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Michael Coote examines some likely exit strategies to manage the eurozone break-up and draws some parallels with Afghanistan

Posted in Opinion

By Michael Coote*

The feckless war in Afghanistan comes to mirror ever more closely the potentially impending breakup of the euro zone. In Afghanistan, Western forces are busy organising the exit they are already completing in Iraq, another place where they weren’t popular, earned no gratitude, and squandered much blood and treasure for scant returns to show for the sacrifice.

In Iraq and Afghanistan a whole lot of people have suffered and died without Western liberal democratic triumph being achieved to the point where it has become recognised that the local survivors are best left to their balkanised fate killing and persecuting each other as they have done for centuries.

In the euro zone, Germany is also getting ready to “evacuate”, if necessary, euro currency union member states that are not up to operating under the hegemony of the Deutsche mark in drag. Like the Western forces in Iraq and Afghanistan, the Germans are sagely implementing the strategic plans required to exit unwanted member states out of the euro common currency bloc, even if those same countries remain on as part of the European Union (EU).

Thus it was uncanny what the UK’s chief of defence staff General Sir David Richards recently told the Royal United Services Institute in the course of confirming that 500 British troops would be withdrawn from Afghanistan by year end, leaving 9,000 remaining as the rump of a supposedly successful drawdown strategy under way.

“Perception is lagging reality by some 18 months,” the general claimed. “While we are, like a chess player, planning three or four moves ahead, we cannot signal our plans openly.” “That leaves the media frequently, and understandably, to... draw the wrong conclusion.”

A losing battle

Let us transpose the general’s remarks to apply to the situation that Germany faces with respect to its possible “drawdown” from the euro zone. The general’s words can be minimally recast to apply to a losing battle being waged in the peripheral economies of the euro common currency zone.

“Perception is lagging reality by some period of time that Germany alone decides,” said German Chancellor Angela Merkel. “While we are, like a chess player, planning by reverse engineering the checkmate of all euro common currency member states who fail to meet our unyielding standards, we cannot signal our plans openly, for example by listing which countries we are willing to be rid of.”

“That leaves the media, financial markets, and credit rating agencies frequently, and understandably, to draw the wrong conclusion.”

Indeed, we have the media, financial markets, and credit rating agencies jumping up and down, dumping risky assets, anticipating Armageddon, and damning the Germans for their Teutonic arrogance and complacency in stupidly letting things drag on so long. Yet can it possibly be imagined that the Germans haven’t already secretly costed out a list of successive “Iraqs” and “Afghanistans” to be unceremoniously abandoned as failed and irredeemable “Muslim” states on the fringes of the euro zone?

Chancellor Merkel is privy to some of the best advice in the world and so it is hard to believe that the Germans lack a euro “war zone” selective withdrawal strategy.

Pawns on the playboard

The list, of course, would be top secret, because like the British in Afghanistan, the Germans in peripheral Europe “cannot signal our plans openly.” If the Germans did signal openly by – say – declaring that Greece, Ireland, and Portugal could be kicked out of the euro zone, and maybe also Spain and Italy, then all hell would break loose before German banks – including the Deutsche Bundesbank - were ready to cope with the traumatic shock.

No – the list is surely drawn up, but some stealth and cunning is yet required to set about implementing its accompanying strategy. Some preparatory moves on the chessboard are necessary. First, certain avenues need to be closed off. Thus Germany and its glove puppet the European Central Bank (ECB) have lined up against printing either euros or eurobonds.

Many have argued for the ECB to undertake unlimited quantitative easing by printing as many euros as are required to staunch the sovereign debt gaps of ailing common currency union states. The anti-inflationary hawks of Germany and the ECB have firmly scotched this suggestion.

The alternative is to print eurobonds that are jointly and severally guaranteed by all seventeen euro zone member states. Just as turkeys don’t vote for Christmas, however, the Germans aren’t interested in the issuance of shared liability sovereign bonds to fund countries that are not trussed up in fiscal straitjackets.

Without the straitjackets, Germany and its fiscal surplus northern European brethren can foresee the day when they will get to pick up the tab for the profligate south’s deficit debts. Supposing the other euro zone members even wanted the straitjackets, it will take some time to get them tightly fitted into their lacy attire. So no printing of euros or eurobonds any time soon, if at all – what’s next? Some hints have emerged.

