Geithner Shunned: What the US Treasury Secretary said to the Europeans and how they shunned him at our collective peril

Back in the era of unquestioned US hegemony, many Europeans (and I include myself) dreamed of the moment when our leaders would find it in their hearts publically to repudiate the heavy handed advice of a high ranking visiting American dignitary. This weekend, the dream came true. Only it turned out a terrible nightmare.

Tim Geithner was in Europe this weekend for the purpose of appealing to European leaders to put their money where their mouth is; to complement lofty declarations of a commitment to saving the euro with actual policies that might achieve the stated objective. Not for the first time since the Crisis erupted in 2008, the visiting US Treasury Secretary had his advice thrown back in his face by a European leadership that seems to have found unity in inanity.

Maria Fekter, Austria’s finance minister, had this to say afterwards: “I found it peculiar that even though the Americans have significantly worse fundamental data than the eurozone, that they tell us what we should do and when we make a suggestion … that they say no straight away.” What this sentence reveals is the deep ignorance in which our European leaders’ thinking is veiled. When they refer, for instance, to “fundamental data” which is worse in the US than in the EU, they are obviously referring to debt-to-GDP ratios. Which means that they, clearly, believe that Europe’s problem is a debt crisis. Which, of course, it is not.

Isn’t it a debt crisis? Of course not! Indeed, the Austrian Finance Minister is right to point out that, by US and Japanese standards, Europe’s aggregate debt is hardly a problem. But then again, how come Europe is immersed in a debt crisis? If Europe is afflicted by a debt crisis, it must surely be less severe than America’s or Japan’s. It is not. US and Japanese bonds are finding legions of willing buyers at record low interest rates (unlike the European bond markets which have almost seized up). Meanwhile the dollar and the yen are doing fine thank you while the euro is under pressure. Something in the Austrian minister’s logic does not add up…

That ‘something’ is, of course, that Europe’s debt troubles are a mere symptom of a problematic architecture of the euro which Europe, in its infinite wisdom, tried to resolve by creating a toxic bailout fund; the EFSF. One wrong to correct another, in simpler words. (See here for an earlier post which explains this point.)

In short, the reason why Tim Geithner has every right to offer the Europeans advice on how to handle their Crisis is because they are stubbornly refusing to grasp its nature. By insisting that Europe’s problem is one of too much debt and insufficient fiscal ‘discipline’, they are running the grave risk of allowing the euro to unravel, with horrid repercussions that will soon travel across the great oceans bringing down with it any chance the global economy currently has to avoid another Great Depression.

So, what did Geithner actually advise the Europeans to do? Three things:

First, to realise that nothing they do in the realm of sovereign debt (e.g. austerity) will work as long as Europe’s banking sector remains practically insolvent. To prevent a repetition of Japan’s fatal error of the 1990s (i.e. allowing the banks to remain in a zombie state through liquidity injections that do not address their underlying insolvency), the US Treasury Secretary urged his European counterparts to turn the European Financial Stability Fund (EFSF) into a Euro-TARP; a pan-European institution that would recapitalise the banks in exchange for equity that will be resold to the private sector immediately after the banks are returned to a modicum of heath. (NB. this idea was first canvassed in our Modest Proposal, see Policy 2, and only last month was also supported by Christine Lagarde, MD of the IMF, during her excellent Jackson Hole speech.)

Secondly, mindful of Germany’s reluctance to increase the EFSF’s funding power (from the current €440 billion, a large chunk of which has been assigned to the ‘bailouts’ of Portugal, Ireland and Greece), so that it can indeed recapitalise Europe’s ailing banks, Geithner tried to educate his European counterparts to the policy trick that he conjured up in 2008 while heading the New York Federal Reserve; a financial technique that would allow the EFSF considerably to expand its €440 billion-euro by means of leverage made possible by the ECB.

Thirdly, Geithner told the Europeans that which a 12 year old child would have known: With world aggregate demand stalling, and the EU’s own growth grinding to a halt, the debt and banking crisis cannot be overcome unless growth is somehow stimulated. He appealed to them to abandon their policy of free riding on the coattails America’s monetary easing and China’s fiscal stimulants. He begged them to do their bit to shore up aggregate demand in Europe in order to avert Europe’s own decline and, by extension, the globe’s next recession.

