Podcast

Alasdair Macleod: Europe is a Hot Mess

Its banks are the weak point in the global financial system
Sunday, July 28, 2013, 10:42 AM

It's almost August, the month everyone in Europe takes off on holiday to forget their troubles. This year may be different, though, as not only can many not afford a vacation, but Europe's troubles loom so large that forgetting them won't be easy...

In this podcast, Chris talks with PeakProsperity.com's European economy expert Alasdair Macleod about the current state of the Continent. As a reminder, Chris is keeping a keen eye on events in Europe, as he sees the region the most likely candidate to serve as the flash-point for the next major global financial crisis. Sadly, Alasdair has few reasons to convince him otherwise.

A quick spin through many of the countries there reveals much instability:

  • Greece: currently living through a capital "D" Depression; destitution has reached the professional classes at this point
  • Italy: teetering on the edge of political collapse as politicians fight any and all austerity measures
  • Spain: rocked by political scandal, its banking system is now insolvent
  • Portugal: experiencing the flight of its younger generation out of the country
  • France: quickly becoming a bankrupt welfare state, as only 17 million of its 66 million citizens are working
  • Holland: stumbling under the highest level of private sector debt to GDP of any EU country
  • Belgium: struggling with the same challenges as Holland
  • Germany: losing its sovereign wealth with every bailout of its clearly insolvent neighbors 

The principal problem with austerity is that governments end up not cutting their spending, but they end up raising taxes on the private sector. Politicians are not in the business of cutting back. They are in the business of extending what they do, and consequently they see the problems as rarely being not of their making, which I know sounds bizarre, but that is the way it is.

Apart from the appalling state of affairs the governments are forcing on their electorates, I think the obvious weak point are the major banks. If you look at the big banks in Europe, they are horrendously geared (i.e., levered) in terms of how much shareholder equity they have in the game, relative to their balance sheets.

But then there is another problem on top of all this, and that is that these large banks have quite large derivative positions. And one of the largest chunks of derivatives is interest rate swaps.

Now, just so that we can get this clear in our minds, basically, what an interest rate swap is you and I might take out a mortgage on a new property. We can see that interest rates are as close to 0% as they are ever likely to be, so we want to lock in that low rate for a long time. On the other end of the transaction is a bank.

Now, the bank will allow us to lock in low rates, let us say, up to three or four years on an interest rate swap. And, the reason they do it is, they are confident that interest rates are going to remain low. Why? Because, Mario Draghi has told them that they will keep them low; that there is no way they are going to go up. And, they sort of feel that, well, when the economy recovers and property prices recover and all the rest of it, okay, we could probably take a little hit on that, particularly if interest rates rise gradually, we can correct our position.

But, that is not actually how it works. Once interest rates start rising, they will probably start rising very quickly. Why? Because of all this money, mainly dollar money around the world, which, at some stage, is going to start impacting on raw material prices and through raw materials, finished goods and so on and so forth.

So, once price inflation starts rising, these interest rates are going to rise irrespective of what the central banks say. Now, under those circumstances, if you think about the level of derivatives in these interest rate swaps, they are enormous. I do not have the figures for individual banks, but I can tell you that according to the Bank of International Settlements, world-wide, these interest rate swaps are $440 Trillion. That is absolutely enormous.

To my mind, when interest rates start rising, the banking system will be at risk of failing at its weakest point. And I think that weakest point, generally, is the European banking system. 

Click the play button below to listen to Chris' interview with Alasdair Macleod (40m:24s):

Transcript: 

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson, and today we are going to be discussing Europe, and we have a very special guest with us today. It is Alasdair Macleod. Alasdair, welcome.

Alasdair Macleod: Thank you. It is very nice to be with you, Chris.

Chris Martenson: Fantastic. I really am looking forward to talking with you about Europe, because, I have to be honest, Europe – no offense, but it is at the top of my list right now for a place where another round of trouble might start. And, obviously, it is southern Europe that has my attention, like everybody’s, and the questions I have really – as we know now, it is not just simple math or what really should happen financially that we have to take into account, but, rather, the reactions of politicians, bureaucrats, central bankers and other interested parties.

And, so, as I look at it, here is what I see. I see Greece, obviously, in a capital-D Depression, possibly worse than anything that has been in recorded history in the past hundred years, certainly, except maybe wartime, at the depths of that. We have got Spain just absolutely crushing all sorts of records, as far as I am concerned, with respect to unemployment and bad loans and things like that. And, they have their own political problems there with Rajoy, obviously, having some issues. And, Portugal, not doing a lot better. I am seeing rates starting to rise across all three of those areas. And then we have got Italy in recession, just getting downgraded to a couple of notches above junk by S&P on the sovereign debt.

