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  December 1, 2011

US Fed Buys Europe Some Time

Rob Johnson: Move by Fed papers over structural issues; austerity policies meant to weaken social safety net and lower workers wages
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US Fed Buys Europe Some TimePAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington. In Europe, the eurozone continues in deep crisis. A lifeline was thrown Wednesday morning by the Federal Reserve, a mechanism to increase liquidity in the European banking system. But most analysts think it's more of just a short breath, and people are still waiting to see if anything more fundamental will be addressed. Now joining us to talk about this new deal by the Federal Reserve, with a few other central banks, is Rob Johnson. Rob is a senior fellow at the Roosevelt Institute, and he joins us from New York City. Thanks for joining us again, Rob.


JAY: So start with what is this deal, and then what do you make of it.

JOHNSON: Well, I think the European banks are not what you might call safe and sound right now. Everybody knows that these sovereign bonds are selling off. Everybody knows they're all over the balance sheets of those big banks. And as a result, people fear losses, fear insolvency. And the banks aren't lending to each other, or, alternatively, if they are lending to each other, they're adding more and more and more to the interest rate, the so-called risk premium at which they lend to each other. And that is freezing up the credit market in Europe. And in particular, many of the European banks have funded themselves in the United States, what they call shadow banking market, which is this market--it's run based on commercial paper and money market deposits. And as we saw in 2008, we had a run there, and it freezed up an awful lot of commercial paper, an awful lot of bank funding. And as the prices were going up, meaning the risk premium were going up, people were getting more scared. Some funding was being cut off altogether. And finally, this morning, because the European officials had not agreed to a wholesome enlargement of the structural change that would support Europe, the Federal Reserve and other central banks had to jump in and provide this dollar funding.

JAY: So if I understand the mechanism correctly, they're calling it a liquidity swap, is that the Federal Reserve essentially swaps American dollars for euros, and there's a certain charge for it, a fixed rate, and this gets US dollars into the European banking system. And this then is supposed to create more liquidity, where the banks--the central banks will loan to the big private banks, and then they're supposed to loan into the economy, if I understand this correctly, except they did this in the US, and I think the American banks are sitting on $1.5 trillion or something of the same kind of liquidity without actually lending it. So why is it going to be any different in Europe?

JOHNSON: Well, when you think about an interbank market when it's normally functioning, everybody's lending to everybody. It looks like a busy network of all the different lines crossing and everybody intertwined with each other. When people become afraid of default--now financiers are acutely afraid that Germany may pull out of the European system, the credit ratings of France and everybody--Belgium, Italy, and others--will deteriorate, there'll be widespread losses and widespread bank failures. That network system, that intertwined system breaks down, and it becomes like a hub and spoke system, where at the hub is the central banks. The central banks lend to each institution, give them loans for collateral in agreement, and the banks have essentially stopped lending to each other, because nobody knows what tomorrow looks like. Everybody sees the strikes going on in Greece, everybody sees the Italians not making major changes in their budgets, and everybody sees that the Germans, the French, and the other architects of core Europe are not coming up with a coherent plan.

JAY: Well, one analyst described this as like giving hydration to a cancer patient. Is this doing any more than buying a few weeks until these--there's going to be some EU meetings on December 9, where I think heads of state are getting together? Is this more than a very short-term Band-Aid to see if yet again there'll be something more fundamental?

JOHNSON: Well, I think the question of time is important here, because as this funding was drying up, you can do one of two things. You can either fund the assets on your balance sheet, or if you can't fund them, you're forced to sell the assets on your balance sheet. And so they are trying to arrest an avalanche of foreselling. That's a very important stabilizing influence, and it's a way of buying time.

JAY: Now, for someone that doesn't understand this, give an example of what you mean. What's an example of an asset and what might you have to sell?

JOHNSON: Sure. You have an Italian bank, and the Italian economy's growing very slowly, their budget deficit is not large, but the whole world is liquidating Italian bonds. So an Italian bank which holds a lot of Italian bonds, just like in the United States banks hold lots of US treasuries, all of a sudden looks like it's losing money, like it's instantly becoming insolvent. Now the money market funds in the US or the British banks say, we won't lend to that Italian bank anymore. When they're funding what's called rollover--meaning between today and tomorrow I've got to renew my funding--when they can't renew the funding 'cause nobody thinks they're going to survive, then they're forced to sell the assets, meaning the Italian bonds on their balance sheet. But go back just a moment ago. What I was saying is the thing that's causing people concern is that the Italian bonds are falling in price. So now, because they can't get funded, they're forced to sell more Italian bonds. What does that do? That makes the situation worse than when it was thought that you could do the funding. It's--they're exacerbating their own problem. They're soiling their own nest. It's--by the central banks stepping in and providing the funding, they obviate the need for panic selling, and they diminish the losses and they diminish the extent to which people become convinced that all these banks are failing and therefore should not be funded.

