Há sempre alternativa

A União Europeia confronta-se com uma crise de legitimidade que se tem acentuado com o avolumar de contradições que podem ser melhor compreendidas, por exemplo, no contexto do debate que opôs Karl Polanyi a Friedrich Hayek e que colocou a economia reconfigurada em função de uma ordem social democrática e igualitária contra um neoliberalismo onde as estruturas não mercantis são valorizadas apenas na medida em que forem instrumentais ao alargamento da esfera de ação dos mercados.

No discurso de Thorstein Veblen dir-se-ia que os valores do cerimonial económico do modelo de governação em crise de legitimidade são os de uma religião onde o mercado é central e ao qual todos os restantes factores da economia, incluindo o trabalho, se subordinam; os de um regime de globalização que permite às grandes empresas transnacionais interferir na capacidade democrática de organização colectiva; os de uma cultura de consumismo ostensivo associada a uma emulação pecuniária que impede a prossecução de objectivos racionais e equitativos de provisão geral; os de um sistema financeiro com lógica de casino; os de um sistema industrial marcado pelo desperdício e pela sabotagem.

Quando a partir do final de 2007, em sequência de um longo período de especulação financeira praticamente irrestrita, a mão invisível começou a faltar ao encontro com o equilíbrio prometido e os EUA, primeiro, e a Europa, logo a seguir, mergulharam numa crise que só encontra paralelo na Grande Depressão de 1929, os mercados desregulados não só não rejeitaram a intervenção do Estado como dela inteiramente dependeram, tendo o colapso certo sido (provisoriamente?) evitado com quantias absolutamente gigantescas de dinheiro público; longe de produzirem a prometida prosperidade universal, os cortes na despesa pública que se seguiram mais não fizeram que aprofundar a crise.

Na zona Euro, o endividamento público caiu de 72% para 67% entre 1999 e 2007 (início da crise financeira) enquanto o endividamento das instituições financeiras, no mesmo período, aumentou de menos de 200% para mais de 250% do PIB; ao contrário do que afirma a narrativa ainda dominante, a explosão na dívida pública que se verificou a partir de 2007 resultou da necessidade de socorrer o sector privado, e em particular o subsector financeiro, e não o contrário.

Na Europa e em Portugal, a crise resulta essencialmente da arquitectura disfuncional de uma moeda única que, desenhada na crença da tendência sistémica para o equilíbrio das economias onde o estado está ausente, pressupõe que o trabalho, assumido como variável única de ajustamento, é uma mercadoria como outras.

Ao contrário do que afirma a utopia neoliberal, o trabalho não é mercadoria e nenhum modelo de governação que o pressuponha pode subsistir; nas palavras de Karl Polanyi, “[t]rabalho é apenas outro nome para a atividade humana que é a vida em si mesmo” e “[p]ermitir que o mecanismo de mercado seja o único administrador da sorte dos seres humanos e do seu ambiente natural, ainda que apenas no que diz respeito à quantidade e uso de poder de compra, resultaria na demolição da sociedade”. 

A 15 de Setembro último, a sociedade defendeu-se do extremismo mercantil e uma massiva manifestação de descontentamento popular, exigindo alternativas, rompeu o fabricado consenso austeritário. Agendado para 5 de Outubro próximo, o Congresso Democrático das Alternativas propõe-se reunir ‘todos os que sentem a necessidade e têm a vontade de debater e construir em conjunto uma alternativa à política de desastre nacional consagrada no memorando da troika’. Lá estarei; peço-te que ponderes, também, a tua presença.

*Texto também publicado no sítio do Congresso Democrático das Alternativas.

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As instituições que não são democraticamente escrutináveis tendem a ser capturadas por interesses particulares

“Nada ilustra melhor as encruzilhadas políticas, os interesses particulares e a miopia da Economia neste momento dominante na Europa do que o debate acerca da restruturação da dívida soberana Grega. A Alemanha insiste numa reestruturação profunda – pelo menos 50% de perdas para credores obrigacionistas – enquanto o Banco Central Europeu insiste que qualquer restruturação da dívida deve ser voluntária. […] 

O comportamento do BCE não deve surpreender: como temos visto noutros lados, as instituições que não são democraticamente escrutináveis tendem a ser capturadas por interesses particulares. Isto foi verdade antes de 2008; infelizmente para a Europa – e para a economia global – o problema não foi adequadamente tratado desde então.”

Tradução de excerto do texto Capturing the ECB de Joseph E. Stiglitz.

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Moment of truth for the eurozone

The biggest question in any debt crisis is whether a credible path back to solvency can be found. For Greece, this now seems very unlikely. The same is true, to a lesser extent, for Ireland and Portugal. This raises three further questions. First, how big is any required restructuring? Second, who should bear the cost? Finally, is restructuring enough? If the answer to the last question is No, then one has to ask whether the currency union will last in its current form.

