Showing posts with label euro. Show all posts
Showing posts with label euro. Show all posts

Thursday, 10 April 2014

So what exactly can the ECB do, anyway?

My latest post at Forbes considers what the ECB's alternatives are for easing in the Eurozone:

The ECB is not going to do QE, or indeed any other form of monetary easing at the moment. But they are talking about it. And for the moment, it seems, talk is enough. The Euro is up and bond yields are down, even for Greece (which isbravely attempting to return to the capital markets this week). European stock markets are worrying about the Ukraine crisis. It’s back to business as usual.
But as Andrew Clare of Cass Business School caustically remarks, “markets won’t be satisfied forever with hot air”. Unless Euro area inflation somehow reverses its current downward trend – which seems unlikely, since the world is on a general disinflationary trend at the moment and the Euro area is hardly a stellar performer  – the ECB will eventually be forced to do more than talk.

Read on here.

UPDATE: The ratings agency Fitch is rather more positive about the ECB buying SME loan securitisations than I am.

Monday, 3 March 2014

The ECB is irrelevant and the Euro is a failure

My post at Pieria looking at the ECB's alternatives for monetary easing. 

The latest money supply figures from the Euro area are awful:



But there's very little the ECB can - or will - do about it. The problem is the combination of a common currency with national politics.....

Read the full article here.


Tuesday, 11 February 2014

It's the Euro, stupid

A few days ago the German constitutional court referred the question of the legality of the ECB’s Outright Monetary Transactions (OMT) to the European Court of Justice (ECJ), claiming that the ECB was straying into fiscal policy that was beyond its mandate and that OMT breached EU treaty directives outlawing monetary financing of governments.
The question of the legality of OMT has been a running sore ever since it wasfirst mooted in August 2012. The ECB has clearly stated that it regards OMT, or rather the threat of OMT, to be part of its monetary policy toolkit. It has nothing whatsoever to do with bailing out Eurozone sovereigns, although that may be an incidental effect. It’s all about the Euro.....
Read on here.

Saturday, 14 December 2013

Germany's investment problem

We all know that Euro membership has been of doubtful benefit to periphery countries such as Greece and Portugal. But Germany has been a net beneficiary of the Euro, hasn't it?

Not according to these charts from Albert Edwards (h/t Edward Harrison).



(larger image here)

Note the point on both charts where the trend changed sharply. Yes, it's 2000 - when the Euro was introduced. Admittedly, Germany's gross fixed investment was already declining, but after 2000 it fell off a cliff. And the current account decomposition chart shows us why. Note the collapse in borrowing by non-financial corporations from 2000 onwards. That is disappearing domestic private sector investment. In fact in 2009-10 NFCs were net saving. This is distinctly unhelpful in an economy which has seen gross fixed investment falling for the last twenty years.

To start with, it appears that government borrowing replaced private sector net borrowing. But even that declined from 2004 onwards, replaced by income from a growing current account surplus. Good news for German households, apparently. They increased their saving. But contrary to popular belief, their hard-earned savings have not been productively invested in the local economy. They have unproductively blown up sovereign and private debt bubbles in other countries. The German banking system - including the marvellous Sparkassen, whose equivalent some people would like to see in Britain - has not been doing its job.

Admittedly these charts only go as far as 2010. But they do not tell a story of a booming Germany benefiting from the single currency. They tell a story of a country from which productive investment is being drained by a banking system that sees greater returns elsewhere.

If the German banking system were genuinely a private, free-enterprise system, this would be understandable. But it is not. The majority of it is either state-owned or state-controlled, and even the parts of it that are not state-owned benefit from implicit sovereign guarantee. No way is Germany going to allow its bigger banks to fail: to do so would put at risk the prized Sparkassen, Volksbanken and Raffeisenbanken. It would surely be reasonable to expect that a state-backed banking system would principally invest domestically. But clearly, it doesn't. German domestic businesses can rightly feel that they have been let down by their banks.

But this is not entirely a story of banking. After all, savers expect banks to generate good returns on their savings, and if that can best be done by investing that money outside the country, then can we really blame banks for doing so? This is a story of the ECB's one-size-fits-all monetary policy and its insane insistence, prior to 2009, that all sovereign debt was of equal quality.

