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04-01-2013, 11:46 PM
(This post was last modified: 04-02-2013, 02:38 AM by admin.)
In southern Europe the hurdle for a case in favour of eurozone exit is shockingly low
It is a question that I have been asking myself for a while: at what point does it become economically rational for a country to leave the eurozone?
There are two things to consider. The first is whether the country’s banking system is viable in the presence of an imperfect banking union – one that will not share any risks in the foreseeable future. The second is whether public and private sector debts are sustainable, given the country’s present and expected future growth rates.
For Cyprus, the answers to both questions are no. The decision to bail in shareholders, bondholders and uninsured depositors would have been logical if the eurozone had a full banking union. There would be no bank run as all banks would be reinsured centrally.
In this parallel universe, one could have wound down Cyprus’s second-largest bank without collateral damage to the wider banking system, or to the Cypriot economy. The US shows how this works: if the Federal Deposit Insurance Corporation raids a bank in San Francisco, and bails in uninsured depositors, there is no bank run on neighbouring banks as California is not liable for the banking system. Instead the US has a federal resolution authority and deposit insurance system.
But as each eurozone country remains responsible for their banking systems, Cyprus had no choice but to impose capital controls after the bail-in. Despite official protestations, these controls will persist for a very long time. The authorities have in effect launched a new parallel currency convertible to the standard euro at an exchange rate of one to one, but only up to €5,000, the monthly transfer limit. It is not hard to imagine that exit from the eurozone would have been more traumatic to the population, but it would have brought the benefit of a devalued exchange rate.
And that answers the second question. Cyprus is more likely to return to debt sustainability outside the eurozone, because a lower exchange rate would reduce net debt, and because of a faster resumption of economic growth.
The same is ultimately true of Spain as well. Jeroen Dijsselbloem, Dutch finance minister and president of the eurogroup of eurozone finance ministers, unwittingly answered that question when – in an interview with the Financial Times – he shocked the world by telling the truth. It is now the stated policy of the creditor countries to solve the problem of a debt overhang in the banking sector in the peripheral countries through the bail-in of bondholders and depositors.
Just think this one through. Minus its two largest banks – BBVA and Santander – Spain’s banking system is broke, even after recently agreed small recapitalisations. The housing bubble is no longer the main problem, but the ongoing depression is likely to last for most of the decade, given current policies.
The logical consequence of Mr Dijsselbloem’s dictum and the reality of austerity and a deficient banking union is a future bail-in of Spanish bank bondholders and depositors.
The problem is that even insured deposits will then not be protected. Look at what happens in Cyprus, where capital controls affect small and large deposits alike. I would expect that to happen in Spain as well. Given the stated policy, it is logically irrational for any Spanish saver to keep even small amounts of savings in the Spanish banking system. There is no way that the Spanish state can guarantee the system without defaulting itself.
The consequence is that for Spain, too, it will eventually become economically rational to leave the eurozone. The best moment would be the time when the country achieves a fiscal balance before the payment of interest on debt.
The same is also true of Greece, where economic growth keeps undershooting the underlying assumptions in the official debt sustainability analysis. In the absence of a willingness by the creditor countries to agree another debt rollover programme, the same routine beckons – more bail-ins, including of Greek bank depositors.
And Italy? Its public sector debt, approaching 130 per cent of gross domestic product, is sustainable if the country manages to return to economic growth rates of 2 per cent. With growth just a little over zero for the past 15 years, it is unclear what a government can do to bring this change about. It would require big downward wage adjustments in the private sector, and efficiency gains in the public sector.
Italy’s next government would have to confront vested interests on lines similar to what happened in the UK in the early 1980s. If the political gridlock could not be resolved to achieve this effect, Italian society would be heading for a straight choice between a default inside the eurozone, or exit.
The first of these choices would be really toxic, especially for depositors. If you believe Mr Dijsselbloem, as I do, then it would be rational for every southern European to take their money out of the country and deposit it outside the eurozone.
In an environment in which the creditor countries refuse a genuine banking union, the hurdle for an economic case in favour of leaving the eurozone is shockingly low. Of course, economics may not be the main criterion in a country’s decision. In the short term, politics may trump economics. But in the long run, you cannot operate a monetary union in the face of economic logic.
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It's the gold standard minus the shiny rocks
(Reuters)
In the beginning, it was just the "Greek debt crisis". Then markets realized Portugal, Ireland, Italy, and Spain were in bad shape too, and the PIIGS ( or GIIPS) were born. But now Cyprus and Slovenia have run into trouble as well, giving us the ... SIC(K) PIGS? At this rate, we're going to have to buy a vowel soon, assuming Estonia doesn't end up needing a bailout.
The euro crisis is entering its fourth year, and, sorry world, this won't be its last. Now, its long periods of boredom have gotten a bit longer, and its moments of sheer financial terror a bit less terrifying ever since the European Central Bank (ECB) promised to do " whatever it takes" to save the common currency. But, as Cyprus and Slovenia show, the battle for the euro isn't over yet. Not even close.
