Water into wine? I think not.
Rather than talk about who went ‘mad borrowing’ last week, let’s focus on why it happened, because I want to explain what is happening right now in the financial markets. I would also like to make the point that central banks are becoming – yet again – instruments of leverage, rather than guardians of prudence. This looks good now, but will cause more problems in the years ahead.
In the past few weeks, the world’s central banks, led by the Fed and the ECB, have opened the floodgates with cheap money. This is driving up everything from European bond markets to commodities and stocks that, last year, people wouldn’t touch with a barge pole.
The reason for the mad borrowing is that money is now cheaper than ever. In our boom, the maddest borrower wasn’t the Irish citizen, but the Irish banking system. In the case of the two biggest banks, they doubled their borrowing in three years. It took Bank of Ireland over 100 years to borrow €60 billion (from depositors); it doubled that in three years (by borrowing from German, French and British banks).
Why did our banks do this? Because they could, because they were allowed to and because they thought they could make a fortune doing it.
When money is made available cheaply, it is borrowed. This sets off an endemically short-term cycle, where the game is to buy whatever asset is moving upwards sharply. The trick is to sell before everyone else.
When the rate of interest is forced down to excessively low levels, the incentive to save disappears because the returns to savings are minimal and the incentive to borrow increases dramatically. We are
seeing this carry-on now in global markets.
Politically, the result of all this will boost significantly Barack Obama’s chances of being re-elected as US president. Research in the US shows that one of the key determinants for presidents getting re-elected is the direction of the economy in the six months leading up to election day. For example, Ronald Reagan won re-election in November 1984 when unemployment was at 7.4 per cent. This was the same rate as when he was elected the first time four years earlier.
Unemployment had been much higher during his term, but he wasn’t punished for that. What counted was the economy on the day. Obama might be similarly lucky if the economy moves in the right direction, at the right time.
Of course, the president is being helped enormously by the Fed’s promise last Wednesday to keep interest rates below the rate of inflation for the next few years. Interest rates below inflation means that people in America will be punished for saving. They will lose money if they save, in real terms. Their savings will be eroded by higher prices. Taking their cue from the Federal Reserve, global funds are borrowing and placing bets with the borrowed money on the world’s stock markets.
The same is happening in Europe. In mid-December, the ECB, under pressure from Nicolas Sarkozy, decided to fund the banks of Europe and give them the wherewithal to buy government bonds. The ECB is making €450 billion available to the banks at 1 per cent. With this they are buying bonds yielding 5 per cent or higher. This is bringing down yields.
This is what the NTMA was playing at last Wednesday. The NTMA was using money borrowed by the bust Irish banks at 1 per cent from the ECB to lend on to the insolvent Irish government. The manoeuvre gives a “carry trade” of a free 5 per cent to the banks. This is the financial equivalent of turning water into wine. But, unlike in Cana, someone has to pick up the bar bill.
You see, this is great for the banks because they can rebuild their balance sheets with the free money. But when you follow the money, you see who pays. You do, of course, yet again.
Let’s follow the money and explain the cash-for-trash scheme in Europe. The banks have managed to give the ECB dreadful collateral and, in return, the ECB gives them real money for 1 per cent, which they then lend to the government at 6 per cent. But someone has to pay the money back. And that is you.
So not only did the banks destroy a generation by borrowing and lending hand over fist, but they have their claws in the next generation by loan-sharking to the government which will use this money to pay today’s bills while giving the tab to the next generation.
Let’s see if all this is sustainable.
First off, are European countries more creditworthy this week than they were last week? Without growth, the answer must be no.
But even more pressing is whether this immediate growth in the western world can inflate another bubble, even for a short while, at a time when it is supposed to be deleveraging (paying money back) not leveraging (borrowing yet more).
Last week, there was a lot of talk about deleveraging. McKinsey Global came out with a widely cited report on deleveraging. It’s well worth a gander, if only for the chart on Ireland’s position.
In the report, the point is made that all western countries will have to go through a prolonged period of paying back debt. McKinsey believes that we are only at the start of this process. But, in fact,
if you examine the data, we have not even got there yet.
Look at the chart. It shows the gross government debt of the major OECD countries. As you can see, the government debts of the western countries are rising rapidly. This is because the private sector pays money back and saves – which it has been doing since the crash – as the government has been taking up the slack. If the governments were not borrowing, the collapse in the economies would be even greater.