And it is also a story of too-tight fiscal policy. Instead of increasing its own borrowing to compensate for the fall in NFC borrowing, the German government gradually reduced its fiscal deficit - indeed in 2007 and 2008, it was net saving (running a surplus). On the face of it, this looks sensible: after all, we are led to believe that governments should net save during booms. But not, emphatically not, when there is a growing current account surplus. A persistent current account surplus is contractionary over the medium-term, because it by definition means that productive investment is leaving the country. Note how the domestic deficit (private and public sector) exactly parallels the current account surplus: as I've noted before, the larger the current account surplus, the greater the capital deficit, and that translates into reduced domestic investment. If Germany were not in a currency union, then the correct course of action would be to raise interest rates to encourage domestic investment. But Germany does not have that option. Its government should therefore have been borrowing to invest even during the boom, which would have had the effect of raising real interest rates. I know it seems counter-intuitive to suggest looser fiscal policy as a counter to too-loose monetary policy, but remember that the problem is lack of investment: if the private sector won't invest domestically (because real returns are higher elsewhere), then government must. When countries have no control of monetary policy, fiscal policy cannot be counter-cyclical.

So it seems that Germany has suffered from poor investment since the start of the Euro as a direct consequence not only of the ECB's interest rate policy but also of its own government's tight fiscal stance. And this story continues. The German government is intent on fiscal consolidation, even as the current account surplus grows ever larger in relation to GDP:

Graph of Total Current Account Balance for Germany


Increasing government investment in Germany would not necessarily mean the current account surplus fell, at least at first. It could be done on a balanced-budget basis, in which case it would mean reduced domestic consumption spending instead (government spending cuts and/or higher taxes, forcing the private sector to cut spending). Given that German GDP is stagnating at present, this is perhaps not the best course of action. Borrowing to finance increased government investment strikes me as a much better approach. This might mean that the German government would face higher borrowing costs - although savvy investors should regard an increase in German government debt for investment as a good thing. But it would stop the bleeding of capital investment from the domestic economy without squashing domestic demand.

The ghosts of Weimar need to be laid to rest. An increase in government borrowing to fund medium-term investment is not going to result in out-of-control inflation. But failure of capital investment due to an out-of-control capital account deficit will in the end impoverish Germany.

UPDATE. Via @wonkmonk_ on twitter, this special report by Natixis into the German current account surplus reaches the same conclusion as me. The fundamental problem is failure of private sector investment in Germany throughout the period of the euro - and it is very bad for Germany.

Thursday, 21 February 2013

A central bank crisis

Vox has an excellent article by the LSE's De Grauwe about the austerity measures in the Eurozone periphery that were imposed by policymakers in response to a buyer's strike among sovereign bond investors. As yields soared, particularly in Greece, there was a growing belief that the cause was high levels of public debt and structural inefficiencies, and that to bring yields down it was necessary to slash public borrowing and make structural reforms. There was also concern about the lack of competitiveness of periphery economies and their high unit labour costs: had they had their own currencies, devaluation would have been the corrective for this problem, but because of the Euro this was not possible and the only solution was to force down wages. The measures adopted in a number of countries to reduce public deficits and force down wages caused GDP to collapse across the Eurozone. And they are still causing it. The Eurozone is formally in recession and shows no real sign of recovery despite the upbeat commentary from the Eurogroup. PMI figures today were ugly.

De Grauwe and his colleague show that the soaring yields were not directly to do with economic fundamentals in the periphery countries. They were a market panic. And unfortunately, the panic in the markets infected policy-makers too, who inflicted harsher and harsher austerity measures on the countries concerned in an attempt to break the spiral of rising yields and growing fears of Euro collapse. De Grauwe argues that correct response would have been for the central bank to provide unlimited liquidity - in this case, by buying bonds as required. Now, the ECB did buy bonds to some extent under the securities market programme (SMP). But it was hardly an "unlimited" response: it was small-scale, grudging and constantly attacked by Bundesbank hard men and German politicians angry about bailouts for what they perceived as "profligate" periphery states. No wonder investors didn't believe it. There was constant discussion about the possibility of various countries, not just Greece, leaving the Eurozone: there were theories about downsizing the Eurozone to a convergent core, or splitting it in two: there were fears that it would collapse completely as its predecessor the Exchange Rate Mechanism (ERM) had done. EU politicians reiterated that the Euro would survive, but analysts examining the market were divided. And throughout all this, the ECB did virtually nothing, despite the clear evidence of very tight monetary conditions in the periphery and runs on banks in crisis-hit countries. It stepped in to rescue the banking system when liquidity all but dried up in December 2011, and it bought a few bonds. That's all.

