Tuesday, December 13, 2011

Today's links

1--EU Debt Story Isn’t Simple Morality Tale, WSJ


Excerpt: It’s tempting to view the European debt crisis as a simple morality tale. Hard-working, fiscally responsible northern Europeans such as the Germans and the Dutch are being forced to pick up the tab for their profligate southern neighbors — the Greeks, the Italians and the Spanish.

Germans tend to see the problem this way and, increasingly, so do many U.S. commentators. Unfortunately, that attractively simple story doesn’t always stack up — most notably in the case of Spain.

In 2007, before the crisis struck, Spain had a modest debt load representing just 36% of its economy, according to European Union figures. And those responsible Germans? They had 65%.

During the past decade, Germany repeatedly breached the euro rules by running too large a budget deficit. Spain actually ran a modest budget surplus in the years before the crisis hit.

But haven’t things changed since then? The German economy has powered through the crisis while the Spanish economy has languished, so you would think the two would have traded places.

You’d be wrong. Last year, Spain’s public debt load represented 61% of its economy. Germany’s rose to 83%. In fact, Spain’s debt burden last year remained below that of the Netherlands (63%), France (83%) and, for comparison, the U.S. (93%).

So if public debt is your yardstick, then the Spaniards were paragons of virtue. They borrowed lightly despite the fact that their euro-zone membership gave them an all-you-can-eat buffet of financing at bargain-basement rates.

As Europe scrambles to find a solution to a debt crisis that’s threatening the world economy, it’s crucial to understand what actually happened in countries like Spain. Otherwise, policymakers will end up prescribing the wrong medicine, with disastrous results.

“The whole euro-zone strategy is predicated on the assumption that fiscal ill-discipline caused this crisis,” said Simon Tilford, chief economist for the Center for European Reform. “That is a radically incomplete analysis.”

If you believe that Spain’s problem was that its government spent and borrowed too much, then the solution is simple: more austerity. But Spain’s problem wasn’t public debt — it was private debt

2--Europe’s suicide pact, macrobusiness.com

Excerpt: So the European summit came and went. I am still struggling to see a credible transition plan from the Europe I see today to the new one that the “fiscal compact” speaks off. The imbalances in Europe exist today as they did yesterday and although I keep reading they have achieved a fiscal union-ship, the truth is what has been agreed to is anything but. There is certainly nothing resembling a usable mechanism to support re-balancing of differences in economic competitiveness.

It seems that the president of the Bundesbank agrees:

Bundesbank President and European Central Bank council member Jens Weidmann said decisions reached at the European summit in Brussels amount to a “fiscal pact, not a fiscal union,” Frankfurt Allgemeine Sonntagszeitung reported.

So, as far as I can tell what was announced on Friday night was nothing more than an agreement to push mass austerity into Europe while attempting to manage the servicing of the existing debts. The issue is, of course, that these two things are mutually exclusive.

Even if you believe that austerity will lead to higher production and stronger economies in the long run, even the most optimistic economist will tell you this will take years and will be deflationary in the medium term. So unless there was a solution delivered out of the summit as to how Europe was going to offset the Franco-German demand for deflationary austerity policies in such a way that these economies could still service their existing debts during the transition, then the summit was always going to be a failure in my eyes.

3--The Sarko and Corzine trade, FT Alphaville

Excerpt: The following raised some eyebrows in the FT newsroom on Friday.

Via Reuters:

French President Nicolas Sarkozy said the ECB’s increased provision of funds meant governments in countries like Italy and Spain could look to their countries’ banks to buy their bonds.

“This means that each state can turn to its banks, which will have liquidity at their disposal,” Sarkozy told reporters at the summit in Brussels.

And it wasn’t just us who were taken aback by the suggestion, which is not too dissimilar to Jon Corzine’s repo-to-maturity brainwave which wrecked MF Global (especially once haircuts hit the underlying assets).

Very briefly, we think the Sarko trade would run as follows: eurozone bank borrows 3-year money from the ECB after putting up acceptable collateral. As luck would have it, sovereign debt is very acceptable. So they buy, say, short-dated Italian debt, pledge the asset (although with a graduated ECB haircut for credit risk) and pocket the difference between the ECB’s lending rate and the yield on the sovereign bond. Retained earnings at the bank improve, the sovereign has a buyer for its debt and the ECB is playing its role in solving the crisis. A certain carry trade is back to the fore.

Everyone’s a winner.

Well that’s the theory anyway...

4--EU Banks Taking Government Cash Seen Sparking ‘Vicious Cycle’, Bloomberg

Excerpt: European banks turning to their governments to raise required capital could trigger a downward spiral of declining sovereign-debt prices and further losses for the lenders.

