Keynesian clowns are concerned about the decline in government jobs in the past few years. They want the government to step up spending and hire more workers to make up for the loss of jobs in the private sector.
Here is a chart from reader Tim Wallace that will help put the recent loss of government jobs in a better perspective.
Percentage Job Growth vs. Population Growth
click on any chart for sharper image
The growth in government jobs is not sustainable nor is there any genuine excuse for it other than political pandering and vote-buying operations.
The deviance between private bobs and population growth is easily explained by the entry of women in the workforce.
Percentage Male and Female Job Growth vs. Population Growth
Note how the percentage growth of men in the labor force closely tracks population growth the percentage growth of women in the workforce has skyrocketed.
Employment in Millions
Entry of women in the workforce allowed much higher household debt levels than ever before.
Now what?
I'll tell you what. Ability of households to take on more debt has peaked. There are no more female workers to add to the pool. Everyone male or female is working (or is looking for work) whether they really want to or not.
Women actually overtook men in the work force way back in 1990.
Percentage of Total Workforce That is Female
Unfortunate Facts
The unfortunate fact of the matter is everyone need to work to pay off accumulated debts and meet living expenses, but the jobs are not there.
The second unfortunate fact is we cannot afford and do not need all of the existing government jobs.
The third unfortunate fact is demographics are no longer favorable. Indeed, there are too few jobs, too much student debt, and too few workers supporting too many retirees on Social Security.
Those unfortunate facts happen to be highly deflationary.
Just 14% expect today's children to be better off than their parents
Just 31% believe the U.S. economy will be stronger in one year
Just 27% think the country is heading in the right direction.
Just 24% of American Adults believe the job market is better than a year ago
44% think the job market is worse, up 15 points from June
Demographics Suggest Majority is Right
I happen to agree with the majority who think those now graduating from high school will not be better off than their parents.
There are too few jobs, too much student debt, and too few workers supporting too many retirees on Social Security.
Who Will Address the Problems?
As I look out on the political landscape, I see little hope that either Republicans or Democrats will address these problems.
Republicans refuse to address the income side of the balance sheet, and Democrats refuse to address the spending side.
Neither party is willing to tackle military spending.
How long the market lets these can-kicking exercises continue is anyone's guess, but the longer this goes on, the more pain there will be.
The culmination will be a currency crisis at some point down the road. Timing is very problematic. Japan proves debt-to-GDP ratios may go on much further than anyone thinks possible.
Markus Söder, Bavarian Finance Minister: The politician from the Christian Social Union, the conservative sister party to Chancellor Angela Merkel's Christian Democratic Union, is known for his tub-thumping rhetoric and has stepped up a gear in the euro crisis with vitriolic comments about Greece. "An example must be made of Athens, that this euro zone can show teeth," he told the Bild am Sonntag tabloid newspaper this week.
Alexis Tsipras, the leader of Greece's leftist Syriza party: In his latest proposal, Tsipras argues the Greek government should refuse to talk to the so-called troika comprised of the European Commission, the European Central Bank and the International Monetary Fund. He wants to "criminalize" the privatization of public enterprises. He has been labelled the "most dangerous man in Europe" since he became leader of the radical left and has been pressuring successive governments to abandon austerity measures that underpin Greece's continued access to international aid.
Silvio Berlusconi, entrepreneur and former Italian prime minister: His Popolo della Libertà (People of Freedom) party supports current Prime Minister Mario Monti but is secretly preparing for Italian elections next year. Berlusconi wants to win a fifth term as prime minister with the help of populist anti-euro rhetoric. He recently said the Italian central bank should simply print more euros to avoid instructions from Brussels. He has also threatened to reintroduce the lira.
Marine Le Pen, leader of the far-right Front National in France: The populist politician campaigned in this year's presidential election by warning about the supposed might of the EU. "Frau Merkel and her friends, Van Rompuy and the European Commission are in the final stages of creating a European Soviet Union," she thundered. "We are about to lose our status as a free nation."
Timo Soini, leader of the True Finns party and a member of the European Parliament: Since the election, Finland has demanded that Greece provide collateral in return for Finnish aid. Soini wants that aid to stop. "Not a penny more," he says. "We've paid enough."
Alexander Dobrindt, general secretary of the conservative Bavarian Christian Social Union (CSU): "It's the end of the line for Greece," Dobrindt said recently. Previously, he had demanded that the Greek government should no longer pay its civil servants and pensioners in euros but in drachmas.
