So, after reading up on the Cyprus deal from the Financial Times, the Economist, and Quartz, I think I have a pretty good idea of what happened. Tyler Cowen isn't happy with the deal, and I can see why, but I don't think that means the deal won't stabilize things for a spell. My four quick takes:
1) I've been pretty insistent that the most surprising thing about the aftermath to the 2008 financial crisis is how much global policy norms haven't changed. By and large the major economies are still rhetorically and substantively committed to trade liberalization, foreign direct investment, and a constrained role for the state in the private sector. The one exception? Capital controls. The earth has moved here, and the fact that this deal will require fair amounts of financial repression and cross-border controls is just the latest sign of this fact.
From a normative perspective, I can't say I'm too broken up about this. It's not that I'm a huge fan of capital controls or anything. In the various policy trilemmas or unholy trinities that Dani Rodrik and others talk about, however, it strikes me that unfettered capital mobility is the policy preference with the least upside. And Cyprus does seem to be the fifth iteration of the lesson that countries that live by large unregulated offshore finance will die by large unregulated offshore finance.
2) If the FT's Peter Siegel and Joshua Chaffin are correct, then the political backlash in Cyprus from this deal won't be that great:
In Nicosia, political leaders generally greeted the deal as painful but necessary.
The city streets were quiet and peaceful, with most businesses closed for a public holiday.
Even before the agreement was clinched, most Cypriots had come to grips with the fact that the offshore financial business sector that has powered the economy since the Turkish invasion in 1974 would be but a shell of its recent self.
And as the Economist explains, the current Cypriot reaction is based on the fact that the new deal is a damn sight better for them than the previous deal:
On March 16th Cyprus’s president, Nicos Anastasiades, desperate to protect Cyprus’s status as an offshore banking model for Russians, had decided to save the two biggest banks and thus to spread the pain thinly. He would have applied a hefty tax to all depositors: 9.9% for those too big to be covered by the EU-mandated €100,000 deposit guarantee, and 6.75% for the smaller depositors.
But after a week of brinkmanship—including protests by Cypriots, the extended closure of banks to avoid the outrush of money, a failed attempt by Cyprus to throw itself at Russia’s feet, an ultimatum by the European Central Bank and an eleventh-hour threat by Cyprus to leave the euro zone—a different decision was made: to apply the pain much more intensely, but on a smaller number of large depositors.
Which leads me to....
3) So much for Russia as a counterweight to the European Union. Cyprus tried to realign itself closer to Moscow, but it didn't take. Furthermore, the new deal really puts the screws on the large deposits of Russian investors that have parked their money in Nicosia. As Felix Salmon explains:
In the Europe vs Russia poker game, the Europeans have played the most aggressive move they can, essentially forcing Russian depositors to contribute maximally to the bailout against their will. If this is how the game ends, it’s an unambiguous loss for Russia, and a win for the EU.
The Financial Times makes a similar point:
One Moscow businessman blamed the harsher haircut on the Kremlin, which he accused of failing to protect Russia’s interests, “thereby allowing the Germans to bully Cyprus and thousands of Russian depositors”.
“As soon as the EU saw that Russia was not going to protect its citizens, the confiscation of Russian money in Cyprus was pushed by the EU. All that was necessary for Russia to do was to provide €2.5bn secured by Cyprus’s nationalised assets,” he said.
With Xi Jinping's visit to Moscow, there's been a lot of chatter about "rise of BRICS" and "Russia turns East" and "SCARY!! SCARY!!" Bear in mind, reading all of this, that Moscow couldn't budge the ostensibly enervated EU from its position on the EU member with the closest ties to Russia.
[Can't Russia just mess with the Europeans on energy?--ed. Um... no. Sure, they could try to do that, but the long-run implications of that move for Russian exports ain't good. To paraphrase an old Woody Allen joke, Russia might find its economic relationship with the European Union to be totally frustrating and irrational and crazy and absurd... but Russia needs the eggs.]
4) What I said about Cyrprus last week still seems to hold for this week. So I guess this means Cyprus now falls under the "good enough" global governance category, with the caveat that this involves eurozone officials, so "good enough" here is defined down to mean "managed not to wreck the rest of the global financial system."
Am I missing anything?
While I was on the road last week, I see that Greek elections managed to accomplish two things:
1) A requirement for yet more Greek elections; and
Sooo ... what happens then? The Financial Times has a useful article that asks the appropriate big questions while providing some useful information. Particularly interesting is the emerging belief that the eurozone now has erected the necessary firewalls to prevent contagion from Greece to the rest of the southern Med and Ireland:
[W]ith a new, permanent €500bn rescue fund backed by the strength of an international treaty with multiple tools to buy sovereign bonds on the open market and inject capital into eurozone banks, some officials believe the contagion could be contained -- much as it was after Athens finally defaulted on private bondholders last month.
"Two years ago a Greek exit would have been catastrophic on the scale of Lehman Brothers,” says a senior EU official involved in discussions about Greece’s future. “Even a year ago, it would have been extremely risky in terms of contagion and chain reaction in the banking system. Two years on, we’re better prepared."
The new eurozone firewall -- now backed with additional resources for the IMF -- is not the only reason some officials are becoming increasingly sanguine about losing Greece. Spain and Italy, they say, have taken huge steps to put their economic houses in order, enabling them to bounce back quickly if credit markets suddenly dry up and their banks wobble.
Still, uncertainty over how Europe’s banks would be affected has continued to be the primary concern.
Paul Krugman is somewhat more pessimistic. Sketching out the possible endgame, he posits that Spanish and Italian banks would experience massive capital flight, triggering the key decision faced by Germany:
4a. Germany has a choice. Accept huge indirect public claims on Italy and Spain, plus a drastic revision of strategy -- basically, to give Spain in particular any hope you need both guarantees on its debt to hold borrowing costs down and a higher eurozone inflation target to make relative price adjustment possible; or:
4b. End of the euro.
