Eurozone Crisis - Italian Government Bonds Yields Hit 7.5%

09 Nov 2011    

Ten year Italian government bond yields today rose to 7.5%. This is an absolutely disastrous yield which cannot be sustained for any period of time. Now is the for action, and this article carefully explains where we have come from, where we are now, and where we need to go next.

Many journalists have been publishing articles calling on the ECB to intervene by buying Italian Bonds - yet this is completely the wrong advice. As one expert in financial markets pointed out repeatedly on Bloomberg News today - "ITALY IS TOO BIG TO BAIL OUT". Over and over again the people he was talking to kept talking about different rescue plans, but over and over again he had to stop them in their tracks with these deadly words. The ECB have already racked up enormous losses buying government bonds, Italy cannot be saved in this way.

Many journalists talk about money printing. If Italy can't pay it's debt they say the ECB should bail them out with printed money. People call money printing the "magic bullet" that can save Europe, but what they forget is that magic tricks are sleigh of hand, if you follow the money carefully you will see it is just moving from Northern Europeans to Southern Europeans. In the last few years dozens of these schemes have been suggested in the press, but they are like the systems muddle headed gamblers dream up to beat the roulette wheel, or the free energy perpetual motion machines hobbyists build in their garages, or the perfectly hedged structured credit derivative swaps that financial salesmen used to claim make positive carry without any risk - they are all fantasies. In the UK and USA today money printing is being used to stimulate the economy at the cost of savers; but when the Eurozone was created the Germans got a guarantee that this soft option would never be used. There is nothing wrong with that at all, the history of economics is filled up with politically cowardly money printing, the whole USA-UK-French campaign against the German constitution is completely and utterly immoral. This crisis is not a humanitarian apocalypse that makes the German constitution absurd, Italy has two trillion euros in debts but it also has about two trillion euros in state assets and over eight trillion euros in private banks accounts and untold private real estate wealth. What we are talking about is some of the richest countries in the world making some reforms, the problem comes out of rich Western democracies being incompetent and cowardly, and the whole purpose of the German constitution is to force cowards and fools to behave responsibly. This crisis highlights, not undermines, the importance of a no money printing constitution. The Germans aren't known for their communications skills, but I think Angel Merkel's inability to argue her case is a tragedy. The way the poor Germans are portrayed in the European press is absolutely disgraceful, and journalist across Europe desperately need to realise that their campaign against the Germans is an injustice that could unleash a nationalism that will destroy Europe. Those Greek newspapers full of swastikas are out there forever now, and they are extremely dangerous.

Lots of journalists are writing articles saying the Germans need to gift the Italians a one off windfall followed by pocket money for the rest of their lives in fiscal union - but there is a difference between treating the symptoms of a disease and treating the disease itself. If you dropped a trillion Euros out of helicopters on Mogadishu, it wouldn't turn Somalia into a nice healthy country, it would ultimately make the situation much more dangerous. When you treat the symptoms of a disease instead of the disease itself, it breaks out in a new more virulent form. In antiquity the disease called "gout" was known as the affliction of Kings. To cure it the Kings had to go on a diet, if a modern doctor had popped back in a time machine and freed the Kings from gout, they might have started getting more deadly heart disease instead. Disease symptoms are messages and clues of an underlying problem, and making the lifestyle modifications that clear up the surface symptoms synchronistically addresses the core inner issue. In the case of Kings the real inner problem was something like "greed", and the tough self disciplined lifestyle change of eating less to prevent the pains of gout made them into better people inside. Now many journalists and politicians have been opposed to austerity from the very start of this crisis, but it is time to face up to the fact that this advice has proven utterly disastrous - it means that now we are just facing a much more painful condition. It reminds me of the King who complained to his doctor "Why have you taken Foie Gras out of my diet? It is a hardship that hasn't cured my gout, it has just made my life worse, this diet of yours is self defeating." The doctor replied "I am just getting started, it won't stop being self defeating until the disease stops. It's not linear -austerity can work if its tough enough"

What I saying in all these disease analogies is that for three years the European elite has wasted time tinkering around with bailouts and bond purchases, but THE ONLY THING THAT CAN KEEP ITALY IN THE EUROZONE IS SHOCK AND AWE ECONOMIC REFORMS. All these rescue packages have bought is a little bit of extra time at a very high cost. Now it's game over, now it's time to cure this disease. Fear of pain prevented action, but these wasted years have simply made what is to follow even more painful. Forget about German bailouts and money printing, show the markets you are serious about reform and the crisis is over, fail and the crisis is never ending. The Western world of journalism and politics is not honest, long term and philosophical; it is dishonest, short term and ideological. People think it's smart to trick people with infantile partisan arguments, but they are completely wrong, it's actually a dark temptation that ends up poisoning one's own soul and one's own analysis. The great danger of democracy and capitalism is that the dark side outsells the good side in the short term, and this terrible, almost unmentionable, fact has poisoned both the elite and the poor people they are supposed to be caring for.