Nigel Farage, leader of the UK Independence Party (UKIP) and a member of the European Parliament: Farage is the man who can cause an uproar in the otherwise dull European Parliament, where he called the Lisbon Treaty "the most spectacular, bureaucratic coup d'etat that the world had ever seen." He has described European Council President Herman Van Rompuy as having the "charisma of a damp rag."
Heinz-Christian Strache, head of the Austrian Freedom Party (FPÖ): Strache claims that the permanent euro bailout fund, the European Stability Mechanism (ESM), will destroy "not only our state, but also our democracy and constitution." He says the ESM is tantamount to an ´Ermächtigungsgesetz, an allusion to the 1933 German law that allowed Hitler to rise to power.
Geert Wilders, head of the Dutch Freedom Party (PVV): Wilders wants to see the return of the Dutch guilder and described the ESM as "a dictate from Brussels."
Viktor Orbán, Hungarian prime minister: Orbán's statement that he would bow to Brussels' power but not to its arguments created considerable irritation.
Der Spiegel is Clueless and Dangerous
While the list does include some fascists and other questionable characters, the main "crime" against the collective group is they seek to end the euro.
Reader "Martin" from Australia writes ...
Hello Mish
Der Spiegel's article on dangerous politicians is a good example of how clueless main stream media is. While some in the list are clearly facists like Orban and Le Pen, the media tries to discredit Nigel Farage by putting him in the same group.
By the way Der Spiegel is considered a major respectable magazine. They all work for the EU.
Regards, Martin, Sydney, Australia
Eurozone Cannot Possibly Survive
Reader Martin is exactly correct. In this regard Der Spiegel is not only clueless, but dangerous, because it fans myths that the eurozone can survive intact (it cannot), and the myth the euro is worth saving in the first place (it's not).
Mish's Top List of Europe's Most Dangerous Politicians
Angela Merkel, Chancellor of Germany, deserves special mention. Merkel is widely blamed for not doing enough to keep the eurozone crisis from spreading. However, her hands are tied by constitutional issues as well as political issues within her coalition. Yet, every step of the way Merkel caved in to demands of those desperately attempting to save the unsaveable. Nothing is more dangerous that ranking politicians on a mission to do the wrong thing, hoping to preserve their legacy.
David Cameron, UK Prime Minister: Cameron refuses to call a vote on exiting the EU even though the UK is damaged by inane EU rules. Last December, Cameron almost gave in to ridiculous EU treaty changes but did not do so only because he was dead set against preposterous financial transaction taxes proposed by Brussels. Were it not for the financial transaction tax, it appears Cameron would have done the wrong thing.
Mario Monti, technocrat Prime Minister of Italy. Monti was never elected, he was installed by eurocrats because he would support the euro.
Herman Van Rompuy, European Council president: Van Rompuy spends his time flying all over Europe promoting discarded eurobond ideas. He seldom shows up in European Parliament.
José Barroso, European Commission president: Farage describes Barroso as "delusional idiot and was a supporter of Chairman Mao"
Reflections On Merkel
Nigel Farage properly classifies Barroso as a "delusional idiot". The same applies to Herman Van Rompuy, and self-admitted liar Jean-Claude Juncker.
In contrast, Chancellor Merkel is anything but a delusional idiot.
Rather, Merkel is an extremely skilled, as well as widely respected if not charismatic leader, with a seriously misguided notion there needs to be a European nannyzone super-state. Worse yet, she appears willing to sell her soul and the future of Germany to secure that outcome.
As noted above, nothing is more dangerous that ranking politicians on a mission to do the wrong thing, hoping to preserve their legacy.
Without a doubt, Merkel's attributes make her the most dangerous politician in Europe.
A Note About Nigel Farage
Der Spiegel labeled Farage Europe's 7th most dangerous politician. Check out the platform of UKIP, Farage's party.
We believe in the minimum necessary government which defends individual freedom, supports those in real need, takes as little of our money as possible, and doesn't interfere in our lives.
I think the Republican Party in the US should adopt that platform and that anything except a platform based on minimal government and individual freedom is dangerous.
No price of labor is too high if you are a supporter of public unions. Here is a case in point: In Hermosa Beach California, Police Chief Steve Johnson and Councilman Howard Fishman defended $100,000 meter maid positions on the grounds "When you outsource, you take away union jobs."
