Now there we were, thinking that financial markets didn’t like defaults. In fact, we were warned that if we were to do something as dastardly as not pay Anglo unsecured creditors, the sky would fall in. This line has been followed by our state as if it were gospel.
Yet on Friday, we see that not only is it not gospel, it is nonsense. The financial markets didn’t sell off, but rallied enthusiastically after the news that Greece had defaulted spectacularly on sovereign debt, not bank debt. So the markets that lent Greece money rallied on the news that Greece wasn’t going to pay the money back.
The largest sovereign default ever – and the only one in a developed country in 60 years – was embraced by the financial markets. In fact, for what it’s worth, the Greek stock market rallied too.
So what does this tell us?
It tells us that financial markets have no memory. They move on. It also means that when something becomes inevitable, sensible people accept it and make provisions. The fact that the default was not orderly or chaotic makes no real difference. Only weeks ago, creditors of Greece were saying that they wouldn’t accept default (as if they had a choice).
Yet by Friday, 95 per cent of all creditors said that they would accept losing half their capital.
The other 5 per cent, let’s call them ‘rouge creditors’, who won’t accept the deal and want all their money back, risk getting nothing.
So what happened to the so-called vindictive financial markets, and what they would do to Greece if Greece defaulted? They rolled over. And what about the ATMs? Remember the notion that the ATMs wouldn’t work if bondholders didn’t get paid? Well, ATMs worked just fine in Athens on Friday evening.
More significant has been the U-turn by the troika. A few months ago, the EU view was that no default could be contemplated yet, on Friday, even the so-called hard-line Wolfgang SchÃŒuble, German finance minister, called the deal an “historic opportunity for the country”.
So what we are seeing is a U-turn in attitudes as events overtake the big players. The biggest enemy of dogmatic positions are rarely other ideas, but events and the march of time. As Greece contracted and contracted, the idea that it could pay its debts evaporated.
The new reality is one that we have been arguing here in this column all along, which can be summed up by the idea that you never make a balance sheet better with more debt – you make it better with less debt.
Now what does all this mean for us in Ireland, as we move forward?
It means that we, too, will get a debt deal on banking debt, not just the promissory note. The question is whether we are best to go for it now or wait for something much bigger down the road.
Let me explain what I am on about when I say “much bigger down the road”.
At the moment, the central banks of the world are responding to this mega-debt crisis and the consequent de-leveraging that we are witnessing everywhere with lower and lower interest rates. Interest rates are as near to zero as possible. In the US, the Federal Reserve said that it would keep rates as low as necessary. In fact, last Tuesday, when Fed chairman Ben Bernanke suggested he might not give all the free money the market wanted, there was a sell-off in the markets the next day. This was followed by a report on Thursday that the Fed would indeed provide more liquidity and, guess what, the markets rallied on Thursday afternoon.
The Bank of Japan, the Bank of England and the ECB are all at the same game. We are in the Year of the Central Bank, where the only action is what policy makers are doing.
They are injecting as much liquidity as necessary because the banks are in a very fragile position. Even the much-maligned stress tests of European banks show that banks need over €150 billion of capital right now. Banks can get this by either selling assets or raising equity. Given that they don’t want to do the former and can’t do the latter, the central banks have stepped in as lender of last resort.
Now, let’s get a handle on how much money we are talking about.
Over the last three and a half years, Britain, Europe, Japan and the US have boosted their central bank balance sheets to $8.76 trillion, and pumped out that much new money into the banking system.
The central banks have opened the discount window and taken in all sorts of collateral and, in return, given out this cash.
Today, the balance sheet of the ECB is 30 per cent of eurozone GDP. The figure for the Federal Reserve is 17 per cent and the Bank of England 18 per cent. This is an increase without historical precedent or parallel in peace time. Under these circumstances, we may say that the economy is ‘recovering’ – as we have been hearing in the US – but it lacks real meaning because we are so awash with central bank cash and credit.
Now here’s the rub. What goes in must come out. As all this cash finds its way ultimately into asset prices and inflation, the central banks will have to take it back out of the system because they can’t countenance mass inflation.
So what will they do?
The will raise interest rates rapidly and maybe much more rapidly than we expect.
Last week, I was lucky enough to hear 87-year-old Paul Volker speak at a conference. As he got up on stage, I thought to myself that when this guy was head of the Federal Reserve, after a bout of inflation he raised interest rates to 20 per cent to purge the system. Last week, the same short-term rates in the US were 0.2 per cent.
Could the greatest monetary splurge in human history be followed by a Volker-style whiplash in interest rates, the likes of which we haven’t seen in a generation?
The answer is yes, but maybe not to the same magnitude seen in the early 1980s. But it could happen if inflation took off, forcing the central banks to reverse their policy of the past three years.
