A panic of sorts is sweeping through European trading desks concerning all things Italian. A sovereign default in the world's third-largest public debt market would be catastrophic.
With the Greek crisis coming to a head this week, traders in Europe have started to worry about the fiscal health of other eurozone members. Now the worry has moved up the scale to one of the core eurozone members: Italy.
A sovereign default in the world's third-largest public debt market would be catastrophic. While such a default doesn't appear imminent, there is growing fear on European trading desks that a default may occur sometime down the road -- set off primarily by troubles in the nation's banking sector. Traders are scrambling to hedge their exposure to the country and its banks just in case the unthinkable happens sooner rather than later. This panic could spread to other core eurozone members if the Italians fail to make a serious effort to rein in spending.
There's a panic of sorts sweeping through European trading desks concerning all things Italian. Moody's has said that it may downgrade the country's debt due to macroeconomic structural weaknesses and the economic turmoil in neighboring countries. And last Thursday the ratings agency said that it might downgrade 13 Italian banks if the nation's sovereign rating was cut.
The market initially ignored the Moody's report, but by midday on Friday traders started to "de-risk" their portfolios en masse. There was a mad dash to buy up protection against Italian debt using credit default swaps. Other traders then started to dump their Italian bank stocks and head for the hills. UniCredit and Intesa SanPaulo, the two largest banks in Italy, saw their stocks fall 10% in the panic, setting off circuit breakers, suspending trading. They later settled the day down 5.5% and 4.3%, respectively, once trading resumed. Meanwhile, the spread between Italian and German 10-year bonds widened to 212 basis points, its highest level since the creation of the euro.
The Italian banks have troubles, but they seem to be acting as a proxy for the general health of Italy's sovereign debt. After all, they hold more than 150 billion euros of the stuff. On Monday, calm seemed to have set in with some of the Italian banks up slightly from Friday's close. But Friday's panic has clearly shaken the market's confidence in Italy.
"Most Dutch and European banks are worried and are not accepting Italian [debt] as collateral and reducing overall exposure in anything southern European," a trader at a major Dutch financial firm tells Fortune. "Even the Dutch pension funds are avoiding it."
Italy was forced to pay a much higher interest rate to investors when it came to the market to sell new debt on Monday. The Italian treasury sold 8 billion euros in six-month bonds at a yield of 1.988%, which is up sharply from the 1.657% paid during the last sale of government debt. Yields on bonds maturing in 2013 were issued at 3.219%, up from 2.851%.
Roots of the crisis
Italy's main economic problem doesn't stem from a large fiscal deficit, as is the case with the other troubled eurozone members. What worries economists and traders is the nation's very high debt-to-GDP ratio emanating from structural inefficiencies in its economy. This has led to decades of declining productivity and poor growth.
Italy's current debt load is around 1.8 trillion euros, making it the fourth-highest public debtor in the world. Having debt is not a bad thing; it just becomes a problem when the amount of debt on the books exceeds productivity. The nation's debt to GDP ratio stands at an alarming 120%, the second-highest in Europe after Greece at 140%. To put that into perspective, Italy's ratio is double that of Spain.
Overspending is of course a problem, but the ratio has popped up recently due to anemic economic growth in the country. Italy's real GDP shrank by 1.3% in 2008 and a whopping 5.2% in 2009. To make matters worse, the unemployment rate has increased by more than two percentage points since the beginning of the financial crisis and stands at around 8.3%, with youth unemployment at around 29%.
Italy has a number of problems it needs to deal with to get its house in order. It needs to cut waste, grow its economy and due a much better job of collecting taxes (the Italian government estimates that tax evasion will cost the nation 120 billion euros in 2011). A strong euro is hurting the country's exports, which accounts for around 30% of Italy's GDP, a very large number.
The Italians are moving to cut spending. The government is targeting a budget deficit of 3.9% this year, down from the 4.6% last year. This week, Prime Minister Silvio Berlusconi plans on holding a vote on austerity measures meant to wipe out the budget deficit by 2014. The 43 billion euros in cuts that have been proposed are deep, with most of the pain pushed down the road. It is widely believed that Berlusconi will be successful in getting the austerity measures through the Italian Parliament, but there has been some grumbling from members in his coalition government who believe that the proposed cuts go too far.
Cutting spending, though, is just one part of the equation. Italy needs to revamp its economy to put it on a strong growth path. This is where it gets tricky. The Italian economy isn't really cutting edge – how many Italian tech firms can you name? It moves manufacturing and tourism, both hurt by the strong euro, and has an aging population who demand higher wages.
To get its house in order, the analysts at Barclays (BCS) believe that the government should increase the retirement age, simplify the tax system and adopt clear budgeting ceilings. They also believe the government should take further measures to enhance labor market participation and should reduce public ownership of some the nation's largest corporations. The analysts believe that this should encourage foreign direct investment inflows in to the country to help dig it out of its debt hole.
But such structural reforms will be hard to accomplish as it becomes increasingly more expensive to service new debt. Every percentage point increase in borrowing costs makes it that much harder to get the nation's fiscal house in order. For now, the interest rate demanded on Italian government debt is manageable. But if Berlusconi doesn't move fast to address the structural problems in Italy's economy, the rate could skyrocket up, handicapping Italy's chances in avoiding a devastating default.
Tuesday, June 28, 2011
Tuesday, June 21, 2011
How the Euro Became Europe's Greatest Threat
Euro zone members on Monday gave the green light to a permanent system to prop up ailing euro-zone economies after 2013. The new measure will take effect in mid-2013, replacing the current temporary bailout fund. The approved fund, called the Europe Stability Mechanism (ESM), will total some €500 billion ($713 billion). It was initially approved at an EU summit in March this year. Jean-Claude Juncker, euro-group head, said the decision reflected the bloc's determination to shore up the currency's stability. The euro-bloc countries will, according to the plan, guarantee more than €620 billion and member states will pay €80 billion directly. Of that, Germany must pay almost €22 billion, payable in five annual installments of €4.3 billion starting in 2013.In the past 14 months, politicians in the euro-zone nations have adopted one bailout package after the next, convening for hectic summit meetings, wrangling over lazy compromises and building up risks of gigantic dimensions.
For just as long, they have been avoiding an important conclusion, namely that things cannot continue this way. The old euro no longer exists in its intended form, and the European Monetary Union isn't working. We need a Plan B.
Instead, those in responsible positions are getting bogged down in crisis management, as they seek to placate the public and sugarcoat the problems. They say that there is only a government debt crisis in a few euro countries but no euro crisis, citing as evidence the fact that the value of the European common currency has remained relatively stable against other currencies like the dollar.
But if it wasn't for the euro, Greece's debt crisis would be an isolated problem -- one that was tough for the country, but easy for Europe to bear. It is only because Greece is part of the euro zone that Athens' debts are a problem for all of its partners -- and pose a threat to the common currency.
If the rest of Europe abandons Greece, the crisis could spin out of control, spreading from one weak euro-zone country to the next. Investors would have no guarantees that Europe would not withdraw its support from Portugal or Ireland, if push came to shove, and they would sell their government bonds. The prices of these bonds would fall and risk premiums would go up. Then these countries would only be able to drum up fresh capital by paying high interest rates, which would only augment their existing budget problems. It's possible that they would no longer be able to raise any money at all, in which case they would become insolvent.
But if the current situation continues, the monetary union will invariably turn into a transfer union, a path the inventors of the euro were determined to prevent.
Democratic Deficiencies
The euro's founding fathers did not anticipate such a crisis, and thus did not include any provisions for it in the European Monetary Union's set of regulations. The euro welds together strong and weak countries, for better or for worse. There is no emergency exit, and there are no rules to follow in an emergency -- only the hope that everything will turn out well in the end. This is why the crises of a few euro countries are a crisis for the euro, as well as a crisis for the European Union, its governments and its institutions. And this is why the euro crisis has suddenly and expectedly mushroomed into a crisis for the political Project Europe, its future and its cohesion.
The fact that the countries funding the bailouts are lacking democratic legitimization is now becoming the greatest impediment to joint crisis management. Gone are the days of subtle debate over whether the European Parliament involves citizens in a just and proportional way in the decisions reached by the European Council, the body headed by the leaders of the European Union member states, and European Commission, the EU's executive. When things get serious, as they are now, decisions will no longer be made in the somewhat democratically legitimized EU bodies, but at the more or less secret meetings of a handful of leaders.
During the German chancellor's and the French president's quiet walks together, and at the behind-the-scenes meetings of discrete central banks, policies are being made that are then handed to the parliaments to rubber-stamp, even though hardly any of their members understand them.
The costly decisions that are ultimately reached by the luminaries of European solidarity don't just affect the citizens of the ailing member states in an existential way; they must also fear for their social security, their jobs and their assets.
The decisions of European politicians are just as troubling for citizens who live, like the Germans, on the sunny side of the union, and are worried that their country is running up debt that could remain on the books into a remotely distant future.
One of the reasons that Europeans are so incensed at their respective governments is that they are not involved in the decision-making process. Another is that they inevitably perceive their political leaders as being motivated by alleged factual constraints and the requirements of the financial markets, without having any plan of their own.
The euro debt crisis has already swept aside two governments, in Ireland and Portugal, and the Spanish and Greek governments could soon follow. Things are also getting precarious for the government in Berlin, where Chancellor Angela Merkel could lose her parliamentary majority in upcoming votes on bailout measures.
Resistance to Austerity Measures
A crack now bisects the continent, running between those countries that need more and more money and those that are expected to pay. With the Greeks frustrated over the Germans and the Germans over the Greeks, the Portuguese, the Spaniards and the Italians, the political peace project of European unity threatens to end in a great economic dispute among the nations.
In the debtor countries, there is growing resistance against the constant barrage of new austerity programs, while the people of the creditor countries are increasingly incensed over the billions in new aid. The "Outraged Citizens" are taking to the streets in Madrid and Athens while the " True Finns" gain strength in the parliament in Helsinki. Some 60 percent of Germans are opposed to a new aid package for Greece, and there is at least as much resistance among the opposition and trade unions in Athens to the government's efforts to rein in spending -- a precondition for additional loans.
Last Wednesday, thousands of Greeks staged a general strike intended to block access to the parliament building, where the new austerity program was being debated. Prime Minister Georgios Papandreou's limousine was showered with oranges, while rocks were thrown elsewhere. The police used tear gas to protect the elected representatives from the people they represent.
To secure payment of the next loan tranche under the European aid package, Papandreou intends to put together another austerity package worth more than €6.5 billion ($9.3 billion) by the end of the month. The protesters outside the parliament building, unwilling to accept the prime minister's course of action, shouted: "Thieves, traitors. What happened to our money?"
How long will citizens in the weak euro countries -- Greece, Portugal, Ireland and Spain -- continue to accept the harsh reforms? And how long will voters in the creditor countries tolerate their own governments taking ever-higher risks to rescue the euro?