Note that meter maid positions do not require much more than the ability to drive a standard transmission car and have a high school diploma.
When contemplating the many reasons cities in California and elsewhere are venturing closer to bankruptcy, look no further than the relatively lucrative and often-unjustifiable salaries bestowed on municipal employees – and the lofty pension benefits attached to the high pay.
One of the latest examples comes from the California coastal city of Hermosa Beach, where some community service staffers who collect money from parking meters and manage their operations – positions once widely known as "meter maids" – are making nearly $100,000 a year in total compensation, according to city documents.
There are 10 parking enforcement employees for the 1.3-square-mile beach city southwest of downtown Los Angeles, and they pull down some disproportionate compensation, considering their job functions. In fact, the two highest-earning employees for fiscal year 2011-12 are estimated to have made more than $92,000 and $93,000, respectively, according to city documents provided by Patrick "Kit" Bobko, one of five council members and who also serves as mayor pro tem. Those two have supervisory roles. The other eight parking-enforcement employees make from $67,367 to $84,267 in total compensation.
Bobko also wrote in a memo that the retirement costs for these 10 employees "from [fiscal year 2011-12] through their retirement age at 62 was nearly $1.6 million, and the medical costs for these employees from this fiscal year to their retirement at age 62 would be $1,353,827." Excluding salaries, the [retirement] contributions and medical costs for the 10 employees performing parking enforcement will cost, on average, nearly $300,000 apiece."
Aside from the personnel costs, there has been criticism from Hermosa Beach Treasurer David Cohn that parking meter operations have been mismanaged. Cohn cited nonfunctioning parking meters, a backlog in disputed parking tickets and problems with the accounting for revenue.
Bobko is pushing a plan to outsource the city's parking enforcement operations, which he says will save money, reduce maintenance costs, relieve the city of accounting functions related to parking enforcement, increase efficiency and, perhaps most importantly, increase revenue and "reduce the city's pension and salary obligations."
There has been opposition to the outsourcing proposal from Hermosa Beach's Police Chief Steve Johnson and Councilman Howard Fishman. Both expressed concerns about letting go full-time city staff. Bobko accurately characterized the resistance: "When you outsource, you take away union jobs."
As I have said repeatedly, the goal of public unions is to little or no work for enormous sums of money at taxpayer expense.
In these trying times, one might think that public union supporters would back off of ludicrous demands, at least a tiny bit.
However, statements by union nutcase supporters like Police Chief Steve Johnson and Councilman Howard Fishman show the only solution is the complete elimination of public unions.
If that sounds harsh, please note that even FDR would agree.
All Government employees should realize that the process of collective bargaining, as usually understood, cannot be transplanted into the public service. The very nature and purposes of Government make it impossible for administrative officials to represent fully or to bind the employer in mutual discussions with Government employee organizations.
Particularly, I want to emphasize my conviction that militant tactics have no place in the functions of any organization of Government employees.
A strike of public employees manifests nothing less than an intent on their part to prevent or obstruct the operations of Government until their demands are satisfied. Such action, looking toward the paralysis of Government by those who have sworn to support it, is unthinkable and intolerable.
Top Chinese banks are involved in Ponzi financing of investment deals, offering interest rates over 7% to depositors, to finance real estate projects gone bust and other projects whose assets are not even disclosed.
Banks label these schemes "Wealth Management Products" (WMPs) but any individuls foolish enough to invest in them are going to lose money, perhaps all of it.
The Chinese investment vehicle known as "Golden Elephant No. 38" promises buyers a 7.2 percent return per year. That's more than double the rate offered on savings accounts nationally.
Absent from the product's prospectus is any indication of the asset underpinning Golden Elephant: a near-empty housing project in the rural town of Taihe, at the end of a dirt path amid rice fields in one of China's poorest provinces.
"They haven't even built a proper road here," said Li Chun, a car repairman, who said he lives in the project. "The local government is holding onto the flats and only wants to sell them when prices go up."
Golden Elephant No. 38 is one of thousands of "wealth-management products", instruments aimed at monied investors, which have shown phenomenal growth over the last five years. Sales of them soared 43 percent in the first half of 2012 to 12.14 trillion yuan ($1.90 trillion), according to a report by CN Benefit, a Chinese wealth-management consultancy.
They are usually created in China's "shadow banking" system - non-banking institutions that are not subject to the same regulations as banks - which has grown to account for around a fifth of all new financing in China.
