Sovereign Default History

 

Today Argentina defaulted on its external debt for the 8th. time since 1800 AD. The Economist publishes this chart ranking countries on the criteria of how many times they have defaulted on their external debt in the last 214 years. Curiously both Germany and Portugal have defaulted 4 times. Nothing seems to last (or have been) forever.

 

Reverse Robin Hood explained

In this article published by Zerohedge we can find a cogent explanation of the present process of wealth redistribution from poor to rich, a phenomenon felt everywhere. Whether this process is an intended one, a sort of conspiracy, or just “collateral damage” of unsound monetary and economic policies, is for the reader to decide. This is, in words of Stanley Druckenmiller, one of the most successful hedge fund managers, “the biggest redistribution of wealth from the middle class and poor to the rich ever”. Don’t miss the charts, they are self explanatory. As a summary, the aim of achieving this wealth redistribution is achieved thru several mechanisms:

A – “the rich hold assets, the poor have debt”

B – QE has resulted in a loss of purchasing power for the US dollar. Faced with this problem, consumers in the middle class are taking on more non-housing debt in order to maintain the same standard of living. In addition, the US government – which continues to run a deficit year after year – continues to accumulate debt. Due to these facts, total debt outstanding – aka credit market instruments for all sectors – is at all time highs. More debt means more interest payments and lower savings rates. These trends do not bode well for the middle class consumer.

C – On the other hand, QE has been great for the rich. QE has inflated the prices of assets such as property, bonds, stocks, and non-home real estate.

D – Taxes as a percentage of real disposable income have more than doubled since 1980. This trend has not been kind to the bottom 90%.

E – Median household income has been in a downtrend since the late 90s.

F – The entitlement problem is only going to get worse as more baby boomers leave the work force. Future generations will have to pay for the debt that the old and rich continue to take on.

In conclusion, QE, taxes, income disparity, and entitlements are contributing to “the biggest redistribution of wealth from the middle class and the poor to the rich ever” If things continue the way they are going, then millennials and future generations will pay the price:

TYReads The End Of German Hyperinflation

Today 90 years ago, on the 15 of November 1923, by fixing the value of the recently created Rentenmark at a rate of 1 trillion (1.000.000.000.000) Papermark per 1 Rentenmark, and one month later, by setting the rate of the Rentenrmark against the US Dollar at a rate of 4,2 Rentenmark per 1 US Dollar, the exchange rate that had prevailed between the Reichsmark and the US dollar before World War I, Hjalmar Schacht, the then new president of the Reichsbank, ended the German Hyperinflation of 1922-1923, a monetary phenomenon that it is often argued paved the way for the later onset of Nazism. Thorsten Polliet of The Ludwig von Mises Institute has written this article about it.

90 Years Ago: The End Of German Hyperinflation by Thorsten Polleit @ The Ludwig von Mises Institute

On 15 November 1923 decisive steps were taken to end the nightmare of hyperinflation in the Weimar Republic: The Reichsbank, the German central bank, stopped monetizing government debt, and a new means of exchange, the Rentenmark, was issued next to the Papermark (in German: Papiermark). These measures succeeded in halting hyperinflation, but the purchasing power of the Papermark was completely ruined. To understand how and why this could happen, one has to take a look at the time shortly before the outbreak of World War I.

Since 1871, the mark had been the official money in the Deutsches Reich. With the outbreak of World War I, the gold redeemability of the Reichsmark was suspended on 4 August 1914. The gold-backed Reichsmark (or “Goldmark,” as it was referred to from 1914) became the unbacked Papermark. Initially, the Reich financed its war outlays in large part through issuing debt. Total public debt rose from 5.2bn Papermark in 1914 to 105.3bn in 1918. In 1914, the quantity of Papermark was 5.9 billion, in 1918 it stood at 32.9 billion. From August 1914 to November 1918, wholesale prices in the Reich had risen 115 percent, and the purchasing power of the Papermark had fallen by more than half. In the same period, the exchange rate of the Papermark depreciated 84 percent against the US dollar.