Euro Has Become Greatest Threat to Continent's Future
Finland is a country that is often held up as a successful model for other European countries, but the success of the right-wing populist "True Finns," who captured 20 percent of the vote in April's parliamentary elections, came as a wakeup call to the political establishment in Brussels. As the skeptics gain ground throughout the EU, anti-European sentiments are growing in even the core countries of the union, like France and Germany.
The euro, created with the aim of permanently uniting Europe, has become the greatest threat to the continent's future. A collapse of the monetary union would set Europe back by decades, dealing it a blow from which it might never recover, especially with Europe's position already threatened by the fast-growing Asian economies. How is a fragmented Europe to prevail against this new competition?
This is why Europe's politicians want to defend the euro at all costs, and why they are approving one bailout package after the next. They are playing for time, hoping that the markets will settle down and the reforms will take hold.
The business community is supporting their efforts, too. In a major advertising campaign scheduled to run in leading publications this week, top German business executives, including ThyssenKrupp Chairman Gerhard Cromme, Siemens CEO Peter Löscher and Daimler CEO Dieter Zetsche, promote the monetary union and insist: "The euro is necessary." They argue that ailing member states must be assisted financially, and that the common currency is "absolutely worth this commitment."
But the causes of the euro crisis are more deep-seated than that. The monetary union is a fair-weather construct, as a number of economists said from the beginning. American economist Milton Friedman, for example, predicted that the euro would not survive its first major crisis, and later, in 2002, he added: "Euroland will collapse in five to 15 years."
For these reasons, the euro crisis, as suddenly as it occurred, was expected. However, the warnings had been ignored and treated as a minor nuisance. More than anything, the euro was a political project. Its advocates, most notably then German Chancellor Helmut Kohl and then French President François Mitterrand, wanted to permanently unite the continent's core countries and embed Germany, which many neighboring countries perceived as a threat following reunification, in the European community.
Politicians hoped that as a result of the common currency, the underlying problem of the euro's design would resolve itself, namely that the member states would almost automatically settle in at the same pace of economic development.
It was a deceptive hope. In fact, it was only interest rates that converged, now that the European Central Bank (ECB) was setting uniform rates for strong and weak members alike throughout the entire economic zone. As a result, a great deal of capital flowed to Spain and Ireland, where a real estate bubble developed, while the Greeks and the Portuguese were able to live shamelessly beyond their means. They imported more than they exported and took on more new debt to pay for their consumption.
This behavior continued unabated until the financial crisis put an end to it. Suddenly money was scarce. The bubbles in Ireland and Spain burst, the economy in the euro zone collapsed, and the Greeks were forced to admit that their debts were much higher than they had ever disclosed before -- and that they had falsified their numbers from the beginning and should, in fact, never have been allowed to join the monetary union in the first place.
Has the Euro Pushed Europe Apart?
Since then, the monetary union has been on the brink of collapse. Far from growing together economically, Europe has in fact grown even further apart. As a result, the chances that the euro will survive in its current form are slimmer than ever. Politicians who ignore the laws of economics cannot go unpunished in the long run.
If national currencies still existed, countries like Greece and Portugal could resort to a proven means of reducing their lack of competitiveness. They would simply have to devalue their drachma or their escudo, and then the laws of supply and demand would see to it that the flow of commodities was diverted.
The prices of Greek and Portuguese products would go down to make them more marketable abroad. At the same time, money would be worth less in Athens or Lisbon, so that residents of those countries could afford to buy fewer imported goods. This would be beneficial for the trade balance. Exports would rise and so would the foreign currency revenues, allowing the countries to service their debts more effectively. Not the government but the markets would reduce economic imbalances.
But in a monetary union, the exchange rate is no longer available as an adjustment valve. Instead, the member countries must regain their competitiveness in different ways, namely by imposing tough austerity measures and reducing wages and prices. In a monetary union, it is up to the governments to enforce what the exchange rate would do in a system of competing currencies.
Muddling Through
If this fails, the mountain of debt will continue to grow. In the end, a country with a large deficit has three options. First, it can declare itself insolvent and, after restructuring its debt, attempt to rebuild its economy. Second, it can also withdraw from the monetary union and reintroduce its national currency. Third, it can convince the creditor countries to keep issuing new loans, thereby providing it with permanent financing.
For more than a year now, European governments have been trying out a fourth option: muddling through.
And for just as long, politicians have been assuring the people that this approach is the alternative, and that it will end up costing taxpayers nothing at all, because the ailing countries will repay the debt, with interest and compound interest, once they've been bailed out. In fact, they argue, the whole thing is even a good business arrangement for the rescuers.
The truth is that governments and monetary watchdogs, despite all protestations to the contrary, have continually expanded their bailout programs, have built up massive risks that could significantly burden future generations and have violated both the European treaties and the iron-clad principles of the ECB.
To date, the history of the euro rescue program has not been a successful one. In fact, it is more of a history of mistakes and broken promises.
'There Will be No Budgetary Funds for Greece '
On March 1, 2010, Chancellor Merkel's spokeswoman said: "A clear no. There will be no budgetary funds for Greece." At that point, Athens was on the verge of bankruptcy, and politicians with Germany's center-right Christian Democratic Union (CDU) and pro-business Free Democratic Party (FDP) were suggesting that the country sell off a few islands.
On May 2, the euro countries and the International Monetary Fund (IMF) approved a €110 billion bailout package for the beleaguered country. Although the German portion of the loans was coming from the government-owned development bank KfW and not the budget, the federal government still served as guarantor. Every euro the Greeks do not repay will constitute a burden on the German taxpayer.
It was the first lapse, the first violation of the European treaties, which categorically rule out aid payments to needy euro countries. This so-called no-bailout clause was intended to guarantee that the monetary union didn't become a transfer union, and that the strong wouldn't have to pay for the weak. It was crucial to the acceptance of the treaty by the national parliaments; without it the German parliament, the Bundestag, would not have agreed to the monetary union.
The second lapse occurred soon afterwards. On May 9, 2010, the first euro bailout fund was launched. Although the volume of €440 billion alone made it clear that the opposite was the case, Merkel and Finance Minister Wolfgang Schäuble tried to downplay the importance of the European Financial Stability Fund (EFSF). They insisted that the fund was purely a precaution, would not be used and, most of all, was temporary.
"An extension of the current bailout funds will not happen on Germany's watch," Merkel said in Brussels on Sept. 16, 2010. This promise, too, lasted only a few months. On March 25, 2011, the leaders of the euro zone approved a new, constant crisis mechanism. Although it has a different name, the European Stability Mechanism (ESM), it will function on the basis of the same principle as its predecessor fund, the EFSF, beginning in mid-2013. The euro countries want to pry loose €700 billion for the fund, which will include a cash contribution for the first time. The Germans will be asked to pay at least €22 billion. To do so, Germany would have to take on additional debt.
'Outcome Is Very Close to a Transfer Union '
As if this weren't enough, in March the euro-zone member states also agreed that both the current bailout fund, the EFSF, and its successor, the ESM, would be authorized to buy government bonds from bankruptcy candidates with low credit ratings in the future. As a result, countries living beyond their means will no longer be punished with high interest rates, and market mechanisms will be eroded. Even the CDU's Michael Meister, one of the financial policy experts loyal to Merkel, says: "The outcome comes very close to a transfer union, which we reject."
All assurances aside, performance in return for Germany's willingness to play along would be absent again and again. Representatives of Merkel's government coalition government in Berlin have outdone each other in calling for strict penalties for countries that violate the euro-zone's deficit rules. There was talk of eliminating voting rights, of freezing EU subsidies like the bloated agriculture fund and, as a last-ditch solution, even of exclusion from the monetary union.
Most of all, however, the penalties were to be imposed automatically in the future when a country's budget deficit exceeded three percent of its gross domestic product. "We support the greatest amount of automatism possible," Merkel said in September 2010.
After taking a walk with French President Nicolas Sarkozy in the French seaside resort of Deauville, the chancellor abandoned the position that the deficit process was to be triggered automatically. Instead, the finance ministers in the euro zone must set it in motion first, meaning that any decision would be subject to the usual horsetrading in Brussels.The reaction by the markets to what is the biggest failure to date in the efforts to rescue the euro has been very clear. The yields for Greek and Irish government bonds rose, and Ireland sought protection from the bailout fund in November 2010, followed by Portugal in April 2011.
In recent months, the governments of the euro-zone countries have gradually expanded their bailout programs, and the risks for the German people and taxpayers have grown with each step.
There are already estimates of how much the Greek crisis will truly end up costing German taxpayers if the crisis drags on for years or a debt haircut becomes necessary. Economists Ansgar Belke of the University of Duisburg-Essen and Christian Dreger of Viadrina University in Frankfurt an der Oder estimate the cost at about €40 billion.
The Cologne Institute for Economic Research (IW) estimates the cost to German taxpayers at €65 billion if Portugal, Ireland and Spain also become insolvent. In the event of a complete collapse of the euro zone, Germany would be liable for all the guarantees and bailout aid it has provided.
And the potential costs for German taxpayers wouldn't stop there because they are also indirectly affected by the risks lurking in the accounts of the ECB and the state-controlled banks. Since May 2010, the ECB has spent €75 billion purchasing government bonds from ailing euro countries. Its goal was to bring calm to the markets and prevent the risk premiums for the bonds from skyrocketing. But many used the opportunity to unload the risky securities on the central bank.
The ECB is believed to have spent €40-50 billion to date on Greek government bonds. In addition, as of the end of April it had refinanced Greek banks to the tune of €90 billion.
Hardly anyone knows how high the risks are for the ECB. It has also accepted €480 billion in structured securities from the banks as collateral. The euro crisis has already turned into a threat to the ECB. German taxpayers bear 27 percent of the risk, which corresponds to the German Bundesbank's share of ECB capital.
Back at the Brink
Despite all of these bailout measures, and despite the risks that their rescuers have assumed, the weak euro countries are back where they were a little over a year ago, namely on the brink. The risk premiums on their government bonds have climbed to new record highs. The Greeks need fresh cash to avert bankruptcy, and the risk of the crisis spreading to other euro countries is far from averted.
The aid that euro countries and the IMF have provided to Greece so far is not enough. They had naïvely assumed that the crisis would end quickly. And they had seriously anticipated that the Greeks would return to the capital markets within the next two years, in order to raise about €60 billion on their own.
The money is missing because the Greek government, despite all of its reform efforts, is still not seen as creditworthy. This is why the funding gap needs to be closed, including with fresh money from the Europeans.
In return, the Greeks must fulfill even more stringent requirements. Given the Greek government crisis, achieving this seems more uncertain than ever. When the first bailout package of €110 billion was approved, Athens reacted with tough measures. Pensions were slashed, tobacco, petroleum and value-added taxes were drastically increased, and it was made easier for companies to lay workers off.
Nevertheless, Prime Minister Papandreou failed to meet the targets set by the so-called troika, consisting of the IMF, the ECB and the European Commission, the EU's executive arm. A maximum budget deficit of 8.1 percent of GDP had been stipulated for 2010, but in the end the deficit was 10.5 percent. After a "strong start" in the summer of 2010, the implementation of reforms has come to a "standstill in recent quarters," the troika concludes in its latest report. It also states that the gap between the planned and the actual deficit has once again "grown significantly" in recent months.
