About Angela Merkel's Prussian Values

I wrote this post last week, in which I provided a disclaimer relating to my views on how Germany views the profligacy of many of its fellow EU members,

"As a disclaimer, let me mention that my own heritage is Germanic. So the Teutonic insistence on the profligate Europeans paying for their sins is not foreign to me."



By the way, I'm not just of German extraction, but Prussian. Both sides- one from the permanently-German states, the other side from borderlands between Poland and Germany.
 
Thus, I was amused to read this in Wednesday's lead Wall Street Journal staff editorial,
 
"In opposing that option, the Germans are said to be imposing their Prussian morality on everyone else. But without reforms, the countries of southern Europe will never pull out of their downward debt spiral. The Germans are at least telling the truth."
 
I highlighted the two words in the passage which I found so amusing. It's not just me who sees this long-evolving crisis as a morality tale now relying on Prussian values and discipline to resolve it.

The Economist's Denial Concerning The Euro & Europe's Entitlements Crisis

The current issue of The Economist entitled it's lead staff editorial "Is This Really The End?" Of the Euro, of course.

The piece then goes on to examine various ways Euros may be printed or borrowed, or back yet another instrument in hopes of fooling investors into overlooking the EU's real problem.

While usually on target, the Economist is hopelessly in denial on this issue. They concentrate mostly on the topic of Germany and Merkel simply bailing out Europe, about which I wrote recently. But that's almost a sideshow.

What the editorial never mentions is that this isn't simply a financial or sovereign debt crisis, per se.

It's a European entitlements crisis.

The Economist can blather on all it wants about the ECB, the EFSF, the Euro, and various means to move the same old monetary pieces around the same board, sometimes with new labels on them. But none of that will solve the problem.

The United States and Europe's nations all share a common, heretofore not experienced problem. Their lush government defined-benefit obligations have finally outstripped their abilities to fund said obligations. They are all gigantic Ponzi schemes, in which 1.5-2 generations have legislated extravagant benefits for themselves, to be paid by borrowing now and taxing later generations, or simply taxing later generations. Thus, there's no possibility of resolving the loss of confidence by global investors, because the money to solve the problems doesn't exist yet.

And with the suffocating tax and regulatory burdens besetting all these nations, it's looking like economic growth won't be helping anytime soon.

Face it, the developed nations are in for a rough economic ride for probably at least one decade- maybe more. Since WWII, governments have voted their older citizens benefits never before enjoyed in the history of civilization. And clearly won't be again, either. It's been a massive acceleration of spending fueled by wealth borrowed from future generations. Thus, GDPs since the war have also probably been artificially pumped up on this monetary equivalent of steroids.

Only a return by all large economies and nations to defined-contribution social welfare and corporate pensions and health care schemes will bring this unsustainable financial joy ride to an end.

And forget what you hear about any of these oldsters having "earned" their promised benefits. That's a lie. Those benefits were legislated without a clear explanation of their funding, while economists stood by and remained silent on the senselessness of promising such large-scale fixed and escalating benefits to be funded by dynamic, competing, uncertain economies throughout the world.

In America, beneficiaries of Ponzi schemes are forced to return their payouts by virtue of the scheme being a fraud and, thus, no real gains being available for anyone to realize. As an example, witness the ongoing recoveries of the Madoff fraud's payouts.

Why should the payouts of similar government-run Ponzi schemes for retirement and medical care be any different? Nobody 'earned' those benefits. They were never really affordable in the first place.

It may take years, but eventually, voters will have to accept that they elected governments which promised benefits many voters knew weren't really affordable. And they'll all have to take haircuts on those benefits.

Which brings me back to my starting point.

Germany can't fix the Euro problems because they aren't, strictly speaking, just about sovereign debt, the Euro and defaults. They are about totally unsustainable government benefit programs which can't be financially finessed back into solvency.

It's not a liquidity or currency issue. It's a social welfare state issue around the globe.

The Economist should know better than to go into denial about this truth.

Germany, Merkel, EuroBonds, The ECB & The Euro-Crisis

It's almost funny now to hear pundits and reporters on CNBC and Bloomberg gush over how the only solution left that will placate investors is for German PM Angela Merkel to agree to either ECB issuance of bonds/printing of Euros, or EuroBond issuances.

Anything else, one European correspondent solemnly intoned, and the world will plunge into financial chaos and ruin. Did the Germans really want this?

Or will they step up to the plate and save the global financial system all by themselves? C'mon, he implied, why can't Germany just open its checkbook to bail out everyone else?

As a disclaimer, let me mention that my own heritage is Germanic. So the Teutonic insistence on the profligate Europeans paying for their sins is not foreign to me.

But I do, honestly, see the Germans' viewpoint. Why should they mortgage their economy to bail out those of France, Greece, Italy, Spain, etc.? Where will it all end?

The foreign correspondent who tut-tutted Germany for playing chicken with global ruin also confessed that, sure, in such a scenario, Germany comes out best among the ruined financial world.

