In a currency union, with no homegrown currency to devalue (relative to your main trading partners), internal price deflation is really the only option for addressing a proce competitiveness problem. But (as I explain here) this is a very difficult road to follow as the Irish government are currently discovering. Excesses on the upside were easy, and (more or less) popular, but on the downside they are another matter altogether.

The Irish government is facing growing calls to abandon the centrepiece of its economic recovery plan after large-scale public protests at the weekend organised by the main trade unions.

A controversial proposal to impose a levy on the pensions of public servants – effectively a pay cut for the 350,000 state employees from ministers to local authority workers – drew 100,000 ordinary people on to the Dublin streets on Saturday in a protest organised by the Irish Congress of Trade Unions.

The levy is the centrepiece of an economic stabilisation programme announced last month aimed at curbing a ballooning budget deficit which, even with the proposed savings, is set to reach 9.5 per cent of gross domestic product this year. This is more than three times the fiscal benchmark set by the European Union.

Just following up on PO’Neill’s post (here) on the IMF loan to Serbia, where he says:

Finally, since this request would seem to shave another $2 billion of whatever headroom the IMF thought it had for such programs, getting them more space to lend might soon be a priority agenda item at the London Summit.

This is absolutely the point. The Financial Times today quotes Simon Johnson, a former IMF chief economist now at the Massachusetts Institute of Technology, to the effect that : “We are seeing the consequences of the lack of IMF resources. Programmes are probably undersized because the IMF is worried about running out of money.” and Ken Rogoff, another former chief economist, who said: “The IMF doesn’t have nearly the resources to backstop all of eastern Europe.”

Mr Rogoff echoed calls from Robert Zoellick, World Bank president, for the EU to take a leading role in rescuing eastern Europe. But the European Commission has already spent nearly €10bn ($12.6bn, £8.8bn) of its €25bn rescue fund on Hungary and Latvia, and EU governments have yet to provide more resources.

According to the FT the IMF, which has $142bn in quickly available resources and $50bn it can raise rapidly, recently finalised an agreement to borrow an extra $100bn from Japan and is seeking a further $150bn from other member governments. The question no one seems to be thinking about is the “what if” one of possible defaults. If the IMF borrow $100 billion from Japan, and the loans are defaulted on, then who covers the debt, or do we just turn the IMF into another “bad bank”? I don’t think people are being at all responsible here.

Ukraine, Belarus and Serbia all have shrinking and rapidly ageing populations, the possibility of defaults here are high, in each case, and it is quite possible we will see continually shrinking GDPs which will effectively turn these countries into IMF economic protectorates (in the absence of some other multilateral agency being created in the mid term to handle the problem).

Hungary and Latvia both look like being dangerously close to default come 2012 if emergency measures are not taken soon (the IMF programmes as currently structured simply cannot work, in either case), and they could quickly be followed down the same road by Bulgaria and Romania. Basically we need some sort of order putting back into this whole situation before things simply get out of hand, simply talking about reform of the IMF quota system is absurd at this point. Europe needs to act, and act decisively. Above all we need something which is sorely lacking from our leaders at the moment, a feeling that they are able to rise to the scale of the problem and start to act, rather than simply react. If you think what we have so far is bad, you just wait till you get to see what comes next.

Once more the forces are marshalling. Today it is the turn of the East. Wolfgang Munchau in the Financial Times this morning:

But Ireland is not the biggest danger for the eurozone. If the country goes down, the eurozone will bail it out. Even the Germans accept this now. A far more imminent danger lurks in central and eastern Europe. The possibility of a financial collapse there is the most urgent policy issue the European Union must confront at this point. If mishandled, it could bring down the eurozone……..

In my view, the smartest answer to the prospect of meltdown is the adoption of the euro as quickly as possible. There is no need to switch over tomorrow. All we need tomorrow is a credible and firm accession strategy – one for each country – which would include a firm membership date and a conversion rate, backed up by credible policies.

Me on Saturday morning (here):

This is not a view I have arrived at lightly, but looking at the extent of the problem we now have before us, a problem which is growing by the day, and taking into account the fact that the origins of the economic crisis in the East must surely rest (at least in part) in the decision to make euro participation a condition for EU membership for these countries (a possibility which was subsequently withdrawn in the critical moment, when the going started to turn rough), and then assessing the risk to the Western European banking system which would be posed by simply sitting back and watching it all happen, I think this move is not only the least damaging of the policies we can now follow, it is the in effect the only viable path left to us if we are to keep the eurozone as an integral entity together.

If this proposal were accepted a new set of membership criteria would need to be drawn up, of course, but the underlying principle would have to be one of offering the certainty of entry as guaranteed forthwith, for those who chose to accept. Rules were made to be broken, and nothing should be so inflexible – not even the Maastricht eurozone membership criteria – that it cannot be ammended as circumstances dictate. And at this point even the undertaking that this – like the long awaited US Stimulus programme – was on the table, would be sufficient to provide immediate, and much needed relief. Flirting with doing nothing here is, in my opinion, flirting with disaster, both in the East and in the West.