"There are many holy cows that were not slaughtered," explains Jens Bastian, an economist living in Athens. While more than 200,000 jobs were cut nationwide, many state-owned companies in particular are still seen as goldmines when it comes to sinecures.
In contrast to those privileged Greeks working in state-owned companies and government agencies, more and more people are now forced to live on small pensions or minimum-wage earnings of €750 to €800 a month, plus bonuses. Such incomes were hardly enough to live on in the past, and now they are to be reduced across the board or offset by drastic increases in the rate of tax on consumer goods.
Suffering and Sacrifices in Greece
"People don't know why they are suffering and making these sacrifices," says Athens political science professor Seraphim Seferiades. "The privilege of being in the euro zone is losing more and more of its value for people, because they benefit less and less from it." Almost 30 percent of Greeks would prefer to return to the drachma sooner rather than later.
Now the government will have to approve additional austerity measures if it is to obtain fresh cash from the EU and the IMF, in the form of a second aid package worth between €90 billion and €120 billion for the period until 2014. Greece will have to pay off old debts and make new ones. The government debt is currently about 150 percent of GDP and will likely rise to 160 percent soon.
How can such a weak country ever pay off such a huge debt? For once, almost all economists agree: It will be impossible without a debt restructuring involving creditors writing off large parts of their debts.
But a so-called haircut on Greek debt is not politically feasible at the moment. The financial markets are still too fragile, opponents argue, warning that it could trigger a new financial crisis like the one that followed the collapse of the US investment bank Lehman Brothers.
Germany Demands Private Investor Participation
But the Germans have been insisting that private sector creditors must also make a contribution to overcoming the crisis. Members of parliament with the governing parties -- the CDU, its Bavarian sister party the CSU, and the FDP -- recently made it clear to the government that they will reject another aid package in parliament if that doesn't happen. The chief budget expert with the CDU/CSU's parliamentary group, Norbert Barthle, urged his fellow members of parliament to act quickly. "If we wait much longer," he says, "there will hardly be any bonds left in the hands of private investors. Then taxpayers will end up shouldering the Greek bailout by themselves."
CSU Chairman Horst Seehofer agrees wholeheartedly. He is all too familiar with the constraints imposed by the general public in Germany, the majority of whom oppose a second bailout for Greece. "Experts have been telling me for a year that a restructuring of Greek debt is necessary," he says. "The time has come to start involving private lenders."
The German government recently came up with a proposal that would involve lenders in a relatively painless fashion: They would exchange their bonds for new securities with longer maturities. The contribution by the euro-zone countries would be reduced accordingly.
But with this demand, the Germans found themselves largely isolated. They were already viewed as troublemakers during the first Greek bailout, when they reluctantly yielded to the will of the majority and pressure from the ECB. Now, once again, they have been pressured from all sides to go along with the majority view.
That point was reached last Friday, when Merkel and Sarkozy agreed to a toothless compromise in Berlin. They agreed that private lenders should be involved in the new bailout package for Greece, but only on a voluntary basis -- a largely ineffective provision.
This solution is much too feeble for many German parliamentarians. "This is not the lender involvement that the Bundestag had demanded," says Frank Schäffler, a financial policy expert with the FDP. His CDU counterpart, Manfred Kolbe, even characterizes it as "fraudulent labeling," saying: "We need a debt haircut, and it won't happen voluntarily." CSU European expert Thomas Silberhorn calls for "binding regulations with the mandatory participation of private investors."
But from Sarkozy's standpoint, a tougher solution could jeopardize French banks. They are heavily exposed to Greek debt and could face serious difficulties.
erman banks and insurance companies have systematically reduced their holdings of Greek government bonds. Since the beginning of 2010, they have reduced their total exposure from €34.8 billion to €17.3 billion, not including debt held by the state-owned development bank KfW. Insurance companies have reduced their investment in Greek bonds from €5.8 billion to only €2.8 billion in the last year.
In Germany, it is state-owned banks who have the greatest exposure to Greek debt. Commerzbank, a quarter of which is owned by the federal government, holds €2.9 billion in Greek bonds. The state-owned regional banks known as Landesbanken and their so-called bad banks hold additional risks of more than €4 billion.
The biggest dangers by far lurk on the books of FMS Wertmanagement, the bad bank for the nationalized mortgage lender Hypo Real Estate. It holds Greek government bonds and loans that constitute an economic risk of €10.8 billion. In the event of a debt restructuring, taxpayers would be hit hardest in Germany. A haircut would mean that FMS alone would need several billion in fresh equity capital.
ECB Considers Debt Crisis Greatest Risk To Banks
Now that the Germans and the French seem to be largely in agreement, they merely have to convince the ECB, the most determined opponent to date of the German proposal to require private sector involvement. The Frankfurt-based central bankers fear that this would trigger massive turmoil on the international money markets. In its new financial market stability report, the ECB categorizes the euro-zone sovereign debt crisis as the greatest risk to banks.
Most of all, the ECB doesn't want investors to be forced to write off part of their debt. The monetary watchdogs warn that the consequences would incalculable.
They argue that as soon as the powerful rating agencies gain the impression that the Greek government is not fulfilling its obligations without the complete consent of its creditors, they will have to downgrade its credit rating to D, the lowest level. The letter stands for "default." Even if the maturities of Greek bonds were extended with the consent of the lenders, they would have to be downgraded to a rating of SD, or "selective default."
Either way, under its statutes the ECB would no longer be allowed to accept such securities as collateral in returning for providing liquidity to banks. The consequences would be catastrophic. Greek banks would be largely cut off from the European money cycle and would thus run the risk of becoming illiquid. The Greek banking system would find itself on the brink of collapse.
Paving the Path to Euro Bonds
This is precisely where a compromise proposal that Finance Minister Schäuble plans to present to the ECB and to his counterparts from the euro-zone countries comes in. Under the proposal, if Greek bonds are no longer accepted as collateral following the participation of private lenders, the ECB will simply have to be offered bonds that satisfy its requirements.
A 10-member "Greece Task Force" at the German Finance Ministry has worked out how this could function. The experts propose that the Greek government, in addition to the €90 billion-€120 billion in fresh cash it may receive from the euro-zone countries and the IMF as part of a second bailout, also be given access to bonds issued by the EFSF, the euro rescue fund. It could pass on these securities, which have the rating agencies' highest rating of AAA, to Greek banks, which in turn could use them as collateral to obtain liquidity from the ECB.
The problem is that this measure would make the new bailout package significantly more expensive. To ensure that the EFSF had sufficient funds for the operation, its financial scope would have to be increased so that it could really make €440 billion available, as it was originally intended to do. To achieve this, the member states would have to double the scope of their respective guarantees. Germany, for example, would be liable for €246 billion in the future, instead of the current €123 billion.
The would-be euro rescuers are also considering accessing the so-called Hellenic Financial Stability Fund. This fund, set up as part of the first Greek bailout package in May 2010, contains €10 billion, which could be used to boost the capital of Greek banks in an emergency. The fund hasn't been touched yet.The details of the new bailout plan are to be worked out by July. This is absolutely necessary, because if the next tranche of aid is not paid by mid-July, Greece will be bankrupt.
Despite all of these hiccups, the money will flow to the Greeks. But no one, including the German government, believes that this will solve the problems in the euro zone. After more than a year of uninterrupted attempts at fighting the crisis, officials in Berlin are expecting the worst and intend to be ready just in case.
For this reason, Schäuble's crisis team has been instructed to review all possible scenarios. For example, what happens if a country can no longer meet its payment obligations or if a member leaves the monetary union? And how can imbalances in a common currency zone be averted?
There are essentially two alternatives. The first is a radical one, in which the governments pull the plug and leave the beleaguered countries to fend for themselves. The second, more pragmatic solution is to continue muddling along, though somewhat more efficiently, and to hope that things improve. Neither option will be cheap.
The radical cure works like this: Disappointed by the lack of progress and prospects for improvement, the euro-zone countries leave Greece to fend for itself. They refuse to throw even more money at Athens after all the money they have already spent.
The country would quickly become insolvent, because it would no longer be able to borrow any money on the markets. Because Greek lenders still shoulder a substantial portion of the government debt, the country's banking sector could see a number of bankruptcies.
This approach also carries with it the threat of contagion. If Greece slides into uncontrolled bankruptcy, investors might refuse to invest their money in other ailing euro-zone members. Even more banks could collapse in the ensuing chain reaction.
The Nuclear Option
In light of these incalculable developments, many are now considering the nuclear option as a real alternative: Greece withdraws from the monetary union and reintroduces the drachma. The government in Athens was already toying with the idea weeks ago, and now even internationally respected economists are recommending it. "A withdrawal from the euro would be the lesser of two evils," says Hans-Werner Sinn, head of the respected Munich-based Ifo Institute for Economic Research.
Nouriel Roubini, an economist at New York University, also supports the idea. The renowned professor argues Greece's only chance is to devalue its own currency and thus improve its competitiveness. Roubini was one of the few to predict the financial crisis three years ago.
In every financial crisis to date, it has taken a devaluation of the currency to reinvigorate the economy of a crisis-stricken country, Roubini argues. But historic examples can only be applied to the conditions in a monetary union to a limited extent.
The crisis would not end after Greece's withdrawal. In fact, it could even get worse. The country's debts would still be denominated in euros, which would turn them into foreign-currency debts overnight. Their value in the new national currency would rise rapidly, because the drachma would be devalued. Greek borrowers would be all but unable to meet their obligations.
Banks, in turn, would come under pressure, both in Greece and in the rest of the euro zone. And costly bailout measures for the banking industry would be needed once again.
At the end of such a development, the monetary union could disintegrate into a hard-currency bloc and a group with its own, weaker currencies. Critics of the common currency, like former Bundesbank board member Wilhelm Nölling, favor such a solution. Nölling and a group of like-minded people once filed and lost a suit against the introduction of the euro before Germany's Federal Constitutional Court, and now he is suing the government once against over the euro bailout fund. The court's decision is still pending.
The alternative to the breakup of the monetary union is hardly any less threatening, leading as it does directly to a transfer union. After a year of Greek bailouts, the beginning is already underway, and starting in 2013 the planned permanent bailout fund, the ESM, (which EU finance ministers approved on Monday) will be yet another step on this dangerous path.
Echoes of Italy's Mezzogiorno and Belgium's Wallonia
The end result could look something like this: The deficit countries would require permanent financing from the more stable north. What was treated as a loan in the past would be transformed into a subsidy, and thus requiring neither interest nor repayment. The monetary union would become a financial union and the debtor countries the permanent recipients of subsidies, dependent on contributions from their economically more powerful neighbors -- much like the Mezzogiorno in Italy or Belgium's Wallonia region.