In the same way many journalists have portrayed the whole austerity debate to the public in a completely misleading and populist way that portrays the Germans as evil disciplinarians destroying the lives of protesting Greeks. It is perfectly obvious even to a child that the problem in Greece is that the Germans, ever conscious of their WW2 record, and headed by a wet and unintelligent chancellor, have done far too little instead of too much. So instead of implementing sensible policies that can create a more competitive economy, the Greek government is dragging its feet and grudgingly choosing tax increases and spending cuts based on mindless corrupt political considerations that pander to various vested interests on the right and left. You can't fix countries like Italy and Greece just by tinkering around with pensions and taxes, you need to implement profound structural reforms. Look at something Kaletsky wrote today, it really sums up how depressing this whole situation is for the smarter commentators:

Politicians in Europe, America or Britain simply see the crisis entirely as a threat to established ways of life and modes of thinking. Nobody is presenting a vision, or even a credible story, about how the crisis could produce a better tomorrow... Despite the “Occupy” movement and the swirl of rhetoric surrounding the protests, Western politicians are focused entirely on rebuilding the old failed system. Germany pins its hope on fiscal discipline. France may have brought forward the raising of its retirement age from 60 to 62 but its politicians won’t consider further reforms. The US Republicans denounce as “class warfare” any suggestion that taxes on millionaires might rise from pre-crisis levels, while Democrats resist any reform of social welfare rules devised 50 years ago... [By contrast] In Asia political and business leaders see the crisis as an opportunity to build a new form of capitalism. They assume that the future can be, and should be, better than the past...

The problem with so many supposedly learned academic economic journalists is that they can't let go of their dogma, they can't embrace new economic paradigms. Traders, businessmen and the “the ripped-off, lied-to little people” are better at responding to paradigm changes because they start loosing money, but Kool-Aid drinking politicians and journalists are last people in society to "wake up". This is especially true of the elite journalists who are in charge of this debate. They are completely blind to the big picture economic and political philosophy, completely focused on discredited old fashioned broad macro economic models. They are so out of touch with reality I call them witch doctors trying to treat heart disease by putting ointment on the patients skin. They have campaigned endlessly for stimulus and bailouts but ignored the critical underlying issue of profound economic reforms. The politicians got caught up in this chaos, and they have wasted the last few years debating the speed of austerity, meanwhile they have done nothing improve efficiency, and now the widow has closed anyway. Because the banks were discredited they lost their voice and these supposedly learned journalists with no practical experience in financial markets campaigned for orderly default. Yet this campaign has disastrously destroyed the market for European sovereign bonds, and until banks and pension funds fall back in love with European sovereign bonds it's just a one way trade to hell.

In order to really understand the enormity of the European elite's failure, think about Tony Blair. He really exemplifies the humanitarian laissez-faire socioeconomic system which is so responsible for Europe's failure. The European elite think this populist sweet centre ground is the perfect blend of yin and yang that most exemplifies the loving essence of all good Christians. Yet the terrible, almost unmentionable, truth is that they have blended the dark side of yin socialism and yang capitalism and created what I call "the passive face of evil". Christians think of evil as a single concept, but Eastern philosophers know all concepts are bifurcated. To understand this passive face of evil idea consider something Plato said: justice is courage, strength, self control, and judgement. Humanitarian laissez-faire is the political philosophy which revolves around REMOVING all four of these goods!

To understand this consider the idea of courage & strength. Whereas the Americans have been trying to persuade the Europeans to throw money at the crisis, the Chinese have constantly talked about the need for Europe "to put its house in order" with economic reforms. My favourite quote was from Jin Liqun, the top man in charge of China's Sovereign Wealth. Jin Liqun said: "If you look at the troubles which have happened in European countries, it is because of the accumulated troubles of their worn out welfare society. I think their labour laws are outdated. I think their labour laws induce sloth and indolence rather than hardworking. Their incentive system is totally out of whack." Deep down in their hearts the European elite know Jin Liqun is right - but they won't admit it because their whole lives are dedicated to trying to win the people's power by pretending to be competent. To admit how bad the situation really is would be to risk the guillotine, so they let the people slide down the slippery slope to hell instead. So the humanitarian part of humanitarian laissez-faire has built a completely cowardly and weak society.