The new Weimar Republic faced tremendous economic and political challenges. In 1920, industrial production was 61 percent of the level seen in 1913, and in 1923 it had fallen further to 54 percent. The land losses following the Versailles Treaty had weakened the Reich’s productive capacity substantially: the Reich lost around 13 percent of its former land mass, and around 10 percent of the German population was now living outside its borders. In addition, Germany had to make reparation payments. Most important, however, the new and fledgling democratic governments wanted to cater as best as possible to the wishes of their voters. As tax revenues were insufficient to finance these outlays, the Reichsbank started running the printing press.

From April 1920 to March 1921, the ratio of tax revenues to spending amounted to just 37 percent. Thereafter, the situation improved somewhat and in June 1922, taxes relative to total spending even reached 75 percent. Then things turned ugly. Toward the end of 1922, Germany was accused of having failed to deliver its reparation payments on time. To back their claim, French and Belgian troops invaded and occupied the Ruhrgebiet, the Reich’s industrial heartland, at the beginning of January 1923. The German government under chancellor Wilhelm Kuno called upon Ruhrgebiet workers to resist any orders from the invaders, promising the Reich would keep paying their wages. The Reichsbank began printing up new money by monetizing debt to keep the government liquid for making up tax-shortfalls and paying wages, social transfers, and subsidies.

From May 1923 on, the quantity of Papermark started spinning out of control. It rose from 8.610 billion in May to 17.340 billion in April, and further to 669.703 billion in August, reaching 400 quintillion (that is 400 x 1018) in November 1923.[2] Wholesale prices skyrocketed to astronomical levels, by rising by 1.813 percent from the end of 1919 to November 1923. At the end of World War I in 1918 you could have bought 500 billion eggs for the same money you would have to spend five years later for just one egg. Through November 1923, the price of the US dollar in terms of Papermark had risen by 8.912  percent. The Papermark had actually sunken to scrap value.

With the collapse of the currency, unemployment was on the rise. Since the end of the war, unemployment had remained fairly low — given that the Weimar governments had kept the economy going by vigorous deficit spending and money printing. At the end of 1919, the unemployment rate stood at 2.9 percent, in 1920 at 4.1 percent, 1921 at 1.6 percent and 1922 at 2.8 percent. With the dying of the Papermark, though, the unemployment rate reached 19.1 percent in October, 23.4 percent in November, and 28.2 percent in December. Hyperinflation had impoverished the great majority of the German population, especially the middle class. People suffered from food shortages and cold. Political extremism was on the rise.

The central problem for sorting out the monetary mess was the Reichsbank itself. The term of its president, Rudolf E. A. Havenstein, was for life, and he was literally unstoppable: under Havenstein, the Reichsbank kept issuing ever greater amounts of Papiermark for keeping the Reich financially afloat. Then, on 15 November 1923, the Reichsbank was made to stop monetizing government debt and issuing new money. At the same time, it was decided to make one trillion Papermark (a number with twelve zeros: 1,000,000,000,000) equal to one Rentenmark. On 20 November 1923, Havenstein died, all of a sudden, through a heart attack. That same day, Hjalmar Schacht, who would become Reichsbank president in December, took action and stabilized the Papermark against the US dollar: the Reichsbank, and through foreign exchange market interventions, made 4.2 trillion Papermark equal to one US Dollar. And as one trillion Papermark was equal to one Rentenmark, the exchange rate was 4.2 Rentenmark for one US dollar. This was exactly the exchange rate that had prevailed between the Reichsmark and the US dollar before World War I. The “miracle of the Rentenmark” marked the end of hyperinflation.

How could such a monetary disaster happen in a civilized and advanced society, leading to the total destruction of the currency? Many explanations have been put forward. It has been argued that, for instance, that reparation payments, chronic balance of payment deficits, and even the depreciation of the Papermark in the foreign exchange markets had actually caused the demise of the German currency. However, these explanations are not convincing, as the German economist Hans F. Sennholz explains: “[E]very mark was printed by Germans and issued by a central bank that was governed by Germans under a government that was purely German. It was German political parties, such as the Socialists, the Catholic Centre Party, and the Democrats, forming various coalition governments that were solely responsible for the policies they conducted. Of course, admission of responsibility for any calamity cannot be expected from any political party.” Indeed, the German hyperinflation was manmade, it was the result of a deliberate political decision to increase the quantity of money de facto without any limit.