On the first of these questions, an analysis by Citigroup provides a negative answer. According to this analysis, by 2014 the ratio of gross debt to gross domestic product will have risen to 180 per cent in Greece, 145 per cent in Ireland and 135 per cent in Portugal. In none of these cases will the debt ratio start moving downwards over this horizon. Spain looks far better, with a debt ratio at about 90 per cent of GDP in 2014, though its path, too, will not have turned down. (See chart.)

The assumptions behind these forecasts are: a cumulative fiscal tightening between 2011 and 2014, inclusive, of 10.8 per cent of GDP in Greece, 8.3 per cent in Portugal, 7.3 per cent in Ireland and 5.7 per cent in Spain; interest cost of new funding rising from close to 5 per cent to 5.6 per cent in 2014 for Greece, Portugal and Ireland (determined by a weighted average of rates from the International Monetary Fund and the European Financial Stability Fund) and higher rates for Spain, since the latter will rely on the market; and, finally, privatisations and bail-outs. The analysis also assumes that a percentage point of fiscal tightening would lower growth by half as much.

Assume that these countries could borrow affordably in private markets at a gross debt ratio of 80 per cent of GDP. Assume, too, that European governments ensure that the IMF takes no losses. Then, the reduction in value of the rest of the debt would need to be as much as 65 per cent of GDP for Greece, 50 per cent for Ireland and 45 per cent for Portugal. The total “haircut” would be €423bn: €224bn for Greece, €107bn for Ireland and €92bn for Portugal.

One can quibble over the figures: these may be too pessimistic. But, without a big restructuring, these countries are now most unlikely to be able to finance themselves in the market on bearable terms. That is also what markets are saying: spreads on 10-year bonds over yields on German Bunds are 1,340 basis points, or 13.4 percentage points for Greece, 875 basis points for Ireland and 818 basis points for Portugal. This is why they are all now in official programmes. Worryingly, spreads for Spain are also now uncomfortably high, at 240 basis points, while those for Italy have reached 190 points. The eurozone, in short, is confronting a frightening sovereign debt challenge, aggravated by the dependence of its banks on support from its states and of its states on finance from its banks.

Now turn to the second question: who should bear the losses? If all the haircuts were to fall on private creditors, their losses in 2014 would be 97 per cent of their holdings of Greek debt, 63 per cent of their Irish debt and 60 per cent of their Portuguese debt. Official creditors would, by then, have to bear a substantial part of the total losses. Since governments would also need to bail out some of the holders of the restructured debt, particularly the banks, the eurozone would be revealed as a “transfer union”. Note, moreover, that this would occur despite a big fiscal effort in the affected countries. But even that would be insufficient to reverse the unfavourable debt dynamics in the medium term, partly because GDP growth is likely to remain so weak.

Against this background, proposals for rollovers by the banks, whether or not deemed technically a default, are neither here nor there. Much more to the point would be debt buy-backs at levels close to current market prices, as discussed in last week’s statement on Greece of the Institute for International Finance, which brings together the biggest international banks. That would crystallise losses. So be it. Let reality be recognised. As the Financial Times has also argued this week, the case for offering a menu of options with partial guarantees, similar to those under the 1989 Brady plan for Latin American debt, is powerful.

The question is whether such voluntary debt reductions would be enough, particularly for Greece. The answer is No. Governments would also have to play a part, by either accepting losses on the face value of their loans or ensuring lower interest rates, as proposed by Jeff Sachs of Columbia University. These are just two ways of achieving a lower net present value of debt service.

The dangers of debt relief are great. But the chances of success with denial are close to zero. True, it is possible for an ever greater share of the debt to be assumed by governments, so bailing out private creditors. Yet, ultimately, the cost of the debt owed to official sources will have to be cut by lowering interest rates or reducing sums outstanding.

It is not a question of whether such adjustments will have to be made, but of when. The history of such crises strongly suggests that it should be done sooner rather than later. Only after debt is on a sustainable path is confidence likely to return. Allowing foolish lenders, incompetent regulators and sloppy policymakers to hide past mistakes is a bad excuse for endless delays.

The doubt, in truth, is not over whether relief on the present value of the debt service is required. The real questions are elsewhere. One is over how to manage a co-operative debt restructuring. The other is over competitiveness and the return to growth. Some point to the success of Latvia in managing its so-called internal devaluation. But its GDP is 23 per cent below its pre-crisis peak. That is a depression. Moreover, the more successful a country turns out to be in cutting its costs, the worse the debt burden becomes. Thus, debt restructuring is merely a necessary condition for an exit. It is unlikely, in all cases, to be enough. Some economies may just wither away.

Alternatively, politicians may pull their countries out of the eurozone regardless of short-run costs. It is far too early to assume this will be the outcome, though some already do. But if there is to be any chance of avoiding this outcome, realism is required. At some point, the present value of the cost of debt must be drastically lowered. This does not have to happen today. But it has to happen soon enough to give people hope. In its absence, failure is not just likely. It is close to a certainty.

Moment of truth for the eurozone, Financial Times, By Martin Wolf.

