Archive for the ‘Think Tanks’ Category
The G20 Meeting: Much Ado About Nothing
The excruciating twists and turns that European leaders have gone through over the past two weeks in their vain efforts to gain control of the sovereign debt emergency have raised the question of whether the eurozone is institutionally incapable of managing the crisis.
Sony Kapoor, head of Re-Define, an economic consultancy, said:
“The divided and sometimes distorted incentives facing EU institutions, their fragmented powers and slow-moving decision- making structures may be fundamentally incompatible with the scope and speed of action needed to contain a crisis of this magnitude. EU institutions were designed for peacetime, not crisis management – and it shows.”
[See, also, Kapoor's article in The American Prospect]
On Friday, Commerzbank became the first to state that it aimed to meet higher capital targets by scrapping lending outside its main German and Polish markets. It is saying what everyone thinks other banks are doing: under intense political pressure to maintain the flow of loans to domestic small businesses, money is funnelled to home markets.
The interconnectedness of the eurozone means this intensifies the risk of a credit crunch, tentative signs of which are visible in money markets. It also knocks another hole in the deal by European leaders at their summit a week ago, which agreed banks would be prevented from taking such action.
Worst of all, it suggests that even if the politicians pull together – and there is little reason to think they will – Europe’s economy has big problems ahead. Slower growth produces a nasty feedback loop of more sovereign debt, weaker banks and thus slower growth. That realisation, at the end of a week when politicians finally acknowledged that the eurozone could break up, confirmed there is little reason for mirth in Europe.
The Group of 20’s latest summit failed to live up to its central ambition to create “strong, stable and balanced” global economic growth. The G20 all but admitted that the so-called “Doha round” of trade talks, launched in December 2001, was dead; it produced an action plan for growth and jobs that committed countries to almost nothing they were not already pursuing; and left the international monetary system almost unchanged.
Throughout Thursday night officials tried to agree on support to increase the firepower of the €440bn European financial stability facility or boost the resources of the International Monetary Fund, but eurozone leaders went home empty-handed. The G20 statement said only that finance ministers would again discuss the issues at their next meeting, in February.
Some ideas were comprehensively ditched at Cannes. IMF chief Lagarde made it clear the IMF would not lend money to the EFSF, because the fund “lends money to countries, not to legal entities”.
Instead of providing firepower or helping to channel bilateral support, the IMF’s role in helping to resolve the eurozone crisis will be one of policing Italy’s existing commitments to reduce its borrowing and provide more rapid credit to non-European countries caught in the fallout from the eurozone woes.
Other ideas – including a plan that countries such as China or Brazil would lend to a new special vehicle, seeded with money from the EFSF – were also played down.
- Editorial, “In God’s name, go!“
The spreads between Italian and German 10-year bonds have doubled over the summer. Yesterday, they reached a euro-era record of 463 basis points and would have probably been higher if the European Central Bank was not buying Italian bonds. Although Rome can sustain high interest rates for a limited time period, this process must be halted before it becomes unmanageable.
Having failed to pass reforms in his two decades in politics, Mr Berlusconi lacks the credibility to bring about meaningful change. It would be naive to assume that, when Mr Berlusconi goes, Italy will instantly reclaim the full confidence of the markets. Clouds remain over the political future of the country and structural reforms will take time before they can affect growth rates. A change of leadership, however, is imperative. A new prime minister committed to the reform agenda would reassure the markets, which are desperate for a credible plan to end the run on the world’s fourth largest debt. This would make it easier for the European Central Bank to continue its bond-purchasing scheme, as it would make it less likely that Italy will renege on its promises.
George Papandreou survived a crucial vote of confidence in parliament on Friday night, but his position as Greek premier will remain at risk as a group of senior socialists have called for a government of national unity to be formed quickly under a new leader. Mr Papandreou on Friday night signalled he may stand down as premier after forming a coalition government to take the country to elections early next year.