It has become borderline-hilarious to me how media pundits and analysts desperately hope that Germany will ruin itself financially in an insufficient attempt to rescue the entire rest of Europe and, by implication, the world financial system. And why? Because it's the last apparently large, solvent European nation, and a fairly comparatively conservatively-managed one, as well.

As I wrote in a prior piece, echoed in a humorous piece by a Harvard economic historian in last weekend's edition of the Wall Street Journal, what the Germans couldn't accomplish with their 88mm guns in WWII, they may well achieve simply by being patient as the rest of Europe offers more and more financial and political control to the Germans, in exchange for a gigantic bailout.

In the meantime, regardless of the global consequences, I can't but respect and agree with the German reticence to be sucked into financially rescuing the rest of Europe.

Europe's Crisis & US Equities

Two asset managers appeared on CNBC this morning- Mario Gabelli and Larry Fink.

Of course, these days every manager is asked about Europe. I didn't pay enormous attention to Gabelli's comments, but recall him pushing industrial sector equities, which probably means that's where his book is.

Fink, however, was more interesting for several reasons. First, his firm, BlackRock, runs much more money than Gabelli. And Fink tends to be more thoughtful and expansive in his comments.

Listening to Fink, I was struck by two aspects of his remarks.

First, like many pundits and observers, he continues to see the prospect of countries leaving the Euro to return to their own currencies strictly in economic terms. This morning, Fink sort of threw up his hands and contended that it would be unmanageable for a country to have Euro-denominated liabilities while leaving the currency. But that's not really true. The country would simply have to manage its positions with the Euro like any other foreign currency. It's liabilities in Euro terms would require FX transactions to settle payments, just like dollar-denominated obligations.

Second, Fink began to describe the US economic condition as not getting worse, but a terrible surrounding environment. Then he generally recommended dividend-paying equities, as if to suggest that it would be unwise to expect price-based total returns going forward for the next several years.

When someone like Larry Fink, who controls the allocation of billions of dollars of investments, makes remarks like the ones he did this morning, I think you have to read between the lines. Fink knows that blunt remarks from the likes of him will move markets. That's not the type of book-talking he can afford to do. It might even make him, and BlackRock, liable for damages resulting from such gloomy public remarks which would negatively affect returns in the portfolios which the firm manages.

In that vein, Fink asserted that the current situation is not at all like that of 2008-09.

Yet, I can't help thinking that it actually is, in several respects.

Back in 2007, there was already a lot of discussion about commercial bank-sourced SIVs. Remember when those off-balance sheet holders of mortgage-backed instruments began to run into problems? Then in late 2007, several large US financial firms began to scour the globe for additional equity investments as they wrote off large losses on mortgage-related assets. By the spring of 2008, Bear Stearns was pushed into bankruptcy as counterparties withdrew funds and short term lending lines dried up.

My own proprietary equity allocation signal moved from long to short by the summer of 2008. In retrospect, the signs of a building problem with US equity valuations could have been said to have been building for nearly a year before the collapse of equity prices in the fall of 2008.

In the current situation, we've seen the European debt crisis begin in earnest in the spring of 2010. Things haven't really gotten better since then. Granted, the Greek and Italian governments have changed, but the realities of outstanding debts haven't.

Meanwhile, some fancy footwork avoided an outright default on Greek debt which would have triggered credit default swaps to pay off. But now, as Fink acknowledged, Europe is entering a recession. His comments about the US economy and equity strategies are tepid, at best.

Will we look back, from a year or so from now, and wonder how anyone could have missed the building signs of problems with global equity values which began to be apparent in the spring of 2010?

Perhaps in that sense, the current developing global financial strains do resemble the period of 2007-2009. A series of unresolved, connected and deepening financial problems that can't be magically resolved by climbing equity values.

It's one thing for equity prices to climb 'a wall of worry' about environmental variables which are missed or misread. But it's an entirely different matter for equities to rise amidst a large scale environmental variable such as global deleveraging in the wake of the 2007-09 financial crisis and its impact on Europe's large economies and nations. That's more like climbing in the face of real problems, not simply worries about whether problems exist.

Re Greece, Europe & Global Economic Conditions

There's so much political turbulence in Greece this week that it's challenging to write anything at a point in time which purports to be current.


So, rather than focus on that, let me opine on what has already transpired.


I thought Papandreou's call for a referendum was a breath of fresh air, and real sensibility, amidst all the political maneuvering among other European national leaders and bankers. As CNBC's Rick Santelli opined, let the Greek people speak out once and for all to either suffer and stay in the Eurozone, or return to the Drachma and experience the consequences of that move. Pain either way, but, in the latter, perhaps a bit more controllable.


What was, I think, as important about Papandreou's call, even though it was subsequently rescinded, is that it reminds everyone who is affected by the European debt crisis, which is pretty much the global economy, that the entire mess among all the free-spending European countries depends on the people of those countries.


