6/5/2013: Self-contradictions & EU Commission

Trapped in their own failures, EU 'leaders' are no longer simply contradicting each other - they are now contradicting themselves. And, I must add, via ever more apparent and bizarre statements.
Behold the latest instalment of absurdity from one of the multiple EU 'Presidents': the man in charge of the EU economic policies and performance, European Commission chief Jose Manuel Barroso. As reported in the EUObserver (http://euobserver.com/economic/120040), Mr Barroso stated that "What is happening in France and Portugal is not Merkel's or Germany's fault … The crisis and their problems are not a result of German policy or the fault of the EU. It is the result of excessive spending, lack of competitiveness and irresponsible trading in the financial markets."
Thus,

1. Loose monetary policy by the ECB that was custom-tailored to suit German needs during 2002-2007 period had nothing to do with the crisis in the peripheral states, despite the fact that it triggered vast inflows of capital from Germany (and other core states) into the euro area periphery, inflating assets bubbles left, right and centre, and leading to unsustainable debt accumulation in these economies.
2. ECB (heavily influenced by German ethos and political economy) and EU Commission and regulatory bodies' insistence on treating all sovereign bonds issued by the euro area states as risk-free assets on banks balance sheets (the main trigger for Cypriot crisis and the reason for massive transfers of banking sector costs onto taxpayers in Ireland and other member states) had nothing to do with Berlin or with Berlin's insistence on closing its eyes on what was happening in regulation / enforcement EU-wide.
3. Berlin's inability to reign in German (among other) banks' gross misplacing of risks in interbank lending to other euro area banks had nothing to do with the crisis.
4. Berlin's insistence, repeated parrot-like by Mr Barroso and his colleagues in the Commission, that the whole crisis can be addressed via fiscal adjustments (recall, that was the position the EU Commission occupied for the last 6 years) and current account rebalancing has nothing to do with mis-shaped economic policy responses across the EU since 2008 crisis onset.
5. Berlin's 'guidance' toward internecine and economically illiterate Fiscal Compact, eagerly endorsed by Mr Barroso and his colleagues in recent past, has nothing to do with the failure of Europe to respond to the crisis.
6. Berlin's opposition to the half-baked EU ideas about stimulating growth in euro periphery that shut the door on any real stimulus has nothing to do with the crisis.
7. Berlin's opposition to increasing domestic demand and abandoning contractionary pursuit of current account surpluses, also noted by Mr Barroso's Commission in the past, had nothing to do with the crisis duration or depth.

Mr Barroso also claimed that Chancellor Merkel is "one of the only [leaders], if not the only leader at the European level who best understands what is going on."

Really? Suppose so. In this case, Mr Barroso has either no clue what is going on, or simply doesn't care to be consistent with his own exhortations of the recent past, because he openly and directly contradicted Ms Merkel couple of weeks ago by claiming that 'austerity was overdone' and had "reached its limits."

Irony has reached so far in Mr. Barroso's waltzing across the ideological & economic policy landscape that according to the EU's 'President', Ms Merkel's brilliance also encompasses the fact she is presiding over German economy currently sliding toward a recession. IMF analysis shows real GDP growth in Germany will fall from 4.024% and 3.096% in 2010 and 2011 to 0.865% and 0.613% in 2012 and 2013. This might be better-than-average record for the euro area, but it is hardly an achievement worth praising.

Someone should point to Mr Barroso that eating one's cake (taking a populist position against austerity, and thus Ms Merkel) and having it (taking an appeasing position toward the major architect of all economic policy blunders so far deployed in Europe since the onset of the crisis) is just something that doesn't happen outside the make-belief world of Brussels.

26/4/2013: Meanwhile, Patients Still Run the Euro Policy Asylum...

Headlines (via Eurointelligence.com):

• Angela Merkel: "The European Central Bank would really have to increase the interest rates for Germany";
• Angela Merkel also said that for other countries, the ECB would have to provide more liquidity for companies;
• German economics minister Phillip Rosler issued a statement to confirm that the ECB was still an independent central bank;
• ECB officials, meanwhile, played down expectations that a rate cut would have much of an effect;
• Joerg Asmussen did not rule out an interest rate cut, but was playing down expectations. He said lower interest rates could work in ways not intended by the ECB, and added that they had virtually no effect in the periphery due to the broken transmission mechanisms;
• Benoit Coeure as saying that the ECB had done what it can. It was now up to all the European institutions to find ways to solve the problem;
• Wolfgang Schauble said Italy’s problems were a lack of reforms, and that it would be wrong to blame others for their own misfortune. "... in the eurozone everybody had to solve their own problems. And that is is what Italy needed to do as well. There was no point in asking Germany to take on more debt. Everybody had to run their government in a responsible way";
• Schauble also said that it would be wrong for member states to depart from austerity path, saying the eurozone problems had nothing to do with strict budget rules, and that "somebody should tell Barroso that".

