Archive for the ‘Fear’ Category

The economic, and democratic, crisis in Europe raises questions. Why were policies that were bound to fail adopted and applied with exceptional ferocity in Ireland, Spain, Portugal and Greece? Are those responsible for pursuing these policies mad, doubling the dose every time their medicine predictably fails to work? How is it that in a democratic system, the people forced to accept cuts and austerity simply replace one failed government with another just as dedicated to the same shock treatment? Is there any alternative?

The answer to the first two questions is clear, once we forget the propaganda about the “public interest”, Europe’s “shared values” and being “all in this together”. The policies are rational and on the whole are achieving their objective. But that objective is not to end the economic and financial crisis but to reap its rich rewards. The crisis means that hundreds of thousands of civil service jobs can be cut (in Greece, nine out of ten civil servants will not be replaced on retirement), salaries and paid leave reduced, tranches of the economy sold off for the benefit of private interests, labour laws questioned, indirect taxes (the most regressive) increased, the cost of public services raised, reimbursement of health care charges reduced. The crisis is heaven-sent for neoliberals, who would have had to fight long and hard for any of these measures, and now get them all. Why should they want to see the end of a tunnel that is a fast track to paradise?

The Irish Business and Employers Confederation (IBEC)’s directors went to Brussels on 15 June to ask the European Commission to pressure Dublin to dismantle some of Ireland’s labour legislation, fast. After the meeting, Brendan McGinty, IBEC director of Industrial Relations and Human Resources, warned: “Ireland needs to show the world it is serious about economic reform and getting labour costs back into line. Foreign observers clearly see that our wage rules are a barrier to job creation, growth and recovery. Major reform is a key part of the programme agreed with the EU and the IMF. Now is not the time for government to shirk from the hard decisions.”

The decisions will not be hard for everyone, following a course that is already familiar: “Pay rates for new workers in unregulated sectors have fallen by about 25% in recent years. This shows the labour market is responding to an economic and unemployment crisis” (1). The lever of sovereign debt enables the European Union and International Monetary Fund to impose the Irish employers’ dream order on Dublin.

The same view seems to apply elsewhere. On 11 June, an Economist editorial observed that “Reform-minded Greeks see the crisis as an opportunity to set their country right. They quietly praise foreigners for turning the screws on their politicians” (2). The same issue analysed the EU and IMF austerity plan for Portugal: “Business leaders are adamant that there should be no deviation from the IMF/EU plan. Pedro Ferraz da Costa, who heads a business think-tank, says no Portuguese party in the past 30 years would have put forward so radical a reform programme. He adds that Portugal cannot afford to miss this opportunity” (3). Long live the crisis.

Catering only to rentiers

Portuguese democracy is just 30 years old. Its young leaders were showered with carnations by crowds grateful for the end of a long dictatorship and colonial wars in Africa, the promise of agrarian reform, literacy programmes and power for factory workers. Now, with reductions in the minimum wage and unemployment benefit, neoliberal reforms in pensions, health and education, and privatisation, they have had a great leap backwards. The new prime minister, Pedro Passos Coelho, has promised to go even further than the EU and the IMF require. He wants to “surprise” investors.

US economist Paul Krugman explains: “Consciously or not, policy makers are catering almost exclusively to the interests of rentiers – those who derive lots of income from assets, who lent large sums of money in the past, often unwisely, but are now being protected from loss at everyone else’s expense.” Krugman says creditor interests naturally prevail because “this is the class that makes big campaign contributions, it’s the class that has personal access to policy makers, many of whom go to work for these people when they exit government through the revolving door” (4). During the EU discussion on funding Greek recovery, Austrian finance minister Maria Fekter initially suggested: “You can’t leave the profits with the banks and make the taxpayers shoulder the losses” (5). This was short-lived. Europe hesitated for 48 hours, then the interests of rentiers prevailed, as usual.

