Another useless EU Summit - thank you Mr. Cameron for killing the new “Merkozy” version of an absurd fiscal union for the entire EU. This time, the absurdity of setting a budget limit of 0.5% of GDP (when it has been unable to comply with the existing limit of 3%), was compounded by requiring its inscription as a rule in national legal systems at constitutional or equivalent level (see here why this is a mistake).
Let us now hope that a referendum in Ireland or any other country will kill the alternative proposal for a fiscal union among Euro Zone members through a new "fiscal compact". As we said here, a fiscal union between Germany and France may make sense but it would be a disaster for the entire Euro Zone.
The potential collapse of the Euro Zone will not be due to a fiscal problem in the Euro Area; which does not exist, despite the fact that three smaller members have excessive debt and Germany has an excessive current account surplus. The problem resides in the ECB’s refusal to act to stop the speculation against the Euro by invoking that its charter does not allow for the monetization of fiscal deficits.
Mr. Draghi is either naïve or wants us to believe in fairy tales. During his last press conference, he said that funding the IMF to finance exclusively the Euro Zone governments would be against the ECB charter. However, the ECB practice of accepting modern day versions of accommodation bills, in the form of bank drafts and bonds issued and subscribed by the same bank with a government guarantee and used to purchase the debt of the said government, is a more dangerous form of debt monetization since it lacks any kind of conditionality. Moreover, it puts those governments in the position of sitting ducks for speculative attacks.
As we said before bank-to-bank loans with strong conditionality are preferable. Obviously, we do not advocate that the ECB should negotiate or monitor such conditionality. Specialized institutions such as the IMF or the EFSF/ESM should do that.
Unfortunately, as we said repeatedly and the experience of Greece, Ireland and Portugal shows the IMF adjustment policies for monetary unions are seriously flawed.
Yet the ECB did not demand from the European Council that the ESM should take its place. Instead, the Council decided that all EU member states would lend to the IMF an extra 200 million Euros in the hope that non-EU countries might do the same.
In summary, by accepting the self-inflicted fiscal Darwinism of Germany that will lead to expelling peripheral countries from the Euro Zone, despite a half-baked mix of ECB and IMF support, will not restore confidence in the Euro. All it does is to replace the previous ECB hara-kiri intent with a slow euthanasia carried out by an IMF firing squad.
Showing posts with label Euro. Show all posts
Showing posts with label Euro. Show all posts
Friday, 9 December 2011
Friday, 2 December 2011
Is the ECB-IMF Proposed Back-to-Back Loan Enough to Stop the Euro Suicide?
It seems that the ECB is considering moving towards the type of back-to-back loan solution that we advocated in a previous post to stop the speculative bet on the collapse of the Euro. Bloomberg has just announced that the ECB is in talks with the IMF to set up a special $270 billion lending facility that would bypass the legal constraint of acting as lender of last resort to Euro Zone governments.
Although the details are not yet known, this is a positive development. Its main advantage is that it leaves the onus of imposing the necessary conditionality terms to the IMF, a task outside the remit of the ECB. However, the IMF failure in the Greek adjustment program raises serious doubts on its ability to deal with the Euro zone crisis.
We would prefer a European solution, intermediated and co-financed by private banks backed by the reformed European Financial Stability Facility, once it gets competence in adjustment lending.
Still, to be credible the ECB needs to go further. First, it needs to make sure that the size of the facility is big enough to leave no doubt about its power (the $270 billion reported are a fraction of what is needed). Second, it needs to ensure that the IMF can speed up its decision-making process. Finally, and most importantly, needs to stop its programs of bond buying in the secondary market that are feeding the speculation. A substantial reduction in the bond supply issued by some sovereigns is indispensable to squeeze those shorting the Euro.
In conclusion, the ECB has finally taken the first step in the right direction. Let us hope that it is followed by additional measures and is not offset by the fiscal fundamentalism that the surplus countries are trying to impose in whole Euro zone.
Although the details are not yet known, this is a positive development. Its main advantage is that it leaves the onus of imposing the necessary conditionality terms to the IMF, a task outside the remit of the ECB. However, the IMF failure in the Greek adjustment program raises serious doubts on its ability to deal with the Euro zone crisis.
We would prefer a European solution, intermediated and co-financed by private banks backed by the reformed European Financial Stability Facility, once it gets competence in adjustment lending.
Still, to be credible the ECB needs to go further. First, it needs to make sure that the size of the facility is big enough to leave no doubt about its power (the $270 billion reported are a fraction of what is needed). Second, it needs to ensure that the IMF can speed up its decision-making process. Finally, and most importantly, needs to stop its programs of bond buying in the secondary market that are feeding the speculation. A substantial reduction in the bond supply issued by some sovereigns is indispensable to squeeze those shorting the Euro.
In conclusion, the ECB has finally taken the first step in the right direction. Let us hope that it is followed by additional measures and is not offset by the fiscal fundamentalism that the surplus countries are trying to impose in whole Euro zone.