To prevent this from happening, many politicians specializing in financial and economic affairs recommend bringing about the political union of Europe as quickly as possible, a union with a strong central government. They argue that if the nations in the euro zone formed a closer union, they could coordinate their financial systems more effectively, thus providing the common currency with a political foundation.
This would make it easier to implement reforms in the recipient countries and improve their competitiveness. Just recently, ECB President Jean-Claude Trichet proposed installing a European finance ministry equipped with the right to intervene in the individual member states.
A Cautionary Tale in German Reunification
But it isn't quite that easy. More integration doesn't necessarily mean that economic imbalances would disappear as a result. No one understands this better than the Germans, who had similar experiences with the monetary union between the two Germanys about 20 years ago. Effective July 1, 1990, the deutschmark became the official currency of East Germany. It was largely exchanged for the former East German mark at a ratio of one-to-one. The East German states joined the Federal Republic of Germany only three months later. It was the model case of a monetary union that was accompanied by a political union.
But anyone who believed that rapid unification would lessen the economic shock of the monetary union between the two Germanys was soon disappointed. In fact, the economic imbalances in reunified Germany became entrenched after that. Thousands of companies in the former East Germany went out of business, because they were unable to bring productivity up to Western standards.
The unemployment figures exploded, and financial transfers between the two parts of the country soon exceeded the trillion mark. To this day, the former East German states still lag behind the former West German states in terms of economic strength, productivity and income.
German reunification did nothing to change this. It merely helped to financially cushion the negative consequences of the monetary union. The states of the former East Germany were incorporated into the West German inter-state fiscal adjustment system (under which money is transferred from richer to poorer states) under favorable terms, and the former East Germans were suddenly given access to the blessings of the generous West German social system.
The lesson is clear: German unification is not a valid role model for European politicians, but rather a cautionary tale. It shows how quickly a poorly designed monetary union can lead to a permanent transfer union.
Such a model would in any case be incompatible with the European treaties. New agreements would have to be negotiated and ratified by all national parliaments, and perhaps even approved in referendums.
But perhaps the people of Europe and their representatives will decide the fate of the monetary union first. It could happen in Athens or in Lisbon, if the necessary reforms fail as a result of popular protests. Or in Berlin -- should the billions in loan guarantees actually come due.
Monday, June 20, 2011
International Economic Conditions
The expansion in the world economy was continuing, although some of the recent data were a little softer, especially in the case of the United States. Sovereign debt problems in Europe had also come to the fore again. However, growth in much of east Asia had remained strong. Inflationary pressures continued to be a concern in a number of regions, particularly in much of Asia.
Information on the Chinese economy had been mixed, with growth in industrial production appearing to have slowed but growth in investment and exports remaining robust. Construction activity had been strong, partly reflecting the Government's policies to encourage supply of low-cost housing. Policy measures to slow demand, especially in property markets, appeared to have had some effect, with housing price inflation falling in recent months and credit growth moderating. However, consumer price inflation remained elevated. Although vegetable prices had fallen recently, higher commodity prices appeared to be feeding into second-round effects on inflation, and non-food inflation was at its highest rate in more than a decade. This was also contributing to an increase in Chinese export prices.
Japanese GDP contracted in the March quarter by nearly 1 per cent and there had been sharp falls in most of the economic indicators for the month of March, following the earthquake and tsunami. Abstracting from the motor vehicle sector, the monthly data for April had shown some signs of stabilisation in activity, and business surveys for May had indicated a recovery was under way. In contrast, production of cars had remained low in April and exports of cars had fallen significantly. Disruptions to supply chains had also resulted in significant falls in sales or production of cars in a range of other countries including the United States, United Kingdom and Thailand, as well as Australia. However, recent indications from the Japanese automotive producers were that production was likely to return to normal levels earlier than had initially been anticipated.
March quarter GDP growth remained strong in India and concern over inflation had prompted the central bank to raise its policy rate again. GDP growth was also strong in east Asia (excluding China and Japan), especially in the higher-income economies. Despite recent falls in food prices in a number of economies, inflationary pressures remained, amid limited spare capacity. Members observed that credit growth was high in most Asian economies and monetary policy stances remained relatively accommodative.
The recovery in the US economy had lost some momentum. Consumption growth had slowed, possibly reflecting the effect of the rise in fuel prices. The housing market was still very weak, with most of the various measures of nationwide prices around 30 per cent below their peak. In the labour market, the most recent payrolls figures had been disappointing. Business survey measures of activity had fallen from their earlier high levels, but were still at levels consistent with ongoing expansion.
Output in the euro area grew strongly in the March quarter, partly due to a recovery from the harsh weather in December. The north-south divide in economic performance in the euro area had continued, with growth strongest in Germany, France and the Netherlands. In contrast, economic conditions in the Italian and Spanish economies remained weak, and there had been a heightening in concerns over the sovereign debt problems in several economies. GDP in Greece had fallen by around 10 per cent from its peak in September 2008 and further declines were expected. Members observed that the economy had been weaker than initially envisaged under the May 2010 IMF/European Union program, and that additional budget measures and asset sales would be needed to meet the program targets for the budget deficit.
Commodity prices were mostly lower than at the time of the previous meeting, although they remained at high levels. There had been falls in the prices of oil, base metals and some rural commodities in early May amid a fall in global financial markets, but prices for most commodities had since recovered somewhat. Spot prices for bulk commodities had also softened a little, but contract prices for iron ore and coking coal were expected to remain at near-record levels in the September quarter.
Information on the Chinese economy had been mixed, with growth in industrial production appearing to have slowed but growth in investment and exports remaining robust. Construction activity had been strong, partly reflecting the Government's policies to encourage supply of low-cost housing. Policy measures to slow demand, especially in property markets, appeared to have had some effect, with housing price inflation falling in recent months and credit growth moderating. However, consumer price inflation remained elevated. Although vegetable prices had fallen recently, higher commodity prices appeared to be feeding into second-round effects on inflation, and non-food inflation was at its highest rate in more than a decade. This was also contributing to an increase in Chinese export prices.
Japanese GDP contracted in the March quarter by nearly 1 per cent and there had been sharp falls in most of the economic indicators for the month of March, following the earthquake and tsunami. Abstracting from the motor vehicle sector, the monthly data for April had shown some signs of stabilisation in activity, and business surveys for May had indicated a recovery was under way. In contrast, production of cars had remained low in April and exports of cars had fallen significantly. Disruptions to supply chains had also resulted in significant falls in sales or production of cars in a range of other countries including the United States, United Kingdom and Thailand, as well as Australia. However, recent indications from the Japanese automotive producers were that production was likely to return to normal levels earlier than had initially been anticipated.
March quarter GDP growth remained strong in India and concern over inflation had prompted the central bank to raise its policy rate again. GDP growth was also strong in east Asia (excluding China and Japan), especially in the higher-income economies. Despite recent falls in food prices in a number of economies, inflationary pressures remained, amid limited spare capacity. Members observed that credit growth was high in most Asian economies and monetary policy stances remained relatively accommodative.
The recovery in the US economy had lost some momentum. Consumption growth had slowed, possibly reflecting the effect of the rise in fuel prices. The housing market was still very weak, with most of the various measures of nationwide prices around 30 per cent below their peak. In the labour market, the most recent payrolls figures had been disappointing. Business survey measures of activity had fallen from their earlier high levels, but were still at levels consistent with ongoing expansion.
Output in the euro area grew strongly in the March quarter, partly due to a recovery from the harsh weather in December. The north-south divide in economic performance in the euro area had continued, with growth strongest in Germany, France and the Netherlands. In contrast, economic conditions in the Italian and Spanish economies remained weak, and there had been a heightening in concerns over the sovereign debt problems in several economies. GDP in Greece had fallen by around 10 per cent from its peak in September 2008 and further declines were expected. Members observed that the economy had been weaker than initially envisaged under the May 2010 IMF/European Union program, and that additional budget measures and asset sales would be needed to meet the program targets for the budget deficit.
Commodity prices were mostly lower than at the time of the previous meeting, although they remained at high levels. There had been falls in the prices of oil, base metals and some rural commodities in early May amid a fall in global financial markets, but prices for most commodities had since recovered somewhat. Spot prices for bulk commodities had also softened a little, but contract prices for iron ore and coking coal were expected to remain at near-record levels in the September quarter.
Sunday, June 19, 2011
Europe Fails to Agree on Greek Aid Payout
European governments failed to agree on releasing a loan payment to spare Greece from default, ramping up pressure on Prime Minister George Papandreou to first deliver budget cuts in the face of domestic opposition.
On the eve of a confidence vote that may bring down Papandreou’s government, euro-area finance ministers pushed Greece to pass laws to cut the deficit and sell state assets. They left open whether the country will get the full 12 billion euros ($17.1 billion) promised for July as part of last year’s 110 billion-euro lifeline.
“We forcefully reminded the Greek government that by the end of this month they have to see to it that we are all convinced that all the commitments they made are fulfilled,” Luxembourg Prime Minister Jean-Claude Juncker told reporters early today after chairing a euro-crisis meeting in Luxembourg.
Decisions on the next payout and a three-year follow-up package were put off until early July, prolonging Greece’s fiscal agony and heightening the brinksmanship that has marked Europe’s handling of the unprecedented debt crisis.
The seven-hour finance ministers’ meeting coincided with the start of a three-day Greek parliamentary debate in Athens over a confidence vote in a new cabinet at what Papandreou called a “critical crossroads.” Papandreou has 155 seats in the 300-seat parliament.
Referendum Proposal
The Greek premier said he planned to hold a referendum later in the year on a constitutional revamp with the goal of tackling the root causes of Greece’s debt and deficits that are “symptoms of the illness, not the cause.”
Papandreou travels to Brussels today to meet European Union President Herman Van Rompuy and European Commission President Jose Barroso. The confidence vote is scheduled for late tomorrow. The Greek crisis is set to dominate an EU summit in Brussels on June 23-24.
“The communication cacophony surrounding the policy response in our view is one of the reasons why the risk of contagion has remained and remains high,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London.
The euro meeting was flanked by a teleconference of Group of Seven financial officials, two weeks after President Barack Obama singled out Germany as the key country responsible for preventing an “uncontrolled spiral of default” in Europe.
Prospects for a second aid package to stave off the euro area’s first default had been enhanced by last week’s decision by German Chancellor Angela Merkel to drop calls for a mandatory bond exchange that might lead credit rating companies to declare Greece unable to pay its bills.
Merkel’s Concession
Merkel’s June 17 concession gave a lift to stocks, bonds and the euro, spurring optimism that Europe would get ahead of the debt crisis that has exposed the weaknesses of the 17- country currency union.
While the German gesture buoyed Greek bonds, the 10-year yield of 16.94 percent remains almost 14 percentage points above the yield on German bonds, Europe’s safest investment. Standard & Poor’s on June 13 cut Greece by three levels to CCC, branding it with the world’s lowest debt grade.
Speculation that Greece will default has bled into other European markets, leading economists such as Nouriel Roubini to predict that the 17-nation euro, the high point of Europe’s economic integration, won’t survive in its current form.