So, those are the host of things I am looking at, and with German car production and purchases way, way down. And, yet, FTSE pretty close to an all-time high, the German DAX pretty close to an all-time high. You have got lots of comforting statements by Eurocrats saying that, things seem to be on the mend. What are you seeing from your perspective over there? Let us start with southern Europe.

Alasdair Macleod: Well, [Laughs] I think you had a pretty comprehensive run-around. You left a few countries [out], but, anyway…

Chris Martenson: [Laughs]

Alasdair Macleod: …I am sure we will come up with it. Yeah, southern Europe has gone absolutely nowhere. The principal problem with austerity is that governments end up not cutting their spending, but they end up raising taxes on the private sector. And you see this all the time. You know, the end of it. Any time a German politician or the IMF has anything to say about Greece, they say, Well, the trouble is, they don’t raise taxes, which are due. [Laughs]

I mean, there is no mention that the Greek government should cut its spending or anything like that. Or if there is, it is very much down in the small print somewhere. And politicians are not in the business of cutting back. They are in the business of extending what they do, and consequently they see the problems as rarely being not of their making, which I know sounds bizarre, but that is the way it is.

So Greece is a hell of a mess, and yet it is not just food stamps and all the rest. People are having to scavenge through bins, through trash cans. It is rather like going to Egypt and seeing how people behave there. Honest Greeks, and many of them of the professional classes, are reduced to that sort of livelihood, and it is completely tragic, it really is.

Going around, I suppose, clockwise, we have then got Italy. Italy is, again, a mess. Politically, it has always been a country where people buy influence over time, and influence is traded, it is all coalitions. And, Berlusconi is being the center of all this, and he has been an arch manipulator; he has almost been like a latter day Borshear.

If I can make the comparison, probably go a bit further than just politics, I could see the Italian political situation falling apart at any moment. What the Italian government wants more than anything is to be excused from this austerity. And by that, they mean they do not want to cut their spending, their lifestyle. And we are not talking about the people; we are talking about government.

Moving on to Spain, it is the same there with Rajoy. We have seen that it has been exposed, that the whole of the political funding for the conservatives there have gone through slush funds, Swiss bank accounts, whatever. This is a big scandal, but in European terms, this is business as normal. And, Spain has huge problems. Basically, the thing that broke Spain was a housing bubble. Spain –before she ended the euro – rather like Greece, was used to borrowing at semi-high rates, because Spain is a fairly risky place to invest. As soon as you have the euro along, then what happened is that people lending money to Spain would not think about the risk in Spain, but they would think, Well, in Spain, I can lend money at, say 6%, when I can only lend it to Germany at 3%. Therefore, in my euros, what I am going to do is I am going to lend more money to Spain.

So you had a massive expansion of bank credit. This is true of all these southern countries. And in the case of Spain, it ended up with an enormous housing bubble, and that eventually went pop, the way these things do. The whole of the construction industry has gone with it. The banking system is more or less gone with it. Certainly, the mortgage lenders have gone with it completely. And you have only got the share price of Bankia, which is the amalgamation of seven Cajas, so the local lenders. And these Cajas, they were badly run to begin with and the depositors were forced to take shares. Those shares were trading at over a hundred euros at the outset. They are now less than one euro each.

Basically, the largest lender – almost like the Fannie Mae of Spain – is demonstrably bust. And yet, proxy prices have been held up. Why? Because, no bank actually wants to admit the collaterals that they have got on their books are well nigh worthless. The result is there are huge, huge developments completely empty still. It really is quite extraordinary.

Portugal, the major industry in Portugal now is exporting the young. They are all going to Angola, to Mozambique, to Brazil; all the old Portuguese colonies where people speak Portuguese and they feel they have got an affinity. And I think this is tragic. There is a complete generation just going from Portugal. And they have got political problems there, too. They cannot force through the austerity. Again, government will not cut itself. Politicians cannot agree to cut their own spending, and so the result is, you have got a crisis there.

Going around, I am going to include France, not just because France has got a Mediterranean border, but – France, it is bizarre. I was calculating the other day, and I had to speak to a number of people about France. So, it is 66 million people in France, of which only 17 million are actually employed in the productive private sector. The taxes on 17 million pay for the welfare of 66 million. This just cannot go on. It is as simple as that.

And what do the politicians do when they get in? They decide that they are going to tax the wealthy, the rich, the high earners, to the point where they leave. And if you live in France now, and you earn over a million euros and you have property there, the combination of wealth taxes plus your income tax takes you to over 100%.

Chris Martenson: Over 100%?

Alasdair Macleod: Yeah, it is complete nonsense. Complete, complete nonsense.

Holland, now there is one. Holland, we do not think of as having any problems, but they have got the highest level of debts of any of the European countries in the private sector, the highest level. It is normally the government, but it is for the private sector. You can see that the private sector is so overburdened with debt, there can really be no recovery. But, there it is the private sector that is bust. And, if the private sector is bust, then the public sector is also bust on the back of it.