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Eurozone Economics are Simple. It’s the Politics Stupid!

The European authorities have had a year to address the sovereign-debt-come-banking crisis in the euro area. They have failed. The situation is much worse than a year ago, the latest manifestation being another downgrade of Greek sovereign debt. There is a real and present danger of contagion and the disorderly break-up of the euro area.

The economics of the problem are very simple. The economics of its solution scarcely more complicated. Alas, the political problems are thorny. For political, not economic reasons, default is looking as if it may be the default option. A break-up of the euro area is a distinct possibility. No-one can seriously assess the outcomes of such a scenario – although that does not stop some commentators pronouncing on the issue as if they did. In my view, it is highly risky. Above all it is completely unnecessary. It can and therefore should be avoided.

Let’s start with the simple, but often neglected, basic economic facts about sovereign debt.

Government debt dynamics depend on precisely four variables. The existing level of debt, the size of primary deficits or surpluses (where ‘primary’ means excluding interest payments), the nominal interest, and the economic growth rates (where ‘nominal’ means at current prices).

A country that owns its own currency can never go broke and need never default. (At least not in its own currency: it can, of course, if it unwisely takes on debt denominated in another currency.) Whatever the government’s debts and deficits, and quite apart from its capacity to oblige the private sector to pay taxes, it can create the currency to service its debts. ‘Printing money’ drives the interest rate down and the nominal growth rate (that is real growth plus inflation) up thus reducing nominal debts as a share of nominal GDP. Such a policy may have negative consequences (notably inflation), but the point remains that a monetary and fiscal sovereign can always service its own-currency-denominated debts. And that very fact reassures investors. It makes a run on government bonds unlikely and is the reason why genuine, in the monetary sense, sovereigns pay a lower interest rate than private sector actors. This is why the US, Japan and the UK can still issue bonds at very low rates of interest despite debt and deficit numbers that are, on the face of it, as bad or worse than those of euro area countries facing default and exorbitant bond rates.

A country that does not control its own currency, such as a member of a currency union, cannot avoid the inexorable logic of the mathematical link between the debt and deficit and the interest and growth rate variables; specifically, lacking control of the nominal interest rate, it is forced, on its own, into a real rather than nominal adjustment. The problem facing euro area members – Greece, Ireland, then Portugal, and prospectively also Spain, Italy and Belgium, can be stated succinctly as follows. The post-crisis combination of high government debt and large current deficits is such that, given the prospects for nominal GDP growth, and at the prevailing interest rates demanded by the market, government debts cannot be brought under control. (The italicised caveat is crucial: statements as to whether a country’s debt is sustainable or not are meaningless without specifying the interest and growth rate.) This is because, under these prevailing conditions, fiscal policy would have to be tightened (in order to achieve the required primary surpluses) to an extent that is either politically impossible, or that will damage growth prospects so badly that even drastic enforced consolidation will not ensure sustainability. (The second point is also crucial: it is not just a question of lily-livered governments unwilling to wield the knife.) Once markets perceive a risk of unsustainability, investors become unwilling to lend; the interest rate demanded rises, substantially worsening the problem. The prospect of consolidation worsens further and the country is essentially shut out from market finance. In the absence of outside intervention it must default.

And that is where the politics starts to come in.

The essence of the EU/ECB/IMF packages for Greece, Ireland and Portugal is to avoid the country having to access private capital markets to roll-over its debts (i.e. to pay creditors as their bonds fall due). Instead, the needed refinancing is provided, in various ways, and by a combination of public authorities; the precise form is irrelevant in economic terms, but may be important politically. This support is provided at a politically determined rate of interest and conditional on a set of fiscal consolidation measures required by the lending authorities and designed to bring government debt dynamics under control such as to permit a subsequent return to the markets.

Yet the provision of such support alters nothing about the fundamental requirement that the combination of debt level, primary deficits/surpluses, interest and growth rates be such as to ensure debt sustainability. The simple fact is that with the EU/IMF packages this is not the case. And that is why the crisis is getting worse and not better. The interest rate is too high, and the austerity measures are either unfeasible or self-defeating by virtue of the damage they wreak on growth prospects. This failure was predicted (Greece, Ireland). The failure manifests itself either in ever more bail-out packages, and possibly contagion to other countries, and very possibly in the default that the packages were intended to avoid.

The economics of the implied policy choices are thus simple. If the debts are to be repaid in full, the interest rate must be lower and/or the nominal economic growth rate must be higher. If not, there will have to be some form of default (call it restructuring, voluntary, forced, what you will). And that is what the whole confused and confusing political debate is, at heart, about. Eurobonds, Brady/Trichet bonds, blue bonds, restructuring, reprofiling, privatisation, even selling the Acropolis; it is all about these basic choices.