Berlusconi said on Friday that he had refused the offer of an IMF loan, arguing that Rome did not need one even as its borrowing costs remained at near-unsustainable levels. Berlusconi instead agreed to accept highly intrusive IMF monitoring of his government’s promised reforms – an unprecedented concession by a eurozone country that has not received a bail-out.
Yields on Italy’s 10-year bonds surged to euro-era highs after Mr Berlusconi said he had declined the offer of a low-interest IMF loan. At 6.4 per cent, they are near the level at which Greece, Ireland and Portugal were forced into IMF-European Union bail-outs. Italy must refinance €300bn ($413bn) in borrowing next year.
The rise in borrowing rates came despite reports from traders that the European Central Bank was purchasing Italian bonds to try to drive yields down. The ECB has bought an estimated €70bn in Italian bonds since panicked selling began in August.
The addition of IMF monitors, who will publish quarterly reports on Italy’s progress, makes the mission almost identical to so-called “troika” teams of Commission and IMF evaluators who conduct reviews of the eurozone’s three bail-out countries.
- Charlemagne’s notebook, “Berlusconi burlesgue“
Christine Lagarde, the IMF’s boss, said she would be reporting quarterly, in public documents, on Italy’s progress. This is what she had to say:
“We will be checking the implementation of the commitments that have been made by Italy under the 15-page commitment that it has made to the members of the euro zone a couple of weeks ago. So it’s verification and certification, if you will, and implementation of a programme that Italy has committed to. As far as I’m concerned, I might be laborious I might be demanding, I might be rigorous but I will be looking at the commitments that have been made to confirm the implementation.
The problem that is at stake, and that is what was clearly identified both by the Italian authorities and by its partners, is a lack of credibility of the measures that are announced. Therefore, to attest the credibility of those measures, in other words their implementation, the typical instrument that we would use is a precautionary credit line. Italy does not need the funding that is associated with such instruments. The next best instrument is fiscal monitoring.”
- Charlemagne’s notebook, “Sympathy, but no money“
The Europeans had been hoping to winkle out some more tens of billions of euros from, or through, the IMF. Three options were under discussion:
• Increase contributions to the IMF, particularly from the bigger emerging countries, such as China. Europe might then be able to draw on a larger pool of funds.
• Get the IMF to generate more of its reserve asset known as Special Drawing Rights, a sort of virtual gold, that Europeans could pool, turn into real currency and pump into the EFSF
• Ask the IMF to establish and supervise a trust fund for the euro zone, into which countries could contribute.
These matters remained contentious until the end of the summit. José Manuel Barroso and Herman Van Rompuy, presidents of the European Commission (the EU’s civil service) and European Council (representing leaders) rashly came out before the end of the meeting to declare that one or all of these measures would almost certainly be approved.
But next door, Angela Merkel, the German chancellor, had stopped pretending. There was no deal on the IMF, she said, and hardly any country was prepared to put money to boost the euro-zone’s bailout fund. The final communique made only a generic promise to provide the IMF with more resources, in a manner to be discussed by finance ministers in February. The key passage said:
“We will ensure the IMF continues to have resources to play its systemic role to the benefit of its whole membership, building on the substantial resources we have already mobilized since London in 2009. We stand ready to ensure additional resources could be mobilised in a timely manner and ask our finance ministers by their next meeting to work on deploying a range of various options including bilateral contributions to the IMF, SDRs, and voluntary contributions to an IMF special structure such as an administered account.”
Council on Foreign Relations
- Ben Steil, “ECB Limitations in Addressing Eurozone Crisis“
European Central Bank President Mario Draghi’s statement that the ECB will not act as a lender of last resort to governments may come back to haunt him. “If the markets are concerned that the ECB will not at least provide a political backstop for the eurozone leadership” he cautions, “that could lead to a total boycott of Spanish and Italian government debt, which could be a catastrophe.” However, Steil emphasizes the ECB’s limitations in solving the eurozone crisis. “Although the ECB does have a lot of ammunition in that it can print money, it doesn’t have unlimited ammunition,” he says. “The European Central Bank is not a power of its own that can manufacture a solution to this debt crisis. It will take leadership in Europe, it will take contributions, further contributions, from the German taxpayer.”
