Germany v "Financial Markets": the only game in town

This morning Herman van Rompuy said in his speech in Strasbourg that he expected Greece to achieve a level of debt of 120% to its GDP by 2020. This is what is considered by eurocrats and the "financial markets" as sustainable. If this figure is anything to go by then we can easily unravel what the "financial markets" game towards Germany is all about. Ultimately the banks love debtors provided they are credible and pay. And none is better than Germany in that respect.

Currently the Germany public debt is on the level of 85% of its GDP. Therefore it would be beneficial for the "financial markets" if Germany "borrowed" additional 35% (to reach a level of 120%). The best way of borrowing would not really be borrowing in a traditional sense of this word (for example to invest) but generating liabilities out of thin air to the financial institutions (e.g. bailouts, rescuing Greece, Italy, etc.). Additional 35% of German GDP would give the "financial markets" around 1 trillion euro.

So by hook or by crook, expect a lot of maneuverings on the "financial markets" to force Germany to part with their money. Another crisis, another "market uncertainty", another threat of bankrupting:... Greece, Italy, Spain, Portugal (take your pick, it does not matter which one). This is what the game is all about, Euro is a very handy tool for the "financial markets" to conduct a process of trying to extort money from Germany for the "financial markets". Printing presses in the US and the UK have a limited speed after all. That is why Germany leaving Euro is quite a plausible proposition. Angela Merkel does not look like a mug and is rather unlikely to be sucked into this game.

Germany Euro Abfahrt?

For some time there has been a discussion going on Greece possibly leaving the Euro. Greece's current sovereign debt is unsustainable. It can only be propped up with Germany's help. In fact this process to some degree suits Germany as long as it does not cost it too much. Greece's financial problems make Euro weaker. This helps German economy which is based to a great degree on export. So Angela Merkel has to play a balancing game of spending as little as possible on saving the Euro from collapse still keeping the Euro weak, whilst at the same time making sure that Germany, and especially their exports, keep growing. But this process cannot go on forever. Now there is a talk of Italy's joining Greece as the financially failed state of Eurozone. This will elevate the crisis onto a stratospheric level. Italy's debt is, circa, six times greater than Greece's (assuming there are no hidden financial arrangements of some sort of creative accounting) and the business of propping up Italians will be a game of completely different magnitude.

Germany is well known for meticulous planning and forward thinking. They must realise that it would only be a matter of time that if Greece's debt is written off to a large degree, others, Italy, Spain, Portugal, will pick up a begging bowl and join the queue. Germany can hardly afford to pay for Greece's debt. Forget about the rest. German policy and decision makers must understand that. They cannot feed the rest of Eurozone and, through them, the entire failed financial industry (which engineered this entire mess in the first instance). Therefore it appears increasingly likely that Germany end-game of bailout delays and never ending discussions is delaying a real market event: Germany leaving Eurozone. The discussions, and agreements even if made, have very little short and medium term market credibility in any event, let alone long term credibility. The discussions and negotiations time is used by Germany to prepare properly for their exit, gearing up their financial system, and in the meantime keep benefiting from a weaker Euro. If Germany leaves it is likely to take with them a couple of financially prudent and trustworthy countries such as the Netherlands, Luxemburg, Austria and Finland. And the rest of the Eurozone led by Sarkozy and Berlusconi will be left to their own devices. No doubt they will hold interesting summits. If the new German currency gets too strong (for example to impede its exports) there are many ways to weaken a currency in a way far more beneficial to Germany than subsidising failed Eurozone with some of its dysfunctional economies (Greece and Italy) and lining up bankers pockets with massive bailout tranches.

If Germany thinks and plans its future in line with its long term national interest, which is a credible assumption, it seems it makes more sense to start considering Eurozone without Germany (and possibly the Netherlands, Luxemburg, Austria and Finland) rather than Eurozone without Greece. Of course before this happens and Germany walks away with pride of the financial bull untarnished, it will have to show all their good will of trying to do impossible: credibly save the Euro. Hence such an impassioned Angela Merkel's speech in Bundenstag today. And what is the alternative: becoming a dairy cow of the rest of Europe and the entire financial industry? Not really an appealing one.


PS. If some in the mainstream media wonder about the logic and rationale of the risk scenario above (as they are likely to) they are actually quite trivial: whenever you see a failing business or enterprise you actually see the strongest leaving first. Unlike the weakest they have options.

PS2. The recent events seem to make a hypothesis of Germany leaving euro even more credible. The Eurozone masters are going to China to ask for help with euro bailout. Until recently Germany was the largest world exporter and only a couple of years ago lost the pole position to China. If China invests in euro bailout it will start wielding considerable influence over the single currency and is also quite likely to gain better export terms to the EU. This would become a mechanism that is likely to weaken the German position as an exporter on the international markets. It is rather inconceivable that Germany do not realise that. The alternative is to leave euro (with China interest in it) and manage own affairs separately (or possibly with other strong nations: the Netherlands, Luxemburg, Finland or Austria).