Belgium has, I think, government borrowings which are approximately 130% of GDP. This is completely unsustainable. Germany, I think, is about 86%, something like, debt-to-GDP. They have got an election coming up in September, and that is probably given the timing on everything in Europe, because the only people who have the resources to the extent they can pretend they can rescue anyone, obviously, is Germany. So, everybody is sort of waiting for the election. Get those out of the way. And then they go along with their begging bowls and talk to Mrs. Merkel and say, Look, you have got to let the ECB print money. Either that, or you have got to lend it to us, or whatever. So, September is when all the negotiations start again. That is, if the situation remains stable.

Chris Martenson: Let us talk about that part then, because as I understand it, there is some important refundings and financings coming up; there is a few debt options between here and September for Greece, Italy, Portugal, I believe. That is the part I really want to get to here, what is really the appetite? It sounds like Germany is going to be a little bit frozen for a while. No politician is really going to want to commit to anything really bail-out risky, excessive, prior to the election, I assume. So part of Europe is sort of holding its breath, hoping nothing happens before the German elections. But, if it does, how do you assess the mood and the tenor? I guess we are going to have to look at this across different power blocks, because the people might think one way, and the politicians might thing another way, and the bankers might think a third way. So, how do we begin to parse this?

Alasdair Macleod: Well, I think the first thing to bear in mind is that the European bankers are very much in the pockets of their governments. So, I think that the way in which financing will be arranged until after the German elections is, basically, it is sort of negotiated between the ECB, the national banks, and the national central banks representing the national governments. So, one way or another, what you end up with is, money goes into the banks to help the banks, but that money then bounces into the government.

And, the one thing that is hidden behind in all this is the Basel II and Basel III idea that is, the best form of collateral is government debt. And the more you built up government debt in your balance sheet as a bank, the safer you are. But, you and I know, that is only true so long as the government debt does not go down in value or go up in yield, because then you have got to start making provisions against your capital.

So, it is in everybody’s interest to try and keep the show on the road, and that, basically, is what is happening. Now, at some stage, rather like the gold prices, it is going to blow. And, there is no knowing when, and if it blows before the German general election, then it is very hard to see how the problems will be resolved.

Chris Martenson: Simply because there will not be the political quorum necessary to effect any sort of solution. Just, Well, let me test this so…

Alasdair Macleod: I am not sure that it is quite a question of a political quorum or consensus. I think it is reality, actually, Chris. The situation is untenable. It is a question of how long they can keep the show on the road.

Chris Martenson: Let us talk about that. What would cause this show to go off the road?

Alasdair Macleod: Well, apart from the appalling state of affairs the governments are forcing on their electorates, I think the obvious weak point are the major banks. If you look at the big banks in Europe, they are horrendously geared in terms of how much shareholder equity they have in the game, relative to their balance sheets. So if you look at the big French banks, for example off the top of my head, Credit Agricole and BNP you are looking at sort of 35, 40 times shareholder’s funds. In the case of Deutsche Bank, it is over 50.

But then there is another problem on top of all this, and that is that these large banks have quite large derivative positions. And one of the largest chunks of derivatives is interest rate swaps. Now, just so that we can sort of get this clear in our minds, basically, what an interest rate swap is you and I might take out a mortgage on a new property. We can see that interest rates are as close to zero as they are ever likely to be, so we want to lock in that low rate for a long time. The other end of the transaction is a bank.

Now, the bank will allow us to lock in low rates, let us say, up to three or four years on an interest rate swap. And, the reason they do it is, they are confident that interest rates are going to remain low. Why? Because, Mario Draghi has told them that they will keep them low; that there is no way they are going to go up. And, they sort of feel that, well, when the economy recovers and property prices recover and all the rest of it, okay, we could probably take a little hit on that, particularly if interest rates rise gradually, we can correct our position.

But, that is not actually how it works. Once interest rates start rising, they will probably start rising very quickly. Why? Because of all this money, mainly dollar money around the world, which, at some stage, is going to start impacting on raw material prices and through raw materials, finished goods and so on and so forth.

So, once price inflation starts rising, these interest rates are going to rise irrespective of what the central banks say. Now, under those circumstances, if you think about the level of derivatives in these interest rate swaps, they are enormous. I do not have the figures for individual banks, but I can tell you that according to the Bank of International Settlements, world-wide, these interest rate swaps are $440 trillion. That is absolutely enormous.

Now, to my mind, when interest rates start rising, the banking system will be at risk of failing at its weakest point. And I think that weakest point, generally, is the European banking system.

Chris Martenson: Well, here we have both Mario Draghi, Ben Bernanke, and the Bank of Japan all saying that interest rates are not going to go up. That they will do whatever it takes to continue printing as much as necessary to keep interest rates low. They feel they have to be accommodative, and this is the odd part of the story; I just have a really hard time getting my hands around this is this idea of what are they really looking at and what are they really looking for. Because, if you had proposed this level of monetary stimulus twenty years ago simply because GDP has slipped to 1%, it would have been absolutely – you would have been a laughing stock. Nobody would have taken you seriously.

