Geert Noels is chief economist of Econopolis. His book ‘Econoshock’ was a bestseller in Europe. He appears regularly in the media, and advises various organizations and governmental agencies. He has extensive experience of economics, financial markets as well as asset management.
The problems with Greece are not an isolated case. Solving the Greek crisis without a reflection on a long chain of monetary and economic errors would be a complete waste of money. Our political leaders should look far beyond the Greek problems and evaluate their economic and financial policies over a period as long as 40 years.
Greece an anecdote in a long history
Greece gets so much attention, that some start to believe that if we give Greece the necessary funds, problems will start to disappear. Worse: one year ago, Europe was convinced that Greece was mostly a problem of speculation. Creating a “money wall” also known as The European Financial Stability Facility (EFSF), would deter speculators and restore stability in the eurozone.
The European politicians also forced the ECB to open their gates, and forget the very principles on which the ECB was founded. The ECB’s balance sheet was flooded with debt from PIIGS countries,happily transferred from European banks.
Meanwhile at the other side of the ocean, the US Federal Reserve has been continuing its programs of “unconventional monetary stimulus”. It is indeed an unorthodox policy, that will undermine the basic principles on which the US central bank has been founded almost one century ago.
The gradual end of orthodoxy
Step by step, the political leaders have been dismantling the discipline, orthodoxy, and safety mechanisms on which, after long periods of crises, the financial system was built . They included (amongst others):
- Gold based central banks and currencies
- Controlled leverage of commercial banks
- A strict division between retail and corporate banking activities
- Budgetary discipline
- Money supply control
- Strict financial controls and regulations, no “parallel” or shadow banking system
- Independent central banks
All these fundamentals have been disappearing or have been strongly weakened over the last 40 years. The end of Bretton Woods marked an important change of policy. In the Eighties and Nineties, the banking sector went on a mergers and acquisitions binge. In the US , banks started coast to coast consolidations. As from the early Nineties, as the Maastricht Treaty formed a basis for the single currency, Pan-European banks slowly emerged on the Old Continent. Walls between merchant and retail banks started to disappear. Finally, a shadow banking system boomed over the last ten years on the back of so-called innovation: derivatives, hedge funds, and off-shore financial centers boomed.
The disappearance of AAA
One of the consequences of this long period of monetary unorthodoxy, is the end of major triple-A (AAA) countries. Japan lost its supreme status long ago, and is slowly fading to a junk status. The US is on the brink of losing its top-notch status, as it is hitting the so-called debt ceiling. The debt to GDP ratio of the US government is around 100%, and this comes on top of substantial private debt levels accumulated in the Greenspan years.
In Europe, Germany is still a AAA, but with highly leveraged banks and an important aging problem, the CDS markets have been increasing the default premium very slowly. As Germany takes on more guarantees and loans to save the eurozone, the inevitable might eventually occur. As a consequence, big AAA-countries have seen their top quality fading. Some smaller countries have kept their top quality status, but they do not have the liquidity to become an anchor for the world financial system.
It is no wonder, that seasoned investors have lost their faith in big and liquid AAA-debt . Only central banks continue to defend the intrinsic quality of big indebted nations. But it is a sign of the times, that the US Federal Reserve has been the biggest buyer of US Treasuries lately.
Gold price as an indicator of unease
The steep rise of the gold price has been called a bubble by many observers, including Nouriel Roubini and George Soros . The charts below show the gold prices in EUR and USD over a long period. The recent climb looks similar to the first giant leap of the gold price in the Seventies. That came after a period of high inflation and monetary instability. The chart also shows that the US Treasury had been selling its gold reserves (expressed in KTon) substantially.
In Europe, gold sales have been increasing as from the Nineties. This has been done as “a diversification strategy”. Central banks argued that gold did not yield a dividend or coupon, and that government debt of triple A countries was just as good, but with a yield. The Belgian National Bank for instance sold most of its gold reserves between 1992 and 1998 at prices of 250 and 400 USD/Ounce (current gold price > 1500 USD/ounce). Other central banks have executed similar policies.
Ironically, the rise of the gold price has offset most of the losses of this policy (the gold price quadrupled after the gold sales).
Gold prices will continue to climb as long as central banks apply unorthodox monetary policies.
I do not believe that gold is the bubble, debt is the bubble, and gold is just mirroring the rise of debt.
The ECB is at an important crossroad in that regard. If the Greek bailout results in further buying of debt paper by the ECB, this will end in loss of confidence in the single currency.
Big declarations and reassuring words of politicians, central bankers and (bank) economists will not change this gradual process. Therefore, the solution to the Greek crisis might just become another step further down a long road of unorthodox policy, that is pushing the World Financial System to the verge of bankruptcy.
Stopping this process, requires a broad view on what has gone wrong (see above), and breaking with the policies of the architects of this derailment: Alan Greenspan, Ben Bernanke, and other prophets that refer to Keynes.
Central banks in emerging countries have been big buyers of gold. The fundamentals of these countries have also been strongly improving, with low public debt levels and strong current account surpluses. Developed countries have seen a degrading quality of their fundamentals: increasing public debt levels and public deficits. The Anglosaxon and PIIGS countries have combined this with important current account deficits. As a consequence, the quality of western debt has been declining, and emerging market debt of selected countries (China, Brazil, Russia,…) has been increasing.
Where “emerging” was once seen as low quality, and developed as high quality, we are witnessing a process of “trading places”.
The Germans have been experiencing a growing unease with the policy of the ECB. May 2010 has marked an important break in their confidence. The euro has been built on German principles of monetary stability, as written in the Maastricht Criteria . Countries with a stable currency like The Netherlands, Austria, Germany and Finland have been only ready to convert their national currencies into the euro, on the basis of a strict adherence to Maastricht and the independence of the ECB .
Ten years later, the very basis on which the stability of the euro has been based, is fading. It is not too late to adjust this process, and get back on the right track. “Pacta sunt servanda” is an important principle, in this case, Maastricht should be executed .
It is just another anecdote, but today Mario Draghi – former Senior Executive of Goldman Sachs in the period 2002-2005 and said to be aware of off-balance sheet financing tools offered to Greece by Goldman Sachs in this period – has been officially nominated as the next ECB president. It is just another small step in the further dilution of norms and standards of our monetary system.
Can someone give me the e-mail address of Paul Volcker please?