What are the lessons to be learned from the German hyperinflation? The first lesson is that even a politically independent central bank does not provide a reliable protection against the destruction of (paper) money. The Reichsbank had been made politically independent as early as 1922; actually on behalf of the allied forces, as a service rendered in return for a temporary deferment of reparation payments. Still, the Reichsbank council decided for hyperinflating the currency. Seeing that the Reich had to increasingly rely on Reichsbank credit to stay afloat, the council of the Reichsbank decided to provide unlimited amounts of money in such an “existential political crisis.” Of course, the credit appetite of the Weimar politicians turned out to be unlimited.

The second lesson is that fiat paper money won’t work. Hjalmar Schacht, in his 1953 biography, noted: “The introduction of the banknote of state paper money was only possible as the state or the central bank promised to redeem the paper money note at any one time in gold. Ensuring the possibility for redeeming in gold at any one time must be the endeavor of all issuers of paper money.” Schacht’s words harbor a central economic insight: Unbacked paper money is political money and as such it is a disruptive element in a system of free markets. The representatives of the Austrian School of economics pointed this out a long time ago.

Paper money, produced “ex nihilo” and injected into the economy through bank credit, is not only chronically inflationary, it also causes malinvestment, “boom-and-bust” cycles, and brings about a situation of over-indebtedness. Once governments and banks in particular start faltering under their debt load and, as a result, the economy is in danger of contracting, the printing up of additional money appears all too easily to be a policy of choosing the lesser evil to escape the problems that have been caused by credit-produced paper money in the first place. Looking at the world today — in which many economies have been using credit-produced paper monies for decades and where debt loads are overwhelmingly high, the current challenges are in a sense quite similar to those prevailing in the Weimar Republic more than 90 years ago. Now as then, a reform of the monetary order is badly needed; and the sooner the challenge of monetary reform is taken on, the smaller will be the costs of adjustment.

TYR reads “…It’s a Different Economy”

College Grads: It’s a Different Economy @ Of Two Minds Charles Hugh Smith aptly summarizes and describes the structure of the post-2008 USA economy, a description that by extension and with some tweaks can be applied to most western economes. An economy in which processes in the making since the end of WW2, if not sooner, are finally rising to the fore. It is not pretty. One could perhaps add a couple of points, but perhaps one  would not dare. Let’s hope that his half-optimistic concluding remarks are right. I am not so sure. CHS:

1. Getting a college degree, even in the STEM (science, technology, engineering and math) subjects, no longer guarantees a job.

2. Those millions of Baby Boomers clinging to their jobs can’t afford to retire, partly as a result of Federal Reserve bubble-blowing and zero-interest rates.

3. Many of those Boomers clinging to jobs are doing so to support you.

4. We now have a bifurcated economy: we have what’s left of the open-market economy and we have the cartel-state economy of various rentier arrangements. Arentier arrangement is one in which the input costs can keep rising due to political power/protection while the output declines.

Our economy is now dominated by rentier arrangements. This is one of the core reasons it is stagnating, the other being a parasitic, corrupt financial sector that depends on phantom collateral and accounting trickery for its survival.

Rentier arrangements include the financial sector (hated by the public but politically sacrosanct), the National Security State (you can never have enough people spying on the world, including Americans), healthcare (costs triple while the availability of care and the health of the populace decline) and education (college tuition rises 600% when adjusted for inflation but a third of the graduates learned essentially nothing).

Protected from the discipline of the market, these quasi-monopolies vacuum up an ever-increasing share of the national income while their output/yield declines. Where $200 million bought four top-line fighter aircraft a decade ago, now it buys one; we have reached the point where we can’t afford our own fighter aircraft. And many in the military conclude the $200 million-each F-35 Lightning (by some estimates of full program costs, $300 million each) is an underpowered, bug-ridden dog, less capable than competitors and the aircraft it replaces at four time the cost, the F-18 E/F Super Hornet.

For decades, those entering the rentier cartels were assured of lifetime security.Get a job in healthcare or education or the defense/national security sectors, and you had it made. But these bloated rentier arrangements are bankrupting the nation.

Lacking any limit on their cost inputs, these sectors have expanded at rates far exceeding the growth rate of the economy that supports them. Healthcare once absorbed roughly 5% of the economy; now it is consuming 18% and is on track to consume 20%. Healthcare alone will bankrupt the Federal government and the economy.