But now it seems structural. It seems that we are stuck in this perpetual accommodative mode, as they call it. I call it money printing and easy money and stuff like that. And now it has gotten to the point where Bernanke will say something, the markets will react a little bit, and he will come right out the next day and say, Oh, the markets did not seem to go the direction I wanted them to, so, you must have misinterpreted me, or something.

And, so there is this it feels to me like we have central banks have inserted themselves as a new permanent participant in markets and I am wondering if that is the same, if you see that as true, and if you see that as true in Europe as I think it is in the U.S.?

Alasdair Macleod: Yes, it is; absolutely. Now, the figures are always different. We accept that, but, the whole point about G20 – G20, you may recall, was formed in the wake of the banking crisis, the Lehman crisis in 2008, as, if you like, the forum for global coordination of dealing with these risks. Now, actually, what the G20 is, is a form of coordinating the level of money printing, and what we are seeing essentially is the dynamics of a situation where whole countries get into a debt trap, and the only way out is to print money. That is exactly what happened in almost every inflation since Roman times government spending is in excess of taxable receipts.

Now, the problem today is interesting, because if they were to stop printing money, not only would governments have a real difficulty, they would actually have to cut spending – can you imagine such a thing? Not only that, but banks themselves would find that interest rates would rise sharply, which would bankrupt their customers, and therefore bankrupt the banks themselves. You also have the problem that because governments have off balance sheet liabilities, particularly in the form of future welfare and pension costs, those costs are going to escalate. And the effect of it will be that you would not be able to discharge their duties under those circumstances either.

So we are in a situation where the last thing that any central bank can possibly do is slow down the rate of growth of money supply. Now, this is a frightening thing. We all sort of laugh at Zimbabwe, we laugh at – oh, we do not really laugh, I suppose, but we think about the horrors and the irresponsibility of central banks printing money, say, in 1920 and 1923 in Austria, Germany, and so on. But, actually, when you see the dynamics of the problem, you can understand why central bankers, if they have got the ability to print money, will always resort to that. I do not think it is anything different today from any other time in history in that respect. I cannot see how we can get off this merry-go-round of printing money.

And, if you look at the Japanese situation – we were talking about Europe, but, if I may digress slightly – under Abenomics, they are going to double the quantity of money. That is the stated objective. The reason they are doing that is, quite simply, savers are now spending their savings, because there are so many old people who now rely on their savings. They outweigh the people who are actually earning, paying taxes, and saving within the system. There is no way the government can raise the money it requires as taxes out of savings.

So, what it is doing is, quite simply, printing money in order to pay its bills. That is an absolutely classic example, but it is all dressed up in the idea that we have got to get the economy shifting, and we are going to really crank up the printing presses and get it going. But, guess what, that never works.

Chris Martenson: Well, so far they will say it has been working, and I think there were two major outcomes that they were seeking. One was for the whole thing not to just fall apart in 2008, and the second was to get back to growth. Okay, things did not fall apart in 2008, in terms of completely flying apart at the seams, but for all of the trillions that have been spent, really, there is very little to show for it at this point in time in terms of real growth. And, from my perspective, my view is that they just have the wrong structural framework that they are using at the Fed, that they are just looking at a couple of levers and wondering why things are not working the same. And I think they are even overlooking the amount of indebtedness as being as critical as it is. But with oil at $100 a barrel, sorry, you just cannot have the type of economic growth you had before.

But, the funny part in the story, the part that is almost never talked about, is that it is not really economic growth that they are after – that is ancillary. What they are really after is growth in credit aggregates.

Alasdair Macleod: Yes.

Chris Martenson: Because that is all they can control. Their view is that as long as those are growing well, the banking system is now healthy, because that is what it needs. Let us hear can I say the truth out loud? If the banking system does not have a sufficient amount of growth in credit and credit derivatives, it seizes up and then it fails. And the unfortunate part of this story is, those credit and credit aggregates had been growing at pretty much, roughly twice the rate of the underlying economic growth which is GDP in most OECD countries for the past two to three decades, depending on where we are looking at. And it had to end.

So, in Europe, is there any – we have no discussion here [in the U.S.] at all that we were on an unsustainable path, because we were growing credit faster than income, and, however we chose to approach it, that was going to have to be modified and rectified and gotten back into balance. There is no talk of that balance at this point over here. Is anybody [there in Europe] looking at it that way?

Alasdair Macleod: Well, it is not really a subject over in Europe either, essentially because we are bewitched by Keynesian economics. [Laughs] The answer to every problem is competitive currency or print some money to stimulate the economy. It never gets beyond there. And nobody actually thinks that our real problem is that we have now got so much debt round our necks, we cannot physically deal with it. And that is actually what we are seeing at a national level in Europe. We are seeing it at a personal level in countries like America and the U.K. But, in Europe this is also happening at a national level, because they cannot print their way out of the problem.

