Sunday, March 03, 2013 10:50:44 PM
World Mess...Alasdair Macleod
...read along as you listen to this...it really is very good.
https://www.youtube.com/watch?feature=player_embedded&v=GzD4MDBDeTk
TRANSCRIPT
Chris Martenson: Welcome to another Peak Prosperity Podcast. I am your host, of course, Chris Martenson. With everything that is going on in Europe, it is time to refocus our attention and center on things going on there. To help us with that today, we have the good fortune of speaking again with Alasdair Macleod, publisher of Finance in Economics.org and a contributing editor of Peak Prosperity.
Given his vantage point from Europe, I am really keen on discussing his latest observations of where things are with the situation there. We have got the Italian elections. There are all sorts of things going on with Spain at this point in time; Portugal, France; you name it. It is a target-rich environment. Alasdair, I am really pleased to have you back as our guest.
Alasdair Macleod: It is very nice to be here. Thank you.
Chris Martenson: I want to start right at the top. I was looking at some reports recently that had come out from major brokerage firms. They were advising their clients that it is time to get back in the water, buy stocks. The crisis in Europe has been averted. Is that true?
Alasdair Macleod: No. In one word, no.
Chris Martenson: Great. We are done.
Alasdair Macleod: The way I would describe it I think, Chris, the ECB (European Central Bank) did a very, very good job by stuffing the market with money, of keeping the show on the road, if I can put it that way. You can only do that for so long. The system is deteriorating quite rapidly underneath.
Your readers would be aware of the Italian election. The thing about the Italian election is that the electorates are saying, no we don’t want this austerity. It’s hardly a surprise. The problem continues.
Chris Martenson: I was under the impression that we had a vehicle over there in which the ECB had promised that they were going to buy all of the sovereign debt as long as the nations adhered to some of their rules, austerity being one of those rules. Italy’s borrowing costs have dropped dramatically from the announcement of that vehicle and indeed, Italian debt has been finding plenty of bitters courtesy of the ECB printing up and taking a lot of that through the OMT (Outright Monetary Transactions), as I believe that vehicle is called. Now you have Italy saying thanks so much for buying our sovereign debt and the people saying and not so much on the austerity. Where does that leave us?
Alasdair Macleod: I think you have to be aware of some basic numbers. Italy’s debt-to-GDP is 126%. Their economy is not growing. They have had two years of recession, which basically means that the GDP is dropping. We don’t have a lot of inflation, so the deflator is not that great. Now with interest rates tonight at about 4.75% for the 10-year bond, in order to pay the interest which accumulates on top of that debt, the whole economy has got to grow in excess of 4.5% to 5% in order for them to have a chance in paying that debt back or stabilizing it. And that assumes that they have a balanced budget. That is really the absolute struggle henceforth the Italians are fighting.
Chris Martenson: Alasdair, that 4.5% to 5% growth – is that nominal or real understanding that if the deflators…
Alasdair Macleod: Really, we are talking about nominal, because if you had seen what the interest’s value is to the overall debt, broadly what happens then is, the GDP has got to grow in order to match that. Consequently, if it doesn’t, the debt-to-GDP ratio rises. It is as simple as that. Thinking about it while I am talking, it has to be real; that is the comparison that is made.
Chris Martenson: That is the comparison. If your deflator is almost zero, nominal and real are about the same. Let’s rewind to the beginning of this crisis starting back in 2007. From 2007 to today, if we look at government debt-to-GDP across the Eurozone, Italy’s, is it higher or lower than at the start of this?
Alasdair Macleod: It is higher.
Chris Martenson: Higher.
Alasdair Macleod: They are all higher.
Chris Martenson: They are all higher. So we can make that a short conversation. Everybody has got much, much higher debt-to-GDP, with some of them really being quite staggering numbers. Greece is over – what is it, 170%?
Alasdair Macleod: Something like that, yes.
Chris Martenson: It is astonishing.
Alasdair Macleod: That is the other thing, Chris. That is officially.
Chris Martenson: Officially.
Alasdair Macleod: Unofficially, a bigger number – it was in excess of 170%.
Chris Martenson: Oh, my gosh. So what happens with Italy now? If they voted for austerity, certainly it sent some rumblings across the market, which got papered over almost instantly one day later, so it was a 24-hour ripple in the market. It seems to me it should be more serious than that because of the exposure of banks to Italian debt. It is not like this is a little bit bigger than Greece; Italy is an order of magnitude different from Greece, in terms of exposure of foreign banks to Italian debt. Failure is not an option here, is it?
Alasdair Macleod: You are absolutely right. I think the question really is how are they going to fund themselves from here? I think we abandon any thoughts of what they are going to do with their debt properly. It is a question of keeping the show on the road. The two ways in which they can do this are either (1) persuade the Germans and the other stronger northern countries to come up with the money, or (2) the ECB. The problem is, I think the Germans are going to backpedal because they have got elections coming up in September. So far Angela Merkel, has had the fortune of an economy with a relatively low level of unemployment, which is the thing that really matters in European politics. German unemployment has only been around 5%, which is about half of the average. Not only that; there is a general satisfaction or at least no dissatisfaction with the political masters, or mistresses in this case. As soon as unemployment rises, you will find the people start thinking, this is a failure. This isn’t good. We want something else.
The reason this is important is because the dynamic markets to which Germany exports are not their European neighbors. That is stagnant and a waste of time as far as she is concerned. It is really China, Russia, Brazil; all of those places. If you can imagine these newly rich countries buying Mercedes and BMWs, but also German machinery and machined goods and tools and so on, that is really where the dynamic export markets have been. That is laying down a bit. Between now and September, it is quite likely the unemployment situation in Germany might deteriorate a little bit, assuming even with stability around her in the Eurozone I think this is going to discourage Angela Merkel from actually writing any checks.
The mechanism by which the countries do this is the European Stability Mechanism (ESM), which is a huge rate fund for which Germany is the main contributor or the largest contributor. But guess what? The other big contributors are [countries] like France, Italy, and Spain. It is a ridiculous situation for the big boys in the fund; most of them are bust, apart from Germany.
Germany is rather on her own here. I think it gives her the opportunity to say thanks, but no thanks. There is not much point in us putting out money if Italy can’t match it. There is this sort of extraordinary impasse, if I can put it that way, which will potentially give Angela Merkel the excuse to pass the buck over to the ECB.
Now, the Bundesbank don’t like that because they instinctively don’t like inflation. They want to prevent and protect their savers. Really I think there is no practical alternative to the ECB funding the problems in the periphery countries. That is essentially done by bank support, by QE, by whatever they can do to get away with it. I think the principal has been established. Mario Draghi stood up not three months ago and said we will do what it takes.
Chris Martenson: So if the ECB receives the ball and they are going to do what Mario has promised, which is “whatever it takes,” that is obviously just code speak for “printing.” You have mentioned some of the mechanisms by which they do that. There has been a lot of talk lately about currency wars. Wouldn’t a weaker euro really serve a lot of purposes, both political and structural, over there at this point in time?
Alasdair Macleod: Well, this is the opinion of the French. They being stasis Keynesian types; they buy into a weak currency to try and correct the too-high labor costs. That has certainly got attraction for a number of these countries. And, yes, I think would support that. I think Germany has a problem with that, because she has more of a savings-driven economy, and in that category I would include Austria and possibly Holland as well.
I think this is the other feature we will probably see over 2013, but I don’t think it will come to an awful lot and that is there will be increasing agitation for Germany and Holland and whoever else wants to join to set up the right currency block as an alternative. You hear rumours about it. I know there are actually quite serious economists in Germany who want to pursue that route. That is another thing maybe to watch out for – the hope of an escape by doing that.
I think one of the attractions of going that route is that you can cast off France and the rest of them into a weaker euro and let them run their own affairs with the ECB, rather than be tied into a rather increasing the inflationary outlook.
Chris Martenson: Are there any rumblings that there is going to be such a schism at this point?
Alasdair Macleod: There were rumblings last year. We aren’t hearing any rumblings about it now. I did interview a Germany economist from Berlin who was very keen to do this. He is quite a serious and senior guy. He has got a name for it. The Guilder Mark – already there are people talking about this. I don’t think it is getting any traction at the moment, for the very simple reason that the political priority is to keep the Eurozone together. They want to keep this grand plan on the go. So long as that is the case, no politician is going to sanction the idea of any alternative.
Chris Martenson: What happens if Europe doesn’t return to growth relatively soon? My understanding of most of these rescue packages were that they had very generous if not foolish assumptions on growth. I saw Greece’s rescue plan included rapid return of 3%, 4%, 5%, even 6% GDP growth starting this year, things like that, and that hasn’t happened. Are there any rumblings that they are starting to consider what happens if growth doesn’t return and why it might be that growth hasn’t returned yet?
