Thursday, September 29, 2011

Today's links

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1--Debt Levels Alone Don’t Tell the Whole Story, New York Times

Excerpt: AS the world’s central bankers and finance ministers gather in Washington this weekend for the annual meetings of the International Monetary Fund and World Bank, government debt is at the top of the agenda. Some governments can no longer borrow money and others can do so only at relatively high interest rates. Reducing budget deficits has become a prime goal for nearly all countries...

In 2007, before the credit crisis hit, an analysis of government debt would have shown that Ireland was by far the most fiscally conservative of the countries. Its net government debt — a figure that deducts government financial assets like gold and foreign exchange reserves from the money owed by the government — stood at just 11 percent of G.D.P.

By contrast, Germany appeared to be in the middle of the pack and Italy was among the most indebted of the group.

Yet Ireland was slated to become one of the first casualties of the credit crisis, and is now among the most heavily indebted. Germany is doing just fine. Italian debt has risen only slowly. The I.M.F. forecasts that Ireland’s debt-to-G.D.P. ratio will be greater than that of Italy by 2013.
It turned out that what mattered most in Ireland was private sector debt. As the charts show, debts of households and nonfinancial corporations then amounted to 241 percent of G.D.P., the highest of any country in the group.

“In Ireland, as in Spain, the government paid down debt while private sector grew,” said Rebecca Wilder, an economist and money manager whose blog at the Roubini Global Economics Web site highlighted the figures this week. She was referring to trends in the early 2000s, before the crisis hit....

The differences highlight the fact that debt numbers alone tell little. For a country, the ability of the economy to generate growth and profit, and thus tax revenue, is more important. For the private sector, it matters greatly what the debt was used to finance. If it created valuable assets that will bring in future income, it may be good. Even if the borrowed money went to support consumption, it may still be fine if the borrowers have ample income to repay the debt.

That is one reason many euro zone countries are struggling even with harsh programs to slash government spending. With unemployment high and growth low — or nonexistent — it is not easy to find the money to reduce debts. And debt-to-G.D.P. ratios will rise when economies shrink, even if the government is not borrowing more money.

2--Europe: Why the One-Size-Fits-All Solution Won’t Work, Rebecca Wilder, Economonitor

Excerpt: Update: the government net-debt data is from the IMF World Economic Outlook, April 2011. I’ve eyeballed the levels and circled the areas that could be considered ‘high leverage’ (generally 90% or above, except for the Spanish household sector which I circled at 84.9% due to its stark contrast with the core countries).

The thing to notice here is, that broadly speaking the 2010 leverage build was not in the government sector (fiscal consolidation) but generally in the private sector. Ireland is in a real quandary – what was previously leverage heavily weighted in the private-sector is now passing through to the public sector via meager growth and harsh fiscal reform (see Edward Hugh’s post on the latest in Ireland).

(see chart)
The only way for some of these countries to drive down fiscal deficits amid such high private-sector leverage (presumably increased desire to save) is to run massive current account surpluses. Just look at Rob Parenteau’s 3 Sector Financial Balances Map. With the US growing at stall-speed and China still in tightening mode, there’s not much hope for the OSFA approach in Europe.

The policy directive needs to change.

3- Split opens over Greek bail-out terms, The Financial Times via Mish's Global Economic Trend Analysis

Excerpt: A split has opened in the eurozone over the terms of Greece's second €109bn bail-out with as many as seven of the bloc's 17 members arguing for private creditors to swallow a bigger writedown on their Greek bond holdings, according to senior European officials.

The divisions have emerged amid mounting concerns that Athens' funding needs are much bigger than estimated just two months ago. They threaten to unpick a painfully negotiated deal reached with private sector bond holders in July.

While hardliners in Germany and the Netherlands are leading the calls for more losses to be imposed on the private sector, France and the European Central Bank are fiercely resisting any such move. They fear re-opening the bond deal could spark renewed selling of shares in European banks, which have significant holdings of Greek and other peripheral eurozone debt.

Senior European said there was significant division over the move to re-open the bondholders' deal, which could trigger a bigger and earlier restructuring of Greek debt. Even within Germany, officials are split over whether to press for a bigger "haircut" for private sector creditors.

Under the terms of the July bail-out, bondholders agreed to trade about €135bn in bonds that come due through 2020 for new, European Union-backed bonds that would not be repaid for decades. This deal implied a haircut of 21 per cent for bondholders, but many German officials say they were forced to agree a deal that was too beneficial for the banks.

4--Europe's Banks Face New Funding Squeeze, Wall Street Journal
Excerpt: An extraordinary dry spell in the market for long-term European bank funding is amplifying pressure on policy makers to devise a solution to the Continent's banking crisis.

For the past three months, European banks have been largely unable to sell debt at affordable prices to investors, who are wary of the banks' vulnerability to risky euro-zone government bonds and other loans.