The Christian Democratic Union (CDU) – the governing political party of Chancellor Merkel – passed a motion at a mid-November party conference in support of changing the EU’s Lisbon Treaty in order to permit euro member countries voluntary exit from the common currency without requiring their accompanying departure from the EU itself.

Parting ways but keeping company

The party’s wording went that the Lisbon Treaty should be amended to enable euro member states “unable or unwilling to permanently obey the rules connected to the common currency… to voluntarily… leave the euro zone without leaving the European Union.”

Presently there is no provision in EU treaties for countries to exit the euro once they have signed up to it, so the CDU’s vote was symbolic but nonetheless telling in signalling that Germany’s governing party would not stand in the way on principle. So goodbye to Greece and all that at the top political level in Germany.

Then in early December, the ECB announced newly liberalised rules for unlimited lending to European banks at 1% interest for three years, including accepting a wider range of collateral with lower credit ratings than before.

This ruse will permit Europe’s commercial banks to borrow at 1% to buy the government bonds of euro zone states and make an easy profit on collecting the yield differentials. Under the rules of Basel III commercial bank recapitalisation implementation currently underway, banks can allocate the highest regulatory capital adequacy ratings to the government securities of their state of domicile.

Thus it is likely that the banks of each euro zone member country will prefer to buy their own government’s debt securities as part of their Basel III regulatory capital requirements. The effect will be to concentrate the government debts of euro zone states within their own domestic banking systems (and borders), meaning that if such states did exit the euro and suffered exchange rate devaluation crises by reverting to their old currencies (eg., the drachma for the Greeks), then their own domestic banking systems would be cushioned by holding drachma-denominated assets on both sides of the ledger.

Exit from the euro zone system under these conditions would not be painless, but it certainly wouldn’t be as painful as leaving in a disorderly manner while holding large quantities of government debts denominated in euros that could not be devalued by the departing country. The Germans of course insist that they have no plans for the breakup of the euro zone, but then they would say that, wouldn’t they?

However, moves afoot by the CDU and the ECB point to the existence of a German Plan B based on assisting the exit of unwanted euro zone members in a manner that would allow the exiting country to stay in the EU while at the same time softening the impact of reintroducing a national currency capable of devaluation.

*Michael Coote is a freelance financial journalist whose publication list includes interest.co.nz, the National Business Review, New Zealand Investor, The Press, and the New Zealand Centre for Political Research.

 

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26 Comments

Thank you for putting that

Thank you for putting that together Michael.

I would assume regular readers would be well and truely aware that Plan A can't possibly work, the speculation is really about what happens next. I bet there won't be a xmas break for some in the eurozone.

Hey Michael it's been a long

Hey Michael it's been a long time since we last partied at the Staircase in K'Rd back in 1995!!  How are ya?

Cameron presumably gets the

Cameron presumably gets the same advice Merkel does which would explain why he would not accept a change in the treaty that would weaken Britains Financial Services industry in order to protect a currency clearly doomed in its current form.

 

If the Europeans can hold things together long enough to have Sovereign debt mostly held in country Armageddon may not happen after all. The flood of Greeks depositing suitcases full of Euros in institutions elsewhere in Euroland must be gathering pace though.

Hmmmmmmmm...so they will end

Hmmmmmmmm...so they will end up with German euro and Greek euro and be traded according to their sovereign state level of bankruptsy...very good....now who got left holding the Greek used toilet paper?....and the debts?.....and the losses?

@ Michael Then in early

@ Michael

Then in early December, the ECB announced newly liberalised rules for unlimited lending to European banks at 1% interest for three years, including accepting a wider range of collateral with lower credit ratings than before.

This ruse will permit Europe’s commercial banks to borrow at 1% to buy the government bonds of euro zone states and make an easy profit on collecting the yield differentials. Under the rules of Basel III commercial bank recapitalisation implementation currently underway, banks can allocate the highest regulatory capital adequacy ratings to the government securities of their state of domicile. 

You barely scratch the scab of the sore which underlies the problems of the western banking system and particularly it's non- segregated investment banking operations . 