Like the subprime-debt lending spree in the United States that helped spark the 2008 financial crisis, the products are often opaque, and usually dependent on high-risk underlying assets, such as the Taihe housing project.
We wrote last week that China's shadow banking system was reflecting and, to an extent, contributing to a growing liquidity risk which in turn is being exacerbated by net capital outflows. Since then, there have been some interesting revelations on the domestic liquidity management, especially in shadow banking, and especially especially in wealth management products.
To recap, wealth management products or WMPs are a little like a term deposit, only they offer Chinese investors a more appealing rate of return than a normal bank deposit (which will deliver a negative real return) and it can be backed by assets — effectively, an informal securitisation.
If you're wondering what sort of assets that includes, Reuters wrote up an excellent investigation of the WMP scene, beginning with the case study of "Golden Elephant no. 38″ which promises a 7.5 per cent return. It shows just how illiquid some of these things are.
At the same time as the risks around WMP issuance are gaining attention, something else is going on in Chinese financial system: interbank assets are surging, as Also Sprach Analyst points out.
There's no knowing when, how or if some kind of liquidity crisis might happen in the Chinese banking system, but there are plenty of possible triggers to be found.
A story on Tuesday in China Daily cited a study by The Chinese Banker that found capital shortfalls among the five biggest banks would grow sharply in 2012 and 2013. The China Daily link is now broken, unfortunately, [Mish Note: the link is now working] but Chinascope Financial has a summary:
"Data from the report shows that capital shortfall in China's major five state-owned banks in 2012 will be: CNY 60.4 billion (Industrial and Commercial Bank of China), CNY 63.5 billion (Agricultural Bank of China), CNY 37.6 billion (Bank of China), CNY 35.4 billion (China Construction Bank), and CNY 47.8 billion (Bank of Communications). By the end of 2013, the capital gap of the five banks will further increase to CNY 69.1 billion, CNY 83.8 billion, CNY 78.7 billion, CNY 39.9 billion and CNY 68.7 billion, respectively."
Capital Shortfalls
Alphaville totaled the above numbers and came up with a capital shortfall of Rmb 244.7 billion for 2012 and a Rmb 340.2 billion shortfall by the end of 2013.
While converting Rmb 244.7 billion to US dollars (the answer is $72.11 billion), I accidentally stumbled across the Rmb 244.7 billion figure in KPMG China's weekly banking news summary
Better than expected profits from Chinese banks
Ten Chinese commercial banks have reported better than expected net profits of RMB 244.7 billion (USD 72.11 billion) in the first half of 2011, approximately 30 percent more than the net profits reported for the same period in 2010. The increase was boosted by strong growth in the banks' net interest income and intermediary business.
Better than expected earnings exactly match expected capital shortfalls. Fancy that.
Poway, Golden Elephants, and Pay Option ARMs This setup sounds much like the "better than expected earnings" reports by US banks in 2006 on Pay Option ARMs. No money came in to banks but accrued interest added to the bottom line (until the deferred payment scheme on questionable assets blew sky high).
Poway vs. "Golden Elephant"
"Golden Elephant" also sounds like the Ponzi scheme in Poway, California.
Poway borrowed $105 million and will defer interest and principal payments for 20 years at which time Poway will owe $1 billion.
Regarding Poway, I was asked "Who is dumber, the city of Poway or the bank that made the loan?"
That's a good question. Certainly the bank that originated the loan will not be paid back if they hold this loan to term. But did they keep it? Given the fiasco in Pay Option ARMs I rather doubt it.
Indeed, I highly suspect the bank that originated the deal sold the loan to some unsuspecting pension plan such as CALPers, or perhaps some plan covering Poway itself.
President Barack Obama tapes the Weekly Address in the Diplomatic Room of the White House, Aug. 10, 2012. (Official White House Photo by Chuck Kennedy)
Photo Gallery: Behind the Scenes of July 2012
The White House Photo Office just released their latest batch of behind-the-scenes photos, including the Independence Day celebrations at the White House, President Obama meeting with Team USA before the Olympics, and the First Lady in London. Check out a few of the images below, then head over to Flickr to see all 50 images in the gallery.
The price of corn is at all all-time high because of extreme drought conditions in the US coupled with the hottest July temperatures since records began 117 years ago.
Inane Policies
US policy mandates production of ethanol for blending in gasoline. That ethanol comes mostly from corn.
