Obituary notice: “Sovereign” debt, theft, Cyprus, and the death of Liberal Capitalism

Gallery

This post, written in March and April 2013, has been updated on Oct 16, 2013; I fixed two typos.  The rest of it remains unchanged. I have written before about Jaruzelski Moments in modern Liberal Capitalism.  Expropriating capital from banks … Continue reading

Vaclav Havel

Vaclav Havel, the Bayard of the Semantic War, died this week. We lost in him one of the towering figures of the 20th century. I first encountered his writing on French television, sitting in the living room of my dear departed friend, Jean Tanguy, in Locquirec, France. On that day, fittingly enough 14 July 1989, I had chosen to share the celebrations with Jean and his family, rather than to sit on the reviewing stand on the Champ Elysées (I was in France to participate in the Bicentennial conference, “L’Image de la Révolution Française”, organized by Michel Vovelle. The conference speakers sat on the reviewing stand with then President Mitterand.)
Jean and Marie-Claire had never seen a play by Havel, and French tv had chosen that night to air a Paris production of Havel’s one-act play, “The Petition.” We all found it a remarkable play, and performance. (Havel had been in the audience.) A few days later, I bought a French version of three of Havel’s plays, “The Petition” among them: I quickly translated it into English, to use in my European Civilization class. We still read it each year. The publication of a splendid collection of Havel’s essays, Open Letters. Selected Writings, 1965-1990, allowed me to assign that text, too. In May 2005, I had the delightful experience of sitting in Georgetown’s Gaston Hall, listening to Havel. In the Q&A that followed his dialogue with Madeleine Albright, all but one student in the queue came from my Euro Civ class: all of them had read Havel and asked wonderful questions. Teachers don’t get many moments that fulfilling.
Why have I insisted that so many Georgetown students read Havel? He spoke the truth, as he saw it. Long before the term “Semantic War” came into usage, Havel understood that the war of ideas, expressed through words, ultimately determines the fate of political systems. [For what it’s worth, I think someone in the Clinton Administration, perhaps Albright, essentially put together Havel’s emphasis on semantics and the American obsession with declaring “war” on everything in sight.] He believed, much as John Stuart Mill did, that the truth has the annoying characteristic of being true, and thus cannot easily and permanently be suppressed. Those who have used the term “Semantic War” have usually meant the conflict between different interpretations of a given event, or different sides in a given conflict (say, the US Government and one of its foreign enemies, state or non-state), but Havel understood it in its genuine essence: the war between truth and falsehood. These political Semantic Wars claim to revolve around that paradigm – each side claims a monopoly on truth, and denounces the other side as minions of Satan and all his lies [my Euro Civ students begin their fall semester with a classic example of this technique, the Chanson de Roland] – but each side mixes genuine truth with falsehood or prevarication. States do not much care about the truth as an abstract concept; they care about their own survival, that’s the ultimate “truth” for them.
Havel could be ruthless in rooting out the truth behind the semantic subterfuge of even his own side: Stanek, in “The Petition,” examines his weaknesses more thoroughly than virtually any character in the history of the theatre. He, not Vanek, takes apart each side of the issue. Havel wonderfully ends the play by the device of Stanek’s political connections getting poor Javurek, the “dissident” musician lover of Stanek’s daughter, out of prison. The petition seemingly has become pointless, at least insofar as Javurek’s fate is concerned. Havel thus forces viewers/readers to get beyond the specific case.
In his 1978 essay, “The Power of the Powerless,” Havel provided an essential theoretical underpinning to the movements all over East Central Europe. The intro to that essay in the Open Letters collection cites Solidarity activist Zbygniew Bujak on its importance to the Gdansk workers in 1979-80. Havel gives one of my favorite examples of how we must understand the Semantic War between truth and falsehood. That War is less a titanic clash of thundering ideological salvos, and more an endless series of seemingly innocuous skirmishes. Havel offers us a simple case (from the version in Open Letters, 132-33):
“The manager of a fruit-and-vegetable shop places in his window, among the onions and carrots, the slogan, “Workers of the world, unite!” Why does he do it? What is he trying to communicate to the world? Is he genuinely enthusiastic about the idea of unity among the workers of the world? Is his enthusiasm so great that he feels an irrepressible impulse to acquaint the public with his ideals? […]