I have heard, even after Papandreou's referendum announcement, several pundits recite, for the umpteenth time, how leaving  the Euro would be so costly for Greece. How, if the ECB will just print money or buy bonds, which is another variant of printing money, the major French banks can probably squeak by. One of those pundits was, I believe, CNBC's wild man, Jim Cramer.


What pundits of that belief miss, yet Papandreou demonstrated, is that this isn't about a few large European banks, the ECB, the ESFS, or just Germany's economy's ability to cover Europe's debts.


On a much deeper level, it's about, now, Europe's populace's and, later, that of the US, tradeoff between significant economic pain now to fund benefits promises that aren't otherwise affordable, or less pain now and probably fewer benefits later, too. The various banks' and nations' debts are simply the circulated, legal instantiations of those promises, and, thus, subject to the vagaries of actual funding over time.


Post-WWII societal structures and benefit schemes were always going to be unaffordable, since they were, for the major European nations and the United States, inappropriately designed as communal defined benefit plans, rather than more sensible and affordable individual defined contribution plans. As such, now, Greece is the proverbial canary in the coal mine, signaling that one nation has reached the point at which its spending can no longer be continued on affordable terms. Other nations aren't far behind, as we know from credit downgrades or problems in Spain and Italy, to name two largish EU members.


I find it not accidental that August saw the 40th anniversary of Nixon taking the US off the gold standard. Similarly, at least one pundit on either CNBC or Bloomberg this week pronounced the Euro the least-credible, purest fiat currency of all. In a post I wrote on the occasion of Lew Lehrman's Wall Street Journal editorial commemorating Nixon's act, I referred to his chart that showed how inflation galloped out of control after that severing of gold and the dollar's value.


Recently, the Vatican has picked up the same theme. Few people are doing an adequate job of seeing the larger global finance and economic picture at work now.


When money supply was related to gold, money supplies had some countervailing pressures which reined in excessive printing or borrowing of a currency.

Fiat currencies have only confidence in a nation's economic capability to fund the government's debts. When that confidence is shaken, as it has been now with a handful of European nations and, imminently, the US, the lack of any real basis for valuation becomes clear.

Beginning with offshore Eurodollar liabilities in the 1960s, in reaction to a tax on Treasury interest, and accelerating with the closing of the gold window, US dollar liability creation has outpaced what anyone can reasonably forecast as the nation's ability to generate wealth to repay such obligations. When US corporations were able to sell dollar-denominated bonds in Europe, dollar obligation creation left the province of just the Fed or Treasury.

But, ultimately, the total claims against a nation's currency lead back to its citizens. Honoring or defaulting upon those obligations, whether by the sitting government, or a change in government, is a decision the citizenry ultimately makes.

In Greece, Papandreou stepped down after surviving a no confidence vote. The referendum will not take place, but it is, again, an open question what Greece will do. Rumors continue that the new coalition will seek better terms from the EU.

I continue to believe that the dry, economic arguments by some pundits focusing just on rational, economic costs and implications of whether this or that country leaves the Euro are misplaced.

We are seeing a rare spectacle of many large countries simultaneously coming to terms with their swollen, unsustainable obligations, whether held by private parties, the nation's banks, or other governments. As I conjectured several years ago, during the 2008 financial crisis, it would seem reasonable that a long term outcome is a global deleveraging. I think we're seeing that now. But when too much money has been created relative to the value being forecast to support it, eventually, some parties will have to take losses for the gap between what was created/borrowed, and what actually can be counted on to support the monetary bases outstanding.

Ed Lazear's Dominos vs. Popcorn Analogy

Ed Lazear wrote a thoughtful Wall Street Journal editorial on Monday contrasting the conventional dominos view of the US 2008 financial panics and the current European debt crisis with one which he calls 'popcorn.'

Lazear, the previous President's chairman of the CEA, suggested that both crises were more like the various, individual kernels of popcorn exploding independently in hot oil, than a case of dominos toppling one after another.

As a strategist and researcher, I put great value on correct conceptual models, and Lazear, in my opinion, has done some good work here pointing out the fundamental mistake of assuming these financial panics are always domino-like.

Lazear went to some lengths to detail how various banks had binged on mortgage-backed securities long before Lehman's demise. That several shotgun mergers/acquisitions, e.g., BofA/Merrill, Chase/WaMu and Chase/Bear Stearns, occurred before Lehman's filing.

Similarly, in Europe, Lazear notes that the general, common problem are continental governments having lived and promised significantly beyond their means for decades. It simply happens that the unpayable debts are now coming due, with no country really capable of funding the others, or sufficiently strong on its own to avoid problems, either.

Thus, Lazear doesn't see Greece as a triggering event, but, rather, simply the first kernel in the popper to pop. If it had not, Spain, Italy, Portugal and Ireland would still be themselves, and one of them would have been first.

That's not to say there aren't knock-on, domino effects once a major entity, whether company or country, goes down. But the initial shock isn't one of dominos, so much as many bad decisions at multiple entities which happen to come a cropper at nearly the same time.

