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Tuesday, March 26, 2013

Let's Do MT - Deferred Promissory Trades

I am sort of laughing at myself, because it is taking me a while to get to the money part. But money is a tool of markets, and markets are function of human biology. group dynamics, and human technology, so I see no other way to honestly have this discussion without first laying down a realistic foundation. The first sets of posts in this series aren't even going to get to money, but the purpose of all this is so that eventually we can have a genuine discussion about money. 

Now it may be reasonable for readers to snark at me about this seemingly random walk, but there is nothing new under the sun. Adam Smith wrote an awful lot about why humans did what they did before he got down to economics. I'm doing my best to be a little more terse.

These posts must be read in order or they will make no sense. Not that reading them in order would necessarily make them make sense - the reader must decide that point. The first post in the series is here.

Deferred trades, as stated previously, are one type of half-trades. There are two primary types of deferred trades, Promissory and Proxy. In this post, we are going to discuss Promissory deferred trades. 

Promissory deferred trades are half-trades in which one party exchanges a good or service now in exchange for the promise of repayment by a good or service later (when the service is needed or when the good is available).

Axiom M_O_MMT 1: This is a hugely important type of trade, because the market and economic instabilities commonly blamed on money or banking or a fiat currency are really generated by deferred promissory trades, which do not rely upon money at all, but upon a functional promissory system. 

A functional promissory system generates the belief that the person first giving the good or service can get repayment later. The functional promissory system could be primarily enforced by social disapproval, it could be based on terror, or it could be enforced by a legal/social system which seizes property for repayment, or confiscates the person of the debtor in repayment. In the world today, we still see all these types of promissory systems, even though some of them are pretty much universally illegal. 

Proposition 1) The more generally efficient, equitable and merciful a promissory system is (a), the more the society using it will benefit(b), BUT the success will come at the cost of increased system instability(c). Thus, for long term benefits, all efficient promissory systems must have ways of periodically destroying the promises they are set up to enforce(d). 

Now I must support this proposition in all its parts, and I must do so without postulating money in the system. 

So let's consider a relatively primitive economy. Economies are defined by what people eat, by how they shelter, and by how they obtain security. This economy is agricultural, pastoral, hunting, primitive family-erected shelters/cloth fur, and defended by the population itself. In other words, we have grain, we have some veggies, we have some goats, we have some hunters in the mountains, we have some flax, we have some fur, family groups build their own housing out of materials at hand, and there ain't no military class. We  have collective markets, we have villages, we have fields, I'm sure we've got a river or two. We have some boats and fishing. Activity at the markets is dominated by barter. No money.

Because the economy is agricultural, there will be periodic times of hardship when crops fail. Agriculture is a more reliable and plentiful food source than hunting or gathering, so the population inevitably expands to rely on crop yields for basic subsistence.

Because crop yields are both the stuff of life and the necessary reserve for the next year's plantings, agricultural societies always have to operate with a reserve of feed/food stock. Thus at certain times farmers are, at a minimum, forced to choose between being very hungry now versus starving in the next growing season:
Psalm 126:
A Song of degrees.} When the LORD turned again the captivity of Zion, we were like them that dream.
2Then was our mouth filled with laughter, and our tongue with singing: then said they among the heathen, The LORD hath done great things for them.
3The LORD hath done great things for us; whereof we are glad.
4Turn again our captivity, O LORD, as the streams in the south.
5They that sow in tears shall reap in joy.
6He that goeth forth and weepeth, bearing precious seed, shall doubtless come again with rejoicing, bringing his sheaves with him.
The reason they went out to sow in tears is that they were hungry, and they were putting precious food in the ground. The reason they come back with rejoicing is that they got a crop and can now eat. This is a very powerful metaphor being used here to express absolute relief and joy in a way that absolutely everyone who hears it cannot possibly misunderstand.

