economics

January 14, 2011

Can Europe Be Saved?

Filed under: Uncategorized — ktetaichinh @ 3:54 pm
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http://www.nytimes.com/2011/01/16/magazine/16Europe-t.html?pagewanted=1&_r=1

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December 15, 2010

Please respect FT.com’s ts&cs and copyright policy which allow you to: share links; copy content for personal use; & redistribute limited extracts. Email ftsales.support@ft.com to buy additional rights or use this link to reference the article – http://www.ft.com/cms/s/0/76f69cd8-077a-11e0-8d80-00144feabdc0.html#ixzz18DAhzWXe After the euro came into force, commercial banks could refinance their holdings of government bonds at the discount window of the European Central Bank and regulators treated such bonds as riskless. This caused interest rate differentials between various countries to shrink. This in turn generated property booms in the weaker economies, reducing their competitiveness. At the same time Germany, suffering from the after- effects of reunification, had to tighten its belt. Trade unions agreed to make concessions on wages and working conditions in exchange for job security. That is how the divergences emerged. Yet the banks continued to load up on the government bonds of the weaker countries in order to benefit from the minuscule interest rate differentials that still remained. That lack of a common treasury first became apparent as a problem after the bankruptcy of Lehman Brothers on October 15 2008, when the threat of a systemic collapse forced governments to guarantee that no other systemically important financial institution would be allowed to fail. At that time Angela Merkel, Germany’s chancellor, insisted that each country should guarantee its own institutions, rejecting a Europe-wide approach. Interestingly, interest rate differentials widened only in 2009 when the newly elected Greek government announced that its predecessor had cheated and the deficit was much larger than reported. That was the start of the euro crisis. The lack of a common treasury is now being remedied: first came the Greek rescue package, then a temporary emergency facility. The financial authorities are a little bit pregnant and it is virtually certain that some permanent institution will be set up. Unfortunately, it is equally certain that the new arrangements will also be flawed. For the euro suffers from other shortcomings. Policymakers are confronted not only by a currency crisis but also by a banking crisis and a crisis in macroeconomic theory. The authorities are making at least two mistakes. One is that they are determined to avoid defaults or haircuts on currently outstanding sovereign debt for fear of provoking a banking crisis. The bondholders of insolvent banks are being protected at the expense of taxpayers. This is politically unacceptable. A new Irish government to be elected next spring is bound to repudiate the current arrangements. Markets recognise this and that is why the Irish rescue brought no relief. Second, high interest rates charged on rescue packages make it impossible for the weaker countries to improve their competitiveness vis-à-vis the stronger ones. Divergences will continue to widen and weaker countries will continue to weaken. Mutual resentment between creditors and debtors is liable to grow and there is a real danger that the euro may destroy the political and social cohesion of the EU. Both mistakes can be corrected. With regard to the first, emergency funds ought to be used to recapitalise banking systems as well as to provide loans to sovereign states. The former would be a more efficient use of funds than the latter. It would leave countries with smaller deficits, and they could regain access to the market sooner if the banking system were properly capitalised. It is better to inject equity now rather than later and it is better to do it on a Europe-wide basis than each country acting on its own. That would create a European regulatory regime. Europe-wide regulation of banks interferes with national sovereignty less than European control over fiscal policy. And European control over banks is less amenable to political abuse than national control. With regard to the second problem, the interest rate on rescue packages should be reduced to the rate at which the EU itself can borrow. This would have the advantage of developing an active Eurobond market. These two structural changes may not be sufficient to provide the countries in need of rescue with an escape route. Additional measures, such as haircuts on sovereign debt, may be needed. But having been properly recapitalised, banks could absorb this. In any case, two clearly visible mistakes that condemn the EU to a bleak future would be avoided. The writer is chairman of Soros Fund Management LLC

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Europe should rescue banks before states

George Soros

Published: December 14 2010 12:22 | Last updated: December 14 2010 12:22

The architects of the euro knew that it was incomplete when they designed it. The currency had a common central bank but no common treasury – unavoidable given that the Maastricht treaty was meant to bring about monetary union without political union. The authorities were confident, however, that if and when the euro ran into a crisis they would be able to overcome it. After all, that is how the European Union was created, taking one step at a time, knowing full well that additional steps would be required.

With hindsight, however, one can identify other deficiencies in the euro of which its architects were unaware. A currency supposed to bring convergence has produced divergences instead. That is because the founders did not realise that imbalances may emerge not only in the public sphere but also in the private sector.
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After the euro came into force, commercial banks could refinance their holdings of government bonds at the discount window of the European Central Bank and regulators treated such bonds as riskless. This caused interest rate differentials between various countries to shrink. This in turn generated property booms in the weaker economies, reducing their competitiveness. At the same time Germany, suffering from the after- effects of reunification, had to tighten its belt. Trade unions agreed to make concessions on wages and working conditions in exchange for job security. That is how the divergences emerged. Yet the banks continued to load up on the government bonds of the weaker countries in order to benefit from the minuscule interest rate differentials that still remained.

That lack of a common treasury first became apparent as a problem after the bankruptcy of Lehman Brothers on October 15 2008, when the threat of a systemic collapse forced governments to guarantee that no other systemically important financial institution would be allowed to fail. At that time Angela Merkel, Germany’s chancellor, insisted that each country should guarantee its own institutions, rejecting a Europe-wide approach. Interestingly, interest rate differentials widened only in 2009 when the newly elected Greek government announced that its predecessor had cheated and the deficit was much larger than reported. That was the start of the euro crisis.

The lack of a common treasury is now being remedied: first came the Greek rescue package, then a temporary emergency facility. The financial authorities are a little bit pregnant and it is virtually certain that some permanent institution will be set up. Unfortunately, it is equally certain that the new arrangements will also be flawed. For the euro suffers from other shortcomings. Policymakers are confronted not only by a currency crisis but also by a banking crisis and a crisis in macroeconomic theory.

The authorities are making at least two mistakes. One is that they are determined to avoid defaults or haircuts on currently outstanding sovereign debt for fear of provoking a banking crisis. The bondholders of insolvent banks are being protected at the expense of taxpayers. This is politically unacceptable. A new Irish government to be elected next spring is bound to repudiate the current arrangements. Markets recognise this and that is why the Irish rescue brought no relief. Second, high interest rates charged on rescue packages make it impossible for the weaker countries to improve their competitiveness vis-à-vis the stronger ones. Divergences will continue to widen and weaker countries will continue to weaken. Mutual resentment between creditors and debtors is liable to grow and there is a real danger that the euro may destroy the political and social cohesion of the EU.

