What's with the 3% deficit ?

I never understood the rational behind the limit of 3% of deficit. As a matter of fact I didn't understand also the limit of 60% of debt.

Don't get me wrong, I'm not in favor of allowing deficits greater than 3%.

I'm in favor of prohibiting deficits. Period. Anything that is below 0% shouldn't be allowed.

For years the Euro Socialists (and others) were arguing that a country can't be managed like a household. Yeah, right! Results are there for everyone to see.

A country should be run just like a household.

And because, generally speaking, people seem unfit to run well their households, they cannot run well their countries.

In credit card terms, the deficit is the difference between what you spent that month and the credit you made to pay the credit card.

Likewise, the total debt is your current negative credit card balance.

Part I - The Deficit (as in income statement)

A deficit means you are spending more than you are earning. It is in corporate language, the net income. In case of a deficit is actually the net loss. Thus, it is the bottom line of an income statement.

I don't know any company that has recurrent, year after year, negatives net incomes, ie, deficits. Why not? Because those companies go bankrupt and cease to exist. Kaput!

The companies that have negative net incomes they will probably run out of cash. When they do, they must borrow, ie, start owing money to someone. Thus, they start paying interests.

Likewise, a country that has run out of internal funds, and have a 3% deficit (ie, 3% GDP of negative net income), that country would have to borrow at least 3% of GDP.

Now is where the economists enter the room and say I'm foolish, because if that country has an economy that grows, than it could sustain that deficit. I disagree, since that is true only provided some ranges of total debt and grow must be observed. I could prove otherwise but that discussion will be for another post. Irrelevant, though! Europe is not growing structurally if you remove the consumption based on acquired debt.

So now you understand that currently (since any country in Europe as a sizable amount of debt), any percentage point in deficit will require an equal percentage point increase in the debt. It is a vicious circle.

Thus, deficits should be prohibited. Period! Countries ought to be forced to build surplus. But that is not people's money? Yes, it is, and should be used wisely, in times of possible depression, to increase public investment. Wisely means spending a little bit of it, not all of it in year of elections to gain votes.  (However voters tend to be not so wise in the year of elections and vote for the guys that give them money that year even if those guys drive the country to ruin).

Part II - The Debt (as in balance sheet)

The debt is nothing more than the accumulated deficits during a period of time. Note that included in the deficit of the current year are included the interest we have to pay regarding the current outstanding debt.

People dealing with negative credit cards balance know this reality too well.

They know that even if you don't spend nothing during one month, you still have to pay interests regarding the current negative credit card balance. As the debt grows bigger and bigger, even your credit aren't enough to pay the interests alone. That's the time to call your parents and ask to move in because you lost your home.

That's why the Maastricht Treaty stipulated a 60% to GDP limit of total debt. To keep the debt under limits, so that countries could at least still pay their interests. 

Part III - The Irrational Stuff

As it should be clearer, as debt increases, the interest paid increase also. Thus, the deficit component that regards the interest increases. When the interest paid reaches 3%, that means the State cannot have any deficit regarding its current operations. In corporation terms, it means that the EBIT (earning before interest and taxes) must be zero or positive.

As you reach the 60% of the Maastricht Treaty, the deficit must be zero. Otherwise you must borrow, but that leads to increase the debt, and overtake the 60% limit. 

Ohhh nooo! Because the economy is growing so fast that it can actually accommodate that deficit. Yeah right! And I'm Santa Claus! Oh, wait, I'm not Santa Claus! Yeah, right, neither an European economy ever grew fast enough to absorb those 3%.

You see the irrational stuff. Even a kid in 6th grade can do the math.

Part IV - Even more Irrational Stuff

But wait, politicians didn't stop here. At some point in time they decide that Keynes is always right, so they kind of abolished the 60% debt rule.

As if... it was possible to unlink the 60% debt rule with the 3% deficit limit. The 3% deficit rule (already a stupid one, because it should be a 0% rule) now is not linked to anything. Thus, politicians continue to argue that is possible to have public finances stabilized with this rule.

Tick (60% debt), tack (63%), tick (67%), tack (81%), tick (86%), tack (92%), tick (100%), KABUM!

Portugal, Spain, Italy, Cyprus, Greece are already or near the final countdown. France and others are working hard to get there too. And they will succeed !

Part V - A Death Wish

A lot of European debt was spent in three major ways:

1) Building a lot of stuff: roads, bridges, more roads, more hospitals, more airports. Those in favor say we needed those things. My personal view is that we could live well waiting a little bit longer for those infra-structures and not borrowing money for building them. As it seems with too many TGV, HighWays and empty Theme Parks, we would be better off without some of them.

