Francisco Azuero's List: Crisis europea 2011

• This promise may well be tested  when the current Greek programme ends in 2014. Will euro area countries really  be willing to provide fresh funds if Greece is still unable to borrow in the  bond markets?
• To satisfy Jean-Claude Trichet, president of the European Central Bank, any  involvement by private creditors had to be “voluntary”; to satisfy the political  needs of Angela Merkel, the German chancellor, (and others) it had to be  “substantial” (see my previous post here and here).
• “In Russian roulette there is one bullet in the cylinder. In Belgian roulette  the whole cylinder is loaded with bullets
• So in the end the decision was to offer creditors a choice of all three, as if a  selection of unpalatable options would appear like a choice made freely.

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• A more fundamental step towards a fiscal union may be needed. One way forward is  to introduce Eurobonds, which would pledge “joint and several” liability
• But critics of Eurobonds say that creating them within the current framework  would actually weaken budgetary discipline, reducing the incentives for weaker  states to get their finances in order
• Barry Eichengreen, a monetary historian at the University of California,  Berkeley, says that the economic costs of disintegration would be catastrophic  for Europe and beyond

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• This is because the profligacy diagnosis is incomplete, and thus misleading. The  symptoms of the crisis were first seen in Greece, and Greece’s mess is indeed  largely thanks to its spendthrift government and its citizens’ refusal to pay  their taxes. But Spain and Ireland had low government debt and in 2006 and 2007  were running small surpluses: their finances were flattered by the boom and  wrecked by the banking and property bust.
• Italy has long had a big public debt, but a reasonably stable one; its budget  deficit is among the euro zone’s smallest. These countries have weaker public  finances than countries in the core, but not simply because their governments  spent more. Nor, particularly in the cases of Spain and Italy, is their weakness  so great as to justify the markets’ sudden reassessment of their risk.

• An alternative diagnosis explains the continuing  chaos by pointing out that an implicit assumption behind Europe’s financial  integration—that sovereign debt was risk-free—has been overturned, and no one  knows what to assume instead.
• The ECB has responded as a lender of last resort to the banking system,  expanding and extending its liquidity lines for banks. But there has been no  similarly comprehensive fallback for sovereign debt

• This is where the two diagnoses collide. One  emphasises conditions as the only way to confidence. The other emphasises a  confidence achievable only with unconditional support. The second diagnosis has  the advantage of explaining why the first course of treatment has failed. It has  the disadvantage of making that failure the doctors’ fault.

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• Banks are being given almost nine months to reach the targets, ostensibly to  allow them to raise capital themselves through cutting dividends or bonuses and  selling shares. Yet few investors are willing to buy bank shares, cheap as they  may seem, given the perceived risks of a series of sovereign defaults in Europe.    

   
• This means that the burden would fall first on national governments and then on  the increasingly stretched resources of the European Financial Stability  Facility (EFSF), Europe’s main bail-out fund.
• Capital is only one issue facing banks. A second is their own ability to borrow.  The ECB can step in for short-term funding, but long-term markets are frozen.

• The favoured option is to get the EFSF to insure  government bonds, acting, in effect, as the issuer of the much-maligned  credit-default swap. By guaranteeing to take, say, the first 20% of any loss on  government bonds, the EFSF could, in theory, support €1 trillion-worth of  Italian and Spanish debt.
• The euro’s crisis boils down to this: national treasuries do not have enough  spare cash both to guarantee outstanding debt and maintain their own credit  ratings. Even mighty Germany cannot stand alone behind the whole euro zone
• If the Chinese are going to chuck money into an SPV or the IMF there will be a  price,” says a European diplomat. “The Chinese want two things: one is greater  voting rights in the IMF, the other is market-economy status.”
• “The blanket prohibition against directly lending to governments is a complete  idiocy,” says Willem Buiter, chief economist at Citigroup, and a former member  of the Bank of England’s monetary-policy committee.
• That is what central banks do. Just because it can be mismanaged does not mean  you have to throw the tool away. You can drown in water, but it does not mean  you cannot have a glass when you are thirsty.”

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• No central bank wants to be put in that position, of course, and institutional  arrangements have sprung up to prevent it. The most common is to require that  bonds be purchased only at market prices.

  • I's the same in Colombia
• The Federal Reserve is prohibited from buying bonds directly from the  government, except to roll over a maturing issue in its portfolio
• It can buy bonds on the secondary market, which is how it enforced the yield  ceiling during the second world war, but its accord with the Treasury in 1951  ended that obligation.