Both mistakes can be corrected. With regard to the first, emergency funds ought to be used to recapitalise banking systems as well as to provide loans to sovereign states. The former would be a more efficient use of funds than the latter. It would leave countries with smaller deficits, and they could regain access to the market sooner if the banking system were properly capitalised. It is better to inject equity now rather than later and it is better to do it on a Europe-wide basis than each country acting on its own. That would create a European regulatory regime. Europe-wide regulation of banks interferes with national sovereignty less than European control over fiscal policy. And European control over banks is less amenable to political abuse than national control.

With regard to the second problem, the interest rate on rescue packages should be reduced to the rate at which the EU itself can borrow. This would have the advantage of developing an active Eurobond market.

These two structural changes may not be sufficient to provide the countries in need of rescue with an escape route. Additional measures, such as haircuts on sovereign debt, may be needed. But having been properly recapitalised, banks could absorb this. In any case, two clearly visible mistakes that condemn the EU to a bleak future would be avoided.

The writer is chairman of Soros Fund Management LLC

December 3, 2010

The Crisis & the Euro August 19, 2010 George Soros

Filed under: Uncategorized — ktetaichinh @ 4:22 am
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http://www.nybooks.com/articles/archives/2010/aug/19/crisis-euro/?pagination=false

The euro was an incomplete currency to start with. In 1992, the Maastricht Treaty established a monetary union without a political union. The euro boasts a common central bank but it lacks a common treasury. It is exactly that sovereign backing that financial markets are now questioning and that is missing from the design. That is why the euro has become the focal point of the current crisis.

Member countries share a common currency, but when it comes to sovereign credit they are on their own. This fact was obscured until recently by the willingness of the European Central Bank (ECB) to accept the sovereign debt of all member countries on equal terms at its discount window. This allowed the member countries to borrow at practically the same interest rate as Germany, and the banks were happy to earn a few extra pennies on supposedly risk-free assets by loading up their balance sheets with the government debt of the weaker countries. These positions now endanger the creditworthiness of the European banking system. For instance, European banks hold nearly a trillion euros of Spanish debt, of which half is held by German and French banks. It can be seen that the European sovereign debt crisis is intricately interconnected with a European bank crisis.

The first clear reminder that the euro does not have a common treasury came after the bankruptcy of Lehman. The finance ministers of the European Union promised that no other financial institution of systemic importance would be allowed to default. But Germany opposed a joint Europe-wide guarantee; each country had to take care of its own banks.

At first, the financial markets were so impressed by the promise of the EU finance ministers that they hardly noticed the difference. Capital fled from the countries that were not in a position to offer similar guarantees, but the differences in interest rates on government debt within the eurozone remained minimal. That was when the countries of Eastern Europe, notably Hungary and the Baltic States, got into difficulties and had to be rescued.

It is only this year that financial markets started to worry about the accumulation of sovereign debt within the eurozone. Greece became the center of attention when the newly elected government revealed that the previous government had lied and the deficit for 2009 was much larger than indicated.

Interest rate differentials started to widen but the European authorities were slow to react because the member countries held radically different views. Germany, which had been traumatized by two episodes of runaway inflation, was allergic to any buildup of inflationary pressures; France and other countries were more willing to show their solidarity. Since Germany was heading for elections, it was unwilling to act, but nothing could be done without Germany. So the Greek crisis festered and spread. When the authorities finally got their act together they had to offer a much larger rescue package than would have been necessary if they had acted earlier.

In the meantime, the crisis spread to the other deficit countries, and in order to reassure the markets the authorities felt obliged to put together a €750 billion European Financial Stabilization Fund, with €500 billion from the member states and €250 billion from the IMF.

But the markets are not reassured because the term sheet of the Fund, i.e., the conditions under which it operates, was dictated by Germany. The Fund is guaranteed not jointly but only severally, so that the weaker countries will in fact be guaranteeing a portion of their own debt. The Fund will be raised by selling bonds to the market and charging a fee on top. It is difficult to see how these bonds will merit an AAA-rating.

Even more troubling is the fact that Germany is not only insisting on strict fiscal discipline for weaker countries but is also reducing its own fiscal deficit. When all countries are reducing deficits at a time of high unemployment they set in motion a downward deflationary spiral. Reductions in employment, tax receipts, and exports reinforce each other, ensuring that the targets will not be met and further reductions will be required. And even if budgetary targets were met, it is difficult to see how the weaker countries could regain their competitiveness and start growing again because, in the absence of exchange rate depreciation, the adjustment process would require reductions in wages and prices, producing deflation.

To some extent a continued decline in the value of the euro may mitigate the deflation. But as long as there is no growth, the relative weight of the debt will continue to grow. This is true not only for the national debt but also for the commercial loans held by banks. This will make the banks even more reluctant to lend, compounding the downward pressures.

The euro is a patently flawed construct, which its architects knew at the time of its creation. They expected its defects to be corrected, if and when they became acute, by the same process that brought the European Union into existence.

The European Union was built by a process of piecemeal social engineering: indeed it is probably the most successful feat of social engineering in history. The architects recognized that perfection is unattainable. They set limited objectives and firm deadlines. They mobilized the political will for a small step forward, knowing full well that when it was accomplished its inadequacy would become apparent and require further steps. That is how the six-nation Coal and Steel Community was gradually developed into the European Union, step by step.

Germany used to be at the heart of the process. German statesmen used to assert that Germany has no independent foreign policy, only a European policy. After the fall of the Berlin Wall, Germany’s leaders realized that unification was possible only in the context of a united Europe and they were willing to make considerable sacrifices to secure European acceptance. When it came to bargaining they were willing to contribute a little more to the pot and take a little less than the others, thereby facilitating agreement. But those days are over. Germany doesn’t feel so rich anymore and doesn’t want to continue serving as the deep pocket for the rest of Europe. This change in attitudes is understandable but it did bring the process of integration to a screeching halt.

Germany now wants to treat the Maastricht Treaty as the scripture that has to be obeyed without any modifications. This is not understandable, because it is in conflict with the incremental method by which the European Union was built. Something has gone fundamentally wrong in Germany’s attitude toward the European Union.

The German public does not understand why it should be blamed for the troubles of the eurozone. After all, it is the most successful economy in Europe, fully capable of competing in world markets. The troubles of the eurozone feel like a burden weighing Germany down. It is difficult to see what would change this perception because the troubles of the eurozone are depressing the euro and, being the most competitive of the countries in the eurozone, Germany benefits the most. As a result Germany is likely to feel the least pain of all the member states.

The error in the German attitude can best be brought home by engaging in a thought experiment. The most ardent instigators of that attitude would prefer that Germany leave the euro rather than modify its position. Let us consider where that would lead.

