Finance

The new gold rush

The price of gold has plunged over the past week, but is still up more than 10% this year and has nearly doubled since the start of 2025.

Is it just a bubble? Or are there sound reasons for gold’s safe-haven appeal?

Clearly, speculation is part of the story. FOMO has amplified fear of geopolitical & financial turmoil.

But in a time of war and Western sanctions, geopolitical upheaval & loss of trust in the dollar, gold is also a valuable form of insurance that has stood the test of time.

And it can also offer a decent return. Ignoring the past year’s exuberance, gold appreciated by an average of 9% a year between Jan 2000 & Jan 2025.

The caveat: if gold becomes a more mainstream financial asset, it may lose some of its safe-haven properties.

Read my latest column for The Brussels Times

Quoted twice in FT on eurozone bank whitewash

Philippe Legrain, an economist and former adviser to then European Commission president José Manuel Barroso, described the tests as a “whitewash”.

“The ECB singles out less important banks in less important countries and gives the German banks a clear bill of health,” Mr Legrain said.

Read more here http://m.ft.com/intl/cms/s/0/5bdcfe20-5cfc-11e4-9753-00144feabdc0.html

Others were less convinced by the outcome of the tests, however. Philippe Legrain, an economist and former EC adviser, said: “It’s ludicrous that there is only a capital shortfall of €9.5bn. The ECB singles out less important banks in less important countries and gives the German banks a clear bill of health.”

Read more here http://m.ft.com/intl/cms/s/0/42fe9b80-5d0f-11e4-873e-00144feabdc0.html

Yet another eurozone bank whitewash

The “comprehensive” assessment of the health of eurozone banks – the ECB’s long-awaited asset-quality review (AQR) of eurozone banks and latest European Banking Authority (EBA) stress tests – concludes that eurozone banks had a capital shortfall of only €24.6 billion as of end-2013 and only €9.5 billion as of now. That is ludicrously overoptimistic. Independent assessments, for example by Professor Viral Acharya of the Stern School of Business at New York University and Sascha Steffen of the European School of Management and Technology, find much larger figures.

Throughout the crisis, the ECB has failed to act independently of eurozone banks, especially those in politically powerful countries such as Germany, while the EBA’s previous stress tests have all quickly been discredited. And given their capture by the banks they oversee, the pressure not to offend powerful governments and their desire not to spark market panic, this latest effort looks like another whitewash. Moreover, captured national supervisors, which tend to see local banks as national champions, were intimately involved in the process and doubtless had plenty of scope to hide problems, as indeed do banks themselves, which are always better informed than watchdogs. As I suggested it would, the assessment singles out less important banks in less politically powerful countries and lets German banks off the hook.

The premise for the banking union was that given that national supervisors had been less than honest about domestic banks’ problems, an independent and more rigorous eurozone supervisor was needed. But given that the AQR finds only small discrepancies with assessments by banks and national supervisors – the book value of banks’ €22 trillion in assets is adjusted by a mere €48 billion, while non-performing loans are increased by only 18% (€136 billion) to $879 billion – either the banks and national supervisors were already honest, which we know isn’t the case, or the ECB isn’t being honest either.

Even if you take the ECB at its word, the exercise is not comprehensive. The AQR covers only 57% of the risk-weighted assets of 130 banks that account for 81.6% of eurozone bank assets, ie, less than half (46.5%) of eurozone bank assets. Some of the exclusions are major and significant: Germany’s savings banks, the Sparkassen, which collectively have more than €1 trillion in assets, are not part of the exercise; the ECB also takes on good faith that many of the residential mortgage assets of German banks are properly valued – because why would they have an incentive to lie? Two of the politically powerful German banks that scraped through the assessment, bailed-out Commerzbank and HSH Nordbank (chaired by former German deputy finance minister and EBRD President Thomas Mirow), are among those benefiting from the ECB’s good faith in them.