(2011-2014 OECD forecast)
So the process of deleveraging is only just beginning.
This means that the short-term boost to stocks and bonds can only be just that. These market rallies, which are real and can allow people to make money if you are clever and get your timing right, should be treated carefully.
As the Canadian economist David Rosenberg – one of the best in the business – stated: “These rallies should be rented, not owned.” Succinct, don’t you think?
Longer term, this age of deleveraging will come to dominate our world. When the magic spell of bubble stock and bond rallies wears off again, the underlying position of too much debt and not enough growth will reassert itself.
Yes, the water was turned into wine for one night only. Next day, we are left with a hangover. No miracle.
DMcW: This means that the short-term boost to stocks and bonds can only be just that. These market rallies, which are real and can allow people to make money if you are clever and get your timing right, should be treated carefully…. I call them Idiot Rallies, and by all means a chart is required to show the tiny percentage of the population in Ireland and OECD who can and who are making money in this casino of bullshitters and gangsters with no ethics. Perhaps, then it becomes more clear what small quantitative fraction of society is responsible. The people… Read more »
David, nice article as usual. Removal of money printing press from the state (government) hands and influence through the central banks is a must. The ability for banks to (ab)use system in according to the law (fractionl-reserve with central banking) and even expand (non)real paper (fiat) money through credit expansion must stop. Central banks play with interest rate leading to the credit expansion must stop. Bailing out (pouring more wealth) dodgy banks, governments and companies should stop. Printing of money is just benefiting first users, banks and governments and their sponsored companies, while last in chain suffer from the so… Read more »
Draghi is doing stealth QE. Berlin will react to this.
Meanwhile the coup against President Wulff, meaning Merkel, to break resistance by Germany, goes ahead.
The ECB is printing money, not any state – the EU is not a state. An independent central bank, like the FED, both flooding the banks totally out of control.
No government benefits from this mad new round yet again.
Exactly.
“Taking their cue from the Federal Reserve, global funds are borrowing and placing bets with the borrowed money on the world’s stock markets”.
This is precisely what Glass-Steagall will instantly put an end to. Let them bet with their own money, if in fact they have any at all.
Very interesting note on the carry-trade. There was a Yen carry-trade a few years ago, followed by the Brazil carry-trade recently. Looks like they have europeanized it.
I wonder if Brazil is still being looted? This was the BRIC idea from Goldman Sachs.
Can someone please explain why the Banking ‘elites’ seem to hold such power over the Political ‘class’. It seems to me repeatedly that the people’s interests are relegated in face of large corporate/banking interests. Have they been bought? Are there some dirty secrets? It is quite grotesque that our representatives have an almost contemptuous regard for the people whose interests they are supposed to champion. All the recent public gaffes by Noonan, Kenny, Varadkar et al only reflect their true opinions IMHO. According to them we are a bunch of mad borrowers who can’t be trusted to vote on anything… Read more »
Fantastic Article. Some day undergraduates will be reading it in university, and trying to get to the bottom of how the ECB created an asset bubble for no reason, which crashed, and then responded with the same techniques that created the mess in the first place. I have just realised the whole thing is a web of deceit. The “leadership” of the West have been lying and deceiving for decades. Since 1971 (Nixon abandoned the Gold Standard, because he could not pay for “Johnson’s Wars”) in the case of the US. Since the early 1960s in the case of Britain,… Read more »
It certainly is “cash4trash”.
It is also a Ponzi scheme. Except now, for lack of willing volunteers queueing up to rush in at the bottom of the ponzi scheme, we have state pressure being forced on the banks to get involved in preventing the unravelling of the State financing ponzi scheme.
All in an effort to “stimulate” a confidence trick…..
The Fiscal Compact. The government do not want a referendum. In fact, no government in Europe wants a referendum. And they certainly do not want a debate. Because a debate will flesh matters out into the open. And that must not happen. The Fiscal Compact will fix nothing. Spain came closest to obeying it’s limitations in the years 1997 to 2007. And now Spain has the highest unemployment in the EuroZone. Despite this Lucinda Creighton talked this morning about how the Fiscal Compact would provide a framework for tackling the crisis, and for preventing future crisis like the current crisis.… Read more »
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A ‘blue scene of death’ scenario has been narrowly avoided several times in the past month. –Mixing metaphors, I once built a house of cards to the 13th floor level.
Central bankers are enjoying a similar frisson of achievement and trepidation as they build towards QE floor 14.