Might I suggest you and your readears make a New Year's resolution to thoroughly read and understand the contents of these two articles linked here and here

Until the regulatory authorities impose transparency and cease and desist orders upon the actions described we will have no favourable resolution of the problems you describe. 

Hello Stephen, Would you be

Hello Stephen,

Would you be kind enough to answer a question for me on the ecb new lending policy.

I do not understand where the money to lend to the banks at 1% is coming from. My understanding was that the ECB was not permitted to print but it is hard to see what difference this policy will make unless they are printing.

The question then is where does the money come from?

Thanks

 

'Out of thin air' - a deposit

'Out of thin air' - a deposit liability is created by the touch of a keyboard against the receipt of an asset. A highly dilutionary action upon the existing value of outstanding Euros - and at the end of the day if all goes wrong a liability that the taxpayer has to make whole.

I must stress this is a simple answer and a series of hoops have to be jumped between the individual European central banks via the ECB - but the principle is sound.    

In other words printing

In other words printing (electronically)

The complexity is increasing

The complexity is increasing Curious.  The latest development is the Ponzi Bonds.  It's explained with diagrams here.

The ECB loaned money to the Italian Bank. The ECB deems it as “safe” because they received a bond Guaranteed by the Italian Government as collateral. The Italian Bank gets money from the ECB, pays itself money on the bonds it issued, and owes the ECB interest on the money they received. The Italian government is happy because they didn’t issue any debt, yet used their guarantee (which somehow they seem to think doesn’t count against them) to get one of their banks much needed money. 

The Italian Government and the ECB both put pressure on the Italian Banks to use at least some of the money to purchase Italian Government bonds.  

The banks have cheap funding via the LTRO facility and some assets against it. They pay an interest rate on the “new bonds” they issued, but receive that money back via the repo agreement that is part of the LTRO. They are the proud owners of Italian government bonds with cheap financing. They could have bought the bonds directly, except they cannot borrow cheaply. Yes, the market had made some attempt to charge banks with bad risk management, awful assets, and opaque books, more than they charged the country they were domiciled in. But rather than let the market (and common sense) rule, a mechanism to let banks fund themselves cheaper than the countries they rely on, was created.

The ECB has apparently created money, and can pretend as though they didn’t print money, and also pretend that they didn’t participate in financing sovereigns directly in new issues (I guess).  

Fabulous farce isn't

Fabulous farce isn't it?

 "You can see how they are attempting to use what little firepower they have left to keep the bank alive and pretend like all is good."

It's worse than a player in a game of Monopoly with his shadow, getting his mirror image to run off a few trillion extra monopoly euros on a printer, while demanding his shadow behave in a prudent and honest manner....to play the game.

Have a read of these links. 

Have a read of these links.  There's plenty of explanations out there.

http://www.zerohedge.com/news/fed-vs-ecb-presenting-correlation-2012-and...

http://www.zerohedge.com/news/ecbs-balance-sheet-now-far-bigger-feds-mor...

http://confoundedinterest.wordpress.com/2011/12/20/clash-of-the-titans-f...

Basically what happens is that the central banks "expand their balance sheets" in exactly the same way that your local bank does when you take out a loan. 

When you take out a loan a bank takes your promissory note and sticks it on the "asset" side of their balance sheet and it then "credits" your account balance electronically with the amount of the loan.  Because you are prepared to accept the electronic balance created as "money" it means this money is debt and when more debt is accepted (by you or a government) then more money enters into the system (it's matched by the the new promissory notes also in circulation).

Use this to visualise the process http://econviz.org/macroeconomic-balance-sheet-visualizer/

When the central bank accepts "collateral" from it's member banks, and provides "cash" to the banks, it's taking the promissory notes (bonds) of individuals and Governments (bundled up or individually) and swapping them for cash (the central bank's liability).  It would argue that it's not actually "printing" any additional money, and this would be true if it was accepting these notes at "market" value (the "mark to market" issue).  The actual "money printing" is the difference between the true market price and the actual price (ie the difference between the central banks' "target" interest rate and the interest rate that would apply in a free market).

When you work this out you can see that it's a straight out wealth transfer from Governments/individuals to the bankers.

Take a look at this http://www.zerohedge.com/news/summarizing-global-balance-sheets-negative... and ask this simple question:  Who is it all owed to, how did it end up this way, and was it deliberately set up and if so by whom?

