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Happy New Decennium 2020
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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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FT.com / Brussels / Economy – The eurozone must take responsibility or it will split

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The aim of the rescue package agreed for Greece cannot conceivably have been to prevent a default. For all the daunting austerity and structural reform it requires, the numbers do not add up. The main purpose I can detect is to reverse the rise in Greek bond yields and stop contagion.

We should not knock this deal from Athens. The eurozone might not have survived otherwise. This column would have been an obituary. I am also glad to note that those in charge gave a positive answer to a question I posed last week, which was whether the authorities would ever get ahead of the situation. They did, and they deserve credit.

But in spite of the readiness to accept extreme austerity, Greece will not get by without some form of debt forgiveness. I can understand why the International Monetary Fund and the European Union did not want to open that can of worms at this point. It would have prolonged the negotiations. In the middle of an acute bond market crisis one has to manage expectations very carefully.

A debt restructuring will eventually be necessary, however, because Greece’s debt to gross domestic product ratio is going to rise from its current 125 per cent to about 140-150 per cent during the adjustment period. Without restructuring, Greece will end up austere, compliant, and crippled.

The decision to take Greece out of the capital markets for three years will prevent immediate ruin but has only a marginal impact on the country’s future solvency. The underlying assumption of the agreement is that Greece can sustain austerity beyond the time horizon of the accord, without falling into a black hole. The latter is particularly optimistic. Standard & Poor’s, the rating agency, last week estimated that Greece would not return to its 2009 level of nominal GDP until 2017.

Last week gave us an inkling of the vicious circles at play in such a crisis. First, a country’s financial situation deteriorates. Then a rating agency downgrades the debt, which in turns triggers a rise in market interest rates. That leads to a further financial deterioration.

Another such loop goes via the banking sector. If a government’s solvency is in doubt, so is the solvency of the banks, whose liabilities are guaranteed by the government. Last week, the banking sector in large parts of southern Europe was in effect cut off from the capital markets.

Angela Merkel and her inexperienced economic advisers have no idea about the dynamics of sovereign crises. They never bothered to look at the experience of other countries, notably Argentina. Waiting until the moment a country is about to fail – which is how the German chancellor interpreted the political agreement she accepted in February – constitutes an abrogation of leadership that is bound to end in financial ruin. It means that everybody, Germany especially, has to pay billions of euros more than would have been the case if the EU had sealed this in February.

On my estimate, the total size of a liquidity backstop for Greece, Portugal, Spain, Ireland and possibly Italy could add up to somewhere between €500bn ($665bn, £435bn) and €1,000bn. All those countries are facing increases in interest rates at a time when they are either in recession or just limping out of one. The private sector in some of those countries is simply not viable at those higher rates.

As I have argued before, three things are required if the eurozone is to survive in the medium term: a crisis resolution system, better fiscal policy co-ordination, and policies to reduce intra-eurozone imbalances. But this is only the minimum necessary to get through the next few years. Beyond that, the eurozone will almost certainly need both an embryonic fiscal union and a single European bond.

I used to think that such constructions would be desirable, albeit politically unrealistic. Now I believe they are without alternative, as the experiment of a monetary union without political union has failed. The EU is thus about to confront a historic choice between integration and disintegration.

Germany can be relied on to resist every one of those measures. In the meantime, European leaders will treat each new crisis with the only instrument they have available: an injection of borrowed liquidity. But this instrument has a finite lifespan. If it is not blocked by popular unrest, it will be blocked by constitutional lawyers.

On one level, I agree with those lawyers. There can really be no doubt about what the “no bail-out” rule was intended to mean. It meant that Greece should not be supported. The EU had to resort to some unseemly legal trickery to argue that advancing junior loans at a massive scale to an effectively insolvent country does not constitute a bail-out. The clause – Article 125 of the Lisbon treaty – is irresponsible. If you follow it, you end up breaking the eurozone. So far, the choice has been to break the clause instead, and now would be the right moment to change it.

So what is the endgame of the eurozone’s multiple crises? For Greece it will be debt restructuring, a polite term for negotiated default. The broader outcome is more difficult to predict: it will either be deep reform of the system or a break-up.

Wolfgang Münchau, FT, May 2 2010

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She’s a witch!

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