And we’re talking about months, not years, for this to play out.
Krugman has been predicting Greece's exit from the euro for some time now, but in this case I do think he's correct about the choice posed by Germany -- as yet more signals accrue about Merkel's declining political strength.
Now, actually, I suspect that Greece stays in the eurozone for longer than anyone suspects. That said, based on my two empirical observations during the past two years -- namely, eurogoggles and the Merkel Algorithm. Here is how I would game out the "Grexit" scenario:
1. Greece's departure is announced at the same time as an EU summit announces a boost to its new rescue fund and modest pro-growth German policies. Markets initially react to this news favorably.
2. Within 48 hours, negative news about the Spanish and Italian economies, combined with a second wave of stories revealing that the rescue fund isn't as big as anyone thought it was, rattles financial markets and triggers the behavior described by Krugman.
3. The ECB does nothing, calling on
MerkelEuropean political leaders to take "decisive action."
4. After a week or two of agnonizing non-action, Germany announces half-measures that end the immediate panic gut set up Spain for more stagnation and a new crisis in 2013.
Am I missing anything?
Yesterday, in commenting on the eurozone crisis, Barack Obama said the two words all political scientists hate to see:
"Europe is wealthy enough that there's no reason why they can't solve this problem," Obama told reporters at the White House.
"If they muster the political will, they have the capacity to settle markets down, make sure that they are acting responsibly and that governments like Italy are able to finance their debt." (emphasis added)
By and large, political scientists hate the concept of political will. As I've said numerous times on the blog, "political will" is usually tantamount to saying, "if only politicians would completely ignore short-term political incentives and do the right thing!" Or, to put a finer point on it, "if only politicians stopped acting like politicians!" Because we as a profession tend to focus on structural forces and immutable preferences, "leadership" as a variable often (though not always) falls by the wayside.
Looking at the latest EU summit/eurozone machinations, however, I'm beginning to wonder if we need to think about "first image" explanations for what just happened. As the Wall Street Journal, Felix Salmon, Financial Times, Paul Krugman, and Economist are all reporting, it was pretty friggin' disastrous. Salmon provides the most complete autopsy -- here's a snippet:
[A]nother half-baked solution is exactly what we got. Which means, I fear, that it is now, officially, too late to save the Eur ozone: the collapse of the entire edifice is now not a matter of if but rather of when.
For one thing, fracture is being built into today’s deal: rather than find something acceptable to all 27 members of the European Union, the deal being done is getting negotiated only between the 17 members of the Euro zone. Where does that leave EU members like Britain which don’t use the euro? Out in the cold, with no leverage. If the UK doesn’t want to help save the euro — and, by all accounts, it doesn’t — then that in and of itself makes the task much more difficult.
But that’s just the beginning of the failures we’re seeing from European leaders right now. It seems that German chancellor Angela Merkel is insisting on a fully-fledged treaty change — something there simply isn’t time for, and which the electorates of nearly all European countries would dismiss out of hand. Europe, whatever its other faults, is still a democracy, and it’s clear that any deal is going to be hugely unpopular among most of Europe’s population. There’s simply no chance that a new treaty will get the unanimous ratification it needs, and in the mean time the EU’s crisis-management tools are just not up to dealing with the magnitude of the current crisis.
The fundamental problem is that there isn’t enough money to go around. The current bailout fund, the European Financial Stability Facility, is barely big enough to cope with Greece; it doesn’t have a chance of being able to bail out a big economy like Italy or Spain. So it needs to beef up: it needs to be able to borrow money from the one entity which is actually capable of printing money, the European Central Bank.
But the ECB’s president, Mario Draghi, has made it clear that’s not going to happen. Draghi is nominally Italian but in reality one of the stateless European technocratic elite: a former vice chairman and managing director of Goldman Sachs, he’s perfectly comfortable delivering Italy the bad news that he’s not going to lend her the money she needs. He’s very reluctant to lend it directly, he won’t lend it to the EFSF, and he won’t lend it to the IMF. Draghi has his instructions, and he’s sticking to them — even if doing so means the end of the euro zone as we know it.
So, what explains this mess -- the inexorable structural problems of the European Union, or the lack of political leadership? At this point, I'm genuinely uncertain. For example, the facile explanation for British Prime Minister David Cameron's rejection of an EU treaty is catering to his domestic interests -- namely the British financial sector. Then, however, we get to this bit from the Economist:
After much studied vagueness on his part about Britain's objectives, Mr Cameron's demand came down to a protocol that would ensure Britain would be given a veto on financial-services regulation (see PDF copy here. The British government has become convinced that the European Commission, usually a bastion of liberalism in Europe, has been issuing regulations hostile to the City of London under the influence of its French single-market commissioner, Michel Barnier. And yet strangely, given the accusation that Brussels was taking aim at the heart of the British economy, almost all of the new rules issued so far have been passed with British approval (albeit after much bitter backroom fighting). Tactically, too, it seemed odd to make a stand in defence of the financiers that politicians, both in Britain and across the rest of European, prefer to denounce....
Britain may assume it will benefit from extra business for the City, should the euro zone ever pass a financial-transaction tax. But what if the new club starts imposing financial regulations among the 17 euro-zone members, or the 23 members of the euro-plus pact? That could begin to force euro-denominated transactions into the euro zone, say Paris or Frankfurt. Britain would, surely, have had more influence had the countries of the euro zone remained under an EU-wide system.
As for Merkel, well, my take on her leadership style has been documented already. She's dealing with an opposition that is castigating her for not taking swifter and more drastic action to resolve the eurocrisis. In response, she's pushing for changes that will take months, if ever, to accomplish -- and, if they are accomplished, have no guarantee of actually solving the problem. It doesn't seem like the eurozone has that time.
