Between Various Rocks and Various Hard Places (January 26, 2012)
The U.S. and European economies are firmly between various rocks and various hard places.
Having stipulated that "Forecasting Is Not Humanity's Strength," I will not make any foolish forecasts that will assuredly be proven wrong, but it is undoubtedly true that the U.S. and Europe are both entering a "crunch time" politically and financially.
In essence, both economies are between multiple rocks and multiple hard places. Eventually, this ceases to be an academic question and becomes one of actual financial impact on people via higher taxes, smaller checks, lower purchasing power, etc.
For example, the dismal failure of the Federal Reserve's QE2 goosing of the economy has eroded its political support and thus its freedom of action. Fed Chairman Ben Bernanke has the look of someone who is realizing his own limits and is thus pondering retirement (a speculative forecast I made last year, i.e. that Ben wouldn't last and would be forced out or quit).
Bernanke has more or less confessed that he 1) doesn't understand why the economy isn't responding "like it should" i.e. as described in textbooks, and 2) that he is tired of the political heat created by QE2 and he is dropping the burden of "saving" the U.S. economy.
He looks like a person who has lost his confidence and is going through the motions until he can figure out a way to exit the leadership stage gracefully. It is painfully obvious to all that his QE2 did nothing to heal the real economy while attracting global attention and ire. The whole project was lose-lose, with the only gain being "extend and pretend."
Meanwhile, the Fed has to keep printing money to enable every debt holder has enough to service their debt next month, never mind next year. As frequent contributor Harun I. noted in a private email to me, the amount of leverage is so staggering that if "real money" (cash, gold, etc.) were applied to debt, a vast sum would still be left unpaid.
That's a rock and a hard place, to be sure, as I have noted on the blog: if you print enough money to keep the Status Quo in "extend and pretend" mode, then you get inflation, which creates another set of difficulties and acts as a tax on the entire economy.
The loss of faith in Fed fixes is profound, part of the delegitimization process I have mentioned in previous Musings and blogs.
The same loss of faith is evident in Europe. The EU leadership has to cobble together another "extend and pretend" bailout of Greece, but nobody believes it will fix anything--that belief has been shattered. Once that faith is lost, then the value of "extend and pretend" is lost as well.
There is no way Greece can meet its debt obligations, even as its creditors clamor for it to sell off its assets. Why bother, if most of the debt will remain unpaid? The answer is to transfer the wealthof thenation to international banks, of course, but the Greek people may not acquiesce in their impoverishment.
The only other option is for bondholders to "take a haircut," that is, get back less than 100% of their bond. The EU leaders are banking (pun intended) on some sort of "minor default" being the "fix" that puts the problem to rest, but they fail to grasp the subsequent loss of faith in the entire euro banking system.
If Greece's bondholders are going to take a loss, then what's stopping those holding Irish, Portuguese, Sanish or Italian debt from taking a loss as well?
The answer is of course nothing: there is no way to stop the "haircut" from happening in every cituation where the borrower is insolvent.
And as borrowers default, then so too do insolvent lenders.
This is the ultimate rock and hard place: the only way to clear the economy for future growth is to clear away the deadwood of uncollectible debts, yet clearing away the impaired debt will necessarily take down all the "too big to fail" banks on both continents, an action that is politically "impossible" as those banks have their hands on the throats of the governments in question.
As I have noted before, once faith in "extend and pretend" policies has been lost, then the next "extend and pretend" fix will no longer have its desired effect of calming the waters. Indeed, the failure of central institutions to grasp the nettle will be recognized as a failure that dooms the Status Quo.
The "solution" for three years has been "extend and pretend," and now that faith in that muddle-through strategy has been lost, then there are only two choice open to policy makers:
1) enact a visibly transparent "extend and pretend" fix once again, basically pushing the crisis forward once agin for a few weeks or months, or 2) grasp the nettle and pursue a politically "impossible" real fix that wipes out uncollectible debt and insolvent borrowers and lenders.
Unfortunately for the Status Quo, the cat is out of the bag, so to speak; nobody believes minor policy tweaks or more bailouts will actually fix their economies. So the "extend and pretend" fixes that will be presented as meaningful will be increasingly recognized as artifice and propaganda.
This will feed the profound political disunity that already characterizes the politics of the U.S. and the E.U.
I would like to believe that the people are finally ready to lead their leadership to real solutions, but their insecurity, doubt and fear about their own slice of the pie seems to have frozen them in a weird warp: they recognize "extend and pretend" is futile, but they have no confidence in the "impossible" choices, either, as the risk is doing anything other than "extend and pretend" frighten them.
The way out of the dilemma would be a new political consensus forms in favor of writing off all bad debt and breaking the banks' grasp on our collective throats. Right now that seems as "impossible," but all sorts of other "impossible" things have happened in the past decade.
The one thing we know is truly impossible is that "extend and pretend" will actually fix anything.
As noted here before, a number of intersecting cycles suggest the end-game of "extend and pretend" will play out in 2012-2013.
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