Thursday, 10 November 2011
How the ECB Can Prevent the Suicide of the Euro Zone
First, three facts:
1) For a currency that is in risk of imploding, the Euro has done better than the Dollar:
2) At the end of 2010 the total foreign net debt (private and public) of Italy was $0.5 trillion (26% of GDP) while that of the US was $2.47 trillion (17% of GDP); the current account deficit of the two countries was identical (3.24% of GDP); and the total central government debt was 109% of GDP in Italy and 61.3% in the US.
3) Yet the markets are pricing their sovereign debt in a way quite unrelated to these fundamentals (yesterday the 10-year Yield for Italy reached 7.48% while in the US it was at 2.01%):
This is clearly a speculative attack against the Euro itself.
Yet, the ECB seems hand-tied to do anything to repel such attack. By hiding behind its statutory limitations in lending to sovereigns; waiting for successive failed schemes of Merkel-Sarkozy to deal with the sovereign debt problems of Greece, Ireland and Portugal; and sticking to self-defeating half-hearted bond buying in the market, the ECB risks letting the downfall of the Euro occur before its own eyes.
This does not need to be so. By itself, the ECB can kill this speculative attack. First, it needs to point out to the European Union governments that if they persist in a simultaneous suicidal pursuit of restrictive budgetary policies it will need to offset them by pursuing an aggressive expansionary monetary policy. Second, it needs to send a strong message to the markets that, if necessary, it is ready to act as lender of last resort for the Governments under attack.
Here is a suggestion of how it can be done. The ECB should replace its bond-buying in the secondary market (which is fueling the speculation) by a new bank lending facility that in practice would work as back to back loan to the governments. There are various ways to structure such facility within the current lending practices of the ECB; and, as long as the loans would not feed back into the market, they would work.
1) For a currency that is in risk of imploding, the Euro has done better than the Dollar:
2) At the end of 2010 the total foreign net debt (private and public) of Italy was $0.5 trillion (26% of GDP) while that of the US was $2.47 trillion (17% of GDP); the current account deficit of the two countries was identical (3.24% of GDP); and the total central government debt was 109% of GDP in Italy and 61.3% in the US.
3) Yet the markets are pricing their sovereign debt in a way quite unrelated to these fundamentals (yesterday the 10-year Yield for Italy reached 7.48% while in the US it was at 2.01%):
This is clearly a speculative attack against the Euro itself.
Yet, the ECB seems hand-tied to do anything to repel such attack. By hiding behind its statutory limitations in lending to sovereigns; waiting for successive failed schemes of Merkel-Sarkozy to deal with the sovereign debt problems of Greece, Ireland and Portugal; and sticking to self-defeating half-hearted bond buying in the market, the ECB risks letting the downfall of the Euro occur before its own eyes.
This does not need to be so. By itself, the ECB can kill this speculative attack. First, it needs to point out to the European Union governments that if they persist in a simultaneous suicidal pursuit of restrictive budgetary policies it will need to offset them by pursuing an aggressive expansionary monetary policy. Second, it needs to send a strong message to the markets that, if necessary, it is ready to act as lender of last resort for the Governments under attack.
Here is a suggestion of how it can be done. The ECB should replace its bond-buying in the secondary market (which is fueling the speculation) by a new bank lending facility that in practice would work as back to back loan to the governments. There are various ways to structure such facility within the current lending practices of the ECB; and, as long as the loans would not feed back into the market, they would work.
Friday, 4 November 2011
Democracy and the Euro-Greek Tragicomedy
It appears that Aristotle defined tragicomedy as a serious action with a happy ending. So can we write the recent tragedy of the Greek bailout and the ongoing comic infighting of the Greek politicians as a prelude to a plot with a happy ending?
Last night’s refusal to agree on a Greek government of national salvation might lead to either new elections or a referendum on the bailout program. This should be the democratic way to solve the current deadlock. The people should be given the last word; even if the results leave the nation divided in two almost identical camps the winning camp has the mandate to carry out his policies. That is the foundation of democracy and it is preferable to forcing the Greeks to accept the undemocratic tutelage of the shameful duo Merkel-Sarkozy.
Now, let’s imagine that the camp opposing the current bailout wins and decides to declare a unilateral default on the Icelandic-style, but decides to keep the Euro. This is the scenario feared by the “very serious people in pin stripes” and some economists who fear the contagion of a disorderly bail-out.
What can Mr. Juncker, Draghi and Barroso do about it? According to Mr. Barroso the Lisbon Treaty does not have any legal mechanism to expel a Euro-zone member. Mr. Draghi’s interpretation of the European Central Bank remit is that it does not include any responsibility as lender of last resort for any member country. Mr. Junker’s Eurogroup meeting of the Finance Ministers of the Eurozone countries was institutionalized by the Lisbon treaty without any power over its members. So, let us image also that they decide to do nothing.
Would this mean the end of the Eurozone? In principle no! For instance, in the Dollarzone (USA) when a local government defaults on its Muni-bonds the Federal Bonds barely move. Yes, I know, the USA has a Federal budget. However, its interstate transfers are not enough to justify the decoupling between the Munis and the Treasuries. What is different is that the FED (the US central bank) has an implicit remit to bailout the major banks whose failure would represent a systemic risk as it has shown in the crisis of 2008.
