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European Stability Bank - Take 2 - Asymptotix analysis ahead of the EU summit tomorrow

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It will be interesting to see how this European summit on rescue funds and euro bonds pans out John and I have had another one of my logic stream thought processes late in the night as to how to deal with the Euro zone mess far more effectively and permanently than currently is proposed anywhere.

To keep you up-to-date with our position in this field I recommend you also read:

http://www.asymptotix.eu/content/lunatix-are-grass-new-bretton-woods-proposition-europe-now and


Given the differences between the 750 billion fund (less the Ireland bailout costs of course) and the doubling to 1,500 billion proposed by the IMF and the utter rejection of this by Merkel and Zarkozy who cant afford it despite the crowing from Deutschland to mask the reality of their exposure to sovereign debt and debt to gdp ratio and the peripheral exposure of a number of their banks to PD and sovereign default as recently mentioned, it will be interesting to see what is finally decided.

Juncker wants bond issues with the obstacle of the Lisbon treaty ratification and the alternative comes back yet again to the stability bank. In any event the ECB is buying sovereign debt in secondary markets to try to stabilise the bond markets so it is intervening anyway albeit via the less obvious route. The question therefore is not whether intervention is required but how it should be carried out. The Soros “think tank” was yesterday recommending fundamental debt re-structuring however, what this impact would be on liquidity and the solvency of a great many institutions and potentially economies with the correspondent balance sheet devastation is less palatable and therefore is unlikely to be the option. Spain is calling here for the ECB to take short term actions to support national sovereign bonds when threatened by the markets and the issue here as I have discussed before is the speculation which given the current investor panic (as I do not believe confidence is a word which even enters the dictionary anymore other than as a euphemism) is the main driver of capital market stability in the bond markets experiencing great volatility some of which is driven by genuine concerns regarding economic health and much of which is driven by propaganda, speculation, ratings agencies and clear market manipulation. 

It is necessary to control these ratings agencies interfering in markets arbitrarily and any credibility at all that anybody should have in their professional capability and neutrality should have disappeared out of the window along with their systematic triple AAA “rubber stamping” of what are now junk securitised credit instruments. It remains a complete mystery to me why anybody takes any notice whatsoever of the ratings agencies and their constant interference in markets spouting and pontificating on entire countries arbitrarily and destabilising markets given events which we are all now paying for. They are utterly discredited in my view after the fiasco of systematically triple A rating junk paper which is the catalyst which caused this mess in the first place yet apparently they still have the market influence to undermine entire economies and destabilise entire bond markets and economies. Why does anybody listen to these people anymore particularly given the fact that their “opinions” are paid for by the instrument seller creating an immediate and obvious conflict of interest which does not appear to bother anybody? The only intelligent manner to remove this clear conflict of interests is that the buyer pays for the rating and the ratings agencies are held fully accountable for the quality of their rating and where this rating is clearly incompetent or negligent there must be legal, financial and regulatory recourse to them directly. If this is not the case that they are regulated, accountable and demonstrably impartial and free of any conflict of interest potential, then they and their opinions are utterly worthless and their obvious conflict of interest and arbitrary opinions for which they are not held accountable which logically destabilises markets should be a matter of deep concern and regulatory action.

So; if it is the case that euro bonds cannot be used as a stability mechanism owing to treaty restrictions then the stability bank comes back onto the table as an optimal control mechanism and as an extension to the ECB to stabilise economic turbulence and to provide short term funding with conditional budgetary prudence by receptor nations and this again comes back to my point regarding debt to gdp ratio management and Trichet is right about the 3% target for deficit ratios as spiralling budget deficits is not a sustainable solution. The Soros think tank was calling last night for a US central bank as the role of the central bank cannot be underestimated given these unprecedented Keynesian interventionist times. It is important that the Euro is protected, and that the bond markets are stabilised via short term liquidity mechanisms but there has to be conditional support for interventions given the disparate nature of euro nation economies and that must be related to prudent fiscal economic management as measured by deficit and debt management as these are the factors which are destabilising and devaluing the bond markets. It is therefore logical given that these are political matters that the central bank is both regulator and macro economic manager as both the control of money supply as pertains to QE measures and control of interest rates and therefore indirectly inflation cannot be disconnected from deficit and debt management at macro economic level which in turn cannot be disconnected from political decision making regarding economic budgetary management. Therefore a direct policy control connect is required between the central bank and the treasury and the exchequer.

So what would this proposal look like? bearing in mind that I propose removing from government arbitrary independent budget policy management given this unprecedented economic situation which calls for unprecedented reform given the proven incompetence of governments acting unilaterally to manage macro economics within prudent limits given that politicians are not in the vast majority of cases economics experts – I will not even bother to cite examples as these are entirely superfluous given the wreckage that is the current pandemic in all developed markets.