“I don’t rule out that Greece and Portugal, if they aren’t able to recover competitiveness and growth and social tension further increases, may go back to the drachma and escudo on the wave of populist governments,” Roubini, head of Roubini Global Economics LLC, told Italy’s Il Sole 24 Ore on June 18.
Spanish Spread
Ireland and Portugal followed Greece in obtaining emergency loans in the past year. Spain’s finances came under the microscope last week, with investors pushing the extra yield on 10-year Spanish bonds to 261 basis points, the highest weekly close since January.
Moody’s Investors Service said June 17 it may cut its Aa2 rating on Italy, with 2010 debt of 119 percent of gross domestic product, Europe’s second highest after Greece.
Greece needs to cover about 4 billion euros of bills maturing between July 15 and July 22, and faces about 3 billion euros of coupon payments in the month, according to Bloomberg calculations. A bigger test comes Aug. 20 when Greece must redeem 6.6 billion euros of maturing bonds.
Venizelos Commitment
The new Greek finance minister, Evangelos Venizelos, who was named in Papandreou’s cabinet overhaul three days ago, came to Luxembourg with a “strong commitment” to the planned 78 billion euros in budget cuts that provoked street protests last week.
“We can achieve our target thanks to the efforts of our people and thanks to the cooperation and the assistance of our partners,” Venizelos said.
More than 47 percent of 1,208 Greeks surveyed by Kapa Research SA for To Vima newspaper oppose the wage and spending cuts and higher taxes, and want early elections. Almost 35 percent said the package should be approved.
Germany, which as Europe’s largest economy is the biggest guarantor of the aid packages to Greece, Ireland and Portugal, insists on an “ambitious” economic overhaul in Athens, Finance Minister Wolfgang Schaeuble said.
“It also depends on Greece making the necessary decisions with a fundamental consensus of the political parties so that we can be confident that Greece will live up to its commitments,” Schaeuble said.
Greek Rollovers
The key plank of a second aid package would be a pledge by banks, insurance companies and asset managers to buy new Greek bonds to replace maturing ones, instead of European governments stepping in with taxpayers money.
In a statement, the ministers said the unlocking of fresh aid depends on working out “voluntary private sector involvement in the form of informal and voluntary rollovers of existing Greek debt at maturity.”
While Germany bowed to European Central Bank and French demands not to compel investors to buy new Greek bonds as old ones expire, the lines are blurry between a “voluntary” and “compulsory” rollover that would lead rating companies to declare Greece in default.
On the table are incentives for bondholders to maintain their exposure to Greece.
On the eve of a confidence vote that may bring down Papandreou’s government, euro-area finance ministers pushed Greece to pass laws to cut the deficit and sell state assets. They left open whether the country will get the full 12 billion euros ($17.1 billion) promised for July as part of last year’s 110 billion-euro lifeline.
“We forcefully reminded the Greek government that by the end of this month they have to see to it that we are all convinced that all the commitments they made are fulfilled,” Luxembourg Prime Minister Jean-Claude Juncker told reporters early today after chairing a euro-crisis meeting in Luxembourg.
Decisions on the next payout and a three-year follow-up package were put off until early July, prolonging Greece’s fiscal agony and heightening the brinksmanship that has marked Europe’s handling of the unprecedented debt crisis.
The seven-hour finance ministers’ meeting coincided with the start of a three-day Greek parliamentary debate in Athens over a confidence vote in a new cabinet at what Papandreou called a “critical crossroads.” Papandreou has 155 seats in the 300-seat parliament.
Referendum Proposal
The Greek premier said he planned to hold a referendum later in the year on a constitutional revamp with the goal of tackling the root causes of Greece’s debt and deficits that are “symptoms of the illness, not the cause.”
Papandreou travels to Brussels today to meet European Union President Herman Van Rompuy and European Commission President Jose Barroso. The confidence vote is scheduled for late tomorrow. The Greek crisis is set to dominate an EU summit in Brussels on June 23-24.
“The communication cacophony surrounding the policy response in our view is one of the reasons why the risk of contagion has remained and remains high,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London.
The euro meeting was flanked by a teleconference of Group of Seven financial officials, two weeks after President Barack Obama singled out Germany as the key country responsible for preventing an “uncontrolled spiral of default” in Europe.
Prospects for a second aid package to stave off the euro area’s first default had been enhanced by last week’s decision by German Chancellor Angela Merkel to drop calls for a mandatory bond exchange that might lead credit rating companies to declare Greece unable to pay its bills.
Merkel’s Concession
Merkel’s June 17 concession gave a lift to stocks, bonds and the euro, spurring optimism that Europe would get ahead of the debt crisis that has exposed the weaknesses of the 17- country currency union.
While the German gesture buoyed Greek bonds, the 10-year yield of 16.94 percent remains almost 14 percentage points above the yield on German bonds, Europe’s safest investment. Standard & Poor’s on June 13 cut Greece by three levels to CCC, branding it with the world’s lowest debt grade.
Speculation that Greece will default has bled into other European markets, leading economists such as Nouriel Roubini to predict that the 17-nation euro, the high point of Europe’s economic integration, won’t survive in its current form.
“I don’t rule out that Greece and Portugal, if they aren’t able to recover competitiveness and growth and social tension further increases, may go back to the drachma and escudo on the wave of populist governments,” Roubini, head of Roubini Global Economics LLC, told Italy’s Il Sole 24 Ore on June 18.
Spanish Spread
Ireland and Portugal followed Greece in obtaining emergency loans in the past year. Spain’s finances came under the microscope last week, with investors pushing the extra yield on 10-year Spanish bonds to 261 basis points, the highest weekly close since January.
Moody’s Investors Service said June 17 it may cut its Aa2 rating on Italy, with 2010 debt of 119 percent of gross domestic product, Europe’s second highest after Greece.
Greece needs to cover about 4 billion euros of bills maturing between July 15 and July 22, and faces about 3 billion euros of coupon payments in the month, according to Bloomberg calculations. A bigger test comes Aug. 20 when Greece must redeem 6.6 billion euros of maturing bonds.
Venizelos Commitment
The new Greek finance minister, Evangelos Venizelos, who was named in Papandreou’s cabinet overhaul three days ago, came to Luxembourg with a “strong commitment” to the planned 78 billion euros in budget cuts that provoked street protests last week.
“We can achieve our target thanks to the efforts of our people and thanks to the cooperation and the assistance of our partners,” Venizelos said.
More than 47 percent of 1,208 Greeks surveyed by Kapa Research SA for To Vima newspaper oppose the wage and spending cuts and higher taxes, and want early elections. Almost 35 percent said the package should be approved.
Germany, which as Europe’s largest economy is the biggest guarantor of the aid packages to Greece, Ireland and Portugal, insists on an “ambitious” economic overhaul in Athens, Finance Minister Wolfgang Schaeuble said.
“It also depends on Greece making the necessary decisions with a fundamental consensus of the political parties so that we can be confident that Greece will live up to its commitments,” Schaeuble said.
Greek Rollovers
The key plank of a second aid package would be a pledge by banks, insurance companies and asset managers to buy new Greek bonds to replace maturing ones, instead of European governments stepping in with taxpayers money.
In a statement, the ministers said the unlocking of fresh aid depends on working out “voluntary private sector involvement in the form of informal and voluntary rollovers of existing Greek debt at maturity.”
While Germany bowed to European Central Bank and French demands not to compel investors to buy new Greek bonds as old ones expire, the lines are blurry between a “voluntary” and “compulsory” rollover that would lead rating companies to declare Greece in default.
On the table are incentives for bondholders to maintain their exposure to Greece.
Saturday, June 18, 2011
Watching a modern Greek tragedy
We all recall from our high school literature classes that the Greeks are especially adept at the art of the tragedy. We can see that expertise playing out in Athens today. The government of Prime Minister George Papandreou is fighting for its life as the nation teeters on the edge of default and descends into violent street protests. He sacked his finance minister on Friday in an attempt to throw the mob a target of their ire and save his own neck. The leaders of Europe are embroiled in embittered disputes over how to resolve Greece's debt problem before it drags its neighbors and perhaps even the euro into the toilet. (Some progress may have been made on Friday when German Chancellor Angela Merkel signaled her willingness to compromise on the main point holding up a new bailout -- whether private creditors of Athens should face a debt restructuring.) The Greeks' plight is a tragedy on so many levels, it is hard to know where to begin.
Let's start, though, with how Greece got into this mess – a drama of the multiple failings of European leadership. Greece probably should never have been allowed to join the euro zone in the first place due to its long history of financial irresponsibility, but Europe's great experiment with monetary union has been propelled more by politics than economics. Once in the union, Greece's politicians took advantage of the stability it brought not to reform and improve competitiveness but to amass debt at low rates of interest to fund a bloated and pointless civil service. Meanwhile, the rest of Europe turned a blind eye, lacking the political will to follow the very rules they designed to prevent emerging crises the Greeks were in the process of creating. Then after the financial crisis, when the depth of the Greeks' debt woes became all too apparent, Europe's leaders dithered again, delaying action until the debt crisis had already raged around Europe. Even when they finally did something – with an EU/IMF bailout in May 2010 – the euro zone leadership failed to heed warnings that the rescue plan was still falling short of what Greece needed. In other words, at every step in Greece's experience with the euro zone, it exposed the tragic flaws built into the design of the monetary union.
Because of that, the Greek tragedy is potentially tragic for all of us. A default by Athens, whether part of a second, EU bailout or not, will likely spread new waves of contagion across the euro zone. Spain's borrowing costs have already been on the rise as the Greek crisis has intensified. That means the euro zone could require more bailouts to dodge more defaults, which would put the euro itself at risk. Losses on their holdings of sovereign bonds would eat into the balance sheets of Europe's major banks, undercutting the strength of the continent's financial system. Shockwaves would ripple around the world as jittery investors fled stocks and other assets in a renewed quest for safe havens.
Perhaps the most heartbreakng part of this Greek tragedy, though, is the impact on the Greeks themselves. Above all, the financial crisis slamming into Greece is a human tragedy. The Greeks are already facing their third consecutive year of economic contraction in 2011, and the outlook is grim. The road ahead is pockmarked with feeble economic prospects, joblessness, deteriorating government services, and a lower standard of living. There is little beyond venting their anger on the streets that the Greeks can do about it. Whatever happens as the crisis unfolds – whether Athens defaults or not, whether the country sticks with the euro or ditches it – years of painful reform and austerity measures to straighten out the nation's finances are unavoidable. Like the classic Greek tragedies of old, the players in this modern drama can't avoid their tragic fate.
It's a tragic end that most of the world's richest countries may face as well. What's happening in Greece is a window into the future of the West. True, the U.S., U.K. and other debt-heavy nations may never tumble into crises as severe as Greece's. America, for a host of reasons, is not Greece. But the Americans, Brits, French, Italians and most other Westerners can't avoid the budget cuts and potentially lower living standards the Greeks are suffering through today as governments across the developed world will inevitably be forced to restore order to their shattered finances. It's the price of living beyond our means like the Greeks have done. Those painful adjustments will have to be made as the West confronts a challenge to its dominance and competitiveness from a rising East. The Greeks need to reform their economy to have any hope of a bright future. So does the rest of the West.
