Posts Tagged E-bonds
Nouriel Roubini famously described the long decline of the euro as a ‘slow motion train wreck’. Mind you, economists disagree on exactly when the wreck will happen. Professor Vincente Nabarro has argued that the euro will survive for as long as it serves the purposes of the German (and European) elite while, in the Financial Times, Wolfgang Münchau mischievously suggests the crisis could last another 20 years given Germany’s proclivity for muddling through. By contrast, Megan Green at RGE sees the confluence of crises in Greece, Spain, and Italy during September and October, 2012, as potentially lethal. But all agree that—sooner or later—it will happen.
In Greece, the coalition government will have to agree a package of measures with the troika to secure the latest tranche of bailout money. The problem is twofold: first, Mr Samaras has asked for an extra two years to impose further austerity measures required by the troika, a request which the Germans have already rejected. Secondly, the Greek Parliament must approve the measures, failing which another general election would almost certainly need to be called.
Even if one assumes that Greeks can be paper over their differences once again (or else that Greek default does not produce catastrophic contagion), Portugal is likely to remain locked out of the financial markets and thus forced into a second round of difficult negotiations with the troika. Because the ESM comes into existence in September—assuming the Germans Constitutional Court rules in its favour—Spain too will require negotiations with the new body both on bailing out its private banks and on sovereign bond purchases.
Elsewhere, the campaign in Italy for the April 2013 general election will begin in earnest and Mr Berlusconi can be expected to launch his political comeback on an anti-euro platform, having said quite plainly earlier this year that either Italy gets bailed out or it leaves the EZ. However one views Berlusconi, there should be no doubt about the seriousness of this threat. In September too, France’s President Hollande will advance a budget which is bound to be controversial, while at the same time the Dutch will hold a general election likely to lead to a euro-sceptic coalition.
The situation might not be so dangerous were it not for growing euro-scepticism in Germany. While a majority of Germans may still favour remaining in the euro, over a third of those questioned favour a return to the old currency, the highest percentage in the large EZ countries. Public opinion, moreover, is strongly against what is perceived as further German ‘aid’ to the Club-Med countries (which is reality is ‘aid’ to their own banking system). Spurred by such neo-liberal economists as Hans-Werner Sinn, centre-right German politicians continue to insist that: (a) neither commonly backed Eurobonds nor bank insurance are an option; (b) further ECB sovereign bond purchases are dangerous, and (c) there can be no bank recapitalisation without EZ banking union, and such banking union must be preceded by political union.
But the strong EZ banking union required is not what the German centre-right has in mind, and even were it to accede on this point, German actions (and inactions) to date mean that the chance of achieving political union is growing ever more remote. Nor can we expect much to change were the SPD to enter into a new grand coalition in late 2013. After all, it was the previous SPD-CDU coalition which embedded austerity into the German constitution in the form of the debt-brake law, and the then SPD Finance Minister Peer Steinbrük—now a strong candidate to lead the party into the 2013 election—famously dismissed the Keynesian notion of a pan-European economic stimulus package. Moreover, the ex-central banker, Thilo Sarazzin , whose 2012 book Europa braucht den Euro nicht (Europe doesn’t need the euro) has been a best-seller, is a well-known SPD member.
Without a fundamental shift in the German position—not just on the above issues but on domestic demand reflation and trade imbalances–the euro seems doomed. Since there is no sign of such a shift, Europe sits on its hands awaiting the inevitable economic shock. One source has put the cost to Germany in the first year alone as a 10 per cent collapse in GDP. Perhaps this is the sort of price which, sooner or later, all of us will pay as a result of accepting the deep flaws in the initial structure of the common currency.
While the punters speculate on the outcome of the Greek election on 17 June, in truth ‘Grexit’ is already happening. Because of massive withdrawals from the Greek banking system, the country is on emergency life support from the ECB. First, following the inconclusive May elections, the ‘troika’ decided that it would postpone the €48bn recapitalisation payment until after the June election. Then, a fortnight ago, the ECB stopped accepting collateral from the Central Bank of Greece (BoG) for several of Greece’s major banks. This collateral is required for weekly refinance operations required to keep the country’s private banks liquid.
In consequence, the central bank has had to seek €100bn from the ECB’s Emergency Liquidity Assistance (ELA), whih is slowly being chanelled to four major private banks. The difference between money received through the ‘normal’ ECB refinancing channel and the ELA is that, in the former case, the loan from the BoG to the private Greek banks is guaranteed by all ECB members while in the latter case it is guaranteed by the Greek state. In the words of one commentator, ‘think of what this means about keeping your money in your local bank?’ Or in the words of another:
“Essentially, ELA represents the ECB passing the risk back to the sovereign. That could be the trigger for potential default … ”
Some think that Greece’s departure may be a good thing. The arguments are familiar enough: first, Merkel and her allies want Greece out ‘pour encourager les autres’. Secondly, a numbrer of prominent economists (eg, Nouriel Roubini) believe Greece will benefit from leaving now rather than later. With Greece gone, a deal can probably be done between Merkel and Hollande over Eurobonds or (minimally at least) ‘project bonds’. The latter would be construed as a victory for the anti-austerity camp. Until recently, that is certainly what I had thought.