To understand the “complex” mechanisms underlying the sovereign debt crisis, you need to know about constant innovations in financial engineering: futures, CDs (credit default swaps) etc. This level of sophistication reserves analysis for select experts who generally profit from their knowledge. They pocket the proceeds while the economically illiterate pay, as a tribute they owe to fate, or to an aspect of the modern world that is beyond them.

Let’s try the simple political explanation instead. Long ago, European kings borrowed from the Doge of Venice or Florentine merchants or Genoese bankers. They were under no obligation to repay these loans and sometimes neglected to do so, a neat way of settling public debt. Many years later, the young Soviet regime announced that it would not be held accountable for money the tsars had borrowed and squandered, so generations of French savers suddenly found they had worthless Russian loans in their attics.

But there were more subtle ways of getting out of debt. In the UK, debt declined from 216% of gross domestic product in 1945 to 138% in 1955, and in the US it fell from 116% of GDP to 66%. Without any austerity plan. Of course, the surge in post-war economic development automatically reduced the proportion of debt in national wealth. But that was not all. States repaid a nominal sum at the time, reduced each year by the level of inflation. If a loan subscribed at 5% annual interest is repaid in currency that is depreciating at the rate of 10% a year, the real interest rate becomes negative to the benefit of the debtor. Between 1945 and 1980, the real interest rate in most western countries was negative almost every year. As a result, as The Economist remarked: “Savers deposited money in banks, which lent to governments at interest rates below the level of inflation” (6). Debt was cut without much trouble. In the US, negative real interest rates were worth the equivalent of 6.3% of GDP per year to the Treasury, from 1945 to 1955 (7).

Why did savers allow themselves to be cheated? They had no choice. Capital controls and the nationalisation of the banks meant that they had to lend to the state, and that is how it got its funds. Wealthy individuals did not have the option to invest on spec in Brazilian stock index-linked to changes in the price of soybeans over the next three years. There was a flight of capital, suitcases of gold ingots leaving France for Switzerland the day before devaluation or an election in which the left might win. However, this was illegal.

Up to the 1980s, index-linked wage rises (sliding scales) protected most workers against the consequences of inflation, and controls on free movement of capital had forced investors to put up with negative real interest rates. After the Reagan/Thatcher years, the opposite applied.

The system has no pity

Sliding wage scales disappeared almost everywhere: in France, the economist Alain Cotta called this major decision, in 1982, “[Jacques] Delors’ gift [to employers]” (8). Between 1981 and 2007, inflation was destroyed and real interest rates were almost always positive. Profiting from the liberalisation of capital movements, “savers” (this does not mean old age pensioners with a post office account in Lisbon or carpenters in Salonika) make states compete for funds and, as François Mitterrand said, “make money in their sleep”. Moving from sliding wage scales and negative real interest rates to a reduction in the purchasing power of labour and a meteoric increase in returns on capital completely upsets the social balance.

Apparently this is not enough. The troika (European Commission, ECB and IMF) has decided to improve the mechanisms designed to favour capital at the expense of labour, by adding coercion, blackmail and ultimatum. States bled by their over-generous efforts to rescue the banks, and begging for loans to balance their monthly accounts, are told to choose between a market-led clean-up and bankruptcy. A swathe of Europe, where the dictatorships of António de Oliveira Salazar, Francisco Franco and the Greek colonels ended, has been reduced to the rank of a protectorate run by Brussels, Frankfurt and Washington, the main aim being to defend the financial sector.

These states still have their own governments, but only to ensure that orders are carried out and to endure abuse from the people who know the system will never take pity on them, however poor they are. According to Le Figaro, “Most Greeks see the international supervision of the budget as a new form of dictatorship, like the old days when the colonels were in charge, between 1967 and 1974” (9). The European ideal will not gain from being associated with a bailiff who seizes islands, beaches, national companies and public services and sells them to private investors. Since 1919 and the Treaty of Versailles, everyone knows that such public humiliation can unleash destructive nationalism – and all the more so as provocations increase. The next ECB governor, Mario Draghi, who – like his predecessor – will issue strict orders in Athens, was vice chairman and managing director of Goldman Sachs when the bank was helping the conservative government in Greece to cook the books (10). The IMF, which also takes a view on the French constitution, has asked Paris to insert a “rule to balance public finances”; Nicolas Sarkozy is already working on it.

