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Following the 20% devaluation of Kazakhstan’s currency on Tuesday, the nation has quietly drifted into a very un-safe scenario. As the following clip shows, tanks and Humvees are lining the streets around Almaty as stores are closed and food is running desperately short. Local accounts note that the people are growing increasingly indignant. At a mere 192bps, the cost of protecting Kazakhstan sovereign debt from default (or further devaluation) seems cheap in light of this.
Tanks and Humvees lining the streets around the largest city in Kazakhstan…
Kazakhstan CDS remain notably cheap…
Having rallied yesterday and totally ignored the fact that Letta’s 10-month-old government was about to collapse, Italian equity and sovereign bond markets are falling this morning by their most in two weeks. The main bone of contention for Renzi-Letta fight is jobs and growth – there is none of either – and while Prime Minister Letta assures that the Italian economy grew in Q4 (GDP data to be released tomorrow) for the first time in 10 quarters, as Bloomberg’s Niraj Shah notes, real GDP is still smaller than it was in 2000. Letta has just canceled his UK visit (planned for 2/24) and did not take part in the Democratic Party meeting with a Renzi friend saying “[Letta] will resign.”
Premier Enrico Letta said Thursday that he would not attend a meeting of his centre-left Democratic Party (PD) that has been called to decide whether it should continue backing his coalition government. New PD leader Matteo Renzi may call on the party to pull its support for Letta so he can take over as premier. Letta said he would not go to the meeting so that his party could “decide with serenity”.
However, with unemployment at record levels, we suspect few will care about some manufactured, goodwill-enhanced GDP print. Italians are, of course, used to the farce that is politics – there have been 64 government since 1945.
Another Conspiracy Theory Becomes Fact: Meet The Men With The Plan Behind Italy’s Bloodless Coup | Zero Hedge
The chart below is very familiar to anyone who was observing the hourly turmoil in the European bond market in November of 2011, when Italian bonds crashed, when yields soared to record levels, and every downtick of the Euro could have been its last.
What the chart may not show are the dramatic transformations in Italy’s government that took place just as the Italian bond spread exploded, which saw the resignation of career-politician Sylvio Berlusconi literally days after yields soared, and the instatement of Goldman technocrat Mario Monti as Italy’s next Prime Minister.
In fact as some, and certainly this website, had suggested the blow out in Italian yields was merely a grand plan orchestrated to usher in a new Italian government that would, with the support of yet another Goldman alum, the ECB’s then brand new head Mario Draghi, unleash a new era in Italian life, supposedly one of austerity (ignoring that two years after Berlusconi, Italy’s debt to GDP ratio has never been higher), and which would give the impression that Europe is being fixed all the while preserving the broken European monetary system for at least another year or two. In other words a grand conspiracy theory of a pre-planned bloodless coup. That all this would take place under the auspices and with the blessing of Italy’s president Napolitano, only made things worse since Italy is not a parliamentary republic but a parliamentary democracy, where such cloak and dagger arrangements are certainly not permitted under the constitution.
And so, as lately so often happens, courtesy of the narrative by Alan Friedman of what really happened that summer, this too conspiracy theory has just become conspiracy fact. Thanks to the FT’s “Monti’s secret summer“, we learn with painful detail (especially for those of our readers who may be Italian), just how the grand conspiracy to out Berlusconi took shape, and how it was deviously executed with the assistance of none other than the European Central Bank.
It all started on In the summer of 2011 when Carlo De Benedetti, the Italian industrial tycoon, hosted Mario Monti, Italy’s then former prime minister and an old friend of De Benedetti’s in the St Moritz-based alpine retreat of the industrialist for dinner, and a private chat to discuss “a development that was to have profound public consequences.” We go to the FT for the full details:
“Mario asked if we could get together, and I chose a typical little Swiss trattoria for dinner, just outside of St Moritz. But at the last minute he said he wanted to talk in private and so I said ‘Sure, stop by my house before dinner’ and so he came by,” Mr De Benedetti says. “And it was then he told me that it was possible that the president of the republic, Napolitano, would ask him to become prime minister, and he asked my advice.”
Mr De Benedetti says the two men “discussed whether he should accept the offer, and when would be the right moment to do so. This happened at my house in August, so in fact he had already spoken with President Napolitano.”
The offer from Giorgio Napolitano, the Italian president, to Mr Monti of the job of prime minister – a post that was still very much occupied by Silvio Berlusconi, the billionaire centre-right politician – is at the core of serious questions of legitimacy in Italy. What happened in Italy that summer and autumn as policy makers battled the crisis gripping the eurozone is still a subject of intense debate.
Here, the story takes a detour to a glimpse of the denouement, by advising readers that the president’s “planning the replacement of the elected Mr Berlusconi by the unelected technocrat Mr Monti – months ahead of the eventual transfer of power in November – reinforces concerns about Mr Napolitano’s repeated and forceful interventions in politics. His outsized role since the crisis has led many to question whether he stretched his constitutional powers to their limits – or even beyond.” Of course, he did – and so did all other European bankers and business tycoons who knew they had to perpetuate the legacy status quo as long as possible or else their fortunes would come crumbling down before their eyes. But we already knew that. What we did not know were the explicit details of how the immaculate plan to wrest control of Italy from the playboy billionaire and hand it over to what essentially were Goldman’s key European tentacles, were conceived. So we read on:
Outside the calm of St Moritz that summer, the eurozone crisis was raging. Market speculation against Italian and Spanish sovereign debt was rampant and the spread between Italian Treasury bonds and German Bunds was rocketing. As its borrowing costs rose there was talk that Italy could default. Italy was in crisis – politically as well as economically.
In Rome, Mr Berlusconi was presiding over a rancorous, unstable coalition and increasingly distracted by allegations over sexual relations with Karim el-Mahroug, a Moroccan nightclub dancer. All of Europe seemed to be lambasting him.
Yet despite the controversy engulfing Mr Berlusconi, he was still the sitting prime minister and his government was legitimate under the rules of Italy’s parliamentary democracy.
How long that might last was a subject of conversation between Mr De Benedetti and Mr Monti that August.
“I told Mario that he should take the job but that it was all a question of timing. If Napolitano formalised the offer in September then that was fine, but if he left it until December then it would be too late,” recounts Mr De Benedetti.
So now we know the timeframe for the upcoming coup: ideally sometime, in October or November of 2011. But before that, it was the turn of another element – this time the European connection Romano Prodi – to give his blessing and to explain to Monti why he would soon be the “happiest man alive:”
Romano Prodi, a former president of the European Commission and another old friend of Mr Monti’s, recalls a similar conversation, but even earlier, towards the end of June 2011. “We had a long and friendly conversation,” Mr Prodi says, “and he asked for my thoughts, and I told him, ‘look here Mario, there is nothing you can do to become prime minister but if the job is offered to you then you cannot say no. So you should be the happiest man alive’.”