The Deutschmark would go through the roof and the euro would fall through the floor. This would indeed help the adjustment process of the other countries but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment. German banks would suffer severe exchange rate losses and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations: pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Let me emphasize that this scenario is totally hypothetical because it is extremely unlikely that Germany would be allowed to leave the euro and to do so in a friendly manner. Germany’s exit would be destabilizing financially, economically, and above all politically. The collapse of the single market would be difficult to avoid. The purpose of this thought experiment is to convince Germany to change its ways without going through the actual experience that its current policies hold in store.

What would be the right policy for Germany to pursue? It cannot be expected to underwrite other countries’ deficits indefinitely. So some tightening of fiscal policies is inevitable. But some way has to be found to allow the countries in crisis to grow their way out of their difficulties. The countries concerned have to do most of the heavy lifting by introducing structural reforms but they do need some outside help to allow them to stimulate their economies. By cutting its budget deficit and resisting a rise in wages to compensate for the decline in the purchasing power of the euro, Germany is actually making it more difficult for the other countries to regain competitiveness.

So what should Germany do? It needs to recognize three guiding principles.

First, the current crisis is more a banking crisis than a fiscal one. The continental European banking system was never properly cleansed after the crash of 2008. Bad assets have not been marked-to-market—i.e., valued according to current market price— but are being held to maturity. When markets started to doubt the creditworthiness of sovereign debt, it was really the solvency of the banking system that was brought into question because the banks were loaded with the bonds of the weaker countries and these are now selling below par—the price at which they were issued. The banks have difficulties in obtaining short-term financing. The interbank market—i.e., for borrowing and lending between banks—and the commercial paper market have dried up and banks have turned to the ECB both for short-term financing and for depositing their excess cash. They are in no position to buy government bonds. That is the main reason why risk premiums on government bonds have widened, setting up a vicious circle.

The crisis has now forced the authorities to disclose the results of their stress tests of banks, which assess the extent to which their resources are sufficient to meet their obligations. We cannot judge how serious the situation is until the results are published, presumably before the end of July. It is clear however that the banks are greatly overleveraged and need to be recapitalized on a compulsory basis. That ought to be the first task of the European Financial Stabilization Fund, and it will go a long way to clear the air. It may be seen, for instance, that Spain does not have a fiscal crisis at all. Recent market moves point in that direction. Germany’s role may also be seen in a very different light if, in recapitalizing its -Landesbanken, it becomes a bigger user of the stabilization fund than contributor to it.

Second, a tightening of fiscal policy must be offset by a loosening of monetary policy. Specifically, the ECB could buy Spanish treasury bills, an action that would significantly reduce the punitive interest rates, set by the German-inspired European Financial Stabilization Fund, that Spain now must pay on its bonds. This would allow Spain to meet its budget reduction targets with less pain. But that is not possible without a change of heart by Germany.

Third, this is the time to put idle resources to work by investing in education and infrastructure. For instance, Europe needs a better gas pipeline system, and the connection between Spain and France is one of the bottlenecks. The European Investment Bank ought to be able to find other investment opportunities as well, such as expanding broadband coverage or creating a smart electricity grid.

It is impossible to be more concrete at the moment but there are grounds for optimism. When the solvency situation of the banks has been clarified and they have been properly recapitalized, it should be possible to devise a growth strategy for Europe. And when the European economy has regained its balance the time will be ripe to correct the structural deficiencies of the euro. Make no mistake about it: the fact that the Maastricht criteria were so flagrantly violated shows that the euro does have deficiencies that need to be corrected.

May 19, 2010

Asian Stocks Fall as Germany Restricts Short Sales, Oil Drops

Filed under: Uncategorized — ktetaichinh @ 3:39 am
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May 19 (Bloomberg) — Germany prohibited naked short- selling and speculating on European government bonds with credit-default swaps in an effort to calm the region’s financial markets, sparking investor anxiety about increasing regulation.

The ban, which took effect at midnight and lasts until March 31, 2011, also applies to the shares of 10 banks and insurers, German financial regulator BaFin said yesterday in an e-mailed statement. The step was needed because of “exceptional volatility” in euro-area bonds, BaFin said.
“Asian markets have been taken by surprise because this was not on the cards,” Sebastien Barbe, head of emerging-market research for Credit Agricole CIB, said in a phone interview from Hong Kong. “Investors are fearful other countries may follow suit and, because it’s only Germany doing this, there’s concern regarding the lack of co-ordination in Europe over how to fix the current crisis.”

“The way it’s been announced is very irresponsible, and it’s sent many market participants into panic mode,” said Darren Fox, a regulator lawyer who advises hedge funds at Simmons & Simmons in London. “We thought regulators had learned their lessons from September 2008. Where is the market emergency that necessitates the introduction of an overnight ban?‘Serious Fundamental’ Mistake

The move may also add to concern that EU nations are not working in coordination, damping their credibility.

“This is a mistake of a serious fundamental nature and of severe consequence and once again demonstrates to me how little the European politicians understand about the world’s financial markets,” Mark Grant, managing director of Fort Lauderdale, Florida-based Southwest Securities Inc. wrote in a note to clients. “They are making, in fact, an obvious attempt to control financial markets across the globe by this action just as they plead for investors to provide funding for the European governments and the banks in the European Union.” Prohibiting speculation in the contracts may cause trading in the market for swaps tied to Europe government bonds to freeze up, possibly increasing borrowing costs or limiting the flow of capital, said Tim Backshall, the chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

“This will close the CDS markets if it is anything like what it appears to be,” Backshall said. “The removal of the possibility to hedge government bond risk will necessarily cause risk premia to rise in bond markets, which could easily lead to a broad-based repricing of government bond risk.”
Futures on the Standard & Poor’s 500 Index sank 0.8 percent. The index fell 1.4 percent yesterday in New York as Germany’s financial-services regulator said that it will introduce a temporary ban on naked short selling and naked credit-default swaps of euro-area government bonds starting.

Short selling involves the sale of borrowed securities in the hope of profiting by buying them later at a lower price and returning them to the owner. When securities are sold naked, the trader fails to borrow the assets before sending an order to sell. Investors own naked credit-default swaps when they don’t hold the bonds the derivatives are linked to.

Yen Appreciation

Japanese exporters fell as a stronger yen threatened to reduce the value of overseas sales when converted into the companies’ home currency. The euro depreciated to 111.89 per yen today from 114.44 at the 3 p.m. close of stock trading in Tokyo yesterday. The dollar weakened versus the yen to 91.84 from 92.56.

Nippon Sheet Glass dropped 5.2 percent to 239 yen in Tokyo. Daiwa Securities Capital Markets Co. cut its rating on the stock to “neutral” from “outperform.”