The key issue is short term populist political measures usually on only 4 year cycles by democratic government. Economics cycles are greater then 4 years and prudent long term economic planning in a globalised market where in many cases from technology adaptation to energy supply and long term infrastructure planning the cycle is more likely to be a 10 year period which could potentially involve 3 different governments with radically different policies causing destabilising and expensive radical policy changes within long term economic planning. Therefore what is needed is greater stability in long term planning not subject to the vagaries of party political politics and the placing of long term economic planning within these short term political cycles. This must be to tie economic policy management from government directly to the control of money supply, interest rates, QE measures, currency valuation, inflation management, debt and deficit provision given the debt burden under which economies are labouring in terms of cost of debt servicing as a proportion of national expenditure, and long term financial management within 10 year cycles and not 4 year cycles. A proactive approach to long term fiscal management rather than a reactive approach to short term political crisis management as the two are innately incongruous and frequently conflict which is why we are where we are. This is not to remove democracy; it is to separate long term economic planning from short term political decision making which is frequently foolhardy, wasteful, causes expensive project creation and cancellation and the obvious wild swings between conflicting ethos and this is not affordable in either globalised and commoditised markets adding in also the clear demographic changes in developed markets and the forward renewals of both technology driven and energy production changes which have to come. These are not matters for debate, simply matters requiring effective optimal management. Therefore these inefficiencies have to be managed out as they are no longer affordable. Coalitions produce inevitably watered down compromise management and a lack of clear leadership so what is required are control mechanisms which are stable and insofar as these relate to economic management must relate to the function of the central bank as macroeconomic manager as a constant within shifting political sands based on 4 year cycles.

At European level we therefore have the ECB setting headline monetary goals and determining the parameters for budgetary performance adapted to the requirements of individual economies as may be appropriate but with targets for deficit and debt level managements proportional to the economic situation and performance of individual member states. Whether 3% deficit to GDP ratio is correct as a one size fits all measure is appropriate or not is a matter for debate; however up to 15% clearly is not either and neither is 70 -115% debt to GDP leveraging either which must also be another target which requires setting and managing. Again; this does not require debate either given the proofs of Greece, Ireland, and the raft of other nations which are in danger of requiring further significant intervention which I have covered. These must be the two key metrics. Deficit to GDP and debt to GDP both considered to avoid one masking the other by political leger du main or mortgaging deficit to debt creating an unlevel playing field or unfair competitive advantage. This also permits appropriate ratios to be set to circumstances and ensures a sustainable environment within differing circumstances in a healthy and managed manner getting us out of the current hole permanently and also preventing it being just moved down the line until the next crisis. The central bank sets these targets and the stability bank sits alongside it to provide support where required and appropriate within the parameters defined. Failure to comply reasonably with the established reasonable targets and be seen to do so cuts off support from the stability bank and this therefore is the mechanism at European level to provide support when required and ensure local compliance. It also prevents for example the stupidity of Irish mismanagement recurring as had this been in place they would not have been permitted to expose themselves to the massive unmanaged risks that we have seen evidenced in relation to the size of their economy, banking systems, GDP, debt ratios and risk taking in peripheral lending which is now being paid for at close to 100 billion and this may well not be sufficient as we have seen as indeed in the case of Greece and a great many others as I have pointed out. This requires management beyond local level. Politicians are at best administrators; they are not economists. So they administer at local level within headline economic parameters set by the ECB. These regional and national deficit and debt targets on a 10 year rolling planning cycle reviewed and revised as necessary annually are agreed between the ECB and the national central banks and the decision makers must be made up of politically neutral expert economists with a demonstrable lack of conflicts of interest and not politicians. The national banks then become responsible for the management and achievement of these economic fiscal targets and take the monetary decisions in all regards of economic management required to achieve them accountable to the ECB.