Diverting corn crops to inefficient ethanol production has members of the Group of 20 leading economies – including France, India and China – concerned about the US ethanol policy.
The US is poised to divert around 40 per cent of its corn into ethanol because of the Congress-enacted mandate despite "huge damage" to the crop because of the worst drought in at least half a century, José Graziano da Silva, director-general of the UN's Food and Agriculture Organisation, warned.
"An immediate, temporary suspension of that [ethanol] mandate would give some respite to the market and allow more of the crop to be channelled towards food and feed uses," he wrote in an opinion piece in the Financial Times.
Tom Vilsack, US agriculture secretary, raised doubts about the impact of waiving the ethanol mandate, arguing that the US biofuel industry had reduced petrol prices and created jobs.
Economic Dimwit or Shill?
The question at hand is whether the US agriculture secretary is an economic dimwit, a shill for the Obama administration, a shill for corn producers, or some combination thereof.
The US biofuel industry certainly has not reduced the price of gasoline. Tariffs on imported ethanol have kept the price of ethanol artificially high (but they did expire in December).
Fundamentally, government policies do not create jobs, they cost jobs. The best way to create jobs is for government to get the hell out of the way and let the free market work.
I do not know how much corn prices would drop if the US ended its inane biofuel policies. What I do know is government interventions and government-sponsored solutions never do any good.
Romney an Energy Pretzel
Which is worse? Being consistently wrong, or blowing so much in the wind voters haven't a clue what you stand for?
Obama, a floundering naif who thinks ATMs aggravate unemployment, is bewildered by a national tragedy of shattered dreams, decaying workforce skills and forgone wealth creation.
Romney cannot enunciate a defensible, or even decipherable, ethanol policy.
Life poses difficult choices, but not about ethanol. Government subsidizes ethanol production, imposes tariffs to protect manufacturers of it and mandates the use of it — and it injures the nation's and the world's economic, environmental, and social (it raises food prices) well-being.
In May, in corn-growing Iowa, Romney said, "I support" — present tense — "the subsidy of ethanol." And: "I believe ethanol is an important part of our energy solution for this country." But in October he told Iowans he is "a business guy," so as president he would review this bipartisan — the last Republican president was an ethanol enthusiast — folly.
Romney said that he once favored (past tense) subsidies to get the ethanol industry "on its feet." But Romney added, "I've indicated I didn't think the subsidy had to go on forever."
Ethanol subsidies expire in December, but "I might have looked at more of a decline over time" because of "the importance of ethanol as a domestic fuel." Besides, "ethanol is part of national security." However, "I don't want to say" I will propose new subsidies. Still, ethanol has "become an important source of amplifying our energy capacity." Anyway, ethanol should "continue to have prospects of growing its share of" transportation fuels.
Got it?
If anyone truly knows where Romney stands on ethanol, please tell me. Better yet, please tell Romney.
Reader "Paul" a high school teacher, wonders whether we have a spending problem or a tax collection problem.
"Paul" (name changed by Mish) writes ...
Hello Mish
I subscribe to your blog and refer to it a lot.
I'm having an argument with a friend who says the problem with the deficit is that many people do not pay their fair share in taxes. For example, my friend notes that Mitt Romney pays taxes at a 13% rate despite his huge riches.
My friend believes that if tax rates were adjusted higher for the rich and super rich we'd be out of debt. He is even a business owner who is part of the 1%!
Can you challenge what my friend says?
I have another question: You did a post that listed all the government funded programs you thought should be eliminated. Do you have a link to that article?
Paul
Hello Paul ...
There is a big information gap at play, actually several of them.
First, let me ask a question: Can you conceptualize $1 trillion? Other than "it's an enormous number", what does $1 trillion mean to you?
Bear in mind the US National Debt Clock shows public debt, not counting unfunded liabilities of Medicare and Social Security $16 trillion.
Forget about that $16 trillion for a bit and simply focus on the current budget deficit.
Notice that the US has had four consecutive budget deficits over $1 trillion. I expect 2013 will be the fifth.
Conceptualizing $1 Trillion
An excellent way to conceptualize a million, vs. a billion, vs. a trillion is in terms of time. Without doing any calculations, how long is a million seconds, a billion seconds, and a trillion seconds?
Here are the answers.
1 Million seconds is 12 days.
1 Billion seconds is nearly 32 years.
1 Trillion seconds 31,688 years.
Think about that while noting the deficit increased from $161 billion to well over $1 trillion for four years running.
