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European Central Bank

Tag Archives | European Central Bank

Financial Predators v. Labor, Industry and Democracy

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Source: Images Money

The Eurozone lacks a central bank to do what most central banks are supposed to do: finance government deficits. To make matters worse, the Lisbon Agreement limits these deficits to 3% – too small to pull economies out of depression by offsetting private-sector debt deflation.

Source: Images Money

Even if central banks could monetize higher levels of deficit spending, there are good reasons not to subsidize unfair tax systems and tax cuts on the real estate and financial “free lunch” windfalls that classical economists urged to be the tax base. Under classical tax policy, Europe would not have had a land-price bubble in the first place. “Free lunch” economic rent would have become the tax base, not capitalized into bank loans to be paid out as interest. Government budgets would have been financed in a way that kept down property prices.

But bank lobbyists have blocked the Eurozone from creating a true central bank to finance public budget deficits. They also have reversed classical tax policy, un-taxing real estate and finance while putting the burden on labor, corporate profits and consumers by the turnover tax (VAT). These twin financial and fiscal policies have strengthened the wrong sectors and made the current sovereign debt crisis inevitable, turning it into a general economic and political crisis.

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The Politics of the Economic Crisis

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Bank of England

Bank of England

“Perhaps the most surprising aspect of the Libor scandal is how familiar it seems. Sure, for some of the world’s leading banks to try to manipulate one of the most important interest rates in contemporary finance is clearly egregious. But is that worse than packaging billions of dollars worth of dubious mortgages into a bond and having it stamped with a Triple-A rating to sell to some dupe down the road while betting against it? Or how about forging documents on an industrial scale to foreclose fraudulently on countless homeowners?”

– Eduardo Porter for the The New York Times

A useful summary of the situation as of today. But of what? What is this? We have been through many answers starting with credit squeeze, then a real estate bubble that burst, toxic assets, credit swaps, hedge funds, derivatives—bets with the money of other people, yours and mine—all finance and banking. A psychologism was added at an early stage, that of greed. Small savings banks wanted to be in it, the pattern was contagious and spread from Wall Street to the Euro zone. Bailout vs. Stimulus, Wall Street vs. Main Street. But as big banks are too big to fail there was bailout for the former and austerity for the latter, resulting in misery.

Jobless growth in the United States, 17 percent unemployment in the European Union; “stocks slump worldwide and euro sinks as bond rates soar to record” (IHT, July 24, 2012). So on and so forth. Whatever it is, the effect is an enormity. It stands to reason that the causes should be commensurate. True, the system could have reached a tipping edge and tumbled down after one small step, but then that tipping edge is a huge cause. Why didn’t we know about it? Was it ignorance or sloppy theory? There could be other causes.

See it as bad finance, economics and banking practice at work—and the structural violence hitting the old, the poor, the underprivileged is without parallel since the Great Depression. See it as politics, as intended acts of commission—and it becomes direct violence hitting people whose only wrongdoing was to trust the system. One hypothesis does not exclude the other. The question becomes: “How much was banking gone mad, how much was politics as usual?”

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How Far is the ECB Prepared to Go to Save the Euro?

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European Central Bank's Mario Draghi with Ramon Tremosa. Source: European Council

Re-reading Mr Draghi’s market-moving remarks last Thursday, one gains a sense that the European Central Bank chief recognizes that the ECB has a banking run on its hand. Most market participants have understandably focused on Mr. Draghi’s pledge that the ECB was “ready to do whatever it takes” to preserve the single currency. “Believe me, it will be enough,” he told a conference in London. We prefer to focus on other aspects of the speech.

European Central Bank’s Mario Draghi with Ramon Tremosa. Source: European Council

It is particularly salient that Mr. Draghi highlights the fatal flaw of the euro zone noted by Professor Peter Garber some 14 years ago: 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. However, Garber recognized that if there arose the prospect of a euro exit and, therefore, a devaluation risk for holders of deposits in the banks domiciled in the country slated for exit (e.g. Greece or Spain), the European monetary system would be exposed to a bank run. Under the EU treaty capital mobility was guaranteed.

Under the common currency deposit transfers from domestically domiciled banks in countries at risk of euro exit (e.g. Greece, Spain) to banks domiciled in other euro nation states (e.g. Germany, Netherlands) was costless. Faced with any non-negligible perceived risk of a euro exit and thereby a devaluation loss, rational market participants should move all their deposit funds from the banks domiciled in the country at risk of euro exit to banks domiciled in nations at the Eurozone’s unassailable core.

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Greece on the Brink…Again

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European Union and Greek flags fly near the Parthenon. Simon Dawson/Bloomberg

Just one month after the so called “make or break” election, the state coffers in Greece are running low as tax revenues continue to miss targets as the economy slows further.