As for Draghi, well, one could attribute his range of half-hearted measures to his excessively cautious leadership -- after all the ECB is an ostensibly independent institution, so presumably Dragh has the greatest amount of autonomy. It's not that simple, however -- Draghi wouldn't have been selected as the new ECB head unless he demonstrated the kind of policy traits that made him acceptable to Germany in the first place. Oddly enough, although Draghi currently has the most freedom of action, the structures that ensured he would become the new ECB head ensured he would be the least likely person to exploit that freedom.
So, stepping back, there appears to be a role for the quality of political leadership as an explanatory factor for the current eurozone crisis. Properly defining that role, however, is beyond the capacity of this blog post.
What do you think?
So the eurozone crisis is metastasizing from really bad to even worse. Over at The New Yorker, James Surowiecki blogs that what's so frustrating about the situation is that the impediments to a solution are easily surmountable:
[W]hat’s easy to miss, amid the market tremors and the political brinksmanship, is that this is that rarest of problems—one that you really can solve just by throwing money at it....
The frustrating thing about all this is that there is a ready-made solution. If the European Central Bank were to commit publicly to backstopping Italian and Spanish debt, by buying as many of their bonds as needed, the worries about default would recede and interest rates would fall. This wouldn’t cure the weakness of the Italian economy or eliminate the hangover from the housing bubble in Spain, but it would avert a Lehman-style meltdown, buy time for economic reforms to work, and let these countries avoid the kind of over-the-top austerity measures that will worsen the debt crisis by killing any prospect of economic growth....
So the problem is not that the E.C.B. can’t act but that it won’t. The obstacles are ideological and, you might say, psychological.
As someone who agrees with Surowiecki on the economic diagnosis, the political scientist in me is forced to call a flagrant foul on this kind of analysis. In labeling the problem as one of "ideology" or "psychology," Surowiecki is explicitly arguing that it's just so absurd that the correct policy is not being pursued. If only someone could talk some sense into the key policymakers, then -- snap! -- the crisis would be resolved.
As someone who studies this stuff for a living, simply saying that political ideology, interest, or institutions can be easily changed borders on the comical. Ideas, interests and institutions are the bread and butter of politics, and all of them are far stickier than economists would like you to believe. There's more than seven decades of entrenched thinking that would require the Bundesbank and the ECB to alter their approach. Crisis or no crisis, that's not just easily dismissed.
Furthermore, looking at the Franco-German crisis bargaining, any actual deal to bolster EFSF resources, empower the ECB, and/or create something approximating a fiscal union would require that Southern Europe agree to remake their domestic economies to more closely resemble the German model. This has always been Merkel's bargain: she's been willing to cede greater power to the EU provided that EU policy preferences looks more like Germany. This makes sense for Germany, but the kind of wrenching changes and adjustments that will be asked of Spain and Italy are massive. The fact that Berlin -- rather than Brussels -- is the source of this diktat will add a fun new level of political difficulties as well.
A deal could be reached, but no one should be kidding themselves -- it is fantastically difficult, and saying that just "politics" or "ideology" or "psychology" is getting in the way doesn't make it any easier.
Hey, remember when about ten days ago I blogged that things were getting so bad in Europe that it was legitimate to bring up the 1930's? What's happened since that seemingly hyperbolic warning?
As Felix Salmon blogged earlier this week, the European banking system is headed towards a full-blown liquidity crisis. Yields on Spanish and Italian debt are hovering around the 7% mark, which was the tipping point that forced Greece, Ireland and Portugal to seek assistance from the European Financial Stability Facility and the IMF. Multiple European countries, including France, have had difficulty completing bond auctions this week.
So it would seem that the European Central Bank needs to do something. The New York Times, Wall Street Journal, and Financial Times all have lead stories today pointing out the enormous pressures that are being put on the European Central Bank this week. We'll excerpt the non-gated NYT story to set things up:
Only the fiercely conservative stewards of the European Central Bank have the firepower to intervene aggressively in the markets with essentially unlimited resources. But the bank itself, and its most important member state, Germany, have steadfastly resisted letting it take up the mantle of lender of last resort....
At issue is whether the bank has the will — or the legal foundation — to become a European version of the Federal Reserve in the United States, with a license to print money in whatever quantity it considers necessary to ensure the smooth functioning of markets and, if needed, to essentially bail out countries that are members of the euro zone.
Traditionally, and according to its charter, the European bank has viewed its role in much narrower terms, as a guardian of the value of the euro with a mission to prevent inflation. But as market unease has spread over the past two years, critics say the bank’s obsession with what they say is a phantom threat of inflation has stifled growth and helped bring the euro zone to the edge of a financial precipice.
With events threatening to spin out of control, the burden now rests on Mario Draghi, an inflation fighter in the president’s job at the bank barely two weeks who surprised many economists by immediately cutting interest rates a quarter point.
This morning, however, in his first speech as the head of the ECB, Draghi pivoted and redirected the pressure back at the politicial stewards of the EU:
National economic policies are equally responsible for restoring and maintaining financial stability. Solid public finances and structural reforms – which lay the basis for competitiveness, sustainable growth and job creation – are two of the essential elements.
But in the euro area there is a third essential element for financial stability and that must be rooted in a much more robust economic governance of the union going forward. In the first place now, it implies the urgent implementation of the European Council and Summit decisions. We are more than one and a half years after the summit that launched the EFSF as part of a financial support package amounting to 750 billion euros or one trillion dollars; we are four months after the summit that decided to make the full EFSF guarantee volume available; and we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five and that declared the EFSF would be fully operational and that all its tools will be used in an effective way to ensure financial stability in the euro area. Where is the implementation of these long-standing decisions?