Inevitably, there will be some families in hard times that cannot make it through to harvest. If they plant the seed, their children will starve. Thus they will borrow grain from another family with surplus in order to keep themselves alive, and they will repay from the proceeds of the next harvest. It is obvious that this is a good and merciful system. However, there will always be some who are more cautious about what they do eat and there will always be times of reiterated hard years, in which the proceeds will be slim. Also, farming is darned hard work, and yields often vary with hard work.

Thus, it is pretty much inevitable that some family groupings in such a system will end up with multiple years of borrowings. If the average crop will be used 20-30% to resow (reserve) and 70-80% to feed the family and barter, and there are a series of hard years in which the average yield drops 50%, you are rapidly going to get to a situation in which multiple family units have promised more out of the next year's crop proceeds than they can possibly repay due to multiple borrowings. They now face years of hardship in which they are going to have to try to get along with minimal diets in order to slowly pay off their debt.

Further, the multiple series of bad crop years hit everyone, so the relative value of the remaining seed reserve grows as the hard time progress. The families that once had plenty now are scant themselves. The fish and game is going to get hunted out. The community as a whole gets hungrier. Eventually, most the goats get eaten. Those who were making a living with flax and furs are now broke too, and the value of that goatskin in grain is just about nil come spring.

The promissory system is really necessary for the life of the community, and therefore it must be defended. There will be some system of recordkeeping, maybe village council. There will be some system of enforcement. There will be debts that cannot be repaid, and there must be some method of resolving them.

In an infinitely merciful promissory system, the seed reserve is always shared out equally. But this is not ultimately functional, because in that system, during the good years the debts will not be repaid, and during the bad years families will eat more than they otherwise would., so inevitably the community's TOTAL seed reserves will be endangered. Thus there will be penalties. 

Penalties might include forced labor (the family who cannot repay must spend some time working in his neighbor's fields), confiscation of property (the family which mismanaged their fields/crop yields and accumulated an unpayable debt lose their fields and are now laborers who must work in the field of others for food), slavery (they won't work but will beg, so now they themselves are now the property of those who will feed them and have the right to enforce their labor), and impalement on a post for hours in the hot sun, followed by slow burning.

If the promissory system is enforcement by impalement/burning, there will be acute reluctance to borrow. However, this will still leave the community with starving people who tend to run out and raid the grain in their neighbors' fields by night, so it is not a very efficient system. Indeed, it is awesomely inefficient, because community yields will net lower than if a more merciful promissory system were in effect. Starving people also get ill and disease spreads, and most people will feed their neighbors' children even if they won't feed their neighbors, so in the long run this is a loser. Nor could most of the currently prosperous people in the community be sure that they would not find themselves faced with the alternative of impalement/burning or watching their children starve. There are storms and raids as well as bad weather - good management can never totally forestall bad luck.

Therefore you get the labor/slavery solutions. However, now we come back to the raid problem. If the labor/slavery solution continues too long, there is a high probability that a few families will end up essentially controlling a larger number of serf/slave families.If your community is tight on food, there is a high probability that other communities nearby are also tight on food. They raid you to get at your food supplies. While the community was mostly autonomous, you had a pretty good repelling force. However people who have been slaves for generations will mostly just run away.

Here we can see how the promissory system developed by the people who wrote the Old Testament evolved. Most of their territory wasn't that defensible. They had a prohibition against selling family lands, and they had a debt cancellation system. They also seem to have evolved a reserve tax so they had a public reserve to prevent most families from falling into ruin. They even had a slavery cancellation system. 

I think I have supported my proposition. If readers don't think so, please tell me.

Monday, March 25, 2013

Let's Do Monetary Theory

I am at home with a bad cold, so let's start on this. I think you will be quite sorry, because no economic theory worth a flip can be anything but rigorous. The problem with all modern economic theories is that they have lost their reality constraints. An awful lot of what we see is mere mental masturbation, sparked by the innate human tendency to generate hope. It is a good tendency, but when we allow it to corrupt our perception of reality, it turns vicious. 

Now for rigor, you need rigorous definitions. So here we start. 

Any theory of money must start with markets. What is the definition of a market? A market is a system that allows half-trades. Money arises from market trading, but markets do not arise from money. Money arises to facilitate half-trades among remote parties.