I can explain the idea of self control & judgement by way of an analogy. When I was school I remember reading a book about the "Ghost Towns" left behind by the Californian "Gold Rush" in the USA. The miners who struck rich liked to spend most of their profits in an orgy of excess, and entire towns grew up around serving them. So some people invested their life savings in gold mining, and some people invested both their own money and borrowed money into building a service industry near them. Then one day the gold stopped flowing and these towns rapidly imploded and were left to rot away. Some lucky people who had cashed up their chips walked away with a profit, but the majority came away with nothing, and the banks were carried out on stretchers. One of the amazing things about all this is that some of these towns even sprung up without anyone really finding any gold. If Joseph Stalin had been running the Wild West instead of the cowboys he would have noticed that these towns had no future and one day nothing worthwhile would come from them, they were just greedy stupid illusions of wealth, and Stalin would have banned gold mining and forced the people to make his idea of socially useful things. I think this Ghost Town story is a good metaphor for a large part of the European economy. Now that the Europeans have stopped borrowing and partying a lot of stuff is going to vanish extremely rapidly. There is no point delaying this process with rescue packages, the Ghost Towns were bound to fail, better to get it over and done with asap. What policy makers need to do to survive this nightmare is avoid self indulgently rescuing failing ideas; also to start judging what is and is not socially useful, and then start building some new towns doing these useful sustainable things so the unemployed people have somewhere new to go.

Greece is another policymaking tragedy. Two years ago I wrote an important article about Greece saying:

Greece is the worst offender, but many other countries are facing impending debt crises too. In fact almost the entire developed democratic world faces considerable difficulty, especially as the proportion of retirees increases over the next few decades... Yet Greece's membership of the Eurozone is bringing her addiction to unsustainable government borrowing to a more rapid climax. The Dollar has strengthened recently, but I see in this crisis a silver lining that could in the long term vastly enhance the reputation of the Eurozone. With most rich democracies facing spiralling government debt I see Eurozone membership as a purging medicine which is forcing early resolution of an illness which could otherwise turn terminal; which is forcing a proper cure not just pain numbing devaluation; and which is treating individual member state cases before a pandemic develops. Countries such as Greece and Italy have been rotting under incompetent economic policy making for generations. With China, with climate change, the challenges are only getting that much harder. The cruel game changing disciple of Eurozone membership is the only hope of turning these dieing states around. If Eurozone members get this right it will put them head and shoulders above the Americans who have no such mechanism to cure them of the modern democratic disease.

I also said:

It is absolutely critical that the EU is seen to be taking the lead, and it must do so quickly before it is forced into a fire fighting mode. The markets have to feel that the EU is making an example of Greece, that other member states have more support, that the EU is willing to sacrifice the profligate and dishonest Greeks in an awesome display of political courage and will. If Greece fails the EU should give them a choice between surrendering sovereignty and having a technocratic government imposed on them, or being kicked out of the both the Eurozone and EU. The fate of Greece, at the end of day, does not really matter much one way or another; the key is to terrify other EU voters, forcing them to accept more responsible policymaking; without that lesson, the Eurozone's long term survival is at risk... Angela Merkel needs to announce: "Greece lied to gain entry to the Eurozone and has been lying ever since. She has taken billions in structural funds, her banks have borrowed billions from the ECB. Greece now threatens the stability and reputation of the Eurozone, even the EU itself. Germany is a generous country, yet we can not help Greece in its current form. Doing so would be morally wrong; it also would be impossible for German taxpayers to accept; and in the long term it would only prolong the economic crisis in Greece, not solve it. Either Greece must sort out its own problems, without defaulting, or it must surrender sovereignty in return for aid. If it requires aid, Greece will be placed under EU guardianship and her parliament suspended, meanwhile the EU will assist financially. Once Greece's economic heath is restored, Greece will be returned to democracy. Welcome to the 21st Century."

I used to describe Greece as almost a gift from the gods, a chance to practice ones boxing skills on a corrupt rich little guy before taking on the Italian gorilla. Now we have to go to war unprepared. Now the pandemic nightmare is upon us. Now the Eurozone's very survival is on the line.

Today lots of journalists have been writing articles saying if the grumpy Germans won't bail out Italy then Italy should leave the Euro. But as the commentator at Bloomberg News repeatedly pointed out to listeners "ITALIAN DEFAULT IS THE END OF THE WORLD". Italy is not another Greece who can be sacrificed as an example to the rest, if Italy defaults on its debt half the banks and insurance companies across Europe are finished. Outside the Eurozone neither the Italian government nor Italian banks are going to repay their debts and the losses are going to be unimaginable. Not only that, Italy has no future outside the Eurozone anyway. What people don't realise it that you can't keep devaluing your currency as an alternative to economic reforms because it twists your economy in ways that make it gradually more an more inefficient. If your management and working practices suck you need to change them, it's not a simple linear thing that can be solved by paying your employees less. For forty years Italy has desperately needed massive reforms, in or out of the Euro the Italians are going to hell if they don't get them.

