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José Reis & Ana Costa debatem, a convite da Attac, alternativas à austeridade – Parte III de III

José Reis & Ana Costa debatem, a convite da Attac, alternativas à austeridade – Parte II de III

José Reis & Ana Costa debatem, a convite da Attac, alternativas à austeridade – Parte I de III

Para memória futura – Lançamento da IAC na Associação 25 de Abril (15Nov2011)

Combate de Blogs – Álvaro Santos Pereira, Miguel Morgado e Paulo Coimbra/Uncut

Também publicado em Portugal Uncut

Only the ECB can halt eurozone contagion

The forces of contagion in the eurozone appear unstoppable. On Thursday investors drove yields on both Italian and Spanish debt to new highs, as fears grew that last month’s Greek rescue deal would prove insufficient to stop Europe’s financial rot. Without swift action from the European Central Bank, this will prove to be a contagion process with a disastrous end.

Why do we face these problems? Government bond markets in a monetary union are inherently fragile. Eurozone nations issue debt in a “foreign” currency, over which they have no real control. As a result, they cannot guarantee to the bondholders that they will always have the necessary liquidity to pay out the bond at maturity. States which issue their own bonds, however, can guarantee that the cash will always be available, because they can always force the central bank to create the money. And there is no limit to the amount of money a central bank can create.

This situation makes bond markets in a monetary union unusually prone to forces of contagion, very much like in banking systems. If one bank experiences a solvency problem, deposit holders start doubting the solvency of their own bank, and run to convert their deposits into cash. When everybody does this at the same time the banks will not have enough cash. This banking system instability was solved by mandating the central bank to be a lender of last resort – and the neat thing about this solution is that, when deposit holders are confident that it exists, it rarely has to be used.

The problem faced by the member countries of a monetary union such as the eurozone is exactly the same. Therefore, the solution is the same. Contagion between sovereign bond markets can only be stopped if there is a central bank willing to be lender of last resort. The only institution able to perform this role is the ECB.

The ECB initially performed this role in a timid way, while making it clear that it was unwilling to continue doing so. Indeed, this reversal in the ECB’s policy is the most important factor explaining why the forces of contagion in the eurozone’s sovereign bond markets cannot be stopped.

Europe’s leaders have tried to solve this problem by creating a surrogate institution, the European financial stability facility. Yet the EFSF will never have the necessary credibility to stop the forces of contagion – precisely because it cannot actually print money. It depends for its resources on the member countries of the union, and these are limited. As a result, it cannot guarantee that the cash will always be available to pay out sovereign bond holders even if its resources are doubled or tripled. Only a central bank that can create unlimited amounts of cash can provide such a guarantee.

The ECB argues that it can abandon its responsibility as lender of last resort, because to provide that guarantee gives wrong signals to politicians. It creates a temptation to add excessive government debt, because the ECB will eventually foot the bill. While this moral hazard risk is indeed a serious one, it is no different from the same risk in the banking system. The way to deal with this is not to abolish the role of lender of last resort, but to create rules that will constrain governments in issuing debt.

Stopping Europe’s current crisis requires fundamental overhaul of the eurozone’s institutions. But the most important part of that overhaul is to ensure that the ECB takes on full responsibility as a lender of last resort in the government bond markets of the eurozone. Without this, the markets cannot be stabilised and crises will remain endemic.

At the same time, further steps towards political unification must be taken, without which control on national government deficits and debts cannot be implemented. Some steps in that direction were taken recently when the European Council strengthened control of national budgetary processes and on national macroeconomic policies. These decisions, however, are insufficient, and more fundamental changes in the governance of the eurozone are needed. These should be such that the ECB can trust that its lender of last resort responsibilities in the government bond markets will not lead to a never-ending dynamic of debt creation.

By Paul De Grauwe, The writer is professor of economics at the University of Leuven, August 3, 2011 

Some useful steps but not much of a strategy

Updated at 15.00 London time

It looks like there will be deal on a eurozone package for Greece. The full details are still missing, but it appears that the eurozone is forcing Greece into a selective default. As part of such a package, short-term Greek debt will be more or less forcibly converted into long-term debt. The wretched bank tax is mercifully off the table. And the European financial stability facility will most likely be allowed to purchase Greek debt at a discount. Let us not mince words here. This would be a default, the first by a western industrialised country in a generation. I am not quite sure how it is possible for the European Central Bank to agree to this, or to all of this. But I will surely be intrigued to hear how Jean-Claude Trichet will manage to be consistent with what he said a few days ago. There are also reports that the eurozone leaders may accept a more flexible EFSF beyond those bond purchases.