This is a key weakness of the current ECB thinking. Should the markets attack the other highly leveraged countries to an extent that would bankrupt some of their major banks in those countries the ECB might feel restrained in continuing to lend to such countries.
Indeed, as illustrated by its continuing purchase of low quality securities, the ECB does not need to have an explicit lender of last resort mandate enshrined in the European Union treaty. Nor does it need to take massive losses on its ABS holdings, as has been propagated by the German Press. For instance, it can simply print money to finance an off-balance sheet vehicle to park such securities and ask the EFSF and the Governments rescued to share on its capitalization.
So here is a script for a happy ending to the Greek tragicomedy:
1) Greece reasserts its firm commitment to remain in the Euro;
2) Greece defaults on its debts and goes to the London and Paris clubs for a restructuring deal with better terms than those currently on offer;
3) To support the debt restructuring program Greece applies to the IMF for a new extended facility;
4) Meanwhile the ECB extends an unlimited liquidity line to one or two of the best Greek banks to keep the financial system afloat, subject to Greece agreeing to points 1-3;
5) The ECB announces that it will provide such lines to any other member who needs them;
6) To kill any doubts about its own strength the ECB will begin selling its low quality assets to special purpose vehicles;
7) Faced with such determination the markets will begin pricing the sovereign debt spreads of the various Eurozone members in accordance with their respective risk profile; and
8) After the successful implementation of programs 2 and 3, Greece regains market access within three years.
Here is the lesson from such tragicomedy. One should never give up on the ability of democracy to find a solution. It may be convoluted; it may take some time, but it will be better than a dictatorial solution under a veil of technocracy or to a shameful begging for help from a mixed bag of world leaders gathering in the G20 group.
Last night’s refusal to agree on a Greek government of national salvation might lead to either new elections or a referendum on the bailout program. This should be the democratic way to solve the current deadlock. The people should be given the last word; even if the results leave the nation divided in two almost identical camps the winning camp has the mandate to carry out his policies. That is the foundation of democracy and it is preferable to forcing the Greeks to accept the undemocratic tutelage of the shameful duo Merkel-Sarkozy.
Now, let’s imagine that the camp opposing the current bailout wins and decides to declare a unilateral default on the Icelandic-style, but decides to keep the Euro. This is the scenario feared by the “very serious people in pin stripes” and some economists who fear the contagion of a disorderly bail-out.
What can Mr. Juncker, Draghi and Barroso do about it? According to Mr. Barroso the Lisbon Treaty does not have any legal mechanism to expel a Euro-zone member. Mr. Draghi’s interpretation of the European Central Bank remit is that it does not include any responsibility as lender of last resort for any member country. Mr. Junker’s Eurogroup meeting of the Finance Ministers of the Eurozone countries was institutionalized by the Lisbon treaty without any power over its members. So, let us image also that they decide to do nothing.
Would this mean the end of the Eurozone? In principle no! For instance, in the Dollarzone (USA) when a local government defaults on its Muni-bonds the Federal Bonds barely move. Yes, I know, the USA has a Federal budget. However, its interstate transfers are not enough to justify the decoupling between the Munis and the Treasuries. What is different is that the FED (the US central bank) has an implicit remit to bailout the major banks whose failure would represent a systemic risk as it has shown in the crisis of 2008.
This is a key weakness of the current ECB thinking. Should the markets attack the other highly leveraged countries to an extent that would bankrupt some of their major banks in those countries the ECB might feel restrained in continuing to lend to such countries.
Indeed, as illustrated by its continuing purchase of low quality securities, the ECB does not need to have an explicit lender of last resort mandate enshrined in the European Union treaty. Nor does it need to take massive losses on its ABS holdings, as has been propagated by the German Press. For instance, it can simply print money to finance an off-balance sheet vehicle to park such securities and ask the EFSF and the Governments rescued to share on its capitalization.
So here is a script for a happy ending to the Greek tragicomedy:
1) Greece reasserts its firm commitment to remain in the Euro;
2) Greece defaults on its debts and goes to the London and Paris clubs for a restructuring deal with better terms than those currently on offer;
3) To support the debt restructuring program Greece applies to the IMF for a new extended facility;
4) Meanwhile the ECB extends an unlimited liquidity line to one or two of the best Greek banks to keep the financial system afloat, subject to Greece agreeing to points 1-3;
5) The ECB announces that it will provide such lines to any other member who needs them;
6) To kill any doubts about its own strength the ECB will begin selling its low quality assets to special purpose vehicles;
7) Faced with such determination the markets will begin pricing the sovereign debt spreads of the various Eurozone members in accordance with their respective risk profile; and
8) After the successful implementation of programs 2 and 3, Greece regains market access within three years.
Here is the lesson from such tragicomedy. One should never give up on the ability of democracy to find a solution. It may be convoluted; it may take some time, but it will be better than a dictatorial solution under a veil of technocracy or to a shameful begging for help from a mixed bag of world leaders gathering in the G20 group.
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