I think it can safely be assumed that the overwhelming majority of shopkeepers never think about the slogans they put in their windows, nor do they use them to express their real opinions. That poster was delivered to our greengrocer from the enterprise headquarters along with the onions and the carrots. He put them all in the window simply because it has always been done that way for years, because everyone does it, and because that is the way it has to be. If he were to refuse, there could be trouble. […]
Obviously the greengrocer is indifferent to the semantic content of the slogan on exhibit; he does not put the slogan in his window from any personal desire to acquaint the public with the ideal it expresses. This, of course, does not mean that his action has no motive or significance at all, or that the slogan communicates nothing to anyone. The slogan is really a sign, and as such it contains a subliminal but very definite message. Verbally, it might be expressed this way: “I, the greengrocer XY, live here and I know what I must do. I behave in the manner expected of me. I can be depended upon and am beyond reproach. I am obedient and therefore I have the right to be left in peace.” […]
Let us take note: if the greengrocer had been instructed to display the slogan “I am afraid and therefore unquestionably obedient,” he would not be nearly as indifferent to its semantics, even though the statement would reflect the truth. The greengrocer would be embarrassed and ashamed to put such an unequivocal statement of his own degradation in the shop window, and quite naturally so, because he is a human being and thus has a sense of his own dignity. […] Thus the sign helps the greengrocer to conceal from himself the low foundations of his obedience, at the same time concealing the low foundations of power.”
Havel later asks the greengrocer to stop “living the lie.” Take down the sign. Refuse to participate in bogus elections. Say what you think. Havel is no fool: he knows (from personal experience) what refusal to “live the lie” will mean. [Think of that wonderful scene from The Lives of Others, when the Stasi officer asks the neighbor, whom he has never seen before, how her daughter’s studies at X University are going.]
It’s hard to think of Havel’s greengrocer without also thinking of Mohammed Bouazizi, isn’t it? He could no longer live the lie. Just as Havel puts it, Bouazizi was “a human being and thus ha(d) a sense of his own dignity.”
When you build your whole system upon lies, Havel reminds us, there will come a point when the person who says 2+2=4 is a threat to the system. We might think of Galileo’s brilliant retort to his opponents, who suggested that Aristotle had insisted the Sun revolved around the Earth, so it must be so. Galileo replied that Aristotle had made that deduction based on the evidence from the naked eye; honest empiricist that he was, Aristotle, had he had access to Galileo’s telescope, and seen what Galileo had seen, would have come to the same conclusion as Galileo. 2+2=4. Poor Galileo spent the last 20 years of his life under house arrest for stating the obvious. The system, in this case the Catholic Church’s hierarchy, could not accept, in a time of conflict about religious dogmas [the Church placed Galileo’s work on the Index at the same time that it condemned a work of Calvin], anyone who questioned any doctrine it had formally approved.
How often do political leaders today lie? How often does a state murder people, often deliberately and in cold blood, and then offer some pathetic and usually transparently false justification? In how many ways are we all the greengrocer? In the US, the Republicans have raised deliberate lying to an art form. Most of them have become such ingrained liars, so deeply committed to an ideology [Havel’s “Powerless” essay explains how that works] that they can no longer recognize the truth. One lie leads inexorably to the next, because the foundation on which they have built their ideology is demonstrably false. The Democrats, in part because they do not, in fact, have an ideological foundation, are very poor liars. They lie, of course, but they can’t stay on message as well as the Republicans: now and again, the truth pops out of their mouths. They can’t help it: 2+2=4. One minute they tell some ridiculous lie (say about the monstrous budget deficits that lie ahead, after about 2014), the next they point out a genuine truth (that taxes on the wealthiest Americans will have to up). They naturally shy away from the truth of that second statement: such a change in the tax system will help reduce the share of national wealth held by the 1% and bring us back to the more equitable wealth distribution of ca. 1980 or even 1994. The Occupy movements are telling that simple truth: no solution is possible until we reduce significantly the share of national wealth held by the 1%.
Maybe we should all post the slogan, “Power to the Powerless,” on our front doors, both literal and virtual.