Here's the Cliff Notes version of the euro crisis. The euro zone doesn't have the fiscal or banking unions it needs to make monetary union work, and it's not close to changing that. In the meantime, the euro's continuing flaws continue to suck countries into crisis. And their politics get radicalized. Most recently, Cyprus was forced to accept a bailout and bail-in, because its too-big-to-save banks made some horrendously bad bets on Greek bonds. Slovenia looks like it could next on the euro-bailout tour, because, as Dylan Matthews of the Washington Post points out, its too-big-to-save-ish banks made some horrendously bad bets on its own companies. Now, banks make bad bets all the time, but those bad bets can bankrupt you as a country if you don't have your own central bank. Like euro countries.
Of course, this " diabolic loop" between weak banks and weak sovereigns isn't the only problem in euroland. The common currency has plenty of other flaws. Here's why the euro, as it's currently constructed, is a doomsday device for mass bankruptcy. (How's that for solidarity?).
1. Too Tight Money
The euro zone isn't what economists call an "optimal currency area". In other words, it was a bad idea. Its different members are different enough that they should have different monetary policies. But they don't. They have the ECB setting a single policy for all 17 of them. That's a particular problem for southern Europe now, because their wages are uncompetitively high relative to northern European ones, and the ECB isn't helping them out.
There are two ways to fix this intra-euro competitiveness gap. Either northern European wages rise faster than normal while southern wages stay flat, or northern European wages grow normally while southern European wages fall. It's the difference between a bit more inflation or not -- in other words, between looser ECB policy or the status quo. Now, it might not sound like it really matters which option they choose, but it very much does. Falling wages make it harder to pay back debts that don't fall, setting off a vicious circle into economic oblivion. The ECB apparently prefers pushing more and more countries into oblivion with too tight money than risk anything resembling more inflation.
2. Too Tight Budgets
Austerity has been a complete disaster. It's actually increased debt burdens across southern Europe, because it's reduced growth more than it's reduced borrowing costs. And now northern Europe is getting in on the act. France (which is really somewhere in between "southern" and "northern"  just missed its deficit target, and is set to slash more; the Netherlands has put through contentious tax hikes and spending cuts, even as its economy has shrunk; and even Germany is contemplating new budget-saving measures. In other words, the euro has become an austerity suicide pact.
3. Too Little Trade
Excluding Germany, just over half of all euro trade is with each other. But with bad policy pushing southern Europe into depression and northern Europe towards recession, euro zone countries can't afford to buy as much stuff from each other. That adds a degree of difficulty to recovery for southern European countries that need to export their way out of trouble. As you can see in the chart below from Eurostat, intra-euro zone trade has stagnated the past few years after rebounding from its post-crash depths. The euro zone's weak links are dragging the rest down -- but only because the rest refuse to pull the weak ones up.
4. Too Much Financial Interconnection
Other country's problems can quickly become your own if your banks own their bonds. Especially if your banks are bigger than your economy. That's the lesson Cyprus learned the very hard way after its banks loaded up on Greek debt in 2010, only to get wiped out a year later. The Financial Times has a great infographic (that you should play around with) on which country's banks are exposed to which other country's debt across the euro zone. As you can see below, any kind of Italian restructuring would be tremendously bad for French banks.
The euro is the gold standard minus the shiny rocks. Both force countries to give up their ability to fight recessions in return for fixed exchange rates and open capital flows. But giving up the ability to fight recessions just makes it easier for recessions to turn into depressions. And that puts all of the pressure on wages to adjust down when a shock hits -- the most painful and destructive way of doing things.
But the gold standard had an even bigger design flaw than creating depressions. That was perpetuating depressions. Under the rules of the game, countries short on gold were supposed to raise interest rates, which would push down wages, and push up exports. More exports would mean more gold, and then lower interest rates. But there was an asymmetry. Countries needed gold to create money, but countries didn't need to create money if they had gold. During the Great Depression, the U.S. and France sucked up most of the world's gold, but didn't turn it into money out of fear of nonexistent inflation. Countries that needed gold needed to push down wages even more to make their exports competitive -- not that there were any booming markets for them to export to due to the self-inflicted economics wounds of the U.S. and France. Instead, the depression just fed on itself.
The euro suffers from a similar asymmetry. Debtor-euro countries are to cut wages and deficits, but creditor-euro countries aren't forced to increase wages and deficits. Perversely, the opposite. In other words, northern Europe isn't doing enough to offset the demand destruction in southern Europe. And it's sinking them all. Even worse, this slow-motion collapse is turning loans that would have otherwise been good into losses -- losses that force bailouts and faster collapses. But, to be clear, this isn't only a problem for the periphery. As the U.S. and France found out in the 1930s, it's generally not a good idea to force your customers into bankruptcy. That just creates depression without end -- until the gold (or euro) standard ends. It's no coincidence that the countries that ditched the gold standard first recovered from the Great Depression first.