JAY: So how long does this help mitigate it? We saw the stock markets go up as a result of it. I mean, is this just a short-term fix? Or does it accomplish any more than that?

JOHNSON: Well, I think at the core of this, Europe has to decide on its architecture. And when it decides on its architecture, we have to understand that Germany really means it. I've often said Germany is like an insurance company that years ago went into a unified euro and essentially wrote an insurance policy. Now, when this crisis erupted, they're like an insurance company, like a health insurance company in America, which says you can pay your premiums, but when you have a big health accident, then we have to go to court to decide whether we're going to back you. Insurance companies under stress often try to wiggle off the hook from paying on big claims. Well, Germany in this recession in Europe always gets in trouble when the United States has a crisis and goes into recession. The exchange rate mechanism, the ERM, in the early '90s, when the British pound and all of the other currencies broke out of the system and devalued, what was going on then was an American recession bringing the fault lines of Europe to the fore through deflationary forces. What's going on now is post-2008 all of those fault lines have come to the fore, and the Germans don't want to pay. When the Germans decided they weren't jointly and severally (meaning all together) guaranteeing everyone's debt, everything in the system started to unravel. To put the system back together, Germany has to renew their commitment and guarantee in a way that convinces investors, along with France, along with the Netherlands, along with Finland and Austria.

JAY: Well, they're setting up a scenario, if you read the press, both popular and financial press. The scenario seems to be the savior is to get more austerity, that the problem is that they're not getting austerity fast enough, governments aren't buying into austerity deeply enough. What do you make of that as the scenario? 'Cause that seems to be the popular wisdom.

JOHNSON: Well, what I would say is that austerity as a long game is madness. Austerity drives down the European economies into recession, which activates things like unemployment insurance and so forth, what they call automatic stabilizers. It also profoundly cuts the revenue, meaning the tax revenue, that's collected. Idle resources don't pay taxes. So when you've got a budget problem, why would you want to narrow your tax base?

JAY: Well, that's my question. Why do they? I mean, what you're saying seems, you know, obvious, that these--austerity's going to give rise to deeper recession, yet they continue to call for it. Why do they do so?

JOHNSON: Well, I don't think it's an ultimate endgame. I do think there are lots of groups, business groups and others, that feel that the end of the American Cold War, that European businesses have had a generous social welfare contract. The social welfare contract that they had was like an insurance premium that was paid so that society did not convert to the communist side. After the Berlin wall fell down, there is no threat of communism, and that whole social architecture, the social contract, the dole, the supports, and so forth that stabilized the social democracies of Europe is now very expensive. They're paying the premium, but there's no risk of accident. So I think in many, many places what's happening right now is that elites in those countries are working very hard to use this crisis to put pressure on to drastically reduce the scope and the scale of the state in places like Spain, places like Italy, and places like Portugal. And many people argue that the reason they have to do that is ultimately they have to compete with the emerging markets like China, like India and portions of Latin America that have none of this social contract architecture. So it's just an inevitability that it will be eroded away by the pressures of competition and you might as well get on with it.

JAY: And what do you make of that argument?

JOHNSON: That's what I think these people are doing. They're keeping the pressure on, right to the brink, to try to break down that social contract as much as they can before they repair things.

JAY: And what do you make of that argument, that they need to do this to stay competitive?

JOHNSON: Well, I think that that argument is saying that essentially we all should be driven as human beings to the lowest common dominator. In the old days, people used to criticize Sweden, and I used to say, well, Sweden has paternity care, maternity care, environmental concerns, pensions, nice holidays. And then I saw sweatshops in Indonesia. And if you ask me, as a human being, I'd rather be in that Swedish model than that Indonesian model. So I would rather see the floor raised than the ceiling lowered. If you were asking me how do you bring this to a head or how do you bring this into balance, it's not so much about liquidating the people in the developed countries; it's about raising the standards and the social contract quality in the developing countries.

JAY: Because it seems the route they're on, not only does it lower the standards in the developed countries; it perhaps gives rise to a decade of deep, deep recession, including even lowering further the emerging markets, because it's not like their wages and living conditions go up in global recession; they'll go down as well.

JOHNSON: Well, they also were very dependent on export-led growth. And so the idea that you're going to compress all the people with living standards in what you might call a modern developed middle class and it's going to not affect the development trajectory and the growth in the developing countries is kind of foolhardy. I do not think this is a zero-sum game. I think what we have here is what economists call the fallacy of composition, which is one businessman or one bank can say, put that guy through austerity so that he has more money to pay me. You know, he can't eat ice cream anymore, 'cause he's got to pay his debt instead of defaulting and restructuring the debt. But when the whole system tries to do that, they drive everything down, they diminish the size of the pie, and nobody eats as much, and we probably end up in restructuring anyway.

JAY: Thanks very much for joining us, Rob.

JOHNSON: My pleasure.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

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