Conclusion: rest assured - the screw up known as "Euro area policy" will go on unabated no matter what JMBarosso & Co are saying.

ECB rate cut might come or it might not, but it will be minor (25bps) and one-off (with rates unchanged throughout the rest of the year) and it will do no difference whatsoever, other than fuel anti-inflationary rhetoric in pre-election Germany.

Fiscal policy will remain largely unchanged with some states (France, Italy, even Spain?) adopting an Irish-government approach to 'stimulus': find one-off non-tax, like pensions funds expropriation, to fund 'jobs creation programme', while leaving net fiscal adjustments intact. Which will, of course, amount to short-term reallocation of productive funds to unproductive GDP supports, with medium-term negative impact of tax increases and reduced confidence in economic institutions.

21/4/2014: Sunday Independent article

My article on Euro area austerity policies failure in Sunday Independent - it's not in levels of cuts, but in the lack of real change from the status quo.

25/2/2013: When 8 out of 10 economists agree?

Eurointelligence today published a neat summary of some of the prominent economists' opinions about the Euro area macroeconomic policies:


"Motivated by the recent controversy between Olli Rehn and economic analysists critical of austerity (including from the IMF), El Pais garners the opinions of 10 prominent economists on whether the European Commission is to blame for Europe's poor economic prospects. ... Some quotes:

• Paul de Grauwe says: "the EU authorities are responsible for the recession … the Eurozone's macroeconomic policy is a disaster"
• James Galbraith says: "the Commission's leadership seems to work in an alternate reality, indifferent to the consequences of its policies"
• Luis Garicano says: "Brussels is incomprehensibly dogmatic [and] neglects the probability of a serious accident"
• José Manuel González-Páramo says: "in a way we're all responsible for the recession … The Commission's proposals are advanced and forward-looking"
• Paul Krugman blogged "these people have done terrible damage and stll have the power to continue"
• Desmond Lachman says: "The Commission was very slow to draw the conclusion that the IMF did: excessive austerity with the Euro as straitjacket is counterproductive"
• Jonathan Portes says: "The optimistic conclusion is that [Rehn] is admitting the justifications for austerity are crumbling"
• Dani Rodrik says: "The Commission has been fooling itself with the illusion that the structural reforms it spouses can stimulate the economy in the middle of an activity plunge made worse by austerity measures"
• Guntram Wolff says: "Considering all the constraints the Commission is subject to, it's adopted generally adequate policies, trying to strike a balance between fiscal consolidation and supporting the economy"
• Charles Wyplosz says: "The Commission makes politically correct forecasts knowing full well they will have to appear surprised when they are not fulfilled."

Paul Krugman also labeled Olli Rehn “the face of denialism”. According to Kurgman, the recent declines in sovereign spreads was due to the LTRO and OMT, and "while unit labour costs have converged a little, they have only converged by a fraction of what needs to be done".

Kevin O’Rourke via the Irish economy blog: “You might have thought that the disastrous but wholly unsurprising eurozone GDP numbers indicate that the bloc is in a bad way, and will continue to be so until the current macroeconomic policy mix is jettisoned. Happily, Olli “Don’t mention the multiplier” Rehn has good news for us: The current situation can be summarised like this: we have disappointing hard data from the end of last year, some more encouraging soft data in the recent past and growing investor confidence in the future. Thank goodness for that.”

I find it very interesting that virtually not a single of the above quotes, save for Krugman's passing reference to labor costs, distinguishes between the necessary structural reforms and pure, brutish, line-across-the-sky cuts that have been adopted by the EU. And even Krugman's references is hardly sufficient - labor costs in and by themselves are not and should not be the target for structural reforms. Instead, market structure, institutional competitiveness, cartel-like structure of some protected sectors, legal systems, moral hazard and other aspects of the crisis should be.

Oh, and lets face it - the drive toward 'austerity' is not only the job of the EU Commission, but also of the EU Parliamentarians (link here), plus all the nation states that adopted the Fiscal Compact.