For answers to these questions read "The creatures from Jekyll Island"

 

Thanks for the explanation.

Thanks for the explanation. So if I understand this correctly. European Bank A will borrow from the ECB using say Greek Government debt valued at par, take the borrowed funds and reinvest in say Government debt of their home country and pocket the interest differential.

Thus additional "money" is created being the difference between the market and par value of the Greek debt.

 

Thinking about this further, in the above example given that the original bond still exists on the bank balance sheet ( as it is only pledged as security) then the total advance by the ECB is an increase in money supply and as such is 100% "printed"

If I have missed something please point it out.

Yes that's the "seigniorage"

Yes that's the "seigniorage" which in the the fiat money system we have is effectively handed over to the banks.  But until it's loaned out again it sits at the banks as excess reserves.  (What Iain Parker says (correctly) is that this seigniorage belongs to the Government and they (or we?) should get the benefit of it by issuing debt free currency that attracts no interest)

See here for example: http://www.zerohedge.com/article/fed-balance-sheet-holdings-excess-reser....

In this case what the banks do with it is "up to them" and that's anyone's guess.

Gonzalo Lira's post here is one view, I think a good one, but read the comments .... http://gonzalolira.blogspot.com/2011/12/european-central-bank-loses-its....

But whatever they do it will be to serve the interests of the real money-power.

The money supply must

The money supply must increase, with or without growth.  This is the goal, it means inflation, devaluing the money you have.  Baisically they take value from you, and give it to the banks and governments.  It's done quietly, and with a lot of denial and rhetoric.  NZ govt deficits achieve the same thing, credit downgrades debase the currency, which is a differnet means to the same end.

Money is being used as a tool by the super rich to take your money from you, without you even realising.

Inflation helps borrowers, but the banks keep interest rates above inflation, this is why when you borrow, you have to use the money to invest in cashflow producing physical assets, that way you are on the right side of inflation.  Capital gains are inflation, and you feel like you are getting richer, while in reality you are standing still.  That is called "The wealth effect."

Savers are losers, cashflow is king, simple message.

Some very confusing replies,

Some very confusing replies, "seiornage" is the profit made when currency is created.

There are actually two types of 'money' which should be considered, commercial bank money and the other kinds of 'money' which commercial banks use as reserves. This second kind includes bonds, other securities, currency. The commercial bank money is the kind used by the economy, but most of it exists only as accounting book or computer entries recording that the bank owes their deposit holder some number or euro's.

As you pointed out some new money is being created in the euro zone by this process, but according to treaty arrangements this must be less than 3% of each countries GDP. It's not a lot of money compared to another process happening in the eurozone (which is causing the crisis). Throughout the eurozone most people are repaying or defaulting on their commercial bank debts or de-leveraging. This means there is a reducing amount of commercial bank money supporting the european economy. This de-leveraging is happening on a much larger scale than government investment. In fact in many countries the government is also repaying debts, exacerbating the economic crisis.

The crisis will be over when this trend reverses and the amount of money supporting the economy begins increasing again. But since almost all 'money' is created when somebody borrows it or goes into debt (either government bonds or borrowing from a commercial bank) this will not be for a long time at the present rate.

How did this happen? Why did nobody see this coming, Steve Keen explains this well,

http://www.debtdeflation.com/blog

Also http://www.positivemoney.org.nz explains how money is created.

Frankly the fact the banks profit from buying government debt is the least of the problems with this system.

 

 

Stephen, if you had been

Stephen, if you had been living in a time when gold and silver were money, and fractional reserves were just starting, you would have (and very rightly) been saying how immoral it was, and it was wrong and we should stop it etc.  This shows integrity, and principal, and I agree with it.

The fact remains though, that money moved on, and those that moved on, with the new ways, were able to take advantage of it.  Those that refused to accept the new reality, were left behind, and disadvantaged.  Yet they also had a lot of knowlege, and were in a good position, to help themselves, and others take advantage of the new rules of money.

We are entering a new age of money, and for better or worse you cannot stop this from occuring.  I suggest the most practicle solution is to equip people to deal with the new rules of money, and to help people not be left behind.

There is a lot that can be done, and there are a lot of opportunities to be had, those with knowlege have a supreme advatage.  Use it.