But, in economic terms, it is, or should be, a non-debate. For the balance of costs, benefits and risks is so blindingly obvious. Consider:

One, collectively the euro-zone countries and the ECB are in control of their common currency. Two, the three currently affected countries account for a mere 6% of euro area GDP. And three, getting these countries on their feet quickly is in the interest of all of Europe, not just of the citizens directly affected. Taking these three basic facts together, the economic solution is self-evident. Some combination of the Member States and the ECB, who can, respectively, borrow and create money more or less at will announce that all sovereign debts in the euro area will be honoured in full. Immediate effect: the massive interest-rate spreads, which are a function of default fears (and not a conspiracy by ratings agencies) melt away. External finance is provided for a defined but extended period at a low interest rate and steps are taken to shore up nominal growth such that the balance between interest and growth rates puts debt ratios on a credible downward path. The government agrees to a politically feasible medium-run trajectory for the primary budget balance that ensures sustainability over a reasonable time-frame. This system is maintained for until such time as the markets are willing to resume lending at ‘normal’ rates of interest. This will not be very soon, but it will be for a limited period: all that markets need, in addition to the short-run no-loss guarantee, is to see debt ratios credibly falling.

In an appendix to this column I provide an illustrative and simplified calculation, using round numbers that approximate to the Greek case.

It’s really that simple. It costs nothing: other eurozone governments merely have to lend on what they themselves can borrow on the markets. For the euro area economy the magnitudes are entirely manageable. The euro area could, in theory, pay off every last euro of the combined government debt of Greece, Ireland and Portugal overnight, by borrowing some 9% of GDP. The peripheral countries stabilise quickly and begin to grow, avoiding the threat of a collapse in export demand from other eurozone countries. Avoiding the risks of banking collapses. Avoiding the risk of contagion.

Given this option, why take the risk of even talking about various default options? All they do is push up spreads further. Risk-averse financial institutions dump the government paper of the peripheral countries as fast as they can, ensuring more of it ends up in (quasi)public institutions anyway. (According to reports in the German media, German insurers have sold around half of their holdings of Greek bonds, and banks around one third).

The answer, in short: it’s the politics stupid. Core-country politicians have utterly failed to explain to voters the basic facts: properly conceived, bail-outs are costless. Pro-cyclical austerity policies are not in the interests of either peripheral or core countries. They are a senseless waste of resources and a serious threat to the future of the European integration project.

Currently, nationalistic parties fan the flames of resentment, unchallenged by mainstream parties who either don’t understand the issues or are running scared of voters (or both). Some on the Left see an opportunity to ‘hit the banks and the speculators’ by calling for a default. I agree that hitting the speculators is preferable to hitting public sector workers and the users of public services. But it is a high-risk strategy and it is, in principle at least, unnecessary. The banks are not separate entities from the economy. All will be hurt if they come crashing down. It is not the real alternative. The real alternative is between nationalistically inspired austerity policies and European growth-oriented policies. The former has been tried and has failed. It will continue to fail if policymakers persist with it. The task of progressives is to fight for the second strategy.

Frankly speaking, I don’t have an answer to how to overcome the political barriers to European solutions Europe. There is certainly no way forward as long as the debate is couched in terms of ‘the core won’t lend any more and the periphery won’t reform any more’. The fact is that most Member States and all the European institutions are in the hands of conservative-liberal majorities. Elsewhere I have proposed a ‘blueprint’ which, if implemented, would enable the various problems afflicting the euro area as a whole and its individual countries to be tackled together. In that way burdens can be shared and political solutions found on the basis of a common understanding of common interests.

The purpose of this column was more limited. To make the economic arguments clear, and to point out where the problems lie. In the politics, stupid!

Appendix: An illustrative and simplified calculation using round numbers that approximate to the Greek case

The debt to GDP ratio is 150% and the current deficit is 10% of GDP.[1]

The EU lends the country sufficient funds to shield it from capital markets at the same rate at which Member States  can borrow on the markets (roughly 3%), a costless transaction. This is instead of the penal roughly 6% being charged under EU/IMF programmes.

What about the nominal growth rate going forward? On the one hand there is a massive output gap implying a large potential for rapid catch-up real economic growth. On the other, the peripheral countries have an overblown nominal price and wage level, implying a need for low inflation. Real growth could be stoked by EU-supported investment. Price and wage inflation could be held in check with an incomes policy. Let us suppose an average of 3% real growth and 1% inflation. (3% real growth may seem high to some, but we are talking about the future, not the past. Depressed economies do bounce back, once confidence is restored. Encouragingly Greece grew at an annual rate of 2.4% in the first quarter of 2011, even if this is not expected to continue.)

This growth-interest-rate constellation would mean, taken by itself, that the country’s debt would fall every year by around 1½ pp of GDP a year. This is already a start: the debt ratio is on a declining, rather than an exploding trend, although the pace of improvement is slow.