This week, the French bank BNP Paribas announced that it had slashed its holdings of euro-zone government bonds, including €2.62 billion worth of Greek debt.
But it wasn’t just bonds from Athens that the bank dumped. BNP Paribas also indicated that it had drastically reduced its holdings of Italian debt. In the three months prior to the end of October, the bank sold off €8.3 billion worth of bonds issued by Rome, reducing its exposure by 40 percent.
Italian borrowing costs soared earlier this week, with interest rates on sovereign bonds rising to 6.4 percent, perilously close to the mark which triggered emergency Italian bond purchases by the European Central Bank in August. Analysts consider a rate of 7 percent to be the level at which investors stop buying sovereign bonds.
Several former Berlusconi loyalists published an open letter in the Italian daily Corriere della Sera on Thursday calling for a change at the top. One of the parliamentarians indicated that a rebellion could be mounted as early as next week, during a budgetary vote on Tuesday. Reuters reported on Thursday that Berlusconi told European leaders in Cannes that he would call a confidence vote within two weeks.
- The World from Berlin, “The Common Currency Endgame Has Begun” — These editorials from the German press were written after Greek Prime Minister Papandreou rescinded his call for a referendum. Fear that the “European Project” may collapse is widepsread.
|Handelsblatt||"No matter who takes over the rudder in Athens, Europe shouldn't expect much. Rather, it should prepare for even greater chaos."
"Instead of simply accepting the aid package ... offered, thus demonstrating political leadership, Papandreou suggested to his countrymen that they had a choice. The bitter truth, however, is that there is no choice -- a truth the Greek prime minister heard with perfect clarity from Merkel and Sarkozy on the French Riviera, where he had been summoned to appear. Either Greece accepts European help, was the message from the EU crisis summit in Cannes on Wednesday night, or Greece has to leave the euro zone."
"With this unprecedented ultimatum from EU leaders, the common currency endgame has begun. Even if the referendum does not take place, the damage has been done: For the first time since the founding ff the currency union, the exit of a member state is no longer mere speculation, it is an official alternative."
"(Were that to happen), the effects would not just be felt in an impoverished Greece, rather in the EU as well. Were Greece to be the first 'sinner' to leave the euro area, despite years of assertions to the contrary, attention would immediately move on to the next weak link in this chain. Were Italy and Spain to become endangered, an uncontrollable domino effect could begin -- which may in the end reach France."
"Whether the Greeks leave the euro zone in the end or not -- neither alternative will calm the situation."
|Die Welt||"At the end of the eventful day, the redemptive message came: Papandreou would withdraw his referendum because conservative Greek opposition leader Antonis Samaras declared he was ready to vote for the aid package with the government and take part in an interim national unity government. At the very last minute, and after two years of refusals, the opposition party (ND) finally showed a sense of responsibility."
"But the reasons behind this welcome development did not lie in Athens, but in Cannes. There, Merkel and Sarkozy beg the house when they took the Greek prime minister to task. They didn't just say that payments to Greece would stop until the Greeks made it clear they would hold up their end of the bargain. They also insisted that the Greek referendum would essentially be a vote on Greece's membership in the euro zone -- the really big question. The politicians in Athens decided they'd rather not take the risk."
|Frankfurter Allgemeine Zeitung||"Until Thursday ... one thing had never been questioned -- namely whether an overly indebted euro zone member, regardless what happens, would still belong to the currency union. The subject of a withdrawal or expulsion was always a taboo. The fact that the European treaties neither envisioned the one scenario or the other was the very least of the reasons for that."
"But this taboo doesn't exist anymore. The German chancellor, the French president and the Luxembourgian chief of the euro group no longer rule out what only a short time ago wasn't even allowed to be considered: that Greece will have to leave the currency union if it can't adhere to its agreements on consolidating its budget. Merkel, Sarkozy and Juncker appear to have run out of patience. The predicament Athens is clear to them and they do not underestimate what the Greek people are having to cope with. But their own voters are breathing down their necks."
