Category Archives: Economics: Currencies

Smoke On The East European Horizon?

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“The market is pricing these sovereigns at much wider levels than where their agency ratings would imply,” said Diana Allmendinger, a director at Fitch Solutions.CDS on Italy imply a rating of BBB, five notches below its agency rating of AA-minus. And Spain’s implied rating is BB-plus, nine notches below its agency rating of AA-plus.

With so much emphasis being placed on what has been happening farther to the South, economic realities on Europe’s Eastern periphery have largely been escaping the close scrutiny of media and analyst attention. In the wake of the belated recognition of the region’s vulnerability which followed the bout of acute stress experienced during the post-Lehman crisis, a new consensus has now emerged (for an in-depth study of the Latvian example see this piece) that the IMF-guided programmes put in place at the time have essentially set things, if not entirely straight then at least on the right track. In particular, as a result of the extensive fiscal discipline and willingness to sacrifice shown a much brighter future now awaits these countries well to the sidelines of all those horrible Greek debt concerns. Continue reading →

Can Italy Grow Its Way Out of Debt?

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What follows is simply a follow-up note to my earlier (Elephant in The Euro Room) piece on Italy. The decision by S&P to put Italian sovereign debt on negative outlook, and the subsequent announcement by Moody’s that it was considering a downgrade has been widely commented on by analysts, and it might be interesting to take a look at some of the views that have been advanced on either side of the argument (although for the detailed analysis see me earlier post). But first, a summary of the problem. Continue reading →

Nine Reasons Why Spain’s Economy Is More Different Than You Think!

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Spain, as those 1990s tourist brochures used to tell us, is different. And it certainly shouldn’t be confused with Greece. Even a cursory look at the most basic of maps should satisfy any doubts we might be harbouring in that regard. But being different is not the same thing as being economically sound. Which is what Societe Generale’s Klaus Baader has just tried to argue in a recent research note: “The Spanish bond market was hit hard in the wake of the quantum leap in the Greece crisis. But fundamentally the case for Spain remains strong”.

In singling out the nine points that Klaus advances in support of his thesis for detailed examination, I do not do so because I find the arguments particulary bad (or even especially “noteworthy” in the negative sense). He has a point of view, and he is doingh is job, and in neither case can I fault him for this.

The reason I have decided to single Klaus out for special treatment here is because he conveniently brings together, in a clear and succinct fashion, a number of arguments which are widely accepted and used by both analysts and policy makers. Unfortunately the fact that arguments are widely held does not make them valid, or in anything other than the most trivial conventialist sense “true”. Indeed it is precisely because I feel that these arguments are not well founded that I have decided to reply to them in this rather detailed way. Basically I don’t buy the idea that Spain is simply suffering from a crisis of confidence, one which, in its turn, puts pressure on the government bond spread. I think Spain has a problem in the fundamentals department, and unless this problem is first accepted and then addressed the wrong (inadequate) remedies will continue to be applied, putting the Eurozone and its citizens at risk of financial catastrophe in the medium term. Continue reading →

Red Lights Flashing For Eurozone Growth

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The June Flash PMI reports, which were out on Thursday, make do not make agreeable reading, in the sense that while the French and German economies both continued to expand during the month, their rate of expansion, and in particular in the leading manufacturing sector, seems to have dropped sharply, and for the second month running. In contrast, the economies on the Eurozone periphery moved closed to outright contraction. All in all the survey results only add to concerns about the global recovery which came into focus after the May PMI results (see my To QE3 or Not to QE3).

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Special Guest Contribution: A simple, repellent plan for Greece

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Ed: At this critical moment for the European project, we have the honour to present a special guest contribution from Norman Strong, who has agreed in the light of the extreme circumstances we are facing to finally resume the occasional series of posts he began here in 2002. Like Duke Nukem Forever and the Stone Roses’ second album, it’s been a while.

The first thing to note is that there is, despite appearances, no urgency. Once one has accepted the fact that a restructuring of Greek debt will be needed, then it is no longer the case that “kicking the can down the road” will “only make things worse in the long run”.

Some simple arithmetic, from the point of view of Greece:

Say that the total sustainable debt burden of Greece is X, while its current debt burden is Y. If we were to reschedule tomorrow, the necessary markdown percentage would be X/Y.

But if we don’t reschedule tomorrow, and instead lend an extra amount Z, then the sustainable burden doesn’t change – the eventual writedown will now just be X/(Y+Z).