Alasdair Macleod: That is the big question. The Keynesians don’t understand why the growth isn’t there. They are very, very disappointed. And of course, their response is, the economy is not flourishing. You have to stimulate the economy more. The fact of the matter is that the average government size in the economy in the Eurozone is 50%. So 50% of every transaction is government. Now that only leaves the private sector of 50%. The private sector, when it comes to recovering, is carrying a huge weighted burden on its back. In carrying the burden is trying to catch the private sector, who is carrying it. The tax burden is so great, the way in which they are doing it in most of these countries is that they are trying to preserve the public sector and they are trying to get the private sector to pay for it. The result is that there is no way there is going to be any growth at all.
If you look at the countries – like Spain, for example, which has come out of this massive property bubble – really the reason for its downfall, the property bubble has not unwind and you got huge great levels of malinvestment, misdirection of funds in the wrong direction, the market is has changed, people don’t want it anymore, and the market has got to adapt.
You cannot expect that to happen until it has actually happened, and taxes are not going to be forthcoming until it has happened. Unfortunately, governments have gotten themselves stuck into this position where they are not prepared to cut their spending enough. They think they can get taxes, like tax the rich, ratchet up the taxes on anyone who you think has got money, but then people avoid it. Like in France, they just go abroad. It is that bad.
We are not seeing any recovery. The burden on private sector is far too great for that recovery to occur. Not only that, but the economies in the Eurozone are angled completely towards the wrong production. It is a huge great burden of malinvestment that needs to be addressed. You are not going to get any meaningful economic recovery without that slump happening.
Given that the slump happens, you’ve got a choice: Either you get it over and done with and get it done quickly, or you have financial repression in the hope that over a long period of time something will turn up. Really, they are going for the latter rather than the former. But I don’t think they have got that much time. One of the things which Europe really does have a problem with is pension costs and the cost of health care of the elderly. You think it is expensive in America; it is twice as expensive in Europe, on average.
Chris Martenson: Twice as expensive on what basis?
Alasdair Macleod: On the basis of the number or the percentage of the population that are pensioners as a percentage of the working population. In Europe you are looking at figures 27%, 33%, that sort of figure. In the U.S. it is about 21% (I am speaking from memory). Also, the level of unemployment in Europe – the average is about 11% in the Eurozone. In America, your unemployment is nearly 8%. In some countries like Greece and Spain, particularly Spain, the level of unemployment is absolutely horrendous. You are looking at 20%, 25%. What this means is, you don’t have the people working to pay the taxes to pay for these escalating pension costs.
And the reason this is important is one your readers will be aware of, in some work that Professor Kotlikoff did at Boston University. He worked out the net present value of future welfare costs and off balance sheet stuff in the year 2012 was an extra $11 trillion on the U.S. economy, which is $15 trillion. We are talking about huge, great welfare costs coming down in the lift, which is going to swamp absolutely everything.
Now, if it is that bad in America, and you take a look at the dynamics of the situation in Europe, an conclude it is twice as bad in Europe. You can see that there is not enough time to sit around and wait for the private sector to recover under financial repression. There just isn’t time. This is a big, big problem that nobody seems to be focusing on. You have to deal with it quickly and then start dealing with that problem, or you have it. That is roughly where they are in Europe.
Chris Martenson: Sounds like it is the same as in America when we have deer-in-headlights, when you get into the big, big stuff like the pension underfundings and intolerable program shortfalls. That $11 trillion you are talking about that is accrual-based deficit that the United States racked up in 2012, according to Kotlikoff, that even the Treasury said was $6.5 trillion. Officially we reported a cash-basis shortfall of $1.2 trillion, but really we are racking up things that are compounding. Every week/month that passes, these things just get larger and larger and larger.
You have raised a very interesting concept, and I am wondering what the similarity might be in Europe to this. I get the sense here in the United States that you have the underclass – which is really what formally needs to be called the little class – contributing almost nothing into the equation at this point in time. And you have large corporations, which have figured out through clever layering how to dodge paying effective tax rates that are above 20%, it seems. The squeeze is on what they are calling the rich, but really it is middle America.
This is our productive class – small and medium businesses, people who have got a real strong entrepreneurial spirit and have worked hard. That seems to be where most of the targeting has fallen when I parse through the details of the Affordable Healthcare Act, also called Obamacare in certain circles. I look at all of the things that have come through they are really targeting the productive class. That seems just grossly counterproductive to me. It might work in the short term, but long-term I am wondering if Europe has a peek into the future for that for us.
Alasdair Macleod: I’m afraid the story in Europe is exactly the same as you have described it, Chris. We are trying to pursue the wealthy, and we are clamping down on taxes. In Italy they literally impound your yacht, then you have to argue about it later sort of thing. As you put it so well, it really is taxing; it is removing wealth from the productive classes. When you do that, what the productive classes do is they start bubbling about trying to make money making things, and they start bubbling about how to make money by keeping it away from the tax man. It is a complete digression of resources into something that is useless, as far as the status is concerned.*****
Over in Europe, there is this belief that if someone is richer than me, he should contribute more in taxes. I know that your politicians are playing that sort of game, but over here it has been like this forever. I am sure we will come onto the UK in a moment, but this is one of the problems that the counsellors – George Osborne has as he is in coalition with a left-wing party win in the sense that they are desperate to redistribute wealth from the rich to the poor. Of course, in the process you just destroy the productive capacity of the economy. That is the story all over Europe. I can see it in America as well. Therefore, there is going to be no meaningful recovery.
Chris Martenson: All right. Well, let’s finish our two or three subjects here first before we move into the UK.
Spain. Let’s finish up on Spain here. Obviously, Spain is still, in my view, looking like they are in relatively poor shape. They have extraordinary – and last I checked, rising – levels of defaults on the outstanding book in balance at the bank. It looks like things are not at all improved there. What is going on in Spain right now?
Alasdair Macleod: I think it goes back to the election, which was a bit over a year ago, when Rajoy was elected. He got in with a pure working majority, which gave him the opportunity to tackle Spain’s problems – and he didn’t. He sort of went at it half-assedly. That was the opportunity missed.
On top of that, Spain’s problems really go back to credit expansion, which fueled property prices. It is very similar to the United States. The fueling of property prices were even greater than we saw in the United States, but so far the correction in house prices has not been as great in the United States, which rather suggests that house prices have a lot further to fall.
Now, on top of that, the mortgage bank system, that was sort of run like slush funds for the vested interest like unions and all of the rest of it, they were unregulated and I think still are unregulated. And of course all the losses appeared in these mortgage banks. They have consolidated certainly the biggest ones into Bankia, which is a new entity, and already they have had to produce about 40 billion euros to stop that from going under. All the original depositors who were forced to accept shares in returns for their deposits have now lost a lot of money. The banking system, mostly through mortgage lending and also lending to construction companies, looks like it is going to require a total of about 100 billion euros. That has been agreed to be provided by the financing ministers in the Eurozone, but we don’t know how that is going to happen. So far, I think I might say about 40 billion [euros] have actually been provided by the ESF (European Social Fund).
Now, I think Germany is going to dig her heals in on this one, in which case it is going to rescue the banks through the ECB. So the ECB will throw money at the Spanish banking system to keep it afloat, and so what’s new? Spain is a tragedy. If they had taken action early, they would have only had the property bubble and the construction industry to deal with. As it is, what they have done by mishandling it is they are effectively sinking the whole economy, and I think that is an absolute tragedy. You have got over 50% unemployment amongst the under-25s, which is a complete lost generation. As a result, there is 25% unemployment. More broadly, you are going to have a strong possibility of social unrest in 2013. Spain is still bad news.
I was talking to an economist the other day, and he was thinking that Spain will actually be the first one to create the next crisis in the Eurozone. He thought Spain was ahead of Italy and France in this. That was before the Italian election.
Chris Martenson: Okay. So Spain is clearly sailing pretty close to the wind here. They’ve got very, very high debt levels. Their industry, such as it is – they are really going through a bubble, and they failed to just address that first while the bubble was going.
Alasdair Macleod: What is interesting in this is that – unlike Italy and France, particularly Italy, who has always had very high levels of debt-to-GDP – Spain started in the banking crisis when the debt-to-GDP was only 40%.
Chris Martenson: Really, 40%?
Alasdair Macleod: It is about 100% now. It just shows you how rapidly a situation can deteriorate.
Chris Martenson: Speaking of rapidly deteriorating situations; what are you seeing in Greece? I know we have all been reading the reports, which almost have the Fukushima effect, where we are reading less and less of it even though the stories are more and more dire – over here [in the U.S.] at least. I think the story is old or something; perhaps it has lost some interest in the media cycle. When I bother to find out what is going on there, I hear about just rampant unemployment, hunger even. People chopping down trees to stay warm. All the usual things you would see in a full-blown economic collapse. Is that view wide of the mark? Has that been exaggerated?
