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Economics

Archive | Economics

European Debt Crisis: George Soros Exudes Optimism

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George Soros at the World Economic Forum in Davos, Switzerland, January 27, 2010. Photo: Sebastian Derungs

George Soros probably understands the nature of the immediate problem facing the Eurozone. Namely, the accelerating bank run which, amongst other things, potentially exposes Germany to trillions of contingent euro liabilities. But even Soros reflects the prevailing – and mistaken – view that Greece might need to become the sacrificial lamb required to save the euro. He said as much in a recent interview in Der Spiegel.

George Soros at the World Economic Forum in Davos, Switzerland, January 27, 2010. Photo: Sebastian Derungs

Questioned about his proposal to rescue the European Monetary Union via a Debt Reduction Fund, Soros was asked whether this measure could also save Greece, “Unlikely. Rescuing Greece would require an enormous kind of magnanimity and generosity. The situation there has simply become too poisoned. I think that by standing firm and not compromising on Greece, Angela Merkel would be in a better position to persuade the German public to be more generous toward other nations and distinguish between the good guys and bad guys in Europe.” Policy makers, market practitioners, indeed anyone like Soros, who keeps saying, “Well, we might have to sacrifice Greece ‘pour decourager les autres” fails to recognize that this type of attitude actually exacerbates the fatal flaw in the euro’s architecture and makes its ultimate demise more likely, not less. The same issues that confront the euro zone today would intensify in the event of a Greek exit.

As Yanis Varoufakis has noted “the lack of a constitutional (or Treaty-enabled) process for exiting the Eurozone has a solid logic behind it. The whole point of creating the common currency was to impress the markets that it is a permanent union that will guarantee huge losses to anyone bold enough to bet against its solidity.” As Varoufakis argues, a single exit suffices to punch a hole through this perceived solidity. It goes back to the fundamental flaw cited by Peter Garber at the time of the euro’s inception. As long as there was no perceived probability of euro exit by any euro nation, the established transfer system coupling private markets with European system of Central Bank support (Target 2, ELA, ECB repos) would function like any other monetary system in a single nation state.

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Angela Merkel’s Nein Problem

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President Obama with Angela Merkel in Washington. Denzel/Bundesregierung

The pattern is becoming despairingly familiar.

President Obama with Angela Merkel in Washington. Denzel/Bundesregierung

The embattled periphery countries, led by Italy and Spain but also endorsed by France, propose more fiscal integration in the form of mutual debt pooling and shared financial liability. Such reforms are met with resounding rejections from Germany who instead point to the long run benefits of austerity in terms of promoting a sustainable economy. Similar responses are also reserved for Greece who is seeking to renegotiate elements of its bailout agreement following a recent general election which resulted in the formation of an awkward coalition government.

The focal point of this resistance is Germany’s Chancellor Angela Merkel who, supported by its Central Bank’s President Jens Wiedmann, is adamant that the focus for the Eurozone should be implementing the necessary fiscal reforms rather than loosening conditions. This position, generally supported by the ‘northern core’ countries, highlights the almost daily division between the creditor and debtor nations in the single currency bloc. The current official line from Germany is that ‘More Europe’ is the solution to the crisis however without a clear prescription as to that definition uncertainty will remain.

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The Eurozone Still Faces Several Challenges

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Greece's Prime Minister Antonis Samaras with French President François Hollande in Paris

European financial officials are preparing their policy package to deal with the current crisis for the meeting scheduled next week. It is not clear whether any of the proposals will be able to stop the ongoing bank run.

Greece’s Prime Minister Antonis Samaras with French President François Hollande in Paris

Here are some of the rumored proposals. Euro members jointly issue short term bills – in effect, short term euro bonds, a debt redemption fund as proposed by economic advisors to Merkel, new procedures for euro area banking supervision and using the ESM to purchase peripheral nations’ bonds in order to reduce their sovereign interest rates. French President Hollande is advocating the ESM purchase program. He is also advocating that the ESM be given a banking licence linked to the European Central Bank’s balance sheet. This makes sense as it addresses the solvency issue.

In the Eurozone we have a solvency problem and a crisis of deficient aggregate demand. Unfortunately, within the European Monetary Union these twin crises ultimately fall entirely in the realm of the issuer of the currency- the ECB, and not the users of the currency- the euro member nations. So without the ECB, directly or indirectly, underwriting the currency union, solvency is always an issue, whether that be Greece, Portugal, Spain, Italy or, indeed, Germany. Likewise deficient spending power has been exacerbated via the austerity imposed as a condition of the ECB’s help.