I have argued for a long time now that the problem in the Eurozone is not the fundamentals in the individual countries, it is the design and construction of the Euro. The Euro is a fiat currency disconnected from a sovereign - and that is a very strange beast indeed. To a considerable extent, the European policy makers are making things up as they go along, and therefore making considerable mistakes. Belatedly, they are now trying to fix the errors in the original construction of the Euro - the lack of a common banking system, the lack of coordination of fiscal policy, the inadequacy of the institutions created to manage it. The last of these in my view is particularly critical. The Eurosystem of central banks (ECB and national CBs) together create and manage the Euro, and there are strict limits on what unilateral actions a national CB can take: they can provide the domestic banking system with liquidity provided that the ECB gives permission, but they can't do much more than that. They have no control of interest rates and cannot use unconventional monetary policy tools such as QE. So effectively the countries that use the Euro have no control of monetary policy: their central banks can do little to protect their economies from exogenous shocks, and their governments can't do much either since EU rules prevent them using unconventional measures such as capital controls.

I first became aware of just how vulnerable Eurozone countries are, and how little power national CBs have, in a recent conversation with two Irish central bankers who were worried about the stresses in the UK economy. If the UK went into a tailspin, they could do nothing to prevent the Irish economy going down with it because of its extensive trade links and borrowings, and they know that the ECB would do nothing. There is no institutional device in place for protecting individual parts of the Eurozone from local shocks. In real currency unions such as the United States and the UK, that device is fiscal support*. That is absent in the Eurozone.

The ECB, as the senior bank in the Eurosystem, is responsible for ensuring that the money supply in all parts of the Eurozone is sufficient to meet economic needs. De Grauwe says that it failed to do this. I agree. And it is still failing to do this. Inflation is down to the target 2% and falling, and the entire Eurozone is in recession - but has the ECB done anything to ease monetary conditions? No. It is holding the policy rate at 0.75% and the deposit rate at zero, and appears to have no plans to change this even though the Euro is soaring against other currencies as other central banks do all manner of unconventional things to improve liquidity in their own economies. The ECB simply is not acting as a central bank should.

There has been some discussion of whether the market panic that De Grauwe alludes to was irrational. I don't think it was irrational at all. Investors were given no reason to believe that the ECB would act to prevent Euro collapse in the event of a country leaving, and they had the precedent of the ERM, which collapsed after the exit of the UK in 1992. It is no accident that the countries that experienced the steepest rises in yields (and the sharpest falls after OMT) were those where fundamentals differed the most from Germany: after all, it was economic divergence with Germany that drove the UK out of the ERM. Until OMT, it all looked very much like a repeat performance, with Greece as the focal point instead of the UK.

In my view the reason why the OMT worked is that for the first time investors were given a clear statement that the ECB would not allow the Euro to collapse, even if that meant buying every sovereign bond in Europe. Admittedly even that clear policy statement was criticised by the Bundesbank, which claimed that bond-buying would break the Lisbon treaty preventing monetary financing of governments. But what right does the Bundesbank - a national CB - have to criticise the ECB and threaten it with legal action over what was very clearly MONETARY policy designed to protect the Euro, and therefore well within the ECB's remit? The Bundesbank would prefer a strong Euro and tight monetary policy because of its ridiculous fear of inflation. The Weimar hyperinflation scars run deep. But that doesn't give it the right to dictate policy to the ECB. Anyway, there is ZERO prospect of hyperinflation, or even ordinary inflation, in the Eurozone. The problem in the Eurozone is deflation, not inflation - and that has been the case for the last 5 years. The ECB should be cutting rates and looking at other ways of easing monetary conditions across the Eurozone, particularly in the countries such as Spain and Portugal where GDP is falling disastrously. That it has not done so, and shows no sign of doing so, is a measure of its inadequacy.

This is not a crisis of public profligacy, nor even of a poorly-constructed political experiment, grim though the consequences of that are. It is first and foremost a crisis created and orchestrated by an inept and politically captive central bank. The ECB is a disaster.


* I know there are debates about whether various US states will be allowed to go bankrupt, but we all know they will be bailed out in the end, don't we....a municipal Lehman would be the last thing the US government would want.

