Living off the global taxpayer

As mentioned in one of my previous blog entries that the government largesse is visible in the domestic economy, it is even more perverse on the international scene.

In What I mean by hazardous government rhetoric I wrote about the perverse incentives that the government implements to keep people from leaving government, this next piece is just as amazing.

According to the Guardian:

“As an official of an international institution, Christine Lagarde’s salary of $467,940 (£298,675) a year plus $83,760 additional allowance a year is not subject to any taxes. […]

The same applies to nearly all United Nations employees – article 34 of the Vienna convention on diplomatic relations of 1961, which has been signed by 187 states, declares: "A diplomatic agent shall be exempt from all dues and taxes, personal or real, national, regional or municipal."

According to Lagarde's contract she is also entitled to a pay rise on 1 July every year during her five-year contract.”

That’s right. When you or me seeks employment, we are forced into progressive tax brackets, while the “elite” get away with a free lunch. The masses endure financial repression and a fall in living standards, but the IMF chief gets a get-out-of-tax free card.

People should also check out the other “privileges” these people have, straight from the UN website:

1. Rental subsidy if newly arrived at the duty station your rent represents too high proportion of the total remuneration.
2.Dependency allowances if you have an eligible dependent spouse and/or child
3.Under certain conditions an education grant if you have eligible children in school.
4.Travel and shipping expenses when you are moving from one duty station to another.
5. Assignment grant to assist you in meeting initial extraordinary costs when arriving at or relocating to a new duty station.
6. At some duty stations, a hardship allowance linked to living and working conditions is paid and where there are restrictions on bringing family members, a non-family hardship allowance is also paid.
7. Hazard pay and rest and recuperation break when you serve in locations where the conditions are particularly hazardous, stressful and difficult.

The last one and first one is just brilliant. I have only one thing to say: Dear Christine, take a hike and get a real job.

Silent debt monetization in Croatia

 

Every week, a new news headline comes out of the Croatian business press that our Finance Minister has successfully indebted the Croatian people by a smaller interest rate. Most of this funding is being done on a short term basis. The main problem however is that these treasury bill purchases are being financed in most part by the Croatian banking system.

The headline reads:

“Banking institutions and other investors have submitted offers worth HRK 2.583 billion and 57.4 million euros. Ultimately, the auction of treasury bills was entered in the value of 1.309 billion and 51 million euros.”

Since banks are battling with foreclosure issues and the inability of the masses to repay their loans tied to the Swiss Franc, it is somewhat surprising that they are flush with a surmountable amount of cash to absorb this kind of auction. Banks had an appetite for nearly double the amount they received signaling that a flight to safety is still intact. My question is: Where are the banks getting all these funds?

Maybe, its because that on April 4th 2012, the Croatian Central Bank lowered the reserve requirement from 15% to 13,5%.

The headline from two months ago goes as:

“Banks get a release of about 4.1 billion kuna, and more than 110 million in foreign exchange”.

Banks, flush with cash aren’t loaning to the business community; mostly to do with the fact that the private sector hasn’t yet deleveraged and the growing uncertainty of outstanding loans, unions contracts and a negative economic outlook.

So, the government is high fiving itself for managing its debt burden with printed money. We will just wait and see what happens when all this “shadow liquidity” hits a certain part of the economy and its perverse effects it will have on the capital structure of the economy.

It’s a shame that, unlike most Western European countries, we don’t have a yield curve that might show how the effects of expansionary monetary policy has on the economy.

A True “Austrian” Money Supply measure (TMS) would also help in seeking out where the next peak is going to be, and from historical data draw the time from peak to through to figure out when the cleansing of the system of malinvestments might occur.

If someone should teach finance and economics, it is definitely this guy–Kyle Bass of Hayman Capital

This short excerpt is from an interview with Kyle Bass of Hayman. For those who are uninformed, Mr. Bass made a billion during the subprime debacle (shorting subprime mortgages through his hedge fund) and is forecasting an even worst future down the rode.

Such elegance as an orator as well as someone well versed in the economics field is second to none. Below is the short interview followed by a Q&A video from AmeriCatalyst 2011. Watch and enjoy is all I can say.

Courtesy of ZeroHedge:

“On gold:

A guy sitting in an office in Dallas, Texas, making sweeping claims about the future of countries he’d hardly set foot in: how on earth could he know how a bunch of people he’d never met might behave? As he laid out his ideas I had an experience I’ve often had, while listening to people who seem perfectly certain about uncertain events. One part of me was swept away by his argument and began to worry the world was about to collapse; the other part suspected he might be nuts. “That’s great,” I said, but I was already thinking about the flight I needed to catch. “But even if you’re right, what can any normal person do about it?”

He stared at me as if he’d just seen an interesting sight: the world’s stupidest man.

“What do you tell your mother when she asks you where to put her money?” I asked.

“Guns and gold,” he said simply.

“Guns and gold,” I said. So he was nuts.

But not gold futures,” he said, paying no attention to my thoughts.

"You need physical gold.” He explained that when the next crisis struck, the gold futures market was likely to seize up, as there were more outstanding futures contracts than available gold. People who thought they owned gold would find they owned pieces of paper instead. He opened his desk drawer, hauled out a giant gold brick, and dropped it on the desk. “We’ve bought a lot of this stuff.” At this point, I was giggling nervously and glancing toward the door.
So many others were giggling along. They were giggling all the way as gold rose from $800 to $1900. Probably not giggling now...

On nickels:

He still owned stacks of gold and platinum bars that had roughly doubled in value, but he remained on the lookout for hard stores of wealth as a hedge against what he assumed was the coming debasement of fiat currency. Nickels, for instance.

“The value of the metal in a nickel is worth six point eight cents,” he said. “Did you know that?”

I didn’t.

“I just bought a million dollars’ worth of them,” he said, and then, perhaps sensing I couldn’t do the math: “twenty million nickels.”

“You bought twenty million nickels?”

“Uh-huh.”

“How do you buy twenty million nickels?”

“Actually, it’s very difficult,” he said, and then explained that he had to call his bank and talk them into ordering him twenty million nickels. The bank had finally done it, but the Federal Reserve had its own questions. “The Fed apparently called my guy at the bank,” he says. “They asked him, ‘Why do you want all these nickels?’ So he called me and asked, ‘Why do you want all these nickels?’ And I said, ‘I just like nickels.’”

He pulled out a photograph of his nickels and handed it to me. There they were, piled up on giant wooden pallets in a Brink’s vault in downtown Dallas.