Finally, the only missing link was the codification of the “reforms” that Italy would undergo the second Berlusconi was booted out.
Corrado Passera, a leading banker who was to become Mr Monti’s minister for economic development, infrastructure and transport, was meanwhile given the green light that summer by Mr Napolitano to prepare a confidential 196-page document containing his own proposals for a wide-ranging “shock therapy” for the Italian economy. It was a programme of proposed government policies and reforms that went through four successive drafts as Mr Napolitano and Mr Passera discussed it back and forth that summer and into the autumn.
With all that in place, it was time to put the plan into effect.
Italy’s crisis intensified throughout the autumn of 2011. All Italians still remember the smirk of scepticism on the faces of Angela Merkel, the German chancellor, and Nicolas Sarkozy, the French president, when they were asked at a press conference in October if they had confidence in Mr Berlusconi’s ability to cut the deficit or reduce the debt, which was then at 120 per cent of gross domestic product. (The latest figure is 133 per cent.)
So yes, for anyone still confused – since total debt/GDP has risen by 13% in the past two years, the last thing Italy engaged in was austerity designed to moderate its out of control public spending. What it did engage in, was epic capital misallocation, even greater corruption, and gross incompetence. All of these, however, were conveniently scapegoated on the only well-known traditional fallback.
At this point, we should remind readers of a concurrent story, one involving Italy’s then-member of the ECB executive council, Lorenzo Bini-Smaghi, who revealed in a recent book that at just around this time Berlusconi was realizing that the trap was closing. Bini-Smaghi revealed that Berlusconi had “discussed (threatened?) Italian withdrawal from the euro in private meetings with other EMU governments, presumably with Chancellor Angela Merkel and France’s Nicolas Sarkozy, since he does not negotiate with underlings.”
And so the ECB went to task, and under its new boss, yet another Italian, former Goldmanite Mario Draghi, allowed Italian bond yields to crater and take the country, and the Eurozone, and thus the entire developed world, to the edge of collapse. Just so Italy’s president had a pretext to accelerate the demise of Berlusconi and catalyze his replacement with a technocrat crony of the financial establishment. Once again, as a reminder, here is the dynamic of bond yields soaring just as Berlusconi was threatening to end the European dream in which “so much political capital is invested”:
What happened after that moment is part of the public record:
On November 9 2011 Mr Napolitano appointed Mr Monti a senator for life, thus making him a member of parliament. On November 12, at a meeting with the president, Mr Berlusconi resigned, ending his third stint as prime minister. Within 24 hours – rather than call for fresh elections – Mr Napolitano named Mr Monti, the economics professor and former European commissioner who had never held elected office, as prime minister. The full cabinet was sworn in three days later.
Mr Berlusconi’s supporters cried foul and made noisy claims that there had been a “coup”.
They were right, and now – from the horse’s mouth – we know the facts.
In a lengthy videotaped interview with Mr Monti, he confirmed the conversation with Mr De Benedetti in St Moritz. He also acknowledged the conversation with Mr Prodi in June 2011, though at first he played down these talks, saying that the idea of him becoming prime minister “was sort of in the air”.
He recalled with a giggle that “Yes, Prodi came to see me at the end of June and the spread [between Italian and German government bond yields] was then about 220 or 250 basis points, and he told me: ‘Get ready, because when the spread hits 300 you will be called in’. And then the spread hit 550!”
… as if by magic. Supposedly Draghi wasn’t quite willing to do “whatever it takes” just yet.
Mr Monti confirmed that he knew all about the Passera document being prepared for the president. “Corrado Passera told me he was working on this and he said he would show it to me, and he did, and he told me he had given it to Napolitano and would give it to me,” Mr Monti said. “And on one occasion I discussed the Passera document with Napolitano, and then later on, months later, when I was named prime minister, I immediately asked Passera to join the Cabinet.”
But when asked if it was made clear to him in the summer of 2011 in his talks with Mr Napolitano that the president was asking him to be ready to take over from Mr Berlusconi, Mr Monti hesitated. “Well, President Napolitano and I had been talking for a long time, for years, not about this, but then things sort of came to a head.”
When pressed further to explain if Mr Napolitano had explicitly asked him to be on standby during their talks back in June and July 2011 – four to five months before he replaced Mr Berlusconi as prime minister – Mr Monti demurred: “Look here: I will not reveal details of conversations that I had with the president of the republic.”
Pressed again, and asked if he wished to deny on the record that in June and July of 2011 President Napolitano had either asked him explicitly or had made it clear that he wanted him to be available to become the new prime minister, Mr Monti replied falteringly, in a voice that became almost a whisper: “Yes. He, uh, he gave me a signal in that direction.” After this revelation a look of extreme discomfort spread across Mr Monti’s face and he stared off to one side.
Perhaps because Monti had just realized he admitted that Italy had undergone presidentially-blessed government coup – one whose execution stretched far beyond any constitutional powers awarded to the president, and one which involved numerous foreign (and financial) interests (and conflicts thereof).
At this point attention turns to Italy’s president, 89-year old Giorgio Napolitan0, whose direct intervention was instrumental in allowing this carefully laid “bloodless coup” plan of bankers and technocrats to proceed:
Mr Napolitano did not agree to an interview despite repeated requests. His spokesman had no comment on a series of written questions, including one about which month in 2011 Mr Napolitano had first sounded out Mr Monti to become prime minister.
But last week Mr Napolitano commented for the first time on the controversy over his naming of Mr Monti. During a visit to the European parliament in Strasbourg, Mr Napolitano said that while some had described his naming of Mr Monti “as almost invented by me as a personal whim”, in fact he had done so on the basis of indications given to him by parliamentary and political leaders “in the course of consultations as is required”.
This explanation could raise further questions in Italy, where such “consultations as is required” would typically have begun only upon the resignation of the prime minister. In Mr Berlusconi’s case, these would have begun upon his November 12 resignation.
We now know that all such consultations took place well before said resignation. But where it gets better is just how grand the chess game truly was:
The Monti government acted swiftly to introduce harsh austerity measures, spending cuts, a value added tax rise and new property duties as well as reform of the pensions system. Praise was duly heaped on him by the European Commission, the International Monetary Fund and financial markets.
Many Italians still despise Mr Monti for the austerity programme and see him as a pawn of the European Commission or of Ms Merkel. In retrospect he lacked a political touch but was a useful transition figure at a time of crisis.
Mr Monti says his greatest achievement was to jump into electoral politics during the election of February 2013 at the expense of Berlusconi’s party. “Had it not been for my taking votes away from the centre-right,” Mr Monti said in the interview, “Berlusconi today would be either the president of the republic or the prime minister, so I did achieve a concrete result in blocking that.”