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Future of Greece and the Eurozone Remains Uncertain

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Greece's Prime Minister Antonis Samaras. alex@faraway/Flickr

So for the short term, it appears we won’t have a “Grexit”, which has led many commentators to suggest (laughably) that a crisis has been averted.

Greece’s Prime Minister Antonis Samaras. alex@faraway/Flickr

Typical of this sentiment is a headline in Bloomberg today “Greece avoids chaos; Big Hurdles Loom”. To paraphrase Pete Townsend, meet the new chaos, same as the old chaos. It is worth pondering how acceptance of the Troika’s program (even if cosmetic adjustments are made) will help hospitals get access to essential medical supplies, whilst the government persists in enforcing a program which is killing its private sector by cutting spending and not paying legitimate bills, and an unemployment rate creeps towards 25 per cent and 50 per cent for youth.

Prior to the June 17th vote, Greek voters were intimidated with a massive number of threats of what would happen if they didn’t vote “the right way” (i.e. anybody but the “radical leftists” in Syriza). Even then, the conservatives just led the vote count against their main anti-austerity rival. Amazingly, New Democracy leader Antonis Samaris suggested in his victory speech last night that the results reflected a vote for “growth.”

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Not so Super Mario Brothers

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From left to right: Mario Monti, Prime Minister of Italy; Mario Draghi, President of the European Central Bank; Angela Merkel, Federal Chancellor of Germany

This week Italy was carted into the spotlight of the Eurozone crisis as its benchmark 10 year borrowing costs moved above 6 percent for the first time since January and with Italy now beginning to suffer as contagion spreads from the currency block’s other problem areas it is clear that tensions are rising in the Euro area.

From left to right: Mario Monti, Prime Minister of Italy; Mario Draghi, President of the European Central Bank; Angela Merkel, Federal Chancellor of Germany

In a further sign of disunity between the Eurozone’s Latin bloc and other EMU member states on Tuesday, Italian Prime Minister, Mario Monti, was forced to reject claims from the Austrian Finance Minster that Italy would require financial assistance. Italy is now seen as the final battleground of the euro project with any bailout for Italy likely to be the final nail in the coffin of the Eurozone.

Having been widely praised for his reform agenda, including the modernisation of antiquated labour laws as well as unprecedented public pension cuts, it appears that the wheels are starting to fall off. Two unconvincing auctions of short and long term debt this week underscored Italy’s need to go further to ensure the confidence of the markets. Battling with public debt levels of 120 percent of GDP, a contracting economy and resentment to reform, a sense of urgency is increasing as Monti’s government tries to distance itself from the other weak periphery countries.

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Spain’s Economy faces many Years of Pain

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Nobel Laureate economist Joseph Stiglitz characterizes the Spanish bank bailout as “voodoo economics” that is certain “to fail.” New York Times economic analyst Andrew Ross Sorkin agrees, “By now it should be apparent that the bailout has failed—or at least on its way to failing.” And columnist and Nobel Prize-winning economist Paul Krugman bemoans that Europe (and the U.S.) “are repeating ancient mistakes” and asks, “why does no one learn from them?”

Spain’s Prime Minister Mariano Rajoy with Herman Van Rompuy, President of the European Council. Source: European Council

Indeed, at first glance, the European Union’s response to the economic chaos gripping the continent does seem a combination of profound delusion, and what a British reporter called “sado-monetarism”—endless cutbacks, savage austerity, and widespread layoffs. But whether something “works” or not depends on what you do for a living. If you work at a regular job, you are in deep trouble. Spanish unemployment is at 25 percent—much higher in the country’s southern regions—and 50 percent among young people. In one way or another, those figures—albeit not quite as high—are replicated across the Euro Zone, particularly in those countries that have sipped from Circe’s bailout cup: Ireland, Portugal, and Greece.

But if you are Josef Ackermann, who heads Deutsche Bank, you earned an 8 million Euro bonus in 2012, because you successfully manipulated the past four years of economic meltdown to make the bank bigger and more powerful than it was before the 2008 crash. In 2009, when people were losing their jobs, their homes, and their pensions, Deutsche Bank’s profits soared 67 percent, eventually raking in almost 8 billion Euros for 2011. The bank took a hit in 2012, but the Spanish bailout will help recoup Deutsche Bank’s losses from its gambling spree in Spain’s real estate market.