History doesn't need to repeat, or even rhyme. Europe doesn't have to keep crucifying itself on a cross of euros, the gold standard of the 21st-century. The euro's northern bloc could decide to let the ECB do more. Or it could decide to start spending more. Or not. Eurocrats seem content to do just enough to keep everything from falling apart, and nothing more. It's one part inflationphobia, and another part strategy. Indeed, it's how they try to keep the pressure on the southern bloc to push through unpopular labor market reforms. But doing enough today eventually won't be enough tomorrow if the southern bloc doesn't have any hope of recovering within the euro. The politics will turn against the common currency long before that.
By that point, Europe won't need an acronym anymore.
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We have long argued the euro worked like the gold standard:
And we too argued it's a disaster
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Published: May 17, 2012
Suddenly, it has become easy to see how the euro — that grand, flawed experiment in monetary union without political union — could come apart at the seams. We’re not talking about a distant prospect, either. Things could fall apart with stunning speed, in a matter of months, not years. And the costs — both economic and, arguably even more important, political — could be huge.
This doesn’t have to happen; the euro (or at least most of it) could still be saved. But this will require that European leaders, especially in Germany and at the European Central Bank, start acting very differently from the way they’ve acted these past few years. They need to stop moralizing and deal with reality; they need to stop temporizing and, for once, get ahead of the curve.
I wish I could say that I was optimistic.
The story so far: When the euro came into existence, there was a great wave of optimism in Europe — and that, it turned out, was the worst thing that could have happened. Money poured into Spain and other nations, which were now seen as safe investments; this flood of capital fueled huge housing bubbles and huge trade deficits. Then, with the financial crisis of 2008, the flood dried up, causing severe slumps in the very nations that had boomed before.
At that point, Europe’s lack of political union became a severe liability. Florida and Spain both had housing bubbles, but when Florida’s bubble burst, retirees could still count on getting their Social Security and Medicare checks from Washington. Spain receives no comparable support. So the burst bubble turned into a fiscal crisis, too.
Europe’s answer has been austerity: savage spending cuts in an attempt to reassure bond markets. Yet as any sensible economist could have told you (and we did, we did), these cuts deepened the depression in Europe’s troubled economies, which both further undermined investor confidence and led to growing political instability.
And now comes the moment of truth.
Greece is, for the moment, the focal point. Voters who are understandably angry at policies that have produced 22 percent unemployment — more than 50 percent among the young — turned on the parties enforcing those policies. And because the entire Greek political establishment was, in effect, bullied into endorsing a doomed economic orthodoxy, the result of voter revulsion has been rising power for extremists. Even if the polls are wrong and the governing coalition somehow ekes out a majority in the next round of voting, this game is basically up: Greece won’t, can’t pursue the policies that Germany and the European Central Bank are demanding.
So now what? Right now, Greece is experiencing what’s being called a “bank jog” — a somewhat slow-motion bank run, as more and more depositors pull out their cash in anticipation of a possible Greek exit from the euro. Europe’s central bank is, in effect, financing this bank run by lending Greece the necessary euros; if and (probably) when the central bank decides it can lend no more, Greece will be forced to abandon the euro and issue its own currency again.
This demonstration that the euro is, in fact, reversible would lead, in turn, to runs on Spanish and Italian banks. Once again the European Central Bank would have to choose whether to provide open-ended financing; if it were to say no, the euro as a whole would blow up.
Yet financing isn’t enough. Italy and, in particular, Spain must be offered hope — an economic environment in which they have some reasonable prospect of emerging from austerity and depression. Realistically, the only way to provide such an environment would be for the central bank to drop its obsession with price stability, to accept and indeed encourage several years of 3 percent or 4 percent inflation in Europe (and more than that in Germany).
Both the central bankers and the Germans hate this idea, but it’s the only plausible way the euro might be saved. For the past two-and-a-half years, European leaders have responded to crisis with half-measures that buy time, yet they have made no use of that time. Now time has run out.
So will Europe finally rise to the occasion? Let’s hope so — and not just because a euro breakup would have negative ripple effects throughout the world. For the biggest costs of European policy failure would probably be political.
Think of it this way: Failure of the euro would amount to a huge defeat for the broader European project, the attempt to bring peace, prosperity and democracy to a continent with a terrible history. It would also have much the same effect that the failure of austerity is having in Greece, discrediting the political mainstream and empowering extremists.
All of us, then, have a big stake in European success — yet it’s up to the Europeans themselves to deliver that success. The whole world is waiting to see whether they’re up to the task.
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The last month of data flow from Europe is nothing short of depressing. It seems that the history of the Eurocrisis can be summed up as a repeated effort to snatch failure from the jaws of defeat. The Euro and the policy framework that supports it is now clearly inconsistent with anything but sustained recession.