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• What has happened, it turns out, is that by going on the euro, Spain and  Italy in effect reduced themselves to the status of third-world countries that  have to borrow in someone else’s currency, with all the loss of flexibility that  implies. In particular, since euro-area countries can’t print money even in an  emergency, they’re subject to funding disruptions in a way that nations that  kept their own currencies aren’t — and the result is what you see right now.  America, which borrows in dollars, doesn’t have that problem.

• Banks are frantically shedding assets both to raise cash and to ration their  capital in order to meet European Union minimum capital-adequacy targets by next  June. The early victims of this deleveraging are borrowers in emerging markets.
• Even so, it seems plain that fiscal tightening will weaken growth. Take the  plans that countries presented to the European Commission and add what has been  advertised since, and the squeeze across the euro area comes to around 1.25% of  GDP next year, reckons Laurence Boone, chief European economist at Bank of  America.
• That alone is enough, says Ms Boone, to chop around a percentage point off GDP  growth in 2012.

• The euro zone’s businesses and consumers will be  drawn into the downward spiral of confidence. In the autumn of 2008 companies  learned that credit lines could not be relied on when banks were fighting for  survival. When banks are short of liquidity, firms have to watch their own  cashflow closely. That implies leaner stocks and reductions in discretionary  spending, such as capital projects or advertising campaigns.
• In such circumstances, the chances of a policy error or broader panic increase  sharply. The calculations of bond investors, bank depositors and politicians are  prone to sudden change.
• Hopes that the fracture of the euro zone might be averted by far-sighted  policymakers could give way to a belief that it is inevitable
• Such beliefs, once they take hold, are likely to be self-fulfilling.
• During the credit boom, cheap capital flowed into Greece, Ireland, Portugal and  Spain to finance trade deficits and housing booms. As a result, the net foreign  liabilities—what businesses, householders and government owe to foreigners, less  the foreign assets they own—of all four are close to 100% of GDP. (By  comparison, America’s net foreign liabilities are 17% of GDP.)
• The higher the cost of funding becomes, the more money flows out to foreigners  to service these debts. This is why the issue of national solvency goes beyond  what governments owe. The euro zone is showing the symptoms of an internal  balance-of-payments crisis, with self-fulfilling runs on countries, because at  bottom that is the nature of its troubles. And such crises put extraordinary  pressure on exchange-rate pegs, no matter how permanent policymakers claim them  to be

• One of the initial attractions of euro membership for peripheral  countries—access to cheap funds—no longer applies. If a messy default is forced  upon a euro-zone country, it might be tempted to reinvent its own currency.  Indeed, it may have little option. That way, at least, it could write down the  value of its private and public debts, as well as cutting its wages and prices  relative to those abroad, improving its competitiveness. The switch would be  hugely costly for debtors and creditors alike. But the alternative is scarcely  more appealing. Austerity, high unemployment, social unrest, high borrowing  costs and banking chaos seem likely either way.
• Italy has €33 billion of debt coming due in the final week of January and a  further €48 billion in the last week of February (see chart 3). Since bond  investors are turning their noses up even at offerings from thrifty Germany, the  odds against Italy’s being able to raise the money it needs early next year are  uncomfortably short.
• The exposure of French banks to Italy and to other countries that have been in  bond traders’ sights for longer implies that contagion would quickly spread to  the euro’s core (see chart 4). Widespread defaults in the periphery would wipe  out a big chunk of Germany’s wealth and begin a chain of bank failures that  could turn recession into depression.

• The few left in the euro (Germany and perhaps a few other creditor countries)  would be at a competitive disadvantage to the new cheaper currencies on their  doorstep. As well as imposing capital controls, countries might retreat towards  autarky, by raising retaliatory tariffs. The survival of the European single  market and of the EU itself would then be under threat.
• Germany’s Council of Economic Experts recently proposed a “European Redemption  Pact”. This scheme would place the debt, in excess of 60% of GDP, of all  euro-zone governments not already in IMF rescue plans into a jointly guaranteed  fund that would be paid off over 25 years.

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• Add the ever greater fiscal austerity being imposed across Europe and a collapse  in business and consumer confidence, and there is little doubt that the euro  zone will see a deep recession in 2012—with a fall in output of perhaps as much  as 2%.
• This cannot go on for much longer. Without a dramatic change of heart by the ECB  and by European leaders, the single currency could break up within weeks.