Alasdair Macleod: You are absolutely right. Greece has disappeared from the headlines partly because Europe, until now, has disappeared from the headlines. Also partly because Greece is a pretty small bear compared to what is coming up in the West.[color=red][/color]
Chris Martenson: Where does Greece go from here? I know at one point it was thought that they were going to be the trigger for the next round in the crisis because they wouldn’t be able to meet some debt payment or another. Are they okay financially for the moment?
Alasdair Macleod: I would hesitate to describe them as okay financially. Basically they are very badly wounded. They are struggling on. Germany, I think, has provided the bulk of the funds to keep it going so far, which creates quite a bit of resentment. But Germany doesn’t want to provide very much more I don’t think. This is a problem. The Greeks are now in a position where they are having to deal with their own problems themselves. I haven’t read reports of them funding the market recently.
I think that they are probably being helped by the ECB – the ECB will help anyone. Their problem is, they don’t want the banking system to fall over. And if you get bankruptcies in the Greek banking system, there is no knowing how far that will spread. I think the answer to your question, Chris, is that Germany has helped them so far, but I guess the ECB will be taking care of their short term needs, if I can put it that way.
Chris Martenson: Fantastic. So we are rolling over the short-term needs. Applying band-aids where necessary. Sticking fingers in the dikes. What will it take to turn this around? It has got to be strong economic growth doesn’t it?
Alasdair Macleod: That is the only thing. As we have already discussed, with an average of 50% government-spending-to-GDP, there isn’t an awful lot of free private sector to grow these countries out of trouble. I just don’t see it happening, unfortunately, now that Germany is effectively backing off. That is not really the official line. And it is now down to the ECB. I think the inevitable outcome at some status will turn into hyperinflation.
Chris Martenson: Wow.
Alasdair Macleod: [color=red]There isn’t any alternative. Having said that, I don’t see things very differently in most other jurisdictions.
Chris Martenson: Really?
Alasdair Macleod: Look at Japan. They have now effectively run out of domestic savings, so they are now printing. There is only one way that is going to go. America, same thing. When I look at the monthly contribution from the Fed into the [U.S.] economy, it is something like $85 billion a month. When I look at the pace the money supply is being grown in the States, it seems to me that is not enough.
That is a horrendous statement to make, but if they don’t accelerate the rate at which they are printing money in the States, then I think interest rates are bound rise sooner than would otherwise. Either that, or you are going to start getting some financial failures. Probably both. I don’t know. Once you get into the debt trap and the requirement to print money to keep governments afloat, to keep banks afloat, you cannot get off the cycle. I think that is what we’ve got in America; it is what we’ve got all around Europe. We’ve got it in the UK, which is, I’m sure, we will come onto in a moment, and you definitely have got it in Japan.[/color]
Chris Martenson: The Fed was always thought to be fearing what they call the liquidity trap. I think you just articulated the real trap is that once you are printing to keep your government afloat, you are pretty much in Phase One of “game over.” Phase Two is when interest rates start to rise. We all know you can just run calculations with a crayon and a napkin and discover that even a slight rise in interest rates – just maybe putting them back at their historical averages –would really crush the fiscal situations of entire nation states at this point, let alone companies and individuals and all of that.
We have gotten ourselves in a position where we can’t survive higher interest rates. What do you do about that? How do you walk down your debt if you can’t get your economies growing, so your debts just keep growing? Alasdair, how do you get out of this?
Alasdair Macleod: Well, I think that there is only one logical computation, and that is a complete default. You have two ways in which you can default: One is to accept reality and face that, and the other way is to try to kick the can down the road, which just involves accelerating the printing. You can print money to quite a degree until such time as your citizens decide that my goodness, this dollar or euro or whatever it is, I don’t want it anymore. I would rather have goods. At that stage, you’ve got a flight out of money into goods.
It doesn’t do your production any good, by the way. What it basically means is that the shelves get cleared out. Prices rise very sharply. It is a slippery slope, because the only thing backing a paper currency is confidence in it. Forget all of this stuff about the quantity theory of money – it doesn’t apply. If you lose confidence in a paper currency, it can become valueless very, very quickly.
I think if we look back to the Weimar inflation, the German one in 1922-23, I think true hyperinflation was probably only about five or six months. Until that time, of course, the market lost well over 99.9% of its value from pre-wartime. It was only in that last phase that people suddenly woke up to the fact that the one thing they did not want to have was paper money. They lost all hope that this inflation would stop.
At that point, the function of how long the hyperinflation lasts becomes one of a practical problem of how you deal with it. In the case of Germany, they had to write a check, they had to draw the money out of the bank, they probably had to wait. They didn’t take checks; they would only take cash. Then they had to wait for the delivery of the cash. The printing presses were running 24 hours a day to supply the demand. That took five months. Now we have credit cards; we have electronic settlements. How are we going to take a paper currency collapse? It could be a minute. It could be a day.
I do remember you mentioned Iceland earlier. I do remember that when the Icelandic crisis hit, I was following the price of the Króna on the day it happened. At one point it lost 70% of its value in one minute in the morning. It got back some of that by the end of the day. That is how it can happen. It can happen very, very quickly.
Funding our way out of the problem by printing up more money can actually bite back on you, and the game can finish without very much notice and very, very quickly. It is not a game where you are going to have time to exit. It really isn’t.
Chris Martenson: I have thought that for a long time as well, noting that hyperinflation really only takes on meaning when there is a border to cross, meaning you can compare that currency to something. So with Japan printing like crazy, the European Central Bank printing, Federal Reserve printing, with all of these characters printing, which border do you compare yourself against?
Of course, for myself, that has always been gold. Gold has just been languishing for a long time. What are you seeing from your perspective over there on gold?
Alasdair Macleod: It is interesting. Going back to my hypothesis about hyperinflation when people lose all of their paper money, we have a situation now where currency in the form of paper money is the only form of exchange in the markets. True money, as you and I know throughout history, has always been gold. People are not yet thinking that gold is something that they need to have to defend themselves in a paper currency collapse, because they don’t see the paper currency collapse. They really don’t. There will come a time I think when that is going to switch, and it will probably switch quite sharply.
Meanwhile, what has been happening is, we have had the deterioration in the European situation. We have had the deterioration in the American statistics. We have had the deterioration in our own here, and Japan (as I have said earlier) has run out of savers. Someone came up with a wonderful statistic within Japan that they sell more diapers to the aged than they do children now. That is not a position you want to get into. They are on the slippery slope of destroying their own paper money by destroying confidence in it.
Gold, meanwhile, has gone sideways. It has done nothing. It has been controlled as much as anything by the bullion banks who have expanded the amount of paper gold and paper silver in circulation to deflate the speculative demand in it. Meanwhile, the true demand from people who are ensuring themselves against systemic risk is there, and people have just been storing it away very, very quietly. In some countries they do this – in India, for example, they have been doing this for decades. China has just started doing it and I see that continuing and building.
with a central bank. They have been quite aggressive building up her gold holdings.
All the time now, while the situation is deteriorating, we see the gold prices being sat on. It is only a matter of time before it can no longer be controlled. The problem is, when that happens, there are going to be some very major banks in quite serious difficulty because of all of the short positions.
Chris Martenson: Well, they almost got in severe trouble all the way back – I believe it was 1998 or 1999 it was when your own illustrious exchequer decided to openly announce a reverse auction and discard UK’s gold at bargain basement prices. I believe that was largely to protect some bullion banks that had gotten into a very, very large amount of trouble because they had been doing leasing of gold and simply didn’t have it.
Alasdair Macleod: You’re right. There have been these few times in history where having tipped the price of bullion down below where it would naturally be a demand from elsewhere taking it away. It is a process that has taken us through the second half of the 80s and through the 90s. It was at that time, I think, when the Middle East started building up their reserves.
India has always had a huge demand for gold. It is only relatively recently, I think about 10 years, maybe more years, when officially people have been able to import gold rather than smuggle it in. I remember going to what used to be called Bombay back in the late 1960s, and I did a very interesting exercise recently on this. I looked up the price of gold in rupees at the time, and you could buy the fabricated gold that Indians buy as their stored wealth – fairly plain jewelry for their wives, that sort of thing, and it would cost you less than 200 rupees an ounce.
Given that the tradition of India is to save into gold and silver; when children are born you buy some for the child. A son gets married, a daughter gets married, for the dowry you give them some gold jewelry to start with. The whole of the middle classes in India revolve their savings around gold. Now, if gold was less than 200 rupees when I was there back in 1968, I think it was – do you know what the price is now? It is about 100,000 rupees.
Chris Martenson: 100,000.