A half-trade: A half-trade is different from a barter swap in that one person receives goods or services, and the other does not. There two types of half-trades. One is a gift, in which the party donating the good or service expects nothing in return but good-will and future cooperation. The smaller and more closely-knit a society is, the more likely it is that gifted half-trades may predominate. The other type is a deferred trade, in which the party giving the good or service expects to get a good or service in return, in the future. Deferred trades are further split into two categories - promissory and by proxy. 

But before we get into deferred trades, we have to stop and dwell for quite a while on the gifts. The reason why we must do this is that gift exchanges form the basis of human societies, and they probably still form the majority of all human trades. Gift exchanges are instinctive, and other trades are not. Gift exchanges arose before humans were humans! If you look at primate groups (or for that matter a wolf pack), gifts of food, companionship and protecton determine the group structure, who mates with whom, and survival priorities when things get nasty. 

Moving forward from the wolves and the chimps, think about human families. Most of what we earn goes to support family members. This is so because human children are very dependent for a very long time, and when we reach our second childhoods in old age (should we be so fortunate), we too are dependent. Human females, despite all the propaganda, need special protections and a lot of rest in order to have human children. Thus the first and irrevocable need for gift exchanges arises from biology, which is immutable. We do these things mostly by instinct.

Now it is true that young unattached don't have families for which to care, although in many human societies, especially when things get tough, the family unit gets stronger rather than weaker. The young unattached male or female is mostly a product of periods of prosperity.. When things get rough, the young unattached stay with their families longer and receive much higher levels of support from their families, and probably give higher levels of support to their older family members later as a result.And even when things are not rough, young unattacheds spend a lot of time and money basically seeking out mates. 

The final reason why it is so important to realize the importance of gift trades, even in a modern economy, is that monetary systems break down when they no longer work to support gift trades. 

Further, there is a distinct and highly instinctive subsegment of the gift economy among males, especially younger human males. The good traded is social prestige, support within the group and protection from others outside the group. Call it the wolf-pack gifting system. Violence and the threat of violence can break down any remote trade market economy with stunning swiftness, in which case wolf-pack economies reemerge. The streets of Chicago, the Somali pirates, the soccer gangs of Europe - all these are an example of that subsegment of the human social economy, as are Nazi Germany.  Almost always wolf-pack economies confer prestige with females.

Now I do not intend to go on and on about this, so if you doubt the significance of the gifting economy, consider the history of the Irish and the fact that Communist party structure always turns into group massacres. Irish history is just wolf-packs. Communist party structure devolves very rapidly into a non-market gifting economy, and the only way to keep it going is to kill a lot of people. The party structure is nothing but a gang of gorillas in which the dominant parties can only keep their place by distributing rewards to their supporters which their supporters have not earned. So they rob, steal and murder to get those rewards. 

Objectivism is wrong not because it values a market-based economy highly - remote market economies do tend to be efficient, peaceful and more just - but because it completely elides the fact that even market-based economies only survive on a firm foundation of gift-based exchanges, and that if the market economy breaks down (stops supporting the gift-based exchanges) then you promptly wind up with wolves instead of gorillas. 

Well, this post is too long already. Neither a wolf or gorilla be! Next we can think about deferred trades.

Thursday, March 21, 2013

The Quality Of Mercy Is Not Strained

Wasn't that a complaint about the wrong ethnic/cultural group? ECB  to Cyprus: "You're up S##@ Creek Without A Paddle."
The European Central Bank, which has kept Cyprus's banks operating with a liquidity lifeline, said the government had until Monday to get a deal in place, or funds would be cut off. "Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks," it said.
Note that the EU/IMF has already stated that a deal which results in the Cyprus government assuming the debt does not suffice. 

Meanwhile, in Italy, Bersani is still trying to get Grillo to come to terms so that a government can be formed.You think there's any talk about banking depositors going on?

