Monday, July 18, 2011

The Emergence of Europe as a Union

The European Monetary Union is the world's first example of an aggregation of "sovereign" nation-states into a single entity of economic exchange. Although there are many similarities between the EMU and the political aggregation known as the "United States", the latter only consists of one truly "sovereign" political authority. The U.S. Constitution provides that it, along with federal law, is the "supreme law of the land" in practically every sphere, while the EU Constitution only allows EU law to trump the laws of member states when the latter have explicitly agreed for the EU to legislate in those spheres.

The EU, therefore, illustrates the world's first "emergent property" of nation-states acting as an economic (currency) collective, without a very significant fiscal/political centralization of authority. Dr. Steve Keen, a renowned "Post-Keynesian" economist, recently published a presentation discussing the fact that prominent research in Neo-Classical economics has actually undercut the entire edifice of Neo-Classical theory currently taught in schools. [Video of Lecture].

Essentially, the research shows beyond a doubt that market demand curves cannot be modeled by aggregating individual demand curves which are subject to the "Law of Demand" ("all else being equal", demand for a commodity falls when its price rises and vice versa). While this law may hold for an isolated individual to some extent, it becomes little more than a coincidence at the macro-economic scale. Instead, complexity theory teaches us that when economic agents are aggregated to the macro-scale, the new collective is governed by novel, non-linear rules and exhibits "emergent properties".

That's why speculative financial bubbles are even capable of endogenously occurring within a capitalist "free-market" economy. When the prices of U.S. and European real estate continued to escalate dramatically throughout the late 1990s and 2000s, demand did not fall off, but instead continued to climb as more irrational investors joined the ranks of an emergent herd. As mentioned above, the European nation-state herd is not quite like any other we have witnessed before, and "emergent behavior" is not necessarily a good thing for economic sustainability or productive growth.

The EU as a collective monetary union is the largest economy by nominal GDP in the world, exceeding the US by more than 10%. [1]. It has been clear for some time that all of the EU's member states, while retaining political "sovereignty" and diverse economic sectors, have become committed to preserving the value of any and all public bonds denominated in Euros. On the surface, there are various stirs about Germany or France not supporting further bailouts, or about Greece refusing the conditions of such bailouts, but it is the IMF, ECB and major bondholders who actually guide the herd.

The new rules governing this herd can be summed up in two words - austerity and privatization (a.k.a. wealth extraction). While the response of U.S., China, Japan and others to the global financial crisis has been marked by increasing levels of government support/intervention in private economies, the EU as a collective has rapidly evolved to the stage of large cuts to expenditures that benefit large swaths of people and the wholesale privatization of public assets.


Reuters: "The IMF said on Wednesday private sector involvement (PSI) was fundamental to a Greek bailout and urged Athens to move faster on fiscal and structural reforms to avoid a debt default."

Greece has now graduated from public "stabilization funds" managed by the IMF and ECB, to a plan for "PSI" that requires fast-acting "fiscal and structural reforms" (i.e. continued gutting of the public sector), which will no doubt be micro-managed by the IMF despite its name.

"...Fitch said it saw contraction at 4 percent in 2011, followed by a weak recovery next year. It said asset sales in 2011 appear feasible but the privatization plan will be increasingly challenging.

The Fund praised the recent creation of a privatization agency to help rake in a targeted 50 billion euros in proceeds until 2015, and said the target was ambitious but achievable."

Despite (because of) the ongoing "bailouts" and austerity in Greece, Fitch tells us that its economy is contracting, and while the PSI plan is a good one, the Greek people will have to try extra hard to sell their assets and meet "the target" (on their backs).

..."The conservative opposition has opposed the bailout plan, saying it stifles the economy, but supports some state selloffs. A public resentful with austerity has staged almost daily protests against the measures."

The Greek population becomes more disenchanted with their economic situation and proposed "solutions" with each passing day, but the so-called "conservative opposition" gradually comes to support the PSI plan, which is fundamentally very much the same as austerity. Now, Greece was the first to reveal the emergent behavior of the EMU collective, but it will by no means be the last. As we get closer to the collective's center, the need to privatize national assets and keep major bondholders afloat becomes even stronger.

When discussing the massive exposure of French banks to the sovereign debt of Spain and Italy, which has recently come under market pressure, Ilargi at The Automatic Earth writes the following:

Ilargi:"Paris will -need to- step in to try and save its financial institutions. The first steps in that direction are already being taken. The International Accounting Standards Board (IASB) has advised Europe to implement their International Financial Reporting Standard 9 (IFRS 9), which is nothing but a sly and underhanded mark to fantasy trick posing as a "standard". Think the US' FASB 157. Basically, IFRS 9 allows investors to hold assets at cost as long as they don't try and sell them. That Greek haircut which is being discussed shaves off as much as 60% of debt value. But they may still appear on the books at 100%."

The first step is to make sure that, if the inevitable does somehow occur and one of the PIIGS technically defaults on their obligations, the major European bondholders (banks and institutional funds) will at least maintain some value on their books through fraudulent accounting. At the same time, however, the banks will need to "raise capital". That can be done directly through fiscal bailouts by their home countries, but those would also be very counter-productive to the underlying issue in the EMU - excessive public debts and deficits.

The more likely behavior is what we have already seen for Greece, Ireland and Portugal - an IMF/ECB sponsored public bond purchasing commitment. Another reason for executing this now standard European tactic is to protect against the trigger of CDS contracts that were taken out as default insurance. This issue is something Ilargi has written about extensively (see The Derivatives Pressure Cooker and Credit Downgrade Swaps), and it can only grow in importance considering Italy's 120% Debt to GDP ratio and the fact its 10-year bond is about 3% rich to Germany's. [2].

The plans for austerity, of course, have been in the works for some time, and the Italian Prime Minister will now present the "package" for passage this Friday, instead of its originally scheduled date in August.


AP: "Italy's finance minister says the government's package of austerity measures will be strengthened and passed in both houses by Friday.

Giulio Tremonti sought to reassure markets during a speech to a banker's association meeting in Rome that Italy would speed reforms and austerity measures that seek to balance the budget by 2014.

But he also said that the pressure on markets in recent days was not a problem "of a single country, but of the structure of Europe."

So, does anyone now think that Rome will not be submerged in extensive "privatization plans" in the near future? Perhaps a big fat "FOR SALE" sign will be stuck in the center of the Coliseum? It is, as Tremonti says, a function of "the structure of Europe". Personally, I would say that Europe has fully emerged as a monetary union, and it is now behaving as any collective of nation-states would. There is no "turning back", and there is no "sustainable" plan to keep the collective together. There are only games, tricks, cons and "private sector involvement"; and, then, there's riots and revolutions.

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