Related links:

Panic-driven austerity in the Eurozone and its implications - Paul De Grauwe and Yuimei Ji
Markit Flash Eurozone PMI - Markit
Draghi's Debt Trap - Coppola Comment
It's the currency, stupid - Coppola Comment
The failure of austerity in Europe - Touchstone Blog

Tuesday, 21 August 2012

It's the currency, stupid

A few days ago the German newspaper Der Spiegel broke a story that the ECB was contemplating capping yields on Eurozone sovereign debt by effectively promising to buy the debt of distressed nations in sufficient quantity to keep yields at sustainable levels. There has understandably been considerable comment on this story, both from those who think this is a good idea because it will provide a lifeline for struggling Eurozone sovereigns (especially Spain), and those who think this is a terrible idea because it will let profligate Eurozone sovereigns (especially Spain) off the hook. But they have all misunderstood. This action - as with everything else proposed and done so far by the ECB - has nothing whatsoever to do with bailing out Eurozone sovereigns, although that may be an incidental effect. It's all about the Euro.

Here is the final paragraph (my emphasis) of Asmussen's commentary on Draghi's suggestion that yields may be capped (h/t FT Alphaville, German translation courtesy of Joseph Cotterill):
We’re acting within our mandate, the priority of which is aimed at guaranteeing price stability for the euro area as a whole. Only a currency about which there are no doubts to its survival can be stable. That’s what we’re working for at the ECB.
So much for the "single mandate" of the ECB. Inflation is no longer its primary concern. If the Euro collapses, the ECB has no mandate, and indeed no reason to exist. So its absolute priority is preservation of the Euro at all costs. And if that means loading its balance sheet with everybody's junk, printing money like it is going out of fashion, bailing out sovereigns, banks, businesses and individuals, IT WILL DO IT - however much the Bundesbank objects and whatever its nominal mandate says.

So is the Euro really at risk? There are conflicting views on this. In my extensive discussions with Freegold supporters recently, they refused to believe that the Euro could collapse. They saw it as completely independent of the countries that use it: in their opinion, the Eurozone crisis is no threat to the existence of the Euro, because the Euro would continue to exist and be used for international trade even if all the Eurozone countries stopped using it domestically. Frankly I think this is naive. The Euro is a creation of the countries that use it. If they were all to stop using it, it would have no purpose - it would be simply a failed currency experiment consigned to the dustbin of history. The Freegolders also believe that the Euro is immune to hyperinflationary currency collapse, because the ECB's single mandate means that it would never monetize sovereign debt. This is arrant nonsense. The ECB has already monetized significant amounts of the debt of Greece, Spain and Italy both directly through the SMP programme and indirectly through the LTROs, and Draghi's proposal could monetize a whole lot more. If the single mandate is being reinterpreted to mean currency survival rather than price stability, the Euro is no more immune to hyperinflation than any other currency. I'm afraid I do not share the confidence of Freegolders (and to be fair, many other people with strong emotional attachment to the Euro project) that the Euro cannot collapse if the Eurozone fails.

At the opposite end of the scale are people who clearly do think the Euro is at risk. Finland was reported as considering "all" options for the Eurozone crisis - including the end of the single currency. Others, too, have openly debated the possibility that the Euro may fail, and there is some evidence that speculators are beginning to bet on its failure. This is potentially disastrous, and in my view explains Draghi's apparent volte-face on bond yields. Speculative attacks can cause exchange rate pegs to fail and currencies to collapse. The ECB leadership will not have forgotten the collapse of the Euro's predecessor, the first Exchange Rate Mechanism (pdf), under sustained speculative attack.

Whether or not the ECB leadership think the collapse of the Euro is a realistic possibility, they are certainly not saying so. In fact they are doing their best to talk it up. And it may work. Giving speculators a clear message that the ECB really will do whatever it takes to support the Euro may frighten them off: after all the ECB is a central bank, so it has more than enough resources to fend off even sustained speculative attacks. But it depends whether the ECB really has the freedom to use its resources. I have to say that at present, it doesn't look as if it has.

Recognising that the ECB's mandate is first and foremost to protect the Euro frees it from the chains of inflation targeting and could permit quasi-fiscal intervention (such as bond-buying to cap yields) within its mandate. And that does seem to be how the ECB leadership is thinking. But the EU leadership, the Bundesbank and as far as I can see most of the press and the economics profession don't get it. So the hawks among them squawk about "moral hazard", "market discipline", "fiscal consolidation". And the doves coo about ECB recapitalising banks and buying sovereign debt to ease fiscal pressures and halt the austerity death spiral. It's all irrelevant. The ECB fundamentally doesn't care if half the countries in the Eurozone collapse, provided the Euro continues: but if their collapse would threaten the Euro's survival, as it seems that it might, the ECB will equally happily buy all their debt, public and private, and recapitalise their banks, if that is what it takes to preserve the single currency.