Olli is nothing more than a mouthpiece for the consensus policies that are continuing to transfer economic crisis burden from the elites to the real economy.

22/12/2011: Europe's policy errors

By now, you have figured it out - I am a big fan of my old UofC professor, John Cochrane. And in this latest article (here) he delivers even more real common sense.

Defaults:

"Conventional wisdom says that sovereign defaults mean the end of the euro: If Greece defaults it has to leave the single currency; German taxpayers have to bail out southern governments to save the union.
This is nonsense. U.S. states and local governments have defaulted on dollar debts, just as companies default."

Cochrane is correct. Orange County, CA - size ca 1/2 Ireland - has defaulted before and so... no end to the State of California or to the Feds and, crucially, no bailout. New York went bust in 1975, Cleveland in 1978. Fitch did a study in 1999, updated in 2003, that shows 2,339 cases of municipal bonds defaults in the US for 1980-2002 totaling USD32.8 billion. And guess what: no bailouts and yet the dollar still exists. Fitch estimated cumulative default rate for 1980-1986 issuance of 1.5%m cumulative default rate for 1987-1994 issuance of 0.63%, average recovery rates were around 63-64%, consistent with standardized CPD pricing practice of 40% haircut. This is not to say that defaults are costless or easy, but there is no ex-ante intrinsic reason for the common currency to implode were a country like Greece - expected by all to default - to restructure its sovereign debts.

Bailouts:
"Bailouts are the real threat to the euro. The ECB has been buying Greek, Italian, Portuguese and Spanish debt. It has been lending money to banks that, in turn, buy the debt. There is strong pressure for the ECB to buy or guarantee more. When the debt finally defaults, either the rest of Europe will have to raise trillions of euros in fresh taxes to replenish the central bank, or the euro will inflate away."

Correct again: latest LTRO allocation of €489bn this week, with €235bn of this being lent in excess of the banks covering shorter-term ECB debt is the case in point. ECB's hope is that the banks - already sick from overloading with low quality sovereign debts on their balance sheets - will use €235bn to buy more sovereign debt. This, of course, will help ECB to cut back its own purchases of Government bonds and to, thus, pretend that 'the market' for sovereign debt in Europe is somehow being repaired. The madness of this 'solution' is that it creates even greater link between ECB, banks and sovereign debt - the very cause of the crisis contagion. You can see an excellent, albeit a bit politically-correct piece on this in the Economist (here).

And to correct for the 'politically correct' bit - here's my view of LTRO: In a nutshell, the ECB will lend the banks unlimited money at 1% so they can buy PIIGS+Belgian+French debt making 2-6% margin as pure profit and benefiting from capital gains in the process. As bonds prices firm up on the back of these purchases, banks collateral deposited with ECB will also improve in value, allowing them to borrow even more. This positive correlation between banks borrowings from ECB and their profits gains will continue until in 3 years from now the entire pyramid collapses - the banks will have to repay ECB funds, prompting massive sales of bonds. And in the mean time, there will be no lending in the real economy, as banks funding will be tied into financing Government spending and banks will continue to deleverage out of real assets. This makes LTRO an equivalent of an RX to a drug addict for unlimited supply of free opiate.

As Cochrane puts it:
"Sovereign default would damage the financial system, however, for the simple reason that Europe has allowed its banks to load up on debt, kept on the books at face value, and treated as riskless and buffered by no capital. Indebted governments have been pressuring banks to buy more debt, not less.

As banks have been increasing capital, they have loaded up even more on “risk-free” sovereign debt, which they can use as collateral for ECB loans. The big ECB “liquidity operation” that took place yesterday will give banks hundreds of billions of euros to increase their sovereign bets. Bank depositors and creditors have figured this out, and are running for the exits.

...By stuffing the banks with sovereign debt, European politicians and regulators are making the inevitable default much more financially dangerous. So much for the faith that regulation will keep banks safe."



Fiscal Union:
"More fiscal union hurts the euro. Think of Poland or Slovakia. ...A common currency without a fiscal union could have universal appeal. A currency union with a bailout-based fiscal union will remain a small affair."

"Europeans leaders think their job is to stop “contagion,” to “calm markets.” They blame “speculation” for their troubles. They keep looking for the Big Announcement that will soothe markets into rolling over another few hundred billion euros of debt. Alas, the problem is reality, not psychology, and governments are poor psychologists. You just can’t fill a trillion-euro hole with psychology."

