euro

Vågar Europa de reformer som behövs?

Större delen av Europa har levt i kris sex hela år. Banker har konkursat – och blivit utlösta. Skulderna har vuxit sig större. Paniken närapå slet sönder euron. Ekonomier har stagnerat eller krympt. Löner har sjunkit. Arbetslösheten har skjutit i höjden. På det hela taget har eurozonen drabbats värre än under den stora depressionen på 1930-talet.

Efter denna långa, mörka vinter har experter och politiker hälsat de första magra tecknen på tillväxt som en signal om att bättre tider är på gång. Fast en svala gör ingen sommar. Även om utsikterna är bättre än för ett år sedan förblir utvecklingen klen i det korta perspektivet, och utmaningarna på längre sikt enorma.

Detta är uppenbart i södra Europa. I Grekland, där nationalinkomsten har sjunkit med en fjärdedel letar barnen efter matrester i soptunnorna medan sjukhusen har brist på mediciner. Krossad under en ohållbar statsskuld fortsätter landets inåtvända ekonomi att krympa. I Spanien, där mer än en av fyra saknar arbete, tar så många livet av sig att självmord blivit den största dödsorsaken efter de naturliga.

I Italien saknar två av fem ungdomar arbete – i Grekland och Spanien nära tre av fem. En förlorad generation håller på att skapas. Är det då förvånande att unga européer föder ännu färre barn sedan krisen bröt ut och att någon emigrerar från Portugal var fjärde minut?

 I norra Europa är situationen inte lika alarmerande, men ändå rätt dyster. Frankrike föll ned i recession under andra halvåret 2013. Det ryck i tillväxten som Storbritannien nyligen gjort ser ut att vara farligt instabilt: trots att lönerna sjunkit med en tiondel, lånar konsumenterna för att spendera mera och därmed blåsa upp ännu en bostadsbubbla.

Till och med Tyskland är mycket svagare än vad folk tror. Inbromsningen i Kina och fallet i Sydeuropa skadar Tysklands export samtidigt som köpkraften förblir svag och investeringsnivåerna når nya bottennoteringar. Sedan 2008 har den tyska ekonomin bara växt med totalt 2,5 procent. Sverige har klarat det dubbla. I Berlin har passiviteten satt in. Enligt OECD har man, sedan krisens början, gjort mindre än något annat land för att reformera sin ekonomi.

På kort sikt är det största hindret för tillväxt en ouppklarad bankkris till följd av överdriven skuldsättning. Hushållen i Europa är nästan lika skuldtyngda som de var 2008 och statsskulden är mycket större. Många banker är zombies–varken påfyllda med tillräckligt nytt kapital att låna ut, eller avlivade. Företagen varken kan eller vill investera. Lovande delar av ekonomin är ofta svältfödda på resurser att växa med, eller bakbundna av snåriga regleringar och konkurrenshinder.

Problemet förvärras av den långvariga avmattningen av produktiviteten och enorma befolkningsförändringar. Sedan mitten av 1990-talet har Europa halkat ännu längre efter USA: medan produktiviteten hos amerikanska arbetare ökade med 1,8 procent om året det senaste decenniet, med Sverige hack i häl, var genomsnittet för eurozonen bara 0,9 procent med Grekland bara en bråkdel före Tyskland, och med Italien på noll. Kombinationen av en klen produktivitetsökning och den demografiska tendensen att arbetskraften minskar i åldrande samhällen gör att den ekonomiska tillväxten blir fortsatt svag.

Stagnation och nedgång är inte oundvikligt. En omstrukturering av banker och nedskrivning av lån skulle ge ekonomierna ett lyft. Djärva reformer skulle kunna starta en våg av innovationer och företagande. Ökad invandring skulle hjälpa. Det går att göra mer för att hjälpa exporten till snabbväxande ekonomier som Kinas. Men har Europas politiker modet att konfrontera alla de etablerade egenintressen som hindrar tillväxten?