"Regardless of whether the (inevitable) breaking of a taboo serves as an effective intimidation strategy or not, European politics have arrived on virgin soil. From now on, the order of the day will no longer be increasing the number of member states and transferring ever more competencies to the EU. From now on, the dismantling of institutions and duties will no longer be ruled out -- either because the voters will it or because objective contradictions exist that can no longer be simply resolved with existing methods. The dangers therein are obvious. It could become a slippery slope and once things start moving it may be hard to stop them. Still, this massive Project Europe, a unique undertaking of organizing peace and prosperity under the shared exercise of sovereignty, is experiencing a major crisis of confidence. Perhaps it is now time to give a radical signal with the goal of protecting it in its entirety from greater damage."
|Berliner Zeitung||"The rescue of the euro zone has failed epically. The conditions (Merkel and Sarkozy) have imposed on the Greeks show just how dramatic the situation has become. No more money will flow (to the country) until it is certain that the savings program will be carried out. If it doesn't? Then the euro will collapse and Greece will have to exit the currency union. Would Europe then collapse, too?"
"Regardless how the Greek drama ends, it has been clear since Wednesday night that confidence in the euro has been further seriously damaged. This is because the message sent by Merkel and Sarkozy in their urgency was that the euro zone is not only not going to cover the debts of its members -- but that the euro has not been planned for the long run."
"The countries seeking to rescue the euro need to be considering now how they will solve the euro zone's main problem: how they will restore trust. More is needed to accomplish this than just the bailout tools approved on Oct. 26. They won't even suffice to nurse the consequences of an orderly insolvency of a euro country. To save the entire euro, much more is necessary: euro bonds, common taxes -- something that will send a strong message of political confidence to angst-riddled investors that the rest of the euro zone wants to remain together and wants to become even more tightly bound."
|Süddeutsche Zeitung||"Neither Europe nor the euro will go down because of Greece alone. The fact is that the fate of the community will be decided in its founding nations. As all the spectators look spellbound towards Athens, the real finale in the European debt crisis has already begun a few hundred kilometres away: Independent of the Greeks, the Italians will determine whether the euro and the union survives. As painful as it might be for Europe, it could still withstand a (provisional) departure of Greece. But beautiful, proud Italy, on the other hand, has much more decisive dimensions: 60 million inhabitants, the third-largest economy in the euro club and €1.2 trillion in debt. The club would not be able to shoulder an Italian insolvency --neither politically nor economically."
"The crisis in Italy is acute and dramatic. Blame can be squarely cast on the disastrous Berlusconi government. Amidst the chaos in Greece, the fact has almost been lost that Italian Prime Minister Silvio Berlusconi has only partly recognized his country's need to conduct austerity and reform measures. He may have admitted out of necessity recently that the Italians live a little bit beyond their means, but that apparently hasn't given the bustling politician any reason to act. He presented an austerity plan in the summer and he brought a few pages with a handfull of proposals to the euro summit last week, but financial industry executives were quick to say what they thought of them: nothing. When Rome floated a bond last week to finance its debt, its interest rates rose to record levels."
"That is fatal. Already highly indebted Italy is having to take out ever greater loans in order to payback the old ones. The vicious cycle has begun and it will get faster and faster so long as Berlusconi doesn't save and reform."
|Die Tageszeitung||"How do you create a 'firewall' in Europe? How do you protect Italy and Spain from being driven to a state of bankruptcy? This question is unbelievably explosive -- particularly if you look at recent news, as unlikely as it may seem at first glance. On Thursday, the major French bank BNP published its quarterly report and disclosed that it had sold a large share of its Spanish and Italian bond holdings -- despite the enormous losses of capital and write downs that entailed. The Paribas action made clear that, by now, Italian government securities are considered to be junk bonds that must be dispensed with quickly."