Financial Apocalypse Now

"no one could buy or sell" - Revelation, 13:17

In autumn 2008 the banks lost liquidity as a result of running a massive global pyramid scheme. The governments stepped in and pumped trillions of euros into the system. This saved the banks from collapse. Yet the governments did not liquidate the global pyramid scheme. The money given to the banks only prolonged the existence of the pyramid and increased it in size. At the same time the governments ended up in heavy debt.

This rescue operation worked at the time as the sovereign debt then was not that high and the governments had enough credibility to repay the debt incurred. (Such repayment was to come from the future tax receipts.) Now, on the back of Greece looming default, a new liquidity crunch in the banking system appears inevitable. Basically if Greece defaults many banks will lose the capital adequacy and will require bail outs. As the European governments have the experience of the autumn of 2008 they want to prevent it by setting up a bail out fund to the tune of 2 trillion euros. In fact the Greek debt crisis is supposed to be saved by taking even more debt. Is such situation sustainable? Solving Greek sovereign debt by even more sovereign debt and spreading it

In 2008 when the governments took on massive debts to bail out banks the governments had credibility that they would be able to repay the debt (of course, with taxpayers' money). However with the debt even growing, with hundreds of billions euros added to it since, and very little economic growth it does not look credible at all that the governments will be able to repay the debt after additional 2 trillion euros are added. 2 trillion euros is more than 2.5 times of an unsustainable annual public deficit for 2010 of the entire EU: a deficit that heavily impedes growth and hence the chance to repay the debt itself. In such situation the sovereign debt will be heavily downgraded. This will result in banks ending up in further liquidity crisis as banks reserves will lose in value. As the sovereign ratings will be downgraded, pumping more money into the banks by the government will not even be a theoretical option.

This is a scenario of banks going bust spectacularly and the currencies (as apart from euro other currencies including the dollar) are likely to lose credibility. The only way out - a technical one - will be fast running printing presses: i.e. a hyperinflation. And, in practice, western economic system will be reduced to some form of a barter. And if the EU or the governments try to keep a tight control over it, well, "no one could buy or sell". Angela Merkel seems to realise that there are such risks.

This scenario is not inevitable. There are ways out. But to implement them, the governments must understand the nature of the current crisis first and then be prepared to make difficult political decisions. And the things can keep going, actually getting worse, for some time with taking half measures: you can only imagine what the ministerial discussions in Brussels are all about.

State investment bank and the European banks meltdown (in slow motion)

As reported on tonight BBC Newsnight, currently politicians and business leaders in the UK propose setting up a structure that would amount to a state investment bank. Originally it was called by the Chancellor of the Exchequer a "credit easing". This means that the government would be lending money directly to businesses bypassing the commercial banking system. Nearly three years ago the author of this blog wrote in the first article "The largest heist in history":

"Deposit accounts records, along with mortgage and genuine business accounts, would be moved to a specially created agency of the Bank of England which would honour them with government help. If a pension fund collapsed due to a bank collapse, individual pensioners would continue receiving their unchanged pensions from the social security system. This would guarantee social stability and a normal flow of cash into the economy."

Finally, years too late some politicians and experts have started realising the obvious: the 2008 crisis exposed the financial system as dysfunctional and that it did not serve the real economy anymore. Therefore any economic stimulus must not have gone through the banks, as it would never reach the business but instead would be consumed by the financial pyramid. A government help for businesses must be provided directly.

In the meantime the European banking system is facing a collapse. There is a talk in Eurozone of setting up a multi trillion euro rescue fund for the banks. But where is this money going to come from? The European countries are in debt to the extent that it prevents them being a source. (Otherwise any more debt will trigger credit rating downgrades and the confidence will collapse. This in turn will trigger another debt meltdown chain reaction.) And there is no other source. However Eurozone countries may still try. This would only prolong the agony and make inevitable collapse even more spectacular.

"If governments do not liquidate the global pyramid scheme, the money they injected will be, in time, converted into toxic instruments (e.g. securities) and cashed in by organisers and privileged customers of these schemes (or in the case of Albania, gangsters and their customer friends). As the amount injected is around 200 times less than the notional value of toxic instruments, the economy will not even see a difference. It will be a step back to September 2008, only now with trillions of dollars of taxpayers’ money spent to sustain the pyramid scheme. It will be merely throwing good money after bad. But can governments afford to come up again with the same amount money and do it 200 times over or more?"

was also stated in "The largest heist in history".