Canon Inc., a camera maker that counts Europe as its largest market, retreated 1.8 percent to 3,905 yen. Panasonic Corp., which gets almost half of its revenue overseas, declined 1.3 percent to 1,211 yen.

“Investors are afraid that Germany’s ban on naked trading will reduce people’s appetite for risk,” said Hiroichi Nishi, an equities manager in Tokyo at Nikko Cordial Securities Inc. “The weakening euro is worrying investors about Japanese exporters’ earnings.”

May 14, 2010

Central banks are losing credibility

Filed under: Uncategorized — ktetaichinh @ 2:00 am
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Whether or not one believes that the €750bn European rescue plan will stabilise financial markets, its consequences for Europe’s economies are surely negative. Indeed, while many cheered the initial rebound in equity markets, the reactions in currency markets on the first trading day after the announcement were a harbinger of these negative consequences: the initial gains of the euro were erased by the end of the trading session.

Of course, the bail-out for holders of Greek government debt – and now possibly Spanish and Portuguese government debt – raises familiar problems of moral hazard that will increase risk-taking and encourage irresponsible government policy in the future. The loans and loan guarantees from other countries in Europe do not deal with the simple fact that the Greek government cannot service its debt and will eventually need to restructure it. At best the package gives officials some breathing room as they endeavour to reduce deficits and eventually restructure debts, though it is more likely that the adjustment problem will be made worse by being pushed down the road. But most worrisome for the euro, and the likely reason for its remarkable reversal in the currency markets on day one, is the agreement by the European Central Bank to buy the debt of the countries with troublesome debt burdens, just days after it said it would not engage in such purchases. This agreement raises questions about the independence of the ECB, thereby creating political obstacles to the conduct of good monetary policy in the future.

Buying the distressed debt of some countries is not monetary policy as conventionally defined, but rather an effort to allocate funds to some creditors and borrowers and not others. Unlike a central bank’s responsibility to provide for price stability and thereby economic growth, there is no established rationale that such credit allocation policy should be the responsibility of an independent agency of government. Most likely the purchases will be financed by money creation – quantitative easing – as the ECB expands its balance sheet. If Angela Merkel, Germany’s chancellor, is right that the ECB will not increase the money supply, then it will have to sell other governments’ securities to offset the purchases of Greek debt. This will further increase the tax burden for citizens of those other countries. Of course, Ms Merkel’s comment about how the ECB should set the money supply is another indicator of reduced independence.

Unfortunately, the ECB’s change of mind about these purchases raises questions about its credibility. Clearly the bank was under pressure from European governments. My understanding is that the governments pointed to the US. You can imagine the phone conversations between Brussels and Frankfurt. “The Fed helped the US Treasury conduct its bail-out policy during their financial crisis; why can’t the ECB help us in our bail-out?” Even the Fed’s “whatever it takes” mantra was being repeated in Brussels last weekend. In my view we are definitely seeing contagion, but it is a contagion of deviations from the independent and credible monetary policy that has served us well in the past. We have seen this recently elsewhere: in 2008 the Reserve Bank of India was evidently pressured to engage in credit allocation by politicians arguing that other central banks were doing it.

Making matters worse for the future of monetary policy is the Fed’s active participation in the European bail-out. The US central bank agreed to provide loans – technically called swaps – to the ECB so that the ECB can more easily make dollar loans in the European markets. In order to loan dollars to the ECB, the Fed will have to increase the size of its own balance sheet. Such swap loans were made to the ECB back in December 2007, but they did not help end the crisis or prevent the panic of autumn 2008. Instead, they merely delayed inevitable action to deal with deteriorating bank balance sheets, thereby making the panic worse.

Was it necessary for the Fed to participate in the European bail-out? At least as evidenced by quantitative measures such as the spread between 3-month Libor and the overnight index swap (OIS), the funding problem in the interbank markets is far less severe now than in December 2007. The international loans also raise questions about the Fed’s independence at a time when many in Congress are calling for a complete audit of the Fed. Even though monetary policy does not warrant such an audit, extraordinary measures such as the loans to the ECB do. By taking these extraordinary measures, the Fed is losing some of its independence as well as adding to the perception that the ECB is losing its independence.

Europe’s monetary union should not be viewed as the problem here. Things would be much worse if Greece left the eurozone and revived the drachma at a depreciated rate. This would make servicing debt even harder for the Greek government and for Greek private sector companies that had borrowed in euros or dollars, wiping out any short-term competitive advantage from the depreciation. The best way to strengthen and preserve the monetary union is to restore the ECB’s independence and credibility, which it earned the hard way over the first decade of its existence.

The writer, a professor of economics at Stanford and senior fellow at Stanford’s Hoover Institution, is co-editor with Kenneth Scott and George Shultz of ‘Ending Government Bailouts As We Know Them’ (Hoover Press, 2010)

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May 13, 2010

Estonia and the euro Long euros Estonia gets a step closer to adopting the single currency

Filed under: Uncategorized — ktetaichinh @ 12:36 pm
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SURPRISES are Estonia’s stock in trade. Its return to the world map in 1991 after a 51-year absence startled outsiders. So did what came next: a fast-growing economy, based on flat taxes, free trade and a currency board. It confounded pessimists’ expectations by joining the European Union (in 2004) and NATO (in 2004). Now the country of 1.4m people is set to pull off another coup, gaining green lights from the European Commission and the European Central Bank for its bid to adopt the euro on January 1st 2011.

Many thought that highly unlikely. Only two years ago a property bubble collapsed, rocking the banking system and sending GDP plunging by 14.1% in 2009 (see story). Doom-mongers said devaluation was inevitable. But they were wrong. Flexible wages and prices have helped the economy stabilise: unit labour costs fell by 7.5% in the final quarter of 2009. Exports were up by a sixth in the first quarter of 2010 and the central bank forecasts growth this year of 1%. Estonia easily meets the euro zone’s rules on public finances. Its gross debt in 2009 was only 7.2% of GDP, and the government deficit is 1.7%. The only real concern is whether inflation will stay low: in the past 12 months the average was negative, at -0.7% comfortably below the 1% target. But the ECB report called for “continued vigilance” on that.

The real problem for Estonia is political, not economic. Some euro zone members (France is often mentioned) think that allowing an obscure and volatile ex-communist economy to join a currency union that has too many dodgy members already should not be a priority. If Estonia is really so solid, why not wait a year to be sure?

Yet that would send a perverse message. Estonia is one of two countries in the whole EU that actually meets the common currency’s rules (Sweden being the other). All the rest (even those that use the euro) have gaily breached the deficit and debt limits. The grit shown by Estonian politicians and the public in shrinking spending, raising taxes, and cutting wages has left outsiders awestruck (see leader). Punishing Estonia which obeyed the rules, while bailing out Greece which has breached them flagrantly, would do little for the euro’s credibility with governments and investors alike.