Nor are the stress tests particularly stressful. They require banks to have at least an 8% Tier 1 capital ratio in the baseline scenario and only 5.5% in the adverse scenario. But as has been pointed out by Bank of England chief economist Andy Haldane and many others, risk-weighted asset ratios are easily manipulable and are a poor guide to a bank’s strength. A simple, unmanipulated leverage ratio of assets to debts should at the very least be used as a backstop. As the calculations by Acharya and Steffen show, they suggest much bigger problems in eurozone banks than the ECB/EBA claim.

The baseline scenario in the stress tests is based on the  winter forecast of the European Commission, which has consistently been over-optimistic throughout the crisis. For example, when my book European Spring: Why Our Economies and Politics are in a Mess – and How to Put Them Right was published in April, the Commission claimed that the eurozone recovery was “strengthening”. It has since stalled. The adverse scenario is based on a eurozone recession and a return of bond-market stress, but fails to cover the possibility of deflation. Indeed, the adverse scenario is based on inflation scenarios that are actually optimistic: 1.0% in 2014 (it is currently 0.3%), 0.6% in 2015 and 0.3% in 2016. Given that deflation would wreak havoc with banks’ balance sheets, that is a farce.

This is just an initial assessment; given the huge volume of information provided by the ECB and EBA, I’ve only had time to look through some of it. But it is enough to suggest that this latest exercise by eurozone banking authorities is another whitewash.

Investors are ignoring eurozone risks

Markets awash with liquidity can both conceal and exacerbate underlying economic problems and long-term solvency issues. Investors and policy makers in the eurozone ought to have learnt that lesson from the pre-crisis bubble years. Instead they have both swung from blind panic to short-sighted complacency within less than two years.

But the crisis in the eurozone is far from over and markets are pinning too much hope on the European Central Bank embarking imminently on quantitative easing.

Sovereign yields in the struggling “periphery” have plunged ever since ECB President Mario Draghi pledged to do “whatever it takes” to save the euro in July 2012.

But while the initial fall in yields from their panicky heights was welcome and justified, the epic rally this year is taking them into bubble territory.

Yes, prospects have improved since a year ago. Southern European economies are no longer reliant on external funding and are finally growing again. But in their hunt for yield, investors are ignoring the risks that remain.

The banking crisis is unresolved. Public debt is still rising. And the recovery remains feeble.

Indeed, with inflation sharply down and prices falling in some parts, nominal GDP growth has scarcely improved. It was minus 1.4 per cent in Ireland and 0.1 per cent in Italy in the year to the fourth quarter of 2013, and 0.3 per cent in Spain in the year to the first quarter of 2014. In effect, the eurozone is relying entirely on achieving and maintaining large primary surpluses for decades to stabilise and bring down debts – a tall order.

At the very least, then, debt dynamics in the “periphery” are precarious. And precisely because the fear of imminent doom has abated, politics in countries with scarily high unemployment and crushing debts could easily become more turbulent.

Yet even with a stagnant, unreformed economy, unstable politics and public debt of 133 per cent of GDP, Italy can now borrow for 10 years at a little over 3 per cent, a euro-era low. So can Spain, for the first time since the bubble era in 2005.

In Ireland, 10-year yields have plunged to a mere 2.89 per cent, only 20 basis points above US Treasuries. Yet the economy tanked in the fourth quarter of last year, it has debts of more than 150 per cent of GNP (adjusted for profits booked there for tax purposes), and it emerged from its EU-International Monetary Fund programme only last December.

Junk-rated Portuguese 10-year bonds yield less than the 4 per cent offered by triple-A rated Australian ones.

Even an insolvent Greece, which restructured its privately held debt only two years ago, owes a mountain more to the EU and the IMF and is still reliant on their funding, recently tapped markets for five years at a mere 4.95 per cent. Since Greece’s public debt – 172 per cent of GDP and rising – remains unsustainably large, investors are in effect gambling that the government will prioritise repaying them and eurozone authorities will be willing to grant Greece some form of debt relief.