Alasdair Macleod: Yes. Who has been the clever guy? There is nothing else that the Indian could have put his money in, in order to preserve his wealth, which has been so effective. And he is not about to change his habits, I can assure you. They know what happens to paper currencies. They know what happens to the rupee. And the average Chinese guy has got exactly the same approach towards his own currency.
Chris Martenson: I imagine in dollar terms, gold has been going sideways. But let’s turn our attention to your home country, the UK. With the pound falling so much, there have been a lot of calls for austerity being the culprit in this case, so the calls are to end austerity. How is gold being viewed in the UK right now? And then, secondarily, what is going on over there economically right now?
Alasdair Macleod: Gold is the question first; I think the view here on gold is probably quite similar to the view in America. Complete disinterest, really. And, you know, people see that the price of it over the last 10, 12 years has risen quite sharply and they say well, it is in a bubble. A bubble only occurs when everyone has got it. Nobody has got it. It hasn’t happened. I am a gold bug, and I am in a tiny minority; I really am. I think if you ask a thousand people on the street would you buy gold as an investment? you would probably find one might say yes. It is literally like that.
I guess it is probably the same with you in America. I don’t know whether I’m right, but I just got a feeling there is complete disinterest in the subject.
Chris Martenson: Oh, absolutely there is. We have none of the social hallmarks of a bubble. We only have prices that seem to have gone up a bit. My view on that is that those prices had to rise, because otherwise if they hadn’t, can you imagine how much gold India would be buying today if it was $280 an ounce like way back in 1999? It would be ridiculous.
Alasdair Macleod: Oh, absolutely. I think the other way to look at it, Chris, is that it is not gold that has gone up; it is the quantity of Euros, the quantity of pounds, whatever, that is has increased so much that it actually buys less gold.
Chris Martenson: And oil and wheat.
Alasdair Macleod: Exactly, and all of those other things.
Chris Martenson: Absolutely. Let’s turn now to the economics I have been reading about, renewed recessionary fears over there in the UK, and the foreign indebtedness of the UK is actually quite extraordinary. There are some really pressing issues there aren’t there?
Alasdair Macleod: Oh, yes. Well, first of all, the economy; last year they managed to do slightly better than break even. We weren’t quite in a recession. All of that stuff is pretty meaningless anyways. We have a budget, and the budget in the UK is a major political and economic event. It is the one time when the chancellor stands up and he arranges the taxes and gives his forecast and all of the rest of it and all the commentators get all excited. So that is on March the 20th.
Now, unfortunately we had Moody’s ratings downgrade earlier this week. Of course, that is being dismissed as well. We knew it was coming, so it really doesn’t matter; this is not news. But when you bear in mind that sterling has fallen from literally the first of January to now from about 162 down to the current level of 151 and a bit, and in the process it has broken some very important support levels that we have seen hold it in the last few years, I think we have the potential makings of a sterling crisis.
The reason that this is important is our economy actually isn’t going anywhere. The chancellor’s numbers when he comes to stand up on March the 20th I don’t think can in any way impress the market. There isn’t going to be any sudden magic elixir.
On top of that, we had with sterling falling an aggravation; that is, the price of petrol – “gas” as you guys would call it over there – has risen from round about 122 pounds a litre to just under 150 pounds per liter today – that is, literally over the last two months. I don’t know if you had, but we had this horsemeat scandal – the result is that horsemeat has been found in burgers. The effect of this scare has been to push people into better quality meat. So the result is a meat crisis here rising quite sharply. Instead of having a background of inflation that might be slightly above target, which is what the Bank of England has been forecasting, we are now looking at a situation where it is likely to be considerably above the target.
Now, the problem is that there is nothing really that the Bank of England can do about it that they would be comfortable doing. What it should do when you have the potential of a sterling crisis is to raise interest rates to take all the expectation out of the market. But we are funding a government deficit. We have a fragile banking system, which I don’t think would survive rising interest rates. Quite literally, the Bank of England is likely to try and wish this problem away. They have done it before.
A guy called Paul Tucker, who is a Deputy Governor for the Treasury Select Committee, last night was saying that the Bank of England was thinking of charging negative interest rates on balances held with it.
Chris Martenson: I had just read that.
Alasdair Macleod: It doesn’t affect ordinary depositors. But it does affect the banks, the commercial banks who have accounts with the Bank of England. Sort of like the Fed turning around on its excess reserves and saying to the banks we are going to charge you if you are going to leave the money here. We want to try to push it out into the economy. I do feel that this idea of having almost zero interest rates and negative interest rates for a bank is likely to accelerate the sterling crisis rather than return it. We do have potential for a sterling crisis. Unfortunately, what happens with a sterling crisis is, the interest rates end up rising until such point as the corrective action is taken. That corrective action is extremely painful.
We are in a situation here in Europe where I think we won’t be looking at what is going in Europe and thinking oh, my god, they have gotten themselves into a mess. Actually, the mess may well be triggered by the UK. The sterling situation I think does need to be watched very, very carefully.
Chris Martenson: Interesting. Let’s talk about timing, then. This has all dragged on far longer than I thought possible. I think there has been a masterful display of printing, obfuscation, propagandizing, jaw boning, you name it. It has been golf clap, golf clap, very nice. How much longer can this all continue, do you think?
Alasdair Macleod: Well, as you so rightly say, these things always drag on longer than you think possible. I do think, however, that we are very much on the last lap on this one. And I think 2013 is going to be very much the year when lots and lots of chickens come home to roost. Whether they start coming home to roost in the next two or three months, or whether it is the next six months, I don’t know. The backstop situation, in the sense that the pension problem and all of the rest of it is not making the headlines at the moment. But there is no doubt about it; that is going to become a huge issue. I think it will become an issue later on this year.
[color=red]We are now in a situation where anyone lending money to Spain or Italy or France is going to start thinking – well hold on a minute; I know they have got a short term problem, and I know the economy isn’t going very well, etc., but am I not right in thinking demographics and pensions and all of the rest of it is going to be [how] this country is going to go bust very quickly anyway?[/color] In other words, I think the market is going to start considering these things. At some stage the markets are going to take control of interest rates and the pricing of money away from the central banks. I do feel that point is not very far away.
As you rightly point out, very often I call recessions that never happen. I do think 2013 is going to be the year when we do really see a sharp deterioration in the overall position.
Chris Martenson: If that happens, I believe that it is going to be rather disappointing for a lot of folks, largely because this will be the third iteration of this crisis. We have already been through a couple of passes of it. With every one of those, people have invested hope. Hope that the authorities know what they are doing, that they have a plan, that this will all resolve itself somehow. I am mystified that so many people, in the investment side in particular, are not looking at this and saying look, we have tried this several times. We have printed trillions of dollars, arguably, we have prevented something worse from happening. We have also not been able to achieve anything that would really look like a sustainable lift-off.
By the way, just editorially, I can’t find any records of oil being well over $110 a barrel on the world stage and having any sort of economic recovery. There is just a problem inherent in that. It just feels to me like there ought to be some sort of reckoning moment that comes with this. I think this next crisis is going to be so much harder to pick ourselves up from because so much political capital had been expended, so much hope capital will have been expended, real capital. There won’t be a whole lot left to spend, and really then at that point we have to get back to what you said before: We have to face the music.
Are you going to default by overt default? We are just going to eliminate a whole lot of these debts. Or are we going to be covert? Are we really going to be serious about the printing and really let the world know? I think that is what Japan is doing. Japan is saying we don’t care. We are going to really print this and make a substantial difference in our inflationary outcomes and the value of the yen. Period. It is going to get done.
It feels to me like the pressures are building for some sort of a resolution to this. Either we go off the knife edge to the left, and it is inflationary, if not hyperinflationary. Or we go off to the right, and it is deflationary. One way or the other, it has been a bit long skating along this knife edge without a lot to show for it.
Alasdair Macleod: I would like to make one observation though about market psychology. I would say that in a bull market, we look forward to things, we anticipate things. We look at a company and we say I think that company has a new product; sales are going to go up. The good things in a bull market get discounted ahead of time. In a bear market it works in a reverse way. Crises, basically, most of the time, are made by people who live on hope. Even though you and I as discerners might look and say oh, my goodness, we don’t like the look of this or whatever, the market sails on regardless. Then there comes a point where reality intervenes. When it happens, it can happen very, very suddenly. Of course, we cannot predict the exact moment that is going to happen. I think there is that difference between bull market and bear market psychology. I think we need to keep that in mind.
Chris Martenson: That is a fair point. I like it a lot. I like everything I have heard so far, and that is all the time we have today. So Alasdair, I just want to thank you from the bottom of my heart for another fascinating interview and discussion about what is going on in Europe, and I hope we can do this again sometime soon.
