Tuesday, December 6, 2011

Today's links

1--Euro-Zone Business Activity Slows, WSJ

Excerpt: The euro zone's four largest economies all showed a slowdown in business activity in November, with German activity shrinking for the first time in 2½ years.

Evidence that the currency bloc's biggest economy is slowing is likely to heighten fears about the euro zone's prospects as its leaders struggle to contain the sovereign-debt crisis.

The composite Purchasing Managers' Index for Germany fell to 49.4 from 50.3 in November, financial-data firm Markit Economics said on Monday. It is the first time the index has fallen below 50—indicating a contraction in business activity—since July 2009.

2--S&P downgrade threat a clarion call for euro reform, Reuters

Excerpt: Sarkozy and Merkel's plan to force states to cut deficits would be accompanied by an early launch of a permanent bailout fund for euro states in distress.

That could provide the political cover that the European Central Bank needs to buy more bonds of ailing countries as a short-term stopgap, preventing countries from running out of money if they cannot sell bonds on the open market.


ECB chief Mario Draghi, who conferred with Geithner on Tuesday, has signaled that a euro zone "fiscal compact" could encourage the central bank to act more decisively on the crisis. It has been reluctant to buy up debt from distressed euro states more aggressively, arguing doing so would take pressure off governments to fix their finances.

Just last month, that fate appeared to be approaching for Italy after the interest rate demanded by investors to lend to it soared above 7 percent. But investors cheered a plan announced on Monday by new technocratic prime minister Mario Monti, slashing Rome's borrowing costs.

Were it not for his 30-billion-euro austerity plan, Monti declared, "Italy would have collapsed, Italy would go into a situation similar to that of Greece." Yields on Italian 10-year bonds fell to 6 percent, a full percentage point lower than last week.

3--Euro zone needs own bonds and tax: Nobel economist, Reuters

Excerpt: An economist who will receive the Nobel prize on Saturday told Reuters the euro zone needs its own jointly issued bonds, a central fiscal authority and its own tax if it is to survive.

Nobel Economics prize winner Christopher Sims said such changes would also help persuade the European Central Bank to become a lender of last resort for euro zone countries in trouble -- a role the ECB has so far resisted.

"I think some kind of (joint) euro bond and some kind of European-wide fiscal authority will have to be part of any solution that is really stable," Sims told Reuters late on Monday, dismissing the idea that simply tightening budget discipline would suffice.

"A euro bond that was clearly backed by some kind of euro-wide fiscal authority would have the same kinds of advantages that U.S. treasury bills do now," added Sims, who will share the 2011 Nobel prize for economics with Thomas Sargent.

A threat by ratings agency Standard & Poor's to downgrade 15 countries in the bloc - including dominant economies Germany and France - has ramped up pressure for radical moves to finally contain the crisis that has spread from one euro sovereign debtor to another over the past two years.

"Fiscal integration needs to involve more than just budget discipline, more than just the centre telling countries they have to shape up and raise taxes or cut expenditures," Sims said, lending his support to views that financial market economists have been pressing.

"... you have to create the other side of fiscal integration which is some way for the centre to cushion countries that are in temporary difficulties," he added.

4--Insight: Conflicting visions at core of euro zone crisis, Reuters

Excerpt: Compromise proposals outlined by Chancellor Angela Merkel and President Nicolas Sarkozy on Monday to anchor stricter budget discipline in the EU treaty owed more to Germany's drive for fiscal virtue than to France's push for more "solidarity".

The issues that divided Paris and Berlin were all too familiar - whether to give supranational EU institutions the power to overrule national budgets and punish deficit offenders; whether to mutualize European debts; whether to let the European Central Bank act as a lender of last resort to states and banks.

As always, the French want elected governments calling the shots with political discretion in taking decisions and a subordinated secretariat role for the European Commission, while the Germans want community bodies to have automatic powers to uphold the rule of law....

Helmut Kohl, German chancellor at the time, saw the euro as a stepping stone on the way to a federal political union, but the French were reluctant to cede sovereignty then as now. Kohl was the last German leader to espouse a United States of Europe.