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Germany’s Constitutional Conundrum

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French President Nicolas Sarkozy with German Chancellor Angela Merkel during the G20 Summit in Cannes, France. F. de la Mure / MAEE

Hans-Werner Sinn, President of Germany’s Ifo Institute and the Director of the Center for Economic Studies at the University of Munich, has taken to the pages of the New York Times to explain why Berlin is balking on a further bailout for Europe.

French President Nicolas Sarkozy with German Chancellor Angela Merkel during the G20 Summit in Cannes, France. F. de la Mure/MAEE

Amongst the points that Sinn makes against German sharing in the debt of the euro zone’s southern nations is a legal one: “For one thing, such a bailout is illegal under the Maastricht Treaty, which governs the euro zone. Because the treaty is law in each member state, a bailout would be rejected by Germany’s Constitutional Court.” Sinn also argues that Germany’s counterparty credit exposure already exposes the country to immense credit risk: “Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion. Should the euro fail, Germany would lose over $1.35 trillion, more than 40 percent of its G.D.P.”

Let’s leave aside Sinn’s broader rhetorical points (“Has the United States ever incurred a similar risk for helping other countries?” Umm, yes, it did – there was that little matter of World War II). Levity aside, professor Sinn does raise a huge potential conundrum as far as Germany and its broader relationship to the Eurozone’s institutions go. In fact, recent German Constitutional Court rulings on bailouts could well blow apart the European Monetary Union. This is because the potential unlimited liabilities to which Germany is exposed under Target 2, the ELA, and various other lender of last resort facilities adopted by the European Central Bank do on the face of it run afoul of the court’s ruling, which argued that any future bailouts had to be limited and subject to the democratic consent of Germany’s Parliament. What happens, for example, if someone in Germany were to challenge the very legality of Target 2 on those grounds?

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From Russia with Love? Cyprus seeks another Bailout

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Russian President Dmitry Medvedev with Cyprus President Dimitris Christofias during an official visit.  Source: Kremlin Press Office

Cyprus today hinted that it was seeking a €5 billion loan from the Russian authorities to bolster its bank’s capital levels before a key regulatory deadline at the end of June. This assistance would follow a €2.5 billion loan in 2011 from the Kremlin which the island nation has been fully dependent on having been effectively shutout of capital markets.

Russian President Dmitry Medvedev with Cyprus President Dimitris Christofias during an official visit. Source: Kremlin Press Office

There had been signs over the past couple of days that Cyprus would formally request financial aid from the current Eurozone bailout fund, the EFSF, but this has yet to materialize, although it has not entirely been ruled out by the Cypriot authorities who claim to be “considering all available options”. Cyprus is under pressure to recapitalise its banking sector, particularly Popular Bank, which requires a capital injection of €1.8 billion this month in order to satisfy the conditions of European regulators. A rights issue underwritten by the Cypriot government is planned to start this Friday and will place further stress on Cyprus’s finances if, as expected, private participation is low.

A bailout, which looks likely, poses an interesting conundrum for the Cypriot authorities. Accepting an EFSF package from its European partners would likely tie the small Mediterranean nation in to austerity conditions akin to those imposed on the other peripheral Eurozone economies. Furthermore, it is presumed that any Russian assistance would be free of fiscal conditions, which would be favourable but may subject Cyprus to other agreements likely to arouse suspicion in Europe and beyond. For Russia, a country flushed with Euro denominated reserves, this could be a targeted investment with potentially lucrative returns. It has been reported that Russia has an interest in developing a deep-water naval capability in this strategic location as well as tapping into the reported sizeable natural gas reserves in the waters surrounding Cyprus.

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Another One Bites the Dust: The ECB Pours Cold Water on Bankia Bailout Solution

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Bankia ATM in Madrid. Source: Global Post

It might seem strange to invoke Freddie Mercury and Queen in the context of the eurozone, but it’s the first thought that springs to mind, as Brussels and the increasingly hapless ECB, continue to mismanage their way to financial and economic catastrophe.