Fair Share Tax Hikes
I have a set of questions for the "fair share" tax proponents.
Would fair share tax hikes be enough to fund US government spending?
What if we took 100% of the profits of Walmart and Exxon Mobile?
What if the corporate tax rate was 100% for every corporation?
What if we confiscated 100% of the wealth of the super-wealthy including Warren Buffet and Bill Gates?
What if we did ALL of the above? Would that balance the budget?
A recent Tony Robbins video making the rounds answers all of those questions. It is about 19 minutes long and well worth a play in entirety.
To meet total spending requirements of $3.2 trillion, but not counting $117 trillion in unfunded liabilities, not only would we have to do everything in the five point list above, but we would have to take the combined salaries of all players in the NFL, Major League Baseball, the NBA, and the NHL, cut military spending by $254 billion, and tax everything people make above $250,000 at a 100% tax rate.
That's what it would take to meet the 2012 budget of $3.8 trillion. It would do nothing to pay down the existing national debt of close to $16 trillion. It would not come remotely close to meeting $117 trillion in unfunded liabilities.
Snyder, referencing Ron Paul and Tony Robbins, writes ...
For the past four decades, the United States has been enjoying a 15 trillion dollar party. All of this borrowed money has enabled us to live far, far beyond our means.
If our politicians voted to severely cut spending or to raise taxes dramatically at this point, our economy would suddenly readjust to a more realistic standard of living. But that would be extremely painful and most Americans voters would be absolutely furious. They would demand that someone "fix" the economy immediately. But the truth is that what we have been enjoying all these years has not been real. It has been bought with trillions of dollars stolen from future generations. But most of our politicians just want to keep the party rolling as long as humanly possible so that they can keep getting voted back into office.
Some hard choices will have to be made, and there will be a lot of pain. The false prosperity that we are enjoying now is going to disappear.
Now is the time to prepare for the massive economic shift that is coming. In the coming economic environment, those that are currently living month to month and those that are 100% dependent on the system are going to be in a huge amount of trouble.
Instead of wildly spending money as if the good times will never end like most Americans are, now is the time to get out of debt, to become more self-sufficient and to set aside the money, resources and supplies you will need to weather the storm that is rapidly approaching.
Hard Choices
I certainly agree with Snyder regarding hard choices. And over the course of the next decade, the projected budgets show the choices are going to get much harder.
2012 Budget vs. 2022 Budget
Please consider projected budgets for the next decade, straight from the White House Office of Management and Budget.
In particular, note Table S-5 on page 210.
The projected cumulative budget for the next 10 years is an unbelievable $46.956 trillion dollars. Government spending is projected to escalate to a whopping $5.8 trillion a year in 10 years.
Noting the difficulty Robbins had in coming up with $3.8 trillion, pray tell what kind of "fair tax" hikes would it take to meet expenses of $5.8 trillion?
So, do we have a spending problem, or a problem of not taxing enough?
The answer is pretty clear.
Cutting Waste
To answer the second question by "Paul", I have written a number of articles about waste in the state of California (easily applicable to all other states), and waste in the US government budget as well.
Via email, Michael Pettis at China Financial Markets makes a compelling case why Spain is destined to leave the euro. For ease in reading, I added the subtitles in bold.
In my forthcoming book (Princeton University Press, February 2012) I argue that there is little chance that the euro survives the next few years, or that we avoid major sovereign restructurings and/or defaults. I am not just talking about Greece, by the way. I think a Spanish devaluation (accompanied inevitably by a sovereign debt restructuring) is pretty much a sure thing too, along with devaluations among many of the other obvious suspects.
After I turned in the completed manuscript of my upcoming book, my editors were a little worried about my extreme pessimism over the euro, and suggested that I hedge a little so as not to look foolish if these things didn't happen, but honestly I am less worried about that possibility than I am worried that by the time my book comes out Spain will have already abandoned the euro. I really don't see any progress at all in resolving the euro crisis, and the longer it takes to resolve, the more financial distress peripheral Europe will suffer, making a resolution of the crisis all the more difficult and urgent.
While they wait, Madrid should stick with the policies it is pursuing but intensify its work on the banking sector. If high yields persist, Spain can bear it for a while – no one should buy the kabbalism according to which a certain level of yields marks the entrance to a black hole. The eurozone needs to convince investors it will be able to act if panic persists, which it can best do by giving the new rescue fund a banking license.