The European Banking Authority ordered the region’s banks on Dec. 8 to raise 115 billion euros ($154 billion) by June. Faced with dwindling profits and unable to tap capital markets to sell new shares, firms may be forced to seek government help. About 70 percent of the capital requirement falls on lenders in Spain, Greece, Italy and Portugal, countries struggling to convince the world they can pay their debts.

“If the Southern governments put money in their banks, their sovereign debt will go up, exacerbating their problems,” said Karel Lannoo, chief executive officer of the Centre for European Policy Studies in Brussels. “Then the banks’ losses will rise because they hold the government debt. That’s a vicious cycle. It’s hard to know which one to stabilize first, the sovereign bonds or the banks.”

5--Euro zone fiscal pact fails to restore confidence, Reuters

Excerpt: A European summit deal to strengthen budget discipline in the euro zone failed to restore financial market confidence on Monday, forcing the European Central Bank to step in again gingerly.

The euro fell, stocks slid and borrowing costs for Italy and Spain rose as investors weighed the outcome of last week's summit that split the European Union, with Britain blocking treaty change and forcing euro zone countries to negotiate a fiscal accord outside the Union.

Friday's initial market rally petered out in less than 24 trading hours due to legal uncertainty surrounding the new pact and the absence of an unlimited financial backstop for the single currency....

Traders said the ECB intervened to buy short-term Italian debt after yields on Italian and Spanish debt spiked. But ECB sources told Reuters last week that purchases would remain limited with a maximum ceiling of 20 billion euros a week.

There is no prospect of a "big bazooka" to shock the markets.

Despite the central bank dabbling, Italian 5-year bond yields shot up above 7 percent, widely seen as a danger level while 10-year yields spiked above 6.8 percent and Spanish 10-year yields topped 6 percent....

S&P has put 14 euro zone governments on watch for a possible rating downgrade in the coming weeks, arguing that the deepening debt crisis and looming recession will increase their potential liabilities and reduce their ability to cope with them.

If some of the euro zone's 'AAA'-rated members are downgraded, it would call into question the solidity of the euro zone's rescue fund, which would likely suffer a similar fate....

Interbank lending rates in the euro zone fell to their lowest level since May after the ECB threw cash-starved banks a lifeline last week by offering unlimited three-year liquidity to counter a credit crunch....

The euro area faces the next potential crunch point in mid-January when Italy, which has a debt mountain of 1.9 billion euros or 120 percent of its annual output, has to start issuing tends of billions of euros in bonds towards a 2012 total of 340 billion euros needed to roll over maturing debt.

6--S&P says euro zone may need another shock, Reuters

Excerpt: Ratings agency Standard & Poor's put more pressure on the euro zone on Monday, with its chief economist saying time was running out for the currency bloc to resolve its debt problems and that it might need another financial shock to get it moving.

Jean-Michel Six, chief economist of the agency that shocked financial markets last week by putting 15 euro zone countries on a watch for a potential downgrade, said last week's EU summit agreement was a significant step forward, but not enough.

S&P usually takes around three months to act after a warning, but has said that in this case it may do so more quickly.

"There is probably yet another shock required before everybody in the euro zone reads from the same page, for instance a major German bank experiencing some real difficulties on the markets, which is a genuine possibility in the near term," Six told a business conference in Tel Aviv.

7--Outlook for Euro Darkens on Summit, ECB Policy, Bloomberg

Excerpt: Investors are fleeing assets denominated in the 17-nation currency as European Union leaders fail to end concern that Italy and Spain will succumb to a sovereign-debt crisis that forced Greece, Ireland and Portugal to seek bailouts. While euro bulls say sentiment is so negative that the currency has nowhere to go but up, bears point to surveys showing the euro zone’s economy will expand 0.5 percent next year, compared with 2.19 percent for the U.S.

“There still has to be further monetary easing by the ECB to support growth in the euro area for 2012 and beyond,” Ken Dickson, investment director of currencies at Standard Life Investments in Edinburgh, which manages about $235 billion, said in a Dec. 9 telephone interview. “There’ll be further weakness, particularly in the first half of next year,” which may push the currency to as low as $1.20 from $1.3386 last week, he said....

Euro Flows

Cumulative outflows from the euro last week were twice the average in the same period last year, according to BNY Mellon, the world’s largest custodial bank, with more than $26 trillion in assets under administration. The firm doesn’t provide specific figures.

Stress in Europe’s financial system, coupled with slower growth, prompted Standard & Poor’s on Dec. 5 to say Germany and France may be stripped of their AAA credit ratings as it put 15 euro nations on review for possible downgrade....

Dollar funding costs for European banks increased after the summit amid concern the measures won’t be enough to stem the crisis. The three-month cross-currency basis swap, the rate banks pay to convert euro payments into dollars, ended last week at 122 basis points below the euro interbank offered rate, from 117 basis points the day before. The measure reached 163 basis points on Nov. 30.