Europeans have 5,000 years history, we could have delayed 10 or 15 years some stuff and not destroy the next 30 years for our children.

2) Spending too much in health care, public schools, social care and so on. The unemployment subsidies only favored situations like Ni-Ni (ni estudia, ni trabaja). It isn't by any means a monopoly of Spain this phenomenon. But I think the "Ni-Ni" is the best I have seen in acronym land.

3) To give employment. The rational is that if the private sector don't create jobs, that the state will create them. Guys! Hello! If the private sector is at danger, don't create public jobs! Maybe, spend a little bit of money, following Keynes suggestion, and award the private sector some contracts.

Please note that the public sector is like a back-office of a company. It is the least of the two evils. Either you spend some money, or your company collapses due to the lack of support processes. But I never, never saw a back-office in a company to be a revenue center, it is always a cost center. And, as all costs, should be kept to a minimum.

So, as European governments did all three things at the same time, with very or few restrictions, I can only assume they had a dead wish. Well they succeeded.

Greece - done;

Ireland - done;

Portugal - done;

Spain - errr, the bailout that it isn't a bailout, but that looks like a bailout, but it is not assumed as bailout... you see what I mean.

Cyprus - oh, yeah, tomorrow we will see the next episode of the soap opera.

Italy - tick, tack, the bomb is still tick tacking, a good sign .... until it explodes.

You get the picture. Now a final quiz:

How many countries in the Euro zone have their debt below 60%?

Cyprus: Only Plan A, no Plan B, oooops, No Plan

"Those who fail to plan, plan the to fail", a common saying. Well it seems that the Euro Bureaucrats did it again!

How many times did we hear that there was no plan B? For the ones that thought it was some sort of pressure so that Cyprus would accept the bail-in, think again. They actually never had a plan B. That's all folks!

And only after a short while, already the ECB says that it will continue to provide liquidity to Cyprus. Aahahahhah! Merkel, who is saying that Cyprus should talk with Troika instead of Germany, is learning (at least we hope) what is a multi-round game. Yes, life is not a single round game, it is a multi round thing.

Well, now either Europe fulfills its promise and let Cyprus burn, or it helps Cyprus no matter today's decision. Either scenarios destroy Europe credibility and will increase the current crisis.

In the first scenario, for sure Cyprus will have to turn to non European funds, like..... russian money. No doubt Russia has a lot of money, as oil and gas continues to be pumped across Europe. A more troublesome idea would be turning to middle east. As we all now Cyprus history that would be unlikely, but desperate times mean desperate measures. As I often said, if Greece wasn't bailout out we risked intervention from uncommon capital sources. Remember that the principal buyers of portuguese recent privatized companies come from one single country, China, which is not by any means a near by neighbor (although the relationship of the countries has more than five centuries of history).

In the second scenario, we will actually wait for the ... third scenario, as I cannot see the incompetent European politicians to come up with a viable plan. Meanwhile, it is only probable that we will assist a bank run, precisely of the deposits above 100K, since depositors that have more than 100K have the knowledge, financial fire power and will to come up to alternative geographies. However, unwinding 60bn plus of foreign  investment (read; from russia) will certainly take a while. Whatever how it will play, any bank run will turn Cyprus banking system into a time bomb, with a very short fuse. If a bank run exists ( i would bet people with turn to their mattresses) , it is probable that it would be a fast one, mimicking the planned bank freeze, but this time is not for only a few days.

With investors in Portugal, Spain and Italy already simulating and planning scenarios, things can eat up. (The Euro Bureaucrats are the only ones you have only a Plan A, every body else runs simulations and alternative scenarios). A Flight to Quality is already under way, and evaluating alternatives like Norway, Canada or Singapure are no more a far distant option. More trivial and fast to execute options like US or UK are already being executed.

Like Einstein said "Only two things are infinite, the universe and human stupidity, and I'm not sure about the former.". Not planning for the expected rejection in Cyprus's parliament for the total annihilation of the essence of the banking system has nothing to do with universe dimension.....

The Euro Bureaucrats pointed and fired a gun at Cyprus parliament. But surprise, surprise, and gun has no ammunition. They can reload the weapon. But who are they? ECB? EU? IMF? ECB already said that it will provide enough liquidity to Cyprus under the current rules, for whatever that means.....If only EU citizens would understand how good this soap opera is, we could save some money importing TV shows from Brazil and US.

Playing the Shutdown, Sleep on Economy

Shutdown and Sleep are techie terms. We are too familiar with Shutdown (and Reboot)  due to the constant Windows updates that forces us to wait helpless looking at a screen.