What would happen here, if real interest rates in Europe went up to 5 per cent to choke off inflation? After all, don’t forget that savers in Germany would benefit from this. Here would be chaos, mass default, bank failure and another credit crunch, but this time on a much greater scale.
A whiplash in interest rates is not remote, in fact, it is quite likely. Given the fragility of our banks, the state of their mortgage books and the fact that people can’t take any hikes in interest rates, the lesson from Greece is that we’d better position ourselves for higher – not lower – interest rates.
At least we now know for sure, creditors will do a deal because events will overtake them. The centre doesn’t hold and the world quickly moves on to the next paradigm.
Great Article David,
The genie is now out of the bottle.
Not surprised if Interest rates shoot up in the future. So, if anyone out there is thinking of getting a mortgage to buy a house now, here is some FREE IMPORTANT advice from a trusted economist with a proven track record. Cue accelerated mortgage defaults. Cue house prices plummeting further, into 90% fall from peak territory.
So don’t come to this forum in 5 years time, worried about negative equity you got yourself into. Don’t listen to Frank Daly and his pals at NAMA, they want to enslave you.
David we are coming to the end of this experiment in Keynesian economics where unlimited amounts of new money are constantly injected into the money supply to stop any hint of a slowdown. The new money is no longer producing any growth at all and we are now at the “debt saturation ” stage in this experiment where no matter how much new money is introduced no new growth will occur. This will not stop the main central banks from trying like crazy to kick start our economies and we are now heading into the “QE to infinity” phase of… Read more »
Paul Volcker Has Read Glass-Steagall… And Saw That It Was Better Than His Own Volcker Rule! Pity someone did not pose this at the conference. The question is not about interest-rate policy, it’s about derivatives. October 28, 2011 In an interview with the Financial Times yesterday, former Federal Reserve Chairman Paul Volcker says that banks should not complain about his provision on proprietary trading in the Frank-Dodd Act, because Glass-Steagall was much stricter. Formally, it’s a defense of his toothless reform, but he himself says that Glass-Steagall was better. Writes the Times, “If the banks do not like his rule,… Read more »
You’re probably right David, once all this moolah finds its way into asset prices many are expecting gargantuan inflation. That’s why I piled what little savings I had into gold and silver bullion rather than put a deposit down on a house back in 2009. So far so good but time will tell if that was a wise decision.
Great article, indeed, but what makes you say that Greece has less debt? In fact, they’ve been relieved of the odd 100 billion euro in bank credit, but are saddled with a new debt of 130 billion sovereign debt, be it on less harsh terms.
As for higher interest rates, never before US general elections in November.
“The central banks have opened the discount window and taken in all sorts of collateral and, in return, given out this cash.” Not in the UK they haven’t. The amount lent on the discount window is zero. There has been no propping up of the capital side (beyond the share purchased of the part nationalised banks). There has only been cash available on the liquidity side – which is nothing more than an asset swap. If there is lending expansion then that is because of tardiness in bringing in tight capital rations, and the fact that banks can still fund… Read more »
Kenny and co the very people who are supost to have the Irish people’s best intrest are not doing what we elected them to do kenny says we will pay our depts ,that’s easy for the likes of him to say the domestic economy is chrashing down around us my mother is sick in the Lourdes hospital and her other son lives in Dublin and works for the HSE can afford diesel to go to drogheda to see his sick mother in hospital because he is trying to survive on low pay with for kids to feed and look after… Read more »
subscribe.
And yet again another fine lucid article. I’ve just heard a guy (sorry Guy, forgot your name, but he was a CEO of a think tank) state on the Al Jazeera economics program that China could buy up all the debt of the PIIGS and have money to spare to buy Microsoft and then some. The reason they won’t, methinks, is twofold. They’ll let the old system sink into a cesspool of a failed Capitalist model to weaken it further and because they haven’t fully developed a new system yet. That system will not be democratic but they see where… Read more »
Great article. The “much bigger down the road” concept says it all. Whether we like it or not, people are not hanging about forever and at the same time, doing a deal too early in an environment where things are starting to take off if just plain crazy. If interest rates are rising, it means there is a demand and that means more exports and people want their money back to start investing again….
Summer’s coming.
It just goes to show that we’ve only just swapped one bunch of feckin ejits for another bunch of feckin ejits to run the country. Kenny and co simply haven’t got ‘the message’. It’s true what David’s said time and time again if a country defaults it’s not going lead to armageddon!!!
Schäuble (German Finance Minister) was just on TV saying that there will be no similar deal for other countries in debt. However as David pointed out what is denied today can be reality next week.
