Tag Archives: eurozone

Dominos

By James Kwak

So, as everyone knows, the ECB came out yesterday with its latest plan to stem the creeping European sovereign debt crisis. This one involves potentially unlimited ECB purchases of sovereign debt, so long as its maturity is less than three years (presumably so that the ECB can pull the plug within three years on non-complying governments) and the country in question agrees to comply with fiscal policy reforms (i.e., austerity).

I don’t have any particular ability to forecast whether this will succeed or fail. My inclination is that it will succeed for a while and then turn out to be insufficient, for the reasons that others have identified. Central bank bond-buying will enable governments to borrow money at manageable yields, so their national debt will not spiral out of control solely because of climbing interest rates. But to bring debt levels down will require actual economic growth, and more austerity—even if it isn’t quite as austere as that imposed on Greece in the past—will not generate growth. In addition, the ECB’s promise to “sterilize” its bond purchases—I believe by selling other assets to raise the cash for bond purchases, so the net effect will not be to create money—means that this is not a particularly expansionary form of monetary policy.

This is as good an occasion as any, however, to ask a question I’ve been wondering about for, oh, years now. Every discussion of the European crisis includes the following domino theory (although no one calls it that anymore, for reasons I’ll get back to): If Greece leaves the Eurozone, that proves that it is possible to leave the Eurozone—or, put another way, that the powers that be cannot keep the Eurozone intact. If people realize that it is possible, then bond markets will bet even more heavily against Spain and Italy, which will force them to leave the Eurozone, which would be terrible. Hence Greece cannot leave the Eurozone.

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The Huntsman Alternative

By Simon Johnson

The eurozone financial situation continues to worsen.  The latest idea from the eurogroup of finance ministers is apparently to have the European Central Bank make a massive loan to the International Monetary Fund, which would then turn around and lend to countries like Italy.  This is a bizarre notion.  If the IMF takes the credit risk of a mega-loan to Italy – e.g., an amount around the $600 billion mark, greater than the fund’s current lending capacity – this would represent an unprecedented and unacceptable risk to the IMF’s shareholders, including U.S. taxpayers.  If the IMF does not take this credit risk, what’s the point?  The ECB should provide financial support directly to Italy, if that is the goal.

But that goal increasingly seems both to be the only idea of officials and the last failed notion of a fading era.  More bailouts and the reinforcement of moral hazard – protecting bankers and other creditors against the downside of their mistakes – is the last thing that the world’s financial system needs.   Yet this is also the main idea of the Obama administration.  Treasury Secretary Tim Geithner told the Fiscal Times this week that European leaders “are going to have to move more quickly to put in place a strong firewall to help protect countries that are undertaking reforms,” meaning more bailouts.  And this week we learned more about the underhand and undemocratic ways in which the Federal Reserve saved big banks last time around.  (You should read Ron Suskind’s book, Confidence Men: Wall Street, Washington, and the Education of a President, to understand Mr. Geithner’s philosophy of unconditional bailouts; remember that he was president of the New York Fed before become treasury secretary.)

Is there really no alternative to pouring good money after bad?

In a policy statement released this week, Governor Jon Huntsman articulates a coherent alternative approach to the financial sector, which begins with a diagnosis of our current problem: Too Big To Fail banks, Continue reading

The 4 Trillion Euro Fantasy

By Peter Boone and Simon Johnson

Some officials and former officials are taking the view that a large fund of financial support for troubled eurozone nations could be decisive in stabilizing the situation.  The headline numbers discussed are up to 2-4 trillion euros – a large amount of money, given that German GDP is only 2.5 trillion euros and the entire eurozone GDP is around 9 trillion euros.

There are some practical difficulties, including the fact that the European Financial Stability Fund (EFSF) as currently designed has only around 240 billion euros available (although this falls if more countries lose their AAA status in the euro area) and the International Monetary Fund – the only ready money at the global level – would be more than stretched to go “all in” at 300 billion euros.  Never mind, say the optimists – we’ll get some “equity” from the EFSF and then “leverage up” by borrowing from the European Central Bank.

Such a scheme, if it could get political approval, would buy time – in the sense that it would hold down interest rates on Italian government debt relative to their current trajectory.  But leaving aside the question of whether the ECB – and the Germans – would ever agree to provide this kind of leverage and ignoring legitimate concerns about the potential impact on inflationary expectations of such measures, could a, for example, 4 trillion euro package really stabilize the situation? Continue reading

Italy And Systemic Risk In The United States

By Simon Johnson

In recent days, Greece’s parliament adopted new austerity measures and Europe’s finance ministers approved another round of Greek loans. So the European debt crisis is under control, right?

Probably not. One obvious reason is Standard & Poor’s July 4 threat to declare a default if banks roll over Greek government bonds coming due over the next year. That could force everyone back to the drawing board.