European Union and Greek flags fly near the Parthenon. Simon Dawson/Bloomberg

The election outcome, dubbed by European political leaders as a victory for the euro, was supposed to ensure that the bailout programme be implemented in order to move Greece back onto a sustainable economic path. Since then the emphasis in Greece has shifted towards a renegotiation of the bailout conditions as the austerity measures hit living standards. A recent statistic published by Eurostat claimed that 27.7 percent of Greeks are now living on or below the poverty line. Such rhetoric is falling on deaf ears elsewhere in Europe as leaders in countries such as Germany, Finland and the Netherlands struggle to sell each of the bailouts to their respective electorates further highlighting the North-South divide in the Eurozone.

Recent figures released suggest that Greece is making progress towards reducing its deficit as the figure for the first six months of 2012 came in at 12.3 billion euros well ahead of the Troika target of 14.9 billion euros and down from 13.1 billion euros from the same period in 2011. However, a closer inspection reveals that, whilst spending cuts are being met, the required taxation income was 1 billion euros behind the plan during the first half of 2012. One consequence of this is that Greece will struggle to survive financially until September when the next bailout tranche is due to be made payable.

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Geithner: Europe Can’t be Left Hanging on the Edge of Abyss

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Treasury Secretary Timothy Geithner

Michael Kinsley once defined a gaffe as “when a politician tells the truth – some obvious truth he isn’t supposed to say.”

Treasury Secretary Timothy Geithner

On that basis, the recent headline that just popped up might well represent a major gaffe of the Kinsley variety by Treasury Secretary Tim Geithner. Speaking on CNBC’s “Delivering Alpha” conference, the Treasury Secretary argued, “What is very important is that [Eurozone officials] not leave the Continent hanging on the edge of the abyss as a device for getting more leverage for reform, because that leaves the rest of the world much more exposed to financial pressure and slower growth from Europe.” In essence, Geithner is letting the cat out of the bag. He is implying that Europe is hanging on the edge of the abyss. Only Germany can prevent it from falling in, and at the same time it appears that Berlin has now moved into a position where they cannot or will not prevent that disasterous scenario, either for economic or legal reasons.

The decision by Germany’s constitutional court to delay its approval of the German Parliament’s ratification of the ESM and fiscal compact may be a warning. The court could have moved to approve quickly. Instead, it will not rule on emergency appeals for an interim injunction against the parliamentary approvals until the end of this month. If the court rules in favor of an interim injunction, the final decision on the ESM and fiscal compact may not be made for several months.

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The Chinese Central Bank’s Delicate Tap Dance

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People’s Bank of China (PBOC) in Beijing. Sim Chi Yin/Bloomberg

This past week’s release of China’s second quarter GDP growth number – at 7.6 percent - was viewed as an ominous sign of the future direction of the global economy by some pundits, while others see the Chinese government’s stimulus measures as a hopeful sign that its economic growth will be higher in the second half of the year.

People’s Bank of China (PBOC) in Beijing. Sim Chi Yin/Bloomberg

It is important to understand that the root cause of the decline in China’s economic growth this year is not the trouble in Europe or funk of the global economy, but rather the unsustainable economic bubbles that have been created by the government, and the collapsing demand that has accompanied it. The central bank’s latest tap dance won’t fix that.

Central banking maneuvering can at best serve to sustain the over-leveraged economy and avoid a systematic short-circuit of debt financing for now. There won’t be much liquidity invested in lending capacity or job creating projects, since there is insufficient demand, so the economic return on credit will deteriorate. If these structural deficiencies aren’t properly addressed by the central government - and soon – the longer-term deterioration of the Chinese economy can only continue. The inevitable chain reaction will accelerate, and China will face its economic end game.

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Spain’s Growing Pains

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Prime Minister Mariano Rajoy in Valencia. Diego Crespo/La Moncloa

Just when you think that things can get no worse in Spain, they do.

Prime Minister Mariano Rajoy in Valencia. Diego Crespo/La Moncloa

Yiagos Alexopoulos at Credit Suisse estimates that Spanish capital outflows are currently running at an annualised rate of 50 per cent of GDP. No question, the bank run is clearly accelerating, and one can easily understand why. The country is turning into a Little House of Economic Horrors. The alleged “rescue” of Madrid’s banks is a non-starter. 100 billion euros won’t begin to cover the scale of the problem on any honest accounting or “stress test” (and that’s before we get to the next phase of announced austerity measures). Chuck Davidson of Wexford Capital has completed a report where he looked at the Spanish banks, extrapolating to all of them from a close look at the big five. He haircutted their assets by 25%, which hardly seems excessive.