Consider a handful of recent reports. First, unemployment continues to reach new highs. From Bloomberg:
Unemployment in the 17-nation euro area was 12 percent in February and the January figure was revised up to the same level from 11.9 percent estimated earlier, the European Union’s statistics office in Luxembourg said today...The European Commission predicts unemployment rates of 12.2 percent this year and 12.1 percent in 2014. ECB President Mario Draghi said on March 7 that “it is of particular importance at this juncture to address the current high long-term and youth unemployment.”
I don't think that 12.2 percent forecast will hold. Greece remains a complete disaster. Via Aljazeera:
Greece's unemployment rate reached a new record of 27.2 percent in January, new data has showed, reflecting the depth of the country's recession after years of austerity imposed under its international bailout.
The latest figure rose from a revised 25.7 percent in December, the country's statistics service ELSTAT said on Thursday...Unemployment among youth aged between 15 and 24 stood at 59.3 percent in January, up from 51 percent in the same month in 2012.
Meanwhile, the Troika continues to demand further job cuts in return for a drip feed of bailouts that have arguably done little other than ensure Greece remains in recession:
An inspection team of international lenders has finished its review of Greece's reform progress, paving the way for another 10 billion euros aid payment, a source with knowledge of the talks said on Saturday....Under Greece's current bailout plan agreed in November, Athens must overall cut 150,000 public sector jobs from 2010 to 2015, about a fifth of the total, through hiring curbs, retirements and dismissals.
As a consequence, the stage is being set for another political crisis in Greece. Ekathimeri reports:
The head of the main leftist opposition SYRIZA, Alexis Tsipras, called on Saturday for the shaky coalition government to step down and pave the way for new elections, claiming that this was “the only way out” for a country seemingly condemned to endless austerity...
...“The situation has reached the absolute limit,” the leftist leader told supporters. “At this moment, there is no other way out for the country than the resignation of the government and the staging of new elections so a new administration can emerge with the mandate and support of the majority of society to implement an alternative plan to exit the crisis.” Tsipras admitted that his plan entailed risks but was preferable to “certain failure.”
Is the price of staying in the Euro finally now too high? Meanwhile, Ambrose Evans-Pritchard reminds us that both Cyprus have gone from bad to worse:
On cue, Angela Merkel's Christian Democrat base in the Bundestag has warned that there can be no increase in the EU-IMF rescue package for Cyprus.
The Cypriot people alone must carry the extra cost of up to €5.5bn beyond what was already agreed in the €17.5bn deal in March.
"Should that not be possible, the assent of the German Bundestag next week is out of the question," said Christian von Stetten, a key member of the finance committee.
And Evans-Pritchard repeats a point that cannot be repeated enough:
If the eurozone refuses to offer any further help, there must surely be a greater temptation to withdraw from the euro and default on sovereign debt in a classic restructuring deal with the IMF.
That is what the IMF is there to do. Such restructurings have been done countless times across the world over the last 50 years. It is traumatic, but countries usually recover after a couple of years.
Currency depreciation is a critical element of traditional IMF restructurings. The inability of troubled Eurozone economies to depreciate remains a key impediment to their return to growth; there is simply no cushion to offset the never-ending austerity. Speaking of never-ending austerity, Evans-Pritchard reviews the situation in Portugal:
So Cyprus is very far from being solved, and so is Portugal. A fresh Troika leak, this time to the Pink Sheet, has confirmed what anybody following Portugal already suspected. The country is stuck in a debt-compound trap. The economic slump is proving much deeper than forecast. The deficit has been rising not falling, in spite of austerity cuts.
And, increasing, it is not just periphery. From Reuters:
Manufacturing across Europe's major economies endured another month of mostly deep decline in March, dragging down even former bright spots, surveys showed on Tuesday....
Factories in Germany and Ireland, the relative stars of February's PMIs, fell back into decline last month. Everywhere else, the industrial rot extended.
Spanish manufacturing declined at its fastest pace since October, which followed news the government will revise its economic forecasts for 2013 to show a 1 percent contraction, from a 0.5 percent decline previously.
In France, factory activity retreated for a 13th month and car registrations there dived 16.4 percent in March, further underlining the malaise sweeping through the euro zone's second-biggest economy.
"The euro zone's March manufacturing PMIs ... (banishes) the recovery scenario projected by the European Central Bank further beyond the realm of likely probabilities," said Lena Komileva from G+ Economics in London.
The ongoing deterioration in Europe is evident to everyone except European policymakers. Clive Crook wonders at European Commission President Jose Barroso's outlook:
Barroso's optimism on Europe's economic recovery, if you can call it a recovery, was harder to understand. This week the IMF's Christine Lagarde talked of a three-speed world: "countries that are doing well, those that are on the mend, and those that still have some distance to travel.” (In other words, fast growth in many emerging economies, slow growth in the U.S., and no growth in Europe.) The euro area's economy is still shrinking. Yet Barroso still thinks (or says he thinks) that policy has been mostly well-judged and the union will emerge stronger from its ordeal.