“I’m telling you, in the next two years they’ll change the content of the nickel,” he said. “You really ought to call your bank and buy some now.”
And on how to prepare for what is coming and why it is coming:

We hopped into his Hummer, decorated with bumper stickers (God Bless Our Troops, Especially Our Snipers) and customized to maximize the amount of fun its owner could have in it: for instance, he could press a button and, James Bond–like, coat the road behind him in giant tacks. We roared out into the Texas hill country, where, with the fortune he’d made off the subprime crisis, Kyle Bass had purchased what amounted to a fort: a forty-thousand-square-foot ranch house on thousands of acres in the middle of nowhere, with its own water supply, and an arsenal of automatic weapons and sniper rifles and small explosives to equip a battalion. That night we tore around his property in the back of his U.S. Army jeep, firing the very latest-issue U.S. Army sniper rifles, equipped with infrared scopes, at the beavers that he felt were a menace to his waterways. “There are these explosives you can buy on the Internet,” he said, as we bounded over the yellow hills. “It’s a molecular reaction. FedEx will deliver hundreds of pounds of these things.” The few beavers that survived the initial night rifle assault would wake up to watch their dams being more or less vaporized.

“It doesn’t exactly sound like a fair fight,” I said.

“Beavers are rodents,” he said.

Whatever else he was doing, he was clearly having fun. He’d spent two and a half years watching the global financial system, and the people who ran it, confirm his dark view of them. It didn’t get him down. It thrilled him to have gotten his mind around seemingly incomprehensible events. “I’m not someone who is hell-bent on being negative his whole life,” he said. “I think this is something we need to go through. It’s atonement. It’s atonement for the sins of the past.”

The importance of conservative accounting

 

It has been stated that monetary calculation is one of the great achievements of the human mind and that double entry bookkeeping is what differentiates the system of free enterprise from one of command and control. It is true that without the elegant superimposition that accounting has on the daily activities of the firm, economic relations between actors in the general economy wouldn’t be possible.

However, there is always a word of caution, especially when accounting standards are concerned. Since there are more than one standard, the businessman-entrepreneur is faced with a distinct possibility of obfuscating his internal documents in favor of modern balance sheet “window dressing”.

In this short excerpt, I will only delve into one issue; accounting of long lived tangible assets.

As there are two prominent standard setting bodies in the accounting sphere. One is the FASB and the other the IASB. As things go, one is American, and the other is European. One set of rules are dubbed GAAP and the other IFRS. Both standard setting bodies encourage the use of their accounting rules, but IFRS is predominant in Europe, while US GAAP in America.

As you guessed, both have rules governing the accounting procedures of bookkeeping involving long lived tangible assets. According to both standards, an asset is booked on the balance sheet if there are expected future benefits deriving from this asset (not to confused with revenues which require a constant economic flow of benefits to the firm). If the asset doesn’t fulfill its role as an asset class it should be written down (taken from the balance sheet and placed in the income statement as a loss.

Under US GAAP assets are acquired through the course of regular business activity and they are kept as an ongoing balance sheet item until disposal; abandoned; held for sale etc. They sit on the balance sheet at carrying value and any costs affiliated with bringing the asset to its current state is capitalized. This includes transportation of parts, costs of bringing it into full operational use, interest that is used, if the asset is bought with debt. This is the conservative approach. The other approach is the revaluation approach (only under IFRS) at which the asset isn’t depreciated, but as it is tested for impairment, the asset may be revalued or written down to its fair market value.

What happens when the economy is in a stage of an inflationary credit cycle? If the credit flows into certain asset classes, then, under the revaluation model, the asset will experience monetary gains which bypass the income statement and enter the statement of changes in equity under revaluation surplus. This gain is then reported as part of net income which may be consumed in the normal operational function of the firm.

But, these are fictional gains which are only there because credit demand has pushed up the price of this asset class. This growth in value induces the firm to take on more debt as it is comfortable to do so. In the event of a default, it can pay down its debt with the overly recognized asset. This is of critical importance. Knowledge of balance sheet movements is only one part of the equation.

Understanding the economic consequences of balance sheet changes is a completely different thing, especially in today’s fiat world of frequent expansions and contractions.

What I mean by hazardous government rhetoric

You got to love Croatia’s new government. It seems that the individuals in the ruling party really cherish the benefits of working in government. The following statement was made on Facebook as an answer to the question, why don’t government officials lower their paycheck? It is argued that they would still have “enough” even with the cuts. This is the governments response:

“If we further reduce salaries of MPs, we would have to  decrease the other state official's salaries, that the Prime Minister and ministers, and judicial official's salaries, means judges, the Attorney General the his deputies. By reducing their wages we would have to reduce the salaries of Assistant Ministers and other professional people who work in public administration, and this would lead to the fact that they would go out to systems in the private sector and the state administration would run out of those who need to help the state work well.”

So, instead that these people actually get a real job in the private sector, and not live of the government teat, the government is keeping the wage rate for these individuals at a artificially inflated level. So, what do you get in any price fixing scheme? Shortages or surpluses. In this case, we get a surplus. A surplus of government officials, or to look it differently, a shortage of private sector jobs. 

We can assume that the crossover price elasticity of demand is negative, which means that for every increase in the price of labor in the private sector (wage increase), their wouldn’t be any such change in quantity demanded for it coming from people in government. Because the government is keeping the price of labor above this point of market equilibrium, people in government aren’t so enthusiastic of leaving their positions.

ε_x= (∆Q_DA) ⁄ (∆P_B ) < 0

I wish somebody would really do empiric research for this, by choosing for example the Finance Ministry as the price of labor in government and then use a set of jobs in the financial industry for quantity demanded and see the cross price elasticity of demand and the income elasticity of demand.

This rule may apply for income elasticity of demand as well. If income elasticity of demand was greater than one, any fall in wages in the government sector, would be followed by an increase in the number of individuals in the private sector. To keep things simple, we may assume homogenous workplaces in government and in the private sector. This would mean that these goods are categorized as normal goods, not inferior goods, as they are now.

This simple analysis doesn’t deter us from the fact that for people in government to survive, they are indebted to the individuals in the private sector, because government doesn’t have any wealth, just a redistribution scheme.

Couple that with an unlimited refinancing deceive (central bank, national banks), it is no wonder why so many people think that a government job is somewhat more noble or prestigious than one in the private sector.

Slavery for the young and highly educated in Croatia

 

Usually this story is reserved for the American student that has $60,000 or more in debt and no job, no experience. But this time, I would like to focus on my home country and its ridiculous new law.

The new law that came in effect gives the option to unemployed youth with a university education to enter a worker experience program and get paid 1600 HRK a month for doing so. 1600 HRK = $290. This will help, as we are told, to alleviate the grand number of students which have no work experience whatsoever. The minimum wage is 3000 HRK.

For an employer who wishes to employ such an individual doesn’t have to pay in for social security, medical or any related taxes. This one year program doesn’t count toward the years of labor service and doesn’t count as accumulated time for pension qualification. The employer gets slave labor, because its now legal for any employer to do such a scheme, void of paying any taxes. This is the way out our leaders think of the youth unemployment.