If the EU leadership, the Bundesbank and other key players wish to ensure the Euro survives, they really must give full support to the ECB. Undermining the ECB leadership and attempting to restrict use of ECB resources with threats of legal action, as some of them are doing, is an open invitation to speculators to test the real ability of the ECB to defend the Euro - and I have no doubt that they will accept that invitation with alacrity. It's unbelievably stupid.

Wednesday, 6 June 2012

Calling International Rescue

I've been arguing for quite some time now that the Eurozone crisis is a sovereign debt crisis and a banking crisis, a balance of payments crisis, a currency crisis and above all a political crisis. Most people now agree with me on the first two and maybe the third, but they still aren't seeing the crucial importance of the last two. So let me explain how I think this ghastly situation came to be and how I believe it will play out.

The creation of the single currency in 1999 created a market expectation that the debt of all Eurozone countries would be backed by the full faith of the whole Eurozone, irrespective of the strength of the issuer's economy. Because of this, smaller and weaker countries in the Eurozone were able to borrow at similar rates to stronger countries. Their debt was too highly priced and they paid too low a rate - so many of them borrowed far too much. And banks, for whom sovereign debt represented an unbeatable risk-free investment because (at the time) it required no capital to support it (as George Soros points out), bought far too much of their debt.

If the single currency had been a full monetary, fiscal and political union FROM THE START, the expectation that weaker countries would effectively be backed by stronger ones would have been reasonable. This, after all, is how other currency unions such as the United States and the United Kingdom operate. These two countries have very different models for their currency unions: the United States operates on a federal model, whereas the United Kingdom works on a shared sovereignty basis. But the effect is the same. There is common tax raising and sharing at the federal or sovereign level, nationwide spending on essential services and common issuance of debt (although US states can issue their own debt as well, unlike UK regions). Much is often made of the fact that US states can and do go bankrupt - but in practice, services to the population are always maintained through Federal intervention and support. And in the UK, regions at present have no independent tax-raising powers: although there are local taxes, the tax take from these is reallocated by central government to level the playing field between richer and poorer areas. All of this makes common monetary policy and a single currency not only workable but desirable.

But the Eurozone is not a full union. The member states share a currency and operate a single monetary policy. But fiscal policy - taxation, spending and debt issuance - is the responsibility of the individual states. And I would argue that even the monetary union is half-baked. The ECB is explicitly prevented from acting as a lender of last resort, so is unusually limited (for a central bank) in the support it can give to distressed banks. It is also limited in how it can intervene in secondary markets: unlike the Bank of England and the Fed, which can buy as much of their own governments' debt as they see fit, the ECB is severely limited in the use it can make of its Securites Market Programme and has had to resort to all manner of fudge to maintain market access for distressed Eurozone sovereigns.

The events of the last two years have proved beyond a doubt that the Eurozone does not wish to guarantee the debt of its weaker members. Because of that, the prices of sovereign debt in the Eurozone are undergoing a severe market correction. This is unbelievably painful, both for the sovereigns who are seeing their borrowing costs rise to unsustainable levels, and the banks who are seeing the value of their assets drop to unsustainable levels. It is this market correction that is causing the near-bankruptcy of sovereigns and in my view the ACTUAL bankruptcy of many Eurozone banks. (I should point out that the Spanish cajas and Irish banks are bankrupt due to collapse of a property construction bubble, not because of their sovereigns' debt problems: it is in my view particularly the large French and German banks that are unsustainably exposed to Eurozone sovereign debt).

Since the underlying cause of both the sovereign debt crisis and the banking crisis is the lack of a full union, the obvious solution would be to create one. This, in one form or another, is what most commentors have suggested. Pooled debt issuance (Eurobonds), a common banking system, Eurozone-wide deposit insurance - all of these are ways of recreating the implicit guarantee. If they worked, they would restore both sovereign borrowing costs and bank asset values to pre-crisis levels.

But none of them solve the real problem. I've already mentioned it, but here it is again: The Eurozone does not wish to guarantee the debt of its weaker members.  The stronger members do not wish to accept the liabilities of the weaker ones: the weaker members do not want to put in place the financial discipline that would force them to balance their budgets and live within their means (as, for example, US states have to do). All of them want to keep the Euro, but only on their own terms. All of them want the benefits of a single currency, but not the risks: all of them want to keep the gains, but palm the losses off on someone else. And above all, all of them resist relinquishing their sovereignty and their right to self-determination for the sake of a greater union.