Chris Martenson: And, yet they try. Here, I want to get back to what the timing of all this might be, and what might happen. So, let us imagine pick a southern European country that suddenly needs a new bailout of some form. They need to roll over a huge amount of debt, or they are going to have to plug a big giant hole in a banking system, or something. And, it will probably be a pretty big number this time. It will not be acute like the numbers out of Cyprus; it will be something pretty major. And, if it involves…

Alasdair Macleod: It will be a major country, yeah.

Chris Martenson: Yeah, somebody big. So, Spain or Italy, so, if one of those two countries needed a large infusion of money for some reason, do you think it would be forthcoming?

Alasdair Macleod: No, I do not. I think lots of jaw-jaw would be forthcoming, and lots of delay, simply because the only people who have just even a quarter of the money available, or perhaps the Germans but remember that what we are talking about is actually taking physical money out of German pockets and moving into, in this case, in your example, into Italy. That is a very difficult thing to persuade folks is a good idea. They will buy the European project, they will buy all sorts of rubbish from the politicians, but when it comes to actually putting your hand in someone’s pocket, someone else’s pocket, and redistributing their money in that fashion, that is a very difficult thing to do. So, I do not see the money being forthcoming at all. It is going to be more “extend and pretend,” if you like.

I think there is another aspect that perhaps we ought to consider in all this, and that is that if the summer in Europe turns out as being half as hot as it is here in sunny Devon, this is going to stoke rebellion, riots, and all the rest of it. And that is likely to be an increasing problem, I think, particularly in the hot months, perhaps August, September. So, I would certainly be concerned that there will be civil unrest. In fact, I would be very surprised if there is no civil unrest.

Chris Martenson: So, if you are implying that if we take the youth and just give them idle time in the middle of August, something could happen?

Alasdair Macleod: Yes, and it is not just the youths. What we have seen in, in North Africa, with Tunis and Egypt…

Chris Martenson: Um, yep.

Alasdair Macleod: …and all the rest of it. Actually, it is something that we may well be prone to, in Greece, Italy, Spain, possibly Portugal, though I think Portugal less so. Because, in these countries, the level of unemployment is absolutely incredible, and I think all you need is a firebrand to get these guys moving. And, they will move, and they will throw stones, and they will throw petrol bombs, and they will do all the rest. And I think it will be indistinguishable to the observer, what is likely to happen in countries like Greece and Spain, compared with what we have already seen in North Africa.

Chris Martenson: Now, are there any voices of reason? I have heard some quotes from Nigel Farage. He seems to get some of this, as he’s a bit of a firebrand himself in certain respects. On the political landscape, is there anybody over there really talking about what the issues really are here?

Alasdair Macleod: Straightforward answer, no, I am sorry to say. It is, basically, governments round the world in their different ways, I think, have found themselves in a dead end. And in Europe, it is particularly noticeable, because they cannot print their way out of the problem. Mr. Draghi can print, but he is actually very restricted in what he can do. And he will do what he can. He said he will do what it takes. He has talked about it more than anything else, but he has not actually managed to do anything about it. It is all jaw-jaw, and I just do not see a way out of this problem for the politicians and the political classes in Europe.

Chris Martenson: All right. So, let us, how does this unfold in your mind, do you think? It is unknowable; it is a complex, chaotic system. But would you roughly say that one or more countries gets in trouble, and then that precipitates this, or does this start in an institution of some form? Where does the phase change begin? Is this at the sovereign level, or…

Alasdair Macleod: Well, I think there are two ways, perhaps broadly, in which this can happen. One is that there can be the political disintegration, which questions the creditworthiness of a European nation. The other way in which I see it happening is perhaps a renewed economic downturn. Now, given that they are printing an awful lot of money all around the world, this may not be all that obvious in GDP figures, which, after all, are just the money total. But, if you do get a renewed economic downturn, then I think that the banks could come under serious pressure.

And that could lead to a situation where interest rates start rising to reflect the increased risk, and the rising interest rates undermine the asset side and the collateral held by the banks, and then various banks could get into trouble. And, I think, on a global basis, that Europe is the obvious place where the banks are most exposed to the risk of either a failing economy or rising interest rates. Either way, they get it in the neck.

Chris Martenson: Well, we saw a preview of this on June 19th and 20th, after Bernanke spoke. There was a bit of a hiccup in the markets. We saw stocks sold, we saw bonds sold, we saw commodities sold. Everything got sold. And we have seen that before. When everything is getting sold, there is no rotation across sectors; there is none of that magic. What is happening is, that is a dash for cash, there is a liquidity problem. And it was a pretty decent impulse, and they came out, and the Federal Reserve, they were a little unhappy with that, and they modified their remarks to turn that all around.