They don’t do the correct thing: letting nominal wage deflation to occur (which should have occurred in a deflationary environment during the crisis) so the price of labor sets at a more competitive level which would allow a more flexible job market and a lower barrier for entry into the workforce. It doesn’t eliminate progressive taxation and the pay-as-you-go social system of retirement which is going to be a burden on my generation as the employment level falls and more people exit the labor force. No. It doesn’t do that. It sets the price of labor at some arbitrary level and makes it law. What stops the employer from firing the individual after that year and rehiring the same person after a certain amount of time passes, paying him the same amount?

Nothing.

The bargaining game which occurs in the free market is taken out and the employer now has massive leverage to do whatever he wants. The youth can’t stand on its own with this kind of pay and a estimated inflation rate of 3,5% per annum. Indebted servitude anyone?

This is truly a lost generation.

President Kirchner of Argentina acknowledges economic slowdown (Blames external factors instead of own policies)

Well, this isn’t really news. After a decade of the so called wondrous economic miracle that is Argentina, a slowdown is imminent. The GDP growth projections are lowered to 2-3% after a constant 7% growth level in the preceding decade. The President called it that their luck has run out and she blames the global slowdown for it. She should get a mirror and start yelling at it.

Even though the President is to blame, the text on business.hr completely missed the point. Google translation goes as:

“The government has poured money into subsidies for industry, public works projects, generous welfare payments and other popular programs, incentives, known as the "Kirchner model."

Argentina possesses large reserves of oil and natural gas, but the production fails to keep pace with economic growth.”

The last statement is utter nonsense. Production can’t keep up with growth, eh? If you ask me this is a classic sign that the economy is heating up and that the miracle growth was nothing but a credit induced bubble that spilled over to the housing sector:

“Building sector is usually the main driver of the economy, and Argentina is turning to real estate as a hedge against of  inflation. However, new projects have slowed significantly this year due to falling sales of 15 percent, mainly due to currency controls introduced by the government to prevent the outflow of capital”,

and into the energy sector. This what happens when the government wants quarter over quarter real GDP growth but without any fall in consumption to accompany savings generated growth.

Also:

“The government has only recently started to remove some of the price controls, which was introduced nearly ten years ago.”

So, the government capped prices from rising when inflation was forced up into input prices? Smart move El Presidente. You not only get higher prices, but shortages. This charade played over the past decade lasted as long as it did because the government was able to subsidize the losing companies and had enough resources to squander. But when the credit crunch came, I am sure that the government wasn’t able to force feed the oil industry anymore. As consumers are demanding more energy, and the funds to replace worn out equipment in the higher end of the capital structure aren’t there, the consumers are going to get the double whammy – higher prices and shortages followed by rationing and ever greater doses of inflation.

And last but not least:

“Cheap energy has enabled the Argentine companies a huge advantage”.

Yeah, cheap energy, subsidized by the government, and capital mixed with inflation went into certain sectors of the economy creating an overproduction in some areas (an artificial boom) which will be accompanied by a bust and a huge glut in whichever sector the money flowed to. 

How a government can influence a segment of the market

 

We can start my giving an example of an individual working in a steel mill which receives a salary (wage) and is taxed by the government in a certain way. Lets suppose that his salary is $1000 dollars. This amount is gross. Governments usually like to tax individuals on their gross salary, as it provides the government with basically free money to engage in any form of expenditure it deems necessary. After taking money for social security and any other coercive form of taxation and “insurance”, it places the individual in certain tax brackets according to his/her income.

Most countries have progressive taxes and the more he makes, the more he is marginally taxed at the higher level. We can assume that this individual doesn’t save, owns no additional form of income and therefore consumes his monetary balance entirely at the end of each month. What he is left with, he uses to consume.

What happens if this individual decides to invest in a bond? Well, he is then effected by the tax code that goes with that investment. The tax code my be as follows:

1.He is taxed for the interest he receives at the annual or semiannual coupon payment dates

2. He maybe taxed for unrealized capital gains on his investments (if these bonds tend to have junk status (speculative grade) or represent cash flows that may come from the pornography industry – the government hates when people invest where they deem fit and look to punish those who do)

3. He maybe taxed by special provisions in the tax code which states that if you invest more than X amount of your funds in this asset class, you will be liable for more taxes and so on.

In each of these cases, capital won’t be allocated in an efficient manner throughout the productive structure. As he will be taxed for the cash flow he receives semiannually, he maybe even taxed due to the accrued interest, which means that before he receives a the coupon payment, he will have a  negative cash flow in the amount of the paid tax. He will certainly, to match his investment objectives of say 6% yield to maturity and a tax rate of 30% request a yield to maturity to equal 0,06/(1-0,3)= 8,57% yield to maturity. Due to the fact that he yearns for higher yield, a more unsuitable investment will be chosen.

If any capital gains will be taxed before he liquidates his holdings, he will again experience a negative cash outflow. If these taxes tend to be large at a relatively small taxable base, he will liquefy the investment. If one segment of the market is affected in this way, large amount of sell orders have the ability to suppress the present values of cash flows of these assets, leading to much higher funding costs.

And last but not not least, if the event of taxation occurs as a penalty for investment in a certain market segment, that market won’t provide the necessary goods and services, as it would because the cost of doing business is greatly overstated.

We should all thanks the government for in their unlimited wisdom. they have managed to keep some products of the market, because they deem it moral and know what’s really the best investment out there….

Capital theory presented by Jesus Huerta de Soto, PhD

 

 

This is the closest you’ll get to a clear and unrivalled expose of the capital theory. It is truly a refresher from the AS/AD curves of the Keynesian realm.

A general unified theory of economics

 

Economists of the mainstream schools have been baffled by the inability of guiding the economies of the world on a sustainable trajectory using their mathematical models; and it clearly frustrates them to say the least. It as if they are unable to connect the micro world of the firm and individuals on the ground with a general overlook of the way the economy works from a macro level.

They clearly are baffled as their scientific colleagues in the field of theoretical physics. Physics has been a quest to find what is dubbed the GUT (General unified theory), or the theory of everything. But, there is a problem. The equations that define the intricate workings of the very large i.e. the movement of celestial bodies, formation of stars, planets, gravity cannot be equated to the laws that define the workings of the very small i.e. the movements of particles in an atom, the fact that probability and the very observation of an event is effected by the observer of the given event when exploring the subatomic world. But that’s physics; a natural science governed by a series of laws. It tries to find the workings of reality.

Economics is completely different; as a social science, it is governed by the laws of human action. And there exits no difference on the small and the large scale, because in economics, the large scale is nothing but the addition of the ever increasing small scale. The social laws which govern the behavior of households, is applied uniformly across the country, as well as across the globe. The laws of higher living standards in Europe are the same as they are in Asia, and everywhere else for that matter.