Now what about the primary balance? The interest rate burden is 4.5% of GDP (3% * 1.5). If the country posts, on average during a consolidation phase, a balanced budget, then it is running a primary surplus of 4.5%. Add to this the 1.5% resulting from the growth-interest differential, and every year Greece would reduce its debt by 6 percentage points. Note: This requires merely that the government spends no more than it takes in in current taxation. This would represent a sensible average pace of debt reduction, comparable to that achieved, for instance, by Belgium during the 1990s and 2000s, which steadily brought its deficit ratio from around 120% to 80% of GDP. As such it would be convincing to market actors, who would be willing to lend money again to the government in question on favourable terms, once the effective consolidation became apparent.

The figures mentioned are averages over the consolidation phase. In fact, because it takes time to reduce current deficits if growth is not to be unduly stifled, the consolidation path would not be at this average rate across the period; initially debt to GDP ratios will in fact rise, and it is precisely during this crucial period that external financing is needed. However, as confidence returns and growth picks up, fiscal policy can be tightened further, accelerating the path of debt-paydown.

I have made some simple simulation calculations (to be presented in the near future) which show how a low interest-rate support strategy, coupled with measured fiscal consolidation (and ideally some externally financed, growth-enhancing public investment) might compare with the current strategy of high interest rate and enforced and pro-cyclical fiscal consolidation. On plausible assumptions, fiscal consolidation performance, in terms of the debt-to-GDP ratio, is worse under the growth-inhibiting austerity approach, in spite of the faster reduction in current deficits and the much higher primary surpluses than under one based on European solidarity and growth. And it goes without saying that real incomes recover much faster under the latter strategy and also perform much better in a longer term perspective.

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[1] The actual figures for Greece for 2010 are debt: 143% and deficit -10.5%. The figures for Ireland and Portugal respectively are: debt: 96% and 93% and 32% and 9%. The calculation simplifies somewhat: after the first year the basis is no longer 150%, but 146%, but the basic dynamic is unchanged.

Related posts:

1. Managing A Fragile Eurozone
2. Five Ways to solve the Eurozone Crisis
3. Debt and Taxes in the Eurozone

Eurozone Economics are Simple. It’s the Politics Stupid!.

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Say no to Germany’s competitiveness pact

It is time to stop pretending that we are about to see a “grand bargain” for the eurozone in March. Last week, the political developments in Germany shifted dramatically in the wrong direction. The Bundesbank, the parliament, the small business community and influential academics have all come out openly against an extension of the various support mechanisms. German society as a whole is in open revolt against the eurozone.

The single most important event was the decision by the three coalition parties in the Bundestag to reject, categorically, bond purchases by the European stability mechanism. The ESM will be the permanent anti-crisis institution from 2013. The Bundesbank came to a similar conclusion in its monthly report. On Thursday, 189 German economists wrote a letter to a newspaper denouncing the ESM, calling for immediate bankruptcy proceedings of insolvent eurozone states. It is no longer just the constitutional court that puts a break on the process.

In last week’s column, I tried to explain the origins of that sentiment. Today, I will focus on the consequences. The best outcome, in my view, would be a failure of the current crisis resolution strategy, followed by a complete rebooting. The worst would be a never-ending stand-off, followed by a financial cardiac arrest. The most likely outcome is a very small compromise of the kind that resolves nothing.

The current bargaining revolves around four pillars: current crisis management; the ESM; a new stability pact with budgetary surveillance; and co-ordination of social and economic policies. Negotiations on the ESM’s funding have been going well, as have discussions on the stability pact. But there is no agreement on bond purchases, and no progress at all on current crisis management.

The least sturdy of the four pillars is policy co-ordination. Chancellor Angela Merkel insists on a German-inspired competitiveness pact as a quid pro quo for Germany’s readiness to provide credit guarantees. But how should other countries respond?

My answer is: reject it. I would recommend eurozone member states to veto the competitiveness pact, even if that jeopardises the entire package. If Germany cannot deliver its side of this quid pro quo, it is not clear to me why anybody would accept a loss of sovereignty – which is effectively what policy co-ordination would imply. The only reason to accept such a loss of sovereignty would be the prize of an ever closer economic union. But that would have to include a common eurozone bond at one point. Through bond purchases the ESM would eventually mutate into a European debt agency, the financial counterpart of an economic union. But if the ESM has its wings clipped from the outset, this will never happen.

There is also the problem inherent in the purely inter-governmental system of policy co-ordination that France and Germany are offering. In such a system, the large countries impose their will on the small. Just witness the arrogance with which Ms Merkel and French president Nicolas Sarkozy presented their six-point competitiveness pact at the last European Council.

But would the financial markets not panic at a failure to agree a deal? Quite possibly. But nobody should fool themselves into thinking that the reaction to a fudged deal would be better. It might come a little later, but it would come. And then you are in a much worse position. Once you get a bad deal in March, there is no way you can crawl back to the Bundestag for a top-up loan in May.