Wednesday, March 20, 2013

Meanwhile, In Italy

The hapless president attempts to form a government. Istat recently reported that the Italian economy contracted 2.8% in 2012, so you can see why Italians are fed up with technocratic government. That is exactly twice the prediction of the technocratic government. They started 2012 with a debt to GDP ratio of about 120%, and ended it at about 128%. This is not a realistic path forward.

But they probably get another square peg in round hole. Bersani's bloc holds a majority in the Italian house, but that is because Italian law specifies that the largest group gets a 54% of the house regardless if they won 26%. The Five Star Movement's announced intentions are to make any such attempt so legislatively ineffective that elections will have to be called again this year - in other words, such a candidate can be legally imposed on the country, but the Five Star Movement will block any legislative proposals, so said PM will be unable to do much. So far the Grillinis have rebuffed highly concessionary diplomatic initiatives from Bersani.

Cyprus banks won't open this week, which means that they won't open before Tuesday of next week at the earliest. Rumors of capital controls when they do reopen abound. It's so bad that the Cypriot church has offered its assets to support the state. More here with a trial subscription. The Cypriot church is a major shareholder in some of the banks. The offer is that they will mortgage their properties and buy government bonds. It is probably quite serious. However the EU troika's theory is that the Cyprus government cannot afford to take on the additional debt, so it is likely that troika would refuse.

Down 30%

It's a landmark. Net imports of petroleum and petroleum products in the US for the most recent 1 week period are down 35% plus over the comparable 4-week period in 2011. See page 8. Total supplied is down 8% since 2011, but the one week numbers are not that reliable. Call it minus 3-4%, and minus 30%, to be safe. YTD YoY net imports are down 15.5%. In the latest four week period, net imports are down 16%.

This year domestic production has increased 22% YTD. Crude inventory ex-SPR is up 10.5% YoY.

FOMC today. Only they can keep US prices high. They will, never fear.  The US is now a pretty strong net exporter of finished petroleum product, which keeps domestic stocks low enough to maintain pricing pressure.

Tuesday, March 19, 2013

Cyprus Legislature Rejects

No votes in favor. Now we see what happens next. They can't reopen the banks.

They could institute capital controls to keep money from being removed - like Iceland. They can institute controls on the amounts removed. However if they do their whole strategy expires - what good is a tax haven in which you can't get your money back out?

Or they can go back to the table to the troika with a different proposal.  

 Actual video of Troika officials trying to solve the problem:

Monday, March 18, 2013

Cyprus, The Shot Fired At Rome

My brother sent me an email saying I should blog on the Cyprus debacle, so I will. Although I won't without being honest, so this will be an ugly, almost vicious post.

Europe has learned nothing. They deserve what they are going to get and they are going to get it good and hard. The idea of a united Europe and a Common Market with equal rights under the law has already been deeply betrayed, and this now makes it clear that there are those who will be sent to the wall in order to send a message to others. 

There is nothing of justice in this. Cyprus is being crucified with Easter coming up, and it is being done to put pressure on the Grillinis in Italy. 

This goes back to the profoundly cynical and indeed evil dealings with Greece. It is true that Greece was originally the malefactor, but for their own purposes, the EU Powers That Be (EUPTB) made the disaster much worse. Instead of permitting Greece to default in a structured way, which would have meant that many banks and other finance cos in the rest of Europe would have had losses they would have had to recognize, they kept the ball rolling in the old-fashioned banking way - they rolled the debt and added more. Of course rough conditions were imposed as a price, so the Greek economy was deeply impacted. But all of that, while clearly a facade, was not evil. Greece had gotten themselves into the situation.

No, what was evil was how they essentially stole money from all the innocents to lower the cost of their facade. Originally, a write-off of about 30% of Greek government debt was necessary, plus various austerity measures. Certainly 40% would have been very sufficient. By issuing new debt and then making that debt primary (preserving it from losses), the EUPTB forced massive losses upon the innocent holders of Greek debt - somewhere around 85%, by my reckoning. More for some, because if you needed the funds you had in these instruments, there was a time when some of them were selling for 10 or 12%.