Bankia ATM in Madrid. Source: Global Post

Yesterday, there were signs that the Spanish plan to recapitalise Bankia (which came with the implied backing of the ECB’s balance sheet) introduced a potential way out of the eurozone’s metastisizing banking crisis. Sadly, it’s another idea which will never get off the bulletin board, as the ECB bluntly rejected any proposal to use its balance sheet to indirectly fund Bankia, the troubled Spanish lender. So we’re back to floundering and the markets are reacting accordingly. What most investors, experts, and policy makers fail to realize is that this bank run is not simply a Greek problem, which will cease if and when Greece is thrown out of the euro zone.

If one looks at the Target 2 balances, the ELA, and the ECB’s lender of last resort facilities, it’s clear that this has extended into all of the periphery countries, including Spain and Italy. It may well end with Germany’s banks effectively serving as the deposit base for all of Europe. Perversely, the ECB and the European authorities acknowledge none of this and seem to be doing nothing about it. At least not publicly. They are like ostriches with their collective heads in the sand. If anything, “tough talk” from some of them may be escalating the bank run, rather than restoring confidence.

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Germany is the Big Loser, Not Greece

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German Chancellor Angela Merkel in Brussels. Source: European Council

Given the German electorate’s long standing aversion to “fiscal profligacy” and soft currency economics (said to lead inexorably to Weimar style hyperinflation), one wonders why on earth Germany actually acceded to a “big and broad” European Monetary Union which included countries such as Greece, Portugal, Spain and Italy.

German Chancellor Angela Merkel in Brussels. Source: European Council

Clearly, this can be better understood by viewing the country through the prism of the Three Germanys: Germany 1 is the Germany of the Bundesbank: the segment of the country which to this day retains huge phobias about the recurrence of Weimar-style inflation, and an almost theological belief in sound money and a corresponding hatred of inflation. It is the Germany of “sound finances” and “monetary discipline”. In many respects, these Germans are Austrian School style economists to the core. In their heart of hearts, many would probably love to be back on an international gold standard system. Germany 2 is the internationalist wing of the country, led by Helmut Kohl. Kohl and his successors are probably the foremost exponents of the idea that Europe can rid itself of the “German problem” once and for all if Germany firmly binds itself to a “United States of Europe” and continues to construct institutions that broadly move the EU in this direction.

It is questionable whether this vision has survived significantly beyond the tenure of Helmut Kohl himself. One can see the inherent tension between these two Germanys. Bundesbank Germany would never allow vague, internationalist aspirations to dilute the goal of sound money, low inflation and fiscal discipline. One could envisage most looking askance at the Treaty of Maastricht and the corresponding threats to these ideals.

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Spain is the New Greece

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Spain’s Prime Minister Mariano Rajoy

Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”.

Spain’s Prime Minister Mariano Rajoy

The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. At this pace, Spanish job losses are equivalent to 1 million per month in the United States. That means more than 5.6m Spaniards or 24.4 percent of the workforce are unemployed, close to a record high set in 1994. Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels).

Moreover, Spain has a huge private debt burden that is twice that of Greece. Although I have warned before that Spain’s austerity program was leading the country to disaster, my reaction to this economic catastrophe has been one of amazement. Yet, until now Rajoy Administration has been saying that the marginal decline in GDP estimated by the Bank of Spain for the first quarter was exaggerating economic weakness. Now we have the spectacle of the Spanish government suggesting that the Bank of Spain estimate of a .4% decline in Q1 Spanish GDP is too pessimistic.

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Argentina’s Economic Policy: Failing to Learn from History

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Argentina's Cristina Kirchner with Brazil's Dilma Rousseff. Photo: Roberto Stuckert Filho

Argentina is heading toward its second economic crisis in just over a decade and national leaders are unwilling to publicly acknowledge that the country’s growth is unsustainable.

Argentina’s Cristina Kirchner with Brazil’s Dilma Rousseff. Photo: Roberto Stuckert Filho

Since the country’s economic collapse a decade ago, President Nestor Kirchner (2003-2007) and President Christina Fernandez de Kirchner (2007 – present) have allowed the national economy to function without interference or direction. Senior officials have refused to dictate economic policy because domestic markets have been expanding and strengthening independently. They defend their position by citing the nation’s cheap currency and continual trade surpluses.