But the best remedy against panic is reassurance. A greater sense of political competence in Madrid and of decisiveness in Brussels would do wonders.
I see it very differently. Policy is certainly adding to the problems in Spain, but I don't think it is because, as the editorial claims, Prime Minister Mariano Rajoy has mismanaged the political process, and I am not sure that greater political competence in Madrid, or decisiveness in Brussels (!), will do anything at all, let alone wonders.
Too Late to Save Spain
The problem, I think, is much more serious than Rajoy's flunking hard choices, and I don't think there was anything he could do to increase the country's credibility in a significant way. We have long passed that stage.
Why? Because, as I have been suggesting for the last six to twelve months, Spain has already started on its downward spiral and there is almost nothing Rajoy or anyone else can do to prevent all parts of the economy – workers, small businesses, large businesses, creditors, depositors, and yes, policymakers – from acting each in their own way to increase the debt burden, increase economic uncertainty, make the balance sheet more fragile, and reduce growth. These different economic agents by now are simply behaving rationally in response to declining credibility, and unless we expect from them a huge burst of irrational cheer, there is no reason to expect them to change their behavior.
All of their actions, of course, reduce credibility further, and as credibility drops it simply reinforces the adverse behavior of all the rationally misbehaving economic agents. This is the dreaded self-reinforcing loop typical of countries in the nightmare stage of a debt crisis.
We have seen this process many times before in the history of sovereign debt crises, and it is mind-numbingly mechanical. No matter how well Rajoy implements fiscal austerity (assuming that this is indeed the right thing to do), no matter how many times policymakers plead with markets to give them time to implement reforms, no matter how often the government begs workers and businesses to have more confidence, at this point it is going to be incredibly difficult for Spain to escape from this cycle.
Problem is Arithmetic
The problem is arithmetic, not confidence. Basic balance of payments math tells us that in order to repay its external debt Spain must run a large trade surplus. If it ends up however with a trade surplus caused simply by a collapse in domestic demand and soaring unemployment, which is the current path, domestic politics will become unmanageable and Spain will eventually be forced to leave the euro in order to regain competitiveness in a less painful way. One of the good things about a well-functioning democracy is that it simply won't permit a debt crisis to be resolved by forcing an unacceptable burden onto the working population.
Trade Surplus Math
The requirement for a trade surplus is the key point. Even if there were no capital flight, and assuming we are unlikely to see large investment-driven private inflows into Spain for many years – a pretty safe bet, I would think – Spain must run a large trade surplus in order to repay foreign debt holders (technically Spain must actually run a current account surplus, but in practice this means a trade surplus). Of course capital flight, which is already large and rising, as I will discuss later, means that Spain must run an even larger trade surplus than otherwise if it is going to repay external debt.
Under what conditions can Spain run a large enough trade surplus? There are really just four ways this can happen. One way is through a collapse in domestic consumption caused by many years of unemployment above 20%. In this case eventually relative wage growth will be sufficiently negative for Spain to regain competitivity, although declining prices and wages also mean that the debt burden will get worse during this period. Of course the political cost of many years of unemployment above 20% will be tremendous and almost certainly unsustainable, and we are already seeing this in the growing popular rage in Spain against the political establishment. There is no reason to think that popular anger won't get worse.
The second way is for Germany to reflate domestic demand enough to cause its large trade surplus to become an equally large trade deficit. This will allow eurozone countries like Spain to reverse their own deficits, which under the conditions of the monetary union were simply the flip side of Germany's surplus. If Germany does this, however, its own real growth will slow significantly and may even become negative for many years.
In addition Germany's debt burden will rise rapidly, because in order to reflate it will need to cut consumption and income taxes sharply, to boost fiscal spending, and to absorb rapidly rising non-performing loans in its banking system. As of now there seems little chance that Germany will do this, especially as it will also need to guarantee Spanish debt directly or indirectly to stop the downward spiral in the debt markets.
The third way is simply a variation on the second. The euro would need to fall sufficiently to allow the whole eurozone to run large – huge – trade surpluses. This is Martin Feldstein's argument in last week's Financial Times, A rapid fall in the euro can save Spain, where he suggested that "financial markets may already be in the process of forcing a solution upon Brussels policy makers".
The problem with this, however, is obvious. It can only work if Europe were small enough and the rest of the world were in good enough economic shape that the global economy could absorb a sharply rising European trade surplus.