“Sovereign debt”, update on Stan and Ollie

Update, Dec 10, 2011.

Ok, we have 26 of the 27 European Union countries signing off on precisely the sort of greater central economic control outlined below (on Nov 24).  They did not agree to a Euro bond, in part, I would suggest, because no such bond can exist until the controls are actually in place.  Have they actually solved the key problem?  No.  Have they saved the Euro?  No.

What is the key immediate problem?  Italian debt.  Several weeks ago (10 Nov), the NY Times ran a lovely series of charts on who holds which debt in Europe.  French banks held over $400 billion in Italian debt.  (German banks own a lot less Italian debt.  Italy’s state debt is the second highest in the Euro zone, after Germany, which has a much, much larger GNP.) Little wonder that Moody’s yesterday dropped their rating of three of the largest French banks.   Moody’s assessment of BNP’s standalone strength (BFSR) dropped to level “C”, meaning “may be in default”. (http://www.moodys.com/research/Moodys-downgrades-BNP-Paribass-long-term-ratings-to-Aa3-concluding–PR_232989)

In plain English, that would seem to mean Moody’s believes BNP is in big trouble.  They  highlight its high exposure to Italian debt ($12.2 billion); BNP has already written down $2.6 billion in Greek debt (and holds $1.6 billion more, as well as $1.4 billion of Portuguese debt). It somehow managed to shed $10+ billion of its $23 billion of Italian debt in a very short period, to get down to current levels.  {The buyer?  The European Central Bank, which purchased $65 billion in sovereign bonds in the first 9 months of 2011, and, to judge from the BNP figures, much more in Oct and Nov. }

German banks don’t get a free lunch, because they own $200+ billion of French debt (and over $100 billion in Italian debt); European banks collectively own close to $1 trillion in French debt.  Not good for the European banking system, not good at all.

Here’s what the British newspaper The Telegraph had to say, in an article on the Eurozone banking system:

“If anyone thinks things are getting better then they simply don’t understand how severe the problems are. I think a major bank could fail within weeks,” said one London-based executive at a major global bank.

Many banks, including some French, Italian and Spanish lenders, have already run out of many of the acceptable forms of collateral such as US Treasuries and other liquid securities used to finance short-term loans and have been forced to resort to lending out their gold reserves to maintain access to dollar funding.

“The system is creaking. There is a large amount of stress,” said Anthony Peters, a strategist at Swissinvest, pointing to soaring interbank lending rates.

Ok, let’s swing over to the British Left, and the Guardian’s (www.guardian.co.uk/) economics editor, L. Elliott:

“Europe is sleepwalking into a prolonged depression. The prospect of 2012 seeing the start of the break-up of the eurozone is a real one. Financial markets are already starting to pick apart what looks like the latest, if more sophisticated, attempt to kick the can down the road. Britain has isolated itself on the fringes of the European Union, perhaps the most significant development at a summit that assuredly did not draw a line under the crisis in the single currency. But at least the interests of the City of London were defended. For now.

In short, the summit that was supposed to save monetary union has been little short of disastrous. Going into the talks, the markets hoped for a happy ending to the sovereign debt saga: a deal to pave the way for the European Central Bank to ride to the rescue of Italy and Spain, under siege from the bond vigilantes. What they got instead was political schism, half-baked reforms and the complete absence of any fresh economic thinking.”

Now, over on the Right, at the Financial Times, the headline suggests the deal won’t last until Christmas, full article at:

Short excerpt:

“Jonathan Loynes of London’s Capital Economics, who accused Mr Draghi of “clumsy communication,” said: “The bottom line is that even our low expectations for last week’s supposedly critical advancements in the eurozone debt crisis appear to have been undershot.” He described further debt writedowns that would affect the private sector as “virtually inevitable”.

The muted market moves on Friday may be misleading. The euro rose against the dollar – but this may have been driven by banks repatriating assets.

European bank shares, while above their lows, trade at half their book value, implying grave fears that some of their assets will be written down.”

Little wonder that 26 of 27 agreed to a general solution.