In London, they may find that the ‘Shard’ becomes a monument to vainglorious ambition shattered by hash reality.
Treason!!!!
Cardiff meets with Anglo’s Tiernan O’Mahony four days before bank bailout is decided on!!!
http://www.independent.ie/business/irish/exanglo-man-briefed-cardiff-on-banks-crisis-3002988.html
The longer we wait for revolution the bloodier it’s gonna be!!
Josey :)
WHY OH WHY is there no PUBLIC SEVICE to inform the public about how money is created and how this relates to our present predicament????? Can RTE not air an educational program about how the present world economy works from banks to bondholders???? How WE fit in to this mess????? I hear soundbites and drivel and plain ignorance about actual economics aired by our politicians and talking heads on radio/tv/newspapers etc which has zero information/education worth for the last few years. It really boggles the mind how ignorant the vast majority of people are about these issues, the same issues… Read more »
The Irish are not on the streets because no one is coordinating such a protest movement. In all other countries including Belgium it is the trade unions who are organising the movement but they have being well and truly paid for here.
You have to give that to the goverment they seem to understand the dynamics at workon this one at least. Keep Croke Park no protests, fleece private sector no protest too many diverse constituents.
I was contemplating the notion of “the Irish on the street” protesting when it came to me.All protest marches to be held between the hours of midnight to 04.30 am Saturday and Sunday.Starting point Temple Bar for a march to Krystle’s Night Club.Should take at least 4 hours to complete, not putting anybody out of their busy schedules as they will already have made their way to the city centre at an early hour.And sure if they can’t walk the distance they can always get a taxi.The days of the 80s protest marches are long gone. Honestly folks, the only… Read more »
New Punk Economics video gets the prize this week…its brill!
“Japan went to its zero interest rate policy 13 years ago and began its quantitative easing campaign almost 11 years ago; news of their successes should be arriving any day now.” :-)
Would there be any chance maybe some of us mere mortals might borrow some money to pay off our mortgages and maybe we could spend the money left over repaying the ECB and spending money in the local economy. The answer is obviously no . Its only the banks that will get the cheap money just like they got bailed out by the taxpayer recently. As far as I can see we need we need another war in Europe to drag these towers of Babylon down and crush them.
If the Irish people are happy to pay and endure austerity , what excatly is the problem ?
The Field
In the absence of an Irish Monarchy the Irish revere in The Board of Directors of Banks and allow them spend as much as they like.
Great article David, and it’s a great headline too. Kenny’s credibility is shot to pieces. We all know it’s Fianna Fail’s fault we’re in this mess, and we won’t forgive them (well I certainly won’t), but Indakinny is in POWER now, and is destroying the country with the notable exception of those sheltered by the self serving Croke Park Agreements. Lookit Inda, if you haven’t got the stomach to tear up Croke Park Agreement, if you feel powerless to stop paying unsecured bonholders, then will you ever take yourself off on your horse and ride into the sunset and let… Read more »
+1 Colin, Nail on the head.
Easy 2-step Mutual Credit solution for a fair future
1) Establish a new political party. Its one singular objective – Mutual Credit. Call it the Mutual Credit Party.
2) Upon election, establish a People’s Bank and a New Irish Money (Nim) currency. Each citizen is given a bank account, zero balance, with a credit cap of 10,000 Nims. The People’s Bank can only increase/decrease the cap in proportion to the amount of savings held by the participants.
Read/google Mr E.C.Riegel for his convincing arguments of such (similar) model.
Hi David
The video is brilliant. Great job and the artist is fantastic.
Sal Khan would be proud of you.
Fantastic Video. But the people in Ireland will not be rioting simply because the Croke Park Agreement is there to defuse any large block discontent which would surely be triggered – if the Gardai, Nurses, Teachers and Army are told to take a haircut.
The nitro glycerene concoction of Croke Park Agreement will be avoided like the plague to try to maintain some level of status quo.