France has let it be known that it would like the Greek political parties to follow the example of their Portuguese counterparts, “join forces, and form an alliance”; and the prime minister, François Fillon, and European Commission president, José Barroso, have tried to persuade the Greek conservative leader, Antonis Samaras, to take this course. ECB head Jean-Claude Trichet considers that “the European authorities could have the right to veto some national economic policy decisions” (11).

Honduras has established an enterprise zone, in which national sovereignty does not apply. Europe is currently establishing a debate zone for all the economic and social issues no longer discussed by the political parties because these areas have gone beyond their control. Inter-party competition now concentrates on social matters: the burqa, the legalisation of cannabis, radar on motorways, the angry gestures or foul language of a reckless politician or intoxicated artist. This confirms a trend already noticeable 20 years ago: real political power is shifting to areas where democracy carries no weight, until the day when indignation finally boils over. Which is where we are.

But indignation is powerless without some understanding of the mechanisms that caused it. We know the alternatives – reject the monetarist, deflationist policies that deepen the crisis, cancel part of the debt if not all of it, take over the banks, get finance under control, reverse globalisation and recover the hundreds of billions of euros the state has lost by tax cuts that favour the wealthy (?70bn in France in the past ten years, more than $1 trillion in the US, especially for the top 1% of income earners). And knowledge of these alternatives has been shared by people who know at least as much about economics as Trichet, but do not serve the same interests.

This is not a technical and financial debate but a political and social battle. Of course, the economic liberals will claim that what progressives demand is impossible. But what have they achieved, apart from creating a situation that is unbearable? Perhaps it is time to remember how Jean-Paul Sartre summed up Paul Nizan’s advice to people who bottle up their aggression: “Do not be ashamed to ask for the moon: we need it” (12).

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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 (GreeceIreland). 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.

[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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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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[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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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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They have proved to be an effective means of dealing with the epidemic of youth on our streets. But now that acoustic dispersal devices are likely to be banned, how will we tackle one of this country’s most distressing and pervasive crimes: being young in a public place?

Acoustic deterrence was, until recently, used only to repel rats, mice and cockroaches. But thanks to an invention by the former British Aerospace engineer Howard Stapleton it is now just as effective at discouraging human vermin. The Mosquito youth dispersal device, manufactured by Compound Security Systems, produces a loud, high-pitched whine that can be heard strongly only by children and teenagers, and not at all by people over 25. It allows councils to keep children out of public places, making them safe for law-abiding citizens. It enables shopkeepers to determine who should and should not be permitted to use the streets. It ensures that society is not subjected, among other intrusions, to the unpleasant and distressing noises that youths are inclined to make.

A survey by the Guardian shows that 25% of local authorities in the UK use or have used these machines in their attempts to discourage the youthwave. Altogether 3,500 Mosquitos have been sold here, far more than in any other country. The product’s success is one of many signs of the enlightened attitudes to the menace of childhood that distinguish the United Kingdom from less civilised parts of the world. But last week the bleeding hearts in the Council of Europe’s parliamentary assembly unanimously recommended that acoustic deterrents be banned from public places, on the preposterous grounds that they discriminate against young people and deny their right to free assembly.

In a blatant attempt at emotional blackmail, the council’s parliament contends that, as well as causing distress to teenagers – whether wearing hooded tops or not – these devices cause “dramatic reactions” in many younger children, particularly babies, who often “cry or shout out and cover their ears, to the surprise of their parents, who, unaware of the noise, do not know why”. Nor, it says, do we yet know what impact high-frequency noise has on unborn children.

Really, who cares?