5. The private-sector economy is bifurcated as well.

6. The older generations will have to adjust to demographic and financial realities.

7. There are two sets of laws now: one for the Elites and the state, and one for the rest of us.

8. We are a free-lance nation.

He concludes:

There are opportunities, but they require a deep understanding of risk and security. A livelihood with day-to-day low-level insecurity and volatility is actually far more stable and secure than the cartel-state one that claims to be guaranteed.

The burdens of Fed manipulation and the cartel-state rentier arrangements will come home to roost between 2015-2017. Those who are willing to seek livelihoods in the non-cartel economy will likely have more security and satisfaction than those who believed that joining a rentier arrangement was a secure career.

There is a price to joining a parasitic rentier arrangement, a loss of integrity, agency and independence. Complicity in an unsustainable neofeudal society has a cost.

“He who controls the spice controls the universe.”

Guild Navigator - Dune (1984)

If you are a science fiction fan you’ll probably remember Dune, the excellent novel (a series of them actually) by Frank Herbert, and the film by David Lynch based on the same book. In it, one of the villains, Baron Vladimir Harkonnen, utters “He who controls the spice controls the universe”, the spice being a rare substance harvested in desert and desolate planet Arrakis and without which the universe would would grind to a halt (if you want to know why and have not read the book or seen the movie…just do it!). Instead of “spice” use “credit” and you’d have an adept metaphor of our universe, our western societies.

This week Spiegel Online interviewed Carmen Reinhart, an american economist known for being the co-author, with Kenneth Rogoff, of the book This Time Is Different: Eight Centuries of Financial Folly, in which they study debt crisis and their aftermaths in the last 800 years.

In this interview Ms. Reinhart gives very clear hints as to what the aftermath of the present debt crisis in western societies might be: inflation and impoverishment of savers and the general population. She also mentions the methods by which such an outcome will be achieved: financial repression and monetization of debt (aka Quantitative Easing aka QE).

Ms. Reinhart holds the thesis that governments have forced Central Banks to relinquish their independence in order to finance government deficits that can no longer be addressed via fiscal policies. What she does not say, be it because she does not believe it or because she does not dare, is that governments are themselves subservient to financial markets, an issue that we addressed in TYR reads “… a de facto coup d’état by Wall Street”. Ms. Reinhart utters some truths and chooses to ignore some other ones. The interview is both illuminating and mystifying, but well worth reading.

At the end of the interview…

…Spiegel asks “That sounds like a perpetual motion…”

…and Ms. Reinhart answers…”Of course it is!”.

It is perpetual motion because credit is the spice of our financial universe, a spice created by Central Banks, where decisions are taken by unelected officials, that channel it, at a very low or no cost, thru the private banking system, that multiplies and redistributes it, at a cost, to the rest of the economy. Ms. Reinhart tries to convince us that it is governments that control money, credit. No, Frank Herbert knew better. It is the Guild, the banking industry and their owners, who control the spice…credit…Central Banks…and in the end governments. How do we know?…ask yourself…Cui Bono? “He who controls the spice controls the universe.”

Some excerpts from the interview:

“So what happens is that money is transferred from savers to borrowers via negative interest rates.”

“If central banks try to accommodate and buy debt, there are risks associated with it. Somewhere down the road you are going to wind up with higher inflation.”

No doubt, pensions are screwed. Governments have a lot of leverage on what kinds of assets pension funds hold.”

“…after World War II austerity was easier to pursue, because you had a younger population and therefore less entitlements. Furthermore, military expenditure was easier to reduce. So, the build-up in debt we have seen since the crisis is very rare. Usually you get that kind of build-up when there is a war.”

4 April 2013 TYR reads

Helicopter QE will never be reversed @ The Telegraph Ambrose Evans-Pritchard hints at what the nature of the end-game of this monetary era might be…and it is printing money…forever. With an apparently neutral style and quoting potentially apocalyptic outcomes if permanent money printing by Central Banks is not considered ( “A breakdown of the global trading system might be one, armed conquest or Fascism may be others – or all together, as in the 1930s.”), the idea of a radical change of the monetary and economic system, without democratic consent, is being gradually introduced to a public opinion that is largely unable to understand the consequences of such monetary policies. He concludes: “Bondholders across the world may suspect that Britain, the US and other deadbeat states are engineering a stealth default on sovereign debts, and they may be right in a sense. But they are warned. This is the next shoe to drop in the temples of central banking.”