Centuries ago, Greece was the leading light of Western civilization. Now Greece may be leading the way towards the decline of that civilization, at least economically. It's enough to make Antigone cry.
Let's start, though, with how Greece got into this mess – a drama of the multiple failings of European leadership. Greece probably should never have been allowed to join the euro zone in the first place due to its long history of financial irresponsibility, but Europe's great experiment with monetary union has been propelled more by politics than economics. Once in the union, Greece's politicians took advantage of the stability it brought not to reform and improve competitiveness but to amass debt at low rates of interest to fund a bloated and pointless civil service. Meanwhile, the rest of Europe turned a blind eye, lacking the political will to follow the very rules they designed to prevent emerging crises the Greeks were in the process of creating. Then after the financial crisis, when the depth of the Greeks' debt woes became all too apparent, Europe's leaders dithered again, delaying action until the debt crisis had already raged around Europe. Even when they finally did something – with an EU/IMF bailout in May 2010 – the euro zone leadership failed to heed warnings that the rescue plan was still falling short of what Greece needed. In other words, at every step in Greece's experience with the euro zone, it exposed the tragic flaws built into the design of the monetary union.
Because of that, the Greek tragedy is potentially tragic for all of us. A default by Athens, whether part of a second, EU bailout or not, will likely spread new waves of contagion across the euro zone. Spain's borrowing costs have already been on the rise as the Greek crisis has intensified. That means the euro zone could require more bailouts to dodge more defaults, which would put the euro itself at risk. Losses on their holdings of sovereign bonds would eat into the balance sheets of Europe's major banks, undercutting the strength of the continent's financial system. Shockwaves would ripple around the world as jittery investors fled stocks and other assets in a renewed quest for safe havens.
Perhaps the most heartbreakng part of this Greek tragedy, though, is the impact on the Greeks themselves. Above all, the financial crisis slamming into Greece is a human tragedy. The Greeks are already facing their third consecutive year of economic contraction in 2011, and the outlook is grim. The road ahead is pockmarked with feeble economic prospects, joblessness, deteriorating government services, and a lower standard of living. There is little beyond venting their anger on the streets that the Greeks can do about it. Whatever happens as the crisis unfolds – whether Athens defaults or not, whether the country sticks with the euro or ditches it – years of painful reform and austerity measures to straighten out the nation's finances are unavoidable. Like the classic Greek tragedies of old, the players in this modern drama can't avoid their tragic fate.
It's a tragic end that most of the world's richest countries may face as well. What's happening in Greece is a window into the future of the West. True, the U.S., U.K. and other debt-heavy nations may never tumble into crises as severe as Greece's. America, for a host of reasons, is not Greece. But the Americans, Brits, French, Italians and most other Westerners can't avoid the budget cuts and potentially lower living standards the Greeks are suffering through today as governments across the developed world will inevitably be forced to restore order to their shattered finances. It's the price of living beyond our means like the Greeks have done. Those painful adjustments will have to be made as the West confronts a challenge to its dominance and competitiveness from a rising East. The Greeks need to reform their economy to have any hope of a bright future. So does the rest of the West.
Centuries ago, Greece was the leading light of Western civilization. Now Greece may be leading the way towards the decline of that civilization, at least economically. It's enough to make Antigone cry.
Thursday, June 16, 2011
Euro Weakens Before Merkel, Sarkozy Meet
Euro Weakens Before Merkel, Sarkozy Meet
By Shiyin Chen - Jun 17, 2011 9:05 AM GMT+0530
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A skeleton holding a copy 500 Euro note in its mouth is displayed as protestors attend a rally in Syntagma Square in front of the Greek Parliament in Athens. Photographer: Matt Cardy/Getty Images
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June 17 (Bloomberg) -- Peter Andersen, senior portfolio manager at Congress Asset Management, talks about his investment strategy for U.S. stocks. Andersen also discusses the Greek debt crisis and its impact on U.S. Treasuries. He speaks from Boston with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
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June 17 (Bloomberg) -- Christopher Gothard, head of foreign exchange at Brown Brothers Harriman (Hong Kong) Ltd., talks about the Greek debt crisis and its implications for global currencies. Gothard, who also discusses European Central Bank monetary policy, speaks with Rishaad Salamat on Bloomberg Television's "On the Move Asia." (Source: Bloomberg)
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June 17 (Bloomberg -- Joseph Capurso, a currency strategist at Commonwealth Bank of Australia in Sydney, talks about the euro and Europe's debt problems. The euro headed for a second weekly decline before European leaders meet to discuss the Greek debt crisis today amid concern the situation is worsening. Capurso, who also discusses the outlook for the U.S. and Australian currencies, speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
The euro slid for a third day versus the yen and Asian stocks headed for a seventh week of losses, the longest slump since 2004, on concern Europe’s crisis won’t be resolved as leaders meet today to discuss a rescue for Greece.
Europe’s shared currency fell 0.3 percent to 114.33 yen and weakened 0.2 percent to $1.4176 at 12:15 p.m. in Tokyo. The MSCI Asia Pacific retreated 0.2 percent, extending its weekly drop to 1.8 percent. Standard & Poor’s 500 Index futures climbed 0.1 percent. Oil erased gains of as much as 0.5 percent in New York, while wheat dropped for a fifth day.
German Chancellor Angela Merkel and French President Nicolas Sarkozy will discuss a rescue package for Greece, where a default is “almost certain” and could help drive the U.S. economy into recession, said Alan Greenspan, former Federal Reserve chairman. A “hard haircut” for investors in Greek securities will risk contagion to other European countries, Jean-Claude Juncker, head of the euro-region finance ministers group said in an interview with newspaper Tagesspiegel.
“At the moment the policy seems to be to kick the can down the road and eventually markets might tire of it,” Geoff Lewis, Hong Kong-based head of investment services at JPMorgan Asset Management, said in a Bloomberg Television interview. “A lot of us expect that at some point there will be a default or reprofiling. A ‘soft’ default now to tackle the question firmly would be the right thing to do.”
Greek Crisis
The euro weakened against 11 of its 16 most-active peers and was headed for a second weekly decline. Prime Minister George Papandreou is due to announce changes to his cabinet at 9 a.m. in Athens after failing to garner opposition support for austerity measures that have spurred weeks of protests.
The prime minister needs to keep his party’s shrinking parliamentary majority in line to pass 78 billion euros ($110 billion) in austerity measures required for Greece to get a second bailout from the European Union.
“The problem you have is that it’s extremely unlikely the political system will work” in a way that solves Greece’s crisis, Greenspan, 85, said in an interview yesterday with Charlie Rose in New York. “The chances of Greece not defaulting are very small.”
Greece’s debt crisis has the potential to push the U.S. into another recession, said Greenspan, who ran the U.S. central bank from 1987 to 2006. The Thomson Reuters/University of Michigan index of U.S. consumer sentiment slipped to 74 from 74.3 in May, according to a Bloomberg News survey before today’s report, while separate data may show an improvement in leading indicators.
U.S. Economy
Americans filing for unemployment benefits totaled 414,000 last week, less than the median economist estimate of 420,000 in a Bloomberg survey, the Labor Department said yesterday. The Commerce Department said housing starts in the U.S. increased more than forecast in May, led by a jump in the West as other parts of the country languished.
Treasuries halted a two-day rally, with yields on 10-year notes little changed at 2.94 percent. The S&P 500 rose 0.2 percent yesterday, rebounding from a three-month low. Research In Motion Ltd. (RIMM) dropped as much as 17 percent in late trading after the maker of BlackBerry phones said quarterly revenue may drop for the first time in nine years. Capital One Financial Corp. (COF) may be active after it agreed to buy ING Groep NV’s U.S. online bank for $9 billion in cash and stock.
“We do expect these rough patches to continue but over time the market will trend upward” Peter Andersen, Boston-based senior portfolio manager at Congress Asset Management, said in a Bloomberg Television interview. “Earnings season is coming up and we’re starting to see companies pre-warn on the negative side, but on the other side, we’re seeing a good amount of merger and acquisition activity.”
Losing Streak
The MSCI Asia Pacific Index’s seventh straight weekly retreat will be its longest slump since August 2004. Declines yesterday drove the gauge’s valuation down to 14.2 times reported profits, the lowest level since March 30.
South Korea’s Kospi index lost 0.6 percent, Japan’s Topix index slipped 0.4 percent and Hong Kong’s Hang Seng Index slid 0.3 percent. Hynix Semiconductor Inc. (000660) dropped 6.5 percent in Seoul after Korea Investment & Securities Co. cut its share- price estimate. DeNA Co. jumped 4.8 percent in Tokyo after the operator of a social media online site lifted its net income forecast.
Yuan Gains
The yuan climbed 0.12 percent to 6.4669 per dollar. It touched 6.4634, the strongest level since China unified official and market exchange rates at the end of 1993, after the National Business Daily newspaper said there is speculation China will announce a “relatively important” currency policy on June 19, the anniversary of the scrapping of a two-year peg.
Oil for July delivery lost 0.1 percent to $94.90 a barrel on the New York Mercantile Exchange, after earlier climbing to $95.40. Futures have declined 4.4 percent this week, the most since the period ended May 6.
Wheat for September delivery dropped 1.4 percent to $6.985 a bushel, on course for an 11 percent weekly slump. Corn retreated 0.3 percent to $6.5075 a bushel. The grains declined amid on speculation an end to the tax subsidy on ethanol production in the U.S. may slow demand for corn, increasing supply of feeds for livestock and hogs.
By Shiyin Chen - Jun 17, 2011 9:05 AM GMT+0530
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A skeleton holding a copy 500 Euro note in its mouth is displayed as protestors attend a rally in Syntagma Square in front of the Greek Parliament in Athens. Photographer: Matt Cardy/Getty Images
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June 17 (Bloomberg) -- Peter Andersen, senior portfolio manager at Congress Asset Management, talks about his investment strategy for U.S. stocks. Andersen also discusses the Greek debt crisis and its impact on U.S. Treasuries. He speaks from Boston with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
Play Video
June 17 (Bloomberg) -- Christopher Gothard, head of foreign exchange at Brown Brothers Harriman (Hong Kong) Ltd., talks about the Greek debt crisis and its implications for global currencies. Gothard, who also discusses European Central Bank monetary policy, speaks with Rishaad Salamat on Bloomberg Television's "On the Move Asia." (Source: Bloomberg)
Play Video
June 17 (Bloomberg -- Joseph Capurso, a currency strategist at Commonwealth Bank of Australia in Sydney, talks about the euro and Europe's debt problems. The euro headed for a second weekly decline before European leaders meet to discuss the Greek debt crisis today amid concern the situation is worsening. Capurso, who also discusses the outlook for the U.S. and Australian currencies, speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
The euro slid for a third day versus the yen and Asian stocks headed for a seventh week of losses, the longest slump since 2004, on concern Europe’s crisis won’t be resolved as leaders meet today to discuss a rescue for Greece.