But with deficit countries doing all they can to reduce their deficits, and surplus countries doing all they can to maintain or increase their surpluses, it is hard to imagine how Europe, which is already a surplus entity, can possibly increase its overall surplus enough to bail out peripheral Europe.
That leaves the fourth way. Spain can freeze banking deposits, abandon the euro, and devalue. This would be very painful, but it would allow the country to regain international competitiveness in much less time and run a trade surplus (mainly at Germany's expense, by the way) with much lower levels of unemployment and economic self-destruction. Of course it would also mean a soaring debt burden as the new currency devalues relative to the country's euro-denominated debt, and so would almost certainly come with a debt restructuring (again mainly at Germany's expense) that would reduce the debt servicing costs.
These are the four conditions under which Spain can run a sufficiently large trade surplus to service its external debt, and since three of them are impractical or highly unlikely, we are left with the fourth. This is why I think the probability of Spain's abandoning the euro is much higher than its staying in the euro.
Downward Spiral
Meanwhile, and in case there is any doubt, we have had more chilling news that indicates just how firmly Spain is caught up in the downward spiral. First, Madrid last week downgraded its growth forecasts, saying that the recession would continue into 2013.
This apparently shocked the market but I cannot see why. I have argued many times over the past three years that quarter after quarter policymakers are going to adjust their forecasts downwards, not because they have been dishonest in their previous forecasts but simply because they never take into consideration the impact that rising debt and declining credibility have on forcing adverse changes in the behavior of economic agents.
Expect Downward Revisions
The economy will always perform more poorly than expected because rational economic agents will always behave in ways that automatically make matters worse. Expect many more years of downward growth revisions, not just for Spain but for all of Europe.
Capital Flight
Second, money is fleeing the country. An article in Germany's Spiegel describes just how bad it is:
Capital outflows from Spain more than quadrupled in May to €41.3 billion (compared with May 2011, according to figures released on Tuesday by the Spanish central bank. In the first five months of 2012, a total of €163 billion left the country, the figures indicate. During the same period a year earlier, Spain recorded a net inflow of €14.6 billion.
Capital flight is one of the most powerful parts of the downward spiral, and of course it is extremely self-reinforcing. Capital flight is driven largely by disinvestment and bank deposit withdrawals, and the former reduces growth while the latter both reduces growth and increases balance sheet fragility.
We may have already reached the point where it will be impossible to stop the outflows, and I can't imagine that already-reluctant Germans are going to be happy to reconcile their increasing investment in Spanish government bonds with increasing disinvestment by Spanish businesses and depositors.
Silliness From Feldstein
I had bookmarked Martin Feldstein's column with an intent of challenging the notion that a falling euro could save Spain, but I failed to get around to it. The irony is just a couple years back, nearly everyone thought the solution to the global financial crisis was a cheaper dollar.
Indeed, a quick search shows that on August 24, 2011, less than a year ago, Feldstein argued in a Bloomberg Interview (Dollar Decline Benefits U.S. Economy) that "A lower dollar means more exports, and it also means a shift from consuming imported products to consuming goods and services that we produce in the United States".
Apparently a lower dollar and a lower euro are both needed. Given the euro is 57% of the US dollar index just how likely is that?
Moreover, a falling euro, even if it did help the eurozone as a whole, would hardly help Spain more than Germany given Germany's productivity advantages over Spain.
What Spain Needs
Spain does not need a lower euro, it actually needs a higher one (with Spain back on the pesata). Alternatively (and in fact preferably) Spain can indeed benefit from a lower euro (provided of course Germany is back on the Deutsche Mark.
The key point is that it is complete silliness to think anything else but a breakup of the eurozone (coupled with genuine work rule reform) can help Spain.
What About Italy?
Pettis did not mention Italy in his email, but I think Italy exits the eurozone before Spain.
Anti-euro and anti-German sentiment is high and rising in Italy, and technocrat prime minister Mario Monti will be gone by April.
It will not take much to push Italy over the edge given the rise of the Five Star Movement. For details, please see
The Human Jukebox is part of a musical video experiment performed by Charles Yang, Michael thurber, and Eddie Barbash. Donations determine what music the performers would play. And all the money was sent to Wingspan Arts, a non-profit that aims to expose diverse and young groups of people to the arts. Beautiful! Oh, and totally wasn't expecting Jurassic Park.
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