Tinker Bell Is Dead
[This article originally ran on LewRockwell.com, June 20, 2012.]
If you have seen the stage version of Peter Pan, you know the scene in which the audience is asked to clap if they want Tinker Bell to live. It's time.
Janet Daley wrote a provocative essay in London's Telegraph on the day before the Greek election (June 16). She did her best to explain why the eurozone is in crisis. Europe's leaders are living in an illusion of their own making.
She began with what should be obvious to the financial markets by now. By entering into the eurozone, the politicians surrendered control over the money supply.
The problem is not that politicians surrendered control over the money supply: it is that they surrendered it to the European Central Bank (ECB). They should have surrendered it to the free market.
The politicians of Europe asserted control over the international money market in 1914, when they abandoned the international gold standard. They set the precedent. Everything that has followed has been one fiat-money crisis after another. But only Austrian School economists teach this. In Europe, bureaucratic control over money has run the show ever since 1999.
The economy is now beyond the control of national governments, and therefore outside the remit of democratic politics. It has become truly global, and thus a law unto itself; nation states have gone broke in their attempt to feed its gargantuan appetites for consumption and debt.
It is not the "world economy" that has a gargantuan appetite for debt. It is each nation's politicians, who want something (increased spending) for almost nothing (borrowed money at low rates). That was what northern commercial bankers gave the PIIGS governments at German rates of interest until the spring of 2010, when the Greek socialist government announced that its predecessor had cooked the books.
The losses must now be parceled out. The losses are in the past. They cannot be avoided. They can only be postponed by covering them up. In short, the eurozone must do what the Greek government did before 2010: cook the books.
Thus, the bailouts continue.
The remedies for this began in panic and are now ending in delusion: first the banks went bust and were bailed out by governments; then the governments went bust and needed to be bailed out by — whom? International funding agencies which get their cash from — where? From central banks which will have to print gigantic amounts of money to replace all the money that simply disappeared in the bad debt that bankrupted the banks in the first place. And if we all agree to accept the illusion that this newly printed cash has actual value — if we all clap really hard and say that we believe in fairies — then the whole show can get back on the road and we will be rich again.
It was exactly a century ago that Ludwig von Mises's book The Theory of Money and Credit laid out the case against central-bank wealth fairies, but few listened then, and fewer listen now. The message is unpleasant to politicians, who want to spend more than the government takes in through taxes. They do not want rising interest rates that will result if the government is to cover its deficit.
The governments of western Europe now face a moment of truth. They much prefer illusion: free money. Truth is always politically painful after years of illusion.
But what will be required is a world-wide agreement to participate in the illusion. It will rely on every country, and every government, and every electorate, being prepared to say: "Wealth can come from thin air. It doesn't need any basis in real income or assets to make it viable."
This is the heart of Keynesian economics, Chicago School economics, and Greenbackism.
The threat is a voter reaction inside a nation that is asked to provide free money for a PIIGS nation.
If the population or the political leadership of one country (Germany) insists that money must be earned before it is spent, then the game is up and Tinker Bell dies.
This is the one electorate that is at least vaguely aware that wealth is not the product of monetary inflation. The rest of Europe wants the Germans to clap loudly and affirm their faith in fairies. They have got to persuade Angela Merkel to quit playing "let's pretend."
What has been happening for the past year — and will continue to happen at the G20 summit in Mexico tomorrow, whichever way the Greek election goes, is the browbeating of Angela Merkel into playing "let's pretend". We know now that she will not do it. She may make small concessions — baby steps in the direction of debt-pooling or Eurobonds — but the conditions and the guarantees will have to be there. Reality will always be asserted. And her country supports her in this with overwhelming approval ratings. Indeed, her population would not permit her to relent, even if she were inclined to do so (which she is clearly not). The Germans know better than anyone where it ends when you tell lies about the value of the currency.
The problem with this analysis is that Merkel has always talked a good line before each concession, but she always conceded. She agrees to every bailout.
The Eurocrats continue to insist that the bailouts must continue. They also insist that the eurozone needs an international government with control over domestic fiscal policy: taxing, spending, and borrowing. They are pushing for the surrender of national political sovereignty, which has been the goal of the Eurocrats ever since the creation by treaty of the European Coal and Steel Community in 1951.