Or you could lend to triple-A rated New Zealand for five years and get 4.2 per cent.

Sentiment can turn quickly. Witness the whiplash emerging markets suffered when the US Federal Reserve announced its quantitative easing taper last year, and again when the taper began. While the prospect of tighter US monetary policy may eventually weaken the euro against the dollar, it also presages higher global interest rates, a big negative for the debt-laden eurozone.

So what? The ECB is about to launch its own QE programme and inflate bond prices. Not so fast. So far, all the ECB has done is try to talk the euro down. Any further loosening is more likely to take the form of a negative deposit rate than QE. Remember that Germans are happy with their inflation at 0.9 per cent. They, and many others at the ECB, tend to see falling prices in southern Europe not as a problem but part of the necessary adjustment process.

Frankfurt will also be reluctant to embark on another experimental policy so soon after the German Constitutional Court ruled its Outright Monetary Transactions illegal. With the ECB still engaged in its asset-quality review of eurozone banks, QE also seems premature and of dubious benefit. And the more markets rally in anticipation of QE, the more likely the ECB is to delay, in the hope that the bond-market bubble will spill over into stronger economic growth.

While the sun shines, governments should rush to pre-fund their borrowing needs. But investors ought to be warier of the looming storm clouds – as should eurozone policy makers, who have yet again prematurely declared victory.

Europe’s bogus banking union

After a 16-hour marathon negotiating session ending on March 20, politicians, technocrats, and journalists were all keen to declare the deal on the final piece of Europe’s banking union a success. But appearances are deceptive. While the “banking union” may soon exist on paper, in practice the eurozone banking system is likely to remain fragmented along national lines and divided between a northern “core,” where governments continue to stand behind local banks, and a southern “periphery,” where governments have run out of money.

Think back to June 2012. Spain’s busted banks threatened to drag down the Spanish state, as Ireland’s had done to the Irish state 18 months earlier, while panic tore through the eurozone. European Union leaders resolved to break the link between weak banks and cash-strapped governments. A European banking union would move responsibility for dealing with bank failures to the eurozone level – akin to America, where distressed banks in, say, Florida are dealt with by federal authorities with the power to bail in bondholders, inject federal funds, and close down financial institutions.

But, a month later, the European Central Bank finally intervened to quell the panic. That saved the euro, but it also relieved the pressure on Germany to cede control of its oft-distressed banks. Since then, the German government has used its clout to eviscerate the proposed banking union; all that remains is a shell to keep up appearances.

For starters, it will not apply to the huge losses incurred during the current crisis. The ECB will directly supervise bigger eurozone banks starting in November (the first step of the banking union), and now it is assessing the strength of their balance sheets. If this exercise is conducted properly – a big if – undercapitalized banks that are viable would be forced to raise additional equity, from bondholders if necessary, while unviable ones would be wound down.

But EU rules on national bank resolution will not yet be in force, while the eurozone’s single resolution mechanism will be initiated only in 2015. So banks in northern Europe that are still backed by creditworthy governments would be treated differently than those in cash-strapped southern Europe: Germany can afford to bail out its banks; Italy cannot.

More likely, the ECB will fudge the exercise, owing to fear of reigniting the financial crisis and pressure from national governments. Small countries will be singled out to make the exercise look tough, while bigger problems will be swept under the carpet: German banks have already succeeded in excluding many of their assets from the assessment.

One argument for making the ECB the watchdog for eurozone banks was that it was less captured by the banks than national supervisors were. But its behavior throughout the crisis suggests otherwise. It has repeatedly prioritized the interests of banks in “core” countries and proved more pliable to political pressure from Berlin and Paris than from Madrid or Rome, let alone Dublin or Athens.

Even after the new banking union framework is fully in place, it will be full of holes. At Germany’s insistence, the ECB will supervise only the eurozone’s 130 or so biggest banks. That will leave the smaller Ländesbanks (state-owned regional banks), many of which made spectacularly bad lending decisions in the bubble years, and Sparkassen (smaller savings banks) in the hands of local politicians and Germany’s pliable financial supervisor.