The European So-Called "Solution"

Having been wary of equity market performance and a host of troubling contextual factors for most of this month, I would, in light of this morning's US GDP and spending data, and the investor reaction to the suspect 'solution' to the European debt crisis, return to a fully-invested long position in my portfolios.

It's not that any of the concerns which roiled the equity markets in early October have disappeared. But there is a sense of unfulfilled, self-fulfilling market behavior. Instead of moving down to a level of 1050 or so, the S&P has fitfully moved higher, then, after news overnight of some sort of initial Greek debt accord in Europe, S&P futures were already at around 1260 this morning. The 8:30AM release of third quarter GDP and spending further boosted investor optimism.

Thus, with market levels well away from those which would signal being out or short, I'd return to full investment levels at this time.

I don't think anyone actually believes the European situation has been resolved in any real sense. The description of the process for handling bond losses provided by a CNBC correspondent this morning was positively laughable. Banks are supposed to take earnings hits to cover writedowns. Then, if necessary, raise capital in public markets. If that doesn't fulfill their needs, then a combination of national treasuries and the EFSF are supposed to provide the necessary capital.

This sounds exactly like what Kyle Bass and others have warned against. It's mostly hope, smoke and mirrors. Spain, Portugal and Italy weren't even mentioned, yet everyone knows they are far larger and share Greece's sovereign debt problems.

Meanwhile, in the US, with unemployment remaining high and real median income down for the past decade, it's tough to see from where the rise in Q3 spending is coming. But when equity markets move decisively in a direction, it's usually foolish to completely ignore that.

In this case, since there are some developments of a non-negative nature in key contextual variables influencing my outlook on equities, their change can lead to a change in my decisions.

Francesco Guerrera's Flawed Euro Debt Solution in the WSJ

I read with some degree of disbelief How To Repair Continent's Ills, a column by Francesco Guerrera in Tuesday's edition of The Wall Street Journal. Guerrera is evidently the paper's Money & Investing editor. Perhaps that explains how his bad idea for resolving the Euro debt crisis managed to escape onto the pages of the Journal that day.

Here's the last part of his piece, where, after describing his understanding of the problem and alternative solutions, he proposes his own,



"There is, however, a third way and it passes through Omaha. Europe should copy the way Warren Buffett buys into companies in times of trouble.



In 2008, when Goldman Sachs Group Inc. and General Electric Co. needed cash and a jolt of confidence, the legendary investor demanded nonvoting preferred stock with a fat annual dividend and warrants to buy shares at reduced prices in the future. He recently struck a similar deal with Bank of America Corp.


Translated into Europe, the Sage's playbook could work thus: Ailing European banks would issue contingent convertible bonds, affectionately known as co-cos, to European authorities, and, crucially, private investors.


The bonds would pay a big annual interest to entice buyers as well as carrying the promise that they will convert into equity if banks' capital falls below a specified level by, say, 2013.


This approach would achieve two symbiotic aims.


It would enable EU institutions to support banks without having to own them. And it would offer investors a belt-and-suspenders approach: a tasty dividend every year and free equity if banks' capital levels slip.


Banks and their shareholders, who are at risk of being diluted if the co-cos convert, might not like the idea of diverting profits to pay outsiders but, then again, beggars can't be choosers.


A more relevant question is whether investors would participate in such a plan. Unwilling to take my own word for it, I asked two fund managers—one from a savvy hedge fund and another from a large bond fund.


"With a big dividend, I would go for it," said the hedgie. "If the governments are in and there is the prospect of conversion, there is money to be made here." The bond-fund honcho also sounded positive but, being less outspoken, muttered something about being adequately compensated for risk.


Coupled with other programs—namely the provision of day-to-day liquidity from the European Central Bank—the "Buffett recap" might be the best way to avoid a ruinous credit crunch in Europe.


Now all we need is action."


It's tough to know where to start shredding Guerrera's bad thinking. But I'll try.

Let's start with the Buffett example. Guerrera is mistaken if he thinks Buffett's preferred equity investments in GE, Goldman and BofA can simply be copied for every potentially troubled European bank.

Buffett knew, in 2008, that GE and Goldman were both "too big to fail," and reasonably good bets for long term survivability. They weren't in trouble because of basic business weakness, so much as poor decisions to fund short in a market that suddenly dried up. With BofA this summer, it's still "too big to fail," only this time actually written into law, plus, again, a sense that the worst outcome is a smaller BofA, not an insolvent one.

If Buffett thought it was worth doing this for SocGen, UBS, or any other continental bank, well, I'm sure he'd be doing it, and we'd have heard about it already. Chris Flowers, in his remarks on Bloomberg Tuesday, mentioned something I didn't include in yesterday's post. He noted that US banks typically have more deposits than liabilities in the form of loans, while European banks are the opposite, relying heavily on purchased money for funding.

European banks simply aren't identical in structure or nature to their American cousins. And the US dollar is the world's reserve currency, is controlled by just one nation, and, thus, is unlikely to, itself, disintegrate in the wake of a financial sector panic. You can't say that of the Euro, which is the currency in which one assumes the bonds would be issued.