So this wiped out pensioners, banks, etc. And it was cruel, dishonest and unnecessary. By magnifying the losses to good-faith holders of the debt, it is true that ECB and Germany did not have to pay the cost of the facade that they had built for their own purposes. But by wiping out pension funds, pensioners and all other private holders, they dropped a bunch of fiscal bowling balls that are still rolling around Europe, knocking over those still standing, not to mention utterly destroying the lives of some very helpless and quite innocent people. It is one thing to lose 40% of your retirement funds. It is quite another to lose 85%.

The moment that this Greek deal was worked out, some very large banking institutions in Cyprus became insolvent. The country is tiny, and does not have much internal industry other than goats and rich people. So the strategy Cyprus has followed for decades is low corporate taxes, which attracts money in. The attempt was to be a sunnier Switzerland. However there is not much to invest in inside the country, so that money is invested outside the country, and there were heavy investments in Greek bonds.

Of course, there were other much more significant consequences. The Greek deal meant that every private holder of, say, Spanish and Italian bonds now had to recalculate their potential losses. To relieve the pressure, the ECB had been buying bonds, but the relief then backfired, because if intervention came at the cost of all private debt holders being junior to the "official" debt holders (all losses being handed to them), then obviously the ECB buying bonds was no protection at all, and indeed it made things much worse. If a country has a structural unpayable debt of say 15%, and protected interests try to hide this by buying 20% of the bonds, the remaining 80% will eventually have to take a larger percentage writeoff, and by allowing the structural default to be hidden for longer, it will be larger. Thus what was a 15% potential loss when you bought the bonds may easily turn into a 30% or 40% loss. And in fact, Italy's structural default is now about 35%. Istat just quietly released the information that the economy contracted not 2.4% in 2012, but 2.8%. That takes Italy's debt to GDP ratio to 128%, with a guarantee that it gets worse in the lucky year of 2013.

So the EUPTB promised that the Greek debacle would never be inflicted again. That Greece had been unique, and that in the future all debt holders from bailouts would be treated equally. Further, the ECB quietly bailed out Cyprus.

It is true that in Cyprus, seizing bank deposits is not technically stealing money from bondholders. If you are a Cypriot who had money in the bank to pay your property or income taxes, it is even worse.

So why was this done? Well, first we  have to understand that the ECB precipitated the "crisis" by abruptly withdrawing its liquidity support. It was effectively a commando raid launched under cover of night. This then forced the Cyprus government onto the rocks. They have no choice but to somehow comply. They clearly realize that they cannot impose losses on the small deposit holders, because if they do, there will be a massive run on the banks as soon as they open and a bunch of smaller banks that are the equivalent of credit unions, and that had no exposure to the Greek losses, will be promptly wiped out. Instant, massive depression. The bank holiday will be extended this week until the legislature can try to figure out some way to save something from the Euroflames.

Cyprus is effectively done. Wiped out. The other condition was that Cyprus has to raise corporate taxes. It's a deliberate attack - the fiscal equivalent of carpet bombing the place. Not only has the troika not saved itself from losses, it is now facing a much larger loss than was necessary to cover the Cypriot situation.

So why? WHY? Well, those damnable truth-telling Grillinis in Italy are a problem. This is a direct attempt to put pressure on them to join with Bersani's bloc and walk the Monti line, to keep the lie going for a few more crucial years. Instead, what was happening was that Bersani's bloc was wandering over to walk the Grillini line. There is nothing that can effectively be used to exert pressure on the recalcitrant populace like a threat to seize their money. The ECB, after refusing to say what its Italian bond  holdings were for years, had suddenly disclosed them before the election. That gentle hint that the ECB could destroy Italy's finances any time it wished by simply selling those bonds was drowned out by the Grillinis and domestic suffering, so now the ECB has joined the internal domestic political affray by nailing the bleeding carcasses of a bunch of entirely innocent Cypriots to some stakes in public squares in Rome. It's the Nero solution to public disorder.