But, in truth, interest rates have been rising since early May in many southern European countries, and since late May, early June, in the United States. So there was already sort of a trend underway. And that moment – which looked exactly like 2008 again – told me that all of the same conditions that we had in 2008 could arise again, which is where you have some sort of a breakdown in the market that creates this vast lack of trust that immediately spikes all different kinds of things. Because, from my perspective, I think institutional trust is probably lower today than it was back then, even though there is maybe greater confidence that the central banks will do everything they possibly can in any circumstance that might arise.

But, post-Lehman, whole credit markets froze right up, because nobody trusted anybody. And, so, like, who is really going to trust a Spanish bank to really be good at this moment in time, in another crisis?

Alasdair Macleod: I agree with what you say entirely, and there is no trust in the system. But we still have, I think, over €3 trillion of cross-border lends amongst the banks, rather than just between banks and commercial entities. So, if you get a bank failure, which could easily happen in Germany, quite easily, then the implications all around Europe are massive. And, guess what? Mr. Draghi has had actually quite a lot of help in terms of swaps and all the rest of it from the Fed. And I think I am right in saying that some of the biggest depositors at the Fed are actually either American offices of European banks, or basically, the European banks are relying to a large extent on the Fed when they cannot access the money from the ECB.

So, to my mind, the banking system is creaking very, very badly, and that is perhaps where the surprise will come from. But, one of the things I think, again, which we have mentioned before, which you need to watch very carefully, and you touched on the subject, is government bond yields. When they start rising and they continue rising, that is really, I think, the forewarning that you would get that the crisis is being brought forward. And, as you say, we seemed to have bottomed out temporarily on the yields. Yields have risen somewhat across the board, and maybe they are pausing a little bit at the moment, but I think if that continues, it then becomes very destructive in terms of keeping countries particularly like France afloat, and also, Italy and Spain.

Chris Martenson: Right. So, what are you tracking in terms of the macroeconomics over there that might suggest this downturn as one of the precipitating events? I mentioned a few at the beginning of this podcast. Auto sales I was really quite shocked by the auto numbers that came out, because it implied the lowest level of auto sales in decades. That does not even remotely line up with what I see happening in the European stock forces. So, of the macroeconomic data, what is on the bright side of this?

Alasdair Macleod: Well, I think auto sales is certainly a very good indicator. I think unemployment is also a very good indicator. And, the reason I think we look at these things, is because government statistics are really so unreliable that, if you look at GDP and things like that, that is not going to tell you what is going on. All it will tell you if they are accurate, which I know is a big if is the total sum of transactions within the economy. It gives you no idea what the quality of those transactions are. But, certainly, when we you see a major manufacturing nation like Germany, producing really good quality products that are wanted all around the world, beginning to suffer, that is as good an economic indicator as you will get.

And, I think unemployment is the great thing and there again, you have got to just watch out that governments do not distort the figures in the way in which John Williams has very sensibly pointed out that the American authorities have been doing for the last 30 years.

Chris Martenson: Let us talk then, briefly apparently there is a little bit of room to run if the numbers you gave us out of France are real. I have trouble believing them – 17 million people supporting how many?

Alasdair Macleod: 66 million.

Chris Martenson: Apparently, you can squeeze the middle class longer than I thought.

Alasdair Macleod: [Laughs] Yes, well, or it is “extend and pretend.” It is horrendous. France is particularly bad, and to me, it is a complete mystery why their ten-year bond yield is, I think, something around about 2-1/2 %. It is a complete mystery, it is complete mispricing, it is almost as mispriced as gold, I think. [Laughs]

Chris Martenson: Yes, and that has been a huge mystery to me. The northern European bond yields were, last I checked, all just a few ticks lower than Treasurys themselves, including France. That one really caught my eye.

Alasdair Macleod: Yes, yes.

Chris Martenson: And U.K. as well. I just did not quite understand, because there was…

Alasdair Macleod: Again, that is complete nonsense. The U.K. government is hampered by the fact that it is a coalition. You have got the Liberals on the one side, who basically are, I suppose call them left-wing socialists; you will not be too far off. They are almost more left-wing than the official Socialist party. So this is actually quite a difficult arrangement, held together because there are individual politicians who actually quite like the idea of having some power, and it’s the only chance they would have some power.

But, to be fair to the Conservatives who need the coalition, they have tried to cut back on welfare costs by raising retirement ages and doing things like that. So they have tried to cut back in quite a number of areas, in terms of the sort of automatic expenditure increases that we see. But they have not managed to cut the overall level of government expenditure. All they have done is, they have managed to reduce the rate at which it grows. And I think it is a very good example of the problem facing modern governments. Having persuaded everybody that you do not need to save [money] and the State will look after you, it is impossible to reverse the process.