Further, the "co-co's," as Guerrera calls them, are hardly doubly-safe. Kyle Bass derides anyone who thinks the banks which would be issuing these liabilities have any reliable long term equity value. So investors could easily lose the dividend as the bank fails, thus also losing the principal, too.

Strike One.

Next, Guerrera overlooks the simple reality that Europe is not America. See my post discussing Kyle Bass' remarks on this crucial topic. It's just not true that the many European sources of financial, political and legislative power are as concentrated and able to stave off financial and economic catastrophe as was the US.

Strike Two.

Finally, we have Guerrera hanging his entire thesis' evaluation on the opinions of two anonymous hedge fund managers. Or people employed at hedge funds. Perhaps not even their wealthy, savvy founders/owners.

Why are hedge fund the right segment to which to listen for this evaluation? How about private equity? Aren't they, as Chris Flowers was asked, the type of firm to express support and interest in this sort of thing? Because Flowers indicated his firm has increased cash levels and is basically staying on the sidelines, away from the Euro problems.

Then, if you felt hedge fund employees are the right group to ask for an opinion on Euro solutions, how much credibility do you attach to only two of them? Perhaps if Guerrera divulged that he'd talked with the founders of 10-20 large hedge funds, and provided their total assets under management, to indicate size, skill and potential influence in and affect on markets, it would be different.

But he didn't, so it's not.
Moreover, Guerrera downplays the two sources' misgivings, which he actually mentioned. They aren't trivial points, if you reread them.

Strike Three, Francesco.

You're idea's out.

What puzzles me is why the Journal's senior management let Guerrera publish an idea containing so many flaws.

Larry Lindsay's Succinct View of the Euro Debt Crisis

I caught some of Larry Lindsay's appearance on CNBC this morning from 7-8AM. While working while listening to the chatter in background, I didn't really hear anything of note until his closing comments.

On the subject of the European debt crisis, Lindsay remarked, to paraphrase,

'The ECB only has about 11B euros. The various national central banks in the EU have about 70B Euros. That's it. So that is why they all look to the EFSF to provide Euros to resolve the crisis.

It's sort of a circularity.'

Not quite the gritty detail of Kyle Bass' game theory and originally-commissioned research on the attitudes of German citizens towards bailing out Greece, Spain, Italy and whoever else winds up insolvent. But Lindsay implies the same end.

That is, insufficient existing funds to simply pay off existing sovereign loans at face value. Thus necessitating defaults, probable bank insolvencies, bankruptcies, and then a re-start of European finance after all concerned have experienced the actual losses from holding either affected sovereign debt, bank equities, or bank liabilities.

Sometimes it's helpful to hear several different approaches to the analysis of an important developing phenomenon. This seems to be one of those times.

Europe's Continuing Debt Crisis

You have to love the determination of the various official players involved in the European debt crisis to proclaim loudly and often that:

1. There won't be any defaults.
2. The Euro is just fine.
3. The crisis is manageable and containable.
4. There's no reason to worry about sovereign European debt.

The prospective solutions from a wide variety of players, including US Treasury secretary Geithner and even former TARP chief, now PIMCO global equities chief, Neel Kashkari, all stress smooth, controlled resolution of the many-faceted European debt crisis.

Meanwhile, you have more riots in Greece. No progress on the privatization of any of the national Greek businesses which, a Wall Street Journal editorial notes, would necessarily lead to lost public sector jobs and corresponding control over those votes. A downgrading of Italian sovereign debt. Continued concerns over French banks and their ability to fund themselves in the money markets.

Oh, and then a cut by the EU in its forecast GDP growth rate.

Personally, I found Kyle Bass' recent comments on CNBC to be the most believable and extensive by any single person. I closed that piece with these observations, as a result of Bass' remarks,

"First, there will be European country defaults. Second, there will be corresponding private sector bank insolvencies. Third, a lot of money will be lost by holders of securities issued by the defaulting countries and bankrupt banks. Fifth, the effect on the US will involve both capital losses and overall economic trade reductions. Sixth, after all this, the global financial and economic systems will then have to pick up and move along, losses absorbed, and work with the resulting situations. "

At present, officials like Geithner and various EU, ECB, French and Greek senior officials keep whistling past the graveyard of defaults in Greece and Spain and likely insolvencies in various European banks.

The longer they insist things will be fine, in the face of Greek riots and continuing deterioration in the Euromarkets, the more one is led to conclude Bass is right.

So why is the US S&P500 Index holding its value? Perhaps a temporary triumph of hope over good sense.

Jurgen Stark Sparks More Euro Jitters

I'm writing this post on Monday afternoon, while listening to some really serious black crepe-paper hanging on Bloomberg concerning Europe's debt problems. Yesterday's latest Euro-panic was apparently sparked by the resignation from the ECB of Germany's Jurgen Stark.

Here's what the weekend edition of the Wall Street Journal reported on the subject,

"Germany's top representative on the European Central Bank resigned in an apparent protest Friday, dealing a severe blow to the steward of Europe's common currency amid the Continent's worsening debt crisis.