So would this be a good deal? Those who are in the thick of it are running the danger that they got so obsessed with the formidable technical complexities that they lose sight of the bigger picture. The problem of the eurozone is not Greece, or some other small country on its periphery. The existential danger is the rise in market interest rates of Italy and Spain, two large countries in the eurozone’s core. To state the goal of today’s meeting in simple terms would be to say: the survival of the eurozone depends on whether its leaders will be able to take decisions that would allow Italy and Spain, and everybody else as well, to remain inside the eurozone on a sustainable basis. Greece is now just a side-show.

If that is the goal, I would judge today’s outcome in terms two priorities. The first, and most important, is the size and flexibility of the European financial stability facility, the rescue umbrella. At present, the overall size of the EFSF is €450bn. With a second Greek credit about to be agreed and second programmes for Ireland and Portugal very likely, the ceiling will not be big enough to bring in Spain, let alone Italy. To do that that the ceiling would have to be doubled, or trebled. Without this increase, it is inconceivable that the eurozone can get through this crisis intact. One could think of other constructions, such as having no fixed limits at all or sliding limits. The structure of the EFSF would have to be changed if it was going to be made this big. It would have to be properly capitalised. Italy’s 18 per cent share in the EFSF would otherwise not be credible.

This will not be agreed today and this alone is why the summit will fall short of what is required. As it stands, the eurozone has a mechanism that can deal with Greece, Ireland and Portugal, but no other country.

Size and flexibility go together. At present the EFSF can only lend money to governments. In turn, the applicant countries are subject to a full European Union/International Monetary Fund supervised austerity programme. You are either in or out. It is important that the EFSF can act pre-emptively, even in respect of countries that are not part of an official programme. The EFSF should also be able to purchase bonds on primary and secondary markets, help refinance banks or give emergency credits during a crisis. It cannot do any of these things now. The bigger and the more flexible the EFSF becomes, the greater the chance that Italy and Spain can get through the crisis.

Second, of course, would be a plausible programme for Greece. The construction currently discussed has some merits, but I am still not sure to which extent it will help Greece. If one accepts the logic of an involuntary private-sector participation, and the advent of a selective default rating, then one should better make sure that one ends up in a situation where Greece defaults, and yet is still not in a position to repay its debt in the long run.

What’s the point of default in such a scenario? If the final construction leads to a reduction in the Greek debt from an estimate year-end level of 175 per cent of gross domestic product to 130 per cent after a default – with no changes to its real exchange rate – it is not clear at all how Greece can be solvent at such a still high level of debt.

The outlines of the agreement, as they have been presented so far, still fall short of the main goals – to have an EFSF capable of dealing with Italy and Spain – and to have a Greek package that reasserts debt sustainability one way or the other. Like all decisions in the European Council, this is a compromise for sure. But there are limits to compromises when you are dealing with a contagious debt crisis. You either do enough, or you do not. They are still lacking a strategy to deal with the wider crisis.

Wolfgang Münchau

The writer is an associate editor of the Financial Times and president of Eurointelligence ASBL

Eurozone’s problems are political, not economic

Europe faces a critical juncture on Thursday – one that may determine not only whether the euro will survive, but whether the global economy will be once again plunged into turmoil. To an economist what needs to be done is simple and clear: Greece’s debt has to be brought to a sustainable level. That can only be done by lowering the interest rate that Greece pays, lowering its indebtedness, and/or increasing gross domestic product. There are several ways this can be accomplished. But the institutional details are less important than an understanding of what will, and what will not, work.

The strategy of the past 18 months of dealing with Greece’s debt difficulties – the minimal response necessary to deal with the moment – has (predictably) not worked. Nor will more of the same. Official lending (from the International Monetary Fund and the European Union) has seniority over the private sector. The riskiness of new private sector lending is thereby increased, with obvious implications for interest rates. Meanwhile, as official lending replaces private sector lending, the risks associated with past lending is shifted to the public. The pattern, and the disappointment, should be familiar to those who watched IMF/G7 programmes of the past.