Conclusion:

"The euro’s fatal flaw then wasn’t to unite areas with differing levels and types of development under one currency. ...Nor was it to deprive governments of the ephemeral pleasures of devaluation. Nor was it to envision a currency union without fiscal union.

Banking misregulation was the euro’s fatal flaw [emphasis is mine]. Sovereign debt, which can always avoid explicit default when countries print money, doesn’t remain risk-free in a currency union. Yet banking regulators and ECB rules continue to pretend otherwise.

So, by artful application of bad ideas, Europe has taken a plain-vanilla sovereign restructuring and turned it into a banking crisis, a currency crisis, a fiscal crisis, and now a political crisis."

And then,
"When the era of wishful thinking ends, Europe will face a stark choice.

1. It can have a monetary union without sovereign defaults. That option means fiscal union, accepting real German control of Greek and Italian (and maybe French) budgets. Nobody wants that, with good reason.
2. Or Europe can have a monetary union without fiscal union. That would work well, but it needs to be based on two central ideas: Sovereigns must be able to default just like companies, and banks, including the central bank, must treat sovereign debt just like company debt.
3. The final option is a breakup, probably after a crisis and inflation. The euro, like the meter, is a great idea. Throwing it away would be a real and needless tragedy."

I agree.

24/11/2011: Beggar thy citizens

Things are desperate on a new level across Euro area, folks. So desperate, the Euro leadership delusions have shifted up a notched from already feverish levels they reached before.

Until now, the talk was all about the miracle pills of first "The Firewall of EFSF" then "ECB rescue" + "Euro bonds", now the convoluted plans to underwrite the failures of the last decades are getting more esoteric and, oh so European, at the same time.

Recall the EFS 'Firewall' - launched at first with ca €275 billion in lending capacity, enlarged to €440 billion capacity, then planned for a 'leveraged' enlargement to €1 trillion capacity. Now, with realisation that (1) €1 trillion is no longer enough of a 'Firewall' once Italy caught fire and the rooftop of Chateau France is getting steamy too; and (2) There is no €1 trillion worth of international idiots (oops... err.. investors) willing to part with their money for the greater good of European 'solidarity' the EFSF 'solution' has fallen off the radar.

Next, enter the idea of the ECB rescue and Euro bonds. These too are largely problematic. The ECB 'rescue' option at this stage will have to involve €1.5-2.5 trillion worth of assets purchases - something that will be (a) costly (imagine what will happen to bonds prices if the ECB were to wade in with that sort of cash into the secondary markets) and (b) internecine to ECB's mandate and reputation (in other words, turning your Central Bank into the financial toxic waste warehouse will do to the Euro just what the PIIGS combined default can - destroy it). The Euro bonds option requires two impossible to achieve things: (1) finding idiots... err... investors willing to pony up even more cash than for the EFSF for an undertaking written against largely non-controllable borrowers with little prospect of achieving economic growth to sustain repayments of their debts, and (2) balancing the need to get another credit against the risk of destroying credit ratings (as Euro bond will in effect simply give Governments more debt and this debt will be senior to their own previously issued national debt). And, of course, the Euro bond idea requires much closer political integration first - something that will take years to deliver.

Smelling the rat... err... failure in the above magic bullets, some Governments are now desperate enough to resort to the classic European response to the crises: fleecing their own citizens to pay for their spending habits. Behold tax increases across Europe and Belgian plans to sell their unwanted bonds to their citizens (the story here). In the nutshell, the idea is that there are no idiots... err... investors out there willing to buy Belgian Government promissory notes (note: Belgium, of course doesn't even have a Government). So the solution - just as Joe Stalin did in the 1930s-1950s - is to sell these bonds to unsuspecting ordinary people of Belgium. To make the 'deal' even more egregious, the bonds are to be sold at a discount on the yields provided to banks purchasers. Not only will Belgian pople join the line of those who hold dodgy paper, cross-linked to their entire risk profile of living and working in Belgium and paying Belgian taxes, but they are expected to do so for less reward!

Priceless, really, folks. Comparable only to Irish Government 'Solidarity Bonds' and efforts to sell state junk to national pensions and insurance companies. In economics, there's a concept of policies that 'beggar thy neighbors' by shifting risks/costs/losses onto other countries via trade and investment restrictions, taxes and subsidies. In Europe, we are getting to the point of having 'beggar thy citizens' policies.