8--President Obama Wants Credit for Avoiding a Great Depression: Where Is the Ridicule?, CEPR

Excerpt: In its top of the hour news segment NPR reported that President Obama hoped that voters would give him credit for avoiding a second Great Depression. If this is an accurate representation of what President Obama said then it should have devoted a segment to economists ridiculing the president for trying to set an unbelievably low bar for measuring the success of his economic policy.

The first Great Depression was the result of a decade of inadequate policy responses. The massive spending associated with World War II that eventually got us out of the Great Depression could have been undertaken a decade sooner, if there had been political will.

There was nothing about the financial crisis at the beginning of President Obama's term that could have condemned the country to decade of double-digit unemployment. This only could have happened if Congress failed to respond adequately to a financial collapse.

9--What Latin America Can Teach Us, NY Times

Excerpt: IN a Bertelsmann Foundation study on social justice released this fall, the United States came in dead last among the rich countries, with only Greece, Chile, Mexico and Turkey faring worse. Whether in poverty prevention, child poverty, income inequality or health ratings, the United States ranked below countries like Spain and South Korea, not to mention Japan, Germany or France.

It was another sign of how badly Americans are hurting their middle class. Wars, famine and violence have devastated middle classes before, in Germany and Japan, Russia and Eastern Europe. But when the smoke cleared and the dust settled, a social structure roughly similar to what existed before would always resurface.

No nation has ever lost an existing middle class, and the United States is not in danger of that yet. But the percentage of national income held by the top 1 percent of Americans went from about 10 percent in 1980 to 24 percent in 2007, and that is a worrisome signal.

So before the United States continues on its current road of dismantling its version of the welfare state, of shredding its social safety net, of expanding the gap between rich and poor, Americans might do well to glance south. The lesson is that even after a large middle class emerges, yawning inequities between rich and poor severely strain any society’s cohesion and harmony.

10--Why Stricter Rules Threaten the Eurozone, Simon Tilford and Philip Whyte, The Center for European Reform

Ed note:  Without question , this is the best and most comprehensive analysis of the debt crisis to date. A "must read" for anyone who is serious about understanding the root of the problem and how it can be resolved.

Excerpt: It is now clear that a monetary union outside a fiscal union is a deeply unstable arrangement; and that efforts to fix this flaw with stricter and more rigid rules are making the eurozone less stable, not more....tighter rules do not amount to greater fiscal integration. The hallmark of fiscal integration is mutualisation – a greater pooling of budgetary resources, joint debt issuance, a common backstop to the banking system, and so on. Tighter rules are not so much a path to mutualisation, as an attempt to prevent it from happening.

How did the eurozone come to find itself in its current predicament?

The short answer is that the introduction of the euro spurred the emergence of enormous macroeconomic imbalances that were unsustainable, and that the eurozone has proved institutionally ill equipped to tackle....

It is wrong, however, to blame government profligacy for the rise in peripheral indebtedness: Greece is the only country where this holds true. In Ireland and Spain, it was the private sector (particularly banks and households) that was to blame. Indeed, in 2007, the Spanish and Irish governments looked more virtuous than Germany’s: they had never broken the fiscal rules, had lower levels of public debt and ran budget surpluses.

Creditor countries cannot be absolved of all blame. Not only was export-led growth in countries like Germany and the Netherlands structurally reliant on rising indebtedness abroad. But creditor countries in the core harboured plenty of vice: the conduits for the capital that flowed from core to periphery were banks, and these were more highly leveraged in countries like Germany, the Netherlands and Belgium than they were in the periphery (or the Anglo-Saxon world). The eurozone crisis is as much a tale of excess bank leverage and poor risk management in the core as of excess consumption and wasteful investment in the periphery.

If the eurozone had been a fully-fledged fiscal union, it would not be in its current predicament. Its aggregate public debt and deficit ratios, after all, are no worse than the US’s. But it is not a fiscal
union – which is why it faces an existential crisis, and the US does not. The absence of a fiscal union explains why economic imbalances between Germany and Spain matter in a way that those between Delaware and New Jersey do not. And it explains why some eurozone members face sovereign debt crises, while states in the US do not (unlike them, members of the euro did not assume joint liability for rescuing banks).

The current crisis, then, is not simply a tale of fiscal irresponsibility and lost competitiveness in the eurozone’s geographical periphery. It is also about the unsustainable macroeconomic imbalances to which
the launch of the euro contributed (in creditor and debtor countries);about the epic misallocation of capital by excessively leveraged banks, notably in the core; about the way in which financial vulnerabilities in distressed countries have been exacerbated by the absence of fiscal integration at European level; and about the
difficulties of adjustment in a monetary union that is politically (and therefore institutionally) incomplete.

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