Of course, Berlusconi’s star has now faded, and with it the danger that the supposedly irrational politician, who once had threatened to dissolve the Eurozone and thus saddle Germany with a TARGET2 bill amounting to almost $1 trillion. Which meant that the status quo of the “equity tranche” (read – the global banker aristocracy) had been preserved. In this way, Napolitano, Prodi and Monti, assisted by their fourth Italian friend – ECB’s Mario Draghi – effectively subjugated the Italian population to call it austerity, call it gross and premeditated capital misallocation, but certainly call it the will of the bankers. And all without firing a shot.
Which brings up the question of just how constitutional, if at all, was the overthrow of Berlusconi.
Adopted in 1948 after more than 20 years of chaos and brutal fascist rule, Italy’s constitution is one of the few documents universally respected by Italians. It guarantees their most basic rights. It is sacrosanct.
Planning in secret, even as a contingency measure, to appoint a new prime minister when a parliamentary majority is in place may be a prudent and responsible action for a president but it is not an explicit power assigned by the constitution, even if there is a financial crisis under way in half of Europe as was the case in the summer of 2011.
Most ironic, however, is that the only person who seems to care about the trampling of the constitution is… a former comedian.
Whatever one thinks of Mr Berlusconi, serious constitutional questions are raised by the behind-the-scenes manoeuvring that resulted in the appointment of his successor. Perhaps the loudest voice to raise these questions is that of Beppe Grillo, the comedian-turned-politician who garnered 25 per cent of the national vote last year.
Mr Napolitano, an 89-year-old former communist, has reacted with anger at Mr Grillo’s incessant accusations of the subversion of democracy. Mr Grillo has frequently called for Mr Napolitano’s impeachment.
Today, Italy is emerging from recession slowly, with an exceedingly weak and uneven economic recovery. This year is expected to bring less than 1 per cent growth in GDP.
Italy remains sharply divided over the events of 2011 and Mr Napolitano’s role in them. The issue of whether Mr Napolitano went beyond his constitutional powers during the summer and autumn of 2011 can be left to future historians. But what is clear now – thanks to Mr Monti’s own admission – is that he and the president had been discussing the prospect of his taking over from Mr Berlusconi long before his official appointment in November of 2011. For Mario Monti it had been a long and secret summer.
Indeed it had. And now we know that in order to effectuate the banker plan of preserving Europe’s “political capital” which is simply another name of trillions in wealth on paper (and on funny-colored pieces of European currency) that would evaporate if and when the Eurozone inevitably dissolves, it took just four Italians – Monti, Prodi, Napolitano and, of course, Draghi – willing to trample their constitution in order to achieve the goal of perpetuating the status quo no matter the cost.
As for the fallout, namely “youth unemployment is at a record high of 41.6 per cent, nationwide joblessness is 12.7 per cent and almost a third of families are near the poverty line. Productivity and competitiveness have dropped sharply in recent years. Mr Monti’s successor, Enrico Letta, another leader championed by Mr Napolitano, is under fire for his handling of the economy”… well, all those are problems of the “99%”. And as everyone knows by know, the 99% is the last thing on the mind of the global ruling class.
Submitted by Adam Taggart of Peak Prosperity,
Argentina is a country re-entering crisis territory it knows too well. The country has defaulted on its sovereign debt three times in the past 32 years and looks poised to do so again soon.
Its currency, the peso, devalued by more than 20% in January alone. Inflation is currently running at 25%. Argentina’s budget deficit is exploding, and, based on credit default swap rates, the market is placing an 85% chance of a sovereign default within the next five years.
Want to know what it’s like living through a currency collapse? Argentina is providing us with a real-time window.
So, we’ve invited Fernando “FerFAL” Aguirre back onto the program to provide commentary on the events on the ground there. What is life like right now for the average Argentinian?
Aguirre began blogging during the hyperinflationary destruction of Argentina’s economy in 2001 and has since dedicated his professional career to educating the public about his experiences and observations of its lingering aftermath. He is the author of Surviving the Economic Collapse and sees many parallels between the path that led to Argentina’s decline and the similar one most countries in the West, including the U.S., are currently on. Our 2011 interview with him “A Case Study in How An Economy Collapses” remains one of Peak Prosperity’s most well-regarded.
Chris Martenson: Okay. Bring us up to date. What is happening in Argentina right now with respect to its currency, the peso?
Fernando Aguirre: Well, actually pretty recently, January 22, the peso lost 15% of its value. It has devalued quite a bit. It ended up losing 20% of its value that week, and it has been pretty crazy since then. Inflation has been rampant in some sectors, going up to 100% in food, grocery stores 20%, 30% in some cases. So it has been pretty complicated. Lots of stores don’t want to be selling stuff until they get updated prices. Suppliers holding on, waiting to see how things go, which is something that we are familiar with because that happened back in 2001 when everything went down as we know it did.
Chris Martenson: So 100%, 20% inflation; are those yearly numbers?
Fernando Aguirre: Those are our numbers in a matter of days. In just one day, for example, cement in Balcarce, one of the towns in Southern Argentina, went up 100% overnight, doubling in price. Grocery stores in Córdoba, even in Buenos Aires, people are talking about increase of prices of 20, 30% just these days. I actually have family in Argentina that are telling me that they go to a hardware store and they aren’t even able to buy stuff from there because stores want to hold on and see how prices unfold in the following days.
Chris Martenson: Right. So this is one of those great mysteries of inflation. It is obviously ‘flying money’, so everyone is trying to get rid of their money. You would think that would actually increase commerce. But if you are on the other end of that transaction, if you happen to be the business owner, you have every incentive to withhold items for as long as possible. So one of the great ironies, I guess, is that even though money is flying around like crazy, goods start to disappear from the shelves. Is that what you are seeing?
Fernando Aguirre: Absolutely. Shelves halfway empty. The government is always trying to muscle its way through these kind of problems, just trying to force companies to stock back products and such, but they just keep holding on. For example, gas has gone up 12% these last few days. And there is really nothing they can do about it. If they don’t increase prices, companies just are not willing to sell. It is a pretty tricky situation to be in.
Chris Martenson: Are there any sort of price controls going on right now? Has anything been mandated?
Fernando Aguirre: As you know, price controls don’t really work. I mean, they tried this before in Argentina. Actually, last year one of the big news stories was that the government was freezing prices on food and certain appliances. It didn’t work. Just a few days later those supposedly “frozen” prices were going up. As soon as they officially released them, they would just double in price.
Chris Martenson: Let me ask you this, then: How many people in Argentina actually still have money in Argentine banks in dollars? One of the features in 2001 was that people had money in dollars, in the banks. There was a banking holiday; a couple of weeks later, banks open up; Surprise, you have the same number in your account, only it’s pesos, not dollars. It was an effective theft, if I could use that term. Is anybody keeping money in the banks at this point, or how is that working?