The truly scary thing is that, given the state of the Italian and Spanish bond markets, even the full EFSF won't be enough to calm markets down.
And so the pressure gets redirected back to Germany, as the most powerful actor in the ECB and EU. As Matthias Matthijs and Mark Blyth explain in Foreign Affairs, however, Germany has not been reading its Charles Kindleberger:
In order to guarantee the strength of any international economic system, Kindleberger explained, a stabilizer -- only one stabilizer -- needs to provide five public goods: a market for distress goods (goods that cannot find a buyer), countercyclical long-term lending, stable exchange rates, macroeconomic policy coordination, and real lending of last resort during financial crises. The United States did not supply these things in the 1930s. Germany fails the test on all five items today.
First, rather than providing peripheral countries with a market for their distress goods, the Germans have been enthusiastically selling their manufactured goods to the periphery. According to Eurostat, Germany's trade surplus with the rest of the EU grew from 46.4 billion euro in 2000 to 126.5 billion in 2007. The evolution of Germany's bilateral trade surpluses with the Mediterranean countries is especially revealing. Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany saw its final total consumption fall from 78.5 percent of GDP to 74.5 percent. Its gross savings rate increased from less than 19 percent of GDP to almost 26 percent over the same period.
Second, instead of countercyclical lending, German lending to the eurozone has been pro-cyclical. Indirectly (through buying bonds) and directly (by spreading its exchange rate through the euro), the country has basically given the periphery the money to buy its goods. During the economic boom of 2003-2008, Germany extended credit on a massive scale to the eurozone's Mediterranean countries. Frankfurt did quite well for itself. "European Financial Linkages," a recent IMF working paper, reveals that in 2008, Germany was one of the two biggest net creditors within the eurozone (after France). Its positive positions were exact mirrors of Portugal, Greece, Italy, and Spain's negative ones. Of course, as the financial crisis began to escalate in 2009, Germany abruptly closed its wallet. Now Europe's periphery needs long-term loans more than ever, but Germany's enthusiasm for extending credit seems to have collapsed.
And what about the third public good, stable exchange rates? By definition, the euro gives the countries that choose to join it a common external float, the credibility that comes with banking in a potential global reserve asset, and the credit rating of its strongest member. This is both true and where the problems begin. At the core of the eurozone lies a belief that, if countries adhere to a set of rules about how much debt, deficit, and inflation they can have, their economies will converge, and the same exchange rate will work for all members. This is true in theory, but only so long as countries obey the rules. And, despite being the author of many of those rules, Germany showed a singular lack of leadership and responsibility when it came to following them. When it broke the Stability and Growth Pact (SGP) in 2003, it sent the signal to the smaller countries that fiscal profligacy would go unpunished. The result was heightened public sector borrowing and increased public spending. Germany's enthusiastic lending to the periphery only exacerbated the problem.
Fourth, economic health requires the stabilizer to coordinate macroeconomic policy within the system. In this domain, Germany failed spectacularly, by insisting that the rest of the world follow its peculiar ordoliberal economic philosophy of export-oriented growth. By ignoring long-established ideas such as the Keynesian "paradox of thrift" or the "fallacy of composition," Germany is advocating a serious dose of austerity in the European periphery without even a hint of offsetting those negative economic effects with stimulus or inflationary policies at home. German growth, after all, was partially fueled by demand in Southern Europe (made possible by excess German savings). By the iron logic of the balance of payments, one country's exports are another country's imports and one country's capital inflows are another's capital outflows. So, the eurozone as a whole cannot become more like Germany. Germany could only be like Germany because the others countries were not. Insisting on ordoliberal convergence is guaranteed to produce economic instability, not stability.
Finally, Kindleberger would want Germany -- or, rather, the ECB, which is dominated by Germany -- to act as a lender of last resort by providing liquidity during the current crisis. Germany instead insisted on IMF conditionality for the bailout countries and on severe fiscal austerity measures in exchange for limited liquidity, thus failing Kindleberger's final test. The most obvious example is German obstinacy against letting the ECB play the role that the Federal Reserve played in the United States in 2008 and 2009. By lending heavily, the Fed was able to arrest the United States' slide into despair. Only a couple of days ago, Jens Weidmann, the president of Germany's powerful Bundesbank, flat-out rejected the idea of using the ECB as "lender of last resort" for governments, warning that such steps "would add to instability by violating European law." It is hard to see how yet one more violation of European code will add significantly to the already horrendous levels of instability, when brushing democracy aside is considered good for the euro.
It looks as if there's a plan in the works for the ECB to do a legal end-around by loaning money to the IMF and then having the Fund loan to the GIIPS economies. If that happens, however, it won't be announced until next month. And the way credit markets are playing out right now, I'm not sure the eurozone has that much time.
Now is usually the point in the post at which the instinct to provide some sweeping narrative about the state of the eurozone -- a la David Brooks -- is very compelling. What's the point, however? The eurozone is in contagion mode right now, which means it doesn't matter which countries were virtuous and which countries weren't during the last decade of binge borrowing. They're all on the same sinking ship, and the Merkel Algorithm seems to be playing out again.
Developing.... in a way that truly scares the living crap out of me.
Hey, remember my last bloggingheads, when I went to the 1930s analogy to describe the current problems in the global political economy? Well, that was a few days ago, and my, how things have changed -- to make that 1930's analogy even more powerful. The eurogoggles metahor may be coming to an end -- because the situation is so dire that even the cheeriest summit won't alter perceptions in financial markets.
After a week of gyrating europolitics on the Greek bailout and meaningless G-20 summitry, markets and media will be focused on Italy this week. This matters -- for both Europe and the world, Greece is a diverting sideshow compared to a major financial collaspse in Italy. The pressure on Italian PM Sylvio Berlusconi to resign have gotten so loud that he had to take to his Facebook page to say, "The rumors of my resignation are groundless." New rule of thumb: any time a politician follows Sarah Palin's lead, there's going to be a problem.