For this reason, I do not believe that a full fiscal, monetary and political union is remotely possible in the limited time that is left before the whole edifice collapses under the weight of unsustainable debt and impossible expectations. The adjustment of sovereign debt prices to the reality of every-country-for-itself will continue unchecked until one or more country is forced to default and a whole raft of banks fails. It is time that the world stopped hoping and praying that the currency union can be made to work. The political will to make it do so simply does not exist.

The best hope for the Eurozone now is a planned and managed breakup. Exactly what form this should take is a matter of debate: some people think Germany should leave, because of the distorting effect its giant economy has on monetary policy: others think the weaker states should leave, leaving Germany as the centre of a small group of similar states. I don't think it much matters which way it is done - the important thing is that it is planned and managed in a way that causes the least disruption to the lives and finances of ordinary people and businesses. The present situation, where the Eurozone leadership appears to be completely in denial, is the worst possible scenario.

Spain's distress call today rebounded around the world. The Eurozone is heading for a brick wall at top speed, and the world economy is already beginning to anticipate the impact.  Things are moving too fast now for Eurozone leaders to deal with this alone: world leaders must act before it is too late. Eurozone breakup is now inevitable. But it's not yet too late to prevent it being a total disaster.

Sunday, 13 May 2012

Who has REALLY benefited from Euro membership?




Just to remind you - the Euro came into being on 1 January 1999. These are the eleven founder members.

To make it even clearer, here is a chart showing only the largest economies among the founder members:



Now, admittedly I am only showing external trade balances. But part of the point of the European Union has always been promotion of trade between its members. The common currency was supposed to improve this by removing currency risk from cross-border trade.

Please tell me what value the common currency has brought to Italy,Spain and France?

And I haven't even included Greece......


The road to hell

I found an interesting chart from the World Bank this week. It shows Greek GDP since 1960.

   

And here's another chart showing the growth rate of Greek GDP. Note that it is currently shrinking (negative growth).



We hear a lot about the collapse of Greek GDP, and the second chart shows the dimensions of this. Greece is now in its fifth year of recession and things are only getting worse. Though it's interesting to note that Greece had a much sharper drop in 1973-5, probably due to the oil embargo, and also in the early 60s. But those were from a much lower GDP base than the current contraction. And therein lies the problem.

Greece was for a long time a poor economy. Its major industries were agriculture, shipping and tourism. But the first chart shows that after it joined the Euro in 2001, its GDP shot up. What caused this?

Well, it certainly wasn't improvement in exports. Here's another chart showing Greece's export performance:



Note that Greece was ALREADY running a trade deficit when it joined the Euro - in fact its current account deficit had been growing steadily since 1960. Externally it was already uncompetitive when it joined the Euro. And for a while after it joined, the trend continued - imports exceeding exports year-on-year. But it appears that from 2005-2008, Greece's trade balance fell off a cliff. It's not clear from the chart whether this is caused by a massive increase in imports or by export collapse due to the growing uncompetitiveness of the Greek economy versus its main trading partners. I suspect it was elements of both.

Here's Greece's capital account for the same period. Note the extraordinary increase in capital formation since 2001 and particularly since 2005. This capital increase mirrors the increase in the trade deficit. It seems highly unlikely that this capital was internally generated, so what we are in effect looking at here is external funding of Greece's trade deficit.



Capital growth has now stopped and since 2008 capital has been leaving the country. The trade balance is much better, but this is undoubtedly due to reduction in imports rather than export growth - as the second chart shows, Greece is deeply in recession. GDP is falling steadily. And this is the problem.

These charts suggest that the growth in GDP seen since Greece joined the Euro, and particularly since 2005, was caused by a consumption bubble funded by external capital inflows. In 2008 those capital flows abruptly reversed and the consumption bubble collapsed, leaving the country as a whole highly indebted and without sufficient domestic production to support its debt burden or maintain its Euro-generated standard of living.

Greece was already declining as an economy when it joined the Euro. All Euro membership gave it was a huge party at foreigners' expense. Its economy is no more productive than it was in 2001. But its population have come to expect a much higher standard of living, and many of their jobs are provided by a Government whose increased spending was also financed by external borrowing.  So as Greece's economy crashes, its population howls and blames the external people who financed their unsustainable boom. Well, I can blame them too - there is no doubt that the main beneficiaries from Greece's Euro membership have been larger Eurozone economies, particularly Germany, whose banks provided that funding as trade finance for exports and whose economic growth has been partly financed by Greece's imports boom.  But blame doesn't help. The fact is that Greece's economy became dependent on external capital flows. Now those have stopped, and there is no political will anywhere in the Eurozone for them to be restored in the form of fiscal transfers such as exist in other currency unions like Germany and the UK. Greece's economy is in the process of collapsing back to where it was when it joined the Euro, and possibly even lower since it has unquestionably lost competitiveness with regard to its main trading partners. And the first World Bank chart shows that the process has hardly begun. Greece's GDP is now about where it was in 2006. It still has an AWFULLY long way to fall.