Estonia has two more hurdles to jump before it can humiliate the scoffers. An EU committee meets at the end of May, followed by a finance ministers’ summit in early June. Few think that France and other doubters will actually block its euro bid: a combination of persuasion and horse-trading will probably bring agreement. Then the decision will be irrevocable. That will give heart to Latvia and Lithuania too, who hope to join the euro later in the decade. Like Estonia, their currencies are pegged to the euro, so they have all the pain of a rigid monetary regime, but miss out on the lower borrowing costs and higher investment that the euro zone brings.

The longer-term question is what Estonia focusses on next. On May 10th it passed another benchmark, joining the Organisation for Economic Cooperation and Development, a Paris-based rich-country thinktank—the first country from the former Soviet Union to do so. The hunt is on for a new national project. Estonia’s presidency of the EU in 2018 will coincide with the country’s 100th birthday. Finding something to surprise outsiders then is a pleasant challenge for the future.

May 12, 2010

Why the Eurozone Is Doomed

Filed under: Uncategorized — ktetaichinh @ 12:26 am
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Beneath the endless announcements of Greece’s “rescue” lie fundamental asymmetries that doom the euro, the joint currency that has been the centerpiece of European unity since its introduction in 1999.

The key imbalance is between export powerhouse Germany, which generates huge trade surpluses, and its trading partners, which run large trade and budget deficits, particularly Portugal, Italy, Ireland, Greece and Spain.

Those outside of Europe may be surprised to learn that Germany’s exports are roughly equal to those of China ($1.2 trillion), even though Germany’s population of 82 million is a mere 6% of China’s 1.3 billion. Germany and China are the world’s top exporters, while the U.S. trails as a distant third.

Germany’s emphasis on exports places it in the so-called mercantilist camp, countries that depend heavily on exports for their growth and profits. Other (non-oil exporting) nations that routinely generate large trade surpluses include China, Japan, Germany, Taiwan and the Netherlands.

While Germany’s exports rose an astonishing 65% from 2000 to 2008, its domestic demand flatlined near zero. Without strong export growth, Germany’s economy would have been at a standstill. The Netherlands is also a big exporter (trade surplus of $33 billion) even though its population is relatively tiny, at only 16 million. The “consumer” countries, on the other hand, run large current-account (trade) deficits and large government deficits. Italy, for instance, has a $55 billion trade deficit and a budget deficit of about $110 billion. Total public debt is a whopping 115.2% of GDP.

Spain, with about half the population of Germany, has a $69 billion annual trade deficit and a staggering $151 billion budget deficit. Fully 23% of the government’s budget is borrowed.

Although the euro was supposed to create efficiencies by removing the costs of multiple currencies, it has had a subtly pernicious disregard for the underlying efficiencies of each eurozone economy.

Though German wages are generous, the German government, industry and labor unions have kept a lid on production costs even as exports leaped. As a result, the cost of labor per unit of output — the wages required to produce a widget — rose a mere 5.8% in Germany in the 2000-09 period, while equivalent labor costs in Ireland, Greece, Spain and Italy rose by roughly 30%.

The consequences of these asymmetries in productivity, debt and deficit spending within the eurozone are subtle. In effect, the euro gave mercantilist, efficient Germany a structural competitive advantage by locking the importing nations into a currency that makes German goods cheaper than the importers’ domestically produced goods.

Put another way: By holding down production costs and becoming more efficient than its eurozone neighbors, Germany engineered a de facto “devaluation” within the eurozone by lowering the labor-per-unit costs of its goods.

The euro has another deceptively harmful consequence: The currency’s overall strength enables debtor nations to rapidly expand their borrowing at low rates of interest. In effect, the euro masks the internal weaknesses of debtor nations running unsustainable deficits and those whose economies had become precariously dependent on the housing bubble (Ireland and Spain) for growth and taxes.

Prior to the euro, whenever overconsumption and overborrowing began hindering an import-dependent “consumer” economy, the imbalance was corrected by an adjustment in the value of the nation’s currency. This currency devaluation would restore the supply-demand and credit-debt balances between mercantilist and consumer nations.

Absent the euro today, the Greek drachma would fall in value versus the German mark, effectively raising the cost of German goods to Greeks, who would then buy fewer German products. Greece’s trade deficit would shrink, and lenders would demand higher rates for Greek government bonds, effectively pressuring the government to reduce its borrowing and deficit spending.

But now, with all 16 nations locked into a single currency, devaluing currencies to enable a new equilibrium is impossible. And it leaves Germany faced with the unenviable task of bailing out its “customer nations” — the same ones that exploited the euro’s strength to overborrow and overconsume. On the other side, residents of Greece, Italy, Spain, Portugal and Ireland now face the unenviable effects of government benefit cuts aimed at realigning budgets with the productivity of the underlying national economy.

While the media has reported the Greek austerity plan and EU promises of assistance as a “fix,” it’s clear that the existing deep structural imbalances cannot be resolved with such Band-Aids.

Either Germany and its export-surplus neighbors continue bailing out the eurozone’s importer/debtor consumer nations, or eventually the weaker nations will default or slide into insolvency.

Germany helped enable the overborrowing of its profligate neighbors by buying their government bonds. According to BusinessWeek, German banks are on the hook for almost $250 billion in the troubled eurozone nations’ bonds.

Now a vicious conundrum has emerged: If Germany lets its weaker neighbors default on their sovereign debt, the euro will be harmed, and German exports within Europe will slide. But if Germany becomes the “lender of last resort,” then its taxpayers end up footing the bill.

If public and private debt in the troubled nations keeps rising at current rates, it’s possible that even mighty Germany may be unable (or unwilling) to fund an essentially endless bailout. That would create pressure within both Germany and the debtor nations to jettison the single currency as a good idea in theory, but ultimately unworkable in a 16-nation bloc as diverse as the eurozone.

Be wary of the endless “fixes” to a structurally doomed system.

April 30, 2010

* APRIL 28, 2010 Contagion Fear Hits Spain Cut to Credit Rating Opens New Phase in Crisis as Cost of Greece Bailout Debated

Filed under: Uncategorized — ktetaichinh @ 4:14 am
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Greece remained at the heart of market woes. The cost of insuring $10 million of Greek government debt against default for five years jumped to more than $900,000, from $824,000 on Tuesday, signaling extreme fear of a default, before falling to $760,000 by evening in London, according to CMA DataVision.

That respite was sparked by the news that the aid package for Greece could be significantly larger than expected and by assurances from senior EU and German officials that it won’t involve restructuring Greece’s debt.