The Daily Telegraph's Ambrose Evans-Pritchard explains the eurofarce that is currently playing out:
As of late Friday, the yield spread on Italian 10-year bonds over German Bunds was a post-EMU record of 458 basis points. This is dangerously close to the point where cascade-selling begins and matters spiral out of control.
The European Central Bank has so far bought time by holding a series of retreating lines but either it has reached its intervention limits after accumulating nearly €80bn of Italian debt, or it is holding fire to force Silvio Berlusconi to resign – if so, a foolish game.
The ECB’s hands are tied. A German veto and EU treaty constraints stop it intervening with overwhelming force as a genuine lender of last resort. The bank is itself at risk of massive over-extension without an EU treasury and single sovereign entity to back it up.
This lack of a back-stop guarantor is an unforgivable failing in the institutional structure of monetary union....
The spreads on EFSF 5-year bonds have already tripled to 151 above German debt, leaving Japan and other early buyers nursing a big loss. The fund suffered a failed auction last week, cutting the issue from €5bn to €3bn on lack of demand.
Gary Jenkins from Evolution Securities said the “frightening” development is that the EFSF is itself being shut out of the capital markets. “If it continues to perform like that then the bailout fund might need a bail out,” he said.
Europe’s attempt to widen the creditor net by drawing in the world’s reserve states evoked near universal scorn in Cannes and a damning put-down by Brazil’s Dilma Rousseff. “I have not the slightest intention of contributing directly to the EFSF; if they are not willing to do it, why should I?”
Europe is resorting to such antics because its richer states – above all Germany -- still refuse to face up to the shattering implications of a currency that they themselves created, and ran destructively by flooding the vulnerable half of monetary union with cheap capital.
Simon Johnson is, er.... less than optimistic about these developments:
MIT Sloan School of Management professor Simon Johnson didn’t equivocate on the perils of the current global economic environment. “We have built a dangerous financial system in the United States and Europe,” said the former chief economist at the International Monetary Fund. “We must step back and reform the system.”
Professor Johnson cited alarming parallels with October 1931, when “people thought the worst was behind them, but the smart people were wrong and instead the crisis just broadened.” (emphasis added)
I've said it before and I'll say it again: any time the global economy is counting on Sylvio Berlusconi to do the right thing is not a good time.
My latest Bloggingheads diavlog is with NSN's Heather Hurlburt. We discuss Greece, Palestinian recognition, and the state of the foreign policy debate among the GOP 2012 candidates.
Given those topics, be warned: I might have been liberal in my use of profanity in the diavlog below.
[NOTE: The following is a public service message from the hard-working team at FP Magazine to the policy wonks and market analysts inside the Beltway--ed.]
Has this happened to you in 2011? You're stressed out from a long day of reading/writing/number crunching/contingency planning and you're looking to unwind and enjoy yourself. Then you see the latest announcement of a European summit meeting and proclamations of a breakthrough deal that will resolve the plight of the Greek economy, the fragile state of European banks, and the perilous credit rating of southern Mediterranean countries.
As you see stocks rise, credit markets soar, and the euro appreciate, the euro-optimism becomes intoxicating. Pretty soon, the euro-giddiness starts to get to you. You start to tweet things like, "the corner has been turned," post on Facebook that, "it's time to Europarty!!" and talk up the metric system again. Nicolas Sarkozy looks like the brilliant progenitor of grand ideas and grand summits, and Angela Merkel is the shrewd politician who made the bankers blink.
After a few hours or so of this, all the problems in the world look eminently solvable. In your head, you've devised brilliant, intricate plans that solve the Israeli/Palestinian peace process, the India/Pakistan enduring rivalry, and the BCS college football rankings. Before you know it, you've organized and presented a talk in which you provide the Mother of All Powerpoint Presentations to Solving Global Problems, charging the entire, catered affair to the Brookings Institution.
Beware!! You are a victim of Eurogoggles. As the Economist will observe, "in the light of day, the holes in the rescue plan are plain to see." Both AFP and Bloomberg will point out that the policy euphoria has faded the next day. It will turn out that details are left unexplained. The size of the bailout package, which looked massive the night before, will prove to be a limp, unsatisfying half-measure the next day. The bank rescue fund and the Greek deal remain incomplete. All you'll be left with is that vague sense of self-loathing at having been suckered again, and a strem of angry voice-mail messages from a DC think tank. The walk of shame to your water-cooler the next day, in which co-workers mock your tweets of the night before, will be humiliating.
Eurogoggles -- don't let it happen to you or your colleagues.
[NOTE: the following reads much better if you read it using the voice of Rod Serling!--ed.]
There's a subtle art to reading broadsheet American journalism. Reporters strain for objectivity, and in the process, strain to avoid anything that smacks of the prejorative. If you squint real hard at the text, however, you can occasionally detect moments when the reporter is dying, just dying, to state their blunt opinion on the matter at hand.
I bring this up because Liz Alderman of the New York Times, in her story on the possibility of a big deal in Europe to enlarge the European Financial Stability Facility, appears to be ever-so-subtly banging her head against her keyboard:
The rally in American stock markets was set off by a report late Tuesday on the Web site of The Guardian, a British newspaper, that France and Germany had agreed to increase the size of the rescue fund — the European Financial Stability Facility — to as much as 2 trillion euros to contain the crisis and backstop Europe’s banks. But almost as soon as those hopes soared, European officials quickly brought them back to earth, with denials flooding forth from Brussels, Paris and Berlin.
This latest round of rumors and rebuttals about a European solution was a repeat of earlier situations. Such episodes have played out several times since the debt crisis intensified this year. Most recently, investors have been pegging hopes on a meeting of Europe’s leaders set for this coming Sunday in Brussels, anticipating that a comprehensive solution to the debt crisis might be unveiled (emphasis added).