The obscurity comes forth when economists, especially in academia and the untrained populace demand something for nothing and expect that goods and services magically appear out of nowhere. Its as if you wanted to generate electricity, but lacked the catalyst to do it (a magnetic field or a source of mechanical or kinetic energy that can be transformed into electricity). Some very fundamental laws of relativistic physics govern economics.

In my view, to generate an output (electricity, widget), you have to have an a priori  input (energy; labor hours, sacrifice) is the basic one. Reshuffling economic resources in the economy from an aggregate viewpoint doesn’t improve the general welfare; it only redistributes it in a dysfunctional way. No magic wand can magically create prosperity.

And by wand I mean the following: Credit expansion, currency debasement, taxes, minimum wage laws, price controls, tariffs, quotas, embargos, vendor financing, government spending, subsidies, public debt, Ponzi schemes.

So, when are we going to wake up?

The futility of currency devaluation

 

Should Greece return to the drachma? Should Spain resort to the peseta? Should Portugal defy the EU and implement the escudo? I personally have a grave disagreement with those that say these countries should resort to monetary nationalism. The idea of switching currencies for a national one is absurd if you think of the following:

Croatia has a massive trade imbalance with the rest of the world. It imports more than it exports. To finance these imports the nation goes into debt to pay for these goods and services. When the bill comes due, we just refinance the debt with our creditors; insomuch we raise the national debt with the help of the banking sector that absorbs this new debt with freshly created deposits.

If the monetary inflation of the domicile country (Croatia) which is greater than the one that exists from the countries from which we import our goods, there will be natural tendency to favor imports over exports, as goods abroad are more cheaper to purchase than at home. One good example would be the hyperinflation of the Croatian dinar during the Croatian homeland war. To finance the war effort, the government couldn’t tax the population, nor could it borrow funds from abroad, so it resorted to printing of the currency. As the central bank increased the monetary supply, prices began to rise and soon enough people were paying up to 1000 Croatian dinars for a pack of gum. People went shopping in Hungary and in Slovenia where the prices were relatively more stable. And they did the shopping in international hard currencies as no one would except the depreciating dinar. Not only that, but the inflation screws up consumer time preferences and leads to capital consumption.

The call for higher doses of inflation in Croatia is not what it needs. Consider this mental experiment: Croatia has a trade imbalance as it purchases goods with funds borrowed from abroad and can’t repay as inflation created at home from the influx of new funds from abroad bids up prices at home. The solution: Devalue the currency – this will boost our export markets.

What happens if Croatia splits up into two countries: North Croatia and South Croatia? Lets assume that this happens and that the South has a constant trade imbalance with the North. The North provides goods and services, and the South pays the North with its borrowed funds (assuming the existence of a North Kuna and a South Kuna). The South may convert the North Kuna at their central bank with newly created South Kuna, and the banks may create new South Kuna deposits from nothing and loan it out to the population. This will start the inflationary cycle which bids up local prices and increases imports from abroad whose goods haven’t risen in price. The answer would be: More inflation to pay of the debt. The exchange rate would surly rise on the market as more South Kuna’s are needed to buy one North Kuna. This cycle continues as the South Kuna is destroyed through inflation.

What if we dig even deeper? One household in South Croatia is its own country and the other household its is own country as well. What if both use their own currency and engage in trade with the exchange of one currency for the other. One household decides to consume more than they produce and pays for these goods with printed currency. The other household delivers the good and receives the printed monies. To purchase goods from the other household he must use the currency that he received for his sale. Lets assume that he decides not to purchase anything for the moment. The household decides to count its wealth as this currency it accumulates. This arrangement continues as the other household pays for its goods with printed money. The good is received and the inflation is exported. As time goes by, the other household is sitting with a bunch of notes and wants to purchase something from the other household. Since the profligate household hasn’t been productive, just inflationary, it hasn’t produced anything of any worth, maybe something, but not enough to offset the funds the other household has accumulated. The other household buys whatever he can with the worthless currency and vows never to engage in reckless behavior of giving something for nothing. The profligate household is left with a bunch of its worthless currency, and since the exchange rate has exploded in favor of the productive household, the reckless consumer household can’t buy anything from the productive household and is forced to engage in austerity.

This short story illustrates that inflation only creates artificial (shadow) demand and impoverishes the populace at the end of the cycle.

Production is halted in the economy, substituted for consumption and the capital structure is also consumed leaving a lower standard of living in the inflationary country.

To fully understand the depth of this process, one should look into Jesus Huerta de Soto’s book: Money, Credit and Economic Cycles, as it is the best book on this subject and explains in simple economic theory what is going on in todays economy.

“Every boom must one day come to an end” – Ludwig von Mises, 1928.”

A future glimpse of Facebook? Thanks to ZeroHedge

 

The present value of post-mortem analysis:

Lets just hope that all these virtual farmers at Farmville will get nice outgoing compensation arrangements when shit hits the fan in a year or two…

A short explanation on J.P. Morgan’s Derivatives Loss

During the past week there has been a buzz around the financial world of J.P. Morgan Chase’s astounding loss on its derivatives position. This has prompted more calls from the economic pundits to declare that Wall Street really, really needs a major regulatory overhaul. The first in line to criticize this bad performance was President Obama who wants tighter regulation and more government intervention.

Now, I understand that a great many people have no idea what a derivative is, and why such a big loss. They just plug in two very painful variables in their skulls: Wall Street and losses; They then demand more regulation and more taxes being bore on these reckless Wall Street tycoons. But simply put, how was this loss generated? Well, in this case, J.P. Morgan tried to come on top this financial quarter with a bunch of bets that didn’t pay out.

What they did was go into long and short positions on certain indices, stocks, interest rates etc., and lost. To keep it simple, a firm can enter a derivatives contract by entering a futures contract. Lets say that J.P. Morgan entered a futures contract to buy the NASDAQ 100 May Futures for 1000 dollars. This means that J.P. Morgan is expecting that a rise in the NASDAQ index in May. If the NASDAQ 100 contract on the open market is worth more than 1000 dollars, than J.P.Morgan will receive the difference the difference of 1000 dollars and the market price at that future date. just a remainder: Derivatives are a zero-sum game, especially when concerning cash settlement.

Digression:Farmers enter derivatives contracts to hedge against uncertainty in prices. A farmer may want to sell his crops 5 months from now, but doesn’t know the price of wheat at that period. He then enters a future contract, selling a contract into the future (going short). He then, locks in the price of his crops. If the price collapses in five months, he is still assured that he will sell his crops for the price stipulated in the contract.

To continue, we may suppose that todays price of the NASDAQ 100 is 950 dollars or 3000 dollars (for the sake of argument, lets suppose that these doesn’t matter at the moment). This really has no bearing on the contract. The only thing that matter is whether a loss or gain will be reported at the end of the period.