The argument that smaller lenders are not a systemic threat is spurious: consider Spain’s cajas. In any case, there will not be a level playing field.

Above all, the single resolution mechanism is a mirage, because national governments retain a veto over closing down any bank. The mechanism is deliberately complex to the point of being unworkable; it is inconceivable that a bank could be wound down over a weekend to avert market panic. And the collective funds that eventually will be at its disposal are meager: a mere €55 billion ($76 billion).

In practice, then, rescuing banks will remain in the hands of national governments, all of which are captured by “their” banks but whose capacity to bail them out varies: French and German banks will be rescued; Cypriot banks will not. To increase their chances of a bailout, banks in the eurozone periphery will doubtless borrow as much as they can from politically connected banks and investors in the core countries. Thus, national taxpayers will remain on the hook for bankers’ losses.

The upshot is that the eurozone as a whole is likely to struggle with a zombie banking system, with only patchy efforts to restructure banks decisively and fairly. Worse, the north-south, core-periphery divide will harden, with taxpayer-backed banks on one side and banks that must fend for themselves on the other.

That is a bonus for struggling southern taxpayers, but it implies that even sound banks could have higher funding costs than dubious northern European banks for the foreseeable future. Southern businesses would then face higher borrowing costs than northern businesses, hindering growth. The bogus banking union is thus a recipe for entrenching economic and political division.

This is primarily a crisis of the banking system, not the euro

European leaders need to face facts: their strategy for tackling the crisis sweeping through the eurozone is failing dismally. Far from preventing contagion, it is spreading it. It is aggravating, not alleviating, Europe’s debt problems. It is provoking political conflict both within countries and between them. And it is failing to address the underlying Europe-wide banking mess. Isn’t it time for a different approach?

The problem is partly that the causes of the crisis are misdiagnosed. This is primarily a crisis not of the euro, but of the global financial system. Not long ago, market fears focused on the dollar and the US Federal Reserve’s quantitative easing. And the key issue in Europe now is not the merits of the single currency but the parlous state of its banking system.

During the bubble years, the global financial system underpriced risk and misallocated capital. Too much was lent too cheaply to American subprime borrowers and Spanish property developers, Icelandic and Irish banks, Dubai and Greece.

Among the biggest lenders were European banks. They now hold mountains of debt – government, bank and property – that they wish they didn’t. Many are illiquid, and depend on cheap ECB finance to stay afloat. Many have also incurred huge losses that they have only partly recognised; as a result, some are, in effect, insolvent. The stress tests of EU banks were not stringent enough to shed light on this – after all, they gave both Bank of Ireland and Allied Irish Bank a clean bill of health.

At heart, the “euro crisis” is a wrestling match over who will ultimately bear these bank losses. So far, EU governments have decided that banks’ bondholders must be protected at all costs, preferring to impose losses on taxpayers instead – even if this stretches governments’ solvency to breaking point. This is explicit in Ireland, much less so elsewhere. Because voters’ tolerance for bank bailouts has worn thin, governments are acting covertly: lending huge sums to Greece and now Ireland so that they can repay German, French and UK banks in full – all under the pretence of “defending the euro”.

This strategy is not just unfair, costly and dangerous; it is ineffective. Governments are burdening taxpayers with huge bills that will impede future growth; Ireland’s “bailout” is actually a high-interest loan of €20,000 per Irish person. They are inviting a populist and extremist backlash; witness Sinn Fein’s recent success. They are corroding support for both the euro and the EU: prudent Germans rage against bailing out profligate Greeks and reckless Irish, the Irish against EU-imposed “reparations”, when their anger ought to be directed at the banks that ultimately benefit. They are encouraging financial speculation, not least by distressed banks: heads they win, tails taxpayers lose. And by guaranteeing banks’ debts, all EU governments are risking their credibility and ultimately their solvency.