Well, we all know how the Europeans reacted: By a mix of denial, ignorant rejoinders and downright impudence. The Austrian Finance minister’s silly remarks are just the tip of an embarrassing hideous iceberg. Our European ministers indulged, once again, their steadfast denial that there is anything fundamentally the matter with Europe’s banks (repeating the unconvincing statements they issued following Christine Lagarde’s Jackson Hole speech). Additionally, they put again (in full Technicolor display) their dogged determination to maintain the pretense that the ECB can afford to (and must) stay out of the debt and banking loss management game. For example, Bundesbank President Jens Weidmann had this to say in response to Geithner’s proposal that the ECB helps the EFSF ratchet up its funding in order to have enough dough to re-capitalise the banks: “The EFSF’s sole purpose is the financing of states and that’s in order as long as it’s done via the capital market.” “If it’s done via the central bank it constitutes monetary state financing.”  How terrible that would be! Seriously Mr Weidmann? Clearly, Mr Weidmann cannot grasp the simple fact that, at a time of an imploding currency union, the line dividing fiscal from monetary financing becomes blurred for a Central Bank whose remit is to be the currency’s guardian.

Conclusion

Tim Geithner, as I have argued in my Global Minotaur, is a US Treasury Secretary with a tainted past. Indeed, as a handmaiden of Wall Street, since his Clinton Administration days, he carries the sin of having released the banks from any constraints that might have prevented their predatory and fraudulent practices in the 1990s. More recently, Geithner played a crucial role in assisting the creation of (what I call) post-2008 Bankruptocracy.

Nonetheless, this does not mean that, on this occasion, his advice is to be ritually discarded. Tim Geithner is a skilled and experienced government man. The Crash of 2008, which caught him at the New York Federal Reserve, has taught him to recognise the signs of an impending financial disaster. His experience of dealing with such a disaster, especially a bankrupt banking sector that resists recapitalisation even when recapitalisation is sine qua non, led him to the conclusion that Europe must turn the EFSF into a European TARP and that, unless it does so, the world’s financial system is in serious peril at a time when government lacks the deep pockets it had in 2008 to come to their rescue.

For these reasons, Tim Geithner rushed to Europe this weekend with pretty good advice. Europe shunned him. I have no doubt we shall all pay for this.

13 Comments

  • so yanis, will LaGarde/IMF deviate from their standard practices and give greece a pass when Troika reviews Greek implementation of the austerity requirements for the next tranche ? seems to me nobody is suggesting Greece has or will make this hurdle, so unless IMF is willing to look the oher way, regardless of what EU/ECB wants , IMF will not approve release of funds and Greece is actually bankrupt…if one is to believe LaGarde , this will all shourld all shake out in a week or so correct ?

    • Greece will get its istallment with or without the IMF. If the IMF baulks, the Europeans will make up the difference. Unless Germany has decided to bail out of the euro at this early stage. My reasoning is simple: No installment means a Greek default. A Greek default will then cascade via Italian bonds and the French banks to France’s triple-A rating. And then Germany will have to choose between either shoring up the EFSF by itself of bailing out of the euro. At which point it will opt for the latter.

  • Probably, what some of the European leaders forget is that the Federal Reserve Bank of US has provided bail out money directly to some of the European banks!

  • Ah … our Maria Fekter again. It was bad enough when she was our Minister for Interior bullying innocent immigrant children. But now as Minister of Finance she’s lecturing whole Europe with her insane “insights”. She’s a real embarrassment for Austria. Unfortunately Austrians buy into her receipt for Europe’s doom and ruin.

  • Yannis is 200% right. It is a sad spectacle to watch, day after day, week after week, month after month….

    It should not be forgotten that that it’s these guys (European finance ministers and central bankers) that want to get their hands on our social systems and, above all, wages and wage bargaining. Total disaster guaranteed if they succeed in getting these powers….

  • Yani,

    The enormous credit expansion of the past 30 years has misallocated so much capital in both the private and public sectors that we now have to somehow pay the price for that. Depression, Zombification, or Growth *after* a Turnaround are the only three options IMO.

    The money bred enormous state bureaucracies, was leveraged to inflate massive asset bubbles, and we have to recognize the losses that they have incurred, along with proceeding with a parallel turnaround and “share capital increase”. The world needs more equity and the corresponding flexibility that it brings at every single level, including the sovereign level. But equity investors need to see light at the operating level prior to disbursing their funds. While Germany is using the following as an excuse to hide behind its responsibilities, it is sadly true that Greece currently lacks *the mechanism* with which to identify, evaluate and manage equity-like investments.

    I find strategies intended to deal with “aggregate demand” as part of the old solution (i.e. what created the problem in the first place). For instance, shoring up a bloated public sector or pushing through “full employment at any cost” initiatives will only make the problem worse. We cannot build on top of this already collapsing structure. Growth from here is impossible – we have to first restructure, and invest where there is true opportunity for sustainable growth.