The story that these World Bank charts tell is a terrible one. Euro membership has been an unmitigated disaster for Greece. It is now on the road to hell. It cannot stop, it cannot go back, and the only exit is a cliff edge. Leaving the Euro would result in sudden catastrophic currency devaluation, production collapse, probably hyperinflation as the Government was forced to monetize debt, terrible poverty, violent disorder (we are already seeing this) and lawlessness. But remaining in the Euro will result in exactly the same, just more slowly.  The Greeks think they are in hell now, but this is paradise compared with what is to come. It's just a question of how quickly they get there.


Tuesday, 25 October 2011

The cold hard truth

On Friday 21st October 2011, a group of economists working for the so-called Troika produced a devastating report. This report was leaked to the press, notably the FT, which promptly produced an article analysing it, and the BBC. Paul Mason, BBC Newsnight's economics editor, gave a 10-point analysis of the report on Twitter which I reproduce here. And the Telegraph released the full text of the report the following day.

European politicians have been fighting ever since. Germany's Merkel and France's Sarkozy had an argument loud enough to be heard in the EU concert hall. The Belgian finance minister left early and refused to attend the press conference. Merkel and Sarkozy jointly turned on Italy's Berlusconi, demanding that he implement fiscal reforms he has so far failed to deliver. And Sarkozy slapped down the UK's Cameron when he complained about the lack of any credible resolution plan for the Eurocrisis.

Entertaining though the politicians' antics are, they arise from a terrible truth. The bailout plan they came up with on July 21st was totally and completely inadequate. Everyone knew this, of course. But the politicians didn't want to admit it. Because actually they haven't the faintest idea what to do.

This crisis reminds me of the "bird within a bird within a bird" roasts that pretentious restaurants like to offer. On the face of it, it is a sovereign debt crisis in the poorer countries of the Eurozone, now extending to richer but highly indebted nations such as Italy. The German official story goes that these countries have borrowed far more than they can afford so must take the pain of massive reductions in their bloated public sectors in order to reduce their debt and return to competitiveness.  This story, and its accompanying denigration of people in the debtor countries as "lazy" and "profligate" despite considerable evidence to the contrary, is now so widely believed that it is difficult to counter it. It has become an article of faith.

But cut through the sovereign debt crisis and you find a bird of a different feather. Regular readers of my blog will know that almost everything I write has banking in it somewhere, and this post is no exception. If Greek debt had been entirely held by its own banks, it could have defaulted long ago - nationalised its banks, wiped its debts, started again. But its debt was held by giant foreign banks, systemically interconnected, crucial to their countries' economies and seriously short of capital and liquidity. The countries to whom those banks "belong" have waged a systematic campaign of disinformation to prevent the world realising that the Greek (and Portuguese, and Spanish, and Italian) sovereign debt crisis is also (and has always been) a BANKING crisis and the main suspects are French and German banks.

Every cent that has gone to "bail out" Greece has been paid straight to banks. Greece has not been "bailed out" at all. Far from it - it has been asset-stripped and its people impoverished to enable it to make some contribution to meeting its creditors' demands. Furthermore, those creditors have demanded severe fiscal austerity as the price of this "bailout".  I say "those creditors" because the principal agents of those demands are the French and German governments whose banks are at risk - plus the IMF, representing more distant financial interests. The Greek economy is now in deep recession.  But the creditors are demanding even harsher austerity measures, despite the appalling consequences for the people of Greece  .

Demanding severe austerity from a country in recession looks like madness, not only for the country itself but also for its creditors, since it makes it even less likely that it will be able to pay its debts. But there is a reason why the creditor nations have insisted on this apparently idiotic course of action. To them, there is no other choice.