Alasdair Macleod: I look forward to it. It was very nice speaking to you again, Chris.
http://www.peakprosperity.com/podcast/81072/alasdair-macleod
World economy is a mess
...read along as you listen to this...it really is very good.
https://www.youtube.com/watch?feature=player_embedded&v=GzD4MDBDeTk
TRANSCRIPT
Chris Martenson: Welcome to another Peak Prosperity Podcast. I am your host, of course, Chris Martenson. With everything that is going on in Europe, it is time to refocus our attention and center on things going on there. To help us with that today, we have the good fortune of speaking again with Alasdair Macleod, publisher of Finance in Economics.org and a contributing editor of Peak Prosperity.
Given his vantage point from Europe, I am really keen on discussing his latest observations of where things are with the situation there. We have got the Italian elections. There are all sorts of things going on with Spain at this point in time; Portugal, France; you name it. It is a target-rich environment. Alasdair, I am really pleased to have you back as our guest.
Alasdair Macleod: It is very nice to be here. Thank you.
Chris Martenson: I want to start right at the top. I was looking at some reports recently that had come out from major brokerage firms. They were advising their clients that it is time to get back in the water, buy stocks. The crisis in Europe has been averted. Is that true?
Alasdair Macleod: No. In one word, no.
Chris Martenson: Great. We are done.
Alasdair Macleod: The way I would describe it I think, Chris, the ECB (European Central Bank) did a very, very good job by stuffing the market with money, of keeping the show on the road, if I can put it that way. You can only do that for so long. The system is deteriorating quite rapidly underneath.
Your readers would be aware of the Italian election. The thing about the Italian election is that the electorates are saying, no we don’t want this austerity. It’s hardly a surprise. The problem continues.
Chris Martenson: I was under the impression that we had a vehicle over there in which the ECB had promised that they were going to buy all of the sovereign debt as long as the nations adhered to some of their rules, austerity being one of those rules. Italy’s borrowing costs have dropped dramatically from the announcement of that vehicle and indeed, Italian debt has been finding plenty of bitters courtesy of the ECB printing up and taking a lot of that through the OMT (Outright Monetary Transactions), as I believe that vehicle is called. Now you have Italy saying thanks so much for buying our sovereign debt and the people saying and not so much on the austerity. Where does that leave us?
Alasdair Macleod: I think you have to be aware of some basic numbers. Italy’s debt-to-GDP is 126%. Their economy is not growing. They have had two years of recession, which basically means that the GDP is dropping. We don’t have a lot of inflation, so the deflator is not that great. Now with interest rates tonight at about 4.75% for the 10-year bond, in order to pay the interest which accumulates on top of that debt, the whole economy has got to grow in excess of 4.5% to 5% in order for them to have a chance in paying that debt back or stabilizing it. And that assumes that they have a balanced budget. That is really the absolute struggle henceforth the Italians are fighting.
Chris Martenson: Alasdair, that 4.5% to 5% growth – is that nominal or real understanding that if the deflators…
Alasdair Macleod: Really, we are talking about nominal, because if you had seen what the interest’s value is to the overall debt, broadly what happens then is, the GDP has got to grow in order to match that. Consequently, if it doesn’t, the debt-to-GDP ratio rises. It is as simple as that. Thinking about it while I am talking, it has to be real; that is the comparison that is made.
Chris Martenson: That is the comparison. If your deflator is almost zero, nominal and real are about the same. Let’s rewind to the beginning of this crisis starting back in 2007. From 2007 to today, if we look at government debt-to-GDP across the Eurozone, Italy’s, is it higher or lower than at the start of this?
Alasdair Macleod: It is higher.
Chris Martenson: Higher.
Alasdair Macleod: They are all higher.
Chris Martenson: They are all higher. So we can make that a short conversation. Everybody has got much, much higher debt-to-GDP, with some of them really being quite staggering numbers. Greece is over – what is it, 170%?
Alasdair Macleod: Something like that, yes.
Chris Martenson: It is astonishing.
Alasdair Macleod: That is the other thing, Chris. That is officially.
Chris Martenson: Officially.
Alasdair Macleod: Unofficially, a bigger number – it was in excess of 170%.
Chris Martenson: Oh, my gosh. So what happens with Italy now? If they voted for austerity, certainly it sent some rumblings across the market, which got papered over almost instantly one day later, so it was a 24-hour ripple in the market. It seems to me it should be more serious than that because of the exposure of banks to Italian debt. It is not like this is a little bit bigger than Greece; Italy is an order of magnitude different from Greece, in terms of exposure of foreign banks to Italian debt. Failure is not an option here, is it?
Alasdair Macleod: You are absolutely right. I think the question really is how are they going to fund themselves from here? I think we abandon any thoughts of what they are going to do with their debt properly. It is a question of keeping the show on the road. The two ways in which they can do this are either (1) persuade the Germans and the other stronger northern countries to come up with the money, or (2) the ECB. The problem is, I think the Germans are going to backpedal because they have got elections coming up in September. So far Angela Merkel, has had the fortune of an economy with a relatively low level of unemployment, which is the thing that really matters in European politics. German unemployment has only been around 5%, which is about half of the average. Not only that; there is a general satisfaction or at least no dissatisfaction with the political masters, or mistresses in this case. As soon as unemployment rises, you will find the people start thinking, this is a failure. This isn’t good. We want something else.
The reason this is important is because the dynamic markets to which Germany exports are not their European neighbors. That is stagnant and a waste of time as far as she is concerned. It is really China, Russia, Brazil; all of those places. If you can imagine these newly rich countries buying Mercedes and BMWs, but also German machinery and machined goods and tools and so on, that is really where the dynamic export markets have been. That is laying down a bit. Between now and September, it is quite likely the unemployment situation in Germany might deteriorate a little bit, assuming even with stability around her in the Eurozone I think this is going to discourage Angela Merkel from actually writing any checks.
The mechanism by which the countries do this is the European Stability Mechanism (ESM), which is a huge rate fund for which Germany is the main contributor or the largest contributor. But guess what? The other big contributors are [countries] like France, Italy, and Spain. It is a ridiculous situation for the big boys in the fund; most of them are bust, apart from Germany.
Germany is rather on her own here. I think it gives her the opportunity to say thanks, but no thanks. There is not much point in us putting out money if Italy can’t match it. There is this sort of extraordinary impasse, if I can put it that way, which will potentially give Angela Merkel the excuse to pass the buck over to the ECB.
Now, the Bundesbank don’t like that because they instinctively don’t like inflation. They want to prevent and protect their savers. Really I think there is no practical alternative to the ECB funding the problems in the periphery countries. That is essentially done by bank support, by QE, by whatever they can do to get away with it. I think the principal has been established. Mario Draghi stood up not three months ago and said we will do what it takes.
Chris Martenson: So if the ECB receives the ball and they are going to do what Mario has promised, which is “whatever it takes,” that is obviously just code speak for “printing.” You have mentioned some of the mechanisms by which they do that. There has been a lot of talk lately about currency wars. Wouldn’t a weaker euro really serve a lot of purposes, both political and structural, over there at this point in time?
Alasdair Macleod: Well, this is the opinion of the French. They being stasis Keynesian types; they buy into a weak currency to try and correct the too-high labor costs. That has certainly got attraction for a number of these countries. And, yes, I think would support that. I think Germany has a problem with that, because she has more of a savings-driven economy, and in that category I would include Austria and possibly Holland as well.
I think this is the other feature we will probably see over 2013, but I don’t think it will come to an awful lot and that is there will be increasing agitation for Germany and Holland and whoever else wants to join to set up the right currency block as an alternative. You hear rumours about it. I know there are actually quite serious economists in Germany who want to pursue that route. That is another thing maybe to watch out for – the hope of an escape by doing that.
I think one of the attractions of going that route is that you can cast off France and the rest of them into a weaker euro and let them run their own affairs with the ECB, rather than be tied into a rather increasing the inflationary outlook.
Chris Martenson: Are there any rumblings that there is going to be such a schism at this point?
Alasdair Macleod: There were rumblings last year. We aren’t hearing any rumblings about it now. I did interview a Germany economist from Berlin who was very keen to do this. He is quite a serious and senior guy. He has got a name for it. The Guilder Mark – already there are people talking about this. I don’t think it is getting any traction at the moment, for the very simple reason that the political priority is to keep the Eurozone together. They want to keep this grand plan on the go. So long as that is the case, no politician is going to sanction the idea of any alternative.
Chris Martenson: What happens if Europe doesn’t return to growth relatively soon? My understanding of most of these rescue packages were that they had very generous if not foolish assumptions on growth. I saw Greece’s rescue plan included rapid return of 3%, 4%, 5%, even 6% GDP growth starting this year, things like that, and that hasn’t happened. Are there any rumblings that they are starting to consider what happens if growth doesn’t return and why it might be that growth hasn’t returned yet?