The IMF appears to hope that signaling a willingness to offer Greece roughly three times what it and the EU have already pledged will achieve what their previous efforts have failed to do—assuage investor concerns about a default. During the global financial crisis, the U.S. and many European countries were successful with a similar strategy, pledging huge sums to backstop their banks.

Economists say Spain is still some way from needing a bailout like Greece, as Spain’s overall public debt is relatively low despite the country’s gaping budget deficit. The IMF expects Spanish public debt to reach around 67% of gross domestic product this year, compared with 124% in Greece.

But countries’ individual circumstances might count for little if the Greek mess isn’t resolved quickly and decisively, economists warn. “Markets tend not to discriminate as much when there’s panic,” says Ken Wattret, European economist at BNP Paribas in London.

S&P said it cut Spain’s credit rating because it expects the Spanish economy to grow by only 0.7% on average until 2016, lower than previous forecasts. Sluggish growth hurts tax revenues and pushes up spending on jobless benefits, making it harder for a country to balance its budget.

Critics Assail Rating Firms For Fueling Woe in Europe

IMF chief Dominique Strauss-Kahn said it wasn’t clear whether the rating firms were reacting to the financial markets, or vice versa. “You shouldn’t believe too much what they say even if it may be useful,” he said in Berlin.

Ratings agencies have been criticized for their role in the U.S. financial crisis, in particular over conflicts of interest and their failure to recognize the high risks inherent in complex structured products. They have also been panned for throwing fuel onto the fire of crises by belatedly ratcheting down ratings.

Many European investment institutions, like those in the U.S., are highly sensitive to debt ratings. Life-insurance companies typically seek to hold only very safe investments, which means that when bonds are downgraded to junk, they sell them.

Many institutions have in-house rules that assign a percentage of a portfolio to top-rated triple-A bonds, and a smaller percentage to lower-rated double-A bonds and so on down the ratings ladder.

After a downgrade, the institutions adjust their holdings, selling the downgraded debt and seeking to replenish their quota of high-rated debt. Many rely on just one agency and for investors in government bonds that was most commonly S&P, Mr. Broyer said.

Banks, big investors in government bonds in Europe, are also sensitive to ratings. They are forced to increase the capital they must have as a cushion against losses if bonds they hold are downgraded to junk. This reduces their profitability, and encourages them to sell.

In the U.S., ratings agencies have been under scrutiny, including a year-and-a-half-long investigation by a Senate subcommittee. Questions have been raised about whether the agencies were too lenient in their evaluation of mortgage-related debts in order to win business.

Many U.S. institutional investors retain guidelines on the credit quality of securities that they can hold and a downgrade from S&P or Moody’s to junk status can force selling.

But after the financial crisis, there have been some moves away from relying on their ratings.

In Spain, Crisis Stays Undercover

By JONATHAN HOUSE

MADRID—Spain’s worsening financial crisis remains a strangely low-key affair. One in five people here are out of work, but generous unemployment benefits, strong family support networks and a bustling informal economy are helping maintain people’s lifestyles. Bars and restaurants in the city center are doing brisk business.

“It seems to me the situation here is less bad than in Greece,” says Manuel Herrera, a 30-year-old Peruvian immigrant, who has seen the recent images of angry mobs protesting in Athens. “Here in Spain, the crisis is not so noticeable: People still go out for beers, to buy cigarettes, whatever.”

But the Asian-restaurant chain he works for as a cook has closed down four of its 12 restaurants, and Mr. Herrera says he sees a sense of hopelessness setting in that could point to prolonged economic stagnation.

“The Spanish were not ready for this crisis,” he says. “The situation’s not getting any worse, but it’s not getting any better either.”

For years, Spain was one of the euro zone’s biggest success stories. Membership in the common currency in 1999 brought historically low interest rates that fueled a credit and construction boom, which transformed the country into one of Europe’s chief growth engines. Through 2007, Spain created more than one-third of all euro-zone jobs and absorbed four million immigrants.

The global financial crisis brought that crashing down. Spain is grappling with 20% unemployment and a double-digit budget deficit that threatens to land the country in a Greek-style financial crisis.

Though the government expects the economy to return to growth in the first quarter, that follows contractions in six consecutive quarters.

On Wednesday, Standard & Poor’s cited low growth prospects resulting from mounting banking-system stress, high household debt levels and low export capacity as primary factors behind its decision to downgrade Spain’s sovereign debt.

Thirty-year-old Eduardo lost his job as a computer programmer a year ago and says many of his friends are also out of work. He still isn’t ready to take just any job: “There are jobs out there, but most of them don’t pay to well, or they require higher levels of experience.”

Until recently, the government of Socialist Prime Minister José Luis Rodríguez Zapatero has focused on anticrisis measures to cushion the pain of the unemployed by extending benefits, cutting taxes and taking measures to create short-term jobs for construction workers. It has gone to great pains to maintain good relations with unions.

But the government has changed gears amid mounting pressure from international investors to show it can pull the economy out of the doldrums and get its debt levels back on a sustainable path. It has announced plans to cut the public-sector wage bill, push back the retirement age and reform Spain’s rigid labor market. The plans are vague thus far and have yet to ruffle many feathers.

The government is counting on a quick agreement on a support package for Greece to contain the euro-zone financial crisis and buy Spain more time to get its fiscal house in order. In an interview, Deputy Finance Minister José Manuel Campa said Spanish bond spreads have been blown out to “exceptional” levels that he believes are temporary. “Considering that they have been affected by the Greek situation, the sooner it is resolved, the better,” he said.

The Euro Can Survive a Greek Default

In many ways, a messy default would actually leave the single currency in better shape.

The Greek government has now hit the panic button and activated the IMF/euro-zone rescue plan. However, it is not clear that this bailout (whose implementation still requires approval by the German parliament) would work. Financial markets remain unconvinced, as evidenced by the elevated risk premia for Greek debt. The experience of Argentina also shows that even repeated IMF programs cannot always stave off failure.

For European Union policy makers this raises a fundamental question: What will happen if the proposed €45 billion aid package doesn’t put an end to the Greek tragedy? Would a default by Greece signify the end of the euro?

Behind this often-posed question is the assumption that the notion of “default” has a precise meaning, which is not the case. Ratings agencies define default as missing any contractual payment beyond the grace period. In reality, however, markets have often been quite forgiving in situations in which a government only reschedules, i.e. does not pay on time, but makes a credible promise to repay the full amounts due at a later date. Such a “soft default” would certainly not mean the end of the euro.

The real question is thus: Would a messy (and massive) default under which the country refuses to repay in full signify the end of the euro?

Yes and no.

