Is Europe Turning Japanese? Starting To Think So

12 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

“I think I’m turning Japanese, I think I’m turning Japanese, I really think so”

12 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

“I think I’m turning Japanese, I think I’m turning Japanese, I really think so”

12 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

“I think I’m turning Japanese, I think I’m turning Japanese, I really think so”

12 May 2010. By David Caploe PhD, Chief Political Economist, EconomyWatch.com

“I think I’m turning Japanese, I think I’m turning Japanese, I really think so”

The Vapors, 1980

After the tumultuous events of the past week/end in Europe, we thought we’d ask our Chief Political Economist, Dr David Caploe, to see what light, if any, he could shed on the current situation there.

EW: So is the crisis solved?

DC: Hah, hardly. I don’t even know where to begin, but let me start by pointing out that the alleged global market rally of Monday had definitely petered out in both Europe and Asia by Tuesday, and I’m pretty sure the same will be the case in the US as well.

EW: But you yourself always say markets don’t mean anything …

DC: No, I say markets don’t mean EVERYTHING 😉 … and there’s a point about that I want to make later, but for the moment, let me make clear that I DO think markets mean something – at least most of the time … maybe … [laughs].

EW: All right, fine, whatever [laughs], but that still doesn’t answer the question: has the crisis been solved?

The ECB is putting up hundreds of billions, the IMF is also part of the deal in a big way, both the EU and the US Federal Reserve are going to start buying the government debt of countries in trouble.

Why shouldn’t we think the problem has been solved?

DC: Let me answer a question with a question:

Did the similar intervention of the Federal Reserve during Black September 2008 solve the problem then – or simply push it further down the road ???

EW: Well, we all know you think it didn’t solve anything, except –

DC: Right, except consolidate the already big banks into even bigger ones,

thus institutionalizing the whole problem of Too Big To Fail — which has now become one of, if not, THE key issue that the United States has to face.

In fact, I got a hell of a laugh from this article I read in today’s New York Times,

which said that Obama played a key role in getting the Europeans to “work together” in order to “solve” the rolling thunder of the debt crisis that is just making a mess of Europe’s economies. [br]

Or, rather, is making obvious the mess that European economies have been in for a while, and which the Euro –

despite its evident political importance, which, by the way, is one reason I very much support the continuation of the Euro, IF it can happen,

has done very little to support from an economic point of view,

and, as we have pointed out in several pieces, has made dealing with the debt crisis even harder than it MIGHT otherwise be in its absence.

EW: Okay, well, before we get to that point – AGAIN – what was it in the Times piece that you found so amusing?

I mean, don’t you think it’s good the US is taking a role in helping make sure Europe doesn’t fall apart?

DC: Well, sure — if that’s what it’s doing. And it’s certainly true that things looked like they were falling apart when Obama stepped in.

But both the substance of what he was saying, as well as the rhetoric he was using, really made my blood run cold,

if such is possible when it’s so damn hot and humid the way it has been in Singapore lately [laughs].

EW: Well, we read the same piece – since, in your usual subtle way, you insisted we all do – and none of us had the same reaction you did. What was the problem?

DC: The first thing was Obama telling the Europeans that they should follow the example of the US during Black September 2008, and go big with their intervention.

EW: What’s wrong with that?

DC: Two things: first, in case you’ve forgotten, it wasn’t Obama that was in office during Black September 2008 — it was Cheney and Bush.

And the idea that he CONTINUES to endorse their basic approach is really problematic.

Now this certainly isn’t the first time we’ve said this, but it’s so disturbing that it cannot be repeated enough:

by both endorsing and continuing the Cheney / Bush approach, Obama has made the WORST possible choice he could in his whole approach to this mess.

And that brings up the second “funny” point – only it’s not a joke.

While he was telling the Europeans they had to “go big” to get the appropriate reaction from “the markets” –

and I DO have a point to make later about their significance in this situation,

the phrase he used was “shock and awe.”

EW: Yes, we DID notice that, and it DID seem a little bizarre.

DC: And that’s putting it mildly.

In case anyone has forgotten, that was ANOTHER Cheney / Bush coinage,

only it referred to their strategy for how they were going to deal with Saddam in the first few days of the Iraq invasion,

yet another US initiative that has turned out so well.

EW: Okay, we’ll admit the rhetoric was poorly-chosen, but wasn’t the substance of the advice positive?

DC: Are you TRYING to get me angry [laughs] ???

EW: [Laughing] Just being a bit of a devil’s advocate here …

DC: Well, I hope so … jeez … no, in fact, what Obama was telling them was they should follow the Cheney / Bush / Obama strategy of “propping up the middlemen” – ie, the banks,

in the hopes that this will “assuage the markets” and everything will go back to being “normal”, whatever that means at this point.