Europe’s shared currency fell 0.3 percent to 114.33 yen and weakened 0.2 percent to $1.4176 at 12:15 p.m. in Tokyo. The MSCI Asia Pacific retreated 0.2 percent, extending its weekly drop to 1.8 percent. Standard & Poor’s 500 Index futures climbed 0.1 percent. Oil erased gains of as much as 0.5 percent in New York, while wheat dropped for a fifth day.
German Chancellor Angela Merkel and French President Nicolas Sarkozy will discuss a rescue package for Greece, where a default is “almost certain” and could help drive the U.S. economy into recession, said Alan Greenspan, former Federal Reserve chairman. A “hard haircut” for investors in Greek securities will risk contagion to other European countries, Jean-Claude Juncker, head of the euro-region finance ministers group said in an interview with newspaper Tagesspiegel.
“At the moment the policy seems to be to kick the can down the road and eventually markets might tire of it,” Geoff Lewis, Hong Kong-based head of investment services at JPMorgan Asset Management, said in a Bloomberg Television interview. “A lot of us expect that at some point there will be a default or reprofiling. A ‘soft’ default now to tackle the question firmly would be the right thing to do.”
Greek Crisis
The euro weakened against 11 of its 16 most-active peers and was headed for a second weekly decline. Prime Minister George Papandreou is due to announce changes to his cabinet at 9 a.m. in Athens after failing to garner opposition support for austerity measures that have spurred weeks of protests.
The prime minister needs to keep his party’s shrinking parliamentary majority in line to pass 78 billion euros ($110 billion) in austerity measures required for Greece to get a second bailout from the European Union.
“The problem you have is that it’s extremely unlikely the political system will work” in a way that solves Greece’s crisis, Greenspan, 85, said in an interview yesterday with Charlie Rose in New York. “The chances of Greece not defaulting are very small.”
Greece’s debt crisis has the potential to push the U.S. into another recession, said Greenspan, who ran the U.S. central bank from 1987 to 2006. The Thomson Reuters/University of Michigan index of U.S. consumer sentiment slipped to 74 from 74.3 in May, according to a Bloomberg News survey before today’s report, while separate data may show an improvement in leading indicators.
U.S. Economy
Americans filing for unemployment benefits totaled 414,000 last week, less than the median economist estimate of 420,000 in a Bloomberg survey, the Labor Department said yesterday. The Commerce Department said housing starts in the U.S. increased more than forecast in May, led by a jump in the West as other parts of the country languished.
Treasuries halted a two-day rally, with yields on 10-year notes little changed at 2.94 percent. The S&P 500 rose 0.2 percent yesterday, rebounding from a three-month low. Research In Motion Ltd. (RIMM) dropped as much as 17 percent in late trading after the maker of BlackBerry phones said quarterly revenue may drop for the first time in nine years. Capital One Financial Corp. (COF) may be active after it agreed to buy ING Groep NV’s U.S. online bank for $9 billion in cash and stock.
“We do expect these rough patches to continue but over time the market will trend upward” Peter Andersen, Boston-based senior portfolio manager at Congress Asset Management, said in a Bloomberg Television interview. “Earnings season is coming up and we’re starting to see companies pre-warn on the negative side, but on the other side, we’re seeing a good amount of merger and acquisition activity.”
Losing Streak
The MSCI Asia Pacific Index’s seventh straight weekly retreat will be its longest slump since August 2004. Declines yesterday drove the gauge’s valuation down to 14.2 times reported profits, the lowest level since March 30.
South Korea’s Kospi index lost 0.6 percent, Japan’s Topix index slipped 0.4 percent and Hong Kong’s Hang Seng Index slid 0.3 percent. Hynix Semiconductor Inc. (000660) dropped 6.5 percent in Seoul after Korea Investment & Securities Co. cut its share- price estimate. DeNA Co. jumped 4.8 percent in Tokyo after the operator of a social media online site lifted its net income forecast.
Yuan Gains
The yuan climbed 0.12 percent to 6.4669 per dollar. It touched 6.4634, the strongest level since China unified official and market exchange rates at the end of 1993, after the National Business Daily newspaper said there is speculation China will announce a “relatively important” currency policy on June 19, the anniversary of the scrapping of a two-year peg.
Oil for July delivery lost 0.1 percent to $94.90 a barrel on the New York Mercantile Exchange, after earlier climbing to $95.40. Futures have declined 4.4 percent this week, the most since the period ended May 6.
Wheat for September delivery dropped 1.4 percent to $6.985 a bushel, on course for an 11 percent weekly slump. Corn retreated 0.3 percent to $6.5075 a bushel. The grains declined amid on speculation an end to the tax subsidy on ethanol production in the U.S. may slow demand for corn, increasing supply of feeds for livestock and hogs.
Economic diversity on both sides of the Atlantic
Speech by Jean-Claude Trichet, President of the ECB,
at the
US Sciences Po Foundation Annual Benefit
in New York on 16 June 2011
Ladies and Gentlemen,
It is a great pleasure for me to speak to you here tonight.
The past few years have been a testing time for the economies of both the United States and Europe. We were faced with the worst financial and economic crisis since the Second World War. Still today – on both sides of the Atlantic – we are dealing with the consequences of the crisis – for economic growth, for employment and for government finances.
The crisis has also exposed the United States and Europe to a number of asymmetric shocks – in which different parts of our economies have had a wide diversity of experience. Some countries within the euro area are the particular focus of market attention at the moment as a result of their sovereign debt issues.
Some observers have been wondering how diversity can be dealt with in Europe’s Economic and Monetary Union (EMU), what it means for monetary policy and whether the variations in economic conditions are aggravated by product and labour market rigidities. It has often been argued that economic diversity or heterogeneity is very significantly larger in Europe than in the United States.
We at the European Central Bank (ECB) have been looking closely at the degree of diversity in the two large, continental advanced economies on either side of the Atlantic. And some of the findings from this comparison are quite interesting. Because they show that economic diversity within the two currency areas is very similar in many ways. The analysis also shows that, in fact, in a large number of respects the two economies are similarly diverse.
I would like to share some of the key insights of this analysis with you tonight.
I. Economic diversity in the euro area and the United States
The United States and Europe are often compared. This is quite natural. Americans and Europeans share a common cultural legacy. But our two economies, and I am speaking here of the economy of the euro area on our side, are also similar. Both are of similar size, in terms of population and in terms of economic output. Both have closely integrated financial and product markets. And both have a single currency.
Let me begin my comparison with an economic indicator that is particularly close to a central banker’s heart: inflation. In historical terms, overall inflation has been low and stable in both the United States and the euro area since the late 1990s.
The ECB aims at an inflation rate of below, but close to, 2% over the medium term. Since the inception of the euro, the ECB has achieved that objective. Annual inflation in the euro area has been 1.97% on average over the first 12 years.
Importantly, the standard deviation in inflation across the members of the euro area has been around 1%. And it has remained broadly stable at similar levels to those observed in the US Metropolitan Statistical Areas. From that standpoint prices in the euro area are broadly homogenous and similar to those in the United States.
My second point of comparison is how diverse the United States and the euro area are in terms of economic growth. The results here are similar to that for inflation. First of all, the overall growth rates over the first twelve years of the euro were actually quite similar in the euro area to those in the US, once you adjust for differences in population growth. In both the euro area and the US, per capita growth was about 1% during 1999-2010. As concerns dispersion within the economies, before the crisis, the standard deviation of growth rates was around 2% in both the euro area and the United States. Dispersion rose somewhat during the crisis in both currency areas but remained broadly in line with pre-crisis patterns. [1]
Allow me to go one step further and compare the sources of this growth dispersion in the United States and the euro area. Both currency areas include regions that experienced a significant boom-and-bust cycle over the past decade. Both also contain regions that are facing significant structural challenges of a more long-term nature.
Let me start off with the United States. Here, several states experienced increases in house prices that outpaced the national average by a wide margin. The steep house price increases probably contributed to above average growth in these states, owing to strong positive contributions from real estate, construction and financial services.
Nevada, Arizona, Florida and California are good examples, where average growth between 1998 and 2006 exceeded that of most other states. The sharp fall in house prices in recent years turned boom into bust. These states experienced the harshest recession among the US states.
At the same time, some other US states have seen a long period of below average growth, particularly the former manufacturing powerhouses in the ''Great Lakes'' region. Structural shifts in the US economy towards services have gradually reduced the value added of manufacturing relative to GDP. In the decade before the financial crisis, growth rates in states with a high concentration of companies in manufacturing industries other than information and communications technology, such as Michigan and Ohio, were lower than in most other US states. Unsurprisingly, GDP growth in these regions remained below average during the crisis.
The euro area also contains examples of these two types of regions. On the one hand, some countries experienced asymmetric boom-and-bust cycles. Several euro area countries had higher than average growth in the pre-crisis years. For example, up to 2006, growth in Ireland was higher than in most other euro area economies, owing much to large increases in house prices.
On the other hand, a few euro area countries – Portugal for example – experienced growth below the euro area average in the decade preceding the crisis. This was typically a consequence of structural issues that could have been tackled earlier and with more determination.
Just a few years ago, this group of countries included Germany, then labelled completely wrongly the “sick man of Europe”. Yet Germany is now an example of how big the dividends of reform can be if structural adjustment is made a strategic priority and implemented with sufficient patience.
In short, the effects of the crisis on the different economies in the euro area follow a similar pattern to those in the United States. The countries in the euro area that have been hit hardest are those in which either large asset-bubble driven imbalances unwound or structural problems were left unaddressed before the crisis. More specifically, Ireland and Greece, in particular, remained in recession in 2010.
Those countries that have yet to implement more far reaching structural reforms also have relatively low growth prospects after the crisis. These relatively low growth rates are linked to a deterioration of competitiveness, driven by persistent losses in relative competitiveness, for example by above average increases in relative labour costs.
Again, this problem is not isolated to the euro area. Disregarding the most recent countries to join the euro area, dispersion of unit labour costs is similar in the euro area and the United States, both before and during the crisis.
It is worth noting that both currency areas include regions with persistently above or below average unit labour cost growth. Again leaving aside the most recent countries to join the euro area, Greece, Portugal and Ireland, in particular, have lost competitiveness vis-à-vis their main trading partners in the euro area. Germany, in contrast, has been able to lower relative unit labour costs.
There have been similar persistent losses and gains in competitiveness in the United States. Some states have experienced large or persistent increases in unit labour costs, currently exceeding the national average by as much as 20%. Other states have been gaining competitiveness vis-à-vis the national average over the past decade.
In summary, economic heterogeneity in the euro area and the United States has been broadly similar on a number of measures over the past 12 years.
II. Economic governance in the euro area
But the crisis has shown us that this should be no reason for any complacency in the euro area. Persistent losses in competitiveness on the part of individual members in a currency union lead to a build-up of external and internal imbalances. When these unravel, the cost for the affected economies can be large. They can also have spillover effects on other members of the currency union.