He noted early on that Europe's public debts still aren't high by U.S or Japanese standards. True -- and that's the point. The EU is insisting on austerity in its weakest economies even though, in the aggregate, its fiscal problem is manageable. The failure to create effective burden-sharing arrangements -- some form of limited fiscal union to work alongside its monetary union -- has been the euro area's biggest error, not counting the creation of the euro itself. And the consequences are crushing countries such as Spain and Barroso's own Portugal.
Note that fiscal union is not the same as an austerity union. The former allows for internal transfer of the type Crook describes. The latter is simply a joint commitment to austerity. But austerity is the only policy possible within the European framework. Calculated Risk caught German Finance Minister Wolfgang Schauble wallowing in self-delusion:
"Nobody in Europe sees this contradiction between fiscal policy consolidation and growth,” Schauble said. “We have a growth-friendly process of consolidation, and we have sustainable growth, however you want to word it.”
With no depreciation for crisis-stricken economies, no fiscal stimulus, and tight credit conditions through half of Europe as banking consolidates within national boundaries, what exactly is the road forward for Europe? I just don't see it.
Bottom Line: How high does unemployment need to rise, how much output needs to be lost, how much poverty must be endured before European policymakers realize that the framework supporting the Euro politcally is an economic failure?
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Tim Duy asks, when can we all admit that the euro is a failure? The answer, of course, is never. Too much history, too many declarations, too much ego is invested in the single currency for those involved ever to admit that maybe they made a mistake. Even if the project ends in total disaster, they will insist that the euro didn’t fail Europe, Europe failed the euro.
But it it occurs to me that it might be a good idea for me to recapitulate my view of what really ails Europe, and what could yet be done.
So, start with Europe as it was in the late 1990s. It was a continent with many problems, but nothing resembling a crisis, and not much sign of being on an unsustainable path. Then came the euro.
The first effect of the euro was an outbreak of europhoria: suddenly, investors believed that all European debt was equally safe. Interest rates dropped all around the European periphery, setting off huge flows of capital to Spain and other economies; these capital flows fed huge housing bubbles in many places, and in general created booms in the countries receiving the inflows.
The booms, in turn, caused differential inflation: costs and prices rose much more in the periphery than in the core. Peripheral economies became increasingly uncompetitive, which wasn’t a problem as long as the inflow-fueled bubbles lasted, but would become a problem once the capital inflows stopped.
And stop they did. The result was serious slumps in the periphery, which lost a lot of internal demand but remained weak on the external side thanks to the loss of competitiveness.
This exposed the deep problem with the single currency: there is no easy way to adjust when you find your costs out of line. At best, peripheral economies found themselves facing a prolonged period of high unemployment while they achieved a slow, grinding, “internal devaluation”.
The problem was greatly exacerbated, however, when the combination of slumping revenues and the prospect of protracted economic weakness led to large budget deficits and concerns about solvency, even in countries like Spain that entered the crisis with budget surpluses and low debt. There was panic in the bond market — and as a condition for aid, the European core demanded harsh austerity programs.
Austerity, in turn, led to much deeper slumps in the periphery — and because peripheral austerity was not offset by expansion in the core, the result was in fact a slump for the European economy as a whole. One consequence has been that austerity is failing even on its own terms: key measures like debt/GDP ratios have gotten worse, not better.
At a couple of points, this ugly scene has threatened to create an immediate European meltdown, with political unrest causing a loss of financial confidence causing a run on sovereign debt causing a run on the banks, and so on into a vicious circle. So far, however, the ECB has managed to contain the threat of meltdown by intervening, indirectly or directly, to support sovereign debt. But while financial panic has been contained, the underling macroeconomics just keep getting worse.
What could Europe be doing differently? From early on in the crisis, critics like me urged a three-part response. First, ECB intervention to stabilize borrowing costs. Second, aggressive monetary and fiscal expansion in the core, to ease the process of internal adjustment. Third, a softening of austerity demands on the periphery — not zero austerity, but less, so that the human costs would be less. We eventually got part 1, more or less — but nothing on parts 2 and 3.
And European officials remain in deep denial about the fundamentals of the situation. They continue to define the problem as one of fiscal profligacy, which is only part of the story even for Greece, and none of the story elsewhere. They keep declaring success for austerity and internal devaluation, using any excuse at hand: a spurious surge in measured Irish productivity becomes evidence that internal devaluation is working, the decline in bond yields following ECB intervention is proclaimed as a vindication of austerity.
So that’s where we are. And it’s hard to envisage a happy ending.
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Old ways die hard. Two months after Italian voters rebelled in fury against the establishment, the country’s elites have chosen yet another insider to be leader
Anarchist comedian Beppe Grillo – patron of the Five Star bloc in parliament – called the shadowy manouevres that led to this a “coup d’etat”, orchestrated over a “quiet weekend of vomit”.