In May, the NASDAQ 100 is priced at 900 dollars on the open market. (Assuming the contract isn’t closed out before the end of the period). J.P. Morgan is now in a losing position, and because it is a cash settlement, the bank must pay 100 dollars to the side that took the short position. (When entering a derivatives contract, one side takes the long (betting on a rise in price), and the other side takes a short position (expecting the price to fall). And that’s really all that is to it.

The game gets more complex when complex structures are used. Usually these speculative instruments in a chained (using multiple call and put options on interest rates swaps that are reverse floaters etc.) manner, or following correlations between a liquid asset and a thinly traded index. it doesn’t change the sustenance of the game. One speculates a rise, and the other a fall. This of course is NOT HEDGING. A hedge would be to go in a offsetting transaction to the one have already entered.  This example was not the case.

Now lets briefly examine what might be the governments role in causing this:

1. Cheap funds that allow banks to gamble freely without any prudence regarding risk

2. The limits to invest or leave certain assets without closing out previous positions

3.The ability to speculate and take margin positions by depositing risk-free securities as collateral (easily available government securities) (a cheap source of leverage)

4. Tax implications and pervasive incentives regarding investments in certain asset classes

5. Making exceptions on positions on one asset class, while allowing it on others

6.Entering a trade because of an explicit government guarantee on a certain asset class (masking the assets true value).

This is just a short list of government meddling. When the monetary authority (central bank) steps in, it gets even more perverse, but you get the general idea.

What interest rates mean in a project

 

There has been constant yammering in the media from the side of the government and their desire to implement projects through the Croatian Bank of Development as soon as possible and the terms of these loans that are to be granted have to be extremely giving to struggling businesses. The request is for loans (in doesn’t say the term of these loans) to be granted at low as 1%. This type of logic ensues because the banks aren’t granting loans to businesses and the subsidy has to kick in.

Is somebody asking the important question: Where are these funds going to come from? Any if they are granted through these banks, that means that we are dealing with a balance sheet. And if we are dealing with a balance sheet, that means profit and loss dynamics are in order. So – loaning out at one percent, eh? What are the investors getting? 0,5%? Less?

It seems that there aren’t enough savings first of all to support this kind of loaning. If the banks were flush with real liquidity (not shadow savings aka inflation), then I would have only the objection of loaning through a privileged program to an anointed few.

This time, we have no savings (probably government borrowing at 5 and more percent) and loaning this out at one percent. Brilliant. Second of all, the simplest way you enter a project is to determine your weighted average cost of capital if you have decided on a complex capital structure or just the marginal cost of debt if you decide to do it with a loan. The interest rate is of extreme importance, because it shows the temporal structure of the endeavor. If for example I were to decide to discount my future cash flows at five percent and then discount those same cash flows at a different rate (assuming the initial cash flow for the project – the outflow – was same in both cases) I would get two different net present values.

A positive one with a lower rate and a lower,even negative one, with a higher rate. If I use subsidized loans and enter the project, assuming certain cash flows and demand for my project I would be dumbfounded to realize that my project would add value, when in reality I would be suffering a loss. What happens when during the course of the project, interest rates (market rates) rise and I am left without cheap borrowing opportunities? I would be forced to liquidate my project and salvage whatever remains of it. This course of action usually occurs in a inflationary credit environment when credit is “easy” and in “the streets”. Projects are valued more than they should be and assets are grossly overvalued.

When the gravy train leaves and the interest rates give a realistic picture of the available funds in the economy or that a splurge of demand is brought to a halt, panic sets in and the company can declare bankruptcy.

Along with the development bank….

The meaning of insurance vs. subsidized insurance

 

I decided to write on this particular subject because it is pivotal to understand the difference between risk and uncertainty in the economy in the economy. We shall keep it simple and focus on two insurable events. One is insurance concerning the aspects of life and death (life insurance) and insurance regarding natural disasters.

Life insurance can be classified as a form of savings and as a form of speculation. Insurance in its pure form is speculation. In the the case of life, it’s a safety net that allows individuals to hedge against certain unforeseeable events in the future. This safety net is activated in the case of death (the insurance policy in its most purest form). The funds are then distributed to the beneficiary of the policy (the family or relatives); depending on the clauses in the insurance contract.

The individual that pays for this protection is concerned for his and his family’s well being decides to make a monthly commitment of a certain amount of funds for a number of years to the insurance company and if it unlikely event were to occur, the insurer is obligated to pay out a certain amount to the beneficiary. In sorts, for those that understand the derivatives market, the premium that is paid is nothing but going long a put option on his well being. If he dies at a certain period of the insurance contract, his well being is valued as zero and his exercise price is  determined at the beginning of the contract. Simple.

The insurance process usually involves determining the probability of his death or at what point during the contract he will activate the policy. This includes falling on actuary tables, the age at which the the consumer of the policy binds himself to the contract, his life style and etc. This is of great importance for the insurance company to know these risks, because the price of the premium is determined by these variables. The total expected premiums can be discounted to the present value at a certain discount rate to determine the acceptable level of the asset side in the balance sheet. When the event occurs, the insurance company will have enough assets to liquidate to pay of the policy with interest as well as maintaining a capital level to satisfy internal growth.

What happens when this premium is subsidized? That is, the inherent uncertainty is borne by someone else. Usually the government steps in and pays part of this premium. The first thing to notice is that this new paid in premium doesn’t reflect the true state of economic affairs. The government first of all, has to take this funds from the economy, or borrow funds to subsidize the insurer. The second step: The demand wasn’t there before the government intervention. The subsidized premium lowers the relative price of the premium payment (the absolute payment is made, but the rate of return has to drop to compensate the higher premium price). The insurer, with these additional funds has the ability of purchasing more assets than he initially could and the assets that he purchases drives the return of these assets down. The insurer is carrying an overvalued asset side of the balance sheet and and liabilities don’t reflect the true cost of capital. This can go on for a number of years, as long as the government subsidizes a certain class of savers and speculators to the detriment of the individuals that don’t take out life insurance and it also helps the companies whose financial paper is purchased, driving down the cost of capital for these key industries. 

We shall comment on only what happens when the subsidy stops. When the subsidy stops, the insurance company sees that it is grossly underfunded. The new premiums that enter the system are much lower than they ought to be concerning the interest generated by the assets of the insurance company. The consumers are willing to insure themselves, but the interest rate that is desired has to be greater to offset the fall in premiums. The interest generated by the assets is insufficient for this. That is, if the base premium is low, a higher interest rate is required. If the insurance company doesn’t change the structure of its asset side it will have a average weighted return of the asset side of lets say 6%, but the liabilities have a 8% discount rate. The insurance company will have to sell its assets because the present values of the asset side is lower than the liability side. If it doesn’t change its asset structure, it will experience losses.

