Trumped! A Nation on the Brink of Ruin... And How to Bring It Back

by David Stockman

  REVOLT OF THE RUBES—WHY THE FINANCIAL ELITE’S DAYS ARE NUMBERED

  To be sure, our financial rulers are not about to take the rise of Trump or the verdict of the British voters lying down. They are already unleashing a wave of propaganda and fear mongering about the dangers of even minor departures from the policies and arrangements of the status quo.

  In Britain, for example, they did not even wait for the body to get cold. Within days of the vote, the establishment oracles were out in force proclaiming that Brexit would be effectively cancelled on a de facto basis because separation from the Eurozone was too complicated for the mind of man to accomplish.

  Apparently, like in the case of the first negative vote on TARP, a few days of currency and stock market turmoil were supposed to have taught the rubes who voted for it the errors of their ways. And if that wasn’t sufficient, a coming wave of economic setbacks would be sure to do the job of repudiating the referendum.

  The argument is that the unwashed masses outside of Greater London—who overwhelmingly voted for Brexit—have shot themselves in the foot economically based on some atavistic fears of immigrants and cultural globalization and racism, even.

  But those impulses are dismissed by the masses’ establishment betters as just momentary emotional outbursts. Right soon the rubes will remember where their bread is buttered, and demand a second referendum in order to reboard the EU’s purported economic gravy train.

  On the heels of the Brexit shock, for example, Gideon Rachman, one of the Financial Times’ numerous globalist scolds, professed that his depression about the Brexit vote had already given way to a worldly vision of relief:

  But then, belatedly, I realized that I have seen this film before. I know how it ends. And it does not end with the UK leaving Europe.

  Any long-term observer of the EU should be familiar with the shock referendum result. In 1992 the Danes voted to reject the Maastricht treaty. The Irish voted to reject both the Nice treaty in 2001 and the Lisbon treaty in 2008.

  And what happened in each case? The EU rolled ever onwards. The Danes and the Irish were granted some concessions by their EU partners. They staged a second referendum. And the second time around they voted to accept the treaty. So why, knowing this history, should anyone believe that Britain’s referendum decision is definitive?

  But of course Rachman’s dismissive meme is exactly why Brexit happened. The international financial elites, who have been controlling the levers of power at the central banks, finance ministries and supranational official institutions for several decades now, have become so accustomed to not taking no for an answer that they can’t see the handwriting on the wall.

  To wit, the rubes are fed up and are not going to take it anymore. In voting to flee the domineering EU superstate domiciled in Brussels, they saw right through and properly dismissed the establishment’s scary bedtime stories about the alleged economic costs.

  REFUTATION OF THE ESTABLISHMENT’S SCARY BEDTIME STORIES—THE UK ECONOMY DOESN’T NEED HELP FROM BRUSSELS

  After all, the UK is a net payer of $10 billion per year in taxes into the EU budget and gets an economically wasteful dose of Continental-style regulatory dirigisme in return. And that is to say nothing of the loss of control at its borders and the de facto devolution of its lawmaking powers and judicial functions to unelected EU bureaucracies.

  At the same time, increased trade is generally a benefit, but it is not one that requires putting up with the statist tyranny of the EU. That’s because the EU-27, and especially Germany, needs the UK market for its exports far more than the other way around.

  So after Brexit is triggered, the EU will come to the table for a new trade arrangement with the UK because these faltering socialist economies desperately need the exports. At the same time, the British negotiators will be free for the first time to seek more advantageous trade arrangements with the United States, Canada, Australia and others.

  It doesn’t take too much investigation to see that the UK has come out on the short end of the trade stick. And contrary to globalist propaganda, persistent and deepening trade deficits are a big problem. If coupled with a weakening domestic savings rate, they mean that a country is getting ever deeper into international debt.

  The UK economy exhibits that dual disability to a fare-thee-well. Its international accounts have been plunging further into the red for 20 years. At 5% of GDP its current-account deficit—which includes the favorable benefits of service exports from the City of London and earnings on foreign investments—is among the highest in the developed-market world.