The ECB said Jürgen Stark, its chief economist, was resigning for "personal" reasons with nearly three years remaining in his term. But people familiar with the matter said his decision was driven by frustration over the bank's expanding role in backstopping the region's finances.


The surprise exit of Mr. Stark—the second senior German official to depart the ECB over ideological differences in recent months—jolted markets in Europe and the U.S., as concerns over the stability of the central bank's senior leadership added to fears about Greece and Europe's banks. The euro suffered its biggest one-day drop in two months, finishing at $1.3657, its lowest finish since February.



ECB officials have taken pains in recent weeks to counter growing criticism that the bank is overstepping its charter and assuming untold financial risk with its actions. Such worries are strongest in Germany, where the country's own central bank, the Bundesbank, is firmly rooted on the principle of independence from politics. Many Germans believe that tradition is at the core of their country's own economic success and worry that it is now being undermined.



"From a German perspective, this is not a very good sign," said Kai Karstensen, an economist at Ifo Institute in Munich.


The resignation is fueling a debate in Germany about whether the euro will become a less-stable currency thanks to the escalating euro-zone debt crisis. Such a debate could indirectly make it harder for Chancellor Angela Merkel to justify expensive government policies to prop up the euro.


"Stark is the second German central banker to leave the ship because he sees that the German stability culture can't be upheld in Europe," says Thorsten Polleit, economist at Barclays Capital in Frankfurt. "There's a clear potential now that the German public will become increasingly disenchanted with the euro project."


That disenchantment is already being expressed by leading politicians. German President Christian Wulff, whose position is largely ceremonial, has called the ECB's bond purchases "politically and legally questionable." The head of German's center-left SPD party, Sigmar Gabriel, has also denounced the purchases.



There are worries within Germany that vulnerable countries in Southern Europe will soon have a stranglehold on ECB decision-making. That impression could further undermine Germans' confidence in the euro at a time when their country is being asked to foot much of the bill to bail out the flagging members.


In an op-ed for the German business daily Handelsblatt, released late Friday, Mr. Stark wrote that government efforts to save the euro zone have fallen short. He called for a "far-reaching reform of the mechanism for decisions and sanctions."



"We find ourselves in a situation in which massive sustainability risks in public budgets are eroding financial stability," he wrote. "


The ECB, like the US Fed, is supposed to be apolitical. But, just as our Fed has shamelessly returned to the financing of Treasury debt since 2008, so, too, is the ECB working closely with the the EU by purchasing sovereign debt of countries in trouble. Now, however, it's clear that those countries include Spain and Italy. Two countries whose economic size will almost surely doom any Euro-wide attempt to rescue them. Italy is, in fact, the third-largest sovereign debt issuer in the world. Spain's economy is no Greece- it's substantial and it's in serious difficulty.

Yesterday afternoon's Bloomberg discussion rather bluntly included predictions of failure for many large European banks. Parallels to the situation of the US financial markets and banks just three years ago this month were explicitly made.

Don't forget that on several occasions, business media such as the Wall Street Journal have reported that US money market funds have significant positions in European bank commercial paper. Guess what happens if those banks become insolvent.

The Euro-funding crisis which is spreading from their sovereign debt to their private sector banks will arrive quite quickly on US shores in the form of 'broken-buck' money market funds which will then need...surprise, surprise....another Fed bailout!

Somehow, it seems truly ironic that eighty years after Hitler's Germany provoked such fear in Europe, the countries of that region are now running to (back) to Germany for financial rescue from their subsequent sovereign economic and financial mistakes. Who'd have guessed that the Germans would ultimately dictate the future of Europe not from the strength of their military, but from the strength of their economy?

Economic Denial from the OECD

Last Wednesday's Wall Street Journal contained an editorial by Jose Angel Gurria, secretary-general of the OECD. It's a study in either institutional denial or simply complete ignorance of economic reality.

Gurria wrote of the recent pronouncements by Sarkozy and Merkel,

"The new Franco-German proposal to strengthen euro-area governance and to speak with one voice is welcome. That clearly has been lacking. But even more important is the call from German Chancellor Angela Merkel and French President Nicolas Sarkozy that the commitment to balanced budgets over the medium term should become legally binding in euro-area countries. Sounder national regulations and institutions coupled with stronger European Union rules and discipline will reduce the need to use the European Financial Stability Fund, which was established last year to issue guaranteed debt to member countries that can't borrow in the markets."

Can you seriously imagine "legally binding" balanced budgets "in the euro-area countries?" The US is one nation and we can't even manage it. The harsh truth that the Euro has benefited southern European economies, to the detriment of the northern ones, is apparently too bitter a pill for Gurria to swallow.

Then Gurria moves to the ECB. Here, he openly calls for the bank to prop up bad sovereign debt, which will insure that private credit risks gone bad become taxpayer obligations.