Today you see endless articles in the press by journalists saying the Euro project was bound to fail and they knew it all along. But European countries were happy as separate nation states under a gold standard up until the 1930s. A currency is just a unit of exchange and what people want from it is simply price stability. That means if you put your money into the bank and leave it there for a few years instead of spending it, when you eventually withdraw it you will be able to buy approximately as many goods as you could have done when you put it in. Italy didn't have that for most of it's history, and they are a lot better off with what they have today, the fact they share it with someone else is irrelevant as long as it works. The Eurozone problem was lax banking regulations and Ghost Town real estate booms etc, not the currency itself. The idea that every sovereign state has to have a separate floating currency is economic mumbo-jumbo bananas. The lesson of history is that national currencies do not work, that's why the gold standard was once so important. Of course the gold standard eventually failed because people want a currency that provides price stability for food, fuel and accommodation etc, not jewellery. Yet that doesn't mean we want national currencies. Even today the failure of national currencies is evident in the plight of Switzerland, Japan, USA, China. Frankly the international global currency system is breaking down, it looks like a period of chaos, capital controls, protectionism etc is coming. So don't be fooled by the hacks, the problem with Italy is not the Euro, it is Italian politics.

What does all that mean? It means, as the commentator at Bloomberg news pointed out: ITALY NEEDS A TECHNOCRATIC GOVERNMENT IMMEDIATELY. What we need is effectively the suspension of Italian democracy and terrifying austerity measures and shocking economic reforms being forced onto hapless voters at a time when the external economic environment is catastrophic. Yes people are going to go hungry and there are going to be riots, but there is absolutely no alternative. We can't have more elections in Greece and Italy right now, what we really need is a five year state of emergency and the suspension of parliament and a team of Chinese technocrats to secretly give the EU a big helping hand in suggesting reforms. The Chinese will come onside if you show you are deadly serious and determined to do what it takes. In fact the Chinese will use the crisis to exit their dollar position and it will bring China and Europe together and build a new political world order.

Of course suspending democracy and implementing terrifying reforms is a political nightmare, but we are in a nightmarish situation. This is not a time for dogma, there is simply no choice. Now is the time for politicians to realise how completely they have failed, to announce to the world that our democratic setup has failed and it is time to bite the bullet of reform. Realise that the economic environment is much worse than the 1970s, it's possibly even worse than the 1930s, several countries across Europe fell into fascist dictatorships back in the 1970s, people are way more spoilt and stupid today, democracy is finished sooner or later in countries like Greece and Italy anyway. The only question that we philosophers and historians are waiting to find out is whether or not failing states ends up as EU technocracies or populist tyrannies.

I realise people find this shocking, but there is no more time left to keep playing muddle headed games. Most of all people in Europe are afraid of death and war, but if countries like Greece and Italy inflict astronomical financial losses on the Germans and Dutch and Finish, their incumbent liberal political parties will certainly collapse and give rise to virulent nationalism and eventually war. Just tell the votes the truth for a change, tell them that Italian default will cost untold amounts of money and create war, tell them you have no choice. Stop trying to calm people down and pretend you are in control, scare them to hell and paint yourself as a saviour.

There is a way to restore some democratic legitimacy, and I have mentioned it in an article of mine called technocratic prison. The idea here is to let everyone in Europe vote in a referendum for a system in which countries that fail are put under technocracy, whilst other countries are given full freedom. I even suggest toning down the EU, abolishing the EU parliament and returning sovereignty to everyone else as part of the treaty change. Because this technocratic prison system is the big huge political bazooka that shocks the world, it ends the crisis instantly on the spot. If it was implemented right away with the Greeks, and combined with a really bold austerity package in Italy, the sovereign debt crisis might just end with only Greece ever being imprisoned. Because it's so bold and violent it will restore the faith of the German masses in Angela Merkel, she will go from wimp to hero, and the German masses might even have the confidence to embrace Eurobonds. It is literally the last option on the table.

Remember when every other path is death, you have to take the last path left standing no matter how morally offensive you think it might be. You can't let the millions of people you care for die because of your moral dogma or reputation. Call the Chinese and discuss it with them if you need a second opinion. The secret is this: analyse the crisis not by thinking about moral dogma, but by using pragmatism to cross out all the things that won't work. The "what is not" pragmatic rather that "what is" moral compass approach to decision making was the secret encapsulated by the myth of Theseus and the Minotaur. Instead of choosing the paths that felt as if they were heading in the right direction, his ball of string told him which way not to go. The myth tells the story of the vital step away from religious decision making that founded the new intellectual paradigm in Ancient Greece. If the politicians do not take this step away from dogma to pragmatism our civilization will perish. This is our existential moment, and our very lives are on the line.