The insurance taken out for natural disasters has a similar twist to it. Consider the following: Which is more expensive: An insurance policy against tornado damage in tornado alley or an insurance policy against tornado damage in Alaska? Well the answer is obvious.

What happens when the government subsidizes tornado insurance in tornado alley? The cost of manufacturing homes and the maintenance of such is lower than it should be. The number of houses built greatly dwarfs the number that should have been built. Any reserve funds (rainy day funds) are severely underfunded in case of a tornado. The insurance company purchases assets that don’t generate the interest income necessary in case of a tornado. When the tornado hits, the insurer has to take a massive loss because the insurer physically can’t make up the massive number of payments now activated due to this disaster. The paid-in premiums are too low (if there is a government guarantee) and the assets are underfunded.

Just as AIG in the US sold default insurance on government bonds, raking in hefty premiums but without any buffer to support them if a default occurred; a default on mortgages written by AIG took this insurance giant down.

Blame the supplier or the dealer or the consumer?

 

Private fractional reserve banks have been labeled the guilty party throughout this financial crisis. There sins are reckless lending and gambling with other peoples money and getting bailed up at the end.

The government is routinely blamed for not providing and implementing a regulatory environment that would disallow such practices. The people face austerity and an increasingly socialist of fascist governments are being constructed in these countries. The central bank is found as a savior and looks on helplessly as the private banking firms take losses, bankrupting individuals who had assets tied up with the loans they granted.

This picture is obfuscated to say the least. The banks unfortunately are placed in a somewhat prisoners dilemma. As the intermediaries in the credit markets, they are rewarded a spread for the successful entrepreneurial activity of placing funds in those assets that provide the highest rates of growth and return for their depositors and shareholders. This of course exists in a non-inflationary system of banking. Banks today are guided by the wise hand of the nations Central Bank who regulates the volume of credit and money at a given time in the economy. Setting reserve requirements it caps the maximum ability of credit expansion, using open market operations it “smoothens” out short term liquidity issues that might arise and effects the term structure of the nations interest rates.

Banks in this environment are forced to play ball with the central bank. The central bank placing minimum reserves forces banks to lend out more than they have stored liquidity in their vaults. If one bank didn’t engage in this sort of practice, other banks would and take a large share of the loanable market, forcing the prudent bank out of business. The bankruptcy of the prudent bank occurs because it can only make a profit by loaning out the funds that it has stored in its vault, charging a safe-keeping fee for the deposits that haven’t left the bank. The other banks make money by amplifying the returns by expanding a greater quantity of credit to the economy and crowding out the prudent bank with favorable loans, lower interest rates, interest only loans and grace period loans. The banks, receiving excess funds from the central bank merrily go about loaning these funds out to the public, essentially pyramiding these funds out. Business is deceived in expanding production due to a appearance in new savings and consumers feel wealthier, as they are able to borrow at increasingly cheaper rates, refinancing mortgages or borrowing against asset appreciation.

To keep the long story short; when it is revealed that the real savings aren’t really real and that the whole expansion is based on resource redistribution and inflation, the game stops, business contracts, unemployment increases and prices should drop. A recession has begun with the populace having to forced to live a life within their means.

So, who is to blame? The banks who want to increase shareholder wealth and market share? The businesses that want to bring a new product to the market as quickly as they can with the lowest possible cost? Or the consumer who can afford a level of existence previously not reached? Well, none of them, really.

The central bank as the source manipulator has brought this recession. The banks, even though they probably know (I’m giving a lot of rope to the banks here) that pyramiding loans would weaken their capital positions and solvency, are forced to comply, because they would be forced out of the market with more expansionary banks. The expansionary banks are safe, as they are always protected from a default from the central bank.

Unfortunately, citizens still blame the mess on greed and incompetence. Greed does occur in this type of environment and so does incompetence, but they are a result from an initial catalyst that brought this on the system in the first place.

Real life austerity

 

What if a family of four suddenly woke up one day and decided not to go to work. (We can assume that these four people are made up of a working father, mother and two elderly adolescents that have recently entered into the workforce.)

After a couple of hours mindlessly walking around the living room, they had an idea to go shopping and live a little, maybe grab a vacation on a cruise ship or even buy a new home. Well, since that they abdicated from their jobs, they will need sustenance to keep them going. They are no longer productive and they need a line of credit (a loan) to finance their extravaganza. This family is now ready to shop till they drop. They will be certainly heralded by the mainstream economic press and university professors of economics as doing the right thing - helping the economy and making sure that a level of demand is out there to support GDP growth.

Just a remainder - The money they received for this activity has been saved from the rest of the population. A baker, shoe manufacturer, a steel worker, teacher, farmer and everybody else, have pooled in their savings and loaned it to the bank. The bank in return to make a profit (spread) will re-loan it out to this family. (We shall a assume a full banking, non fraudulent system to keep things simple).

Now, these funds, given to this family is a form of personal sacrifice coming from rest of society in the form of present goods. The family will take these present goods and promise to make good on the loan in the future. They will of course provide future goods for the individuals that have sacrificed in the present. The passage of time will reflect an interest component. To keep it really simple, we will just use the present versus future value of a good difference as a function of time, not including the various risk components that go into making a loan. As time passes, the family has to rely on a way to return this loan plus interest. But, it can't. It doesn't have the means of commerce anymore, only of frugality. The next logical step would be to refinance the current loan for an even bigger loan. Lets for the sake of fun call these NINJA loans (No income, no job, no asset).

To obtain a new loan, there must be unused present resources in the economy that haven't been consumed to finance this loan. Let's move ahead and say that such funds don't exist. Society has extinguished its savings. What will the family do? It can't repay its debt. It will have to restructure its debt. This means a negotiation between them and its creditors. The family might say that it will return to work and pay a couple of percent on the dollar, forcing them into bankruptcy. The creditors are forced to take a loss. There future standard of living has been diminished as they not only sacrificed so far, but will not receive any compensation for this sacrifice. They will have worked for nothing.

This analogy is the same on a nation wide basis between two countries: One that supplies the funds, and the other one, that consumes the funds. One country makes goods and renders services, while the other consumes those that are imported. The render of the good may even make loans to the consumer country, giving them an ability to consume even more in the present. This, however cannot continue indefinitely. This sort of behavior never can occur in a full banking system in which loanable funds are not created out to nothing. Sooner or later, the creditor doesn't only ask for the interest, but the principal as well. If the consumer driven country can't pay, they are forced to live within their means. They are forced to take harsh austerity reality. A smaller level of consumption, lower wages, more work hours etc. marks an austerity. But don't be fooled that they suffer alone. The creditor nation has to take a loss as they will never be repaid. Society ends up poorer and demoralized.