"The European Central Bank should for the time being continue to play a key role in crisis containment, not least as a buyer of last resort of sovereign debt. But we need to consider greater involvement by private-sector creditors to tackle the debt problems of some European nations, so that the resources of taxpayers support the growth prospects of the countries in trouble rather than being used to pay their private creditors."



Just guessing here, but I would think that means German and perhaps French taxpayers, those being the largest European economies. Curiously, Gurria seems to be hypocritical within a single paragraph. First he argues for the ECB to rescue troubled Euro banks, then writes that those banks need to clean up their own messes. Which do you suppose he actually means?

The secretary-general then turns to general monetary and fiscal policy, writing,

"Given the weaker outlook, central banks should postpone or even reverse their previous plans for tightening. The U.S. Federal Reserve's signal that it expects rates to stay exceptionally low for another two years is very forceful.


Given that state coffers are empty in most cases, governments need to go structural. Reforms to product and labor markets should be a primary focus of the long-term strategy to restore sustained growth. This will create jobs and help tackle debt."



Pretty funny, eh? Near-zero rates, which distort private investment decisions and suppress investment generally, are lauded. Meanwhile, governments will magically "reform...product and labor markets" because that will "restore sustained growth....(and) create jobs."

I know that in America, low rates have completely screwed up asset pricing since 2008. Meanwhile, lots of government intervention, such as abrogating bankruptcy laws and favoring unions in the GM and Chrysler bailouts, plus obstructing business with lots of new regulations, has slowed business activity and hiring to a near-halt.

But my favorite head-in-the-sand passage by Gurria is this one,

"Governments should also go social, focusing on policies to help those made most vulnerable by the crisis. The urgency of this is evident in the streets of a growing number of cities in countries at different levels of development. Unemployment benefits or targeted job-creating measures should be enhanced, both to reduce hardship and to stimulate demand. Help for overindebted households and those with "underwater" mortgages also needs to be more effective. Giving people hope and a sense of common purpose is not only crucial for their involvement but also for creating the necessary consensus to support the reforms."



Already-lush unemployment benefits are to be further sweetened. Again, we see the wrong-headed notion that paying more for people not to work is really a 'demand stimulus'.

Let's hope Gurria doesn't actually hold an economics degree.
Then he addresses housing by declaring that those who unwisely bought homes in hopes of ever-rising prices, and now cannot afford those homes, should not be expected to comply with standing legal processes of loss, foreclosure and resale, at lower prices, to families who can actually afford the houses. Instead, more financial aid must be given so those who took unwise risks may continue to enjoy the benefits of those risks without any of the pain of their mistakes.

Nevermind the support of those who behaved prudently and now could afford those homes as their foreclosure provides housing markets with their much-needed bottoms.

Well, with economic thinking like this, is it any wonder nobody looks to the OECD to help solve any serious global economic problems?

The Euro-Based Changes In The EU

This past weekend's Wall Street Journal featured a half-page editorial by Brian Carney & Anne Jolis entitled Toward a United States of Europe. It's amazing to me how relatively little attention this major change is receiving in US business and other mainstream media.

Most of us Americans don't really understand the specific limits of the original Treaty of Lisbon which gave birth to the European Union. Among them was, with the birth of the Euro and the European Central Bank, to quote the Journal article,

"each member state would be responsible for looking after its own budgetary and borrowing needs. Going forward, the euro zone's members will stand as guarantors of each others' national debts."

Thus, the title of the editorial, because there is joint responsibility among the EU members for all sovereign liabilities. Very much the same effect as Alexander Hamilton's original plan for the United States government's assumption of all debts of the thirteen member states.

Rather troubling, however, for the Euro and the EU, is the fact that the politicians aren't giving this massive change its due, ramming it through as a "limited treaty change."

On the contrary, France's Finance Minister, Christine Lagarde, said,

"It's a major adjustment. We violated all the rules because we wanted to close ranks and really rescue the euro zone."

Further, Lagarde said that the original Treaty "was very straightforward. No bailing out."

I recalled, with interest, early on in the Euro's existence, that France and Germany were two of the first members to violate the currency union's economic guidelines regarding budget deficits and/or deficits. The rules were, as Lagarde admits, flouted from the very start.

Carney and Jolis cite Germany's one-time Bundebank head, the venerable Hans Tietmeyer, writing,

"that monetary union required 'the degree of solidarity characteristic of a nation.' "

That's a big jump for the EU member states. Unlike US states, most of which have some sort of balanced-budget requirement, however loosely-enforced or defined, formerly sovereign states in the EU were, only decades ago, issuing their own currencies, and running budget deficits even now.

The editorial's authors make the insightful point,

"Economic competition is to be replaced by consultation and cooperation. Whether that is an improvement is doubtful, but it is also, in a sense, beside the point. Europe has chosen its path. The common currency will stand or fall based on the ability of the EU to impose ever-more intrusive spending and taxation oversight on the euro zone's members. Does Europe have the necessary solidarity for that to succeed where less coercive measures have failed in the past?"