At national level, the central banks now controlling both regulation of the banking sector, compliance to Basel, and the control of monetary supply and all the other mentioned economic variables defined to achieve these targets now also have a direct role in supervising political economic policy whether via the MPC equivalent or an independent management board which again must be politically neutral, able to demonstrate no conflict of interest and made up of expert economists and NOT consulting organisations who have clear conflicts of interest as do banks. I would be inclined to recommend leading economics and financial university professors appropriately experienced and entirely independent of any political influence. In practise this would mean that annual government budgets would have to be overseen by this management board not in terms of content, but in terms of result and impact on both targets, the 10 year rolling plan, and the appropriate decisions that the central bank would need to take resultant from the proposed government plan to ensure the direct connect between government forward policy and economic planning and the measures taken by the bank in terms of monetary policy and economic management. They can propose what they like, but if it does not fall within the agreed targets on the 10 year rolling plan or cannot be agreed with the ECB as a revision to plan based upon sound economic foundations then it is not approved. This forces all European government to take prudent fiscal budgetary decisions within agreed parameters, avoids short term populist short term decision making, constant policy reversals on 4 year cycles for economic management, avoids them stoking up debt to cover bungling incompetence, screwing their successors by disastrous decisions (example the last 13 years of “new” labour in the UK achieving a 250 billion budget deficit and record debt levels in British history) and leaves government responsible for all administration in all areas OTHER than economic headline management within an agreed European framework. They may do what they wish from a management perspective and can get approved within the House but within an agreed economic framework for the long term financial health of the nation to an agreed strategic economic plan outside the interests of local party politics. Annual budgets, annual approval, rolling 10 year plan and the central bank responds with the appropriate economic measures to finance the plan and manage the economy in response to plan. Not letters of concern from the central bank to the Chancellor. The Chancellor requires approval of the plan from the central bank who in turn requires agreement from the ECB. It is the ECB who is paying for it when the Chancellors get it wrong and therefore the ECB has a right to have a say on the validity of the plan. Proactive and not reactive. It is absolutely proven across Europe without one scintilla of doubt that governments cannot manage economic health and prosperity of a nation adequately. There is not one exception to this rule as the figures and this ongoing economic disaster zone prove beyond any question. Not even one example which gainsays this unquestionable logic.

This provides stability, effective expert economic management, the de-politicisation of economic management, forward thinking to a 10 year rolling sustainable plan per nation, compliance to regulation controlled by the central bank in each nation based upon Basel and thus the IMF, eliminates systemic risk, avoids politically orientated risk taking and incompetence, reduces spiralling debts and deficits to agreed management parameters, provides a safety mechanism fair to all via the stability bank, prevents any nation being prejudiced by the stupidity of action of other nations, provides a coordinated plan, restores confidence in the Euro and the region’s ability to manage itself as a coherent entity, adjusts for the differences between national economic circumstances, delivers sensible 10 year economic planning cycles outside the realms of short term party politics and political decision making, ensures the planning of sustainable development of infrastructure, energy, demographic management and the other issues requiring a strategic forward plan, ensures expert economic management across the region by expert independent economists and not politicians, levels the playing field in a globalised and commoditised market within Europe on an equitable basis fair to all nations, introduces proportional contributions and proportional management, removes excessive risk taking and leveraging, places those who refuse to manage economics sensibly in both national and European interests outside the rescue remit of the stability bank and therefore at their own economic risk if they refuse to manage their economies sensibly and proportionally to their realistic gdp performance capability without leveraging debt, deficit or overcooking risk exposure and if they do they are expelled from the Euro and will have to fend for themselves thus restoring stability to the wider Euro zone and the common currency such risk no nation would take currently, and provides the optimal management and stability infrastructure within a coherent economic framework.

This I consider to be the optimal effective, realistic and equitable long term forward and permanent management solution to the European and Euro crisis which addresses all current issues properly having considered all current variables. It would also work and sort out this continual wasteful radical swing of short termism in party political politics without removing democratic government whilst ensuring the long term financial health of the Euro zone and the currency itself. It also avoids any nation arguing against this proposal as it is fair and proportional to all member nations in accordance with their circumstances.

PS: Whilst we are at it; proposed new changes for ratings agencies.

  • The buyer pays for their ratings and it becomes an offence under impartial conflict of interest rules for them to rate any financial products on behalf of a seller as this innately is a clear conflict of interest.
  • Ratings agencies subject to new regulation on the quality of their ratings upon which they will have to apply for and secure a license to rate proving a credible methodology which will be audited. No license; no ratings business. They would be subject to a license to operate which requires annual review and approval.
  • Recourse. If their ratings prove to be inaccurate, fraudulent or incompetent, they may be sued for all consequential losses either under Sarbanes Oxley or new regulation and would be required to insure themselves for adequate funds to cover the court cases which will undoubtedly ensue in light of the quality of their ratings of securitised debt instruments as AAA when clearly many were no such thing.
  • They must prove due diligence in any rating that they give and are subject to independent audit and supervision.
  • Where they arbitrarily and publicly rate nations which could give rise to market manipulation of sovereign debt, the nation has a right to challenge them in a court of law for their rating and where this is proven in court in any respect to have unjustly caused a deleterious effect upon markets, sovereign bond values, external investment, or any other economic consequence of their actions they are fully liable for all costs and full compensation to the claimant nation or institution for all economic consequences associated with their incompetent rating of said entity.

This will deal with these matters also as well and get these arbitrary and unaccountable agencies with such ill deserved power to influence markets brought under proper and responsible diligent management as is the case with any other professional advisory agency that charges for advice where said professional fee charging advisor later proves to have been incompetent, negligent, fraudulent or inaccurate in their professional advice for which they have charged.

By David R Bristow, Siag Risk Management, an Asymptotix partner

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