We need to get a number of things straight. Germany and France are doing well from a devalued Euro. Were they on their own currencies, they’d be wiped out. These are not the powerhouse economies we are led to believe them to be. They are slightly modernised capital intensive traditional industry driven economies with out moded and inflexible labour and business laws – it sickens me to hear these countries preach austerity and the need to me more competitive when they forget where their competitiveness came from over the last 10 years. Anyway…it is a banking mess and there is… Read more »
Behind all the whoopee, hoopla is this : DERIVATIVES `GOIN’ HOME…’ TO DIE IN LONDON Jan. 30 — The majority of the $1.5 quadrillion or so in global financial derivatives contracts are held in banks in the City of London — although now 97% of the REST of the world’s derivatives are concentrated in a handful of big TBTF U.S.-based banks. (Remember at least 2 of these TBTF’s are under FED tutelage). Now a Bloomberg News analysis of reports to the Federal Reserve by the five big U.S. “derivatives banks” — JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, and Bank… Read more »
Afternoon all,
Glad you liked the video. I am in Italy for a day or two. Will write about my impressions when I get back.
Best
David
Some here know this already, but it must still be reported. Never forget German citizens never got a SINGLE chance to vote on ANY of the EU Treaties. Eire got TWO chances on 1 treaty. If someone has the sheer brazen neck to blame industrial workers anywhere just try posting it here. 72 Percent of Irish Want Referendum, Sinn Fein Threatens Legal Action Jan. 30 –No less than 72% of the Irish people want a referendum over the Eurozone austerity treaty changes according to a Sunday Business Post-RedC poll. Citing the poll Sinn Féin spokesperson on foreign affairs Padraig Mac… Read more »
Crotty High/Supreme Court judgement 1987
Legal precedence set , all issue’s went to referendum after this.
As far as understand , they have to have a referendum which hopefully will be soundly defeated………….
RR6
I have finally discovered a solution to all our problems and gripes. It is a general election every year.Yes things are changing so fast right now that it seems we need a general election. Think of it would you be inclined to vote for the same person you voted during the last election.Lets be honest Fine Gael /Labour are a huge disappointment. They have achieved nothing really . We need a few strikes, a few pickets, alot of change etc. If there was an election in the morning I would vote Sinn Fein. I voted Fine Gael / Labour the… Read more »
Text from IT this morning: “We drafted the text for the treaty so that it has a chance to avoid a referendum,” this from a nameless, faceless and unelected official in Brussels, Further, Asked whether the authorities in Brussels believed a referendum was likely, the official said it was more a matter of hope. “It’s not in terms of likely or not likely, it is hopefully or not hopefully, so we’d hope they don’t need to go to a referendum.” Do the people of this country believe the more power that is devolved to Europe will mean the greater the… Read more »
David
It seems like they are building a desperate last few yards of road for the can kicking finale.
Austerity Merkel Earns “Frau Kommissar” Title The alleged “German victory” at the Brussels EU summit, where 25 governments signed on to a drastic austerity regime called “fiscal compact,” will soon prove to be a Pyrrhic one: Most of the rest of Europe has been rallied against “Frau Kommissar Merkel,” and the hug which the German Chancellor got from Britain’s Prime Minister David Cameron in Brussels indicates a British interest in this German-made insanity. Cameron, by the way, declined to sign on to that pact. The summit yesterday gave the go-ahead for a new austerity pact, which is not only to… Read more »
Austerity for Governments but a Trillion for banks. Nice deal eh? The EU/Eurozone summitry, including the flood of media “soundbites,” is actually being made totally irrelevant by the banks’ own steps to secure the money they urgently need right now, rather than wait for some summit decision to come at some time: as leaked by the FT, particularly the bigger European banks plan to borrow EU 1 trillion from the ECB’s special window at the end of February. And the word is already out among bankers that this will naturally not be the end of borrowing, that more money will… Read more »
Economic Terrorism The term economic terrorism is strictly defined to indicate an attempt at economic destabilization by a group. More precisely, in 2005 the Geneva Centre for Security Policy defined economic terrorism in the following terms: Contrary to “economic warfare” which is undertaken by states against other states, “economic terrorism” would be undertaken by transnational or non-state actors. This could entail varied, coordinated and sophisticated or massive destabilizing actions in order to disrupt the economic and financial stability of a state, a group of states or a society (such as market oriented western societies) for ideological or religious motives. These… Read more »
Thanks David This is all smoke and mirrors. It is election year in America and the media are keeping people stupid with the presidential circus. It takes their minds off reality Politicians are there to put rules in place and in Irelands case there were no rules and regulations keeping the banks in check. Mama Harney and crew are to thank for that. Enda Kenny’s remarks are sickening but they only show us the true allegiences of our politicians. They are sleaze merchants and it sickening to think that this guy would still get elected if there was an Irish… Read more »