The transition from common currency to facilitate individual competitive advantages among the EU members, to its use to enforce top-down budgetary and taxation policies, is a sea-change. Even the US does not have this wrinkle in its Constitution.

The EU's members are much more ethnically distinct, and more recently, than are US states. I've always thought that this reality would prohibit a truly-shared fiscal and monetary union in the EU.

Now I guess we'll see whether I, and so many other observers, are correct. The effects of Euro failure aren't clear, but one has to suspect, if the establishment of the Euro brought so many benefits, its disappearance would reverse those, and bring new costs for the member states and businesses operating therein.

Karl Otto Pohl On The Eurozone Bailout

A hard-to-notice, easily overlooked section of the Wall Street Journal's editorial page is its "Notable & Quotable" feature.

The other day, the section reprinted this exchange from a Spiegel Online interview with former Bundesbank head Karl Otto Pohl,

"Pohl: The foundation of the euro has fundamentally changed as a result of the decision by euro-zone governments to transform themselves into a transfer union. That is a violation of every rule. In the treaties governing the functioning of the European Union, it explicitly states that no country is liable for the debts of any other. But what we are doing right now, is exactly that. Added to this is the fact that, against all its vows, and against an explicit ban within its own constitution, the European Central Bank (ECB) has become involved in financing states. Obviously, all of that will have an impact. . . .

The European Union should have declared half a year ago—or even earlier—that Greek debt needed restructuring.

Spiegel: But according to Chancellor Angela Merkel, that would have led to a domino effect, with repercussions for other European states facing debt crises of their own.

Pöhl: I do not believe that. I think it was about something altogether different. . . .

It was about protecting German banks, but especially the French banks, from debt write offs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24 percent. Looking at that, you can see what this was really about—namely, rescuing the banks and the rich Greeks."

Given my comments about the Euro in this recent post, I found Pohl's comments very insightful and sensible.

Sad to say, you tend to trust ex-officials to be more candid and honest than the ones in power. Pohl didn't actually judge Merkel, but he did not shrink from explicitly disagreeing with Merkel's alleged reasons for the Greek bailout by Germany.

While the excerpt doesn't cover Pohl's thoughts on the future for the Euro or the EC, I can't help but wonder what responses to those questions would have been.

When Pohl says "obviously, it will have an impact," one senses he may mean economic, financial and political.

Sounds about right to me.

Innocent or Idiot Abroad? Geithner In China & Europe

Am I alone, shaking in fear as I hear our naive Treasury Secretary, Tim Geithner, babbling about economics while abroad in China earlier this week?

After much hoopla surrounding his visit, I heard part of an interview with him on CNBC. Asked about China's insatiable appetite for raw materials, and its potential affects on the US, Geithner chirped about how great it was that China is an important, large global economic power. How wonderful that they, too, have a growing demand for basic commodity metals and energy.

Huh?

What's our chief tax cheat been smoking lately?

Of course, it's true that Geithner's claims to fame have mostly been as a governmental-entity-employed financial systems plumber.

Faced with a real crisis at the New York Fed two years ago, Geithner blinked in negotiations with the French and, in contravention of normal bankruptcy law, promptly paid off AIG's derivatives creditors in full.

An economic sage Geithner is not. What he's doing spreading economic falsehoods is anybody's guess. But last time I checked, US consumers would benefit by less demand for commodities, not more, as that would allow prices to drift lower, not higher.

Yesterday morning, Geithner was already in Europe, making inane comments about the Eurozone's situation.

I can't wait for this idiot to get home and hide out somewhere where he won't embarrass himself or the American people.

Doug Dachille on CNBC This Morning

I caught a fair amount of Doug Dachille's appearance for, I think, an hour this morning on CNBC.

As always, his comments were lucid, powerful and candid.

Dachille crystallized something which has always bothered me about the creation of the Euro.

In effect, Dachille, more clearly than anyone else whom I've heard on the subject, noted that the EU chose to create a currency, but no centralized taxing authority. Thus, unlike the US, the countries share a currency, and some loose federation policies, but have no effective means to back the Euro as a currency.

It really brings to mind something I said just yesterday to a colleague about Alexander Hamilton. Our first Treasury Secretary was truly brilliant. He had the federal government assume the debts of the states and created the dollar, thus seamlessly unifying the nation fiscally and monetarily.

Pity the Eurozone. As Dachille so succinctly put it, they can't take unified measures to support the Euro because there is no federal taxing power. Everything has to be a country-by-country vote to fund actions in support of their shared currency.

This addresses what I had misgivings about so many years ago, i.e., that the Euro countries weren't sufficiently unified in both fiscal and monetary policies. As such, at some point, their lack of federal authority to coordinate the monetary and fiscal aspects of the Euro would come back to bite them. In effect, Germany, with the most stable currency and strongest economy of the EU, had not ceded its fiscal authority to the EU.

You might not be able to clearly define how the monetary and fiscal aspects of a nation's currency interact, but you know it's an important phenomenon. In the Eurozone, it's now clear they just don't have that linkage in a manner that global investors trust or believe.