Moving from the big 5 to the entire banking system, he came up with 990 billion euros as the capital needed to get Spain’s banks to Basel 3 risk weighted capital standards. Madrid, we have a problem! That’s of course after these very same banks have ripped off thousands of depositors, who were strongly encouraged to buy preferred equity shares and subordinated debt, which were touted to them as higher yielding, low risk fixed income replacements instead of lower yielding deposits

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The ECB is Quickly Running out of Options

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European Central Bank President Mario Draghi. Photo: Pietro Naj-Oleari

When policymakers are lacking in credibility and competence, confidence in their ability to govern is likely to be in short supply. This is particularly notable in reference to the Eurozone and its steadily deteriorating economy – most acutely felt by the ‘sin states’ of the Mediterranean.

European Central Bank President Mario Draghi. Photo: Pietro Naj-Oleari

With Europe’s leaders now finally in admission of the debt fuelled malaises, the emphasis has turned to crisis and resolution management, and the markets are feeling uneasy. As the economic data releases worsen by the week investors increasingly look to the European institutions, most commonly the European Central Bank, to provide the financial stimulus to drive an economic recovery. As the crisis shifts to the business end of the cycle it is clear that a solution for the Spanish and Italian sovereigns is barely making progress as borrowing costs teeter at unsustainable levels.

Last week the European Central Bank pitched in with a seemingly last ditch attempt to contain the crisis by cutting its benchmark interest rate to 0.75% and lowering its deposit rate to 0%. With the ECB quickly running out of options, its President Mario Draghi, once again re-iterated that the ultimate remedy must be driven by Eurozone governments in the form of structural reforms and progression towards an economic and political union.

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Paul De Grauwe is Right: All Roads Lead Back to the ECB

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Italy's Prime Minister Mario Monti with Ireland's Prime Minister Enda Kenny in Brussels. Source: European Council

We’ve always been a fan of Professor Paul De Grauwe from University of Leuven, who has consistently pointed out the structural flaws inherent in the original structures of the EU.

Italy’s Prime Minister Mario Monti with Ireland’s Prime Minister Enda Kenny in Brussels. Source: European Council

Recently, Professor de Grauwe wrote an excellent analysis explaining why the latest “rescue plan” cobbled together by the Eurozone authorities is destined to fail. The key points: ECB is not currently a ‘lender of last resort’. The ECB was set up with fundamental flaws, where “… one of the ECB’s main concerns is the defense of its balance sheet quality. That is, a concern about avoiding losses and showing positive equity- even if that leads to financial instability.”

This is a profoundly misconceived idea. As we have noted many times, a private bank needs capital – clearly because there are prudential regulations requiring that – but because it can become insolvent. It has not currency-issuing capacity in its own right. While the ECB has an elaborate formula for determining how capital is from the national member banks at an intrinsic level, it has no need for capital. It could operate forever with a balance sheet that if held by a private bank would signal insolvency. There are no comparable concepts for a currency issuer and a currency user in terms of solvency. The latter is always at risk of insolvency the former never, so the ECB’s focus on profitability is not only misguided, but leading to inadequate policy responses.

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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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The Mysterious François Hollande

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French President François Hollande. Source: Ministère des Affaires étrangères

Not since Charles De Gaulle has a French president confronted an economic and international situation as tumultuous as the one faced by François Hollande.

French President François Hollande. Source: Ministère des Affaires étrangères

Hollande, who took over the presidency from Nicolas Sarkozy last month, is facing an unemployment rate in the double digits and a national debt that stands at 90% of GDP. In addition to his domestic challenges, Hollande finds himself at the center of a deepening European crisis, with Greece on the brink of collapse and most euro-zone countries in a recession. While the challenges facing the new president are enormous, there seems to be little consensus on how he will govern. This is largely because Hollande managed to capture France’s highest office while remaining a relatively unknown commodity. Even though he is now the most powerful man in French politics, many still wonder – who is François Hollande?

The new French leader’s electoral campaign does provide a few clues about the man and his politics. Throughout his campaign, Hollande wooed his left-wing electorate, while at the same time putting himself in a position to deliver on his promise to keep deficits under control. Take his rollback of Sarkozy’s pension reforms, which would allow French workers to retire at 60. This policy proposal is actually more of a modest tweak than a fundamental revamp, as it only impacts the few workers who have worked continuously for 41 years. Hollande also promised to hire 60,000 new teachers, a pledge that has deficit hawks concerned. However, the new president plans to pay for these new teachers through an equal reduction in the number of civil servants elsewhere in France’s sprawling bureaucracy.

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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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