At $34 billion, the amount of senior unsecured debt issued by the Continent's financial institutions this quarter is on track to be the smallest of any quarter in more than a decade, according to data provider Dealogic. Most of those were bite-size deals of less than $500 million apiece. Traditionally, issuing such debt has been among the most popular ways for banks to finance themselves over the long term.

Now market observers are worried that the funding freeze is going to continue and perhaps worsen heading into 2012, with potentially serious repercussions for the banking industry.

Most banks say they have raised enough money to get through the final three months of the year, and they have access to safety valves like central-bank liquidity to ensure they can meet their day-to-day funding needs.

Yet analysts estimate that the banks face a mountain of debt, totaling nearly €800 billion ($1.08 trillion), that comes due in 2012. Much of that will need to be replaced with new debt. If banks can't raise this, they might have to shrink their balance sheets by selling assets or curbing lending.

5--Are the banks creating a permanent depression?, Naked Capitalism

Michael Hudson---That’s the outcome of their business plan, which is to take the entire economic surplus in the form of debt service. Banks want to create as much debt as they can. Debt is their “product.” The economy is merely “collateral damage” to a financial dynamic that is impersonal, not deliberate.

Every economy for hundreds of years has seen debts grow more rapidly than can be paid. At a point there’s a crash, which normally wipes out debts. It also wipes out savings on the other side of the balance sheet, of course. But this time the government has tried to keep the debt overhead on the books – and to tax the population to give banks enough to make sure that the rich don’t lose money. Only industry and labor will lose.

The effect will be to de-industrialize the economy even more, because markets shrink without consumer spending. Companies won’t invest, stores will close, “for rent” signs will go up, tax payments to the cities will fall, and municipal employees will be laid off while social services are cut back. The economy will shrink and life will get harder.

Why aren’t economists talking more about this obvious phenomenon of debt deflation? It is the distinguishing phenomenon of our time. But opinion-makers are insisting that the solution is simply to give more money to the banks. Not many people are asking why this isn’t working. And when they do ask, they don’t get much media coverage.

6--Causes of the Eurozone Crisis (Part 2): Policy Implications, The Streetlight Blog

Excerpt: In the previous post I sketched out the origins of the eurozone crisis, and argued that powerful systemic forces, not irresponsible behavior, pushed the periphery countries toward crisis – and may well have done so no matter what the peripheral eurozone countries had done. The common currency encouraged (in fact, was designed to encourage) large-scale capital flows from the eurozone (EZ) core to periphery. We know from experience that such “capital flow bonanzas” are susceptible to sudden changes in investor sentiment, and very often come to a sudden stop. The sudden stop in this case happened in 2009 (exploring the specific reasons for that stop is interesting, but will have to wait for another day), made it difficult for the periphery countries to roll over their debt, and thus caused a crisis.

But note that other aspects of the common currency meant that the odds were stacked even more heavily against the peripheral EZ countries. Euro-adoption not only set the stage for the crisis by encouraging a capital flow bonanza to the EZ periphery; it also made it impossible for the periphery countries to deal with the sudden stop to those capital flows if and when it came. In his excellent recent paper (pdf), Paul De Grauwe has pointed out that the adoption of the euro by Europe’s periphery effectively caused them to be “downgraded to the status of emerging countries”, in the sense that they could no longer issue sovereign debt in their own currency. This made those countries peculiarly vulnerable to changes in investor sentiment. As Paul Krugman recently put it, thanks to the common currency, the periphery countries lacked the tools to manage their balance of payments....

Austerity is not helpful.

Severe fiscal austerity by the periphery EZ countries has been the condition attached to assistance from the core EZ. But that austerity requirement brings with it several problems.

First, it is largely counterproductive with respect to reducing annual deficits; a simple textbook example illustrates how fiscal contraction during a recession will typically fail to meet deficit reduction goals, because the austerity itself makes the recession worse. That’s exactly why Greece keeps missing its deficit reduction goals: not because they aren’t trying hard enough, but because it’s inherently unrealistic and unreasonable to try to balance a budget through austerity during a recession.

Second, austerity is completely counterproductive with respect to reducing debt burdens. As the economy shrinks thanks to austerity, the debt burden skyrockets relative to the country's income. Just look at the debt, GDP, and debt-to-GDP ratios for Greece to see how that works. It's no wonder that it has recently become crystal clear that Greece will never have enough income to repay this level of debt....

But finally, and most importantly in the context of this analysis, austerity shifts most of the burden of dealing with the crisis onto the EZ periphery countries. And that means that citizens of the core EZ countries like Germany, France, and Benelux are essentially getting a free ride...
But there is a fundamental asymmetry that goes along with international capital flows: the country on the receiving end risks a serious financial crisis when that flow stops, while the country that is the source of the capital bears no similar risk. In other words, the periphery of the EZ bore the bulk of the systemic risks inherent to the common currency area, while the benefits were shared by both the core and the periphery. In a sense, the periphery countries “took one for the team” when they allowed themselves to be placed at risk for the greater good of the entire eurozone....