His successors, Gerhard Schroeder and Angela Merkel, grew up after World War Two and saw the EU more pragmatically as a vital forum for advancing German interests. But they did not want "Brussels" interfering in their own conduct of government and no longer felt a moral duty to pay for Germany's historical guilt.

Like the French, they are today closer to President Charles de Gaulle's vision of a Europe of nations, than to EU founding father Jean Monnet's supranational community method.

"France and Germany make no secret of wanting less Monnet and more de Gaulle," Charles Grant, director of the Centre for European Reform, wrote in an essay....

When the euro zone debt crisis struck, the German reflex was to tighten enforcement of the budget rules, and for each state to make savings to cut its deficit and debt.

"When the euro was introduced by the Maastricht treaty in 1992, there was a historic compromise," Peter Altmaier, parliamentary business manager of Merkel's conservatives, told Reuters in an interview.

"1) The awfully strong Deutsche Mark was abolished, and 2) German stability culture would be implemented Europe-wide. The first part was implemented. The second part is still valid and binding in the treaty, but it hasn't yet been implemented."

The German discourse carries heavy moral overtones. "Deficit sinners" have to "atone" for their sins and "do their homework" by cutting public spending, wages, pensions and benefits and working longer and harder....

The Germans believe the answer to the euro zone's policy mistakes is a stricter application of the rule of law, with the European Commission empowered to reject budgets that breach agreed EU rules and the European Court of Justice to punish offenders.

5--What Can Save the Euro?, Joseph E. Stiglitz, Project Syndicate

Excerpt: It is increasingly evident that Europe’s political leaders, for all their commitment to the euro’s survival, do not have a good grasp of what is required to make the single currency work. The prevailing view when the euro was established was that all that was required was fiscal discipline – no country’s fiscal deficit or public debt, relative to GDP, should be too large. But Ireland and Spain had budget surpluses and low debt before the crisis, which quickly turned into large deficits and high debt. So now European leaders say that it is the current-account deficits of the eurozone’s member countries that must be kept in check.

In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the United States, which has had an enormous current-account deficit for years. So, how will the European Union distinguish between “good” current-account deficits – a government creates a favorable business climate, generating inflows of foreign direct investment – and “bad” current-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euro’s founding would imply.

In Spain, for example, money flowed into the private sector from private banks. Should such irrational exuberance force the government, willy-nilly, to curtail public investment? Does this mean that government must decide which capital flows – say into real-estate investment, for example – are bad, and so must be taxed or otherwise curbed? To me, this makes sense, but such policies should be anathema to the EU’s free-market advocates....

There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.

These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment – the interest rate and the exchange rate – and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition – a race to the bottom to attract investment and boost output that could be freely sold throughout the EU.

...that doesn’t address today’s problem: huge debts, whether a result of private or public miscalculations, must be managed within the euro framework.

Public-sector cutbacks today do not solve the problem of yesterday’s profligacy; they simply push economies into deeper recessions. Europe’s leaders know this. They know that growth is needed. But, rather than deal with today’s problems and find a formula for growth, they prefer to deliver homilies about what some previous government should have done. This may be satisfying for the sermonizer, but it won’t solve Europe’s problems – and it won’t save the euro.

6--“Flip This House”: Investor Speculation and the Housing Bubble, by Andrew Haughwout, Donghoon Lee, Joseph Tracy, and Wilbert van der Klaauw, FRBNY via economist's view

Excerpt: The recent financial crisis—the worst in eighty years—had its origins in the enormous increase and subsequent collapse in housing prices during the 2000s. While the housing bubble has been the subject of intense public debate and research, no single answer has emerged to explain why prices rose so fast and fell so precipitously. In this post, we present new findings from our recent New York Fed study that uses unique data to suggest that real estate “investors”—borrowers who use financial leverage in the form of mortgage credit to purchase multiple residential properties—played a previously unrecognized, but very important, role. These investors likely helped push prices up during 2004-06; but when prices turned down in early 2006, they defaulted in large numbers and thereby contributed importantly to the intensity of the housing cycle’s downward leg. ...