So the only way that the World Economy, which has now become an apolitical, undemocratic, supra-national force of nature, could be brought under control is to erase the divisive historical memory of nations and create an equal and opposite force of World Government. This, of course, is just what the EU was designed to do on a continental scale, and that hasn't quite worked out. The official solution — endlessly reiterated by increasingly desperate European commissars — is to eradicate more forcibly than ever the messy democratic accountability of national governments to their people.
There is a way out, and Daley sees it. But this way out is not acceptable to voters: the dismantling of the welfare state, nation by nation.
A really serious cutback in state spending — not the Osborne nibble but drastic, meaningful reductions in the size of government — could reduce the dependence of democracies on global capital. It is government entitlement programmes which devour wealth and produce nothing in return. If they were stripped away — and if government got out of the wealth redistribution business — taxation could be reduced. So instead of "stimulating" the economy by offering more debt (as Mr Osborne proposed at the Mansion House), and so getting even deeper into hock to the Beast, we might get the genuine stimulus that comes from people spending money that they have earned.
Voters Want a Tinker Bell Economy
The voters do not want major cutbacks in government welfare spending. They will throw out of office any political party that suggests this as a permanent remedy.
The voters also do not want to see their treasuries raided by the Eurocrats and commercial bankers to bail out the PIIGS one more time, because this will never end.
They also do not want to surrender political sovereignty to the eurozone. They do not want Germans to have a say as to how large a deficit to run.
They also do not want to leave the eurozone, because they expect Germany to foot the bill for the deficits forever, letting locals build up bank accounts in euros in Germany rather than their own insolvent banks.
All calls to have another round of ECB inflation are calls for the destruction of the euro. The voters say they don't want that, either.
What do the voters want?
They want to clap and cheer and keep Tinker Bell alive.
No one is more faithful in his belief in and support of Tinker Bell economics than Paul Krugman. He wrote this on the day of Greece's vote:
So Greece, although not without sin, is mainly in trouble thanks to the arrogance of European officials, mostly from richer countries, who convinced themselves that they could make a single currency work without a single government. And these same officials have made the situation even worse by insisting, in the teeth of the evidence, that all the currency's troubles were caused by irresponsible behavior on the part of those Southern Europeans, and that everything would work out if only people were willing to suffer some more.
Which brings us to Sunday's Greek election, which ended up settling nothing. The governing coalition may have managed to stay in power, although even that's not clear (the junior partner in the coalition is threatening to defect). But the Greeks can't solve this crisis anyway.
The only way the euro might — might — be saved is if the Germans and the European Central Bank realize that they're the ones who need to change their behavior, spending more and, yes, accepting higher inflation. If not — well, Greece will basically go down in history as the victim of other people's hubris.
Blame Germany! Blame the tightwads at the ECB. Blame Greek politicians hardly at all. And do not, under any circumstances, blame the Eurocrats and commercial bankers who oversaw this disaster.
The Germans are going to take the hit. Their bankers have led them into the trap. They cannot get out. The German central bank cooperated with the commercial bankers in their foolhardy extension of credit to the PIIGS.
Bank Runs Have Begun
Mohamed El-Erian is the CEO of the largest bond fund in the world, PIMCO. He made this statement on CNBC on June 16, the day before the Greek elections:
It is not easy to stop bank runs once they start. Indeed, as a famous investor once observed, the rational thing to do when you see a line outside a bank is to join it; and if you do not have your deposits at that bank, go quickly to where you do and join the line there.
He followed with this:
After all, it is a very asymmetrical payoff for your life savings. Therefore, in most states of the world it is better to be overcautious and pull your money out rather than face the risk of confiscation and redenomination.
He was speaking of the threat called Drachmageddon. The Greek government may pull out of the eurozone and have its central bank return to the drachma. If this happens, those Greeks or other investors who are holding drachmas rather than euros will suffer substantial losses. In contrast, those Greeks who got their euros into a northern European bank will be able to buy far more drachmas after the pullout.
