more than that of France, Germany, the U.K. and Italy.  And while China’s economy is now larger than Japan’s because of its burgeoning population (1.3 billion versus 128 million), China’s $5,414 GDP per capita is only 12 percent of Japan’s $45,920.

How to explain these anomalies?  Fully 95 percent of Japan’s national debt is held domestically by the Japanese themselves.

Over 20% of the debt is held by Japan Post Bank, the Bank of Japan, and other government entities.  Japan Post is the largest holder of domestic savings in the world, and it returns interest to its Japanese customers.  Although theoretically privatized in 2007, it has been a political football, and 100% of its stock is still owned by the government.  The Bank of Japan is 55% government-owned and 100% government-controlled.

Of the remaining debt, over 60% is held by Japanese banks, insurance companies and pension funds.  Another chunk is held by individual Japanese savers.  Only 5% is held by foreigners, mostly central banks.  As noted in a September 2011 article in The New York Times:

The Japanese government is in deep debt, but the rest of Japan has ample money to spare.

The Japanese government’s debt is the people’s money.  They own each other, and they collectively reap the benefits.

Myths of the Japanese Debt-to-GDP Ratio

Japan’s debt-to-GDP ratio looks bad.  But as economist Hazel Henderson notes, this is just a matter of accounting practice—a practice that she and other experts contend is misleading.  Japan leads globally in virtually all areas of high-tech manufacturing, including aerospace.  The debt on the other side of its balance sheet represents the payoffs from all this productivity to the Japanese people.

According to Gary Shilling, writing on Bloomberg in June 2012, more than half of Japanese public spending goes for debt service and social security payments.  Debt service is paid as interest to Japanese “savers.”  Social security and interest on the national debt are not included in GDP, but these are actually the social safety net and public dividends of a highly productive economy.  These, more than the military weapons and “financial products” that compose a major portion of U.S. GDP, are the real fruits of a nation’s industry.  For Japan, they represent the enjoyment by the people of the enormous output of their high-tech industrial base.

Shilling writes:

Government deficits are supposed to stimulate the economy, yet the composition of Japanese public spending isn’t particularly helpful. Debt service and social-security payments — generally non-stimulative — are expected to consume 53.5 percent of total outlays for 2012 . . . .

So says conventional theory, but social security and interest paid to domestic savers actually do stimulate the economy.  They do it by getting money into the pockets of the people, increasing “demand.”  Consumers with money to spend then fill the shopping malls, increasing orders for more products, driving up manufacturing and employment.

Myths About Quantitative Easing

Some of the money for these government expenditures has come directly from “money printing” by the central bank, also known as “quantitative easing.”  For over a decade, the Bank of Japan has been engaged in this practice; yet the hyperinflation that deficit hawks said it would trigger has not occurred.  To the contrary, as noted by Wolf Richter in a May 9, 2012 article:

[T]he Japanese [are] in fact among the few people in the world enjoying actual price stability, with interchanging periods of minor inflation and minor deflation—as opposed to the 27% inflation per decade that the Fed has conjured up and continues to call, moronically, “price stability.”

He cites as evidence the following graph from the Japanese Ministry of Internal Affairs:

How is that possible?  It all depends on where the money generated by quantitative easing ends up.  In Japan, the money borrowed by the government has found its way back into the pockets of the Japanese people in the form of social security and interest on their savings.  Money in consumer bank accounts stimulates demand, stimulating the production of goods and services, increasing supply; and when supply and demand rise together, prices remain stable.

Myths About the “Lost Decade”

Japan’s finances have long been shrouded in secrecy, perhaps because when the country was more open about printing money and using it to support its industries, it got embroiled in World War II.  In his 2008 book In the Jaws of the Dragon, Fingleton suggests that Japan feigned insolvency in the “lost decade” of the 1990s to avoid drawing the ire of protectionist Americans for its booming export trade in automobiles and other products.  Belying the weak reported statistics, Japanese exports increased by 73% during that decade, foreign assets increased, and electricity use increased by 30%, a tell-tale indicator of a flourishing industrial sector.  By 2006, Japan’s exports were three times what they were in 1989.

The Japanese government has maintained the façade of complying with international banking regulations by “borrowing” money rather than “printing” it outright.  But borrowing money issued by the government’s own central bank is the functional equivalent of the government printing it, particularly when the debt is just carried on the books and never paid back.

Implications for the “Fiscal Cliff”

All of this has implications for Americans concerned with an out-of-control national debt.  Properly managed and directed, it seems, the debt need be nothing to fear.  Like Japan, and unlike Greece and other Eurozone countries, the U.S. is the sovereign issuer of its own currency.  If it wished, Congress could fund its budget without resorting to foreign creditors or private banks.  It could do this either by issuing the money directly or by borrowing from its own central bank, effectively interest-free, since the Fed rebates its profits to the government after deducting its costs.

A little quantitative easing can be a good thing, if the money winds up with the government and the people rather than simply in the reserve accounts of banks.  The national debt can also be a good thing.  As Federal Reserve Board Chairman Marriner Eccles testified in hearings before the House Committee on Banking and Currency in 1941, government credit (or debt) “is what our money system is.  If there were no debts in our money system, there wouldn’t be any money.”

Properly directed, the national debt becomes the spending money of the people.  It stimulates demand, stimulating productivity.  To keep the system stable and sustainable, the money just needs to come from the nation’s own government and its own people, and needs to return to the government and people.”

End of article from Global Research

So the fundamental difference seems to be that in Japan the people are beneficiaries of government debt whereas in the USA the banks are the beneficiaries and it is the people who have to pay. When the financial crisis hit back in 2007 and the world went into recession I remember thinking that surely it would be more useful for the governments to use QE (Quantitative Easing) to give money directly to the people. If that had happened then the economy would have been truly stimulated. Using average figures, the US government bought bank debt of about $1.7 trillion to fend off collapse of  the financial system. All that has happened with the money the banks received is that they have lent it back to The Fed and are earning interest on it. Basically the government used taxpayers money to bail out the banks. The banks are now earning interest on this money as they lend it back to the government. How perverse is that?

If instead the government had used this $1.7 trillion and divided it up between the people of the USA then there would have been enough to give every individual, from baby to pensioner over $5,600. Let’s be more practical and say the money would have been better distributed on a household basis. There are just under 115 million households in the USA, if the money were divided equally then each one would have received about $14,782. Can you imagine the stimulus this would have given to the real economy as people used the money to buy goods, pay off debt or to use as a deposit on a home. The real economy would have recovered from recession rapidly.

If the government had done this then the entire banking system would have failed, or would it? I’m not so sure. All the banks were so indebted to each other that after seeing a few big banks go down they would have realized that the only way to stop a total collapse would have been to cancel out each others debts. The effect would have been dramatic, the financial sector would have shrunk enormously in value but it would still exist, the only difference being that all the artificial money and speculation would have vanished. This is what they meant when they said the banking system would collapse, all the derivatives and other financial instruments that are based on plucking numbers from the air would no longer be. Banks would have to go back to dealing with money that actually exists.

We need banks, they offer a very valuable service, they lend us money to buy our homes, they help business to grow. In this context banks are invaluable. The problem is they are now only interested in enriching themselves and they are doing it at the taxpayers expense.

It is ironic that Japan with its huge debt is also the country that lends the most to the USA yet the effect of debt on these two countries could not be more different. For Japan it is borrowing from itself and its people and pays back to itself and its people. The USA borrows from abroad to prop up a perverse banking system and in addition takes money from its people to do so.