The reason for Argentina’s economic success is due to self-deception on the part of the national leadership. The international community has vocalized concern that it would be in Argentina’s best interest to slow down economic progress; however, these concerns were met with increased transportation and energy subsidies, as well as more funding being allocated for social programs. These policies were initially subsidized by the nationalization of private pensions, but, as spending continued to grow, the Central Bank began printing money.

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Ireland’s Debt and the Heart of St. O’Toole

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Graffiti on a wall in south Dublin, Ireland. Photo: William Murphy

Someone has pinched the heart of St. Lawrence O’Toole, and thereby hangs a typical Irish tale filled with metaphors, parallels, and some pretty serious weirdness. Who done it?

Graffiti on a wall in south Dublin, Ireland. Photo: William Murphy

The suspects are many and varied. Could the heist from Dublin’s Christ Church Cathedral have been engineered by the infamous “troika” of the European Commission, the European Bank, and the International Monetary Fund? Seems like a stretch, but consider the following: O’Toole—patron saint of Dublin—was, according to the Catholic Church, famous for practicing “the greatest austerity.” Lawrence liked to wear a hair shirt underneath his Episcopal gowns and spent 40 days in a cave each year.

That is a point of view the troika can respect. They have overseen a massive austerity program in Ireland that has strangled the economy, cut wages 22 percent, slashed education, health care, and public transport, raised taxes and fees, and driven the jobless rate up to 15percent—30% if you are young. At this rate many Irish will soon be living in caves, and while hair shirts may be uncomfortable, they are warm. There are other suspects as well. For instance, St. O’Toole was friendly with the Norman/English King Henry II, who conquered the island in 1171. The Irish are not enamored of Henry II, indeed most of them did their level best to drive the bastard into the sea. Not Lawrence. He welcomed Henry to Dublin and, according to the Church, “Paid him due deference.”

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Do Country Acronyms have a Meaningful Place in a Dynamic World?

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When Goldman Sachs first coined the term “BRICs” in 2001, it did so on the assumption that these four countries were going to heavily influence the direction of the global economy.

Russia’s Dmitry Medvedev in India for the BRICS Summit. Source: Kremlin Press Office

It turned out that China was much more influential than any of the other three, and that Brazil well underperformed the others based on its decade-long average GDP growth rate of approximately 3.5%. Since then, the dynamics of the global economy have continued to change significantly, with the rise of ‘the rest’ becoming a dominant feature of the landscape. So, just how relevant and useful are acronyms in defining the likelihood of growth and influence of countries in today’s constantly evolving world?

It did not take long for Goldman to itself question the wisdom and applicability of the BRICs incarnation, which quickly became outdated. Indeed, it wasn’t long before some analysts argued that Indonesia and South Africa should be added to the acronym, and that perhaps Brazil and Russia should be removed. Similarly, the G-8 morphed into the G-20 over the past decade, and some would argue it should be G-40 today, based on the declining influence of Europe and the rising influence of Asia and the Middle East in the global economy. The debate over whether acronyms have a useful shelf life and just how applicable they are in such a dynamic world has gained new momentum.

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Trouble in Euro Zone Paradise?

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The Europeans evidently thrive on instability and the ongoing threat of systemic risk.

Deutsche Bundesbank President Jens Weidmann. Source: Chatham House

There is nothing else to explain the renewed hardline stance adopted by both Mario Draghi of the ECB and the German government on fiscal policy, just as the markets appeared to be calming down again. In response to the question as to whether Greece was a “one-off”, or a deal which would presage similar claims on the part of the other Mediterranean debtor nations, there has been a growing prevailing belief that either the terms demanded of Greece would be so punitive (“pour decourager les autres”) or that, if Greece were to default, a sufficiently large firewall would be constructed by the Troika to ensure that the contagion wouldn’t extend to other countries.

This is what Greek economist Yanis Varoufakis has called “cauterize and print”: “Germany’s belated epiphany is that, without a major redesign of the euro architecture, a number (>1) of eurozone member states are irretrievably insolvent. As for the two strategic choices, the first is Berlin’s conclusion that German politics have no stomach for, or interest in, a structural redesign of the euro system. The second choice involves a massive bet in attempting to save the eurozone by shrinking it forcefully while, at the same time, authorising the ECB to print trillions of euros to cauterise the stumps left when the states earmarked for the chop are severed.”  Well, the 2nd leg of that strategy seems to be falling apart, even as Greece is slowly being severed from the euro zone.

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