The strangest part about this is that the Grillinis actually have some ideas that could work. For example, a dual currency system would effectively allow internal devaluation without crushing the economy, thus boosting exports. Of course Italy must default on some of its debt, but it is not yet a basket case. Under the gentle, benevolent hand of the EU it would get there, and for some reason, the Italians, who in effect invented modern banking, seem disinclined to hold an auto da fe and fling half the country into the flames.

Here we must grimly contemplate the terrifying reality that Europe is now a House of Destruction, a Temple of Wrath, in which the babes and the Roma must be sacrificed to Baal. (That's because for some reason they seem to be short on the traditional victims - the Jews.)

The reason we must concede this is that instead of allowing troubled countries to actually work out their problems, which always requires a public accounting and write-down, the EUPTB are now actively frustrating attempts to deal with it. Thus, the original accusations against Greece of financial dishonesty (which were true) are now the mandates issued to various fiscally unstable countries.

This is the reason that Portugal bonds reacted so badly to the War on Cyprus is that they too are a small country which can be annihilated without meaningful impact on the big Euro countries.

Everything you see now in Europe is a lie. Perhaps the Euro could not be saved. Perhaps it could have been. But now the Common Market is deeply jeopardized. The hatred, fear and distrust which are now being generated will not die for generations to come.

I think that in the end Germany, its manufacturing client states of the Czech Republic and Poland, and the northern Republics will form a sort of union. That would leave the entire Eastern bloc forced to cleave to that Novo-Hanseatic League as protection from Russia, to ensure that Putin doesn't start wrestling bears in the forests of Latvia.

The question is whether France will go with the north or go with the south. Germany needs the larger army of France. But France may not wish to be the client state of Germany, which in effect it would be.Hollande has not been a success for France, and the reality is that the EU problems are pushing Germany's economy to restructure around exports to Asia and weapons exports. Oh, isn't this going to be fun!

This post needs a soundtrack. Here it is:

The evil you do will live after you.

Wednesday, March 13, 2013

It Starts

We all get treated to endless punditish dronings of horror over the fact that the Pope's a Catholic. 

5, 4, 3, 2, 1

Tuesday, March 12, 2013

Sorry, Just Don't Have Time

To blog. I'm kind of short on sleep, too. 

NFIB shows some improvement this morning, but it's still worse than 2008 and this is hardly reassuring. The problem is earnings, and the need to improve compensation without being able to raise prices to recoup higher costs. 

However, given the NACM's "holding pace" trend, we can hope for a slowly improving economy for a couple of months more. The YoYs are down, but the improvement in negative factors shows that businesses are running tightly and mostly compensating.

Around April/May, things can get very dicey. There's a bunch of feckless economic reporting about consumers continuing to spend, but really spending at this point is more dependent for the lower range on tax refunds. That's what they spend right now. By July we should see most the effect.

The almost "on-hold" pace of Other Deposits in banks indicates that we have a problem. I'll wait for one more month before trying to figure this in, because tax refunds this year should have been deferred on average, so there can be some seasonal adjustment effects. But the FICA tax increase effect is due to gather momentum at least through the first six months of the year, and commenters mostly don't seem to realize that. The way this works is that consumers will spend as normal until they start coming up short at the end of the month in paying bills, and then they pull back.

A riproaring stock market may support higher-end spending, but that has less effect on employment. Asking around, groceries and lower-end retail chains seemed mostly despondent over February. Services are being impacted by the situation. Manufacturing hopefully will continue to uptick.

Rail freight shows a clear trend of improvement. January started very slow, but things (esp. intermodal) are picking up now. We have gotten back to marginal YoY gains on motor vehicles and parts, so industrial production for February and March should be better. 

Manufacturer's shipments, orders and inventories shows some weakness, specifically in motor vehicles unfilled orders, which are down 7% YoY.  But that is for January, and I hope to see some improvement through March at least. Also for January, the Wholesale Trade report shows a rebound in inventories. We'll see how that develops. 

Petroleum gains continue apace. If gas prices were to abate later in the year, it would help the picture a lot.

I don't think the sequester will have much of an effect. We do, however, need a continuing spending authorization and we have to raise the debt limit again, so there are some potential wild cards there. It's not going to look too good when they get done.