And let’s not kid ourselves about something: policy-makers in Europe know exactly how the crisis can be solved. It’s not a mystery that if the core EZ countries contribute sufficient funds to finance Greece’s debts for the foreseeable future, accept a substantial write-down on the amount owed by Greece, and provide funds to recapitalize banks in Greece and elsewhere in the EZ, then the crisis will be over. So the question is simply whether the core EZ countries are willing to pay that required price. If they are, then the EZ will remain intact. If not, it will not. The current debate going on among European policy-makers is simply the unpretty process of figuring out the answer to that question. (Brilliant, comprehensive analysis)

7--A European Plan Can Be Big Or Fast, But Not Both.., Wall Street Journal

Excerpt: In a note called “Still Too Early for a ‘Grand Plan,’” economists Jurgen Michels, Giada Giani, Willem Buiter and Ebrahim Rahbari write:
Although there are different possibilities to leverage up the EFSF capacity of €440bn based on the amended framework, we believe all options have their shortcomings and are unlikely to be implemented quickly. Even in the unlikely case of a smooth process, a leveraged EFSF, with a bond purchasing capacity of €2,000bn, would not be available before end October/early November.

Therefore it is likely that market participants will, once again, be disappointed by euro area policymakers. However, with multiple sovereign defaults looming, the pressure on policymakers to act decisively has increased substantially in recent weeks.

Here’s why they think it’s going to take a long time to get a plan off the ground:

For the leveraged EFSF to be a success in the near-term in our view, four conditions have to be met: i) it has to increase the available effective firepower without increasing the (maximum) amount of support provided by the EA member states, ii) it must avoid the need to reopen national (in particular parliamentary) approval processes, iii) it must not run foul of constraints set by the amended EFSF Treaty and the German Constitutional Court, and iv) it must be able to generate sufficient consensus at the level of decision makers in the European Council. Several proposals for how to leverage the EFSF exist, but none of the options currently discussed appears to satisfy all four constraints concurrently.

This suggests that for the time being the talks regarding the leveraging-up of the EFSF are at an early stage, and that it is very unlikely that there will be an agreement on a “grand plan” to deal with the sovereign debt crisis in the next week or two.

8--The Daily Show (archives) Diane Ravitch believes education reform should focus on getting children out of poverty, not finding the bad teachers. (Video)

9--Bernanke Lacks Tools to Prevent Double Dip, Stiglitz Says, Bloomberg

Excerpt: Monetary policy changes aren’t enough to save the U.S. from a “double dip” recession, as the Federal Reserve has only limited ability to boost the economy, Nobel-prize winning economist Joseph Stiglitz said.
“So just like QE1 didn’t work, QE2, QE2-and-a-half is not going to work,” Stiglitz said in an interview with Bloomberg HT television in Istanbul yesterday. “If we’re going to get out of the current mess it will take fiscal policy.”

Federal Reserve ChairmanBen Bernanke and his predecessor Alan Greenspan “obviously did a very bad job managing monetary policy in the run up to the crisis and letting the bubble grow, not putting in place adequate regulation,” Stiglitz said.

“Now the Fed is going to try and seem relevant so it will try to do something,” he said. “Monetary policy is much better at restraining the economy than pushing it when you’re in a severe downturn such as the current time.”

Fixing problems created by Fed chairmen is much more difficult than creating them, he said.

Stiglitz, who won the Nobel prize in 2001 and is now a professor at Columbia University, said there’s “a serious risk at least for a double-dip for the United States and Europe” and growth will “almost surely” be “too anemic” to create jobs.

“The jobs deficit is going to be growing and the sense of the American economy not working is going to be worse,” he said.

10--German Parliament Backs Euro Rescue Fund, Bloomberg

Excerpt: German lawmakers approved an expansion of the euro-area rescue fund’s firepower, freeing the way for European officials to focus on what next steps may be needed to stem the debt crisis.

The lower house of parliament passed the measure with 523 votes in favor and 85 against, granting the fund powers to buy bonds in secondary markets, enable bank recapitalizations and offer precautionary credit lines. It raises Germany’s guarantees to 211 billion euros ($287 billion) from 123 billion euros. The main opposition Social Democrats and Greens said before today’s session in Berlin that they’d vote with Chancellor Angela Merkel’s government, assuring passage.

The bill’s passage by Europe’s biggest economy allows euro- area officials to weigh further measures to bolster Greece and stem investor concern that helped end the biggest three-day rally in 16 months for European stocks. Options include seeking further writedowns on Greek sovereign bonds, adding yet more firepower to the rescue fund and a plan to protect banks.

Beefing up the fund bolsters defenses against the crisis, setting the stage for German policy makers to focus on Greece’s second bailout, said Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co. in London. That “may morph into a debate about an orderly Greek default later this year, with a haircut on Greek debt, an immediate recapitalization of Greek banks, European guarantees for restructured Greek debt and conditional fiscal support” for Greece, he said.

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