Incoming prime minister Enrico Letta is no doubt a decent, steady, honourable technocrat. He has good intentions. He vowed on Wednesday to lead the charge against austerity in Europe.
Yet it is hard to imagine a man less inclined to throw down the gauntlet and force a radical change in EU policy before Italy’s economy chokes to death. He grew up in Strasbourg. He wrote his PhD on EU community law.
He is just as wedded to the EU Project as the man he replaces, ex-EU commissioner Mario Monti, who surrounded himself in Rome with Brussels emigres still on the EU payroll.
Italy’s business lobby Confindustria said this week that austerity policies had caused “devastating damage, comparable with a war”. This follows its warning that the country faces a “full credit emergency”.
One hates to cite Grillo as an authority, but he was more right than wrong to warn on Wednesday that Italy is running out of time. “A firm is closing every minute. By autumn we will have reached the point of no return.”
Let me be clear, Italy is not a fundamental basket case. The European Central Bank’s wealth survey shows that average household assets are €275,000 (£234,000), compared with €195,000 for Germany, or €170,000 for Holland.
Private debt is lower than in Holland, France, the US, Britain or Japan. Its International Investment Position is near balance, unlike the Iberian disaster stories.
It has a primary surplus of 2.5pc of GDP, meaning it can leave EMU and regain competitiveness at any moment it wishes without facing a funding crisis.
It is often said that Italy’s bond yields would surge if it tried, but this muddles “nominal” and “real” rates.
North Europeans might fruitfully ask themselves who really stands to lose most from a showdown as they enforce contractionary policies on Rome.
Italy’s elemental problem is that it is in the wrong currency, with a chronically overvalued exchange within EMU and against the dollar and yuan. All else is manageable. How it got to this point is by now a tedious subject. Suffice to say that 15 years of creeping pay deals under the Scala Mobile have left it high and dry, with unit labour costs 30pc out of kilter with Germany.
What risks turning Italy into an EMU-created basket case is the ill-judged austerity policy forced upon it. There was no economic justification for fiscal tightening of 3.2pc of GDP last year. It was overkill. The budget had been near primary surplus for five years. Public debt was stable at around 120pc of GDP.
The situation had become urgent only because EMU had no lender of last resort at that point. The crisis in Greece, Portugal and Ireland was unfairly infecting Italy.
The ECB has since stepped up to its responsibility. But the quid pro quo for Italy itself was slash-and-burn cuts. This grave error shattered political consensus for the reforms that Italy really does need, and has been largely self-defeating in economic terms.
Bank of Italy data show that the economy contracted by 2.4pc last year, national demand fell 5.3pc, and fixed investment fell 8pc. House sales have crashed and the economy has shrunk by 6.9pc since 2007. This is the profile of a country in depression.
To crown it all, public debt jumped from 121pc to 127pc of GDP last year. Italy is a big step closer to a debt compound spiral after the EU’s medieval cure than it was before.
It risks moving closer yet as Euroland lurches into a seventh quarter of self-imposed recession. Citigroup expects Italy’s GDP to contract by 1.6pc in 2013 and by 1.2pc in 2014, with near zero growth thereafter, ending in debt restructuring anyway.
Without Churchillian leadership, Italy seems doomed to this fate, attempting to restore viability within EMU by means of an “internal devaluation”, with youth unemployment pushing above 50pc in Naples and the cities of the Mezzorgiorno.
If Mr Letta thinks EU policy elites are retreating from the austerity, he will be disabused soon. Yes, Commission chief Jose Barroso let slip this week that Europe is “reaching the limits of the current policies” and must do more to secure popular support, but he says such things on and off.
He also insisted that the policy is “fundamentally right” and working in Ireland, a fond hope that the Celtic comeback – less clear than he states – can be replicated in countries with Ireland’s flexible labour markets and vibrant exports.
The Commission’s position was clear in a joint op-ed last week by currency chief Ollie Rehn. It claimed a string of successes – all dubious – and concluded that “the eurozone has shown a degree of resilience and problem-solving capacity that many observers and policymakers would not have predicted even a year ago”.
This is humbug. Only one thing has changed. The ECB has agreed to buy Spanish and Italian bonds if need be, under strict terms. It did so because the euro would have blown apart last summer if Chancellor Merkel had not authorised the bank to act.
The op-ed was co-signed by the Dutch head of the Eurogroup and two top German officials, and that is the point. The policy is being set by the AAA core. The Commission bends to power, and will not move unless the rest of EMU mobilises superior counter-power. All else has become irrelevant in the euro snake pit.
Mrs Merkel has not resiled from austerity, or “balancing the budget” as she says with seductive simplicity. By the time Mr Letta has learnt the hard way what this means, Italy will have lost yet more time to a pre-modern economic belief system.
it is possible that Berlin will warm to monetary stimulus now that Germany itself is flagging, with new orders crumbling, but it would take more than a quarter-point rate cut to repair the broken credit channels in Italy, Spain and Portugal.