The reason we are in this pickle is, ironically, the lack of market pressure. With their enthusiasm about a deal, the financial markets might have killed it. Eurozone countries only act when under immediate pressure. Germany, for example, has a massive problem in its state-owned banking sector, but apart from a reluctant restructuring of WestLB, this is currently no policy priority. The Bundesbank tells everyone that it is not happy about transparency in stress tests, and there is no law in place to force recapitalisations. The relatively calm market situation also explains why 189 economists find the time to write a long letter, criticising what they clearly consider to be the resolution of someone else’s crisis. I am afraid that without a force majeure event, there will be no crisis resolution. A good example is the Spanish recapitalisation of the savings banks. The Spanish government would never have had the courage to force this without the fear of being next in line for a speculative attack.

The EU’s crisis resolution strategy is to draw attention away from the underlying causes of the crisis: that you cannot have nationally controlled and undercapitalised banking systems in a monetary union with structural current account imbalances. The difficult job is to translate this technical statement into a language understood by politicians and their constituents, and to do so without lying. This is not a fiscal crisis. It is not a crisis of the south. It is a crisis of the private sector and of undercapitalised banks. It is as much a German crisis as it is a Spanish crisis. This acknowledgement must be the starting point of any effective resolution system. A veto in March is thus a necessary first step in crisis resolution.

Wolfgang Münchau, February 27 2011, FT

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A misguided German narrative of the crisis

[The ECB presidency] is something we are going to decide later. And then we will see what cards we still have in the game.

— Angela Merkel, NDR Info radio

To understand Angela Merkel’s next strategic move, it is essential to become acquainted with the German narrative for explaining the crisis in the eurozone. It is a story of fiscal irresponsibility and lack of competitiveness. There is a banking crisis, but it is not central. It is the crisis the European Union is trying to solve right now.

In a warped variant of this narrative that is popular among conservative europhobic circles in Berlin, the European financial stability facility (EFSF) is the foil through which Germany surrenders national sovereignty. Frankfurter Allgemeine Zeitung, the paper of record for conservative Germany, captured the country’s ultimate fear in a dark and moody picture of Ms Merkel and Nicolas Sarkozy. It shows the German chancellor and French president walking on the beach at Deauville, venue of a fateful Franco-German summit last autumn, when Ms Merkel supposedly capitulated to France. The headline read: “Europe on the way to the transfer union”.

Worse, most Germans believe that the transfer union has already happened. The media reports the crisis as though Germany was simply giving money away. Few people, even politicians, are aware that the bail-out is, in fact, a remunerated loan guarantee.

So while the rest of us are debating how to solve Europe’s banking crisis, and become exasperated by the lack of progress, Ms Merkel is solving a crisis in a parallel universe. The German narrative is the outgrowth of a lie the country’s establishment has peddled ever since debate on the single currency started 20 years ago: that a monetary union can be sustained through a simple set of rules for monetary and fiscal policy; that financial regulation and current account imbalances do not matter. The eurozone crisis has proved this is not the case. But the conservatives cling to this old, comfortable straw. If there is a crisis, then it must be fiscal. And austerity is the answer.

Ms Merkel is a resourceful politician. Tired of being accused of being complacent, she wanted to regain the initiative. And so she offered her European colleagues a Faustian pact: German acceptance of a higher lending ceiling for the EFSF, on condition that every member of the eurozone becomes, economically, like Germany. To that effect, her policy advisers drafted a six-point programme of economic torture instruments. It triggered a revolt in the European Council at a meeting 10 days ago. The concrete plan itself is now dead. Herman van Rompuy, president of the European Council, is trying to pick up the rubble.

Once Germany’s six-point plan imploded, the last hope was the proposed nomination of Axel Weber to the presidency of the European Central Bank. A German central banker would be a sufficient symbol of the country’s dominance of the system. Members of the Bundestag would surely not turn their pitchforks against one of their own.

But Mr Weber’s sudden withdrawal from the race has put Ms Merkel in a difficult position. She now needs a material agreement on what she still insists on calling a competitiveness pact. She cannot come home from March’s European summit both with a weak compromise and with Mario Draghi as new president of the ECB. German officials are telling everybody that they have nothing against the governor of the Bank of Italy personally. He is just not vermittelbar. You cannot sell him to the public in the context of a xenophobic narrative that blames mostly southern Europeans.

So what now? In her statement above, Ms Merkel is essentially suggesting that her flexibility on Mr Draghi is linked to the kind of deal she is going to get in March. And what would constitute a good deal from her perspective? Given her own crisis narrative, the minimum she needs is a firm commitment on public debt reduction.

Germany wants member states to introduce binding balanced budget agreements in their constitutions. I think such constitutional amendments are crazy – even for Germany – because they are either damaging or not sustainable. But it is one thing to shoot yourself in the head, quite another to shoot others. And, of course, constitutional debt brakes, even if they had been in place everywhere and kept to by everyone, would have done nothing to prevent the crisis.

So what if she does not get a sufficiently good deal? Will she veto Mr Draghi’s appointment? Or is she just bluffing? I cannot fathom what the Italian government would do if its candidate were to be rejected purely on xenophobic grounds, as any rejection of Mr Draghi would invariably be interpreted.