This story is extremely simple, and profound, as it truly governs the relationships between countries. The next twist is adding a fractional reserve banking system, a disincentive tax system made by the government and special interest groups that compound this problem greatly.

Gas prices and the like

 

Does it always seem that some asset classes catch the attention of the public and even amateur economists. Professional economists talk about this asset class, as a perfect gauge of overall economic activity. We are talking of course about oil,that is, the different kinds of oil derivatives: Brent Crude, West Texas and other, but these two are the most widely traded. One if a hallmark of Europe and the other of the USA.

Gas has been on a rocky ride these past ten years and more. The beginning of the millennium say gas prices at around three dollars a barrel on the international markets. The inflationary decade that preceded us gave us a $ 150 price tag. The Great Recession of 2007 created an environment of a collapse in the price of gas, which isn’t strange due to the overall slump in global demand, the price had to fall, but barely two years and going, the price has crept from its lows of $30 a barrel to $100 a barrel.

The normal theme concerning the gas prices at home and abroad is the problem of speculators. The speculators were blamed for the run up of the price of gas in the past decade and they are blamed for the current situation as well. Its strange how they are never blamed for the fall in price? Usually, the politicians brag that the fall is attributed to their wise stewardship of the economy and forcing the price of gas down. They do this through releasing strategic reserves, built up over the past decades or the more infamous way by means of price controls and the like. Like all government actions, putting a floor or a ceiling on the price of gas is not going to solve the problem in the long run; its just going to distort it.

The price of gas is currently being influenced by the policies of the Federal Reserve. The global demand for oil has not reached the peaks of 2007, and yet the price is almost but the same. The demand for gasoline in the United States is the lowest in the past couple of years, and the production, believe it or not, is at the highest. Its so high, that American producers are exporting gas to Europe. Why is price for a gallon of gas in America and a liter of gas in Croatia so high?

Well, there is a massive influx of dollars in the oil market, pushing the price of gas higher and higher. That’s why there was discussion of releasing the oil reserves in The USA and from the British Prime Minister David Cameron in the UK. They are desperate to lower the price of gas and the so called cost push inflation that is draining the US GDP every day. According to ZeroHedge, every $10 increase in crude prices, cuts US GDP by 1%. The same logic applies to any country, as input costs rise, it gets increasingly difficult to pass these prices to consumers. The consumers can bear these costs as long as if the so called price elasticity of demand and the consumer short run budget lines go hand in hand.

After a while, it becomes unbearable and production processes can no longer absorb these increasing costs and production falls, taking consumer demand and the rest of the economy with it.

Being taught ignorant economics

 

As an economist, I have been through my educational process at the nation’s capital University at which I was taught a lot of strange things concerning the youngest scientific field in human history – economics. During my studies, I have come to some pretty startling conclusions that maybe the “stuff” that I was taught, probably has no resemblance with the real world what so ever.

For example, on my graduate year, I was taught in a class called “Fiscal policy” that economic activities come and go in waves of prosperities and troughs of recessions. This was called normal, because the capitalistic system has certain built in defects that cause strange recurrences of happiness and sorrow. Entire books have been riddled with this subject and still, it is said, we have no idea on how to stop this plague and once and for all enter a golden of everlasting prosperity, a so called “New Economics” and what the American economist Irving Fisher dubbed in 1929, just before the Wall Street crash:

"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months."

or, the great Keynesian demigod that brought upon multiple generations of wrongly taught economists in the mainstream and permanently destroyed what is a truly elegant science by saying in 1927:

"We will not have any more crashes in our time."

Why on Earth are these individuals heralded as the great thinkers of our time?

This blog post is merely a reflection on things gone by and the uncertain future that lies ahead if we keep on burying our heads in the sand and pretending that these guys and there modern protégés have a clue what they are talking about.

I leave you with two final quotes, one from a Princeton Professor of economics also a Nobel laureate and a former dean of Harvard (I let the reader guess the antagonists) commenting on todays depression.

“To fight this recession [Nasdaq bubble of 2001] the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, […], Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

“The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending.”

Productivity comes from workdays, not holidays? Really?

 

This economic malaise has really brought forth the spectacular failure of the welfare state as we know it.

Portugal has just announced that it will suspend a number of holidays for at least five years. The rough translation from index.hr goes as follows:

“The decision about which religious holidays, has been reached in agreement with the Vatican. Authorities have already, in the austerity measures reduced public sector wages, increased taxes, and now they have decided on more drastic measures.

The four holidays that were abolished include All Saints Day (November 1st), Corpus Christi (60 days after Easter), Republic Day (5th October) and Independence Day (December 1st).”

The text goes on telling that this step has been taken to bring about more “government savings”. Thus is a half truth. What the story presumably meant is that due to falling government revenues due to the great many number of holidays and lack of production and savings, the government can no longer force employers to subsidizes workers for not showing up at the workplace.

The fact that the Vatican has gone along shows the gravity of the situation. Not celebrating a country's Independence Day does show that the concept of social identity is not an important factor is a nations pride, but the number of productive labor hours put into the manufacturing of goods and rendering services.

Portugal has around 15 or so more holidays in the calendar year. Croatia, my home country has 14. Remember, these figures are the so-called mandatory holidays. Only certain business activities may be completed on these days. If employers don’t give these days to employees, they can be targeted for inhumanity and possibly slapped with a fine.

The best possible thing to do is let the market state the number of labor hours completed in a given year. If you go on Mish’s web blog, you will find certain references to the so called right-to-work legislation which would implement free market principles in determining wages and labor negotiations between employer and employee. A given list from Mish’s website is a good reason why coercion is always a bad thing in the labor market:

1. Collective bargaining agreements take away the right of individuals to pursue a career of their dreams void of union affiliation
2. Collective bargaining agreements force individuals into organizations against the free will of those members
3. Collective bargaining agreements force union dues out of members who do not even want to belong
4. Collective bargaining agreements dictate what members can and cannot do with their free time.
5. Collective bargaining agreements even dictate what non-members can and cannot do with their free time!

Since I am not aware of certain privileges that Croatian union members have, this list is certainly a good guideline.     

Referring back to holiday termination dates, it is often frequent that union members impose which days they will not work, justifying the same as a social and moral norm and punishing and even threatening others who do not wish to take those days off.

No wonder that governments are toppling in Europe; you remove an incentive for a coercive system (unions) to back up another coercive system (government), you will have political turmoil. But, the fault doesn’t lie in terminating these holidays, it is because these holidays are forced upon those who want to work but can’t that causes the problem.

Croatia is no different.

Circular economics

 

“The problem isn’t France, its Greece.” – a Swiss banker

Its interesting how the blame game gets played out all over Europe. The Swiss blame the French banking problem on Greece’s inability to service its debt in an appropriate manner, the Greeks blame the IMF for imposing austerity so that they can’t repay their debts, the Greek people are also pissed because the Greek bailout money didn’t hit the real sector, but went straight to the indebted Greek banks, so that they may by more of their own sovereign debt and so on and so forth.