I think we have substantive agreement. C’mon Dominique, now its your turn to push.

According to Forbes:

Momentum grew on Saturday behind a proposed common European bond to help bolster fragile member states during the global economic crisis as the International Monetary Fund threw its weight behind the idea.

At this point in time it isn’t entirely clear who issued this particular “call”, but still, we’re up and running, and this one is gaining traction by the day. It would be nice to be able to say that all this started on a blog (see here) but in fairness Wolfgang Munchau was first off the block with the public call (followed perhaps by the Italian finance minister).

“We have a big player which is the European Union and there is no reason why it shouldn’t have its own way of financing and to issue bonds is a good idea,” IMF Managing-Director Dominique Strauss-Kahn told a news conference in Rome. “I really support this initiative,” he said. “It really depends on the European Commission and the EU authorities but I see no reason why the EU cannot do this.”

and of course Italy’s Giulio Tremonti is still pushing, but then as someone once said, he would wouldn’t he, since Italy’s debt to GDP is 105% and rising.

Asked if he thought there was growing political support among European governments for such a bond, Italian Economy Minister Giulio Tremonti said: “Honestly, yes.” “We are lacking a common European vision and the idea that Europe issues European bonds to finance Europe itself – it would be crazy and suicidal not to do it,” Tremonti told Italy’s state television RAI.

Latvia’s four-party coalition government resigned today after two of the coalition partners called for Prime Minister Ivars Godmanis to step down. President Valdis Zatlers told a news conference in Riga today that he had accepted the resignation and that talks on forming a new government would begin next week, a timing that coincides perfectly with the forthcoming visit of an International Monetary Fund mission.

“I told the parties this was the moment of truth,” Godmanis, 57, said adding that a government that has resigned may not have the authority to sign international documents. The IMF has some requests for the government and the “it’s very important for them to know our position,” he said, declining to say what the requests were.

Zatlers said on Feb. 13 that Godmanis had “lost his trust” after the government abandoned plans to cut the number of ministries. Zatlers then said on Feb. 16 that Godmanis had admitted he made a “mistake” and agreed to continue with plans to reorganize the government.

The IMF in its report on the Standby Arrangement for Latvia said the following:

Maintaining the peg also requires substantial political commitment.

If this commitment were to falter, there is a risk that the execution of the difficult but necessary policies required under the authorities’ program could also weaken. However, all political parties are strongly committed to the exchange rate peg. Thus the revised 2009 budget was passed by a 57-21 majority, despite the exceptional fiscal tightening measures it contained. Maintaining this commitment through an anticipated prolonged recession could be challenging.

and
The authorities’ unequivocal commitment to the exchange rate peg has determined their choice of program strategy.

Though this commitment augurs well for program ownership, the authorities also recognize that their choice brings difficult consequences, including the need for fiscal tightening and the possibility that recession could be protracted, perhaps more so than if an alternative strategy had been adopted.

Of course this program ownership disappeared almost as quickly as the ink dried on the paper they all signed. Basically the problem of maintaining political will during what was always bound to be a very harsh economic correction lay at the heart of my critique of the decision to attempt to maintain the peg. See my:

Why Latvia Needs To Devalue Soon – A Reply To Christoph Rosenberg

and

The Long And Difficult Road To Wage Cuts As An Alternative To Devaluation

and Manuel Alvarez Rivera (Election Resources On The Internet) writes:

I wrote at the beginning of this month that “Governments in Latvia are usually short-lived – since regaining independence in 1991, the Baltic republic has had more than a dozen cabinets – in no small measure because of its constantly changing and fractious party system. From that perspective, the question may be not so much whether Prime Minister Godmanis will remain in power, but for how long”.

As it was, the “how long” turned out to be an unexpectedly short reprieve: on February 20, Latvia’s coalition government became the second casualty of the global financial crisis, after the People’s Party and the Union of Greens and Farmers – the two largest parties in the government and the Saeima (Parliament) – announced they had lost confidence in Prime Minister Ivars Godmanis, and forced him to step down.

President Valdis Zatlers will start consultations with leaders from all political parties in Parliament on the formation of a new cabinet. However, the upcoming government will have to implement further unpopular measures to cope with the worsening economic situation, and an early election remains a distinct possibility.

The full text of Manuel’s background on the current political crisis can be found here.

“It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again.”
Robert Zoellick, World Bank president, in an interview with the Financial Times

(Click On Image To View Video)

World Bank president, Robert Zoellick, made a call this week – in an interview with the Financial Times – for a European Union-led and co-ordinated global support programme for the economies of Central and Eastern Europe. I agree wholeheartedly, and even if I have, reluctantly, to accept the point made last week by our Economy & Finance Commissioner Joaquin Almunia that our pockets, though deep, are certainly not bottomless (and thus it is probably beyond our means right now to rescue the non-EU Eastern states), I still feel we should make good on our responsibilities to those who are EU members, and to do so by opening the doors of the Eurozone to those who wish to join. Since this proposal is fairly radical, the justification that follows will be lengthy.