Here's why. Were Greece a currency-issuing sovereign state, it could say "up yours" to its external creditors, default on its debts, nationalise its banks, devalue its currency and impose capital controls. The ensuing economic adjustment would be painful, but at least Greece would be controlling its own future. But it can't do this - because it is a member of the Euro.  In effect it has adopted a foreign currency as its national currency. Yes, the Bank of Greece is one of the central banks that supports the European Central Bank (ECB), which is responsible for determining Eurozone monetary policy. But historically the ECB has pursued monetary policies that suit the larger, richer nations, particularly Germany, and are disastrous for the smaller, poorer nations. It is still doing so now: it raised interest rates despite mounting evidence of impending recession throughout the distressed debtor countries, thus making their problems worse. This would be fine if there was a commitment within the Eurozone that stronger countries would support weaker ones with fiscal transfers. But there is no such commitment - in fact it is specifically ruled out in the treaty directives. Nor have the convergence criteria defined in the European Stability and Growth pact ever been adhered to: the 60% debt limit was exceeded for several years by - France and Germany. Convergence criteria that are so widely flouted are pointless, and for creditor countries to blame Greece and others for failing to adhere to them is rank hypocrisy.

When a nation has no control of its currency, it has no control of monetary policy. The only means it has of solving economic problems are fiscal ones. If it is over-indebted, it must increase tax income and/or cut public spending. That means tax rises, sales of state-owned assets, wage cuts, benefit cuts, pension cuts, public sector job cuts. This is the "austerity" that is demanded of Greece and others. The reason why Eurozone creditor nations have demanded such austerity is that they see no other way that preserves the Euro. The only other alternative is for Greece to leave the Euro - and the fear is that other debt distressed nations would then follow.

But fiscal austerity in recession-hit countries doesn't work, does it? Greece's problems have got worse, not better. Its deficit is increasing, not decreasing. There is no prospect of it returning to economic health for at least a decade, if ever, if current policies continue. And this is the cold hard truth that Eurozone leaders are now facing. The policies they have pursued have turned a small sovereign default into a potential continent-wide debt crisis and banking collapse. And they have no other policies to offer.

So the politicians argue among themselves about exactly how much of a loss the private sector should "voluntarily" accept on Greek debt. Germany, whose taxpayers stand to take the biggest hit if Greece defaults, wants a 60% haircut. France, whose taxpayers will have to bail out its under-capitalised banks, can't afford won't accept anything more than 40%. Both of them are furious with (and terrified of) Italy, which owes far too much even for Germany to bail out. And the ever-so-virtuous UK is just seriously irritating. Why should Eurozone politicians care about the impact on them? They didn't join the Euro, after all, and they've scotched every bright idea that the Eurozone whizzkids have come up with for extracting more money from their bloated financial sector to help with the Euro blues.

It's all so much hot air. Every country is fighting for its own survival now. The figleaf of European union has finally fallen off and the fundamental misconception of the Euro project is evident for all the world to see.  THERE IS NO UNITY. The only possible future for the Euro lay in fiscal and political union - the creation of a "United States of Europe". But there can be no political union while politicians pursue the interests of their own countries at the expense of the rest. And without political union there can be no fiscal union - given what has happened with monetary policy, is any Eurozone country really going to give up its tax raising powers to Brussels?

The Euro is doomed. Exactly how it will break up remains to be seen - perhaps Greece and other debtor nations will leave or be expelled, perhaps Germany will reinstate Deutschmarks, perhaps it will split along North-South lines (the so-called "2-speed Euro"). But break up it will, and really the sooner this happens the better for all concerned. Trying to preserve it at all costs has already wrecked Greece's economy and threatens to ruin the rest as well.  I'm not pretending that a Euro breakup will be easy. It won't - it will be exceedingly painful and very, very messy. But I don't see how it can be avoided.

Greece's economic decline has gone too far now for an orderly default with maybe a 60% haircut to be sufficient. What is required is comprehensive debt forgiveness and economic aid, not more loans. It would be difficult enough for this to be achieved even within a more accommodating Eurozone. But in the present political climate I don't see how a sufficient aid package can be put together. The political will simply doesn't seem to be there. Eurozone politicians will no doubt kick around some numbers and come up with yet more ever-so-clever ways of leveraging fictional money to bail out banks and pay creditors without doing anything to relieve the debt burden or restore Greece's economy. It won't achieve anything and it won't fool anyone.

Greece is dying before our eyes and its only hope now is default, exit from the Euro and international economic aid. Others are queuing up to take its place as Eurozone basket case. Portugal, Spain, Italy.....even France is now on the hook for a possible credit rating downgrade because of the weakness of its banks. And Germany, that powerhouse economy, will soon feel the effects of the economic demise of the countries it has come to rely on as its main export market.

The Eurozone is heading into the mother of all recessions, and it will be entirely of its own making.  But the consequences of its folly will be felt throughout the world.