  To put it bluntly, the UK is slowly going bankrupt.

  Moreover, the source of the abysmal overall current-account deterioration shown above is absolutely attributable to its one-sided trade imbalance with the EU-27. As shown in the following graph, Britain’s EU deficit has been widening ever since 2000, while its trade surplus with the rest of the world has actually been steadily growing.

  This point here is not about mercantilism. The bilateral balance with any particular country or trading bloc does not ultimately matter if the overall current-account trend is healthy. That’s just comparative advantage at work.

  Instead, the point is that the EU-27 needs British markets to the tune of a net 65-billion-euro surplus annually. And more than half of that surplus is attributable to Germany, which earns upward of 40% of its trade surplus with the rest of the EU from the UK.

  Continuation of an open trade arrangement, therefore, does not require the sacrifice of British democracy and home rule to the statist overlords of Brussels; it only requires a trade deal that provides mutual economic benefits and no entangling engagements with the socialist infrastructure of the Continent.

  Moreover, these negative trade trends have not been ameliorated by a domestic savings frenzy that could finance the outflow in a healthy manner. To the contrary, the British household savings rate has been heading dangerously south for the last several decades.

  In a manner similar to the Greenspan-era debt spree in the United States that we described in Chapter 5, the Bank of England has induced British households to live high on the hog by leveraging up their balance sheets.

  From a pre-1980 ratio at 50% debt to income, the leverage ratio of British households rose to 100% by the turn of the century and peaked at 140% on the eve of the financial crisis. Like in the United States, it has come down slightly since then, but at 130% it is still 2.5x its historic level.

  So the UK’s giant current-account deficits, in fact, are being financed by foreign lenders and central banks and the Bank of England.

  The UK’s huge current-account deficits so beloved by the Keynesian and Goldman Sachs apparatchiks who run its policies are not a gift of EU membership at all. They are the curse of the horrid money-printing excesses of the Bank of England and the European Central Bank that have left the UK economy leveraged to the hilt.

  WHY STAYING IN THE EU WILL NOT CURE THE UK’S REAL PROBLEMS

  The same is true of the public sector. The UK has run chronic, deep budget deficits since the early 1990s. Since then, its public-debt-to-GDP ratio has soared from 35% to nearly 85%.

  These data make crystal clear, of course, that the UK has a giant problem of living far beyond its means, and that all of the leftist kvetching about the conservative government’s so-called “austerity” policies is a lot of political balderdash.

  In fact, the Cameron government has buried British taxpayers in debt, even as it proclaimed its adherence to fiscal rectitude. As is evident from the chart, the only reduction in the spending share of GDP on its watch is due to the end of the global recession. At nearly 44%, state outlays still take a larger share of the economic production than they did under the previous Labour governments.

  Here’s the point. Staying in the EU cannot help ameliorate the UK’s real economic and fiscal problems in the slightest. What it needs is lower taxes, less welfare and a dramatic reduction of government regulatory intervention. These are n
ot policy directions that stir the juices in Brussels.

  So the noisy meme that the Brexit voters have done themselves irreparable economic harm is patent nonsense. By contrast, whether they fully understood it or not, they have liberated the UK from what will be the economic disaster of “more Europe.”

  ESCAPE FROM THE EUROZONE TRAIN WRECK JUST IN THE NICK OF TIME

  Indeed, if there ever was a phrase that encapsulated the idea of an incendiary contradiction, “more Europe” is surely it. What it means to the French and Mediterranean left is debt mutualization and a common treasury from which to expropriate German prosperity.

  By contrast, to the Germans it means the imposition of ever-more-onerous EU fiscal controls so that it can continue to kick the can of its giant liabilities for the EU bailouts and the European Central Bank’s “Target2” balances down the road.