"The development suggests that Italy is close to bankruptcy given that the country has a national debt of €1.9 trillion that must be regularly refinanced. But what bank is going to buy Italian government bonds if its competitors are selling them?"
"This danger is far greater than some theoretically conceivable development, as climbing risk premiums being demanded for Italian government bonds show. The euro zone is facing a crash -- and it may come now rather than at some point many years down the rode. It is entirely inconceivable that the euro would survive if Italy and Spain topple."
"So what can be done? One thing is certain: Despite its recent €1 trillion in leveraging, we can forget about the EFSF backstop fund. Investors don't have faith in it; otherwise they wouldn't demand constantly increasing interest rates on Italian and Spanish bonds. The last thing remaining for a rescue is the European Central Bank. Like the US Fed, it could purchase unlimited amounts of government bonds until the panic among investors quiets down. That's precisely what Obama proposed during his meeting with Chancellor Merkel in Cannes."
"The chancellor has declined because she knows most Germans wouldn't accept having the ECB 'print money'. But the chancellor and Germany need to know: That is the cheapest solution. A crash of the euro would be infinitely more expensive."
This paper, published by the New America Foundation and authored by Daniel Alpert, Robert Hockett and Nouriel Roubini, is the best analysis of the economic crisis than I’ve read. Policymakers here and abroad should study it carefully. I hope that readers of this blog will do the same.
John Mauldin introduces the following article with these words:
Folks, you hear a lot about the eurozone crisis, but what you don’t run across very often is a coherent idea on how to move forward. My friends at STRATFOR, a private intelligence company, have done us all the courtesy of saying out loud what everyone else shies away from: Eject Greece from the eurozone.
It’s not pretty. It belies the lovely concept of a unified and prosperous Europe. And the worst part: it comes with a big fat price tag, of the 2-trillion-euro variety. But it may be the only way to steer the train before it derails completely.
STRATFOR regularly produces very high quality, broad canvas analyses. This piece is a must read.
- Attempts to resolve the problems in Europe are failing, and the crisis is spreading from Greece, Ireland, and Portugal to larger nations.
- Europe’s financial system relies on moral hazard, i.e., a “no defaults” policy, to attract the funding needed to roll overlarge amounts of short–term bank and sovereign debt. Now that politicians in creditor nations are calling for private sector burden sharing, investors are demanding higher interest rates to hold these debts. But higher rates may tip banks and nations toward bankruptcy.
- Europe’s banks and financial system are highly integrated across countries. Rising expectations of default in some countries could lead to large-scale capital flight into “safe” countries. This shift will raise concerns regarding solvency and liquidity of many financial institutions.
- The payments system of the euro area is serving as an opaque bailout mechanism that is currently preventing the euro area from falling apart at this time. If the number of nations in trouble spreads beyond Greece, Ireland, and Portugal, this bailout system will be stressed because of the potential size of accumulated funding.
- The European Central Bank (ECB) could soon see a vocal debate between inflationist and hawkish (anti–inflation) members. Inflationists will call for large–scale interventions, including bond buybacks and emergency loans, while the hawks will attempt to close loopholes in the payments system that effectively permit each troubled nation to create money needed to finance capital flight and budget deficits.
- At this stage in the debate, we see little chance that Europe can avoid ending the “moral hazard” regime, in which case it needs to plan for widespread sovereign and bank debt restructurings.
We see three plausible scenarios in the coming months:
1. The euro area manages to regain credibility regarding its willingness to “do whatever it takes” to resolve the current crisis while avoiding defaults and inflation. This ironically requires far more rapid and larger austerity than currently planned in the periphery.
2. The euro area choses decisively to end the moral hazard regime. While this will not be orderly, the problems can be reduced through comprehensive and rapid actions to restructure sovereign and bank debt in highly indebted nations, while recapitalizing banks elsewhere.