Bond markets are now testing governments’ promises: you bailed out holders of Greek government bonds and Irish bank bonds, what about Portuguese, Spanish and other debt? This is a self-fulfilling prophecy: even a sound credit is in trouble if markets refuse to lend. And whereas Greece’s bailout cost €110 billion and Ireland’s €85 billion, Spain’s could top €400 billion – and then, who knows? The crisis could sweep on to Italy, Belgium, France and eventually Germany too. At some point the cost of bailing out banks would prove unbearable – there is a limit to Germany’s ability and willingness to borrow –and the euro could needlessly fall victim to the resulting political and financial turmoil.

Even if EU governments’ ability and willingness to bail out banks is not tested to destruction, the strategy remains misguided. Instead of sacrificing taxpayers to protect bondholders, watching the sovereign dominos fall and failing to tackle the underlying banking problem, what is needed is an EU-wide solution that forces banks to recognise their losses and bondholders to recapitalise them if necessary.

This would involve a much more rigorous stress test to find the holes in banks’ balance sheets. Banks would then be forced to raise additional capital, first from the market and then by converting bondholders’ bonds into shares. The weakest would be sold or closed down.  Until then, the ECB would continue to provide liquidity to banks as necessary.

Freed from worries about bank debt, most governments’ debts would be manageable; only Greece would need to restructure its debts. There would less need for self-defeating austerity; the EU could instead launch infrastructure bonds to boost growth. All this would arrest the financial crisis, boost economic growth, reduce political and social tensions, and safeguard the euro.

This is a decisive moment for the EU. Will the narrow interests of financiers prevail or those of society as a whole?

Thought of the day: banks

The debate in the UK about whether to tax bank bonuses (Labour) or balance-sheets (Conservative) is a sideshow.

Both are stopgap measures.

The key issue is that banks need to be broken up on competition grounds so they don’t earn huge profits in the first place.

Thought of the day: Ireland

I spent a fantastic weekend in Kilkenny, at Kilkenomics, Ireland’s first economics (and comedy) festival. Despite (and because of) the crisis, it was a sell-out. Congrats to Richard Cook and David McWilliams for putting on a superb event, hopefully the first of many.

The Irish government now appears to be in talks with the EU about a possible bailout, but politicians don’t want to lose face by accepting help.

Despite the huge housing bubble and now bust, it needn’t have come to this, as I explain in Aftershock: Reshaping the World Economy After the Crisis.

The Irish government had very small debts going in to the crisis.

Its crucial mistake was guaranteeing the creditors of its bust banks.

Now it’s bust too.

An EU/IMF bailout without restructuring the banks’/government debt is not the solution.

Irish taxpayers would be bled dry to pay off investors who took a punt on lending to Irish banks.

Those creditors should take a haircut (or lose their shirts).

The way forward is debt restructuring/default, with either the EU/IMF providing a bridging loan until Ireland has eliminated its budget deficit.

Thought of the day: Barclays

Please can we kill, once and for all, the lie that Barclays survived without government aid.

It benefited from government guarantees, the bailout of its counterparties and deposit insurance.

Thoughts of the day

1. No wonder France is deporting the Roma. How could a country of 60 million people possibly cope with 15,000 Roma migrants?

Interesting article in the New York Times on how the Roma are testing the EU’s open borders policy.

2. Vince Cable says the UK government’s immigration cap is costing jobs and harming the fragile recovery. His honesty is welcome, but now it’s time to do something about it. Otherwise, what’s the point of being in government?

3. The Guardian claims the coalition is to review right-to-buy policy for council homes. Sounds like pre-LibDem conference spin to me.

4. Indonesia defaulted on its debts just over a decade ago yet it can borrow more cheaply than Spain. An emerging market bubble?

5.  Why emerging economies should follow Taiwan’s example and use capital controls to stem hot money flows