If Mr Letta is lucky, he can hope to hold together a fractious “grand coalition” for a few months. It is hard to see how this can reverse the slow rot of debt deflation and job wastage.
The deeper crisis will grind on until the Italian people find a leader willing to play rough.
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The euro has a “limited chance of survival” and may only endure another five years, Kai Konrad, one of the German government’s closest economic advisers, has claimed.
In notably outspoken remarks for a senior German figure, Dr Konrad, chairman of a scientific council that advises the finance ministry, said: “Europe is important to me. Not the euro. And I would only give the euro a limited chance of survival.”
Asked whether he thought the single currency would last five years, the economist said: “A concrete period is hard to identify as it depends on so many factors. But five years sounds realistic.”
This pessimistic judgment by a senior adviser runs counter to the official German government view that the euro must be held together for the sake of unity in Europe. Dr Konrad’s remarks came in an interview with the newspaper Welt am Sonntag, on the debt crisis in Europe.
The economic adviser warned that: “No country can pile up debt without running the risk that their investors will pull the plug. It’s in each [country’s] interests to keep their own debts as small as possible.
"Where the limit lies has to be individually decided. That depends among other things on economic growth and the growth of population.”
Dr Konrad said that countries should have the freedom to get into debt, provided they carried the “sole responsibility” for these debts. He made his blunt remarks about the future of the euro, when the interviewer suggested that he was advocating a return to the nation state,
The German chancellor Angela Merkel has always insisted that she wants to preserve the single currency and maintain the eurozone in its current form.
In a speech to the Bundestag two years ago, she told German MPs: "Nobody should take for granted another 50 years of peace and prosperity in Europe ... that's why I say: If the euro fails, Europe fails.”
The German government's official line is that the euro is essential for the prosperity of an export-oriented nation.
Rather than accept the break-up of the euro, the German government is demanding tighter, Europe-wide controls over national budgets.
Finance minister Wolfgang Schaeuble recently warned against increasing liquidity to promote economic growth, though he has also acknowledged that the soaring unemployment of southern Europe needs to be addressed.
Mr Schaeuble said in an interview for the economic weekly Wirtschaftswoche: “We are dealing with almost an economic schizophrenia. Everyone says we have deficits that are too large and a high level of liquidity would make everything more dangerous. And then some say, but we have too little growth, and so we need more liquidity.”
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Oskar Lafontaine, the German finance minister who launched the euro, has called for a break-up of the single currency to let southern Europe recover, warning that the current course is "leading to disaster".
Mr Lafontaine said on the parliamentary website of Germany's Left Party that Chancellor Angela Merkel will "awake from her self-righteous slumber" once the countries in trouble unite to force a change in crisis policy at Germany's expense. Photo: Reuters
"The economic situation is worsening from month to month, and unemployment has reached a level that puts democratic structures ever more in doubt," he said.
"The Germans have not yet realised that southern Europe, including France, will be forced by their current misery to fight back against German hegemony sooner or later," he said, blaming much of the crisis on Germany's wage squeeze to gain export share.
Mr Lafontaine said on the parliamentary website of Germany's Left Party that Chancellor Angela Merkel will "awake from her self-righteous slumber" once the countries in trouble unite to force a change in crisis policy at Germany's expense.
His prediction appeared confirmed as French finance minister Pierre Moscovici yesterday proclaimed the end of austerity and a triumph of French policy, risking further damage to the tattered relations between Paris and Berlin.
"Austerity is finished. This is a decisive turn in the history of the EU project since the euro," he told French TV. "We're seeing the end of austerity dogma. It's a victory of the French point of view."
Mr Moscovici's comments follow a deal with Brussels to give France and Spain two extra years to meet a deficit target of 3pc of GDP. The triumphalist tone may enrage hard-liners in Berlin and confirm fears that concessions will lead to a slippery slope towards fiscal chaos.
German Vice-Chancellor Philipp Rösler lashed out at the European Commission over the weekend, calling it "irresponsible" for undermining the belt-tightening agenda.
The Franco-German alliance that has driven EU politics for half a century is in ruins after France's Socialist Party hit out at the "selfish intransigence" of Mrs Merkel, accusing her thinking only of the "German savers, her trade balance, and her electoral future".
It is unclear whether the EU retreat from austerity goes much beyond rhetoric. Mr Moscovici conceded last week that the budget delay merely avoids extra austerity cuts to close the shortfall in tax revenues caused by the recession.
The new policy allows automatic fiscal stabilisers to kick in, but France will stay the course on the original austerity. "It is not about relaxing the effort to cut spending. There will no extra adjustment just to satisfy a number," he said.
Mr Lafontaine said he backed EMU but no longer believes it is sustainable. "Hopes that the creation of the euro would force rational economic behaviour on all sides were in vain," he said, adding that the policy of forcing Spain, Portugal, and Greece to carry out internal devaluations was a "catastrophe".