    The entire West needs a major turnaround project, but instead of doing it top-down at a global level (and thus further catastrophically synchronizing the world economy’s business cycle), it has to happen as a collection of scale-free, almost infinite turnarounds at the state, local, municipal, corporate and even household levels. Of course, in order for something like this to happen, one needs to *at least* establish some top-down stability and universal rule-sets (which is what is desperately lacking today).

    I cannot agree more with you, when you touch on the need for investment at a Pan-European (and perhaps Global-West) level. It is in the interest of surplus countries to find investment outlets for said surpluses in order to make their growth scalable and sustainable. And it is absolutely essential for the deficit countries in order for them to reach escape velocity.

    In the case of Greece, it is not just a pre-requisite for survival. If done right, Greece has the opportunity to become a case study for how to rejig western economies in general. Greeks have to become turnaround artists whether they like it or not. If they pull it off, their expertise will very soon prove invaluable to the rest of the world. If they don’t, they run the risk of being another case study…That of the first (and certainly not the last) western failed state of the 21st Century.

    It certainly looks convenient to sum things up in such a binary bet, but this is where we stand today.

    • “….it has to happen as a collection of scale-free, almost infinite turnarounds at the state, local, municipal, corporate and even household levels. Of course, in order for something like this to happen, one needs to *at least* establish some top-down stability and universal rule-sets (which is what is desperately lacking today)….”

      Allow me to add this.

      In nature there are always fluctuations. One can not constantly go up. One must stall ,rest ,even go back a little bit. It is only natural.

      What is not natural is the tyrannic parasitic global economy that we have.

      And why do i say that?
      Because what i see is that when the economy is in an upwave ,only certain countries and certain people of certain behavior without neccessarily deserving it ,get most of the goodies.
      When the economy is in a downwave ,other countries etc. get most of the s… .

      How convenient.

      It is too convenient.

      If we are to have corruption and stupidity at least it should be of local level.

      I am trying to be an optimist here by saying that we have gone back and still go. But will it be back enough for rules to change?
      Or once more people will “need” to see disaster?

  • Ok- so Greece makes it through October, perhaps through December, and by that time Merkl knows where she stands in Parliament and whether voter sentiment wants to bail on the euro ? – if thats the case Greek resolution is deferred until Germany has time to decide (“poll”) what it wants –

    Thus we can expect Greek default to not be the first shoe to drop (ie they will keep proppong greece up with temp measues until they do soemthing more robust /long term,
    OR Germany will leave Euro actualy BEFORE Greece defaults , no ?

    Bottom line- germans will not allow Greek default until Germans are ready to leave the Euro. Is this a game of chicken between the Greeks and Germans to see who leaves Euro first ? Greeks through pain of austerity measures, or Germans hrough concern of endless/open eneded obligatison (without fiscal influence) on europeriphery ?

    such a drama will certainly be good for the financial media and hold markets hostage /in limbo….

  • so what country should I emigrate to (from Southern Europe)? Canada maybe? Singapore? Or is EVERYONE f****d?

  • According to Zero Hedge, countries outside of the U.S. dumped 74 billion dollars in U.S. Treasuries, most of it over the weekend:

    “Over the weekend, we observed the perplexing sell off of $56 billion in US Treasurys courtesy of weekly disclosure in the Fed’s custodial account (source: H.4.1) and speculated if this may be due to an asset rotation, under duress or otherwise, out of bonds and into stocks, to prevent the collapse of the global ponzi (because when the BRICs tell the IMF to boost its bailout capacity you know it is global). We also proposed a far simpler theory: “the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity (although not with the element of surprise – China has made it abundantly clear it will sell its Treasury holdings, the only question is when), has finally arrived.” In hindsight the Occam’s Razor should have been applied. Little did we know 5 short days ago just how violent the reaction by China would be (both post and pre-facto) to the Senate decision to propose a law for all out trade warfare with China. Now we know – in the week ended October 12, a further $17.7 billion was “removed” from the Fed’s custodial Treasury account, meaning that someone, somewhere is very displeased with US paper, and, far more importantly, what it represents, and wants to make their displeasure heard loud and clear. (Source)

    Undoubtedly, the Chinese and other countries have recently discovered that Italy and Greece, with smaller debt to income ratios than the United States, are less riskier and carry a higher rate of return. This is because, unlike the US, the Rothschild/Rockefeller bond rating agencies have trashed their country’s debt ratings, forcing them to pay a much higher interest rate than U.S. Treasuries. Hey, if you take the risk, you might as well earn the reward!

    • Unfortunately (for Greeks and Italians) it is not true that US T-bills are riskier than Greek and Italian bonds. While trade is becoming more volatily, there is no trend against US debt.