Death by a thousand cuts for the EU perhaps or if defaults were allowed for the rest of those countries who are actually already insolvent would this actually save Europe?
Is it worth saving?
Great article.
When the ECB was founded, a lot of noise was made about how it would not be controlled by the politicians. The EC would have institutional independence.
The fact is that the ECB is controlled by the Big banks.
And so are the politicians. (Well Sarkozy is, but Hollande is making the noises of somebody who is not controlled by big finances).
They call him super-Mario now. But in the history books, he will be hyper Mario.
Portugal – the next shoe to drop ?
http://www.economonitor.com/blog/2012/03/portugal-gradually-shuffles-its-way-up-towards-the-front-of-the-debt-queue/
Edward Hugh is a UK economist who is in semi-retirement in Spain. His views on Spain have been predictive. Here he reflects on austerity in Portugal.
Ireland was dudded – again: which makes me more interested in the result of the vote than ever, to see if the Irish people actually get kicks out of sporting the hair shirt.
Great article David and rite on the money. Bit if the track of the article, I’m looking for advice. Have a bit of cash to invest and I am thinking of buying about €10,000 worth of BOI shares – am I mad?
David please what do you think the Irish government is doing wrong to protect the Irish people at the present time.
SPIEGEL reports this week that the German government didn’t reach even half of its planned savings in the federal budget. Only 42 percent of the spending cuts named by Merkel’s coalition government, comprised of the conservative Christian Democrats and the business-friendly Free Democratic Party, were actually not implemented.
Calculations made by the influential Cologne Institute for Economic Research indicate that only €4.7 billion ($6.16 billion) of the €11.2 billion in austerity measures stipulated by the savings package actually took shape in 2011
http://www.spiegel.de/international/germany/0,1518,820828,00.html
So for those interested in the Icelandic model… Worth a read http://blogs.ft.com/economistsforum/2012/02/iceland%E2%80%99s-new-banking-disaster/
I was over with my dad during the week, he found a bank letter from April 1980 announcing an increase in interest rates to 16.5%. It was scary to hold it. Rates went even higher after that.
Yes, another great read, David. As always I learn from both your articles and the discussions that follow. Just one point. I often feel it’s like watching a lecture where the speaker immediately leaves the podium without answering questions. I know you are very busy, and sometimes you do give short replies; also you may prefer to have others let the ball roll whither it may. But, looking at regulars like Furrylugs and Molly66 asking heart-felt questions as they do above directly to you, I just feel you could address them personally. That would be icing on the cake, and… Read more »
[…] experience hasn’t proved this to be false, the Greece default last week certainly has. David McWilliams had this to say Now there we were, thinking that financial markets didn’t like defaults. In fact, we were warned […]
I disagree with the big love-in going on here. The punch in this article rests on a single prediction on the role of the central banks in the near future; “The (sic) will raise interest rates rapidly and maybe much more rapidly than we expect”. Will this not mean curtailing the never ending profit bandwagon the banks, and financial institutions, been on? ( i.e. with faux profits reckless asset and bond lending and real profits from bailouts/carry trade/repo speculation on assets and bonds ). Concerted interest rate rises will kill growth across the world too. This would mean the show… Read more »
Why have we subordinated government to big banks? Let them all collapse and bring in Canadian banks to to replace them.
heres The view of Ireland form the Australian abc television show Four Corners,an Australian version of panorama or primetime…Features interviews with such illustrious individuals as Simon Kelly….one breakfast deal in the shelbourne was worth 220 million….many others….iinteresting comment about connections and links on the board of Anglo Irish to friends of Brian Cowen……ah well…what did we expect ???
http://www.abc.net.au/iview/#/view/908646
cut and paste….45 minutes long…..
Everytime I hear a quote from our government in regards to europe, I cant help but feel that the movie “Invasion of the body snatchers” was not a piece of fiction after all. I mean everytime an official boards a plane on the way to brussels they give speeches etc…on how they will fight for ireland. But as soon as the meeting in europe is over and they return they cant remember what they went to europe for or what the people want. They then spew some euro waffle. Have they been replaced already? Now, coming back to the article… Read more »
to: finegael@finegael.com
Dear Taoiseach,
in the light of Greece getting a 100 billion Euro write-down on their debt, I now ask that you seek similar terms for this countries Government volunteered debt!
You may be a martyr for the banks but by G-d I am not!!!
by the people, for the people….remember!!!