Fernando Aguirre: Well, first of all, I would like to clarify for people listening: Those banks that did that are the same banks that are found all over the world. They are not like strange South American, Argentinean banks – they are the same banks. If they are willing to steal from people in one place, don’t be surprised if they are willing to do it in other places as well.
Click the play button below to listen to Chris’ interview with Fernando Aguirre (36m:42s):
Submitted by Ben Hunt of Epsilon Theory
It Was Barzini All Along
Tattaglia is a pimp. He never could have outfought Santino. But I didn’t know until this day that it was Barzini all along.
— Don Vito Corleone
Like many in the investments business, I am a big fan of the Godfather movies, or at least those that don’t have Sofia Coppola in a supporting role. The strategic crux of the first movie is the realization by Don Corleone at a peace-making meeting of the Five Families that the garden variety gangland war he thought he was fighting with the Tattaglia Family was actually part of an existential war being waged by the nominal head of the Families, Don Barzini. Vito warns his son Michael, who becomes the new head of the Corleone Family, and the two of them plot a strategy of revenge and survival to be put into motion after Vito’s death. The movie concludes with Michael successfully murdering Barzini and his various supporters, a plot arc that depends entirely on Vito’s earlier recognition of the underlying cause of the Tattaglia conflict. Once Vito understood WHY Philip Tattaglia was coming after him, that he was just a stooge for Emilio Barzini, everything changed for the Corleone Family’s strategy.
Now imagine that Don Corleone wasn’t a gangster at all, but was a macro fund portfolio manager or, really, any investor or allocator who views the label of “Emerging Market” as a useful differentiation … maybe not as a separate asset class per se, but as a meaningful way of thinking about one broad set of securities versus another. With the expansion of investment options and liquid securities that reflect this differentiation — from Emerging Market ETF’s to Emerging Market mutual funds — anyone can be a macro investor today, and most of us are to some extent.
You might think that the ease with which anyone can be an Emerging Markets investor today would make the investment behavior around these securities more complex from a game theory perspective as more and more players enter the game, but actually just the opposite is true. The old Emerging Markets investment game had very high informational and institutional barriers to entry, which meant that the players relied heavily on their private information and relatively little on public signals and Common Knowledge. There may be far more players in the new Emerging Markets investment game, but they are essentially one type of player with a very heavy reliance on Common Knowledge and public Narratives. Also, these new players are not (necessarily) retail investors, but are (mostly) institutional investors that see Emerging Markets or sub-classifications of Emerging Markets as an asset class with certain attractive characteristics as part of a broad portfolio. Because these institutional investors have so much money that must be put to work and because their portfolio preference functions are so uniform, there is a very powerful and very predictable game dynamic in play here.
Since the 2008 Crisis the Corleone Family has had a pretty good run with their Emerging Markets investments, and even more importantly Vito believes that he understands WHY those investments have worked. In the words of Olivier Blanchard, Chief Economist for the IMF:
In emerging market countries by contrast, the crisis has not left lasting wounds. Their fiscal and financial positions were typically stronger to start, and adverse effects of the crisis have been more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have largely recovered, and whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand. Capital outflows have turned into capital inflows, due to both better growth prospects and higher interest rates than in advanced countries. … The challenge for most emerging countries is quite different from that of advanced countries, namely how to avoid overheating in the face of closing output gaps and higher capital flows. — April 11, 2011
As late as January 23rd of this year, Blanchard wrote that “we forecast that both emerging market and developing economies will sustain strong growth“.
Now we all know what actually happened in 2013. Growth has been disappointing around the world, particularly in Emerging Markets, and most of these local stock and bond markets have been hit really hard. But if you’re Vito Corleone, macro investor extraordinaire, that’s not necessarily a terrible thing. Sure, you don’t like to see any of your investments go down, but Emerging Markets are notably volatile and maybe this is a great buying opportunity across the board. In fact, so long as the core growth STORY is intact, it almost certainly is a buying opportunity.
But then you wake up on July 9th to read in the WSJ that Olivier Blanchard has changed his tune. He now says “It’s clear that these countries [China, Russia, India, Brazil, South Africa] are not going to grow at the same rate as they did before the crisis.” Huh? Or rather, WTF? How did the Chief Economist of the IMF go from predicting “strong growth” to declaring that the party is over and the story has fundamentally changed in six months?
It’s important to point out that Blanchard is not some inconsequential opinion leader, but is one of the most influential economists in the world today. His position at the IMF is a temporary gig from his permanent position as the Robert M. Solow Professor of Economics at MIT, where he has taught since 1983. He also received his Ph.D. in economics from MIT (1977), where his fellow graduate students were Ben Bernanke (1979), Mario Draghi (1976), and Paul Krugman (1977), among other modern-day luminaries; Stanley Fischer, current Governor of the Bank of Israel, was the dissertation advisor for both Blanchard and Bernanke; Mervyn King and Larry Summers (and many, many more) were Blanchard’s contemporaries or colleagues at MIT at one point or another. The centrality of MIT to the core orthodoxy of modern economic theory in general and monetary policy in particular has been well documented by Jon Hilsenrath and others and it’s not a stretch to say that MIT provided a personal bond and a formative intellectual experience for a group of people that by and large rule the world today. Suffice it to say that Blanchard is smack in the middle of that orthodoxy and that group. I’m not saying that anything Blanchard says is amazingly influential in and of itself, certainly not to the degree of a Bernanke or a Draghi (or even a Krugman), but I believe it is highly representative of the shared beliefs and opinions that exist among these enormously influential policy makers and policy advisors. Two years ago the global economic intelligentsia believed that Emerging Markets had emerged from the 2008 crisis essentially unscathed, but today they believe that EM growth rates are permanently diminished from pre-crisis levels. That’s a big deal, and anyone who invests or allocates to “Emerging Markets” as a differentiated group of securities had better take notice.
Here’s what I think happened.
First, an error pattern has emerged over the past few years from global growth data and IMF prediction models that forced a re-evaluation of those models and the prevailing Narrative of “unscathed” Emerging Markets. Below is a chart showing actual Emerging Market growth rates for each year listed, as well as the IMF prediction at the mid-year mark within that year and the mid-year mark within the prior year (generating an 18-month forward estimate).