EU must tackle Germany’s dangerously destabilising current-account surplus

In additional to its fiscal enforcement powers, the European Commission is now mandated to tackle excessive imbalances in the eurozone that could endanger its stability.

Due to German lobbying, EU rules on imbalances are dangerously unbalanced: while they deem a current-account deficit of 4% of GDP problematic, a surplus has to exceed 6% of GDP before it is considered excessive. Nor do EU rules take account of absolute size, so a surplus in tiny Luxembourg is treated like one in mighty Germany. That tilt allowed the Commission to overlook Germany’s vast current-account surplus in its first assessment of dangerous imbalances last year: Germany’s surplus averaged 5.9% over the three preceding years. Yet in dollar terms, Germany’s surplus is now the world’s largest.

The Commission’s directorate-general for economic and financial affairs is due to deliver its latest assessment of imbalances on 15 November. This time, Germany’s surplus is well above the prescribed 6% limit: according to official Eurostat figures, Germany’s current account surplus was 6.3% of GDP in 2010, 6.2% in 2011 and 7.0% in 2012. Thus, far from being a “growth locomotive”, as Wolfgang Schäuble claims, Germany is a drag on growth: not only does it buy less than it sells, the gap between its exports and imports is growing.

As an impartial enforcer of EU law, the Commission is obliged to act. It must demand corrective action in Germany. Higher wages and increased investment would be a good place to start.

Is a British-style devaluation really what Spain needs?

Paul Krugman argues that a benefit for Britain of keeping the pound is that it has been able to devalue – unlike, for instance, Spain, which is part of the euro – and illustrates the point with a chart that shows the 20% devaluation of the UK’s real exchange rate since the crisis hit.

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Fine. But a fall in the real exchange rate is just a means to an end: the real aim is to boost net exports and consequently swing the current-account deficit towards balance.

And here’s the thing: despite Britain’s devaluation, neither its trade deficit nor its current-account deficit have shrunk. Astonishingly, in a slump Britain’s current-account deficit has actually widened, from 2.3% of GDP in 2007 to 3.5% of GDP last year.

In Spain, in contrast, there has been a huge improvement in both the trade and the current-account balance. A current-account deficit of 10% of GDP in 2007 had shrunk to 1.1% of GDP by last year.

To which Krugman would doubtless retort: that’s because domestic demand has collapsed and with it imports.

Yes, imports have fallen – and I agree with Krugman that the excessive austerity in Spain has been a huge mistake (as, I would add, has the failure to fix the banking system).

But the volume of Spanish exports – even without devaluation – has also soared, as the chart shows. In Britain, in contrast, export volumes are scarcely higher than before the devaluation.

Export volumes

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Source: Eurostat, Exports and imports by the EU countries and by third countries – volumes [nama_exi_k]

So is a British-style devaluation really what Spain needs?

 

The ECB Fear Factor

Panic is beginning to overwhelm the eurozone. Italy and Spain are caught in the maelstrom. Belgium is slipping into the danger zone. As France is dragged down, the widening gap between its bond yields and Germany’s is severely testing the political partnership that has driven six decades of European integration.

Even strong swimmers such as Finland and the Netherlands are straining against the undertow. Banks are struggling to stay afloat – their capital providing little buoyancy as funds drain away – while businesses that rely on credit are in trouble, too. All signs point to a eurozone recession.

Left unchecked, this panic about sovereign solvency will prove self-fulfilling: just as a healthy bank can fail if it suffers a run, even the most creditworthy government is at risk if the market refuses to refinance its debt. One can scarcely bear imagining the consequences: cascading bank and sovereign defaults, a devastating depression, the collapse of the euro (and perhaps even that of the European Union), global contagion, and potentially tragic political turmoil. So why aren’t policymakers doing whatever it takes to avoid catastrophe?