97% Of Spanish Social Security Pension Fund In Domestic Bonds @ Zerohedge “It appears, since the Spanish government does not explicitly have its own Fed to monetize debt, that it has merely plundered another quasi-governmental entity to do the bond-buying reach-around.”

Bank of Japan unveils aggressive easing @ Financial Times “The BoJ said it would double Japan’s monetary base from Y135tn ($1.43tn) to Y270tn by March 2015, mainly by buying more long-term government bonds.”. “We can’t escape deflation with the incremental approach that’s been taken until now,” Mr Kuroda said after the announcement. “We need to use every means available.”.

As Mr. Evans-Pritchard mentions in his article, “There were two extreme episodes of money printing in the inter-war years. The Reichsbank’s financing of Weimar deficits from 1922 to 1924 – like lesser variants in France, Belgium and Poland – is well known. The result was hyperinflation. Clever people made hay. The slow-witted – or the patriotic – lost their savings.”. The policies and situations described in the articles above suggest that it might happen, again.

Back to Mesopotamia by the way of Cyprus

In Back to Mesopotamia? a now prescient report by the Boston Consulting Group (BCG) published in September 2011 it was argued that, while inflation is the unstated and preferred “solution” to the present debt crisis in the western societies, for a variety of reasons, among them the deleveraging pressure, low demand for credit and potential social upheaval, the inflation “solution” might not work or not be enough to solve the debt overhang in most western countries. Other “solutions” would have to be found. The report of the BCC explores what other options would western governments likely undertake to address the crisis, arguing and concluding that “it is likely that wiping out the debt overhang will be at the heart of any solution”.

This weekend we have found out that Cyprus is on the route to Mesopotamia.

Some excerpts from the BCG report:

“In ancient Mesopotamia, debt was commonplace; individual debts were recorded on clay tablets. Periodically, upon the ascendancy of a new monarch, debts would be forgiven: in other words, the slate would be wiped clean. The challenge facing today’s politicians is how clean to wipe the slates. In considering some of the potential measures likely to be required, the reader may be struck by the essential problem facing politicians: there may be only painful ways out of the crisis.”

“If the overall debt load continues to grow faster than the economy of the euro zone, at some point the politicians might conclude that debt restructuring is inevitable. For this to be effective, they would need to restructure all debt, probably at around a maximum combined level of 180 percent per country. This number is based on the assumption that governments, non Financial corporations, and private house-holds can each sustain a debt load of 60 percent of GDP, at an interest rate of 5 percent and a nominal economic growth rate of 3 percent per year. Given this assumption, the total debt overhang within the euro zone amounts to €6.1trillion.”

“The probability of economies growing out of their debt problem is therefore limited, and the authors conclude that “the debt problems facing advanced economies are even worse than we thought””

“These write-offs would have to lead to a real reduction of the debt burden of the
debtor, and not just to an adjustment on the creditor’s balance sheet. If governments chose this course of action, only true debt relief (and thus an end to the painful deleveraging process) could lay the foundation for a return to economic growth. To follow this path, they would need to convince themselves that the overall benefit of an economic restart outweighed the risk of moral hazard in some areas.”

“Writing off more than €6 trillion would have significant implications for lenders. Just look at the numbers. Assuming a proportional distribution between banks and insurers, banks in the euro zone would have to write off 10 percent of total assets (€3 trillion out of €36.9 trillion in total assets).”

“If politicians pursued this course, the losses would almost certainly exceed the equity of the banking sector— making it insolvent at an aggregate level.”

“Restructuring the debt overhang in the euro zone would require financing and would be a daunting task. In order to finance controlled restructuring, politicians could well conclude that it was necessary to tax the existing wealth of the private sector. Many politicians would see taxing financial assets as the fairest way of resolving the problem.”

“For most countries, a haircut of 11 to 30 percent would be sufficient to cover the costs of an orderly debt restructuring. Only in Greece, Spain, and Portugal would the burden for the private sector be significantly higher; In Ireland it would be too high because the financial assets of the Irish people are smaller than the required adjustment of debt levels. This underscores the dimension of the Irish real estate and debt bubble.”