But now European Politicians discover that they like to play a different game: the "quasi-Sleep" game. Sleep is a Windows feature not as widely known as Reboot, that basically freezes the computer to save power and allow you to resume at the same state before you executed the Sleep.

However, unlike the real Sleep, the Cyprus bank freeze is like a "quasi-Sleep". And the "quasi" is the key word.

You see, what was to be a "sleep" mode during non bank business days, now we know only Thursday banks will open. During that time any bank transaction is blocked. So forget about going out for a meal,  go to the cinema, offer something for the Father's Day, or .... pay your suppliers. And if you don't pay your suppliers, you cannot sell your products and services.

The Bureaucrats seems to forget that you cannot actually freeze people lives. You still have to eat, drink and do a bunch of other stuff.

But technology is awesome, and now the Bureaucrats just discovered they can freeze an entire group of mainframes, SEPA infra-structure, debit / credit cards operations with a single click.

Today's world is controlled by software, and  a global software freeze has the capacity of global destruction.

What is really frightening is that those guys don't understand that freezing bits and bytes, aka "Money", they are actually destroying real goods and services.

Get Ready, Get Set, Go

Money, of course ! Money is getting ready to fly from Cyprus. Why?

Because I guess the people from Cyprus would like to keep the remaining capital.

ECB, Merkel or Schäuble may have a secret plan to capitalize the German banks. Flight to quality is happening, with german bonds hitting negative yields.

Now, the not so trivial question: if you were a cyprus citizien would you put your remaining cash in a german bank, the same banks that pressured for a deposit levy on your money. Would you help even more the enemy of your capital ?

The deposit levy, and the way it was conducted, it is a "no return" atomic bomb.

First, we already are seeing the "not me" show. Schäuble is saying that he is not responsible. Merkel says that she must explain to the voters why Germany has to save everybody, but now it is under fire internally and had to reassure that the german deposits are guaranteed.

Second, I really don't get the deposit levy rates. At current amounts Cyprus will not be able to repay the debt for a long, long time. The problem is that the reforms were not done. Taking money from people that have very few doesn't solve the problem. And the 20bn of Russian money will be a hot patato as Putin is already showing. Getting some money are providing the bailout only mean that in short time a second levy will be necessary.

What should be done is gaining control over the Cyprus financial system, ie, the banks. By controlling the banks, but guaranteeing the deposits, the respect of the depositors will happen. It is idiotic to make each small depositor a sharehold of the cyprus bank. A much more effective way would be to deliver those shares to Merkel ..... and from that point on, the Cyprus banks would be german banks, no bank runs, financial discipline, and more important, Germany would become committed to the solution.

Cyprus - A real mess

Can someone explain me how they will do the deposits levy if you have a loan ?

Scenario 1 - You were granted a loan of 200,000 Eur a week ago for starting a new company. You are investing now primarily in people wages. Now, because of some really bad and stupid decisions from the ECB, you find yourself only with 180,000 Eur. Question: Will you still owe 200,000 or just 180,000 ?

Scenario 2 - You do nothing. You didn't apply for a loan. You have 0  Eur in your accounts. Thus you are now 20,000 richer than guy in scenario 1. Hence, doing nothing is better than doing something. The socialist politicians in Europe at their best. Do nothing and reap off the guys that actually work - that's the message our European politicians are delivering.

Basic Instinct

The Cyprus factor! Yet another proof politicians aren't capable of understanding that we are playing a multiple round game.

Scenario 1 - The bill get approved. If you had 100K, now you just own around 90K (I still don't get why the 9.9%, instead of 10%). Well, I'll guess that as soon as you get your hands on the remaining 90K they will fly at Concorde speed to somewhere else. Result: Bank Run. (checkmate in 2 moves).

Scenario 2 - The bill don't get approved. Your still get your hands on 100K. They will fly at Blackbird speeds somewhere else, with a tank refueling in between, so that the money can actually travel around the entire planet. Result: Bank Run. (checkmate in 1 move).

What European leaders don't grasp is that anyone in Italy, Spain, Portugal are asking now, not if they will fuel their money for take-off, but where are the possible destinations for their money planes. And guess what? The wealthier you are, the less you need the money to be where it is, the faster you can move it. Ooops.... I'm guessing US Wealth Management guys are hiring 10,000 ft call centers. With such moves from Euro guys, you don't even need sophisticated private bankers to attract the green ones.

Is like someone tells you: your neighbor got robbed and you maybe next. Do you still keep your Picasso's at home? Nope? That's strange, because it is what Euro Zone Politicians are betting that is precisely what you will do.