Financial Stability News

Flashing news about financial stability and central banking

Category Archives: Euro crisis

The Reinhart – Roghoff story

The highlight of this week has been the high-profile critique by Pollin & Co from UMassAmherst of professors Reinhart and Roghoff and their “austerity” paper, where they showed that the danger zone of public debt is 90 % of GDP. Their results has been used by the UK finance minister Osborn to justify their current harsh budget policy, and by many otheres to justify the current fashion of “austerity growth driven policies”.

Financial Times has given the debate wide coverage, see here and this very good summary blog post by G. Davis here. But you may also be interested in these posts by Prof. Mitchell here and prof. Wray here that is much more direct in their critique of R&R and also show the absurdity in their initial paper. As Wray and co-author Nersisyan noted in a Levy WP from 2010:

R&R … have no idea what sovereign debt is. They add together government debts issued by states on gold standards, fixed exchange rates and floating rates. They aggregated across governments that issue debt in their own currency and states that issue debt denominated in foreign currency. It is not even possible to determine from their book exactly what is government debt versus private debt.

So, it does not make sense to compare apples and oranges; the debt ratio of Spain (w/o its own currency) is obviously not the same as the debt ratio for the UK. And the debt ratio for Japan (borrowing mainly domestically) has a different meaning than the US debt ratio (most US debt is to foreigners; and the US dollar enjoy resever currency status).

This has huge implications for macroeconomic policy going forward. The IMF is gradually coming around to a “less austerity” position, and the FT notes that they will get into a fight with the UK government in the forthcoming Article IV discussion. So watch out for the continuation of the contiuation of the R&R story.

EU’s unemployment continue to increase

Unemployment continue to increase, as reported by Eurostat yesterday. Depressing figures; should be of greater concern for everybody! For a good review of the situation, see this blog from Professor Bill Mitchell, University of Newcastle, NSW Australia.

Brad DeLong on FT’s call for austerity

The FT’s editorial today with a balanced call for austerity in Europa was surprising and disappointing, given all the writings of Martin Wolf and others in the paper before. Today Brad de Long take charge at the ed and discuss why it is that people who should know better fall in the “austerity trap”. He points out that even Milton Friedman would have to to stabilize nominal GDP and buy stuff for until inflation and growth are reestablished on a sustainable path.Well written.

Also included are the response from Paul Krugman which is even better, and probably well to the mark (still scary):

My best theory here is that it’s political and sociological: conservative-leaning economists who should know better are driven by peer pressure to suppress their better instincts.

Think about Greg Mankiw and inflation. Early on in the Lesser Depression Greg came out for inflation — fairly high inflation! — as the solution, to give us negative real interest rates. But he encountered a firestorm of criticism from his political allies — and went silent.

The point is that even among academics with tenure and established reputations, there is apparently enough leverage in the hands of the enforcers of right-wing orthodoxy that they end up bowing to the reign of error.

As for Rachman: I think this is a subtler form of peer pressure. And for what it’s worth, Ryan Avent has already written the devastating reply to Rachman I haven’t had time for because I’m on Reddit!

Making finance servant, not master of the economy

This heading seems like a good companion post to the previous one on hedge funds speculation against the euro countries. It is the title of a presentation by Ann Pettifor at a conference on Just Banking (for program, see here). She gives a good overview of the problems in Europe and then draw extensively on Keynes in her proposal for a radical alternative to the current austerity approach:

Keynes’s six tools for recovery:

First, independent monetary policy: liquidity created by both public and private financial institutions should be directed towards sound public and private investment in productive, job creation activity. Any attempt to divert liquidity/credit into speculation had to be curtailed.

Second, fiscal policy: Keynes understood that it was not enough simply to create liquidity. That money had to be spent, and spent wisely. Today economists and politicians like David Cameron (“.. a fiscal conservative and a monetary activist”) rely simply on monetary policy to inject liquidity into zombie banks. This helps the banks, but does precious little to direct lending to firms and to stimulate recovery.

Third, managing debt de-leveraging: Keynes understood that the vast bubble of debt had to be de-leveraged in a managed way. Some debts inevitably have to be written off, with debtors granted a jubilee – as Steve Keen argues – simply because a high proportion of private debts are ultimately unpayable.