I don't agree with all the BS going on, but I can see the opportunities, and I appreciate your's and Iain's opinions on the subject.

 

The other option

The other option skudiv....... "to help people not be left behind"......is for people to decide they would rather be left behind....and this is what you can expect.....an increasing number of Kiwi walking away from the debt ridden politically sick concept of 'country'.

First to see the light are the school leavers facing a lifetime of debt to buy 'qualifications' that open the door to a job in which they must work 4 days out of 5 just to feed the govt tax take take take.....go and ask them at the school gates....they see a future of debt and misery.

Along for the ride are the masses who know dam well they have been ripped off by lying thieving govt.....they prefer the black market...they trade and barter....this segment of society expands daily

Leaving us with the criminals...who have no fear of prison, don't pay fines, don't turn up for imposed community service......and are happy to have a cell expecially over the cold wet months...and free food....and dental care...and health care...

Exactly Wolly.  The old world

Exactly Wolly.  The old world of; go to school, get a job, save money, invest in a managed fund, etc are over.

Yup....ok for the really

Yup....ok for the really gifted what can score themselves quals in areas the promise fat incomes forever..like dentists doctors lawyers surgeons pilots engineers and council CEOs...but for young Plod the future is bleak made worse if Plod believed the BS and borrowed heaps to be a winner.

So the question becomes...how soon will we see a steady fall in the demand for student debt financed qualifications in NZ...I suspect it has already begun.

Why burden and mash your life with debts and misery when you can go surfing all day long.

And how soon before Lotto offers a new range of prizes...qualifications...you too can become a Lotto engineer...ten bucks please.

Sorry, when was fractional

Sorry, when was fractional reserve banking ever not the banking system? The US dollar-gold standard still used fractional reserve banking (which is why they needed to keep shifting the gold-dollar peg), the prior gold standard used fractional reserve banking (which is why they ran out of reserves and modified the system).

Maybe you could suggest which historical period you are describing.

Fractional reserve banking is the process of creating money by double entry book keeping accounting, keeping only a fraction of the monetary base in reserve.

 

 

Iain would be able to give

Iain would be able to give some exact dates.  I cbf looking it up.  Roman times coins were used, then deposit slips were used instead of actual coins.  The deposit slips allowed the beginings of FRB.  It's a simplistic explanation, but to understand the current monetary system you really do need a good understanding of the history of money and debt.  It's all out there, free on the web.  FRB was at the start of the banking system, but not the start of money.

I don't think a good

I don't think a good knowledge of the history is important actually, but it helps to understand that the controllers of the monetary system can manage it to favour them.

Alexander the Great used to issue currency to people he had conquered and then require them to pay tax in it. This ensured he could employ their armies and maintain control of the population.

When the UK was trying to maintain control of the colonies it demanded payment of taxes in gold, and massively counterfeited colonial script, a similar issue of control. This lead to the Boston Tea party.

The only time that a monetary system is really just is when it is maintained in the interests of its users. This is of course not true of modern banking, which creates and manages most modern money systems. I think most historical examples have been worse in general. Though it could be better still, in my opinion by making all creation of money democratically accountable.

 

I think we are muddying the

I think we are muddying the waters.

Seigniorage relates to the government and in our case the RBNZ issuing notes and coins to the banks - this a cost structure incurred by the banks as they purchase this money at face value and there is no interest payable. Obviously the RBNZ makes a tidy profit which is normally passed back to the government via the annual dividend payment.  

The ECB LTRO loans being discussed in the article are long term reversible loans which are not considered printing money in the manner which the US Federal Reserve undertook with QE2.  The Fed actioned permanent purchases of US Treasury notes and bonds, where as the ECB actioned term repurchase agreements. (RP or RRP). 

Read more to understand RP accounting and the shenanigans of Treasury settlement fails.

"Ready  READY steady

"Ready  READY steady now....evacuate...get out...get out of the quakezone..."

 http://www.stuff.co.nz/the-press/news/6223772/Parker-dismisses-abandoning-city

Bob he don't like this sort of talk one little bit..too many fingers in the mud!

Liam Halligan is fast

Liam Halligan is fast overtaking AEP for digestible honest analysis. 

http://www.telegraph.co.uk/finance/comment/liamhalligan/9000114/Printed-...