Pre-crisis the IMF systematically under-estimated growth in Emerging Markets. Post-crisis the IMF has systematically over-estimated growth in Emerging Markets. Now to be sure, this IMF over-estimation of growth exists for Developed Markets, too, but between the EuroZone sovereign debt crisis and the US fiscal cliff drama there’s a “reason” for the unexpected weakness in Developed Markets. There’s no obvious reason for the persistent Emerging Market weakness given the party line that “whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand.” Trust me, IMF economists know full well that their models under-estimated EM growth pre-crisis and have now flipped their bias to over-estimate growth today. Nothing freaks out a statistician more than this sort of flipped sign. It means that a set of historical correlations has “gone perverse” by remaining predictive, but in the opposite manner that it used to be predictive. This should never happen if your underlying theory of how the world works is correct. So now the IMF (and every other mainstream macroeconomic analysis effort in the world) has a big problem. They know that their models are perversely over-estimating growth, which given the current projections means that we’re probably looking at three straight years of sub-5% growth in Emerging Markets (!!) more than three years after the 2008 crisis ended, and — worse — they have no plausible explanation for what’s going on.
Fortunately for all concerned, a Narrative of Central Bank Omnipotence has emerged over the past nine months, where it has become Common Knowledge that US monetary policy is responsible for everything that happens in global markets, for good and for ill (see “How Gold Lost Its Luster”). This Narrative is incredibly useful to the Olivier Blanchard’s of the world, as it provides a STORY for why their prediction models have collapsed. And maybe it really does rescue their models. I have no idea. All I’m saying is that whether the Narrative is “true” or not, it will be adopted and proselytized by those whose interests — bureaucratic, economic, political, etc. — are served by that Narrative. That’s not evil, it’s just human nature.
Nor is the usefulness of the Narrative of Central Bank Omnipotence limited to IMF economists. To listen to Emerging Market central bankers at Jackson Hole two weeks ago or to Emerging Market politicians at the G-20 meeting last week you would think that a great revelation had been delivered from on high. Agustin Carstens, Mexico’s equivalent to Ben Bernanke, gave a speech on the “massive carry trade strategies” caused by ZIRP and pleaded for more Fed sensitivity to their capital flow risks. Interesting how the Fed is to blame now that the cash is flowing out, but it was Mexico’s wonderful growth profile to credit when the cash was flowing in. South Africa’s finance minister, Pravin Gordhan, gave an interview to the FT from Jackson Hole where he bemoaned the “inability to find coherent and cohesive responses across the globe to ensure that we reduce the volatility in currencies in particular, but also in sentiment” now that the Fed is talking about a Taper. Christine Lagarde got into the act, of course, calling on the world to build “further lines of defense” even as she noted that the IMF would (gulp) have to stand in the breach as the Fed left the field. To paraphrase Job: the Fed gave, and the Fed hath taken away; blessed be the name of the Fed.
The problem, though, is that once you embrace the Narrative of Central Bank Omnipotence to “explain” recent events, you can’t compartmentalize it there. If the pattern of post-crisis Emerging Market growth rates is largely explained by US monetary accommodation or lack thereof … well, the same must be true for pre-crisis Emerging Market growth rates. The inexorable conclusion is that Emerging Market growth rates are a function of Developed Market central bank liquidity measures and monetary policy, and that all Emerging Markets are, to one degree or another, Greece-like in their creation of unsustainable growth rates on the back of 20 years of The Great Moderation (as Bernanke referred to the decline in macroeconomic volatility from accommodative monetary policy) and the last 4 years of ZIRP. It was Barzini all along!
This shift in the Narrative around Emerging Markets — that the Fed is the “true” engine of global growth — is a new thing. As evidence of its novelty, I would point you to another bastion of modern economic orthodoxy, the National Bureau of Economic Research (NBER), in particular their repository of working papers. Pretty much every US economist of note in the past 40 years has published an NBER working paper, and I only say “pretty much every” because I want to be careful; my real estimate is that there are zero mainstream US economists who don’t have a working paper here.
If you search the NBER working paper database for “emerging market crises”, you see 16 papers. Again, the author list reads like a who’s who of famous economists: Martin Feldstein, Jeffrey Sachs, Rudi Dornbusch, Fredric Mishkin, Barry Eichengreen, Nouriel Roubini, etc. Of these 16 papers, only 2 — Frankel and Roubini (2001) and Arellano and Mendoza (2002) — even mention the words “Federal Reserve” in the context of an analysis of these crises, and in both cases the primary point is that some Emerging Market crises, like the 1998 Russian default, force the Fed to cut interest rates. They see a causal relationship here, but in the opposite direction of today’s Narrative! Now to be fair, several of the papers point to rising Developed Market interest rates as a “shock” or contributing factor to Emerging Market crises, and Eichengreen and Rose (1998) make this their central claim. But even here the argument is that “a one percent increase in Northern interest rates is associated with an increase in the probability of Southern banking crises of around three percent” … not exactly an earth-shattering causal relationship. More fundamentally, none of these authors ever raise the possibility that low Developed Market interest rates are the core engine of Emerging Market growth rates. It’s just not even contemplated as an explanation.
Today, though, this new Narrative is everywhere. It pervades both the popular media and the academic “media”, such as the prominent Jackson Hole paper by Helene Rey of the London Business School, where the nutshell argument is that global financial cycles are creatures of Fed policy … period, end of story. Not only is every other country just along for the ride, but Emerging Markets are kidding themselves if they think that their plight matters one whit to the US and the Fed.
Market participants today see Barzini/Bernanke everywhere, behind every news announcement and every market tick. They may be right. They may be reading the situation as smartly as Vito Corleone did. I doubt it, but it really doesn’t matter. Whether or not I privately believe that Barzini/Bernanke is behind everything that happens in the world, I am constantly told that this is WHY market events happen the way they do. And because I know that everyone else is seeing the same media explanations of WHY that I am seeing … because I know that everyone else is going through the same tortured decision process that I’m going through … because I know that everyone else is thinking about me in the same way that I am thinking about them … because I know that if everyone else acts as if he or she believes the Narrative then I should act as if I believe the Narrative … then the only rational conclusion is that I should act as if I believe it. That’s the Common Knowledge game in action. This is what people mean when they say that a market behavior of any sort “takes on a life of its own.”
For the short term, at least, the smart play is probably just to go along with the Barzini/Bernanke Narrative, just like the Corleone family went along with the idea that Barzini was running them out of New York (and yes, I understand that at this point I’m probably taking this Godfather analogy too far). By going along I mean thinking of the current market dynamic in terms of risk management, understanding that the overall information structure of this market is remarkably unstable. Risk-On / Risk-Off behavior is likely to increase significantly in the months ahead, and there’s really no predicting when Bernanke will open his mouth or what he’ll say, or who will be appointed to take his place, or what he or she will say. It’s hard to justify any large exposure to public securities in this environment, long or short, because all public securities will be dominated by this Narrative so long as everyone thinks that everyone thinks they will be dominated. This the sort of game can go on for a long time, particularly when the Narrative serves the interests of incredibly powerful institutions around the world.