At the peak of the boom in 2006, over a third of all U.S. home purchase lending was made to people who already owned at least one house. In the four states with the most pronounced housing cycles, the investor share was nearly half—45 percent. Investor shares roughly doubled between 2000 and 2006. While some of these loans went to borrowers with “just” two homes, the increase in percentage terms is largest among those owning three or more properties. In 2006, Arizona, California, Florida, and Nevada investors owning three or more properties were responsible for nearly 20 percent of originations, almost triple their share in 2000.

Because investors don’t plan to own properties for long, they care much more about reducing their down-payments than reducing their interest rates. The expansion of the nonprime mortgage market during the 2000s provided the perfect opportunity for optimistic investors to get low-down-payment credit, albeit at high interest rates..., investors were far more likely than owner-occupants to use nonprime credit to make their purchases, especially at the peak. ...

7--The eurozone’s terrible mistake, Felix Salmon, economists view

Excerpt: The FT is reporting today that the new fiscal rules for the EU “include a commitment not to force private sector bondholders to take losses on any future eurozone bail-outs”. If this principle really does get enshrined into some new treaty, it will be one of the most fiscally insane derelictions of statesmanship the world has seen — but it certainly helps explain the short-term rally that we saw today in Italian government debt.
Right now, the commitment is still vague...

To understand just how stupid this is, all you need to do is go back and read Michael Lewis’s Ireland article. The fateful decision in Ireland was to take the insolvent banks and give them a blanket bailout, with the banks’ creditors all getting 100 cents on the euro. That only served to put a positively evil debt burden onto the Irish people, forcing a massive austerity program and causing untold billions of euros in foregone growth, while bailing out lenders who deserved no such thing.

Are we really going to repeat — on a much larger scale — the very same mistake that Ireland made? ...

8--Euro enters the last chance saloon, Telegraph

Excerpt: It is an article of faith in markets that once Germany gets the treaty changes it wants, once it can be satisfied that the rules are in place to keep national budgets on the straight and narrow, then it will drop its opposition to "mutualisation" of sovereign debt and agree to more significant ECB bond purchases.

Yet so far, talks seem to have concentrated almost entirely on putting in place an effective framework for controlling the fiscally ill-disciplined. It's being called "fiscal union", but as my colleague, Ambrose Evans-Pritchard, has already pointed out, this is not fiscal union at all, but merely a toughened-up version of the old stability and growth pact. It offers no prospect of support for countries that get themselves into difficulty, only punishment.

By attempting to address the long-term problem before the immediate one, Germany has chosen a curiously back-to-front approach to the crisis. Ah, say the markets, but that's how the Germans like it. They want the cart before the horse. Once the cart is in place, then they can start talking about the horse.

That's the assumption, but what if Ms Merkel means what she says? What if she actually believes that budget discipline and structural reform alone are enough to solve the eurozone's problems? Crazy though this might seem, that's the implication of the rhetoric.

9--Deficit limits for the eurozone?, PBS

Excerpt: JEFFREY BROWN: I'm joined by Thomas Kleine-Brockhoff, senior director for strategy at the German Marshall Fund of the United States. He leads its EuroFuture Project, exploring the economic and political dimensions of the euro crisis.

I want to start with a larger context here, as we look at a very important week. Why do people say we may be at a turning point for the entire European Union Project?

THOMAS KLEINE-BROCKHOFF, Senior Director for Strategy, German Marshall Fund of the United States: I think we are at a fork of the road.

Either we will see that a virtuous or a vicious cycle is being set off. The vicious cycle would result in defaults, in recession, maybe even depression, into disintegration, and finally in decline. Or you set off a virtuous cycle in which market confidence can be restored, in which reforms can be given time to work, and in which a stronger Europe can result....

JEFFREY BROWN: And now you have, as Judy just said, the S&P stepping in with a kind of warning on the credit rating. Now, that shows even more of the pressures, right?

THOMAS KLEINE-BROCKHOFF: It is the increasing pressure in front of the -- before the summit. And the warning clearly says it's the governance structure and it's the role of the European Central Bank that are inhibited about our outlook.

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