Le Monde gives two different views, suggesting in one article that the worst is over and that the three “vices” of Maastricht were addressed:  1) letting Britain opt out of the euro – Le Monde argues that the 26 kicked the UK out of Europe;  2) lack of economic central governance (see below, original posting); and 3) lack of a stabilization mechanism.  Le Monde argues that Draghi, head of the ECB, has agreed to “unlimited” funding of banks, at 1% interest, for 3 years.

A second article, “L’Eurozone n’agit pas, mais cause”, takes an entirely skeptical approach.  On the key issue of the 26:

“Les chefs d’Etat et de gouvernement de la Bulgarie, du Danemark, de la Hongrie, de la République tchèque, de la Lettonie, de la Lituanie, de la Pologne, de la Roumanie et de la Suède ont évoqué la possibilité de rejoindre ce processus après consultation de leur Parlement le cas échéant”.

In other words, they gave tentative assent, but have to get approval from their parliaments.  Nice way to pretend to go along. The article points out that this agreement is not a treaty, but a statement of principles, a declaration, not legally binding on anyone, not agreed to by any elected body, even the European Parliament.

So far, the geniuses (led by Chancellor Merkel) managing this crisis have allowed Greece to go bankrupt, have waited until Spain, Portugal, and Italy are lined up to do the same (Ireland, too), and are fiddling while the banking system burns to the ground.

China’s Dagong Credit Rating Agency yesterday lowered its rating of France’s “sovereign” debt (down from one of the three levels in the upper medium grade, to a level in lower medium grade), following up its reduction of Italy’s rating from A- to BBB (second category of lower medium grade, just a short hop from junk bond status).  Dagong believes France will have to intervene to save its big three banks, the ones Moody’s just downgraded: they refer to potential partial nationalization of those banks.

Western observers may belittle Dagong, which is an obvious effort to remove Western monopoly on credit ratings, but it’s worth remember that most of the Western countries, especially the USA, borrow lots of money from China.  If the Chinese government and other Chinese investors start to place high credence in Dagong’s ratings (which, it should be noted, rate the US as lower than many European countries), then Western borrowers may have to pay higher rates of interest to Chinese investors.

One poster on Le Monde compared the summit to putting up three bags of sand against a tsunami.  Nice.

And I love Sec’y Geithner, channeling Oliver Hardy, telling Sarkozy (in the role of poor Stanley),  “and this is another fine mess you’ve gotten us into.”

Original post of 24 Nov, unmodified:

European political leaders seem to be facing the obvious reality pointed out in the earlier post: “sovereign” debt of Euro zone countries is an oxymoron.  We hear now that they are finally discussing the only possible solution:  creating real European sovereign debt, by means of a common bond issue, guaranteed by all member states.  Alas, as my father used to say, all solutions create new problems:  this one makes no sense absent a more unified sovereignty within the Euro zone.  Creating a common Euro bond cannot take place in a situation in which key elements of sovereignty remain in national hands.

Tax collection offers a simple example.  If published estimates are correct, roughly 15-20% of Italy’s economy is in the black market: that would mean $300-400 billion escapes taxation.  Italy’s VAT is 20% (much less on necessities like most foods), so the Italian government loses $60-80 billion a year in VAT revenues alone.  Add to that the lost revenue from income taxes and you probably get something like $100 billion in annual losses due to the black market.  That $100 billion would close Italy’s budget gap to zero, with no need for tax hikes or service cuts.

Italian non-compliance has many causes, but we need not fall into the facile generalization that it’s all the fault of the Mafia and Camorra, or a simple reflection of Italian cultural norms.  Italian companies have powerful economic incentives for non-compliance:  corporate total tax rates (TTR) in Italy are 68.6%  as against 41.2% in the EU.  France, which also has compliance issues, ranks close by, at 67%, and Spain is also high, at 56%, whereas the TTR is far lower in the other large European economies:  Germany, 48%; the Netherlands, 40.5%; UK, 37%.   (TTR, from World Bank, IFC, Paying Taxes 2011.  The Global Picture, figure 2.17).  The key difference is  labor taxes, which are vastly higher in France and Italy:  they make up 3/4ths of the corporate tax burden in France, about 2/3rds in Italy, only half in Germany, about 40% in the Netherlands, a third in the UK, and only 1/5th in the US.  Italy has a ridiculously complicated corporate tax system, to judge from compliance hours:  285 hours per year, as against only 110 in the UK, 132 France, 134 in the Netherlands, and, surprisingly, 215 in Germany.  Unsurprisingly, most of this time goes toward figuring out and paying labor taxes (shares of social security, unemployment tax, etc.).