This is not a view I have arrived at lightly, but looking at the extent of the problem we now have before us, a problem which is growing by the day, and taking into account the fact that the origins of the economic crisis in the East must surely rest (at least in part) in the decision to make euro participation a condition for EU membership for these countries (a possibility which was subsequently withdrawn in the critical moment, when the going started to turn rough), and then assessing the risk to the Western European banking system which would be posed by simply sitting back and watching it all happen, I think this move is not only the least damaging of the policies we can now follow, it is the in effect the only viable path left to us if we are to keep the eurozone as an integral entity together.

If this proposal were accepted a new set of membership criteria would need to be drawn up, of course, but the underlying principle would have to be one of offering the certainty of entry as guaranteed forthwith, for those who chose to accept. Rules were made to be broken, and nothing should be so inflexible – not even the Maastricht eurozone membership criteria – that it cannot be ammended as circumstances dictate. And at this point even the undertaking that this – like the long awaited US Stimulus programme – was on the table, would be sufficient to provide immediate, and much needed relief. Flirting with doing nothing here is, in my opinion, flirting with disaster, both in the East and in the West. Continue reading →

According to Deputy Polish Prime Minister Grzegorz Schetyna on Polish Radio this morning the talk of issuing Euro bonds by some EU countries is “ unfortunately true.” What is more interesting is the explanation of the “unfortunately” part, since Schetyna claimed that he feared, in the face of the economy crisis, there was a real threat that the EU would turn against new members. He also said that such a situation would result in the creation of “a two speed Europe.”

“The richest countries within the EU are intending to release Euro bonds, which would prevent the countries outside of the Euro Zone from selling theirs,” he said.
According to News Poland.

The Czech prime minister, Mirek Topalanek, currently president of the European Union, also expressed similar sentiments in a meeting of European parliamentarians in Brussels. “I would warn against the [euro bonds] idea, against the issue of new bonds, because we are going to run into difficulty repaying government debt,” he said.

Basically I think that both these comments are based on a misunderstanding, since if EU bonds are to be issued (and, as I keep saying, they already have been to help Hungary and Latvia) to help Austria say, this would be precisely to try to prevent the Austrian banks ahving to retreat from lending in the East, as I will explain in a post which is coming behind this one.

But the heart of the solution here is to overcome the East-West divide altogether, and open euro membership to the East as part of a comprehensive resolution of our collective difficulties.

Dow Jones Newswires ran a story early this morning which is provoking shockwaves somewhere.

The German finance ministry is examining rescue measures for euro-zone countries which are struggling financially, Der Spiegel weekly magazine said in an advance release of a report to be published in its next edition.

Four options are under consideration. The first option is helping such countries which face insolvency via a bilateral bond, with a creditworthy country taking up the loan and providing it to a needy country. A second option would be a joint bond issued by creditworthy countries. Also under consideration is a rescue package led by the European Union, either on its own or with the involvement of the International Monetary Fund, the magazine reports without disclosing sources. The finance ministry wasn ‘t immediately available to comment on the report. German Finance Minister Peer Steinbrueck said Wednesday that a breakup of the euro zone was an “absurd” suggestion and governments would stand ready to act if any country struggled with severe financial problems. Chancellor Angela Merkel said Thursday that Germany would give its contribution to the IMF if it were asked for help. The euro has declined sharply against the dollar this week as investors are worried about euro-zone banks active in Eastern Europe. Austria, which has several large banks active in the region, is seen as particularly vulnerable. European Commissioner for Economic and Monetary Affairs Joaquin Almunia said Wednesday that the commission shares Austria ‘s concerns, but added that the bloc has limited instruments at its disposal.

But Market Watch carry this:

The German Finance Ministry on Friday denied a report in weekly magazine Der Spiegel that it is weighing plans for a coordinated rescue of financially distressed euro-zone countries. “The Spiegel report doesn’t correspond with the facts. The Federal Finance Ministry isn’t working on any such concepts,” said finance ministry spokeswoman Jeanette Schwamberger in Berlin, according to Dow Jones Newswires. The spokeswoman said Germany has “no doubt about the unity of the monetary union,” but that rising bond yield spreads within the euro zone warrant “joint action by the European Commission, European Central Bank” and euro-zone finance ministers “to discuss measures with the affected member states to reverse this development.”

However if you look carefully at the last sentence in the Reuters report on the same story, you will see that nothing is really being denied, since there are “theoretical considerations” in the works, we just aren’t at the formal report stage yet.

German FinMin dismisses report on euro bond issues

Germany’s Finance Ministry on Friday dismissed a report by Der Spiegel magazine that it was looking at possible rescue measures for other euro zone states with severe financial difficulties.

“The above mentioned article by Der Spiegel magazine does not represent the facts,” the ministry said in a statement. “The German finance ministry is not working on such concepts.” The ministry added that wider bond spreads within the euro zone were an issue for the European Commission, European Central Bank and Eurogroup. The EU’s budget rules remained important, as well as structural reforms to improve competitiveness, it said.

“Everything beyond this are theoretical considerations,” it added.

And if you notice the headline, you will see we are already up and over the radar folks :).