But what ultimately saved the Corleone family wasn’t just the observation of Barzini’s underlying causal influence, it was the strategy that adjusted to the new reality of WHY. What’s necessary here is not just a gnashing of teeth or tsk-tsk’ing about how awful it is that monetary policy has achieved such behavioral dominance over markets, but a recognition that it IS, that there are investment opportunities created by its existence, and that the greatest danger is to continue on as if nothing has changed.
I believe that there are two important investment implications that stem from this sea change in the Narrative around Emerging Markets, which I’ll introduce today and develop at length in subsequent notes.
First, I think it’s necessary for active investors to recalibrate their analysis towards individual securities that happen to be found in Emerging Markets, not aggregations of securities with an “Emerging Markets” label. I say this because in the aggregate, Emerging Market securities (ETF’s, broad-based funds, etc.) are now the equivalent of a growth stock with a broken story, and that’s a very difficult row to hoe. Take note, though, the language you will have to speak in this analytic recalibration of Emerging Market securities is Value, not Growth, and the critical attribute of a successful investment will have little to do with the security’s inherent qualities (particularly growth qualities) but a great deal to do with whether a critical mass of Value-speaking investors take an interest in the security.
Second, there’s a Big Trade here related to the predictable behaviors and preference functions of the giant institutional investors or advisors that — by size and by strategy — are locked into a perception of Emerging Market meaning that can only be expressed through aggregations of securities or related fungible asset classes (foreign exchange and commodities). These mega-allocators do not “see” Emerging Markets as an opportunity set of individual securities, but as an asset class with useful diversification qualities within an overall portfolio. So long as market behaviors around Emerging Markets in the aggregate are driven by the Barzini/Bernanke Narrative, that diversification quality will decline, as the same Fed-speak engine is driving behaviors in both Emerging Markets and Developed Markets. Mega-allocators care more about diversification and correlations than they do about price, which means that the selling pressure will continue/increase so long as the old models aren’t working and the Barzini/Bernanke Narrative diminishes what made Emerging Markets as an asset class useful to these institutions in the first place. But when that selling pressure dissipates — either because the Barzini/Bernanke Narrative wanes or the mega-portfolios are balanced for the new correlation models that take the Barzini/Bernanke market effect into account — that’s when Emerging Market securities in the aggregate will work again. You will never identify that turning point in Emerging Market security prices by staring at a price chart. To use a poker analogy you must play the player — in this case the mega-allocators who care a lot about correlation and little about price — not the cards in order to know when to place a big bet.
In future weeks I’ll be expanding on each of these investment themes, as well as taking them into the realm of foreign exchange and commodities. Also, there’s a lot still to be said about Fed communication policy and the Frankenstein’s Monster it has become. I hope you will join me for the journey, and if you’d like to be on the direct distribution list for these free weekly notes please sign up at Follow Epsilon Theory.
This is part two of a Q&A with Willem Middelkoop about his new book The Big Reset. In his book a chapter on the ‘War on Gold’ takes a prominent position. Willem has been writing about the manipulation of the gold pricesince 2002 based on information collected by GATA since the late 1990’s. So part two of our interview will focus on this topic.
The War On Gold
Why does the US fight gold?
The US wants its dollar system to prevail for as long as possible. It therefore has every interest in preventing a ‘rush out of dollars into gold’. By selling (paper) gold, bankers have been trying in the last few decades to keep the price of gold under control. This war on gold has been going on for almost one hundred years, but it gained traction in the 1960’s with the forming of the London Gold Pool. Just like the London Gold Pool failed in 1969, the current manipulation scheme of gold (and silver prices) cannot be maintained for much longer.
What is the essence of the war on gold?
The survival of our current financial system depends on people preferring fiat money over gold. After the dollar was taken of the gold standard in 1971, bankers have tried to demonetize gold. One of the arguments they use to deter investors from buying gold and silver is that these metals do not deliver a direct return such as interest or dividends. But interest and dividend are payments to compensate for counterparty risk – the risk that your counterparty is unable to live up to its obligations. Gold doesn’t carry that risk. The war on gold is, in essence, an endeavor to support the dollar. But this is certainly not the only reason. According to a number of studies, the level of the gold price and the general public’s expectations of inflation are highly correlated. Central bankers work hard to influence inflation expectations. A 1988 study by Summers and Barsky confirmed that the price of gold and interest rates are highly correlated, as well with a lower gold price leading to lower interest rates.
When did the war on gold start?
The first evidence of US meddling in the gold market can be found as early as 1925 when the Fed falsified information regarding the Bank of England’s possession of gold in order to influence interest rate levels. However, the war on gold only really took off in the 1960’s when trust in the dollar started to fray. Geopolitical conflicts such as the building of the Berlin Wall, the Cuban Missile Crisis and the escalation of violence in Vietnam led to increasing military spending by the US, which in turn resulted in growing US budget deficits. A memorandum from 1961 entitled ‘US Foreign Exchange Operations: Needs and Methods’ described a detailed plan to manipulate the currency and gold markets via structural interventions in order to support the dollar and maintain the gold price at $ 35 per ounce. It was vital for the US to ‘manage’ the gold market; otherwise countries could exchange their surplus dollars for gold and then sell these ounces on the free gold market for a higher price
How was the gold price managed in the 1960’s?
During meetings of the central bank presidents at the BIS in 1961, it was agreed that a pool of $ 270 million in gold would be made available by the eight participating (western) countries. This so-called ‘London Gold Pool’ was focused on preventing the gold price from rising above $ 35 per ounce by selling official gold holdings from the central banks gold vaults. The idea was that if investors attempted to flee to the safe haven of gold, the London Gold Pool would dump gold onto the market in order to keep the gold price from rising. During the Cuban Missile Crisis in 1962, for instance, at least $ 60 million in gold was sold between 22 and 24 October. The IMF provided extra gold to be sold on the market when needed. In 2010, a number of previously secret US telex reports from 1968 were made public by Wikileaks. These messages describe what had to be done in order to keep the gold price under control. The aim was to convince investors that it was completely pointless to speculate on a rise in the price of gold. One of the reports mentions a propaganda campaign to convince the public that the central banks would remain ‘the masters of gold’. Despite these efforts, in March 1968, the London Gold Pool was disbanded because France would no longer cooperate. The London gold market remained closed for two weeks. In other gold markets around the world, gold immediately rose 25% in value. This can happen again when the COMEX will default.
More evidence about this manipulation?
From the transcript of a March 1978 Fed-meeting, we know that the manipulation of the gold price was a point of discussion at that time. During the meeting Fed Chairman Miller pointed out that it was not even necessary to sell gold in order to bring the price down. According to him, it was enough to bring out a statement that the Fed was intending to sell gold.