EW: And, as you’ve been arguing for the past several months, you think this approach is doomed to failure, and it’s at this point you always bring up your favorite analogy

DC: Not that I generally USE analogies – and practically NEVER metaphors,

but this is one situation where it’s actually useful TO use an analogy … oops, excuse me for interrupting [laughs] …

EW: [Laughs] Oh, don’t worry, we’re used to it by now [laughs more] … but your favorite analogy, namely, Japan – is that what you’re going to say?

DC: It’s nice to know that someone around here is listening [laughs] … no, yes, exactly … you’re correct … it’s at this point that I’m afraid I always DO bring up the Japan analogy.

EW: But how can that be? We can sort of understand it vis-a-vis the US, but how does it work for Europe? It doesn’t make sense.

DC: Okay, remember the key point is about who’s telling who what to do.

The crucial mistake Japan made in the aftermath of ITS real estate collapse in 1989 is EXACTLY the same one Cheney / Bush, and then Obama, made in the aftermath of Black September 2008:

namely, instead of forcing the banks to declare their losses,

a move that would certainly send almost all their stock prices tumbling, and some of them to bankruptcy,

the political leadership in BOTH countries decided to let them get away with NOT, as the phrase goes, “marking to market” – that is, valuing their assets as the market is valuing them.

Instead, the governments in both Japan and the US have allowed these huge banks –

that really are, in a way, Too-Big-To-Fail, lest they bring down the current system, at least as currently constituted –

to PRETEND that the assets they hold have whatever inflated values they want to assign to them.

In this sense, as you know, I always say in both the US and Japan the banks tell the governments what to do, and not, as in China, the other way around [laughs]. [br]

EW: Okay, that may be fine as far as the US and Japan go, but what does that have to do with Europe, where government spending is the problem?

DC: Good point, but it doesn’t change the situation.

What’s the same is that in all three cases, there are debts being held by banks.

In the case of the US and Japan, it is collapsed real estate assets, ie, mortgages, on properties that have lost their value.

In the case of Europe, it is bonds that have been issued by governments,

that, as with mortgages, those who are responsible for paying CANNOT pay.

Thus the problems for banks holding government debt that can’t be paid is EXACTLY the same problem as banks holding mortgage debt,

and, even worse, derivatives that were supposedly BACKED by that mortgage debt — that can’t be paid.

In ALL of these cases, the banks that hold that debt are forcing whatever governments over which they have leverage –

which is a GREAT TV show, btw, that often deals with these sorts of issues –

EW: Oh come on, keep to the point … next you’ll be off on MAD MEN and SONS OF ANARCHY …

DC: And FLASH FORWARD is also looking pretty good too [laughs] …

Well, it actually IS the point of Leverage the tv show, which is why it’s so great … [laughs]

But, anyway, all these banks are forcing “their” governments NOT to force them to “mark to market” the assets that were perhaps ONCE worth something, but are now relatively worthless.

And this is enabling those TBTF banks and other financial institutions to pretend they are still in good shape,

when, in fact, they are in very BAD shape, but they don’t have to admit it,

so their stock prices remain way inflated, and the weakest of them can avoid bankruptcy.

Now in order to keep this little shell game going, a lot of money is needed BY these banks,

and it is this – taxpayer, I might remind you – money that is being used to prop up what would otherwise be a self-evidently weak financial sector.

This is where you get the immortal Japanese expression “zombie banks” –

banks that are in fact dead, but still walking around and eating the flesh of economic beings that are still alive,

but won’t be much longer after the zombie banks get finished with them.

And this, of course, has disastrous effects on the rest of the “real economies” of these countries,

since, after the financial sector has been taken care of,

there is RELATIVELY little “free” money floating around that can pay for the – always expensive, in the short run –

process of creating the technological innovation that – in the LONG run –

creates the effective demand for new products and processes that powers REAL economic growth, again in the long run.

So taxpayers get screwed twice:

first, in having so much of their money go directly to propping up “zombie” banks,

who show NO hesitation in handing it out to themselves as quickly as they can, before it runs out, as they know it will,

and second, in the “lost forever” or “long-delayed” technological innovation,

that, in the long run, is the ONLY thing that is going to move all the advanced economies out of the recession / deflation trap in which they find themselves.

EW: Wait, so where are all these record profits and high levels of banker salaries, bonuses and other compensation coming from? It doesn’t make sense.

DC: That’s the beauty of Too-Big-To-Fail.

Those banks can essentially do whatever they want, and they don’t have to worry that they are ever going to have to suffer for any mistakes they make,

because they know “their” government is always going to be there to back them up. It’s a complete scam from every point of view.