This is just the sort of Eurotrash we have come to expect from the fat cats of Strasbourg. Happily their decision is not binding, but it can be only a matter of time before the pressure on our legislators – especially high-pitched whining from do-gooders such as the Children’s Rights Alliance for England – becomes intolerable, and they cave in to the forces of political correctness.

What this will mean is that the police, councils and owners of property will be deprived of an essential weapon in the fight against youth. Youth statistics might be improving, but there are still far too many occasions on which young people venture out of their homes, sometimes in concert. It is true that the police have specific, if limited, powers to deal with individual cases. Admittedly the United Kingdom has one of the world’s most enlightened policies on the age of criminal responsibility. Children can be tried and imprisoned here at the age of 10. This is four years younger than in China, whose government is notoriously soft on crime, and six years younger than in the pinko, wet-blanket state of Texas. Admittedly, we have more child prisoners than any other country in Europe, and behaviour laws – asbos, extrajudicial fines, house arrest for excluded children, £5,000 fines for the parents of antisocial toddlers – that dictatorships can only dream of.

But while these measures offer society some protection against actual offences, they do nothing to address the general issue of young people in our midst. Worse, they attempt to draw a distinction between criminals and teenagers. As everyone over the age of 40 knows, this distinction is a false one. Now that the Mosquito is likely to be excluded from the armoury, now that police officers may no longer respond to the incidence of youth with a simple cuff round the ear, or a falling down the stairs or out of a police station window, how will Britain deal with this menace?

The authorities have been seeking creative solutions, but none meets the challenge we face. Some councils have imported an idea pioneered in New Zealand and Australia whose purpose is to disperse teenagers from public places: playing the songs of Barry Manilow over their loudspeaker systems. The problem with the Manilow method is that it is too blunt an instrument, as it disperses everyone except the hard of hearing.

Youth curfews, introduced by the Crime and Disorder Act 1998, and dispersal orders, brought into effect by the Antisocial Behaviour Act 2003, go some of the way towards tackling the problem, but they require the active involvement of the police, and apply only where and when they have been implemented. There is as yet no universal provision against those who insist, often in active collaboration with others, on being young people in public view.

I have a modest proposal for dealing with this problem. While forestalling sterner measures that might otherwise be deployed to address the troubling existence of youth, it enables good citizens to go about their lives at liberty. It also prevents young people from getting into trouble and ending up in the worst situation of all: the horror and humiliation of prison, where their golden years are blighted and they fall into the clutches of people ready to exploit them.

I propose that from school age onwards young people should, for the good of themselves and society, be kept in a safe, secure environment, under supervision and out of situations that might tempt them into trouble. Each would be given a small room, simple but comfortable, which in some cases they might share with another. They would be permitted one hour of exercise a day in a purpose-built yard offering appropriate facilities.

Besides schooling, occupations would be designed to keep them busy and happy, and prevent them from engaging in the kind of group activities the citizens of this country deplore. These pastimes might include assembling bags of the kind used for postal deliveries. They would also be offered the opportunity to pursue vocational qualifications, particularly in the sub-surface fossil fuel extraction and smoke duct-cleansing industries.

This firm but fair treatment programme will consolidate the policies introduced in a piecemeal and incoherent fashion by the last government, reverse the disastrous social experiment of the past 100 years that unleashed the youthwave on to our streets, and make devices such as the Mosquito redundant, useful as they are in the current legislative vacuum. It will ensure that the youth class ceases to blight the lives of law-abiding owners of property.

Juvenile citizens would be restrained from engaging with society until they have learned to shoulder the burden of respect and responsibility this entails. By this means we will rear the young people we all want to see: happy, well-adjusted, out of sight and out of mind.

Turn up the Mosquito and Manilow. And better still, lock the young up | George Monbiot | Comment is free | The Guardian.

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Thank God for José Luis Rodríguez Zapatero, the Spanish prime minister. For the first time in the three years since the outbreak of the financial crisis, a European leader has done something intelligent and surprising. Spain’s unilateral decision to publish the stress tests of its banks has bounced the European Union – at a summit in Brussels last Thursday – into following a Spanish lead, and to accept an uncharacteristic degree of transparency.