Less obvious, but no less worrisome, is Italy. With a precarious fiscal picture, it could be the next to come under pressure. And this time, U.S. banks are in the line of fire, with about $35 billion in loans to Italy and potentially more exposure to risk through derivatives markets.

U.S. regulators should call for a new round of stress tests that assume sovereign-debt restructurings in Europe and take a realistic view of counter-party risks in opaque markets such as foreign exchange swaps. Based on those tests, the biggest banks probably need to suspend dividends and raise more capital as a buffer against losses.

To read the rest of this post, click here (this link is to the full article on Bloomberg: http://www.bloomberg.com/news/2011-07-05/could-italy-be-next-european-domino-to-fall-commentary-by-simon-johnson.html)

China and the Saving of Europe

By Simon Johnson

The Greek government owes more than it can afford to pay, now or in the near future, at market interest rates.  There are two options: reduce the payments through some form of restructuring, or move the debt into the hands of people who are willing to charge below market rates for the foreseeable future.

In this decision, the International Monetary Fund has relatively little say – this is really a political decision to be made by the European Union, with discrete backing from the US and China. Continue reading

Imminent Eurozone Default: How Likely?

By Simon Johnson

The big question of the week in Europe is deceptively simple – will any countries that share the euro as their currency default on their government or bank debts in the foreseeable future?  The answer to this question determines how you regard bonds from countries such as Portugal, Spain, Italy, and Belgium.

Answering this question is not as simple as it seems, however, because it involves taking a view on three intricate issues: What exactly is the eurozone policy now on bailouts, can big eurozone countries really be bailed out if needed, and what happens to the politics of these countries and of the eurozone has a whole as pressure from the financial markets mounts?

The prevailing consensus – and definite official spin – is that over the weekend European leaders backed away from the German proposal to impose losses on creditors as a condition of future bailouts, i.e., from 2013.  The markets, in this view, should and likely will calm now; there is no immediate prospect of any kind of sovereign default or (more politely) “reprofiling” on debt, including the obligations of big banks.

But a close reading of the Eurogroup ministers’ statement from Sunday suggests quite a different interpretation.  It’s a straightforward text, just 2 ½ pages long, but it has potentially momentous consequences – as it envisages dividing future eurozone crises into two kinds. Continue reading

The Eurozone Endgame: Four Scenarios

By Peter Boone and Simon Johnson

In the aftermath of the Irish bailout, the German proposal for a future sovereign and/or senior bank debt restructuring mechanism within the eurozone makes complete political sense to the electorate in stronger European countries.  They do not want to write “blank checks” to weaker countries and to out-of-control financial institutions going forward; creditors to countries that run into trouble will face likely losses.

While the details of this “burden sharing” approach remain to be hammered out (after Sunday’s announcements), there is no way for German or other politicians to backtrack on the broad strategic principles.  But once this arrangement is in place, say in 2013 or thereabouts, all eurozone countries will (a) be able to sustain less debt than has recently been regarded as the norm, and (b) become vulnerable to the kinds of speculative attacks in debt markets that we have seen in recent weeks – to reduce funding rollover dangers, they will all need to lengthen the maturity of their outstanding debt. 

The end point is clear.  Last week the markets began to work backwards to today’s debt profiles; major disruptions still lie ahead.

Ultimately, there will be a eurozone will greater shared fiscal authority, a common cross-border resolution authority for failed banks, and likely greater economic integration.  But there are four scenarios regarding who ends up in that eurozone – and how we get there. Continue reading

Who Gains From The Eurozone Fiasco? China

By Simon Johnson

Ireland will get a package of support from the EU and the IMF.  Will the money and the accompanying policy changes be enough to stabilize the situation in Ireland or more broadly around Europe?  Does it prevent Ireland from restructuring its debt – or move the Irish (and other parts of the European periphery) further in that direction?

And who gains from the delay and mismanagement we continue to see at the highest European levels?

This is complicated economic chess within Ireland, across Europe, and at the international level.  In my Bloomberg column this morning, I suggest we look several moves ahead, recognizing the underlying political dynamic:

There is a much more general or global phenomenon in which powerful people cooperate to build an economic model that provides growth based on a great deal of debt. When the crisis comes, those who control the state try to save their favorite oligarchs, but there aren’t enough resources to go around

…..

Here is the present problem: It’s not just the Irish elite that is under pressure and struggling to sort out who should be saved. It’s also the European bankers who funded them. Continue reading

The Debt Problems of the European Periphery

By Anders Åslund, Peter Boone and Simon Johnson

Last week’s renewed anxiety over bond market collapse in Europe’s periphery should come as no surprise.  Greece’s EU/IMF program heaps more public debt onto a nation that is already insolvent, and Ireland is now on the same track. Despite massive fiscal cuts and several years of deep recession Greece and Ireland will accumulate 150% of GNP in debt by 2014.   A new road is necessary: The burden of financial failure should be shared with the culprits and not only born by the victims.