In any union, an economic governance framework is needed to prevent developments in an individual member state endangering the smooth functioning of the union. This is particularly true in a currency union that – in contrast to the United States – does not have a large federal budget to balance severe asymmetric developments.
For EMU, the economic governance framework devised in the 1990s has not been correctly implemented and, in any case, has proved too weak during the crisis.
As I speak today, the reform debate is still in progress. Allow me to take a few more minutes to outline the reforms required to make Europe’s institutions of economic governance commensurate with monetary union.
As you may know, the ECB takes the strong view that there is the need for more speed and automaticity in the sanctioning mechanism. This is particularly true for the Stability and Growth Pact, the EU’s framework for fiscal governance. But it is also the case for the broader framework for macroeconomic policy surveillance. The experience of recent months has vividly demonstrated the importance of a timely correction of internal and external imbalances.
But faster and more automatic sanctions alone will not be enough. The enforcement tools will also need to be made more effective. The macroeconomic surveillance framework, in particular, needs to provide clear incentives for sound policies in the member states by imposing financial sanctions at an early stage. This also means that there should be no room for discretion in the implementation of the surveillance framework.
At the same time, requirements on fiscal and other macroeconomic policies should be more ambitious. To ensure that none of the euro area members are left behind, they have to bring national policies in line with membership of a currency union.
Finally, the implementation of sound fiscal and macroeconomic policies is best ensured if these are solidly anchored at the national level. An effective way of achieving this is to implement strong national budgetary frameworks in the members of the euro area.
III. Conclusion
Let me conclude. The European Union and the Euro area on one side of the Atlantic, the United States on the other side not only share the common heritage of their culture and their nature of advanced economies. They are not only of similar size. Our economies are also showing remarkable resemblance in their diversity – among the 50 states on this side of the Atlantic and among the 17 euro area members on the other side. This is true for both the euro area and the United States before the crisis and also in their reaction to the asymmetric shocks during the crisis.
Therefore we have a common challenge. That of governing, in the best fashion possible, very large and similarly diversified economies as regards the economic features of member countries and states. This is naturally done in the US through the federal institutional framework.
We Europeans need to reform our economic governance framework, as I have briefly outlined here tonight. Here, we would do well to heed the words of Alexander Hamilton, a founding father of America’s economic and political union,. Just as Hamilton once called to his fellow Americans, we Europeans should call on our leaders to “learn to think (more) continentally”.
at the
US Sciences Po Foundation Annual Benefit
in New York on 16 June 2011
Ladies and Gentlemen,
It is a great pleasure for me to speak to you here tonight.
The past few years have been a testing time for the economies of both the United States and Europe. We were faced with the worst financial and economic crisis since the Second World War. Still today – on both sides of the Atlantic – we are dealing with the consequences of the crisis – for economic growth, for employment and for government finances.
The crisis has also exposed the United States and Europe to a number of asymmetric shocks – in which different parts of our economies have had a wide diversity of experience. Some countries within the euro area are the particular focus of market attention at the moment as a result of their sovereign debt issues.
Some observers have been wondering how diversity can be dealt with in Europe’s Economic and Monetary Union (EMU), what it means for monetary policy and whether the variations in economic conditions are aggravated by product and labour market rigidities. It has often been argued that economic diversity or heterogeneity is very significantly larger in Europe than in the United States.
We at the European Central Bank (ECB) have been looking closely at the degree of diversity in the two large, continental advanced economies on either side of the Atlantic. And some of the findings from this comparison are quite interesting. Because they show that economic diversity within the two currency areas is very similar in many ways. The analysis also shows that, in fact, in a large number of respects the two economies are similarly diverse.
I would like to share some of the key insights of this analysis with you tonight.
I. Economic diversity in the euro area and the United States
The United States and Europe are often compared. This is quite natural. Americans and Europeans share a common cultural legacy. But our two economies, and I am speaking here of the economy of the euro area on our side, are also similar. Both are of similar size, in terms of population and in terms of economic output. Both have closely integrated financial and product markets. And both have a single currency.
Let me begin my comparison with an economic indicator that is particularly close to a central banker’s heart: inflation. In historical terms, overall inflation has been low and stable in both the United States and the euro area since the late 1990s.
The ECB aims at an inflation rate of below, but close to, 2% over the medium term. Since the inception of the euro, the ECB has achieved that objective. Annual inflation in the euro area has been 1.97% on average over the first 12 years.
Importantly, the standard deviation in inflation across the members of the euro area has been around 1%. And it has remained broadly stable at similar levels to those observed in the US Metropolitan Statistical Areas. From that standpoint prices in the euro area are broadly homogenous and similar to those in the United States.
My second point of comparison is how diverse the United States and the euro area are in terms of economic growth. The results here are similar to that for inflation. First of all, the overall growth rates over the first twelve years of the euro were actually quite similar in the euro area to those in the US, once you adjust for differences in population growth. In both the euro area and the US, per capita growth was about 1% during 1999-2010. As concerns dispersion within the economies, before the crisis, the standard deviation of growth rates was around 2% in both the euro area and the United States. Dispersion rose somewhat during the crisis in both currency areas but remained broadly in line with pre-crisis patterns. [1]
Allow me to go one step further and compare the sources of this growth dispersion in the United States and the euro area. Both currency areas include regions that experienced a significant boom-and-bust cycle over the past decade. Both also contain regions that are facing significant structural challenges of a more long-term nature.
Let me start off with the United States. Here, several states experienced increases in house prices that outpaced the national average by a wide margin. The steep house price increases probably contributed to above average growth in these states, owing to strong positive contributions from real estate, construction and financial services.
Nevada, Arizona, Florida and California are good examples, where average growth between 1998 and 2006 exceeded that of most other states. The sharp fall in house prices in recent years turned boom into bust. These states experienced the harshest recession among the US states.
At the same time, some other US states have seen a long period of below average growth, particularly the former manufacturing powerhouses in the ''Great Lakes'' region. Structural shifts in the US economy towards services have gradually reduced the value added of manufacturing relative to GDP. In the decade before the financial crisis, growth rates in states with a high concentration of companies in manufacturing industries other than information and communications technology, such as Michigan and Ohio, were lower than in most other US states. Unsurprisingly, GDP growth in these regions remained below average during the crisis.
The euro area also contains examples of these two types of regions. On the one hand, some countries experienced asymmetric boom-and-bust cycles. Several euro area countries had higher than average growth in the pre-crisis years. For example, up to 2006, growth in Ireland was higher than in most other euro area economies, owing much to large increases in house prices.
On the other hand, a few euro area countries – Portugal for example – experienced growth below the euro area average in the decade preceding the crisis. This was typically a consequence of structural issues that could have been tackled earlier and with more determination.
Just a few years ago, this group of countries included Germany, then labelled completely wrongly the “sick man of Europe”. Yet Germany is now an example of how big the dividends of reform can be if structural adjustment is made a strategic priority and implemented with sufficient patience.
In short, the effects of the crisis on the different economies in the euro area follow a similar pattern to those in the United States. The countries in the euro area that have been hit hardest are those in which either large asset-bubble driven imbalances unwound or structural problems were left unaddressed before the crisis. More specifically, Ireland and Greece, in particular, remained in recession in 2010.
Those countries that have yet to implement more far reaching structural reforms also have relatively low growth prospects after the crisis. These relatively low growth rates are linked to a deterioration of competitiveness, driven by persistent losses in relative competitiveness, for example by above average increases in relative labour costs.
Again, this problem is not isolated to the euro area. Disregarding the most recent countries to join the euro area, dispersion of unit labour costs is similar in the euro area and the United States, both before and during the crisis.
It is worth noting that both currency areas include regions with persistently above or below average unit labour cost growth. Again leaving aside the most recent countries to join the euro area, Greece, Portugal and Ireland, in particular, have lost competitiveness vis-à-vis their main trading partners in the euro area. Germany, in contrast, has been able to lower relative unit labour costs.
There have been similar persistent losses and gains in competitiveness in the United States. Some states have experienced large or persistent increases in unit labour costs, currently exceeding the national average by as much as 20%. Other states have been gaining competitiveness vis-à-vis the national average over the past decade.
In summary, economic heterogeneity in the euro area and the United States has been broadly similar on a number of measures over the past 12 years.
II. Economic governance in the euro area
But the crisis has shown us that this should be no reason for any complacency in the euro area. Persistent losses in competitiveness on the part of individual members in a currency union lead to a build-up of external and internal imbalances. When these unravel, the cost for the affected economies can be large. They can also have spillover effects on other members of the currency union.
In any union, an economic governance framework is needed to prevent developments in an individual member state endangering the smooth functioning of the union. This is particularly true in a currency union that – in contrast to the United States – does not have a large federal budget to balance severe asymmetric developments.
For EMU, the economic governance framework devised in the 1990s has not been correctly implemented and, in any case, has proved too weak during the crisis.
As I speak today, the reform debate is still in progress. Allow me to take a few more minutes to outline the reforms required to make Europe’s institutions of economic governance commensurate with monetary union.
As you may know, the ECB takes the strong view that there is the need for more speed and automaticity in the sanctioning mechanism. This is particularly true for the Stability and Growth Pact, the EU’s framework for fiscal governance. But it is also the case for the broader framework for macroeconomic policy surveillance. The experience of recent months has vividly demonstrated the importance of a timely correction of internal and external imbalances.
But faster and more automatic sanctions alone will not be enough. The enforcement tools will also need to be made more effective. The macroeconomic surveillance framework, in particular, needs to provide clear incentives for sound policies in the member states by imposing financial sanctions at an early stage. This also means that there should be no room for discretion in the implementation of the surveillance framework.
At the same time, requirements on fiscal and other macroeconomic policies should be more ambitious. To ensure that none of the euro area members are left behind, they have to bring national policies in line with membership of a currency union.
Finally, the implementation of sound fiscal and macroeconomic policies is best ensured if these are solidly anchored at the national level. An effective way of achieving this is to implement strong national budgetary frameworks in the members of the euro area.
III. Conclusion
Let me conclude. The European Union and the Euro area on one side of the Atlantic, the United States on the other side not only share the common heritage of their culture and their nature of advanced economies. They are not only of similar size. Our economies are also showing remarkable resemblance in their diversity – among the 50 states on this side of the Atlantic and among the 17 euro area members on the other side. This is true for both the euro area and the United States before the crisis and also in their reaction to the asymmetric shocks during the crisis.
Therefore we have a common challenge. That of governing, in the best fashion possible, very large and similarly diversified economies as regards the economic features of member countries and states. This is naturally done in the US through the federal institutional framework.
We Europeans need to reform our economic governance framework, as I have briefly outlined here tonight. Here, we would do well to heed the words of Alexander Hamilton, a founding father of America’s economic and political union,. Just as Hamilton once called to his fellow Americans, we Europeans should call on our leaders to “learn to think (more) continentally”.
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