Does this mean that we are about to get on top of this wretched crisis? Well, so far, the EU has agreed to publish the stress tests of only 25 banks. They are not the main problem banks in the eurozone. There is a good chance that governments will extend those tests to other banks. But it is no reason to get too excited.

The fundamental problem is that governments are still fighting the wrong crisis. Global investors have recognised a fundamental truth, that this is not a sovereign debt crisis at heart, as Germany and the European Central Bank keep on telling us, but a banking crisis and a crisis of policy co-ordination failures.

Since the banks are guaranteed by their respective governments, most private debt is ultimately public debt. The European Central Bank and the newly created European Financial Stability Facility – the €440bn ($545bn, £368bn) special purpose vehicle to stabilise the European bond markets – will absorb billions of euros of junk debt which, on default, would trigger a massive redistribution of income from northern Europe to southern Europe. So far, this crisis has cost European taxpayers nothing. But that would change if, or when, some of the Greek debt gets restructured. That will not happen for three years. But, by then, most of that Greek debt would wind up in the hands of the EFSF and the ECB. A default at that point would confront the EU with a binary decision: either to go for fiscal union, or to break up. The investors do not know which way the EU will jump. Nobody does.

One conceivable strategy for getting out of this mess is to remove the lingering doubts about the banking sector. Except for Greece, the sovereign debt situation is under control everywhere. The problem is not the actual government debt, but the contingent debt, most of which is located in the banking sector. If there is more transparency about the banking sector, the situation would be eased.

If the publication of the stress tests would lead to a process of bank recapitalisation, we would be well on the way. But I do not see it. Germany’s bad bank scheme is so incredibly unattractive that hardly any banks have taken it up. Yet, the German government is in no position to force the banking sector to accept new capital. The Landesbanken – probably the biggest financial toxic waste dumps on earth – are controlled by the state governments.

The situation is not much better in Spain, where the Bank of Spain is already pushing hard for a consolidation of the cajas, the local savings banks. We will no doubt get a lot more bad news from the Spanish banking sector, as Spain goes through the adjustment. Having been sceptical about Mr Zapatero’s willingness to do what needs to be done, I am a touch more optimistic now. His recently decreed labour market reforms are a step in the right direction, but probably insufficient.

Elsewhere in the eurozone, there are several other trouble spots. France also has its share of poorly capitalised banks, and so do Austria and Belgium.

Uncertainty will persist, until we have a reliable estimate of the remaining toxic waste in bank balance sheets, and some resolution trajectory. The only information that was ever leaked in Germany was a worst-case estimate by the banking regulator a year ago of a total write-down volume of €800bn, about a third of Germany’s annual gross domestic product. I have no idea what the number would be today.

To resolve this crisis, we need to know those numbers and a lot more. Most importantly, the EU must set up a workable system of economic policy co-ordination, including a strategy to deal with resurgent internal imbalances. On that point, we are actually regressing.

The decision to publish the stress tests masked an otherwise disappointing European summit. After months of debate, all the European Council had to show was another stability pact and another Lisbon agenda – a now defunct growth initiative. One of the lessons of the early stability pact – from 1999 until 2003 – was that sanctions do not work, because they cannot be applied in the real world. The revised stability pact, agreed in 2005, moved away from an emphasis on sanctions to incentives. The idea was sound, but ultimately failed because of insufficient policy co-ordination. The decision to revert to the original sanctions-based approach is silly. If sanctions do not work, then surely, lots of sanctions are not going to work either. As for the Lisbon agenda, it is now called Agenda 2020, and it is just as hopeless.

What has become clear in the last few months is that Herman Van Rompuy, the president of the European Council, is not providing sufficient leadership to move the process forward. Without a plausible end game in sight, I would expect investors to continue to place bets on the eurozone’s demise.

via FT.com / Columnists / Wolfgang Münchau – We need the figures on Europe’s toxic banks.