That is roughly where we are. We think it is bad here; it is a lot worse in Europe, because the level of pension liabilities is far higher in Europe than it is here. And, all the welfare stuff that goes with it, like health, education, and so on and so forth, that is also extraordinarily expensive. And, certainly, on the health side is increasing at a phenomenal rate.

Chris Martenson: Absolutely. So, if you cannot print your way out of it, and austerity is not the way out of it, how does this resolve?

Alasdair Macleod: Bankruptcy. And bankruptcy of a government happens in either of two ways. Either they stop paying their bills which is basically what is going to happen, I think, in a lot of these European countries or they print. And, if they can print, like – we can print, because we have still got the pound Sterling – then, we just devalue the currency to the point where suddenly nobody has any confidence in it. And, that is the logical outcome, and it is very difficult to see we are going to get off that path.

Chris Martenson: Well, better coordinate carefully, because Japan is trying the same strategy, and obviously, the U.S. has got a bit of a head start on that whole process, too.

Alasdair Macleod: Indeed. And again, I am very cynical, as I said earlier, but the real reason for Japan printing money has got more to do with the fact that they cannot borrow money without driving up interest rates now, because the underlying balance of saving has changed, fundamentally altered. And, in the case of America, if I look at true money supply plus excess reserve, that is $3 trillion above the exponential trend, which basically means that to come back to stability, Mr. Bernanke needs to take $3 trillion out of the economy.

Chris Martenson: If you can call an exponential curve stability, I agree. [Laughs]

Alasdair Macleod: Well, it is, in the sense that if you are going to expand a quantity of money, and it is going to expand as a controlled rate, then the exponential curve is the maximum level at which you can expand.

Chris Martenson: Yep, just pick your rate and go with that.

Alasdair Macleod: Yeah.

Chris Martenson: So we are at a new rate; a much higher rate. So, if you were going to cast forward – we are coming up on the end of our time I am just interested, looking forward the next 3 to 6 months, what are the major themes and possibly events that might transpire in Europe, in your mind?

Alasdair Macleod: Well, I am looking at the banks, obviously. And I think in the very short run, I would expect, perhaps, developments in the Spanish banking system. And to my mind, it is only a matter of a very short amount of time before Bankia has to rescued again or goes bust for a second time. And I think the crisis from that could be quite severe, particularly since the government is losing credibility over slush fund allegations. So, that is one thing I would look at.

I am watching the French situation, and I think we are going to see that economy deteriorate. It is already disappointing a lot of the economists, who expected more growth out of France. I think they are looking at the wrong thing. It is just, the burden is on employment, which is just so great in France. There is no way they are going to recover. The economy is being strangled completely. So, watch for the French economy and various economies struggle and maybe begin to visibly deteriorate to the point where we start worrying about the banking system.

I think those are the things I would really watch out for. And we have got the German elections in September. I think it is going to be an interesting bet as to whether the whole thing destabilizes before those elections, or whether we manage to keep the show on the road until those elections are out of the way.

Chris Martenson: All right. Well, that is a very fair summary. We are going to watch the banks, France, and just keep our eye on the political situation in Germany. Alasdair, thank you so much for your time today.

Alasdair Macleod: It is very much my pleasure, Chris.

About the guest

Alasdair Macleod

Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm.

Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director.

For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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6 Comments

RogerA's picture
RogerA
Status: Silver Member (Offline)
Joined: Jun 18 2009
Posts: 106
Not to worry.

At least one group has been working since 88/89 to prepare for the times coming.
 The so called “post democratic era".
They have connections to some of the big banks (the usual families)
Started in UK, has spread to several more countries,  these include France, Germany, Ghana, Hungary, India, Ireland, Netherlands, South Africa, Spain, Sweden, Switzerland and Turkey. Possibly also the United States.

This is its stated goal: "Common Purpose aims to improve the way society works by expanding the vision, decision making ability and influence of all kinds of leaders. The organisation runs a variety of educational programmes for leaders of all ages, backgrounds and sectors, in order to provide them with the inspiration, information and opportunities they need to change the world." From such bland descriptions come two questions immediately: A common purpose to what end? And change the world? in what way exactly?

It (Common purpose) has members in the NHS, BBC, the police, the legal profession, the church, many of Britain’s 8,500 quangos, local councils, schools, social services, the Civil Service, government ministries, Parliament, and it controls many RDA's (Regional Development Agencies).
CP influence is seen in force throughout the BBC, Local Councils, Police, Schools, National Health Service, and many government agencies that run towns in the UK bringing people in through 'Self Improvement' courses.