3. The euro area remains in limbo, unable to choose a clear path. This would lead to a large disorderly series of financial sector and sovereign defaults, while an “inflationary majority” is likely to eventually assert control of the ECB and manage a massive liquidity expansion.
The euro crisis is not under control. Deep structural flaws have become apparent—particularly the extent to which moral hazard has underpinned credit flows within the euro area. Ending this moral hazard will not be easy, particularly as European decision–making structures are struggling to find a
The leader (editorial) in the current issue of The Economist addresses our debt problem. It takes special note of the proposed split between spending cuts and tax increases:
Earlier this year House Republicans produced a report noting that an 85%-15% split between spending cuts and tax rises was the average for successful fiscal consolidations, according to historical evidence.
The report to which The Economist refers, dated March 15, was authored by the Republicans on the House Joint Economic Committee. Some of the “Highlights” of this “empirically-based” report are as follows:
Fiscal consolidation programs that rely predominately or entirely on spending reductions are more likely to achieve their goals of government budget deficit reduction and debt stabilization as a percentage of GDP than programs that rely primarily on tax increases.
In the long term, fiscal consolidation programs that reduce government spending as a percentage of GDP accelerate economic growth.In the short term, fiscal consolidation programs that rely predominately or entirely on spending reductions have expansionary “non-Keynesian” effects that may offset the contractionary Keynesian reduction in aggregate demand. [Emphasis added]
In some cases, “non-Keynesian” effects may be strong enough to make fiscal consolidation programs expansionary in the short term. [Emphasis added]
Can it possibly be true that, in the short-term, reduced government spending (“fiscal consolidation programs”) could produce “non-Keynesian” effects that would offset — or even more than offset — Keynesian effects? Remember this equation from Economics 101:
Gross Domestic Product = Consumption + Investment + Government + Net Exports
The Republican argument boils down to this: a reduction in government spending will, in the short term, be compensated for by increases in consumption and/or investment (because it’s a small number, net exports can be ignored). The increases in consumption and/or investment might even be larger than the decrease in government spending.
If only this were true. The immediate effect of “fiscal consolidation programs” will be to reduce employment directly, through reductions in the sizes of the federal government workforce and in the workforces of companies dependent on federal contracts; and, indirectly, on the private sector businesses that provide goods and services to those people and firms directly effected. Would an economic environment in which fiscal policy puts short-term pressure on consumption provide an incentive for business to accelerate spending on property, plant and equipment? Quite the opposite.
But what about the “empirically-based” House report? Well, it turns out that it relied on a single study written by the American Enterprise Institute in reaching its conclusions:
Economists Andrew Biggs, Kevin Hassett, and Matt Jensen demonstrated that the degree of success in reducing budget deficits and stabilizing the debt-to-GDP ratio correlates to the share of spending cuts in fiscal consolidation programs. Biggs, Hassett, and Jensen found that successful fiscal consolidations averaged 85% spending cuts and 15% revenue increases, while unsuccessful fiscal consolidations averaged 47% spending cuts and 53% revenue increases.
Elsewhere in The Economist (in the “Free Exchange” section), we find this:
Having just read the Biggs, Hasset and Jensen paper, I note two features. First, the vast majority of the successful consolidations studied took place in Europe, in particular Scandinavia, Italy and Portugal. Scandinavian and southern European governments tend to tax more and spend more than America’s (as a percentage of GDP). They may therefore have more public-spending fat to cut than America, and less scope to raise taxes.
Second, the study relies on a dataset which the IMF rejected for, “[failing] to identify consolidations when governments took substantial actions to reduce the deficit, but the actions were associated with severe economic downturns”. When Biggs, Hasset and Jensen apply their methodology to fiscal consolidations which the IMF define as successful, “the lowest expenditure share for a successful fiscal consolidation was just over 66% and the highest just under 83%”.
Put simply, no fiscal consolidation that the IMF has judged to be successful relied on public spending cuts for more than 83% of its impact. In successful fiscal consolidations, tax rises accounted for between 17% and 33% of deficit-reduction measures.