Alasdair Macleod: That is the big question. The Keynesians don’t understand why the growth isn’t there. They are very, very disappointed. And of course, their response is, the economy is not flourishing. You have to stimulate the economy more. The fact of the matter is that the average government size in the economy in the Eurozone is 50%. So 50% of every transaction is government. Now that only leaves the private sector of 50%. The private sector, when it comes to recovering, is carrying a huge weighted burden on its back. In carrying the burden is trying to catch the private sector, who is carrying it. The tax burden is so great, the way in which they are doing it in most of these countries is that they are trying to preserve the public sector and they are trying to get the private sector to pay for it. The result is that there is no way there is going to be any growth at all.
If you look at the countries – like Spain, for example, which has come out of this massive property bubble – really the reason for its downfall, the property bubble has not unwind and you got huge great levels of malinvestment, misdirection of funds in the wrong direction, the market is has changed, people don’t want it anymore, and the market has got to adapt.
You cannot expect that to happen until it has actually happened, and taxes are not going to be forthcoming until it has happened. Unfortunately, governments have gotten themselves stuck into this position where they are not prepared to cut their spending enough. They think they can get taxes, like tax the rich, ratchet up the taxes on anyone who you think has got money, but then people avoid it. Like in France, they just go abroad. It is that bad.
We are not seeing any recovery. The burden on private sector is far too great for that recovery to occur. Not only that, but the economies in the Eurozone are angled completely towards the wrong production. It is a huge great burden of malinvestment that needs to be addressed. You are not going to get any meaningful economic recovery without that slump happening.
Given that the slump happens, you’ve got a choice: Either you get it over and done with and get it done quickly, or you have financial repression in the hope that over a long period of time something will turn up. Really, they are going for the latter rather than the former. But I don’t think they have got that much time. One of the things which Europe really does have a problem with is pension costs and the cost of health care of the elderly. You think it is expensive in America; it is twice as expensive in Europe, on average.
Chris Martenson: Twice as expensive on what basis?
Alasdair Macleod: On the basis of the number or the percentage of the population that are pensioners as a percentage of the working population. In Europe you are looking at figures 27%, 33%, that sort of figure. In the U.S. it is about 21% (I am speaking from memory). Also, the level of unemployment in Europe – the average is about 11% in the Eurozone. In America, your unemployment is nearly 8%. In some countries like Greece and Spain, particularly Spain, the level of unemployment is absolutely horrendous. You are looking at 20%, 25%. What this means is, you don’t have the people working to pay the taxes to pay for these escalating pension costs.
And the reason this is important is one your readers will be aware of, in some work that Professor Kotlikoff did at Boston University. He worked out the net present value of future welfare costs and off balance sheet stuff in the year 2012 was an extra $11 trillion on the U.S. economy, which is $15 trillion. We are talking about huge, great welfare costs coming down in the lift, which is going to swamp absolutely everything.
Now, if it is that bad in America, and you take a look at the dynamics of the situation in Europe, an conclude it is twice as bad in Europe. You can see that there is not enough time to sit around and wait for the private sector to recover under financial repression. There just isn’t time. This is a big, big problem that nobody seems to be focusing on. You have to deal with it quickly and then start dealing with that problem, or you have it. That is roughly where they are in Europe.
Chris Martenson: Sounds like it is the same as in America when we have deer-in-headlights, when you get into the big, big stuff like the pension underfundings and intolerable program shortfalls. That $11 trillion you are talking about that is accrual-based deficit that the United States racked up in 2012, according to Kotlikoff, that even the Treasury said was $6.5 trillion. Officially we reported a cash-basis shortfall of $1.2 trillion, but really we are racking up things that are compounding. Every week/month that passes, these things just get larger and larger and larger.
You have raised a very interesting concept, and I am wondering what the similarity might be in Europe to this. I get the sense here in the United States that you have the underclass – which is really what formally needs to be called the little class – contributing almost nothing into the equation at this point in time. And you have large corporations, which have figured out through clever layering how to dodge paying effective tax rates that are above 20%, it seems. The squeeze is on what they are calling the rich, but really it is middle America.
This is our productive class – small and medium businesses, people who have got a real strong entrepreneurial spirit and have worked hard. That seems to be where most of the targeting has fallen when I parse through the details of the Affordable Healthcare Act, also called Obamacare in certain circles. I look at all of the things that have come through they are really targeting the productive class. That seems just grossly counterproductive to me. It might work in the short term, but long-term I am wondering if Europe has a peek into the future for that for us.
Alasdair Macleod: I’m afraid the story in Europe is exactly the same as you have described it, Chris. We are trying to pursue the wealthy, and we are clamping down on taxes. In Italy they literally impound your yacht, then you have to argue about it later sort of thing. As you put it so well, it really is taxing; it is removing wealth from the productive classes. When you do that, what the productive classes do is they start bubbling about trying to make money making things, and they start bubbling about how to make money by keeping it away from the tax man. It is a complete digression of resources into something that is useless, as far as the status is concerned.*****
Over in Europe, there is this belief that if someone is richer than me, he should contribute more in taxes. I know that your politicians are playing that sort of game, but over here it has been like this forever. I am sure we will come onto the UK in a moment, but this is one of the problems that the counsellors – George Osborne has as he is in coalition with a left-wing party win in the sense that they are desperate to redistribute wealth from the rich to the poor. Of course, in the process you just destroy the productive capacity of the economy. That is the story all over Europe. I can see it in America as well. Therefore, there is going to be no meaningful recovery.
Chris Martenson: All right. Well, let’s finish our two or three subjects here first before we move into the UK.
Spain. Let’s finish up on Spain here. Obviously, Spain is still, in my view, looking like they are in relatively poor shape. They have extraordinary – and last I checked, rising – levels of defaults on the outstanding book in balance at the bank. It looks like things are not at all improved there. What is going on in Spain right now?
Alasdair Macleod: I think it goes back to the election, which was a bit over a year ago, when Rajoy was elected. He got in with a pure working majority, which gave him the opportunity to tackle Spain’s problems – and he didn’t. He sort of went at it half-assedly. That was the opportunity missed.
On top of that, Spain’s problems really go back to credit expansion, which fueled property prices. It is very similar to the United States. The fueling of property prices were even greater than we saw in the United States, but so far the correction in house prices has not been as great in the United States, which rather suggests that house prices have a lot further to fall.
Now, on top of that, the mortgage bank system, that was sort of run like slush funds for the vested interest like unions and all of the rest of it, they were unregulated and I think still are unregulated. And of course all the losses appeared in these mortgage banks. They have consolidated certainly the biggest ones into Bankia, which is a new entity, and already they have had to produce about 40 billion euros to stop that from going under. All the original depositors who were forced to accept shares in returns for their deposits have now lost a lot of money. The banking system, mostly through mortgage lending and also lending to construction companies, looks like it is going to require a total of about 100 billion euros. That has been agreed to be provided by the financing ministers in the Eurozone, but we don’t know how that is going to happen. So far, I think I might say about 40 billion [euros] have actually been provided by the ESF (European Social Fund).
Now, I think Germany is going to dig her heals in on this one, in which case it is going to rescue the banks through the ECB. So the ECB will throw money at the Spanish banking system to keep it afloat, and so what’s new? Spain is a tragedy. If they had taken action early, they would have only had the property bubble and the construction industry to deal with. As it is, what they have done by mishandling it is they are effectively sinking the whole economy, and I think that is an absolute tragedy. You have got over 50% unemployment amongst the under-25s, which is a complete lost generation. As a result, there is 25% unemployment. More broadly, you are going to have a strong possibility of social unrest in 2013. Spain is still bad news.
I was talking to an economist the other day, and he was thinking that Spain will actually be the first one to create the next crisis in the Eurozone. He thought Spain was ahead of Italy and France in this. That was before the Italian election.
Chris Martenson: Okay. So Spain is clearly sailing pretty close to the wind here. They’ve got very, very high debt levels. Their industry, such as it is – they are really going through a bubble, and they failed to just address that first while the bubble was going.
Alasdair Macleod: What is interesting in this is that – unlike Italy and France, particularly Italy, who has always had very high levels of debt-to-GDP – Spain started in the banking crisis when the debt-to-GDP was only 40%.
Chris Martenson: Really, 40%?
Alasdair Macleod: It is about 100% now. It just shows you how rapidly a situation can deteriorate.
Chris Martenson: Speaking of rapidly deteriorating situations; what are you seeing in Greece? I know we have all been reading the reports, which almost have the Fukushima effect, where we are reading less and less of it even though the stories are more and more dire – over here [in the U.S.] at least. I think the story is old or something; perhaps it has lost some interest in the media cycle. When I bother to find out what is going on there, I hear about just rampant unemployment, hunger even. People chopping down trees to stay warm. All the usual things you would see in a full-blown economic collapse. Is that view wide of the mark? Has that been exaggerated?