It would appear that Ms. Alderman has discovered that there is a fifth dimension of reporting, beyond that which is known to ordinary economic journalism. It is a dimension as vast as developed country sovereign debt and as timeless as currency itself. It is the middle ground between austerity and stimulus, between national sovereignty and supranational authority, and it lies between the pit of man's fears and the summit of his knowledge. This is the dimension of European political economy. It is an area which we call... the eurozone.
Your humble blogger is near the capital of
Waterworld Pennsylvania at the moment and all conferenced out. Regular blogging will resume after some sleep.
In the meanwhile, however, please check out FP's latest Deep Dive on the future of currencies. I have a contribution on the dollar's future as the world's reserve currency. It's depressing to note that the thing I like best about it is it's title -- which, of course, someone else at FP created.
When I woke up this morning and scanned the headlines, I knew what I was going to blog about -- the stories in the press about how the European Union was, after much hemming and hawing, beginning to move towards a closer fiscal union. I was then going to not-so-humblebrag about my own prediction that this would indeed happen. This was all going to be a great set-up to the last-minute reverse course -- i.e., this Financial Times op-ed by German Finance Minister Wolfgang Schäuble in which he declared his "unease when some politicians and economists call on the eurozone to take a sudden leap into fiscal union and joint liability."
Here's the thing, however -- if you read my eurozone blog post from this past February, you'll see that almost the exact same dynamic played itself out six months ago. This time the Germans are pre-emptively balking before the peripheral countries can balk in response to German calls for austerity... but you get the general idea.
So... in the interest of avoiding IPE déjà vu for readers, I hereby promise not to blog about this again until something actually happens beyond news reports of preliminary steps-towards-fiscal-centralization-followed-by-political-pushback. I will simply observe that Ryan Avent's basic question will be the one to ask going forward:
Europe's leaders know what they'll have to do to stabilise the situation. The key question now is: what is the set of euro-zone countries consistent with the political will to save the currency area? Europeans in Europe's core will share a currency with "outsider" countries, but they won't fight to save them. So who are the outsiders? Who has to go to convince core voters that the cost of saving the euro zone is worth bearing?....
With which countries do core voters sufficiently identify themselves as to make a large, ongoing commitment acceptable? Answer that, and you probably have a good idea how this mess will end.
Readers are requested to state which countries get the Euroboot in the comments below.
Your humble blogger has not been
contributing to the Osama-a-thon here at FP blogging all that much, because he was busy being a moosehead attending the 2011 Estoril Conference. Many Important topics were covered at this conference, including:
1) The eurozone crisis;
2) The global governance crisis;
3) The crisis in the Middle East;
4) Other global security challenges;
5) The life and times of Larry King.
It was that kind of conclave.
Actually, that really doesn't do it justice. Here's a link to the opening video. Even that doesn't do it justice -- the opening ceremonies featured a sporano suspended 50 feet in the air, a gospel choir, a drum corps, and what I can only assume are the backup dancers for Lady Gaga's music videos.
For a rundown of what the Big Cheeses said at the conference, check out my Twitter feed. The major substantive takeaway I got from the conference is that Portugal would like to do a serious hurt dance on Fitch, Moody's, and Standard & Poor. Half of the conference presenters were Portuguese, and most of the audience was as well. Here is a sampling of the questions the Portuguese asked anyone talking about anything remotely related to economics:
"Why do the bond rating agencies still influence markets after they failed so badly in 2008?"
"Shouldn't the bond-rating agencies be punished for their malfeasance last decade?"
"Aren't the bond-rating agencies to blame for everything bad that has happened since 2008?"
"What do you think of the idea of creating a European standard-ratings agency?"
"Say, has anyone thought about taking the heads of the bond-rating agencies and putting them in a duffel bag?"
OK, I made that last one up, but not the others.
Obviously, the Portuguese have very good reasons to be stressed out. And the bond-rating agencies deserrve an awful amount of flack. Still, the idea that they -- and they alone -- triggered both the 2008 financial crisis and Europe's sovereign debt crisis is absurd. They are far more the symptom than the cause of the crisis.
More blogging after
my eyes adjust to not seeing Lady Gaga's backup dancers everywhere I turn the weekend.
Your humble blogger is taking a brief break from teaching and
zombie book-whoring publicizing recently-released research to start work on new research. This requires me to be in Europe for the week. So, for some local color, it's worth asking how things are in the land of the euro, the eurozone, and the eurocracy.
Last year, during the epth of the Greek crisis, I argued that, "When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project."
Last week, it seemed that France and Germany had come to the same conclusion. The Guardian's John Palmer provided a cogent summary on the deal that was being negotiated at Friday's European leaders' summit:
Angela Merkel, Nicolas Sarkozy and the other EU chiefs will sound out the parameters of a breakthrough deal which could take the euro area – at the heart of the EU – towards a de facto economic government. The deal will offer massive financial support for countries under the currency market cosh in return for governments accepting that national economic policy in future will first have to secure the broad approval of the rest of the euro area.
[You must be feeling sooooo vindicated right now!!--ed.] Oh, you betcha, got this one right on the money... wait, what's this Financial Times story by Peggy Hollinger and Peter Spiegel saying?
New cracks emerged at a summit of European leaders on Friday, as the prime ministers of several countries raised strong objections to a Franco-German plan that would commit all 17 users of the single currency to co-ordinating their economic policies....
[T]heir initiative triggered a backlash from other European Union leaders anxious to defend their national economic, labour and welfare policies.
In the summit’s concluding communiqué, European leaders also appeared to back off a commitment to give the eurozone’s €440bn bail-out fund new tools to help shore up struggling “peripheral” economies.