As always, the trusting souls who believe politicians and bureaucrats about the trustworthiness of the national currency in the face of numbers that do not add up are the victims. The people who understand economics and who know the politicians are liars can get their money out of the country. There, less blatant liars rule.
Rich Greeks understand this. For a year, Greek bank depositors with a lot of money have been withdrawing funds in euros. They have not been taking out currency. They have been opening accounts in German banks. This is legal. The eurozone banking system of 17 nations (the UK excepted) uses a single currency. Their banks are linked digitally. To open an account in a nation outside your own is a matter of digital paperwork.
Legally, eurozone banks operate under the laws of their respective nations. But with a common currency and a common central bank, there is no way that a commercial bank in northern Europe can insulate itself from an influx of digits out of Greece, Spain, Portugal, or Italy. If the northern bank is offered euros from a foreign bank, it must accept them.
The commercial bank in Greece must sell assets in order to hand over the digits to a depositor, who has the digits sent by bank wire to a bank outside the PIIGS. But Greek banks are running out of liquid assets to sell. This is why Europe is facing the possibility — I would say inevitability — of Greece's withdrawal from the eurozone. Greek banks cannot continue to honor their depositors' requests for digital currency to be transferred to banks outside of Greece.
According to the Wall Street Journal (May 15), about $900 million worth of euros were pulled out of Greek banks on Monday, May 14. The Greek banks cannot sustain this.
As of March, privately owned euro deposits in Greek commercial banks totaled 165.36 billion. To cover these, Greek banks borrowed 73 billion from the ECB in January, plus an additional 54 billion from the ECB's emergency lending facility. That is a total of $127 billion. That means 77 percent of the total private deposits in Greece as of March had been borrowed from the ECB. Put another way, the banks' "total borrowing from the ECB accounts for more than one-half of Greece's gross domestic product."
The election on Sunday June 17 did not make clear whether Greek political parties can put together a coalition government. It is also not clear that any new government will maintain the socialist government's pledge to European lenders to cut government spending. This had been the quid pro quo for getting further loans last January.
Philipp Bagus, an Austrian School economist, saw all of this coming. He wrote a book on this, published in 2010: The Tragedy of the Euro. It was released just as the Greek crisis began. In a June 15, 2012, article, "Passing the Bailout Buck," he described what the German Central Bank has done by issuing credits to the PIIGS. It cooperated with the TARGET2 system of the eurozone, which clears interbank transfers.
Indeed, TARGET2 debits and credits have been built up since the beginning of the financial crisis. While peripheral countries accumulated TARGET2 debits, in April 2012 TARGET2 claims of the Bundesbank amounted to almost 644 billion. That is almost 8,000 per German.
If Greece leaves the eurozone, it will still not repay interest on its debts in euros. It will pay, if at all, in depreciated drachmas. The ECB will suffer a loss, and the German central bank's share of this is 27 percent.
Can the ECB inflate its way out of this? Of course. The result will be depreciation.
However, creating money does not take away the fact that the wealth is gone when the periphery defaults. It is like B not paying with real goods because he dies. A may receive new paper money from his bank, but this will not feed him through retirement. Unfortunately, as long as the European periphery remains uncompetitive relative to Germany, nothing will be produced to settle the German TARGET2 credits. Most likely, their real value is gone forever. To think that they will represent real wealth is an illusion that will be ended in one of three possible ways. The first is the already-mentioned inflation when the ECB just prints money to keep the system afloat.
The irony here is that the Greeks who got their money into German banks will suffer losses. They had better get their money into safer banks, in a safer currency. They must trust a new set of lying politicians and central bankers.
Tinker Bell has terminal cancer. The audience can clap all it likes. The audience will find that, after the show is over, their banks have a stack of IOUs on their books that cannot be collected in stable euros.
This is reality. This is not the fantasy of the bailouts.
It is the underlying reality of every Western nation. They have all written IOUs that cannot be repaid. The eurozone's politicians found out sooner because there are 18 nations that have made impossible promises, and idiot bankers who made loans to these politicians. They all expect the Germans to bail them out.
Think of Tinker Bell as Angela Merkel with wings. Not too appealing, is it? Not too believable, either.