In other words, new net lending to Greece, from the EU, IMF and/or EFSF to finance the current deficit, is just pushing down the eventual recovery rate on all debt. The marginal rate of writedown on new credit extended to Greece is one hundred per cent. It is effectively a fiscal transfer, financed by either a tax on all bondholders (if the new debt goes in pari passu), a tax on pre-crisis bondholders (if the new debt were to go in on a senior basis), or a tax on the official sector (if the new debt is wholly or partially financing an exit at par for pre-crisis bondholders as they redeem). The Greek government should be trying to borrow as much as anyone will lend them, since the repayment terms don’t matter if you’re planning to default. It is analogous to the practice of “trading while insolvent” for a company; this is an illegal thing to do for a corporation, but countries aren’t corporations.

With that in mind, we realise we are under no time constraint at all, and we can organise the eventual bailout at our leisure and for our political convenience. Particularly, we can stick it out past 2013, by which time the German Presidential elections will be out of the way, and a raft of new European legislation will be in place with respect to sovereign and bank debt restructuring, allowing the whole business to be carried out on a more civilised basis.

(Academic economists and bond traders alike, by the way, always underestimate the need for legal certainty, while policymakers never do. Much avoidable misunderstanding results from this, and from the fact that I have never seen a “plan to save the world” from either an economist or a bond investor, no matter how otherwise sensible, which didn’t have a giant great lacuna in the middle where anyone with policy experience would immediately say “that’s the bit where a thousand lawyers suddenly pop out of the woodwork and start arguing with each other, resulting in something absolutely critical not getting done”.)

So with time on our side, and no real intention of doing anything until we have as much legal and political certainty as we need, what would be the least painful way to achieve our end? I am assuming that our objective here is to get Greece back to a sustainable fiscal position, without destroying the Eurozone banking system on the way, with as little pain as possible. That is the plan, isn’t it guys? I assume so, but I am often reminded of Enron’s legendary fixer, John Wing and his cry of “Everyone trying to do this deal, that side of the room – everyone trying to screw it up, over there!”. the easy way to do this is by using the equipment provided; a central bank. The ECB currently owns EUR62bn of Greek government bonds outright, via the Securities Market Purchase program. There is also a substantial debit balance on the part of the Bank of Greece at the ECB, reflecting payment imbalances in the Eurosystem. This is not a fiscal exposure (the Greek government has no use of the proceeds and the debt is collateralised). But if need be, it could be converted into one; one would only need the Greek banking system to sell their collateral to the ECB in an extension of the SMPP.

The only point I’m trying to make here is that, in stage 1 of my plan, I can get the ECB into a position where it is as big or as small a creditor of the Greek state as it needs to be. (Stage zero, helas, involves getting Greece to a position of primary fiscal surplus, and that is going to hurt. Fundamentally, fifteen years ago, Greece faced a choice between being the kind of country that doesn’t collect taxes on the middle and upper class, or the kind of country that pays generous benefits and public sector salaries, and chose both. There is no financial whizzkid trick in the world that will let you get over that one).

But my flexibility in making the ECB the largest creditor in stage 1 is important, because stage 2 involves the EFSF providing a special loan facility for the Hellenic Republic to make an open market tender offer for its outstanding bonds at a discount to face value. My guess is that few private-sector holders would tender into such an offer, but the ECB certainly could, as long as it was given an indemnity for the costs of doing so by its shareholders. The ECB actually holds a substantial proportion of its GGBs at a significant discount to face in any case, as it bought them in the market, while any further transactions would take place at current market price, so the indemnity would not necessarily need to be huge. In actual fact, the ECB could do this solo, without any indemnity – the losses would wipe out its capital, but under the ECB treaty, this would immediately be replaced by its shareholders (the fiscal authorities of Euroland) in proportion to their holdings of the ECB’s initial capital. But that would be an example of the kind of “bright idea with an obvious legal black hole” I was talking about earlier, whereas the provision of fiscal indemnities for central bank rescue operations is very orthodox practice.

What about “private sector participation”? Well, the private sector would have already participated in this one, by crystallising their mark-to-market losses on sale of their bonds to the ECB. It is true that the scale of private sector participation might be less in total than one might wish (as the market price would presumably rally if the ECB were a large buyer), and certain kinds of unpopular players like vulture funds might not bear as much of the burden as policymakers might wish. But if you don’t like this, Euroland, then remember that you have the power to tax. There are all manner of fiscal instruments that can be used to equalise and spread the pain about – the ratings agencies would presumably regard such fiscal rough justice as equivalent to a selective default, but come on – you didn’t really think we were going to get out of this without defaulting, did you?