Economists may differ on whether the austerity prescription will work – though the evidence from Ireland, Greece, Spain, Latvia, and host of other experiments shows that the ensuing economic downturns reduce tax revenue, so the improvement in the fiscal position is inevitably disappointing – but the market has rendered its verdict: it too is signalling that more of the same will not work. Lowering GDP worsens debt-sustainability (typically measured by the debt to GDP ratio) every bit as much as increasing indebtedness. The speculators have been handed an opportunity, and they have seized it. They make money from volatility. Of this we can be certain: Europe’s response so far has amplified uncertainty concerning the future of the euro. “Contagion” has now spread from the periphery to the centre, namely Spain and Italy.

So too “reprofiling” – changing the timing of payments leaving the level of indebtedness unchanged – simply postpones the day of reckoning. If, as often happens, it is accompanied by higher interest payments, the likelihood of an even worse crisis down the line is enhanced. The reason that Greece and the other crisis countries of the periphery face a liquidity problem is that markets believe, probably correctly, that – without access to better terms and/or a debt writedown – there is a real risk of non-repayment.

The problem facing Europe is not so much economic as political. It is easy to see what should be done. If Europe issues eurobonds – supported by the collective commitment of all the governments – and passes on the low interest to those in need – debts are manageable. Even a 150 per cent debt to GDP ratio can be handled if interest rates are low enough, but if rates are high they cannot be. At 6 per cent it takes a primary surplus of 9 per cent just to service the debt. Europe can access capital at low interest rates; after all, its collective debt to GDP ratio is actually better than that of the US.

Those who, putting aside any sense of European solidarity, worry about creating a “transfer union” should be comforted: at such low interest rates the likelihood of a need for real subsidies is limited. But even if there were some subsidy, Europe could afford it. With a $16,000bn dollar economy, even if Europe had to bear costs commensurate with the size of Greece’s debt, these are minuscule compared to what will be lost if Europe does not come to the assistance of the countries facing trouble.

The current strategy has reached not only its economic, but also its political, limits. In at least some of the countries, citizens have put the EU on notice – not just through protests, but though actions. With free mobility of labour and capital, neither workers nor entrepreneurs can be forced to pay too much for the sins of the past. They can move, and they are moving.

Europe is lucky that in most of the countries in its periphery, there were responsible governments that did not take populist stands. What George Papandreou has done in the past eighteen months has been truly impressive. One could hardly have expected more. That the improvement in Greece’s fiscal position has been less than what was hoped is not because he did not deliver but because the benefits of structural reforms take time to be realised – more time than the political process allows; because austerity seldom works and because Greece’s trading partners’ economies have not done as well as hoped.

In at least one of the countries – and perhaps in the future, in others – there wait in the wings less responsible politicians who would take advantage of widespread views that Europe has not done what it should, while imposing harsh conditions. Rather than shared sacrifice, they are even calling for tax cuts. The IMF may have been able to impose harsh conditions in Asia and Latin America, but Europe has vibrant democracies, with an informed and active citizenry. What was possible there may not be possible here.

There is one more ingredient to a successful response: restoring growth. The current uncertainty has had an especially adverse effect on banks and bank lending. Even well-run small and medium-sized businesses are being starved of funds. Growth tax revenues languish, even if governments do a good job at tax collection. A solidarity fund for stabilisation could, together with the European Investment Bank, make needed investments in the countries in trouble – investments that would more than pay off at the low current interest rates. A small business revolving loan fund could provide money to proven enterprises, to help restart the engines of growth.

Europe’s problems today are not the result of a natural disaster, like those confronting Japan. They are man-made, partly the result of a well-intentioned, but imperfectly-conceived, monetary union. It was hoped that, in spite of the marked differences, if countries only managed their debts, all would work well. Spain and Ireland, which both had surpluses and low debt to GDP ratios before the crisis, showed the fallacy in this logic.

As Europe stands at the precipice, it is time to end brinkmanship and political squabbles. The European Central Bank should realise that a restructuring – even if it entails a “credit event” as determined by some American rating agencies – means that Greek bonds are safer than they were before. If they were acceptable as collateral before, they should be more acceptable after. Put bluntly, to not accept Greek bonds is to end Greece’s membership in the euro, with all the consequences thereto.

The ECB must recognise too that for citizens of many countries, a deal without shared sacrifice of the private sector – meaning debt reduction – is politically unacceptable. But those advocating private sector involvement need to realise that the private sector will be reluctant to take a haircut on old loans, and will refuse to accept less than a risk-adjusted interest rate on new.

The resolution of this crisis is easily within Europe’s grasp. It is not a matter of economics. It is only a matter of political will.

Joseph Stiglitz

The writer is a recipient of the 2001 Nobel Memorial Prize in economics and University Professor at Columbia University

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.