An initial version of the conclusions committed the EU to giving the fund more “flexibility” – a code word for new authorities such as buying sovereign bonds of struggling countries on the open market. After extensive debate, that language was taken out, however, and now only binds members to give the fund “necessary effectiveness”, a clear watering-down.
What happened? The Wall Street Journal's Irwin Stelzer explains:
Most countries profess broad agreement of the need for reforms along the lines Germany is demanding. Yet when confronted with the German-French package—the French have always favored some form of centralized economic management of the EU, including strict regulation and heavy taxation of the financial services sector that is centered in Britain—they balked.
Austria, with one of the lowest effective retirement ages in the euro zone, won't go along with an increase in the retirement age. Portugal won't buy into the end of wage indexation with inflation because it wants to offer a sop to public-sector workers whose wages have been cut by 5%. Neither will Belgium, Spain and Luxembourg. All in all, almost 20 countries at Friday's EU summit objected to the Germanization of their countries for one reason or another. So Germany refused to sign on to an increase in the size of the euro-zone bailout fund. "It was truly a surreal summit," commented Yves Leterme, Belgium's prime minister.
Stezler goes on to predict that there will be yet more Euro-muddling as a result of this deadlock. I'm sticking to my original prediction, however. As much as the European periphery dislikes the proposed grand bargain, some form of it will likely be accepted because the alternative outcomes seem even more unappetizing.
Europe's debt crisis is not going away anytime soon, which means that the crisis over European monetary union won't be going away either. As it turns out, the European Commission is on this, proposing things like "excessive deficit procedures" and the like.
Will this work? Well … let's go to the Economist's explanation for why the previous set of rules failed to prevent this from happening:
The “stability and growth pact” was supposed to limit each country’s budget deficit to 3% of gdp and public debt to 60% of GDP. It failed, in part because France and Germany refused to abide by it -- and even rewrote the rules when they breached the deficit limit.
In contrast, the problems that arose because different economies responded differently to the zone’s common monetary policy were underestimated. The sudden drop in real interest rates on joining the euro in Greece, Ireland and Spain fuelled huge spending booms. (Portugal had enjoyed its growth spurt in the late 1990s in anticipation of euro membership.) Rampant domestic demand pushed up unit-wage costs relative to those in the rest of the euro area, notably in Germany, hurting export competitiveness and producing big current-account deficits.
The euro allowed these internal imbalances to grow unchecked and now stands in the way of a speedy adjustment, because euro-area countries whose wages are out of whack with their peers’ cannot devalue.
So, what is to be done? In the past, European integrationists have been quite adroit at using periods of crisis and malaise to jumpstart further integration efforts. It's possible that this could happen again.
In this case, however, integration efforts are going to be very costly. The Economist explains:
[T]here are three ways for a country to restore competitiveness: devaluation (which reduces wages relative to those in other exporting countries), wage cuts or higher productivity. In the euro area, the first option is out. The other two rely on easing job-market rules so that pay matches workers’ efficiency more closely, and workers can move freely from dying industries and firms to growing ones.
I'm thinking unions will
develop breakout nuclear capabilities aren't going to be big fans of that second option. The third option seems like the ultimate political dream, except it involves eliminating regulations that likely benefit a lot of entrenched interest groups.
Another possibility is greater fiscal centralization. The Economist is not keen on this, but that's besides the point -- as Mary Sarotte points out at Foreign Affairs, there's a Very Important Country that's not going to go along with the move:
The challenge now is governance reform, not expulsion of member states. Reverting to national currencies would drive the values of reissued southern currencies into the ground and the deutsche mark into the sky, thereby undermining Germany's export competitiveness and job market, to say nothing of the collateral damage to the European Union and the single market. The eurozone crisis should not signal the end of the euro but rather the start of a long-overdue overhaul. The idea of a European Monetary Fund, endorsed by Wolfgang Schäuble (an elder statesman from the days of German unification and now a subordinate of Merkel), faded after Merkel dismissed it but deserves broader support. Germany also needs to reconsider its calls for painful fiscal discipline on the part of the weakest countries until their economies regain footing. Ideally, but perhaps not realistically, Merkel should return to previous German form and spearhead a revision of the Maastricht Treaty, leading a fresh effort to do for political union what Kohl and Mitterrand did for monetary union.
The unlikelihood of such a move exemplifies a fundamental problem within the whole European Union: there exists a built-in tension between the lofty goals of integration and member states' collective unpreparedness to think through the consequences of their ambitious project. The great achievement of the past has been to reconcile these contradictory impulses by focusing on practical agreements. It is time to do so once again and realize that the necessary consequence of monetary union is greater political union.
In some ways, what happens from here on out will be an excellent test of whether economic interdependence really alters national incentives. As I blogged a few months ago, "When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project."
Of course, the European have spent the past few months muddling through some more. Given current trends, however, that option is going to disappear sooner rather than later.
Last week I predicted that, contrary to expectaions, the Greek crisis would force the European Union to abandon their "muddling through" approach to
security regulation volcanoes everything under the sun economic policy and start some serious centralization. Not that this was a great option -- but all the other options were even less palatable.
So, did the weekend package confirm my hunch? Well, Anne Applebaum seems to think so:
Though the European Union has always required a partial surrender of sovereignty from its member states, Greece no longer has much sovereignty at all. IMF agreements also impose conditions, but the language is somewhat different: The indebted country requests help, the IMF responds. In this case, the EU has decided what Greece "shall" do. I don't believe anybody knew that the EU had so much power over its member states, least of all the Greeks.