The idea is so simple (as JK Galbraith said about the creation of money in a fractional reserve banking system) that it repels the mind. To repeat – all we need is the existing Euro, the existing EFSF, and a legal opinion that this would not constitute monetisation of the Greek national debt, which as far as I can see it wouldn’t. But there is no rush.

To QE3 Or Not To QE3, That Is The Question

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Back in July 2010, in introducing a blog post with the title “Is There Global Economic Slowdown In The Works?” I couldn’t help posing the following question:

“According to Ralph Atkins writing in the Financial Times last week, “the pace of Germany’s recovery is helping dispel fears of a “double dip” recession across the continent as a result of the crisis over public finances in southern European countries”. Coincidentally, however, on the very same day, Alan Beattie writing from Washington informed us that the IMF feel “the risk of a slowdown in the global economic recovery has risen sharply”. This left me asking myself which is it: is the global recovery a question of up up and away, or are we at the start of a renewed slowdown (whether or not you wish to term this a “double-dip”)? So I thought I would take a look through some of the most recent data (both hard and soft) to see if I could make any sense of the situation”.

Strangely, just this week, and nearly 12 months later, I now find myself asking almost the very same question. Naturally I am not alone in this. Here’s a link to ECRI’s Lakshman Achuthan talking with MSNBC’s Tom Roberts about the US May jobs report and the reality of a global industrial slowdown. As Achuthan emphasises, in the US context this is still all about growth, about less growth rather than more growth, since we are not talking about recession, merely slower growth, but at the same time it isn’t simply a “soft-patch” either, since the many “exceptional factors” which are lined up (like supply chain problems following the Japan tsunami, or bad weather in the US) aren’t sufficient on their own to explain the scale of the phenomenon. Continue reading →

BELLS in Hell that Don’t Go Ting-a-Ling-a-Ling

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After the BRICS, came the PIGS. Now a new acronym is being born, that of the BELLS. These particular “ding-dongs”, however, are not a set of hollow cast-metal instruments suspended from the vertex and rung by the strokes of a clapper, they are countries, countries which may, like those unfortunate WWI British soldiers whose love of their country and sense of duty lured them into one of the most senseless conflicts of modern European history, be headed towards their own pretty unique form of modern purgatory. Continue reading →

How I was wrong about the euro

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This Transitions Online piece is fascinating – as south-eastern Europe has changed, the location of “Europe” or “the West” has swung around all over the place. Once upon a time, Bulgarians and Romanians looked at Yugoslavia as the future, a better version of their own society, and both a reasonable substitute for Germany or Italy and a transit route on the way there. People watched Yugoslav TV illegally. Then, the earthquake, the nightmare. Nobody wanted to be anything like it. People in what had been Yugoslavia looked east, both because there was peace, because that was where the smuggled fuel came from, and also for political support.

Meanwhile, people in the rest of the Balkans looked north at Hungary or south at Greece. Of course, that was because the European Union came to them. Now, well, not so much. If there was ever a time to be eurosceptic, this is the moment. Greeks are quite possibly looking north and wishing they weren’t in the eurozone.

I remember that in the mid-1990s, I was quite sceptical about the single currency for the usual reasons from the left – basically, Keynesian concerns. Having grown up in a succession of recessions, the prospect of joining the Stability & Growth Pact and signing up to the monetarist second pillar of what wasn’t then the ECB didn’t seem great. However, I was (still am) very pro-European on all other issues and eventually I came round to it for not much of a better reason than that it offended the right people. Also, this was the early 2000s and economic policy based on rules seemed to be a pretty good idea. As it happened, of course, when a dose of stimulus was wanted this didn’t keep anyone’s hands out of the medicine chest. Neither did the austerity hold back anyone who was determined to have a monster property boom.

The other big concern was the optimal currency-area problem – could the interest rate be right for the whole eurozone? This is about the most conventional critique of the euro there is. In the UK, it used to be quite a commonplace that the country itself wasn’t an optimal currency area, with the corollary that it therefore didn’t matter so much about the euro. I never quite grasped the logic here, although I admit I may have used the argument. Perhaps the underlying thinking was that there is really no such thing as an optimal currency area – a currency system that was sufficiently decentralised to offer an optimal credit environment in its whole territory would have such high transactions costs it wouldn’t be worthwhile, and therefore we would always have to tolerate some inefficiency due to this effect.