As Martin Wolf and others have noted, Greece’s disorderly departure will in all likelihood shatter faith in the Eurozone forever. Given the slow motion bank run in Spain, a Greek bank run will almost certainly trigger massive flight from the single currency. We shall not return to the comfortable prosperity of post-war Europe soon or even later—in all probability, that world has now died.
Despite Wimbledon week, the main centre court contest that many economists are watching is that between the German government and the ECB. An abbreviated summary of the action so far is as follows. The German Finance Minister, Herr Schäuble, initially appeared to gain the advantage by admitting that the Greek situation is so perilous that they should be allowed in effect to default—the phrase he used was ‘voluntary restructuring’. Monsieur Trichet then fought back hard arguing that a Greek default would be catastrophic and implying that eurozone governments (not the ECB) should continue lending. The ECB even threatened to stop accepting Greek Eurobonds as collateral for its continued lending to the Greek central bank, a move that would effectively pull the plug on the Greek banking system. Who will prevail?
On the face of it, Herr Schäuble has a strong case, albeit rendered more palatable to his critics by such sweeteners as having Greece sell off public assets, voluntarily ‘reprofile’ its sovereign debt and so forth. The real case for default, though, is that the retrenchment medicine is not working and risks killing the patient. Instead of extracting a vengeful levy entirely from ordinary Greeks, German and French banks should be made to pay their fair share—a ‘haircut’ variously estimated as between 35% and 70% of the bonds they hold. Indeed, given the dramatic turn of events in Athens in recent days, default now looks almost certain.
But here is the rub. A default—however sugar-coated—is still a default. The ECB argument is that if Greece is allowed to do so, other highly indebted members will follow suit and, as contagion spreads, the markets will cease buying members’ sovereign debt altogether. The ECB would be left to bail out not just the small peripheral economies, but probably Spain and Italy too. That would spell the end of the euro. That is partly why Jean-Claude Trichet will be replaced in October by another tough conservative, Italy’s Mario Draghi who famously prefaced an interview with the Financial Times by the phrase “The euro is not in question.”
On the face of it, then, the first set of the match will almost certainly end in a nail-biting tie break. But whoever wins, the match will be far from over. To borrow Wolfgang Münchau’s phrase, the existing union is too weak to function properly, but too strong to blow up. Assuming the eurozone does not blow up, how might it be strengthened?
The central pillar of a new economic architecture for the eurozone would be the creation of a Treasury Secretary with a secretariat; ie, an embryonic Eurozone Treasury (Ministry of Finance). Indeed, the idea was floated earlier in June by Monsieur Trichet himself who added that such a Ministry would also carry out “all the typical responsibilities of the executive branches as regards the union’s integrated financial sector, so as to accompany the full integration of financial services, and third, the representation of the union confederation in international financial institutions.”. The key points to retain are, first, that such a Ministry would have real power (ie, it could override national bickering in the Council); and secondly, that the Eurozone would have a single banking system.
Another pillar would be fiscal-financial. Like its US counterpart, a Eurozone Treasury would need to be able to emit E-bonds jointly guaranteed by all members. Not only would this enable the eurozone to supersede the now-discredited system of relying on national Eurobonds, it would greatly strengthen the euro as a reserve currency since euro-assets would be far more desirable (and available) to hold. Additionally, a Euro-Treasury might start by improved ‘co-ordination’ of member-states’ fiscal policy, but it would soon need to raise significant amounts of revenue. A useful mechanism would be to follow up on a suggestion by Spain a decade ago that a tax on member-states (ie, a share of their VAT receipts) be levied progressively in proportion to their per capita income.
The third pillar would be political. The eurozone cannot survive unless its citizens benefit from its existence. And here is where serious political courage is needed—the courage to set up a Eurozone unemployment benefit scheme, and/or for that matter, a Eurozone pension scheme. Initially such schemes would complement the national schemes already in place, but as they grew in size, they would come to play the same macroeconomic stabilisation and redistributive functions as the US Treasury.
How do these proposals relate to the current contest between the Germans and the ECB? The answer is straightforward. Although the Greeks, the Irish and other countries at risk will doubtless be offered further loans, at the end of the day what we are witnessing is a slow-motion default. Why? Because ‘internal devaluation’ and the fiscal straightjacket imposed upon the weakest members means they can never repay. Ultimately, Germany, France et al will have to bail out their own banks. If slow-motion default leads to another major financial crisis, we shall all pay.
In truth, Eurozone member-states already live in a ‘transfer union’, and the sooner members realise it and adopt a common macro-economic framework, the better. The practical details may take a long time, but one thing is certain: the gruelling match on centre-court is far from over.
 See ‘Interview with Mario Draghi: Action on the addicts’ http://www.ft.com/cms/s/0/af24be36-03ca-11e0-8c3f-00144feabdc0.html#ixzz1PAShPhkq
 See Wolfgang Münchau ‘Ingredients of a European political union’ Financial Times, June 5 2011.