EW: So how does all this play out in Europe?

DC: It’s the same game, only you’ve got different people/ groups in society legally responsible for those debts.

In the US and Japan, they are real estate owners, whether residential or commercial.

In Europe, they are other banks that own derivatives based on either mortgages OR government bonds,

or the governments themselves that cannot now pay, like Greece, and perhaps, Portugal and then Spain.

Regardless, the governments involved ALLOW the banks to NOT “mark to market” these relatively worthless “assets”,

but to PRETEND that these debts are, in fact, going to be paid BY SOMEONE.

EW: Hold on a second. So you’re saying that there’s no difference, in a structural political economic sense, between the unwillingness of banks to accept unpayable mortgages in Japan and the US, and unpayable government bonds in Europe.

DC: EXACTLY !!!

And that’s precisely what concerns me. The US got into a terrible mess, and it chose to deal with it by mimicking the Japanese response of letting the banks avoid EITHER being broken up OR having to realistically assess their liabilities.

NOW, it seems, Europe is doing the EXACT SAME THING:

allowing the French and German and other banks, who are, after all, the TRUE beneficiaries of the so-called “Greek bailout”,

since THEY hold most of the debt issued by the Greek government, and will get their money back,

while the Greek government and Greek people have to live with “austerity” programs that are forced on them

in order for the Greek government to be able to continue to borrow money for either short- or long-term expenses.

EW: And so this is where the markets actually DO come into play —

because THEY have to believe that Greece or Portugal or Spain or Ireland or any other “dubious” government is going to, somehow, be able to back up their EXISTING obligations,

and will, therefore, be “eligible” to receive more money IN THE FUTURE, through the purchase of their NEW government bonds.

DC: Absolutely correct.

And that’s why the political issues become so important.

In Japan, the TBTF banks & other institutions – or so-called keiretsu – are already deeply tied up with the Liberal Democrats,

who governed Japan basically since the US “granted” it autonomy in 1955, that is, more than 50 years ago,

even though the government is now in the hands of the Democratic Party, which IS doing some interesting and innovative things

in order to deal with the mess the Liberal Democrats so unceremoniously dumped in their laps when they were actually voted out of office.

And Obama, of course, has completely abandoned the groups and principles that got him elected on a platform of “change,”

the results of which are almost impossible to see, since nearly every major policy —

including the so-called health “care” “reform” is calculated to bring huge paydays to the main elements of the “health care industrial complex”:

Big Pharma / health insurance companies / hospitals / HMOs / the AMA & its affiliated doctors.

As we always point out, the Euro-zone itself has 16 different governments / tax systems / state spending policies,

which they are going to be loath to relinquish to any sort of supra-European Commission, as they proved over the weekend.

And now both Germany and the UK are confronting serious internal political problems.

In Germany, Chancellor Angela Merkel’s governing Christian Democrat / Free Democrat coalition lost an election last week in German’s largest state, North Rhine / Westphalia,

which is not only a significant symbolic rejection of her whole approach,

but also meant a loss for the governing coalition’s majority in the Bundesrat, or upper chamber, which means that,

however long the current national government lasts, which many observers think unlikely to be very long,

there will be NO automatic passage of ANY controversial measures.

And in the UK, this weekend’s national elections resulted in a rare “hung parliament,”

in which NO party won a majority, and so there will be either a minority Conservative government,

for the first time since the mid-1970s,

OR some kind of coalition, whose last time practically no one can remember.

In both cases, political weakness at the top is only going to make ANY kind of problems harder to solve:

for Germany, being the “strongest” economy in Europe – which, frankly, isn’t saying very much –

whom the other countries will look to for “leadership”, but which Merkel was un-willing to provide BEFORE the election,

and will now be un-able to offer AFTERWARDS;

and for the UK, an evident lack of political will to be able to deal with ITS own impending sovereign debt crisis.

EW: Which is why you think Europe is, in the words of the 80s song, turning Japanese?

DC: Exactly. The governments are becoming more weak and direction-less just at the moment when decisive action is needed,

and by following the US “example”, Europe is only making the kind of TBTF situation that has paralyzed BOTH Japan AND now the US that much more likely.

Japan has now had more than two “Lost Decades”.

Given its utterly inadequate response to Black September 2008, the US has been following right along in its footsteps.

And if Europe is now heeding America’s advice about how to deal with their political economic crises,

it seems more than likely that Europe will be right behind both Japan and the US heading into Lost Decades for the foreseeable future –

which is a tragedy for all concerned, but it’s becoming increasingly hard to see a way around it.

EW: Great, thanks for another depressing conversation.

DC: My sad and unfortunate pleasure.

David Caploe PhD
Chief Political Economist
EconomyWatch.com