Alasdair Macleod: You are absolutely right. Greece has disappeared from the headlines partly because Europe, until now, has disappeared from the headlines. Also partly because Greece is a pretty small bear compared to what is coming up in the West.[color=red][/color]
Chris Martenson: Where does Greece go from here? I know at one point it was thought that they were going to be the trigger for the next round in the crisis because they wouldn’t be able to meet some debt payment or another. Are they okay financially for the moment?
Alasdair Macleod: I would hesitate to describe them as okay financially. Basically they are very badly wounded. They are struggling on. Germany, I think, has provided the bulk of the funds to keep it going so far, which creates quite a bit of resentment. But Germany doesn’t want to provide very much more I don’t think. This is a problem. The Greeks are now in a position where they are having to deal with their own problems themselves. I haven’t read reports of them funding the market recently.
I think that they are probably being helped by the ECB – the ECB will help anyone. Their problem is, they don’t want the banking system to fall over. And if you get bankruptcies in the Greek banking system, there is no knowing how far that will spread. I think the answer to your question, Chris, is that Germany has helped them so far, but I guess the ECB will be taking care of their short term needs, if I can put it that way.
Chris Martenson: Fantastic. So we are rolling over the short-term needs. Applying band-aids where necessary. Sticking fingers in the dikes. What will it take to turn this around? It has got to be strong economic growth doesn’t it?
Alasdair Macleod: That is the only thing. As we have already discussed, with an average of 50% government-spending-to-GDP, there isn’t an awful lot of free private sector to grow these countries out of trouble. I just don’t see it happening, unfortunately, now that Germany is effectively backing off. That is not really the official line. And it is now down to the ECB. I think the inevitable outcome at some status will turn into hyperinflation.
Chris Martenson: Wow.
Alasdair Macleod: [color=red]There isn’t any alternative. Having said that, I don’t see things very differently in most other jurisdictions.
Chris Martenson: Really?
Alasdair Macleod: Look at Japan. They have now effectively run out of domestic savings, so they are now printing. There is only one way that is going to go. America, same thing. When I look at the monthly contribution from the Fed into the [U.S.] economy, it is something like $85 billion a month. When I look at the pace the money supply is being grown in the States, it seems to me that is not enough.
That is a horrendous statement to make, but if they don’t accelerate the rate at which they are printing money in the States, then I think interest rates are bound rise sooner than would otherwise. Either that, or you are going to start getting some financial failures. Probably both. I don’t know. Once you get into the debt trap and the requirement to print money to keep governments afloat, to keep banks afloat, you cannot get off the cycle. I think that is what we’ve got in America; it is what we’ve got all around Europe. We’ve got it in the UK, which is, I’m sure, we will come onto in a moment, and you definitely have got it in Japan.[/color]
Chris Martenson: The Fed was always thought to be fearing what they call the liquidity trap. I think you just articulated the real trap is that once you are printing to keep your government afloat, you are pretty much in Phase One of “game over.” Phase Two is when interest rates start to rise. We all know you can just run calculations with a crayon and a napkin and discover that even a slight rise in interest rates – just maybe putting them back at their historical averages –would really crush the fiscal situations of entire nation states at this point, let alone companies and individuals and all of that.
We have gotten ourselves in a position where we can’t survive higher interest rates. What do you do about that? How do you walk down your debt if you can’t get your economies growing, so your debts just keep growing? Alasdair, how do you get out of this?
Alasdair Macleod: Well, I think that there is only one logical computation, and that is a complete default. You have two ways in which you can default: One is to accept reality and face that, and the other way is to try to kick the can down the road, which just involves accelerating the printing. You can print money to quite a degree until such time as your citizens decide that my goodness, this dollar or euro or whatever it is, I don’t want it anymore. I would rather have goods. At that stage, you’ve got a flight out of money into goods.
It doesn’t do your production any good, by the way. What it basically means is that the shelves get cleared out. Prices rise very sharply. It is a slippery slope, because the only thing backing a paper currency is confidence in it. Forget all of this stuff about the quantity theory of money – it doesn’t apply. If you lose confidence in a paper currency, it can become valueless very, very quickly.
I think if we look back to the Weimar inflation, the German one in 1922-23, I think true hyperinflation was probably only about five or six months. Until that time, of course, the market lost well over 99.9% of its value from pre-wartime. It was only in that last phase that people suddenly woke up to the fact that the one thing they did not want to have was paper money. They lost all hope that this inflation would stop.
At that point, the function of how long the hyperinflation lasts becomes one of a practical problem of how you deal with it. In the case of Germany, they had to write a check, they had to draw the money out of the bank, they probably had to wait. They didn’t take checks; they would only take cash. Then they had to wait for the delivery of the cash. The printing presses were running 24 hours a day to supply the demand. That took five months. Now we have credit cards; we have electronic settlements. How are we going to take a paper currency collapse? It could be a minute. It could be a day.
I do remember you mentioned Iceland earlier. I do remember that when the Icelandic crisis hit, I was following the price of the Króna on the day it happened. At one point it lost 70% of its value in one minute in the morning. It got back some of that by the end of the day. That is how it can happen. It can happen very, very quickly.
Funding our way out of the problem by printing up more money can actually bite back on you, and the game can finish without very much notice and very, very quickly. It is not a game where you are going to have time to exit. It really isn’t.
Chris Martenson: I have thought that for a long time as well, noting that hyperinflation really only takes on meaning when there is a border to cross, meaning you can compare that currency to something. So with Japan printing like crazy, the European Central Bank printing, Federal Reserve printing, with all of these characters printing, which border do you compare yourself against?
Of course, for myself, that has always been gold. Gold has just been languishing for a long time. What are you seeing from your perspective over there on gold?
Alasdair Macleod: It is interesting. Going back to my hypothesis about hyperinflation when people lose all of their paper money, we have a situation now where currency in the form of paper money is the only form of exchange in the markets. True money, as you and I know throughout history, has always been gold. People are not yet thinking that gold is something that they need to have to defend themselves in a paper currency collapse, because they don’t see the paper currency collapse. They really don’t. There will come a time I think when that is going to switch, and it will probably switch quite sharply.
Meanwhile, what has been happening is, we have had the deterioration in the European situation. We have had the deterioration in the American statistics. We have had the deterioration in our own here, and Japan (as I have said earlier) has run out of savers. Someone came up with a wonderful statistic within Japan that they sell more diapers to the aged than they do children now. That is not a position you want to get into. They are on the slippery slope of destroying their own paper money by destroying confidence in it.
Gold, meanwhile, has gone sideways. It has done nothing. It has been controlled as much as anything by the bullion banks who have expanded the amount of paper gold and paper silver in circulation to deflate the speculative demand in it. Meanwhile, the true demand from people who are ensuring themselves against systemic risk is there, and people have just been storing it away very, very quietly. In some countries they do this – in India, for example, they have been doing this for decades. China has just started doing it and I see that continuing and building.
All the time now, while the situation is deteriorating, we see the gold prices being sat on. It is only a matter of time before it can no longer be controlled. The problem is, when that happens, there are going to be some very major banks in quite serious difficulty because of all of the short positions.
Chris Martenson: Well, they almost got in severe trouble all the way back – I believe it was 1998 or 1999 it was when your own illustrious exchequer decided to openly announce a reverse auction and discard UK’s gold at bargain basement prices. I believe that was largely to protect some bullion banks that had gotten into a very, very large amount of trouble because they had been doing leasing of gold and simply didn’t have it.
Alasdair Macleod: You’re right. There have been these few times in history where having tipped the price of bullion down below where it would naturally be a demand from elsewhere taking it away. It is a process that has taken us through the second half of the 80s and through the 90s. It was at that time, I think, when the Middle East started building up their reserves.
India has always had a huge demand for gold. It is only relatively recently, I think about 10 years, maybe more years, when officially people have been able to import gold rather than smuggle it in. I remember going to what used to be called Bombay back in the late 1960s, and I did a very interesting exercise recently on this. I looked up the price of gold in rupees at the time, and you could buy the fabricated gold that Indians buy as their stored wealth – fairly plain jewelry for their wives, that sort of thing, and it would cost you less than 200 rupees an ounce.
Given that the tradition of India is to save into gold and silver; when children are born you buy some for the child. A son gets married, a daughter gets married, for the dowry you give them some gold jewelry to start with. The whole of the middle classes in India revolve their savings around gold. Now, if gold was less than 200 rupees when I was there back in 1968, I think it was – do you know what the price is now? It is about 100,000 rupees.
Chris Martenson: 100,000.