Wednesday, March 06, 2013

Big News - Italy

Okay, to sum it up every major faction after the Italian election is now anti-austerity. Bersani has caved and is putting forth a plan much closer to the Five Star Movement's agenda than the Monti agenda. He has been forced to do so because without this step he cannot form a government. 

Bloomberg article, which is at least in English.Don't say I don't try. The Reuters Italian edition usually has good coverage, but it is in Italian. Bersani's bloc is farting in Berlusconi's face and trying to come to an arrangement with the Five Stars. After looking at the cards, Bersani and his allies have realized that if it comes to another election, they will be the big losers - out of the running, and Berlusconi and the Five Stars will be controlling the outcome.

What this means is that Draghi may have to ante up on the ECB commitment, but if he does so to save Italy, it obviously will throw out all the restrictions of the program announced last year. Italy's public finances will probably worsen considerably this year - they have severe drag from unemployment and a continuing recession, and even if increased social spending passes, it will take a while for the recession to unwind.

Seismographs around the world will be recording the thuds as the Bundesbank staff collectively hit the floor in a dead faint. 

Italy is very much in the driver's seat here. Without their cooperation, the Germans have to ante up on hundreds of billions of dollars worth of guarantees to bailout funds. So everybody now has skin in the game, and the bargaining (Ireland, for example, is trying renegotiate debt terms) now gets down and dirty. ECB already has a huge chunk of Italian bonds in hand, so the ECB has an incentive to keep the play going.

So, the Italians have seized control of Eurofinances and the Grillinis have seized control of the Italian agenda. The next few months are going to be epic. The Czech and Polish economies are deeply linked with the German economy. With the failure of the traditional German-French bloc and German elections pending, any hope of picking up enough votes to pressure Europeans in a more German-friendly direction will now probably require the Germans getting the northern countries (which they already have) plus the eastern European countries together. However, of the countries in the Euro, the anti-austerity group now predominates. 

ADP - One Graph Says Everything

ADP employment report here - headline +198,000 in February:

But here's the tell-tale graph:

The gray line is the only one above baseline, and it is for small and start-ups. I believe a lot of this is construction, but some of it is surely startups.

When you see that, it's a sure bet that the structural underpinnings of the economy are finally starting to really improve. This one segment works differently from the others. It arcs up sooner, and then troughs considerably later (in early 2011). And now we have some energy there. 

A lot of this is just timing - it takes time to work off the structural problems from a panic. But five to six years in, a lot of that has worked through the system and now things have a strong natural bias for growth. 

Of course, all of CA appears likely to commit suicide, which is going to hurt us. The combination of high local tax rates, capital gains taxed as ordinary income, and the recent federal capital gains tax increase is probably fatal for CA, because investment has to be suppressed there.

But there is a natural growth surge in the system. This is one of the things that makes me believe that the Fed is a little off in its timing. It's really reacting to last year's slowdown, but its reaction is off-cycle. Therefore I conclude that there really is a hidden inflation risk in the system, and that the Fed is currently feeding it.

This growth impulse will work its way through the economy very quietly, but two years out all the money in the banking system is going to feed an expansion cycle, and once that really gets off and running, it will be hard for the Fed to stop it. Those cycles are self-feeding.

Monday, March 04, 2013


I have been deeply frustrated by the lack of realism in the US, but unfortunately it's not just confined to the US. And since the US is currently hysterical about the asteroid Sequestra's devastating impact square on the DC metro area, it might be well to contemplate Italy's situation.

Take this Bloomberg article on Italy's political and fiscal predicament:
Rehn, the EU’s budget enforcer, said the bloc has no leeway to depart from its course of reining in spending and debt. 

“We’re not going to solve our growth problems by piling new debt on the old,” Rehn told Spiegel in an interview. 
No kidding, but that doesn't mean you are going to solve the problem by continuing to pretend that the debt is payable, either. Europe is repeating the Greek debacle with Italy, with, haha, the same results. Cue Einstein.