The French banking sector is going to have a capital impairment issue if they continue to saddle up on Greek, Spanish, Italian and other dubious debts. But, in the banker world, buying trash is an excellent way to make money. They can:

1. Buy Spanish, Italian, Greek debt with money loaned to them from the ECB at dirt cheap manipulated interest rates – for 3 years (LTRO I & II). Making a spread of the 100 basis points to the ECB and 700 basis points on Spanish debt.

2. They can after obtaining these funds, buy the debt, and if,  either according to local regulatory rules or banking capital rules, dispose of some of this debt by collateralizing it at the ECB, at par, and getting even more excess reserves that they then gamble with in the derivatives market.

3. Get the funds from the ECB at 0,25% and directly park it back at the ECB for 1%. A spike in this liquidity category, that happens frequently during this crisis is a sign of immense supply (shadow inflation) and demand imbalance in the loan market.

The ring-around-the-rosy continues.

Is it still late to ignite economic freedom (aka Classical Liberalism)in Europe?

 

It’s official: The French have decided to go back forty and some years back, and the Greeks, well, the Greeks as it seems have made a statement to Europe that they couldn’t care less of what the EU-in-chieftain says. The electoral results that came in two days ago gave rise to some unlikely victors and EU orientated losers.

Tribal politics is the best way to explain the results of the election in Greece. The results are as follows for Greece:

New Democracy: 17-20%
Pasok: 14-17%
Syriza: 15.5%-18.5%
Independent Greeks: 10-12%
Golden Dawn 6-8%

The New Democracy party, as stated on Wikipedia, are the conservative liberal party that won this years election. How liberal (in the European sense) they will be, is yet to be seen.

The election of the other parties are a sign of frustration, in my opinion. Nothing more, nothing less. When the till now ruling PASOK party is being challenged by the radical Left: Syrizia and the radical Right: Golden Dawn, you know that the depression has lingered on in its fifth year and that the population is ready to go native.

The French, yet again have disappointed. Not that Sarkozy was any better; I personally see no difference between the two. Hollande is a Mitterand wannabe and a firm believer in the socialist doctrine. Not surprising, he is calling for greater ECB firepower to bring growth to France, even if that means purchasing power redistribution from its neighboring co-Europeans, the Germans. Saying NO to austerity and a burgeoning public sector, Hollande at least publicly says what the supranational institutions of The EU were made for: Buying political votes and making sure that the next credit cycle doesn’t happen; at least well into his last term as El-Presidente.

Just like the Germans, Mr. Hollande has to stop the rise of national debt, which is unlike the current mainstream figure of 86,1%, but more like 150%, when all the liabilities, guarantees and rescue money (which doesn’t exist) is added up. A great iconography is brought to you by ZeroHedge.

So, if France chooses to rise its absolute debt level, it will have to rely on the ECB to step in and make sure that its debt targets are met.

Because, if they don’t, it will bring about an interest rate spike that happened in Italy, Portugal and Spain. The additional ECB funds will certainly end up in the banking system at the largest French banks, who will in turn step in and by whatever the ECB deems too much. The banks will take the purchased bonds and collateralize them at the ECB for even new funds.

The ring-around-the-rosy splurge will continue. Maybe after fascilism has its go to run the economies of Europe for about a couple of years, maybe, just maybe, the serfs will finally realize the fact that freedom doesn’t only have a social concept tied into it, but rather an economic one as well.

Blessed be thy European (Union) Comrades

 

It still amazes me how gullible the press is, when large numbers are involved. This next news headline from business.hr in a rough Google translation goes as follows:

“The European Commission is preparing a master plan that would use  200 billion euros of public and private investment in order to activate economic growth in Europe, according to Spanish newspaper El Pais, which refers to "European sources."

The plan is focused on investments worth 200 billion euros in infrastructure, renewable energy and advanced technology, writes El Pais.

The European Union may decide to use double funding. One would have relied on the European Investment Bank (EIB) and European mechanism for financial stability (ESFS), continues  El Pais.”

Now, I know it may seem that the translation it a bit skewed, but the EU Commission is acting like Big Brother that possess infinite knowledge and a foresight which is second to none. The greater irony of this, is that, the news headline came out of Spain, the next PIIGS domino ready to fall in the over indebted Eurozone.

My only question is: Where is the money going to come from? If this is a project coming from the EU brass, which country will be on the hook for this cash? The cash I would like to remind doesn’t exist at the current moment.

If the plan is, as it is alleged in this report, going to be supported by the EIB, who will be the glorious capital contributor to this project? Has anyone done ANY calculation on the cost of capital of such an immense project? But, lets put all that aside and focus on the number at hand: 200 billion euros.

I really had no idea that the Eurozone as a whole has packed away in a nice tight closet somewhere the accumulated savings for financing such a venture. The back of this financing might fall on Germany, as is reported, the only country in Europe that has productive infrastructure. But, isn’t Germany also in debt?

The next list of items showing official vs. unofficial German debt is brought to you courtesy of ZeroHedge.

Germany in debt:

German Gross Domestic Product (GDP):                                   $3.2 trillion

Official German Sovereign Debt:                                               $2.618 trillion

Percentage of Liabilities at the European Union:                          27%
 
Percentage of Liabilities at the ECB                                           18.94%

Germany’s Percentage of the ECB Debt ($4 trillion)                    $757.6 billion

German annual cost for the EU budget                                      $46.36 billion

German Guarantees for the Stabilization Funds                          $280.6 billion

German Guarantees for the Macro Financial Assistance Fund      $211.14 billion

German Target-2 Liabilities                                                     $656 billion

German Guarantee for the EIB Debt                                        $157.29 billion

Sovereign Guarantee for KFW                                                 $588 billion

Total German Sovereign Debt & Guarantees                             $5.315 trillion

Official debt to GDP Ratio                                                             81.8%

Actual German Debt to GDP Ratio                                            139.8%

I highlighted some of the key debt measures in addition to official debt taken in when calculating the debt to GDP ratio.

As can be seen, the German economy tries to act as a sort of capital buffer to the debt of the other profligate Eurozone members (without any capital of course). Writing blank derivative checks to other stakeholders who own debt from various munis, corporations, banks and other agencies doesn’t really help solve the problem of DEBT, especially when these are guarantees written on who-knows what shady financial paper.

Germany, having written guarantees on EIB debt will probably be forced to take on more shadow debt and therefore indirectly subsidizing any investment project deemed satisfactory by the EU-in-chief.

And if the EU-in-chief decide to finance this splurge with another round of LTRO nonsense, we will have to wait and see where the next Keynesian bubble forms…

and subsequently implodes all around Europe.