Because the US Treasury is not legally allowed to sell its gold reserves, the Fed decided in 1995 to examine whether it was possible to set up a special construction whereby so-called ‘gold swaps’ could bring in gold from the gold reserves of Western central banks. In this construction, the gold would be ‘swapped’ with the Fed, which would then be sold by Wall Street banks in order to keep prices down. Because of the ‘swap agreement’, the gold is officially only lent out, so Western central banks could keep it on their balance sheets as ‘gold receivables’. The Fed started to informing foreign central bankers that they expected that the gold price to decline further, and large quantities of central banks’ gold became be available to sell in the open market. Logistically this was an easy operation, since the New York Fed vaults had the largest collection of foreign gold holdings. Since the 1930’s, many Western countries had chosen to store their gold safely in the US out of fears of a German or Soviet invasion.
Didn’t the British help as well by unloading gold at the bottom of the market?
Between 1999 and 2002, the UK embarked on an aggressive selling of its gold reserves, when gold prices were at their lowest in 20 years. Prior to starting, the Chancellor of the Exchequer, Gordon Brown, announced that the UK would be selling more than half of its gold reserves in a series of auctions in order to diversify the assets of the UK’s reserves. The markets’ reaction was one of shock, because sales of gold reserves by governments had until then always taken place without any advance warning to investors. Brown was following the Fed’s strategy of inducing a fall in the gold price via an announcement of possible sales. Brown’s move was therefore not intended to receive the best price for its gold but rather to bring down the price of gold as low as possible. The UK eventually sold almost 400 tons of gold over 17 auctions in just three years, just as the gold market was bottoming out. Gordon Brown’s sale of the UK’s gold reserves probably came about following a request from the US. The US supported Brown ever since.
How do they manipulate gold nowadays?
The transition from open outcry (where traders stand in a trading pit and shout out orders) to electronic trading gave new opportunities to control financial markets. Wall Street veteran lawyer Jim Rickards presented a paper in 2006 in which he explained how ‘derivatives could be used to manipulate underlying physical markets such as oil, copper and gold’. In his bestseller entitled Currency Wars, he explains how the prohibition of derivatives regulation in the Commodity Futures Modernization Act (2000) had ‘opened the door to exponentially greater size and variety in these instruments that are now hidden off the balance sheets of the major banks, making them almost impossible to monitor’. These changes made it much easier to manipulate financial markets, especially because prices for metals such as gold and silver are set by trading future contracts on the global markets. Because up to 99% of these transactions are conducted on behalf of speculators who do not aim for physical delivery and are content with paper profits, markets can be manipulated by selling large amounts of contracts in gold, silver or other commodities (on paper). The $200 crash of the gold price April 12 and 15, 2013 is a perfect example of this strategy. The crash after silver reached $50 on May 1, 2011 is another textbook example.
For how long can this paper-gold game continue?
As you have been reporting yourself we can witness several indications pointing towards great stress in the physical gold market. I would be very surprised when the current paper gold game can be continued for another two years. This system might even fall apart in 2014. A default in gold and/or silver futures on the COMEX is a real possibility. It happened to the potato market in 1976 when a potato-futures default happened on the NYMEX. An Idaho potato magnate went short potatoes in huge numbers, leaving a large amount of contracts unsettled at the expiration date, resulting in a large number of defaulted delivery contracts. So it has happened before. In such a scenario futures contracts holders will be cash settled. So I expect the Comex will have to move to cash settlement rather than gold delivery at a certain point in the not too distant future. After such an event the price of gold will be set in Asian markets, like the Shanghai Gold Exchange. I expect gold to jump $1000 in a short period of time and silver prices could easily double overnight. That’s one of the reasons our Commodity Discovery Fund invests in undervalued precious metal companies with large gold/silver reserves. They all have huge up-side potential in the next few years when this scenario will play out.
In Gold We Trust
Synopsis of The Big Reset: Now five years after the near fatal collapse of world’s financial system we have to conclude central bankers and politicians have merely been buying time by trying to solve a credit crisis by creating even more debt. As a result worldwide central bank’s balance sheets expanded by $10 trillion. With this newly created money central banks have been buying up national bonds so long term interest rates and bond yields have collapsed. But ‘parking’ debt at national banks is no structural solution. The idea we can grow our way back out of this mountain of debt is a little naïve. In a recent working paper by the IMF titled ‘Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten’ the economist Reinhart and Rogoff point to this ‘denial problem’. According to them future economic growth will ‘not be sufficient to cope with the sheer magnitude of public and private debt overhangs. Rogoff and Reinhart conclude the size of the debt problems suggests that debt restructurings will be needed ‘far beyond anything discussed in public to this point.’ The endgame to the global financial crisis is likely to require restructuring of debt on a broad scale.
About the author: Willem Middelkoop (1962) is founder of the Commodity Discovery Fund and a bestselling Dutch author, who has been writing about the world’s financial system since the early 2000s. Between 2001 and 2008 he was a market commentator for RTL Television in the Netherlands and also appeared on CNBC. He predicted the credit crisis in his first bestseller in 2007.
Editor’s Note: The following is the first installment of a three-part series on growing debt for Russia’s regional governments.
Since the 2009 financial crisis, the Kremlin has allowed Russia’s regions to take the brunt of the country’s economic decline in order to keep the federal government seemingly healthy, with a nominally small budget deficit and large currency reserves. But now most of Russia’s regional governments’ debt is so high, it is becoming dangerous for the federal government and big banks and could soon become unmanageable.
Russia is so large that the Kremlin lacks the resources to run each region of the country directly. Currently Russia is split into 83 regions of all shapes and sizes, which fall into categories of oblasts, republics, krais, federal cities and autonomous okrugs. Historically, the Kremlin has given regional leaders (mayors, governors, heads or republic presidents) the power to run their own regions and ensure loyalty to the Kremlin and stability for the country.
However, the Kremlin is constantly concerned with its control over the regions. The federal government’s ability to maintain the loyalty of each region has been tested often throughout history. For instance, dozens of regions attempted to break away after the fall of the Soviet Union, occasionally leading to wars such as those in Chechnya.
The central government’s control over the regions was demolished during the devastating financial crisis in 1998. Many of the regional heads defied the federal government in order to look out for their own regions’ survival. It was the second-worst regional breakdown in Russia following the collapse of the Soviet Union, and it was related directly to the chaos caused by that collapse. This is why the currently growing economic strains in the regions will be of great concern for the Kremlin.
The Regions’ Mounting Debts
Most of Russia’s regional governments have always had some level of debt, but resource-based export revenues have kept it mostly manageable since the 1998 crisis. However, since the 2008-2009 financial crisis, most of the regions’ debt has risen by more than 100 percent — from $35 billion in 2010 to an estimated $78 billion in 2014, and Standard & Poor’s has estimated that this will rise to $103 billion in 2015. Russia’s overall government debt — the federal and regional governments combined — is around $300 billion, or 14 percent of gross domestic product. This is small for a country as large as Russia, but the problem is that so much of the debt is concentrated in the regions, which do not have as many debt reduction tools as the federal government does.
