Financial Stability News

News about financial stability, central banking and theory of money

Tag Archives: euro

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.

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.


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.

Next ECB LTRO at €1tn?

As the ECB is actively propping up European banks with its new liquidity operations, its balance sheet has increased by 40 % since last summer. This post by ZeroHedge discusses the prospects for further increases in February and shows how the ECB has overtaken the FED in balance sheet size. Quite remarkable, given their strong rhetoric against any form for bail-out.

Greece from bad to worse

According to this post from Naked Capitalism today, the situation in Greece is deteriorating rapidly. Unemployment is approaching 20 %, suicides are up over 20 % since 2009, and pharmacies are running out of medicines. The only solution around seem to be more budget cutting, with further devastating effects.

As GDP contracts, the IMF targets for the budget deficits seems more and more elusive, and there are suggestions that the only way out is for bigger haircuts on private creditors (i.e. banks and hedge funds, sitting with most of the Greek bonds). However, the current Private Sector Initiative (PSI) is running into headwind, and according to this story is about to break down (even based on the current proposal for haircuts).

At the same time, hedge funds are positioning  to reap profits either way: If no haircut, they will get their money back in full; with a haircut, they bet on cashing in on their CDS protection or force a 100% conversion. Latest estimate was for hedge funds to sit on 80 % of the Greek debt, after European banks unloaded it before Christmas.

So, is an exit from the Euro an option for Greece? Not according to London-based hedge fund firm Toscafund: “A Greek exit from the euro zone would be worse than catastrophic and could provoke greater social unrest, Zimbabwe-style inflation and a military coup”. But as someone noted in a comment: They must be heavily invested in Greek bonds to pull such a horrible story. But then, you never know.

With so much focus on the problems in the peripheral countries, S&P came with a welcome balancing news in the afternoon: A possible downgrade of France and Austria. Which shows that all the EU countries are in the soup together. Perhaps it is time to find ways to get out of it together as well. This alternative view is presented by Dr. Heiner Flassbeck from UNCTAD in thisYouTube video. If you have the time, watch it over the week-end and learn how Germany is the real villain in the story. Refreshingly different perspective to the current travails of Europe.

The pain in Spain

Zero Hedge has this story today about “the pain in Spain is plain for all to see”. Really sad to see how bad the situation is there (youth unemployment > 40 %).  And ironic that FT today reports that unemployment in Germany is at its lowest level for two decades, and should get lower as the euro weakens. Question now is for how long this can go on before the internal tensions in the EU becomes unbearable.

Willem Buiter on the Euro crisis

Citigroup’s  chief economist Willem Buiter has earlier written a host of academic papers on the deficiencies of the Euro system. Now in his new capacity at Citigroup he has some sobering thoughts about the Euro crisis and the future bleak prospects for the EU:

Slow growth or negative growth with high and/or rising unemployment is the new normal for the EA, the UK, Japan and the US, unless non-market ways of restructuring excessive sovereign, bank and household debt are pursued.

The question is if this new normalcy can prevail without riots in the streets? We will have to wait and see.