So this is what we might end up with: a pact that addresses the wrong crisis, is vetoed or fudged; no credible banking resolution strategy; a third-rate central banker at the top of the ECB; and a policy co-ordination process where decisions get taken by two leaders on long walks on beaches.

You could not make it up.

Wolfgang Münchau, FT, February 20 2011

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Germany’s rebound is no cause for cheer

One of the weirder experiences for anyone who lives in the eurozone is a visit to a German supermarket. I had the pleasure the other day, and found the general price level there to be a little over half of what it is in Belgium, Italy or Spain. This, of course, is just an unscientific guess. I also found price differences of some 30 per cent when comparing certain categories of goods on various Ebay sites in the eurozone.These differences go some way to explaining the eurozone’s divergent economic performance, and give a pointer as to what to expect in the future. The really intriguing aspect of the divergences is not how they happened, but why they are not correcting themselves. We know how they happened: Germany entered the eurozone at an uncompetitive exchange rate and embarked on a long period of wage moderation. Macroeconomists would say Germany benefited from a real devaluation against other members. But while real exchange rates tend to move around, one would not normally expect extreme misalignments to be persistent. In this case, one would expect Spanish and Italian consumers to abandon their expensive retail stores and swamp German internet sites with mail order purchases, especially for durable goods. Eventually there would be some price realignment.

It is not happening.

You would also expect some pressure for realignment from the labour market. As the German export sector returns to full capacity, one would expect wage costs to rise by more than the eurozone average.

This is not happening either.

The reason for the lack of demand-side adjustment is that Europe’s internal market is not fully functioning, certainly not at the consumer level. I spoke to an executive of one of Germany’s mail order companies and asked him why people in Belgium, where I live, cannot buy his extremely cheap products. He told me that national tastes were so different as to preclude a European-wide mail order service. My response was that the Belgians, and the Italians, probably share the Germans’ taste for low prices, and would probably shop if only given an opportunity. Despite some recent improvements it remains surprisingly hard to shop cross-border.

While adjustment of the product side is prevented by an imperfect single market, adjustment on the labour market side is prevented by a complete absence of market integration. You would expect German workers to seek higher wages outside the country. But this is not happening, as the European labour market remains almost perfectly fragmented. That means German wage moderation can persist uncorrected for a long time. Nominal wages are effectively frozen, and are set to rise by only small percentages in the next few years.

Taken together, this means the intra-eurozone imbalances will not only persist, but probably increase. This will make the economic adjustment for Spain, Portugal or Greece even more difficult than it already is. Those persistent imbalances, much more than the build-up of debt, are my deep cause of concern about the long-term health of the eurozone.

But from a German perspective, this strategy boosts growth in the short term. It is, of course, a beggar-thy-neighbour strategy. The improvement in Germany’s economic growth is driven not by productivity gains but by real devaluation.

So while I expect the German economy to perform better than the eurozone average, it is important to keep some perspective and not draw false inferences from the 9 per cent annualised growth rate during the second quarter. If you look at the period since the beginning of the financial crisis, Germany’s economic performance has been dismal. If you compare levels of gross domestic product between Germany and the US since the crisis, you find the US significantly outperformed Germany during that period. That situation may still be reversed if the US were to go into a double-dip recession. But the best judgment we can make now is that of Christine Lagarde, the French finance minister, in her recent interview in the Financial Times: Germany is recovering faster this year because it contracted faster last year, when GDP fell by 5 per cent. So far, this looks like classic dead-cat bounce.

Given its export-dependence, the performance of the German economy will ultimately depend on the global economy. As the US is heading for another downturn, it is hard to see how Germany can maintain its recent rates of growth. To do so would require a sudden increase in domestic demand. But I cannot see where that would come from.

The bottom line is that Germany’s economic performance will almost certainly improve relative to the eurozone average in the years ahead, but also that the current wave of enthusiasm is much exaggerated.

The real danger – to the eurozone, but ultimately to Germany itself – is the strains stemming from the policy of a real devaluation. I cannot see how southern Europe can ever fully reverse the misalignments in the real exchange rate. Nor are there any signs that the reforms in the EU’s product and labour markets will be sufficient to ensure that economic adjustment mechanisms can kick in. In other words, Germany’s economic strength is likely to be persistent, toxic and quite possibly self-defeating in the long-run.

munchau@eurointelligence.com

via FT.com / Columnists / Wolfgang Münchau – Germany’s rebound is no cause for cheer.

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Radical reforms can save the euro

By Peter Sutherland

Published: June 29 2010

An honourable tradition of the European Union is that of turning a crisis into an opportunity. “Eurosclerosis” and budgetary squabbles in the 1980s were the precursors of the Single European Act of 1986; and the crisis of the exchange rate mechanism in 1992-1993 accelerated the creation of the European single currency. There is reason to believe that the current crisis of governance in the eurozone will follow this pattern if only because the alternative is really dreadful.