Of the 83 regional subjects in Russia, only 20 will be able to keep a budget surplus or a moderate level of debt by 2015, according to Standard & Poor’s calculations. This leaves the other 63 regions at risk of needing a federal bailout or defaulting on their debt.
Currently, the Russian regions are financing their debt via bank loans, bonds and budget credits (federal loans, for example). Each region has to get federal approval to issue bonds, because regional bonds create more market competition for the federal and business bonds. Most of the banking loans to the regions carry high interest rates and are short term (mostly between two and five years). The federal loans come with much lower rates and longer repayment schedules (mostly between five and 20 years), so naturally federal credits and loans are more attractive for the local governments, though unprofitable for the federal government. The issuance of federal credits or loans to the regions in 2013 was limited; initially, Moscow said it would issue $4.8 billion in new credits to the regions in 2013, but only issued $2.4 billion due to its own budgetary restrictions. This is one contributing factor to the dramatic local-government debt increases.
The next contributing factor to the rise in regional debt is the overall economic stagnation that has plagued Russia since the 2009 financial crisis and subsequent stimulus aimed at pulling Russia out of the crisis. Despite high energy prices all year, Russia’s gross domestic product growth slowed dramatically in 2013 to 1.5 percent growth after an initial 3-4 percent growth target by the Kremlin at the start of that year. This is low compared to the 7-8 percent growth seen yearly in Russia in the mid-2000s. Most analysts believe the only way Russia’s growth remained positive was through its large energy revenues, which make up half of the federal government’s budget and 20-25 percent of the country’s gross domestic product.
There are a handful of reasons for Russia’s economic stagnation. First, investment in Russia was lower than expected in 2013. Fixed investment was down 1.8 percent year-on-year in the first 10 months of 2013, compared with a 9.1 percent year-on-year growth in the same period in 2012. Private sector outflows of capital were high in 2013, with a net outflow of $48 billion leaving Russia in the first nine months of 2013, compared with $46 billion for the same period in 2012. Moreover, the investment sentiment in Russia is poor at the moment, as the Central Bank of Russia has begun closing some 800 smaller banks in a consolidation. Many of those banks were regionally based, and their closure is making investment in the regions less attractive.
Lower investment, coupled with less corporate borrowing and a decline in demand in many sectors, such as metals, led to lower industrial production. In the first 10 months of 2013, industrial production was flat compared with 2.8 percent growth in the same period in 2012. Industrial production is region-specific in Russia; industry provides nearly the entire economy in some regions. Thirty-one Russian regions, including Komi and Barents, had negative industrial production indexes for 2013. This could get worse in 2014, as many of the metals giants are planning to continue shutting down plants due to a lack of demand and low prices. For example, the world’s largest aluminum producer, Rusal, is shutting down five aluminum plants in the Volgograd, Karelia, Leningrad and Urals regions and laying off tens of thousands of workers.
Another factor contributing to the regions’ rising debts is increasingly burdensome obligations to the federal government. Of the income generated in a particular region, only 37 percent of the income stays in that region and the rest goes to the federal budget. The federal government does return some of the funds to the region in the form of subsidies and intergovernmental transfers, but not more than 20 percent. The amount of income that the Kremlin has taken from the regions has increased 12 percent in the past three years (via increases in taxes and decreases in subsidizations), leaving less and less for the regions to work with.
There has also been a large outcry from the regional governments in response to a series of presidential edicts that Vladimir Putin declared when he was re-elected to his third term in late 2011. Putin ordered the regional governments to do a series of tasks, such as replace all dilapidated housing by 2014, and to raise regional and municipal salaries by 7-10 percent in 2014 and another 10 percent in 2015. The regions are calling these “unfunded mandates,” as the federal government is not helping the regions pay for these projects. Already, the Kremlin has had to postpone the housing replacement edict to 2016 due to lack of funding in the regions, but the salary edict remains in place and is estimated to cost the regions $56.6 billion over the next two years.
- Part 1: Russia’s Growing Regional Debts Threaten Stability
- Part 2: Russia’s 1998 Financial Crisis in the Regions: A Case Study
- Part 3: Russia Weighs its Options for Managing Regional Debts
Tax burdens are so high that it might not be possible to pay off the high levels of indebtedness in most of the Western world. At least, that is the conclusion of a new IMF paper from Carmen Reinhart and Kenneth Rogoff.
Reinhart and Rogoff gained recent fame for their book “This Time It’s Different”, in whichthey argued that high levels of public debt have historically been associated with reduced growth opportunities.
As they now note, “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point.” Up to this point in the Eurocrisis the primary tools used to rescue profligate countries have included increased taxes, EU and IMF bailouts, and haircuts on government debt.
These bailouts have largely exacerbated the debt problems that existed five short years ago. Indeed, as Reinhart and Rogoff well note, the once fiscally sound North of Europe is now increasingly unable to continue shouldering the debts of its Southern neighbours.
General government debt (% GDP)
Source: Eurostat (2012)
Six European countries currently have a government debt to GDP ratio – a metric popularlised by Reinhart and Rogoff to signal reduced growth prospects – of over 90%. Countries that were relatively debt-free just five short years ago are now encumbered by the debt repayments necessitated by bailouts. Ireland is a case in point – as recently as 2007 its government debt to GDP ratio was below 25%. Six years later that figure stands north of 120%! “Fiscally secure” Scandinavia should keep in mind that fortunes can change quickly, as happened to the luck of the Irish.
The debt crisis to date has been mitigated in large part by tax increases and transfers from the wealthy “core” of Europe to the periphery. The problem with tax increases is that they cannot continue unabated.
Total government tax revenue (% GDP)
Source: Eurostat (2012)
Already in Europe there are seven countries where tax revenues are greater than 48% of GDP. There once was a time when only Scandinavia was chided for its high tax regimes and large public sectors. Today both Austria and France have more than half of their economies involved in the public sector and financed through taxes. (Note also that as they both run government budget deficits the actual size of their governments is greater yet.)
With high unemployment in Europe (and especially in its periphery), governments cannot raise much revenue by raising taxes – who would pay it? With already high levels of debt it is questionable how much revenue can be raised by further debt issuances, at least without increasing interest rates and imperiling already fragile government finances with higher interest charges.
Instead, Reinhart and Rogoff see two facts of life for Europe’s future: financial repression through higher inflation rates and taxes levied on savings and wealth. This time is no different than other cases of highly indebted countries in Europe’s history – just look to the post-War examples as similar cases in point. Don’t say you haven’t been warned.
David Howden is Chair of the Department of Business and Economics, and professor of economics at St. Louis University, at its Madrid Campus, Academic Vice President of the Ludwig von Mises Institute of Canada, and winner of the Mises Institute’s Douglas E. French Prize. Send him mail.