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Thursday, 24 November 2011

Failed German bond sale reconfirms US Vs German Euro stalemate.

The inability to reconcile the threat of European inflation with those who want to print Euros will probably lead to an inevitable third outcome:  dismantling of the Euro.  The US advocates money printing, euphemistically known as quantitative easing (QE), because they do not fear inflation; whereas Germany has a profound abhorrence of inflation.  Germany strenuously resists European QE, for fear of letting inflation consume Europe, with the risk of political extremism and potentially ominous consequences.  The US strongly advocates QE for fear of bankrupting their large financial insurance institutions if called upon to cover a Greek or other sovereign debt default.

The US, UK and some Euro-currency nations have been pressuring wider Europe and mainly Germany (most other European nations are too deeply in debt to bail-out one another) to buy Greek and other government bonds:  to lend them more Euros.  The intent is that the European Central Bank (ECB) or the European Financial Stability Facility (EFSF) would purchase debt:  
·         to prevent Greek and other sovereign default;  
·         to avert a “credit event” which would require US and other financial institutions to meet large credit default swap (CDS) insurance pay-out obligations; 
·         to protect those financial institutions against bankruptcy; 
·         to keep interest rates low for those European nations;  and,
·         to restore confidence in the European sovereign debt markets.

That would require more money to achieve than is available.  Some have proposed that the only solution is for the ECB to “print” more Euros to purchase that debt:  pan-European QE to emulate US federal QE.

The purpose of European quantitative easing would be:
·         to bolster market confidence in Greek, Italian and other European sovereign debt; 
·         to create money to support bankrupt nations;
·         to create the appearance that bankrupt nations are not bankrupt;  and thus
·         to create positive market sentiment where it does not exist.

For QE to succeed it must be implemented unhesitatingly and immediately at the very first sign of collapsing market confidence.  Hesitation destroys confidence.  Usually only the first round of QE has much, if any, desired effect.  Second and subsequent rounds of QE confirm QE doesn’t work (but that’s another story).

Sentiment can’t be bought:  it is felt.  It is now probably too late to reverse snowballing negative sentiment, and Europe has probably hesitated for too long.  Collapsing European sovereign bond prices betray rapidly dwindling sentiment.

Quantitative easing is designed to make people feel better, but only in the short term, before the next elections.  Printing money temporarily makes people feel wealthy, indirectly enhancing confidence and sentiment, which is what some authorities hope to achieve.  But wider collective market sentiment can’t be so easily fooled, because it is clear that the lack of confidence is based on a more profound real economic problem than sentiment.  The problem is not negative sentiment, it is the reason for negative sentiment.  Negative sentiment is the indicator of the problems.

The Global Financial Crisis and the European sovereign debt problems were not caused by a lack of money.  Therefore, printing more money can’t solve the core problem, because the problem was not a lack of money.  The problem is debt:  people who’ve spent more than they have and more than they are likely to earn.  Repeatedly giving money to bankrupts is a superficial way to help a bankrupt, akin to giving narcotics to an addict to solve their problem.  They feel better;  the donors feel better;  but they aren’t better:  they’re worse.

Quantitative easing ultimately causes inflation.  Printing too much money causes hyperinflation, as Zimbabwe did, and as the German Weimar Republic did, and as other destroyed economies did.  Destroyed economies foster political extremes.  Quantitative easing defers and amplifies economic problems;  an ideal solution for governments focused only upon the next elections.  They perceive that it works only during the small number of years before the inflation becomes apparent:  during the window of opportunism.

Quantitative easing and inflation devalue currency, which further devalues sovereign debt.  It makes Greek loans easier to repay to lenders.  Lenders receive the same number of Euros, but they can’t buy as much with them anymore.  Broke nations repay a pittance relative to that borrowed.  Devaluation of the Euro by QE therefore only further destroys the outlook for Euro-zone sovereign debt:  the debts would be repaid in devalued Euros.  Proposals for European QE therefore compound negative sentiment towards the Euro and European sovereign debt:  of every European nation including Germany. 

The failed German bond sale in November 2011 only reconfirms that.  The lack of market confidence was not in Germany:  it was in Germany’s currency, for the reasons above, and others.

Germany, for its own sake, and because of decades of international condemnation, can not afford to be responsible for, or take any part in, any solution which will risk future inflation.  Germany is morally obliged to prevent at all costs a repetition of Weimar Republic hyperinflation which resulted in political turmoil and Hitler’s assumption of dictatorship. 

Therefore Germany is likely to continue very strong resistance to European quantitative easing.  And the US and others, on the other hand, need to continue to apply very strong pressure upon Germany to prevent the collapse of their large financial institutions should they be called upon to make good their insurance of Greek or Italian sovereign debt.

So one aspect of a European solution is the struggle between those advocating quantitative easing to save those financial institutions and those rejecting it to prevent the ominous consequences of hyperinflation.  The fact that the struggle is so intense suggests that a third solution is likely, one which avoids that struggle, and that would probably be a fundamental reconstruction or dismantling of the Euro.

I gratefully acknowledge the following sources which have contributed to my thoughts above.  Jim Sinclair's Mineset, Guildinvestment, Business Insider.

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