As someone who has worked a great deal on tax systems, I would suggest that the Italian system is deliberately complex to enable fraud;  many less-developed countries have a similar situation. Any time you have an obvious crook like Berlusconi (who has been prosecuted for tax evasion) running your country, you can be sure that the tax system will be set up in a way so complicated as to assure that business tycoons, like Berlusconi, can practice non-compliance with a high level of impunity.

Can there be Euro bonds when one of the main economies (Italy) has a tax system that, in performance, resembles the systems in the African Union far more than it does those in the European Union?

The only possible way to get to Euro zone bonds is for the countries in that zone, perhaps through the European Central Bank, to get centralized control of economic policy and fiscal administration (in terms of oversight) throughout the 17 states.  Angela Merkel made that clear when she vetoed the idea of a plebiscite in Greece.  This fiscal crisis, among its other elements, marks the end of representative democracy in the 17 member states, if those states go to a Euro zone bond and to the sort of economic controls that can make such a bond work.

The Euro zone countries would then look like the US in economic and borrowing policy.  The Euro zone would issue “sovereign debt” bonds, like US bonds; the member states would issue bonds similar to those of US states, like New York or Alabama.  Member states would generally have to pay higher rates of interest than the Euro zone as a whole.  Euro zone bonds would have to be limited to specific purposes and some sort of central governing authority (drawn not from elected bodies, but from technocrats) would have to regulate who got which share of the Euro bond issues.  Bonds issued by individual states would be like bonds issued by US states or even municipalities; they would likely be guaranteed by given tax revenues (a system widely practiced, btw, in 16th-century Europe). The rise of a genuine public debt (in the 18th and 19th centuries) lowered central government borrowing costs, which in that earlier system had been generally higher than those of regional or local governments.  Right down to 1788, the King of France regularly borrowed money through such intermediaries because they paid much lower risk premiums than the central government.

The danger is that such a pattern will repeat itself, that Germany will borrow at a lower rate of interest than the Euro zone bond.  If that turns out to be true, as one would suspect, then the Euro zone bond will essentially be nothing more than a way for the suspect economies (like Italy) to borrow ostensibly through a central agency, but, in reality, through the intermediary of a more solvent regional government (i.e., the German or Dutch one).  You would then have the dangerous situation that a large German bank (or another investor, like China) could play the spread between the two.  Markets may already be anticipating such an outcome: Germany could not sell its bonds yesterday, because the interest rate is so low.  What investor would want to buy a German bond  at 1.98% (yesterday’s rate), when s/he could buy a Euro bond, also guaranteed by Germany, at 3% or even 4%?  Those willing to buy at 1.98% are betting that the Euro bond will not become a reality.

 