Here's the situation. Italy debt-to-GDP ratio at the end of 2011 was 120%. Italy continued and ramped up its efforts to deal with the situation, including raising taxes and cutting some spending. Istat (Italy's statistics agency) disclosed an official 127% debt-to-GDP ratio at the end of 2012

So, regardless of the mindless-but-unified rhetoric of the European leaders, the fact is that Italy is accumulating new debt, despite the fact that Italy is truly doing the austerity dance.Italy will also close out 2013 with a higher debt-to-GDP ratio. 

Here are some graphs from Istat:

You can't have any doubt that there is a carry-on economic drag from that big rise in unemployment, and it is obvious that when your total of employed persons starts dropping like this, tax revenues must decline also. Bank of Italy projects 2013 GDP will shrink a net 1%, and Confindustria (whose figures I use), now predicts -1.1%.

Now, very simple math will tell you that if Italy is paying interest on 127% of GDP, at 4% average, the total interest on original debt will be 5% of GDP. This means that if GDP were stable (not declining), in order not to increase the debt, Italy would have to run a primary surplus (government receipts - government spending less interest on debt) of 5%. With, mind you, unemployment heading toward 12%????

Italy's GDP shrank 2.4% in 2012, so Confindustria was too optimistic in December. It's completely plausible that Italy's GDP will shrink more than 1% in 2013. If you attempt to raise taxes, it is certain that it will. Italy's current budget shortfall (receipts less expenditures including interest) was 3% in 2012. That matches EU guidelines, but it means that the debt-to-GDP ratio keeps increasing even without recession. Furthermore, it's a good guess that tax revenues were disappointing later in the year. 

So now we have an optimistic forecast that Italy will end 2013 with around 130% debt-to-GDP ratio. These numbers cannot go in any favorable direction. 

Now it is clear why the Grillinis are trying to fight the system, because the plan is to fail. If Italy continues on its path and the Greek solution is applied, the write-offs will be forced on government debt held by the private sector, which means that banks and some pensions will take the hit.

Obviously under these circumstances Italy's private domestic investment continues to fall. Who could invest in a setting like this? It's very difficult. 

Italy's demographics are not favorable, and now they will be worsened by emigration of the young: For example, Italy has more 65-69 year olds than it has 20-24 year olds. The number of 60-64 year olds is 3.6 million. The number of 15-19 year olds is 2.9 million. The mere idea that Italy will be chipping away at this mountain of debt ten years from now is mind-bogglingly ludicrous.

The only feasible way for Italy not to default on its debt is to make the old farts into soup and distribute the soup for free to the younger population. I suspect that's not going to happen. 

So it is screamingly obvious that Italy is going to default on its debt. It would be just about impossible for it not to default if it had favorable demographics and it sold off a lot of state assets in order to cut the debt load. As it is, it is not possible. 

The question really being negotiated is how Italy will default on its debt. Will it leave the Euro and pay debt in a degraded new lira? If it does, it will default on a lot of its debt, and have import problems. Will it get a European bailout by the means of an investment pool that cuts Italy's average interest to about 2%? That would cut default risks to oh, say, about 60%. And where does Europe get the money? 

The US is screaming about a sequestration pinprick when it ought to be willing to do WHATEVER IT TAKES not to let our debt-to-GDP ratio get above 80%. That would have to include large cuts in spending and large increases in upper middle-class taxation, but it would mean that 20 years down the line old farts wouldn't find themselves starving. 

Instead, we argue about the asteroid Sequestra. 

The official US debt-to-GDP (for issued debt) is about 73%. We have already monetized a lot of the Big O deficit financing, and as I have repeatedly pointed out, there is a downside to monetizing debt. You raise domestic needs prices, you make your population poor by confiscating their money, and you slowly degrade the ability of the central bank to negotiate future financial shocks.

The US is playing a game that will end in some sudden monetary cataclysm, but it is not clear which one. If we continue on without correcting course, we could shift into high inflation or we could shift into deflation, or we could do both (a sudden spike in inflation followed by persistent deflation). 

Whatever we do, we will not get stability on our current trajectory.

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