  These German exposures are enormous—with upward of $75 billion already drawn on the European Stability Mechanism and European Financial Stability Facility bailout funds and Target2 balances of $700 billion at the present time. These Target2 balances represent the credits and debits among the national central banks of the EU-19 that execute day-to-day policy for the European Central Bank.

  Needless to say, were the Eurozone and euro to go down in flames, the German Bundesbank would end up with enormous claims against other central banks, especially those of Spain, Greece, Portugal and Italy, and little ability to collect.

  Indeed, short of reviving the Panzer divisions, Germany has no options at all. It has effectively taken itself hostage to the tune of the $700 billion it has “loaned” to its central bank partners that cannot possible pay. Thus, those monumental Target2 balances are a ticking financial bomb and the real reason that Germany’s historic monetary orthodoxy has given way to Draghi’s money-printing madness.

  In a word, Germany has acquiesced in an insane fiscal transfer system conducted by the European Central Bank in the guise of monetary policy because it dare not allow the euro and European Central Bank system to collapse.

  Likewise, Draghi’s $90 billion monthly rate of QE purchases is really not about “low-flation,” private-sector credit stimulation, job growth or any of the other macroeconomic variables, anyway.

  To the contrary, its not-so-hidden purpose is to flat-out monetize the debt of Italy, Spain, Greece, Portugal, France and the rest of the Eurozone bankrupts at negligible interest rates, thereby gifting them with deeply subsidized cost of carry on their crushing public debts.

  Self-evidently, these Draghi-confected bond rates could never be remotely attained in an honest bond market. Yet they are absolutely necessary to maintain the charade of fiscal solvency among these woebegone practitioners of welfare-state socialism.

  So the doomsday machine rolls on. Recently, Greece’s Target2 balance was negative $100 billion, while Spain’s was negative $325 billion and Italy’s was negative $300 billion. In short, the “EU-18” owes Germany so much that permitting any country to leave is unthinkable in Berlin.

  The call for “more Europe,” therefore, does not arise from cosmopolitan enlightenment, as the elite media avers; it is a desperate gambit to keep alive an utterly flawed and contradiction-ridden monetary, fiscal and political union that never should have been concocted in the first place and that is now several decades past its “sell by” date.

  By the same token, the forces of Brexit and their populist counterparts throughout the Continent are not simply an instance of the rubes venting nationalistic, xenophobic, racist and other dark impulses. To the contrary, the rubes simply want their governments back, and in that impulse they are on the right side of history.

  The truth is, it is the “European project” that represents the darker impulses. The Brussels/Frankfurt rule of the financial elite has little to do with free trade or the maintenance of peaceful relationships among the states of Europe, and nothing at all to do with furthering capitalist prosperity.

  Instead, it is a tyranny based on a muddled brew of globalism, statism, financialization and the cult of central banking. Its days are numbered because even the rubes can see that it doesn’t work and that its massive internal contradictions are heading for a spectacular implosion.

  The British voters have decided to get out of harm’s way. Hopefully, there will soon be many other cases of the rubes in revolt.

  THE BANKING-SYSTEM ROT AT THE HEART OF THE EUROZONE

  So the shocking Brexit vote was about a lot more than the unwashed British masses rebuking their ruling-class betters. It actually marked the beginning of the end for the EU superstate and the incendiary regime of Bubble Finance that lies at the heart of it.

  In fact, the rot is well advanced in the two large Eurozone economies outside of Germany. That is, France and Italy are especially vulnerable to a banking-system breakdown, and the associated spillover impact on debt-burdened fiscal accounts and already-fragile national economies.

  As we have insisted, financial prices cannot be falsified indefinitely. At length, they become the subject of a pure confidence game and the risk of shocks and black swans that even the central banks are unable to offset. Then the day of reckoning arrives in traumatic and violent aspect.

  Exactly that kind of Lehman-scale crisis is now descending on Europe and its massive, bad-debt-ridden banking system.