“Sovereign” debt

At long last, some public commentators have begun to focus on the core of the so-called “sovereign debt” crisis: it’s not sovereign debt. Our modern definition of sovereignty began with Jean Bodin (Les Six Livres de la République, 1576), who defined “souveraineté” as the right to make law binding on all in general and each in particular. Bodin mentioned some of the key elements of this right to make law: coining money was one of them. Any country that does not control its own currency has no sovereign debt; it’s as simple as that.
The countries in the Euro zone, with the possible exception of Germany, do not control their own currency. The recent negotiations make it clear that Germany has the deciding vote on questions related to the Euro, so one could argue that it has something close to sovereignty with respect to currency. Sovereign countries also control their fiscal policy. Once again, the Euro zone countries do not qualify, because they clearly do not control such policies.
The Business section of the NY Times has, at long last, begun to address this issue (other mainstream media have been little better). On Wednesday, 2 November, a story quoted V. Serafeimakis, identified as a senior official as one of Greece’s main oil and gas distribution companies (Avinoil), as saying “The real problem is that we are now operating under a foreign currency.” Quite so. On Friday, 4 November, in an excellent column, Floyd Norris posed the issue of why it was so anathema to European leaders that Greek voters actually have a say in the financial policies of Greece. As Norris rightly pointed out, European leaders essentially have said fiscal policy no longer belongs to the people of Europe: they must henceforth do what the Brussels bureaucrats, under orders from German bankers, tell them to do.
Norris and others (for example, al-Jazeera’s news anchors) have suddenly discovered that the combination of a common currency (i.e., a fundamental element of sovereignty in the hands of an external authority) and “sovereign state” political and economic policies is an oxymoron. The choice appears simple: create a common set of political and economic policies, set by a central authority, or return control of currencies to the states.
Banks have fallen victim to their own hype and disingenuousness: Greek debt is not sovereign debt. It’s not the equivalent of borrowing by the governments of the US or the UK; it’s the equivalent of borrowing by Rhode Island or Mississippi. The markets have gotten around to that point of view in a hurry, raising Greek short-term debt interest rates from under 2% to close to 30% over the last two years. As Americans look at this situation, we might consider that Greece looks a lot more like Germany than Mississippi looks like the Megalopolis states running from Boston down to northern Virginia. Greece’s per capita GDP, about $30k, is far closer to those of Germany or France ($40-42k) than the per capita SDP of Mississippi ($32k) is to that of NY, NJ, or Massachusetts ($56-58k), let alone Connecticut ($64k). West Virginia, with its per capita SDP of $35k is a different world from Virginia ($53k, a figure that does not take into account the massive gap between wealthy Virginia north of the Rappahannock and impoverished Virginia, west and south: the median household income in Lee County is $29k, in Loudoun County, it’s $114k). Europe’s “state” economic disequilibria are little different from those in the US, and within those “states” Europe has far less economic inequality among social groups than we have in the US (in terms of the Gini index of inequality). The Euro zone’s real outliers are the East Central states (Czech Rep., Slovakia), whose per capita GDPs are well under $20k. No wonder Slovakia balked at bailing out Greece (in American terms, it’s like asking Mississippi to bail out Georgia, both in terms of per capita GDP and in terms of overall GDP size).
The Federal solution (deeply rooted in European history, by the way) will create a central monetary and fiscal policy and dramatically reduce the authority of national governments (and, by extension, the effective power of those who elect them). Listening this morning to a German analyst discussing the Greek situation, one got a clear sense of how thoroughly Germany dominates the Euro zone. As he said, many other countries have an anti-Europe party; Germany does not. Why should it? Europe dances to Germany’s tune. Any country that does not understand that rule, has to leave, as Chancellor Merkel made crystal clear to PM Papandreou with her comments about the referendum.
What will happen if Greece does leave the Euro zone? We have plenty of historical evidence of countries leaving what were, in effect, imperial currency zones. We could look to the newly created states of 1919, like Poland or the Baltics or Czechoslovakia, which had to create new currencies and abandon old ones (often more than one – the Poland of 1920, for example, had been part of three different currency zones in 1914). The shift did lead to massive inflation, in part because the largest nearby economy (Germany) had government induced runaway inflation.
Assets valued in drachmas will lose much of their value, because the Greek government – following in the footsteps of countless predecessors, including those 1920s Germans – will inflate its way out of debt. More recently, we can follow the case of the split between the Czech Rep. and Slovakia in the 1990s. Once all the dust had settled, the Slovak koruna was worth about 20% less than the Czech one. That’s roughly the difference in the per capita GDPs: the three easily accessible estimates for that statistic – from the World Bank, the IMF, and the CIA – disagree sharply about Slovak per capita GDP – a high of $18.4k from the CIA, a low of $13.5k from the WB. The IMF figures suggest a difference of about 13%, the WB figures a difference of 30%. (The CIA figure for Slovakia seems grossly inflated.) By that standard, one would expect a devaluation of the drachma, vis-à-vis the Euro, by something like 33% [if we make the comparison to the Euro big boys, France and Germany; bringing in the other three states that matter – Italy, Spain, Netherlands – would lower the comparative per capita GDP and suggest an inflation more like 20%]. Greece’s catastrophic debt ratio to GDP, however, is far, far worse than anything seen in the Czech Rep. or Slovakia in the 1990s, so the initial period of adjustment will likely be even worse.