Is mise et cetera,
Josey
Very insightful stuff and feels like looking into a crystal ball containing a kaleidoscopic view of events in the near future You are reminding us that we should take anything we hear in the media with a large grain of salt and to trust our own judgement and common sense. No one knows what the world will look like in a years time but you told us three years ago that the creditors, politicians and mainstream media were all bluffing and now you have been proved correct. A man with vision and a track record cannot be easily ignored This… Read more »
When will the Irish people finally realize that Ireland’s two governments, elected and non-elected, have zero to negative interest in the Irish peoples’ welfare with regard to European diktats? Their missives regarding the ‘green jersey’ run counter to the ‘blue and yellow jersey’ once aboard Air Corps One en route to meet their EU bedfellows. Resolved, we are an export economy. Our latest budget ‘mission statement’ is a concerted drive to cement trading relationships with the BRICS nations (Brazil, Russia, India, China & South Africa). Good call. What part of the Euro are any of these nations aligned to? A… Read more »
David,
In regards article I reckon the figures and stats with CB etc are official figures used to window dress the public.
The shadow banking system and its CDS ponzi pyramid doomsday device is ticking away and when do the CB and relevant authorities etc ever even mention these numbers in tandem.
Never.
The official figures are nothing but a falsity and to sift through them to find sense IMO is really just fools gold.
I’m tempted to say that Greece should be used as a model of how to do things in the present circumstances and after reading this article. I wonder what would be wrong if all EU countries followed suit and even offloaded all it’s debt onto the ECB? The ECB would then have control over interest rates and curb inflation.
Greece defaults and we are all still here
Spain,this evening gets a softer deal from EU on its budgetary constraints.
Ollie Reihn says No to Noonan and Ireland regarding the postponement of Anglo 3.1 Billion payment at end of March.
Why are we asking for permission when all the disaster forecasting has proven to be bullshit ? and………….we are over 12 years old !
Property Crash
Cote D’Azure is currently suffering a property fall and this has been announced today in the local press .Is this the beginning of a shaky road in France . Paris has no report issued yet .How long more will that take ?
David is Elliot Ness just a fantasy figure?
Or do you ever imagine Ireland being cleansed to the extent that we will have real democracy and people who are incorruptable?
There are people of principle and who are incorrputable but they are few
1 out of 35 people in this world today is a migrant…. just saying
Doom and gloom and worst case scenario economics on Newsnight right now – might be worth a watch.
http://www.youtube.com/watch?feature=player_embedded&v=yjhxp-JJqDo
Noonan argues against paying Anglo promissory Note December 2010.
Clear conscise overview of the entire anglo promissory note by Noonan and shocking how he has changed his tune….
So to summarise, following years of austerity and pain, central banks who caused the credit bubble to begin with, are now in the process of acquiring our assets. Sound familiar? Who are the ECB? We didn’t elect them and they don’t answer to our leaders.
Year Of The Central *ank
^^ Plank?
Morning,
Interesting piece on deleveraging by Martin Wolf in FT. Also, I came across this link last night which puts Ireland into perspective. BTW the original book is a must read.
http://www.reinhartandrogoff.com/data/browse-by-country/
Best
David
Just read the first paragraph of this before heading to class, looks like it might be a good read:
http://www.nytimes.com/2012/03/14/opinion/why-i-am-leaving-goldman-sachs.html?_r=4&pagewanted=1
For perspective, Gerry Adams said yesterday : “Olli Rehn’s claim that respecting commitments and obligations is a key tradition in EU law is a nonsense. It was never applied to France or Germany when both regularly breached the stability and growth rules. “Germany breached the deficit rules in 1994, 1996, between 2003 and 2006 and each year since 2009. It has broken the debt to GDP rule every year since 2003. “France has broken the deficit rule every year since 2003 and has breached the debt rule every year since 2003. “It is clear that for Mr. Rehn there is… Read more »
Off topic…Never too late…. to die for your country!… -Motherfuckers! –
Survivors of Britain’s 1950s atomic tests in the Pacific….the supreme court ruled that their action should be time-barred because it had been brought too late.
http://www.guardian.co.uk/law/2012/mar/14/pacific-atomic-test-survivors-mod
In France Presidential Candidate Cheminade confronts “Collective Anaesthesia.”
That has now worked, and British press is having a fit.
I hope no one here is pursuing collective anaesthesia?
[…] Keep your pension pot away from the sharks Energy index rises 8 per centenergy index up Year of the central bank Government pledges ?45m to boost exports Richest 300 Irish now worth ?62bn If we all want jobs, […]
Who is Olli Rehn?? and when did he buy Ireland?
Don’t remember that transaction!
MUST READ!
Ex Goldman Sachs Banker
http://www.nytimes.com/2012/03/14/opinion/why-i-am-leaving-goldman-sachs.html
Brief but detailed picture of how the Irish taxpayer is being screwed to benefit foreign banks (names names).
http://dailybail.com/home/rothschild-bank-and-goldman-sachs-are-both-on-the-list-of-bo.html