It is of no particular satisfaction to the author of this blog, in fact it is a rather sad reflection, that the process of the financial collapse that he predicted nearly three years ago is happening now. This process was easily avoidable if the decision-makers followed the recommendations described in "The largest heist in history" and refined in "Prime Minister, sort out this mess, please". Of course the particular events and their timing could not have been predicted. But the logic of the process or rather its result, the financial meltdown that is happening now, was trivial to anticipate and prevent. A multi trillion euro question is why the decision-makers did not act accordingly.

It's a pyramid indeed

The analysis on this blog was written as an intellectual exercise deliberately outside the mainstream academic research, so it was not influenced by the conventional thinking. But the work, especially its technical aspect, was meant to be serious and correct. In August last year the work on this blog was reviewed and used by Ms Marina Stoop of Swiss Federal Institute of Technology in Zurich (one of the world leading universities, alma mater of Albert Einstein and no less than 30 Nobel Prize winners). Under the supervision of Professor Didier Sornette, she wrote her Master Thesis "Credit Creation and its Contribution to the Financial Crisis".

The thesis acknowledges the taxonomy of credit creation process introduced in an article on this blog "Computational complexity analysis of Credit Creation": Full reserve banking, Fractional reserve banking, No reserve banking and Depleting reserve banking (page 29 of the thesis). It concurs that as a result of practice of Depleting reserve banking (or Depletion banking system as it was called in the thesis) "the money multiplier tends to infinity and the liquidity risk is 100% in a finite time." (page 30 of the thesis)

The thesis also cites financial perpetuum mobile example from the blog article showing how Depleting reserve banking works and then concludes:

"This describes well how the bubble economy worked that led to the current financial crisis. In the years preceding the crisis, the money (“wealth”) created in the system was not tied to the real growth rate of the economy. It therefore created the illusion of a perpetual money machine where wealth would grow at an accelerated pace." (page 31 of the thesis).

Having acknowledged that a "Ponzi scheme is a fraudulent investment operation", with respect to Depleting reserve banking, the thesis confirms that it "is a classic example of a Ponzi (pyramid) scheme". (page 92 of the thesis) This is exactly what the author of this blog asserted since the end of 2008: the financial system had been been turned into a pyramid scheme and its collapse was inevitable (and indeed easily predictable).

As this conclusion comes from a leading university in the world, are politicians and, more importantly, prosecutors going to do anything about it?. The ball is in their court.

The graph below shows exactly an exponential growth of Money Multiplier (this time it is expressed as a ratio of broad money to currency supplies in the United States), the direct effect of Depleting Reserve Banking: (source: US Federal Reserve)


Looking at the diverging trend of M3 (broad money) to currency on this graph, it is simply too terrifying to discuss what happened after 2006, when the reporting was ceased. The graph HERE shows even faster increase till 2008, then a decrease of growth, deleveraging between 2009 and mid 2011 and back to the old pyramid pattern. So the current collapse should not come as a surprise.

This is precisely what is achieved by lending with loan to deposit ratio greater than 100%. It is a classic representation of a pyramid scheme. (Both top and bottom graphs: top one showing broad money exponentially diverging from currency and the bottom one - as near linear on a logarithmic scale - showing a pretty steady pace of exponential growth.) This is what is called a Depleting Reserve Banking (not Fractional Reserve Banking any more). This is what the model presented in "The largest heist in history" captures (as said: "the proof of the pudding is in the eating").

Money multiplier v loan to deposit ratio

I have noted that in discussions going about my blog on some fora - including financial and bankers' ones - many confuse a concept of money multiplier with a concept of loan to deposit ratio. For example:

"Comment:

Re Rosie's excellent questions and the subsequent discussion, it's well worth looking at http://gregpytel.blogspot.com/

The author looks at what happens if the Reserve Ratio is allowed to go negative -- i.e. the banks loan out £101 (or more!) for every £100 deposited. Couldn't happen, right? Read for yourself...

RGB

Response:

That would actually be a very prudent reserve ratio...the banks traditionally would lend £900 for every £100 reserve.and that was in the good old days of Capt Mainwaring,in some cases recently that was stretched to a £100 deposit turning into £4900 in loans!(stupid boys)

The Comment clearly refers to loan to deposit ratio whilst the Response is about money multiplier.

Just as example, loan to deposit ratio of 90% - i.e. lending £90 out of every £100 - gives money multiplier 10, whilst loan to deposit ratio of 101% - i.e. lending £101 out of every £100 - gives unbounded money multiplier (i.e. the money multiplier tends to infinity at exponential pace).

Still confused? Then please read: "Computational complexity analysis of Credit Creation".