  The latter carries $35 trillion of assets, which represents twice the combined GDP of the EU-28 (including the UK), and also reflects a ratio to GDP that is twice that of the U.S. banking system.

  The problem is that Europe’s monster banking system has $1.5 trillion of bad debt according to official institutions like the IMF—and in reality probably will have much more when the next global recession sweeps through its welfare-state-encumbered economies.

  Worse still, it is highly leveraged with assets equal to 25x equity capital at the big French banks, for example. In fact, leverage risk is actually much worse when the true measure of capital—tangible net worth—is compared to total asset footings.

  In that regard, even Deutsche Bank is imperiled. Its current asset footings of $1.8 trillion compare to only $57 billion of tangible net worth, meaning it is leveraged at 31X. Likewise, Italy’s largest bank, Unicredit, has $16 billion of tangible net worth against $940 billion of assets. That gives it a leverage ratio of 59X.

  At the same time, the European Central Bank’s massive interest-rate-repression policies since Draghi’s “whatever it takes” edict of August 2012 have crushed earnings on corporate and sovereign bonds, even as banks have incurred huge charges against soured loan books.

  Accordingly, during the most recent year the largest European banks earned a miniscule 0.18% return on assets compared to just under 1.0% for the largest U.S. banks.

  These baleful conditions have been no secret, but until last summer speculators in European bank stocks were willing to believe Mario Draghi could do no wrong and that Europe could print its way back to prosperity.

  No more. Bank stocks were already down by 30% prior to the UK referendum, and subsequently plunged by as much as 50% from the highs of 2015. And what changed, above all else, was confidence.

  It has now become evident that Draghi’s $90 billion per month of bond buying has not shocked the Eurozone economies out of their torpor, meaning that bad debts continue to rise. At the same time, the European Central Bank’s desperate lurch into subzero rates has essentially eliminated bond yields entirely, as we documented in Chapter 14.

  In short, Draghi has impaled Europe’s loss-ridden banking system on a profitless yield curve, even as loan demand among Europe debt-ridden businesses and households hugs to the flat line of a struggling economy.

  This means there is no solution except for the European banking system to raise massive amounts of new capital. Not surprisingly, this potential dilution shock has sent even the bank-stock gamblers heading for the exit ramps.

  Indeed, the STOXX 600 bank index is now back to its mid-2012 level. Draghi’s bluff has been called.


  In a word, we think Brexit was the match that lit a European banking crisis, and that the implosion of Europe’s banking system will take down the EU and the European economies, as well.

  The enormity of that threat, in fact, could not be more aptly symbolized than by the virtual meltdown of Deutsche Bank (DB). Until a few years ago it was Europe’s most prestigious and profitable bank, but now its very survival outside of a German/EU bailout is in question.

  More importantly, the collapse of its earnings and market cap since the eve of Draghi’s “whatever it takes” ukase is a powerful tell.

  Despite the fact that the European Central Bank’s printing presses were running white hot, DB’s market cap has now imploded by $50 billion, or 75%. Likewise, its bottom line has shifted from a $7.5 billion annual profit to an $8 billion loss in the most recent year.

  Indeed, this collapse of Europe’s most important bank occurred in an economic backdrop of crab-like real GDP growth that amounted to just a cumulative 2.2% in the EU-19 during the entire seven-year period since 2008. Even much of that was attributable to the German export machine and booming markets for high-end capital and consumer goods in China and its supply chain.

  Those markets are now drying up. The gathering global deflation, in fact, leaves European economies fully exposed to its rapidly unfolding banking crisis, the failure of the European Central Bank’s money-printing campaign, and the rise of anti-EU populist movements throughout the Continent.

  WHY THE EU SUPERSTATE WILL FAIL—THE FRENCH DISCONNECTION

  As indicated above, we believe the impending breakdown of the EU amidst a global recession will hit France and Italy especially hard. That’s because they have the most oversized and undercapitalized banking systems in Europe, along with horrid economic and fiscal fundamentals.