Ever since Italian bond yields first spiked in early August, I have believed that only an open-ended commitment by the European Central Bank to keep solvent governments’ bond yields at sustainable rates could calm the panic and create the breathing space needed to implement confidence-boosting reforms. Everything that has happened since then has only confirmed this view.

Now that the crisis has reached the “core” of the eurozone, the resources needed to backstop weaker sovereigns exceed the limited fiscal capacity of stronger ones. Financial wizardry cannot disguise that, while throwing a bigger lifeline risks dragging everyone down. Piling everyone on to the same life raft – through Eurobonds backed by joint and several guarantees – is not legally feasible for now, and would be politically toxic if attempted prematurely. Nor can a systemic crisis be resolved by individual governments’ actions – not least because the panic is outpacing politicians’ ability to respond. Only the ECB has the unlimited wherewithal to save Europe from the abyss now.

The ECB has a strong rationale to act: to ensure the smooth transmission of monetary policy, to prevent a depression that would lead to deflation, and to avoid the breakup of the euro. Yet it has so far refused to do so, hiding behind a legal fig leaf.

Granted, Article 123 of the Lisbon Treaty prohibits the ECB from purchasing bonds directly from public bodies, but intervening in the secondary market is permitted. The ECB has long been doing so through its Securities Market Program. Where in the treaty does it say that extending the SMP is prohibited? Indeed, a credible open-ended commitment to contain interest-rate spreads would actually require fewer purchases than the ECB’s current limited and temporary program does.

Unfortunately, many Germans, notably at the Bundesbank, loathe the idea of central-bank intervention, because it conjures up memories of 1923, when the Reichsbank printed money to fund government borrowing, the resulting hyperinflation destroyed middle-class savings, and a decade later Hitler came to power. Yet Germans ought to remember that it was in fact the financial panic provoked by the collapse of the Austrian bank Creditanstalt, the resulting slump, and misjudgment by the German political establishment that cleared the Nazis’ path.

Far from precluding action, history justifies it. Besides, there is no reason to panic about inflation when monetary growth is low, bank credit is contracting, and people are hoarding money rather than spending it. Moreover, any ECB purchases could continue to be sterilized.

Another objection is that ECB intervention would ease the pressure on the new governments in Italy and Spain to reform. Yet, as it is, reformers have no time to establish their credentials, and if the eurozone collapses, the door will be open to populist extremists. So why doesn’t the ECB strike a bargain with solvent governments to keep rates down as long as they stick to their reform programs?

Eurozone leaders could also set out a roadmap towards Eurobonds, subject to strict conditionality, and tied to a credible mechanism for ensuring fiscal prudence. This would provide an additional incentive for governments that wish to qualify to introduce the necessary reforms, while reassuring the ECB and markets that governments remain committed to making the euro work.

Exceptional times demand exceptional measures – and I believe that the ECB will feel obliged to act if the eurozone is pushed to the brink. But the longer the ECB delays, the greater the hit to people’s jobs and savings, the deeper the enduring damage to investors’ confidence in the eurozone financial system, and the bigger the risk of a catastrophic mishap. The time to act is now.

This is primarily a crisis of the banking system, not the euro

European leaders need to face facts: their strategy for tackling the crisis sweeping through the eurozone is failing dismally. Far from preventing contagion, it is spreading it. It is aggravating, not alleviating, Europe’s debt problems. It is provoking political conflict both within countries and between them. And it is failing to address the underlying Europe-wide banking mess. Isn’t it time for a different approach?

The problem is partly that the causes of the crisis are misdiagnosed. This is primarily a crisis not of the euro, but of the global financial system. Not long ago, market fears focused on the dollar and the US Federal Reserve’s quantitative easing. And the key issue in Europe now is not the merits of the single currency but the parlous state of its banking system.

During the bubble years, the global financial system underpriced risk and misallocated capital. Too much was lent too cheaply to American subprime borrowers and Spanish property developers, Icelandic and Irish banks, Dubai and Greece.