Mr Lafontaine was labelled "Europe's Most Dangerous Man" by The Sun after he called for a "united Europe" and the "end of the nation state" in 1998. The euro was launched on January 1 1999, with bank notes following three years later. He later left the Social Democrats to found the Left Party.
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06-01-2013, 04:45 AM
(This post was last modified: 06-01-2013, 04:56 AM by admin.)
Joao Ferreira do Amaral on the cover of the Expresso newspaper's Revista magazine
Portugal is waking up. A new book calling for withdrawal from the euro and a return to the escudo has vaulted to the top of the bestseller list.
The professor has already secured the backing of Luís António Noronha Nascimento, the chief justice of Portugal’s Supreme Court.
This follows the apostasy of Jerónimo de Sousa, the Secretary-General of the Portuguese Communist Party, who has called for a referendum on both the euro and the EU. De Sousa says the EU is “unreformable”, has been hijacked by a “directorate” of dominant powers, and has led to the death of Portuguese sovereignty.
The new book makes a poignant parallel with Portugal’s subjugation by Phillip II of Spain, and its travails as a captive province of the Spanish Empire for 60 years.
“In 1581 Portugal surrendered to Spain. In 1992 it laid itself at the feet of a European Commission increasingly answering to Germany’s tune. There was no referendum, the voters were never consulted. The Portuguese elites, who hoped to benefit richly from European Structural Funds, cavalierly handed over our currency – and with it our monetary sovereignty. The rest is history.”
“From 2008 onwards, the European Commission broke with tradition and became an organ at the service of a new power. The Portuguese economy succumbed, choked by the new Mark. The tragedy was widely foretold in advance. In the 1990s several voices had alerted us to the dangers of joining the single currency”
One of them of course was the economist João Ferreira do Amaral himself, now relishing his bitter/sweet moment of vindication. The nub of his argument is that euro exit is not a luxury choice. It is the only possible way for Portugal to recover under the current EMU structure.
Unlike some, the Professor does not think the situation will get any better for Portugal if the eurozone crisis calms down. On the contrary, the deeper damage will be ever greater.
He warns that the euro could rise to $1.50 or $1.60 to the dollar, leading to the final devastation of Portugal’s manufacturing industry (which often competes directly with China, emerging Asia, and North Africa).
This debate was bound to occur eventually. Portugal’s EMU position is self-evidently untenable, though many on this blog thread insist otherwise.
Its combined (non-financial) public and private debt has hit 370pc of GDP, the highest in the world after Japan. The difference is that Japan remains a fully sovereign nation with a sovereign central bank and currency, and can therefore do something about it.
The Portuguese economy is shrinking by 3pc to 4pc a year and keeps missing its deficit targets – like Greece before it, though less dramatically – as it chases its own tail in a downward deflationary spiral. The crucial point is that “nominal” GDP is contracting violently. This means that the nominal debt load is rising on a shrinking nominal base, what is known as a negative “denominator effect”.
Do the leaders of Portugal fully understand the implications of this? Does the brilliant finance minister Vitor Gaspar – an ECB veteran – have a credible answer to this fundamental point? Does he recognise that the policy of internal devaluation must necessarily make this worse?
They hope to claw their way back to growth through exports as Ireland has done. Good luck to them, but remember that Ireland has an export gearing of 105pc of GDP and Portugal is nearer 30pc.
As unemployment punches above 18pc – or 39pc for youth – this experiment is graduating from unwise to cruel. My sympathies are entirely with Prof Ferreira do Amaral.
Yes, the government can keep things going, perhaps for a lot longer. The ECB’s new willingness to act as a lender of last resort removes the threat – or liberating effect, depending on your view – of a financial meltdown.
But the underlying problem persists. Portugal is in the wrong currency with an overvalued exchange rate for its needs, and the consequences are visibly ruinous.
A point worth remembering: Portugal’s net international investment position (NIIP) was in surplus in the early 1990s. It is now in deficit by almost 100pc of GDP.
The country was poor a generation ago but it was living within its means and was fundamentally in balance. It is the euro that has turned the country into a structural gargoyle.
Yes, euro exits means default, and that is something that the proud and honourable Portuguese people will struggle to avoid at all costs.
But they will be forced to default whether they remain in the euro or leave it – unless Euroland undergoes a Damascene conversion and opts for Abenomics – so this is a false debate.
The only relevant question is whether it makes sense to break Portuguese society on the wheel for year after year, or whether it is better to get the shock over and done with as Iceland has done. We routinely hear claims that euro exit would be catastrophic but has everybody forgotten that there is a body called the IMF that has fifty years experience nursing countries through such shocks?
The IMF formula is well-known: devaluation, debt-restructuring, supply-side reform, bridging finance at cheap rates, followed by recovery within a couple of years. Portugal would be just the same, if they act now. The longer they wait, the worse the lasting damage from labour hysteresis. There is nothing to be gained from waiting
Needless to say, most Portuguese voters still believe EMU propaganda, so this will be a long, long, saga.
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