Alasdair Macleod: Yes. Who has been the clever guy? There is nothing else that the Indian could have put his money in, in order to preserve his wealth, which has been so effective. And he is not about to change his habits, I can assure you. They know what happens to paper currencies. They know what happens to the rupee. And the average Chinese guy has got exactly the same approach towards his own currency.
Chris Martenson: I imagine in dollar terms, gold has been going sideways. But let’s turn our attention to your home country, the UK. With the pound falling so much, there have been a lot of calls for austerity being the culprit in this case, so the calls are to end austerity. How is gold being viewed in the UK right now? And then, secondarily, what is going on over there economically right now?
Alasdair Macleod: Gold is the question first; I think the view here on gold is probably quite similar to the view in America. Complete disinterest, really. And, you know, people see that the price of it over the last 10, 12 years has risen quite sharply and they say well, it is in a bubble. A bubble only occurs when everyone has got it. Nobody has got it. It hasn’t happened. I am a gold bug, and I am in a tiny minority; I really am. I think if you ask a thousand people on the street would you buy gold as an investment? you would probably find one might say yes. It is literally like that.
I guess it is probably the same with you in America. I don’t know whether I’m right, but I just got a feeling there is complete disinterest in the subject.
Chris Martenson: Oh, absolutely there is. We have none of the social hallmarks of a bubble. We only have prices that seem to have gone up a bit. My view on that is that those prices had to rise, because otherwise if they hadn’t, can you imagine how much gold India would be buying today if it was $280 an ounce like way back in 1999? It would be ridiculous.
Alasdair Macleod: Oh, absolutely. I think the other way to look at it, Chris, is that it is not gold that has gone up; it is the quantity of Euros, the quantity of pounds, whatever, that is has increased so much that it actually buys less gold.
Chris Martenson: And oil and wheat.
Alasdair Macleod: Exactly, and all of those other things.
Chris Martenson: Absolutely. Let’s turn now to the economics I have been reading about, renewed recessionary fears over there in the UK, and the foreign indebtedness of the UK is actually quite extraordinary. There are some really pressing issues there aren’t there?
Alasdair Macleod: Oh, yes. Well, first of all, the economy; last year they managed to do slightly better than break even. We weren’t quite in a recession. All of that stuff is pretty meaningless anyways. We have a budget, and the budget in the UK is a major political and economic event. It is the one time when the chancellor stands up and he arranges the taxes and gives his forecast and all of the rest of it and all the commentators get all excited. So that is on March the 20th.
Now, unfortunately we had Moody’s ratings downgrade earlier this week. Of course, that is being dismissed as well. We knew it was coming, so it really doesn’t matter; this is not news. But when you bear in mind that sterling has fallen from literally the first of January to now from about 162 down to the current level of 151 and a bit, and in the process it has broken some very important support levels that we have seen hold it in the last few years, I think we have the potential makings of a sterling crisis.
The reason that this is important is our economy actually isn’t going anywhere. The chancellor’s numbers when he comes to stand up on March the 20th I don’t think can in any way impress the market. There isn’t going to be any sudden magic elixir.
On top of that, we had with sterling falling an aggravation; that is, the price of petrol – “gas” as you guys would call it over there – has risen from round about 122 pounds a litre to just under 150 pounds per liter today – that is, literally over the last two months. I don’t know if you had, but we had this horsemeat scandal – the result is that horsemeat has been found in burgers. The effect of this scare has been to push people into better quality meat. So the result is a meat crisis here rising quite sharply. Instead of having a background of inflation that might be slightly above target, which is what the Bank of England has been forecasting, we are now looking at a situation where it is likely to be considerably above the target.
Now, the problem is that there is nothing really that the Bank of England can do about it that they would be comfortable doing. What it should do when you have the potential of a sterling crisis is to raise interest rates to take all the expectation out of the market. But we are funding a government deficit. We have a fragile banking system, which I don’t think would survive rising interest rates. Quite literally, the Bank of England is likely to try and wish this problem away. They have done it before.
A guy called Paul Tucker, who is a Deputy Governor for the Treasury Select Committee, last night was saying that the Bank of England was thinking of charging negative interest rates on balances held with it.
Chris Martenson: I had just read that.
Alasdair Macleod: It doesn’t affect ordinary depositors. But it does affect the banks, the commercial banks who have accounts with the Bank of England. Sort of like the Fed turning around on its excess reserves and saying to the banks we are going to charge you if you are going to leave the money here. We want to try to push it out into the economy. I do feel that this idea of having almost zero interest rates and negative interest rates for a bank is likely to accelerate the sterling crisis rather than return it. We do have potential for a sterling crisis. Unfortunately, what happens with a sterling crisis is, the interest rates end up rising until such point as the corrective action is taken. That corrective action is extremely painful.
We are in a situation here in Europe where I think we won’t be looking at what is going in Europe and thinking oh, my god, they have gotten themselves into a mess. Actually, the mess may well be triggered by the UK. The sterling situation I think does need to be watched very, very carefully.
Chris Martenson: Interesting. Let’s talk about timing, then. This has all dragged on far longer than I thought possible. I think there has been a masterful display of printing, obfuscation, propagandizing, jaw boning, you name it. It has been golf clap, golf clap, very nice. How much longer can this all continue, do you think?
Alasdair Macleod: Well, as you so rightly say, these things always drag on longer than you think possible. I do think, however, that we are very much on the last lap on this one. And I think 2013 is going to be very much the year when lots and lots of chickens come home to roost. Whether they start coming home to roost in the next two or three months, or whether it is the next six months, I don’t know. The backstop situation, in the sense that the pension problem and all of the rest of it is not making the headlines at the moment. But there is no doubt about it; that is going to become a huge issue. I think it will become an issue later on this year.
[color=red]We are now in a situation where anyone lending money to Spain or Italy or France is going to start thinking – well hold on a minute; I know they have got a short term problem, and I know the economy isn’t going very well, etc., but am I not right in thinking demographics and pensions and all of the rest of it is going to be [how] this country is going to go bust very quickly anyway?[/color] In other words, I think the market is going to start considering these things. At some stage the markets are going to take control of interest rates and the pricing of money away from the central banks. I do feel that point is not very far away.
As you rightly point out, very often I call recessions that never happen. I do think 2013 is going to be the year when we do really see a sharp deterioration in the overall position.
Chris Martenson: If that happens, I believe that it is going to be rather disappointing for a lot of folks, largely because this will be the third iteration of this crisis. We have already been through a couple of passes of it. With every one of those, people have invested hope. Hope that the authorities know what they are doing, that they have a plan, that this will all resolve itself somehow. I am mystified that so many people, in the investment side in particular, are not looking at this and saying look, we have tried this several times. We have printed trillions of dollars, arguably, we have prevented something worse from happening. We have also not been able to achieve anything that would really look like a sustainable lift-off.
By the way, just editorially, I can’t find any records of oil being well over $110 a barrel on the world stage and having any sort of economic recovery. There is just a problem inherent in that. It just feels to me like there ought to be some sort of reckoning moment that comes with this. I think this next crisis is going to be so much harder to pick ourselves up from because so much political capital had been expended, so much hope capital will have been expended, real capital. There won’t be a whole lot left to spend, and really then at that point we have to get back to what you said before: We have to face the music.
Are you going to default by overt default? We are just going to eliminate a whole lot of these debts. Or are we going to be covert? Are we really going to be serious about the printing and really let the world know? I think that is what Japan is doing. Japan is saying we don’t care. We are going to really print this and make a substantial difference in our inflationary outcomes and the value of the yen. Period. It is going to get done.
It feels to me like the pressures are building for some sort of a resolution to this. Either we go off the knife edge to the left, and it is inflationary, if not hyperinflationary. Or we go off to the right, and it is deflationary. One way or the other, it has been a bit long skating along this knife edge without a lot to show for it.
Alasdair Macleod: I would like to make one observation though about market psychology. I would say that in a bull market, we look forward to things, we anticipate things. We look at a company and we say I think that company has a new product; sales are going to go up. The good things in a bull market get discounted ahead of time. In a bear market it works in a reverse way. Crises, basically, most of the time, are made by people who live on hope. Even though you and I as discerners might look and say oh, my goodness, we don’t like the look of this or whatever, the market sails on regardless. Then there comes a point where reality intervenes. When it happens, it can happen very, very suddenly. Of course, we cannot predict the exact moment that is going to happen. I think there is that difference between bull market and bear market psychology. I think we need to keep that in mind.
Chris Martenson: That is a fair point. I like it a lot. I like everything I have heard so far, and that is all the time we have today. So Alasdair, I just want to thank you from the bottom of my heart for another fascinating interview and discussion about what is going on in Europe, and I hope we can do this again sometime soon.
Alasdair Macleod: I look forward to it. It was very nice speaking to you again, Chris.
http://www.peakprosperity.com/podcast/81072/alasdair-macleod
World economy is a mess
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