So I was very pro-euro and pro-European while it was a live issue in the UK (about 2003, IIRC – I wonder what happened then?).

What I don’t remember anyone discussing much was the Eurosystem as opposed to the Euro or the ECB – the transactional, flow-of-funds financial workings between the member central banks and the ECB. Nor do I remember anyone talking very much about the fact that the ECB doesn’t have an explicit lender-of-last-resort function. And even discussing whether member states should do anything to manage their trade balances with one another – that was so far out of fashion, of course, that even I didn’t give it any thought.

Of course, this was the bit that bit us.

To put it another way, we argued enormously about the fiscal aspects of the Euro, which turned out to be absurdly easy to fudge when it became necessary to do so. We argued quite a bit about interest rate policy. We hardly even mentioned banking or the issue of money. This is quite a cock-up when you remember we were talking about setting up a new central bank. No wonder west is north and east south.

Is this just my fault? Was there serious discussion of how the Eurosystem might work or not in a financial crisis back in the 90s? Working on my own private black swan theory – apparently unlikely events are both predictable and usually predicted, but they tend to be ones it was unrespectable to predict – somebody must have been.

Also, has anyone else in Britain changed their mind, or is it only me?

Greece: Last Exit To Nowhere?

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“Some economists, myself included, look at Europe’s woes and have the feeling that we’ve seen this movie before, a decade ago on another continent — specifically, in Argentina” – Paul Krugman: Can Europe Be Saved

“Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling.”
Paul Krugman – How Reversible Is The Euro?

Krugman is certainly right. Looking over towards Athens right now, you can’t help having that horrible feeling of deja vu. Adding to the uncomfortable feeling of travelling backwards rather than forwards in time (oh, I know, I know, when history repeats itself it only piles one tragedy onto another) is the uncomfortable presence of Charles Calomiris, a US economist of Greek origins. I can still remember reading, back then in the autumn of 2001, an article by the then Argentine Economy Minister Domingo Cavallo published in the Spanish newspaper El Pais which proudly proclaimed that everything was going well, and that the country’s reforms were being generally well received with the regretable exception of “a small number of neurotic US economists who continue to insist that we will default and break the peg”. He was, of course, referring to Calomiris, and at the time we were only a matter of weeks away from the dramatic moment when Adolfo Rodríguez Saá (the man who was President for a mere 8 days) would enter both history and the Argentine parliamentary chamber to utter the now immortal phrase “vamos a coger el torro por los cuernos” (we are going to take the bull by the horns). A phrase which was obviously belonged to the class of so called Austinian performatives, since at one and the same time as uttering it he effectively ended the peg. Well today Calomiris is again with us, and he is still hard at work going through the numbers, only this time round he is using his special insights to scrutinise his family homeland, for which he is prophesying not only eventual default, but also the generation of sufficient contagion to bring the whole Euro project itself to an untimely end. In an article in Foreign Affairs entitled “The End Of The Euro”, he tells us:

Europe is living in denial. Even after the economic crisis exposed the eurozone’s troubled future, its leaders are struggling to sustain the status quo. At this point, several European countries will likely be forced to abandon the euro within the next year or two….The only way out of this conundrum is for countries with insurmountable debt burdens to default on their euro-denominated debts and exit the eurozone so that they can finance their continuing fiscal deficits by printing their own currency. Here’s a hint for Europe’s politicians: If the math says one thing and the law says something different, it will be the law that ends up changing

Really, I don’t think of Calomiris as a prophet (or even as a Cassandra), I don’t even think of him as an especially insightful economist when it comes to the macro problems of the real economy, but I do think he has one exceptionally strong merit: he can do the math, and as he says, if it gets down to a battle between legal details and arithmetic, arithmetic will always win. Continue reading →

The Great Greek And Spanish GDP Mystery – One Hypothesis

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Many an economic eyebrow must have been raised last Friday when Europe’s first quarter GDP data was released, and people discovered that the Greek economy had suddenly surged forward, rising by 0.8% over the level it had attained in the last three months of 2010 (or at a 3.2% annual rate, or faster than the US). Since almost everyone with knowledge of the situation is forecasting a further contraction in the economy this year, the result may have been thought to be a surprising one. Continue reading →