A messy default would certainly end the idea of the euro area as a club whose members are all equal and work toward a common goal, namely the stability of the common currency. Membership in such a club protects against financial problems because members are supposed to behave well and help each other in case of unjustified speculative attacks. Although the EU treaty says that members are not liable for each other’s public debt, there is an implicit political commitment, as we are seeing right now, to provide emergency help.

The quid pro quo for this solidarity is of course the expectation that all members abide by certain standards, for example those embodied in the Stability and Growth Pact, that aim to limit budget deficits and debts. The continuing misreporting of fiscal data by Greece has already severely damaged the idea of the euro as a “gentlemen’s club.” But the club could still be saved if Greece undertook a determined national effort to service its debt and avoid a messy default.

However, even a messy default by Greece alone would not necessarily mean the end of the euro area. The day after a formal default, Greek banks would no longer have access to the regular monetary policy operations of the European Central Bank because the ECB could no longer accept their collateral—Greek debt—which would immediately have junk status. The country would thus effectively cease to be part of the euro area. Its status would resemble that of Montenegro, which adopted the euro as legal tender without officially being a member of the single currency zone.

In Greece, following a messy default, euro notes and coins would still circulate in the economy, but one euro in a Greek bank account would no longer be automatically equivalent to a euro in a bank account elsewhere in the euro area, as Greek banks might immediately become insolvent and thus be shut out of the payment systems. Until Greek solvency was re-established, the euro zone would thus de facto have lost one of its members, even though the Greek Central Bank head would still sit on the Governing Council of the ECB and the Greek finance minister would still be a member of the Euro Group, with their normal voting powers intact.

Given the problems in credit markets that would result, the Greek economy would be hit hard. But the impact on the rest of the single currency zone should be minor given that the country represents only about 2% of the euro area’s GDP and is not home to any systemically relevant financial institution.

In many ways, a messy Greek default would actually leave the euro zone in better shape. Its institutions would probably be strengthened because it would have become clear that the framework is strong enough to withstand the failure of one of its members. Tolerance toward violating deficit and reporting standards would be much reduced. The club would have been transformed into a federation whose peripheral members can be told to “get lost” so to speak. As a result, majority voting would tend to replace consensus as the normal way of decision-making.

The spanner in the works would of course be contagion. The main reason why even Germany has agreed to the bailout package for Greece is the fear that a messy default would trigger speculative attacks on government debt and financial institutions in systemic countries like Spain and Italy.

But there is no fundamental justification for contagion. The self-financing capacities of Spain and especially Italy are much stronger than those of Greece. However, markets can at times be irrational. The real test of the euro zone is thus whether it can protect from speculative attacks those members that do follow at least the spirit of its rules. Despite its large debt level, Italy, for example, has for most of the time kept its budget deficit below 3% of GDP.

So far the signals from financial markets are encouraging. After an initial bout of nervousness in February of this year, when it first became clear that the second leg of the financial crisis could imply sovereign default, markets have increasingly differentiated between the weaker members of the euro area. Risk premia have tended to move together in the same direction, but with completely different orders of magnitude. (The credit default swaps for Greek debt are now trading at around 600 basis points, compared to only 170 for Spain and even less for Italy.)

The default of any systemic country would indeed mean the end of the euro zone, but for the time being this remains fortunately only a tail risk.

April 28, 2010

Bailing out Greece An extreme necessity Greece’s request for aid from the euro zone and the IMF will provide only temporary relief

Filed under: Uncategorized — ktetaichinh @ 12:24 am
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Apr 23rd 2010 | From The Economist online

GREECE’S prime minister, George Papandreou, faced the television cameras on Friday 23rd April to anounce that his government would draw on emergency aid to tide it over for the rest of the year. Mr Papandreou decribed the rather embarassing request to to other euro zone members and the IMF as “an extreme necessity.” This followed a week in which yields on Greek bonds reached an alarming 8.9%. That in part reflected an announcement by Eurostat, the European statistics agency, that Greece’s budget deficit reached 13.6% of GDP in 2009, even worse than it had previously thought. The agency added that the number might be revised up again, owing to the poor quality of the available data. Moody’s, a credit-rating agency, responded by giving the latest of many downgrades by agencies to Greece’s sovereign bonds.

The interest rate for emergency aid from other members of the euro zone will be 3.5 percentage points above the benchmark “risk-free” rates for euro loans. That works out at around 5% for a fixed-rate loan, which is less than markets were asking of Greece before the deal was struck but still steep. Portugal and Ireland, the next-riskiest borrowers in the euro area, pay less than half as much for three-year money. Germany pays a mere 1.3%.

The IMF is expected to make €15 billion available, at interest rates that are likely to be a little kinder to the Greeks. The resulting package of €45 billion should be enough to finance Greece’s budget deficit for the rest of this year as well as repay its maturing debts. Yet Greece is likely to need far more support than this as it struggles to put right its public finances.

An earlier analysis by The Economist suggested that Greece would need at least €75 billion of official aid. We based this figure on several assumptions: that Greece would need five years to stabilise its ratio of debt to GDP; that it could take the pain of a brutal fiscal retrenchment; that private investors would still be willing to refinance existing debts, at an interest rate of 6%, if a rescue fund covered the country’s new borrowing; and that the economy would start to grow again in 2013.

An updated set of projections is set out on the right. We have made two changes so the analysis is a bit rosier. We now assume that Greece cuts its budget deficit, as a share of GDP, by four percentage points this year, as planned, so it has less to do later. We also assume that the interest charged on all maturing and new borrowing is 5%, in line with the cost of the aid offered by Greece’s euro-zone partners. With those changes, we reckon Greece would need to cut its primary budget deficit (ie, excluding interest costs) by 12 percentage points to cap its debt burden—a slightly less fierce adjustment than in our first simulation. On that basis Greece will run up an extra €67 billion of debt by 2014, by which time its debt will stabilise at a scary 149% of GDP. That sum is less than our previous estimate, but still half as much again as the amount on offer.

Some will see this scenario as too pessimistic. It is far gloomier, for instance, than that envisaged in the EU retrenchment programme, which assumes that Greece will get its deficit below 3% of GDP in three years and that the economy can continue to grow as it does so. However, even with a more benign assumption about growth, Greece’s debts would still be very large. For instance, suppose that any losses in nominal GDP during recession are quickly recovered. Debt would still then stabilise at 142% of GDP.

It will be hard for Greece to make such savage cuts in its budget and emerge from recession at the same time. Furthermore, prices and wages will have to fall if Greece is to regain the cost competitiveness needed for sustained economic growth. That will drag down nominal GDP in the short term, and make budget cuts more difficult to carry out.