Fourth: regulation of credit creation. To ensure that credit created by the private banking system was aimed at the real economy, and not speculation, Keynes advocated wise regulation of the credit creation powers of private banks (‘tight money’). In other words loans had to be carefully assessed for their ability to generate income to finance repayment; and for their ability to generate sound employment and economic activity.

Fifth: permanently low interest rates. This was one of the central pillars of the Keynesian revolution. It was also the one that invited the greatest hostility from private bankers – whose profits and capital gains depend on exacting high rents from the effortless activity of creating new loans, and from speculative activities.

Six: capital controls are important for a number of reasons. One of the most important reasons for control over the mobility of capital is that management of financial flows gives democracies the freedom and autonomy to conduct their economic policies in the interests of society and the economy as a whole. In the absence of capital control, democracies are subject to the whims and interests of unaccountable global financial elites.

Hedge funds bet against eurozone – again

While unemployment is heading for 25 % in Spain, the FT report today (Hedge funds get against eurozone) that hedge funds are now betting against the core euro countries as well. With Hollande predicted to win the election in France and German growth weakening, Poulson and the other big macro funds are taking directional bets against the key euro bonds, including the German Bunds. A bet against Germany is currently “cheap”, since the cost of hedging the credit risk through a CDS is “only” 86 basis points compared with 660 bp for Spain.

For how long can this game go on, with euro countries imposing austerity to please the markets, just to be undercut with additional speculation? S&P’s downgrade last week of Spain shows that there is not much reward to be gained from austerity programs. And as Marin Wolf observed in the FT today: small contractions bring recessions and big contractions bring depressions. “Since a large number of countries are expected to tighten their fiscal positions substantially in coming years, their economies are likely to contract. How long the political glue will hold in these circumstances is a really interesting question.”

Two very interesting conferences

INET is hosting its second conference in Berlin shortly: Paradigm Lost: Rethinking Economics and Politics

The program is broad with a host of good speakers. By invitation only, but they usually post a lot of video.

Levy Institute will also host its 21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability at around the same time in NY City

with Gillian Tett, Claudio Borio, Andrea Enria, Peter Praet, Christine Cumming, Martin Wolf, Joseph Stiglitz among others.

Should be greatly interesting! Will keep you posted. Conference website is here.

The EU Core remains massively exposed to the PIIGS

This table from Credit Suisse has recently updated the bank exposure (by country) to peripheral sovereign debt that shows just how massively dependent each peripheral nation’s banking system is on its own government for capital and more importantly, how the core (France and Germany) remains massively exposed (in terms of Tier 1 Capital) to the PIIGS.

See Zero Hedge for the full story.


LTRO will boost TARGET2 imbalances

This is technical stuff for the devoted, but still interesting background on the interactions between the new long term refinancing facility to ECB and the balances in the Euro payment system TARGET2.


Greek default is inevitable

According to Zero Hedge, who quotes several rating agencies, Greek default is by now inevitable. According to Handelsblatt, the agreement with private creditors (Private Sector Initiative) seems to be insufficient. Greece will then try to make the “voluntary” write-down mandatory, which will technically imply a default, with all the unforeseen ramifications.

… the rating agencies have long warned a Greek default is now inevitable, and a CDS trigger will follow. The only thing that there is massive confusion over is whether and how this event will impact everyone else, and whether it will lead to an expulsion of Greece from the Euro zone.

We are certainly heading into uncharted territory!

Better for Greece to default

Marshall Auerback argues in this post on Naked Capitalism today that it will be better for Greece to default than to accept the deal on offer. He notes that Germany may indeed have come to the same conclusion:

Politically, of course, the Merkel government can’t actually come out and advocate a Greek default or, indeed, outright expulsion from the euro zone. Far more politically astute to promote fiscal austerity on top of yet more fiscal austerity, (even though that is certainly not winning Mrs. Merkel any popularity points in Greece), until the Greeks themselves scream “Uncle!” and default outright.

It would certainly be messy, but he notes that

With a super-cheap exchange rate, Greece would be a Mecca for retirement homes, research hospitals, trans-European liberal arts colleges, and maybe low-overhead software startups. Plus, a permanent home for the Olympics. It could live happily ever after, as Florida does, on the pension income of the elderly and the beer money of the young.

It is difficult to judge which way will prevail, but surely anything is be better than the current austerity program that, combined with a totally unrealistic exchange rate, will keep Greece on its knees for years to come.