The past three months have provided painful lessons to the leaders of the eurozone about the design flaws of the single European currency. The financial package agreed in May is proof of the seriousness with which these leaders are willing to implement these lessons. But this is only part of the story. Equally significant is the willingness of the eurozone’s leaders to look again at the principles of the way the euro is run. National positions have greatly shifted over the past three months. It would be very surprising if they did not shift further over the next three months.

Without the single currency, Europe would be an economic wasteland. The cost of not having the euro would have been far greater over the past two years than the cost of having it has been over the past three months. Competitive devaluations of national currencies after the financial crisis of 2008 would have led to economic chaos incomparably worse than the turbulence we are now experiencing. The eurozone’s leaders recognise this. The task that confronts them is to ensure that the eurozone functions in such a way that the risk of disintegration is minimised and its potential advantages are exploited to the utmost. There is scope for improvement in both respects.

I am hopeful this will occur because I sense a growing acceptance among decision-makers that, for all its merits, the original system of governance for the European single currency was intellectually and politically schizophrenic. On the one hand, it represented the culmination of 40 years of integration, based on the obvious inadequacy of national procedures to confront continental and global challenges. On the other hand, it was concerned with preserving absolute national sovereignty in fiscal, budgetary and ­macroeconomic matters.

This latter concern was the fundamental reason why the main tool of economic governance that the single European currency gave itself, namely the “stability pact,” could never be a reliable foundation upon which to build. Its implementation was to be left to national governments and they themselves would be entitled to vote on whether they should be sanctioned for breaches of the pact. The current debt crisis is a direct result of a governance structure for the single currency that was excessively respectful of national economic sovereignty.

It is understandable that those who set up the euro wished to tread carefully over the sharing of economic sovereignty. Many probably believed that initial arrangements would be subject to refinement in the light of experience. The limitations of their approach, however, are clear. Their common membership of the single European currency entails a measure of economic sovereignty-sharing between, for example, Germany and Greece. This will not disappear because there are no political structures to manage and reflect their shared sovereignty. On the contrary, the absence of structures to deal with such problems has ensured that Greece’s eurozone partners have become ever more entangled in its difficulties. The implausible insistence that Greece’s financial problems were a matter for Greece only was the surest possible way of ensuring that they would become a pressing matter for the whole eurozone.

Herman Van Rompuy, the president of the European Council, has been charged with making recommendations to the council on the reform of the eurozone’s governance in October. It is both desirable and inevitable that his proposals will represent a substantial step forward in the integration of the European political economy. Recent experience points to a more binding surveillance of national economic, not merely budgetary, policies. A natural counterpart would be enhanced macroeconomic co-ordination within the eurozone. Even within the single European market, national economic policies have substantial repercussions for that country’s neighbours. That the eurozone has been so reluctant to set up mechanisms for managing this interdependence is a tribute to the fetish of national sovereignty rather than a reflection of reality.

I cannot share the views of those commentators, who claim it will be impossible to gain agreement for any radical reform of the euro’s governance. The German government is sometimes mentioned in this context as a potential stumbling block. But we have heard repeated assurances from Berlin that it is happy to engage in constructive negotiations with its partners on such reform. Its own proposals represent a starting point for discussion and reflection.

This is in contrast to the uncompromising rhetoric sometimes heard in Berlin earlier this year. European integration has never proceeded other than by reconciling apparently irreconcilable national views. Germany has every interest in playing its traditional central role in that process, not merely as a good neighbour in Europe, but as a matter of pressing national interest.

The writer is a former European Union commissioner

FT.com / Comment / Opinion – Radical reforms can save the euro.

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Fresh fears over European bank sector

By David Oakley, Capital Markets Correspondent

Published: June 29 2010 13:34

Fears rose over the health of the European banking system on Tuesday as interbank rates jumped to nine-month highs amid worries that the European Central Bank may be reducing emergency financial support to financial institutions too soon.

Key three-month euribor rates, which measure the cost at which banks are prepared to lend to each other, jumped to the highest level since September and the biggest one-day rise since April 28. Euribor rates rose to 0.761 per cent from 0.754 per cent.

Bankers warn that the ECB’s decision to offer banks loans for only three months instead of a year is raising concerns that many institutions will come under further pressure in the strained interbank markets.

Don Smith, economist at Icap, said: “There are major worries over the systemic risks for banks, with many struggling to access the private markets. The ECB is in effect weaning the banks off the artificial support system – and this is a concern.”

The ECB will on Wednesday offer unlimited loans to European banks for three months as it seeks to smooth funding for those banks that have to return one-year loans to the central bank on Thursday.

However, in spite of the vast amount of support the ECB is offering to the market, with more than €800bn in outstanding loans to eurozone banks, analysts say the fact the ECB is no longer offering loans for a year has worried some investors.

This is because the shorter-term loans create more dangers of so-called rollover risk. In other words, weaker banks relying on the ECB for lending as they struggle to access the private markets have less certainty over their financing than if they had the loans for a year.

via FT.com / Markets – Fresh fears over European bank sector.

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Wage Moderation Does Not Work: Unemployment in Europe

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