Our analysis may even be too optimistic. If economic growth does not return, deficit reduction proves too painful or interest rates are much higher than we assume, the debt ratio is likely to spiral upwards until default becomes all but inevitable. Even if that is avoided, Greece’s rescuers may have to shoulder more of the financing burden than we have estimated, should private investors reduce their exposure to Greece.

They have plenty of reasons to do so. As Greece’s debt mountain grows, investors are increasingly likely to shun its bonds in favour of those of other, more creditworthy, euro-zone countries. Though IMF cash is welcome, private investors know that the fund is first in the queue when money has to be paid back. A euro-zone rescue party may also demand priority.

The bolder sort of investor may reckon that the high yields on offer are ample reward for the risk that Greece may be unable to repay all it has borrowed. But some will be more cautious. And others may judge that an interest rate big enough to compensate for the risk of default would only add to the pressure on Greece, making default more likely. Asian central banks that want to balance their dollar holdings with euros may choose to park their cash in France or Germany and save themselves any worries about Greece and its politics.

Greece’s euro-zone partners could find themselves with a large and open-ended commitment to roll over the country’s existing debts and to provide cash to cover its budget deficits. The rescue package may over time evolve into a rolling series of soft loans, at ever-lower interest rates and increasing maturity, designed to prop up Greece and keep default at bay. Such loans—in effect, grants—would amount to a kind of fiscal drip-feed. That could spur a political backlash, and perhaps legal challenges, in the countries supplying the funds.

The default option

Is a sovereign default by Greece imaginable? Conventional wisdom has it that sovereign defaults are always messy and painful. In fact the lesson of such defaults over the past decade or more is that this is not necessarily so. More than a dozen emerging economies have restructured their sovereign debt in the past decade without huge losses of output and without paying enormous penalties in exclusion from capital markets or higher spreads. With a few exceptions (notably Argentina) the process has been much quicker than in earlier sovereign restructurings, and governments and creditors have managed to work together. Governments sometimes negotiated a restructuring with creditors before formally missing a payment of interest or principal—a process known, in the jargon, as “pre-emptive” restructuring. Legal innovations to encourage creditors to take part in restructurings and make it harder for holdouts to litigate have helped.

In 2003 Uruguay restructured all its domestic and external debt, exchanging old bonds at par and at the same coupon rate for new ones but stretching maturity dates by five years. The country returned to capital markets a month later. The “haircut”, or loss to bondholders, was small (13.3%, in net present value), as were the amounts restructured ($5.4 billion), but it showed that orderly sovereign workouts are possible. Countries such as Jamaica and Belize have had orderly restructurings recently.

Greece is different because it has much more debt outstanding and because bondholders may face a more severe haircut—although with sufficient fiscal consolidation a more modest restructuring could be feasible. Sovereign-debt lawyers say that in some ways a restructuring of Greek debt would be easier than many people think. But other things would be new and harder, especially the complexity caused by credit-default swaps, which have not yet played a big role in any sovereign-debt restructurings. It is uncertain, for instance, whether a pre-emptive restructuring would trigger the default clause in credit-default swaps. But Lee Buchheit, a leading sovereign-debt lawyer, says that the biggest risk in most debt-restructuring cases is governments that try to put off the inevitable. “By far the greater risk is pathological procrastination by the debtor in the face of an obviously untenable financial situation,” he argues, in which a country pursues frantic and ruinously expensive emergency financing in the lead-up to an eventual restructuring.

Would a defaulting country have to leave the euro? No. It is perhaps natural to conflate default with devaluation because they often occur together. But a euro member has no currency to devalue. Nor is there a means to force a defaulter out, since membership is meant to be for keeps. A new currency would have to be invented from scratch, a logistical nightmare. All contracts—for bonds, bank deposits, wages and so forth—would have to be switched to the new currency. The changeover to the euro was planned in detail and in co-operation. The reverse operation would be nothing like as orderly. A country that had lost the faith of investors in its public finances would find it hard to reconstruct a sound monetary system. Default by a member would be a body blow to the euro’s standing. But it need not spell the end of the currency.

April 5, 2010

German stand on loan rates to Greece

Filed under: Uncategorized — ktetaichinh @ 5:18 pm
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Germany is at loggerheads with other eurozone countries over how much interest to charge debt-ridden Greece if it calls on the emergency loans package agreed in Brussels last month.

The dispute could hold up swift agreement about technical details of a safety net agreed by European leaders and seen as crucial to reducing the risk that Greece will need to call on the loans.

Eurozone leaders agreed at the end of March to offer Greece an emergency loan package from the International Monetary Fund and the eurozone if it was unable to raise debt in the market, but they insisted the interest rate on the European portion of a bail would be unsubsidised.

Most eurozone nations are prepared to offer loans at 4 to 4.5 per cent, the rate paid by the eurozone’s other other big debtors, Ireland and Portugal, EU officials told the Financial Times. But Germany says Athens should pay 6 to 6.5 per cent, the rate it pays on its 10-year bonds.

Donor nations would be able to refinance money lent to Athens at the lower rate without themselves losing money. Germany, these officials said, took the view “unsubsidised” rates meant Greece could only borrow at rates it last paid on the market. Berlin fears a veto from its Constitutional Court if it agrees to cheaper financing.

“If you say Greece’s whole consolidation effort is endangered by it paying such extremely high spreads [against German government bonds] you have to ensure the spread comes down,” one senior EU official told the FT.

“But the Germans say the Greeks have lived beyond their means, they must solve their problems themselves” – and thus pay 3 percentage points more in interest, or twice as much, as Berlin pays on its 10-year bonds.

Greece is pushing for an emergency-loan rate of 4 to 4.5 per cent. “A comparable rate to Portugal is what we’d like to see,” an official said – even as hope is growing in Athens that help might not be needed until later this year.

Like other eurozone capitals, including Berlin, Athens hopes that swift agreement about the details of emergency funding could push Greek rates down and reduce the likelihood of Greece having to tap the emergency reserve.

But even if Greece manages to raise €10bn for its budget in May – and billions more during the year – EU officials fear 2011 and 2012 will prove even tougher for a country with a meagre economic base that might fail to grow.

While officials in several countries said the sum of a package had not been officially set, they said the IMF portion could hit, but not exceed, €10bn – 10 times Greece’s so-called quota at the Washington institution.

Access to the IMF’s standby arrangements should allow Greece to borrow just under a third of this sum at 1.25 per cent, with interest most probably rising to 3.25 per cent for the remaining IMF amount, EU officials said.

Given that European Commission officials said in late March that the eurozone would shoulder two-thirds of any aid, this suggests that combined IMF-eurozone aid could hit €30bn. But EU officials said a total had not been set.

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