Brian Gerrish discovered CP when he was involved with a group in Plymouth in the west of England helping people find jobs and one of their projects was repairing wooden boats. He said they had lots of public support and backing from the local authorities and everything was going fine. But then it suddenly changed and the council support was withdrawn. When they tried to continue alone, he said that within a short time key people were being threatened: 'When we started to explore why we were being threatened we were absolutely staggered to find a very strange organisation called Common Purpose operating in the city. And we were absolutely amazed that there were so many people involved but they were not declaring themselves ... they were operating throughout the structure of the city, in the city council, in the government offices, in the police, in the judiciary. Essentially we discovered what is effectively, at best, a quasi secret society which doesn't declare itself to ordinary people.'

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 3936
Money Map.

So. The Africans are fleeing Africa for Europe and the Europeans are fleeing Europe for Africa. That makes sense.

Money is a call on resources. If I believe that my dollar maps onto that amount of fuel and another dollar pops into existence then we have two claims on that one jerrycan.

However money might mean different things to different people.

Personally I think that it has become too abstract.  (No. That is not right.)

It has become impossibly abstract. (Closer)

It is so abstract as it has lost all relevance. (Nearly)

Money no longer maps onto reality in any way at all. (Future tense)

Weaken the "Future tense".

Nick Hill's picture
Nick Hill
Status: Member (Offline)
Joined: Nov 19 2012
Posts: 5
Debate is being framed in debt context. What is behind the debt?

Inflation has and is kept low by the very cheap labour in the far east. The labour produces goods and services at a tiny fraction of the cost if we were to employ western workers. As a greater proportion of such labour moves to low wage economies, products get cheaper.

The combination of improving efficiency of production combined with lower wage costs have had a dramatic lowering effect on inflation.

A natural economic effect of a low labour cost, highly productive economy will be for the currency of that economy to appreciate so that wage costs move towards a world average for that level of productivity.

There have been mechanisms preventing this; preventing eastern currencies appreciating against the western currencies. The Chinese government, for example, has been busy for some time purchasing western currency denominated treasury bonds.

The nett effect is that eastern governments have been subsidising western governments welfare and bureaucracy programs. So long as the Chinese are happy to go out to work hard, then invest their savings in dollars and pounds, and we are happy to sit on the sofa watching Jeremy Kyle, the economic system could be said to be in equilibrium.

With this equilibrium, we can expect that “productive” industries in France such as automobile manufacture would likely not even exist if it were not for government financial support to counter the costs of high wages and trade unionism for some of these industries! I wonder if it would even be cheaper for the government to allow the industries to fail then pay the workers dole.

Examples of what might upset this equilibrium:

1) Increasing competition for raw materials

2) Fall in confidence in western currencies.

3) Change in policy by eastern governments

4) Chinese rebellion for better living standards – to consume more of the goods they produce.

5) Chinese standards to reduce pollution

6) Chinese decide assets are better than currency.

7) Some unforeseen black swan event such as a pandemic

The debt levels only measure how far things have gone. Not how far things can go.

If and when eastern governments close the inflation spigot, it is check mate for western governments.

 

Adam Taggart's picture
Adam Taggart
Status: Peak Prosperity Co-founder (Online)
Joined: May 26 2009
Posts: 3080
Former ECB head "The Euro crisis will worsen in late autumn"

It seems Juergen Stark, former head of the ECB, agrees with Alasdair. As quoted in Handelsblatt (and translated by Google):

The Euro crisis will worsen in late autumn

A year ago, ECB chief Draghi announced plans to do anything to save the euro. The former ECB chief economist Juergen Stark considers this fatal. He fears that the ECB will soon have to support France with bond purchases.

The former chief economist of the European Central Bank (ECB), Juergen Stark, warns of severe kickback in the euro-debt crisis. "I think the crisis will come to a head in late autumn. We are entering a new phase of crisis management, "Stark told the Handelsblatt (Friday edition).After the parliamentary elections in late September that France would increase the pressure on the ECB and Germany. The government bond purchase program OMT should actually be used in Spain and Italy. "But the pressure will be enormous, use the instrument in France. And without that, the country must go to the rescue, "said Stark.

 

yogiismyhero's picture
yogiismyhero
Status: Silver Member (Offline)
Joined: Jun 28 2013
Posts: 173
Thank you Adam...

I tried sharing this earlier from Mishs site. Office internet issues. Chris call is starting to take form and is why I am all a buzz. 

Dwig's picture
Dwig
Status: Silver Member (Offline)
Joined: Mar 5 2009
Posts: 141
Alternative currencies in Europe

I did a search for the above, and came up with the following links (among others):

They're all pretty much skimming the surface, but you get the idea.

This isn't a new thing; alternative currencies (and more broadly, ways of enabling economic transactions) have been adopted, sometimes just within a local community, sometimes at the local government level.

One of the more interesting types of such currency are those using a system of demurrage to discourage hoarding.  (Some systems of this type were used successfully in Austria during the Great Depression, until they were shut down by the national government.  The current Chiemgauer system is another example).

So, would there be any interest here in PP to investigate this topic more fully, especially since Europe's present may well be America's future?

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