The fundamental flaw in these programs is the morally dubious decision to bail out the bank creditors while foisting the burden of adjustment on taxpayers.  Especially the Irish government has, for no good reason, nationalized the debts of its failing private banks, passing on the burden to its increasingly poor citizens.  On the donor side, German and French taxpayers are angry at the thought of having to pay for the bonanza of Irish banks and their irresponsible creditors.

Such lopsided burden-sharing is rightly angering both donors and recipients.  Rising public resentment is testing German and French willingness to promise more taxpayer funds.  German Chancellor Angela Merkel’s hasty and ill thought out plan to demand private sector burden sharing, but only “after mid-2013”, marks a first response to these popular demands.  We should expect more. Continue reading

It’s Not About Ireland Anymore

By Simon Johnson

On the Project Syndicate website, Peter Boone and I argue, with regard to the European situation in this coming week:

The Germans, responding to the understandable public backlash against taxpayer-financed bailouts for banks and indebted countries, are sensibly calling for mechanisms to permit “wider burden sharing” – meaning losses for creditors. Yet their new proposals, which bizarrely imply that defaults can happen only after mid-2013, defy the basic economics of debt defaults.

Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels. Continue reading

The Very Bad Luck of The Irish

By Peter Boone and Simon Johnson

With the European Central Bank announcing that it has bought more than $20 billion of mostly high-risk euro zone government debt in one week, its new strategy is crystal clear: We will take the risk from bank balance sheets and give it to the central bank, and we expect Portugal-Ireland-Italy-Greece-Spain to cut fiscal spending sharply and pull themselves out of this mess through austerity.

But the bank’s head, Jean-Claude Trichet, faces a potential major issue: the task assigned to the profligate nations could be impossible. Some of these nations may be stuck in a downward debt spiral that makes greater economic decline ever more likely. Continue reading

Euro Falling, US Recovery Under Threat

Intensified fears over government debt in the eurozone are pushing the euro weaker against the dollar.  The G7 achieved nothing over the weekend, the IMF is stuck on the sidelines, and the Europeans are sitting on their hands at least until a summit on Thursday.  There is a lot of trading time between now and then – and most of it is likely to be spent weakening the euro further.

The UK also faces serious pressure, and there is no telling where this goes next around the world – or how it gets there.

There may be direct effects on the US, as our banking system remains undercapitalized.  Or the effect may be through making it harder to export – one of the few bright spots for the American economy over the past 12 months has been trade.  But this is unlikely to hold up as a driver of growth if the euro depreciation continues.

Some financial market participants cling to the hope that the stronger eurozone countries, particularly Germany, will soon help out the weaker countries in a generous manner.   But this view completely misreads the situation. Continue reading

The Risk Of Deflation In The Eurozone

In January, Lucas Papademos, Vice-President of the European Central Bank ECB), strongly suggested that inflation would not fall much below 2% in the eurozone (see the end of this post).  Translated from the language of central bankers, he implied that the risk of deflation in the eurozone was virtually nil.

Now Jean-Claude Trichet, head of the ECB, with reference to the latest eurozone (0%) inflation rate, says that we should disregard the data because a recovery is just around the corner.

Alternatively, we are close to the baseline eurozone view laid out in my January presentation (part of a panel discussion with Mr Papademos).  You can break this down into three specifics. Continue reading

The Smell Of Coffee

The late Rudi Dornbsuch of MIT had a way of cutting to the chase, preferably in public and with a minister of finance present.  He knew a huge amount about financial crisis, and could distill a lifetime of study and involvement in collapses succinctly: “it always takes longer than you think; but when it happens, it always happens faster than you can imagine.”

The latest credit default swap data for European banks bring Rudi’s perspective to mind – for the United States.  We’ve debated this week what to do about U.S. banks, arguing about which unappealing options are less bad.  In my view, the choice is not “nationalize vs. don’t nationalize,” but rather “keep our current partial nationalization/bottomless pit subsidy system vs. start down the road to reprivatization.”

But, honestly, this entire debate may be overtaken by events.  Continue reading

The Choice: Save Europe Now Or Later?

In major every crisis you have a choice.  You cannot choose between inaction and action, because ultimately you will be forced to act.  You do not really choose between bailout and no bailout, because very soon you find that all the reasonable options involve some sort of bailout for some people (and not for others).  And, try as you might, there is no way to choose to let your neighbors fail completely – because that failure has such awful consequences for their citizens and, in all likelihood, for your banks, that you finally come across with the money.

But you do have a choice on when to come to help your neighbors and your friends, and you can definitely choose the form of this assistance.  if you come in earlier and in a more systematic fashion, the cost for everyone is lower and the chances of a fast recovery are stronger.

The sensible decision might seems obvious from a distance or in retrospect, but it’s this exact choice that the richer and more stable countries in Western Europe are now struggling with. Continue reading