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Para memória futura – capa original do The Sun

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In truth, Greece does have an alternative. Instead of submitting to the ferocious and pro-cyclical conditionality imposed by Germany and the IMF – cutting its budget deficit by 11% over three years in return for a €120bn (£104bn) loan – it could follow Argentina’s example in 2001-02, and default on the bulk of its sovereign debt. This would mean abandoning the euro, introducing a “new drachma” and probably devaluing by 50% or more.

Some weeks ago, I had a private exchange about this scenario with Mark Weisbrot of the Centre for Economic Policy Research in Washington. He favoured Argentinian-style default; I did not. But given Angela Merkel’s politically motivated foot-dragging, the failure of the European Central Bank to deal with the problem at an earlier stage and the strongly pro-cyclical nature of the cuts required, I am having second thoughts.

Eight years ago, Argentina defaulted on the major part of its sovereign debt and survived quite well. Many economists predicted that Argentina’s debt default would result in currency collapse, hyperinflation and even greater economic contraction than it had endured during its 1999-2002 recession. Instead, after the 2001-02 debt default and subsequent devaluation against the dollar (from 1:1 to 3:1), GDP grew at over 8% per annum over the period 2003-2007 and annual inflation fell from over 10% per month in early 2002 to less than 10% per annum. By 2005, Argentina had sufficient reserves to allow President Néstor Kirchner to pay off its remaining $9.8bn (£6.4bn) loan from the IMF in full and discontinue its programme with them.European leaders would do well to read up on the Asian, Russian and Latin American financial crises of 1997-2002. The Nobel laureate Joseph Stiglitz famously published an open letter citing his reasons for resigning from his post of chief economist at the World Bank. Among his criticisms of the bank and the IMF was the imposition of drastic deflationary measures on Thailand and Korea in 1997, and on Russia in 1998, mainly to protect the balance sheets of private western banks. The conditionality imposed was paid for dearly by cuts in economic and social expenditure thrust on ordinary citizens.

A central lesson of all this is that unless protective action is taken early, a country can rapidly be overpowered by the financial markets. Once traders start betting against a country’s bonds or its currency, the herd instinct takes over. Greece’s budget deficit is not particularly high by world standards – 13.6% versus 11% in the UK, and 12.3% in the US. But traders perceived its sovereign debt structure as too risky and prophecies of doom became self-fulfilling. There is a further problem. The spending cuts needed to meet the government’s deficit target will undermine Greek government revenues. As an economist at London-based Capital Economics put it: “The key risk to its target is that deeper recession will lead to lower tax revenues, offsetting some of the savings that the government expects to make as a result of its fiscal tightening.” In short, even though the bailout package has been agreed, the cuts may prove counterproductive and Greek recovery is far from assured.

The ECB could have nipped this crisis in the bud several months ago, both by continuing to accept Greek government bonds as collateral and by quantitative easing. Although the ECB had used quantitative easing to bailout the EU banking system, it refused to do so for Greece. There are clear signs that contagion is spreading to Portugal, and possibly to Spain and Italy. Can the ECB really be counted on in future to prevent the gradual unravelling of the euro?

As the French economist Jean-Paul Fitoussi argued in a recent interview in Libération, even if the Greek crisis is successfully contained for a time by an EU-IMF package, the financial markets will hope to profit by squeezing other European countries. Meanwhile, ordinary Greeks are taking to the streets to protest against further draconian austerity measures, while the EU’s political class continues to focus entirely on its narrow domestic interests. Here in Britain, a bemused electorate apparently has not yet woken up to the nature and magnitude of the cuts we will almost certainly suffer as a result of the 2008 bank bailout. Most important, we have not begun to question seriously whether placating the financial markets by means of such cuts is unavoidable. Perhaps it’s time to start thinking the unthinkable: namely, that financial markets should be our servants, not our masters.

George Irvin, guardian.co.uk, Sunday 2 May 2010

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