Well, yes, but on the overall question of the centralization of eurozone decision-making, I think the weekend's events actually prove me wrong. Indeed, this New York Times story by Steven Erlanger, Katrin Bennhold, and David Sanger suggests that the member states have managed to come up with yet a new way to muddle through without arrogating power to the Commission:
Germany was insisting on a solution that involved bilateral loans from European member states, similar to the much smaller Greek bailout agreed to a week earlier. But countries like Italy and Spain feared that they would be unable to raise the amounts required and lobbied for loan guarantees on funds raised by the European Commission.
As the evening unfolded, Germany, Britain and the Netherlands all opposed the commission’s proposal to raise money on capital markets guaranteed by member states. The British and Dutch said the proposal was tantamount to giving a “blank check” to the European Union’s governing commission, according to a European diplomat who spoke on condition of anonymity.
Near midnight Sunday night, the talks appeared deadlocked, these participants said. “The deal is exploding,” read the text message of one French official to Paris, where Mr. Sarkozy was demanding regular updates and was pushing for a bigger agreement.
Then came the deal-making idea — put together, according to different officials from different countries, by the French, the Italians, the Dutch and a crucial German banker.
Axel Weber, the president of the conservative Bundesbank, who is favored to succeed Jean-Claude Trichet as the next president of the European Central Bank, suggested a mechanism for Europewide loan guarantees that finally won support from a reluctant German government during a midnight call, participants said.
The idea was for a new mechanism euphemistically called “a special purpose vehicle” — essentially eurobonds created by intergovernmental agreement among euro zone countries. That vehicle, supposedly to last only three years, would raise up to 440 billion euros on the markets with loans and loan guarantees, depending on the need.
The Germans, together with other northern Europeans like the Dutch, British and Austrians, insisted that the European Commission not control the vehicle but only manage it — in conjunction, as with the Greek deal, with the International Monetary Fund. The fund would provide discipline, as well as roughly one euro for every two from Europe.
The “special purpose vehicle” finally broke the French-German deadlock.
[F]or all the excitement about the scale of the effort, it is important to remember that the core fund does not now exist. The fund, known as a special purpose vehicle, would raise money by issuing debt and making loans to support ailing economies. The European countries would guarantee that fund.
So the package is merely a commitment for the vehicle to borrow money if a large economy like Spain, which represents 12 percent of the output in the euro zone, asks for assistance. The International Monetary Fund is pledging 250 billion euros to support the effort. Sixty billion euros under an existing lending program pushes the total to near $1 trillion.
The fund is therefore more a theoretical construct than the Troubled Asset Relief Program that was created in the United States, and that is where things get tricky.
By definition, if Spain came to a point where it could no longer finance itself, interest rates would be on the rise. The several hundred billion euros for the fund would not only come at a high cost, but would bring additional pain to already indebted countries like Portugal, France, Italy and the United Kingdom, which back the special purpose entity, thus compounding the region’s debt woes.
So, in other words, because Germany and others don't want to transfer either real power or real ability to borrow to the European Commission, the result is a jerry-rigged bailout fund that has some disturbing dynamics if things go further south.
We'll see how the markets respond in the coming days and months. For everyone's sake, I hope I'm wrong and the EU can muddle through. But my fear is that this strategy is not going to be viable for that much longer.
So, the question of the day is, will bond markets feel suitably shocked and awed by the eurozone's decision to throw more than $950 billion at the Greece problem in order to prevent the spread of contagion?
For some reason, I can't get this scene from Dirty Harry out of my head when I think about the answer. To paraphrase it for our purposes, wouldn't this whole drama be easier if some eurozone finance minister could confront bond traders with the following speech:
I know what you're thinking. Is this my last rescue package, or do I have another source of credit in reserve? Well, to tell the truth, in all this excitement I kinda lost track myself. But being this is a €720bn rescue package, the most powerful one in the world, and would wipe away any short position you've taken in the past week, you've got to ask yourself one question. 'Do I feel lucky?' Well do you, punk?"
The thing is, Dirty Harry is a lot more convincing than Angela Merkel.
Following up on my dollar post from earlier this week, I see that Paul Krugman is talking a related issue in his New York Times column today -- the refusal of the renminbi to depreciate against the dollar:
Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.
Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.
But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.
Krugman then goes on to excoriate the U.S. Treasury department for not upbraiding the Chinese more on this.
Fair enough, but the thing is, the United States is not the country that's hurt the most by this tactic. It's the rest of the world -- particularly Europe and the Pacific Rim -- that are getting royally screwed by China's policy. These countries are seeing their currencies appreciating against both the dollar and the renminbi, which means their products are less competitive in the U.S. market compared to domestic production and Chinese exports.
This leads to the title of this post. Krugman presumes that the U.S. has the strongest incentive to talk to China about this issue. If one thinks of the U.S. acting as the hegemon, that's possibly true. As a matter of direct economic interest, however, why haven't the Europeans and East Asians been screaming bloody murder about this? China's policies are forcing them to take actions they don't want to take -- so why aren't they complaining more loudly about this?
It's been fashionable as of late to predict the end of the dollar's hegemony as a reserve currency. And, to be sure, the U.S. performance in recent years does not recommend the dollar as a great store of value.
World politics is a relarive game, however, so while the dollar might have its problems, what are the alternatives? China might have its fiscal house in order, but the renminbi is not fully convertible. The yen is appreciating, but Japan's economy is too small (and its growth opportunities are not exactly robust).
The only viable alternative is the euro. But as Landon Thomas Jr. story in the New York Times suggests, that currency's odd political status is creating economic fissures within the Eurozone. The key paragraph:
For some of the countries on the periphery of the 16-member euro currency zone — Greece, Ireland, Italy, Portugal and Spain — this debt-fired dream of endless consumption has turned into the rudest of nightmares, raising the risk that a euro country may be forced to declare bankruptcy or abandon the currency.
As the story makes clear, the odds of this happening are still small. Because they are not trivial, however, uncertainty surrounding the euro will remain high. Which means that it is not going to displace the dollar anytime soon.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.