Among the biggest lenders were European banks. They now hold mountains of debt – government, bank and property – that they wish they didn’t. Many are illiquid, and depend on cheap ECB finance to stay afloat. Many have also incurred huge losses that they have only partly recognised; as a result, some are, in effect, insolvent. The stress tests of EU banks were not stringent enough to shed light on this – after all, they gave both Bank of Ireland and Allied Irish Bank a clean bill of health.

At heart, the “euro crisis” is a wrestling match over who will ultimately bear these bank losses. So far, EU governments have decided that banks’ bondholders must be protected at all costs, preferring to impose losses on taxpayers instead – even if this stretches governments’ solvency to breaking point. This is explicit in Ireland, much less so elsewhere. Because voters’ tolerance for bank bailouts has worn thin, governments are acting covertly: lending huge sums to Greece and now Ireland so that they can repay German, French and UK banks in full – all under the pretence of “defending the euro”.

This strategy is not just unfair, costly and dangerous; it is ineffective. Governments are burdening taxpayers with huge bills that will impede future growth; Ireland’s “bailout” is actually a high-interest loan of €20,000 per Irish person. They are inviting a populist and extremist backlash; witness Sinn Fein’s recent success. They are corroding support for both the euro and the EU: prudent Germans rage against bailing out profligate Greeks and reckless Irish, the Irish against EU-imposed “reparations”, when their anger ought to be directed at the banks that ultimately benefit. They are encouraging financial speculation, not least by distressed banks: heads they win, tails taxpayers lose. And by guaranteeing banks’ debts, all EU governments are risking their credibility and ultimately their solvency.

Bond markets are now testing governments’ promises: you bailed out holders of Greek government bonds and Irish bank bonds, what about Portuguese, Spanish and other debt? This is a self-fulfilling prophecy: even a sound credit is in trouble if markets refuse to lend. And whereas Greece’s bailout cost €110 billion and Ireland’s €85 billion, Spain’s could top €400 billion – and then, who knows? The crisis could sweep on to Italy, Belgium, France and eventually Germany too. At some point the cost of bailing out banks would prove unbearable – there is a limit to Germany’s ability and willingness to borrow –and the euro could needlessly fall victim to the resulting political and financial turmoil.

Even if EU governments’ ability and willingness to bail out banks is not tested to destruction, the strategy remains misguided. Instead of sacrificing taxpayers to protect bondholders, watching the sovereign dominos fall and failing to tackle the underlying banking problem, what is needed is an EU-wide solution that forces banks to recognise their losses and bondholders to recapitalise them if necessary.

This would involve a much more rigorous stress test to find the holes in banks’ balance sheets. Banks would then be forced to raise additional capital, first from the market and then by converting bondholders’ bonds into shares. The weakest would be sold or closed down.  Until then, the ECB would continue to provide liquidity to banks as necessary.

Freed from worries about bank debt, most governments’ debts would be manageable; only Greece would need to restructure its debts. There would less need for self-defeating austerity; the EU could instead launch infrastructure bonds to boost growth. All this would arrest the financial crisis, boost economic growth, reduce political and social tensions, and safeguard the euro.

This is a decisive moment for the EU. Will the narrow interests of financiers prevail or those of society as a whole?

Don’t blame the euro for Ireland’s mess

Sceptics of the euro see the Irish crisis as proof of the single currency’s folly. But while the eurozone needs reform, the notion that the euro is to blame for Ireland’s travails is simplistic.

Even many euro supporters now regret that in the boom years the currency permitted huge capital flows from Germany and other surplus countries to Spain, Portugal, Greece, and Ireland. These imbalances, conventional wisdom has it, are unhealthy – and the European Union is now drafting rules to limit them.

Yet enabling capital to flow from one member country to another without exchange-rate risk is a key advantage of the euro. If this were possible globally, emerging economies would not feel compelled to amass huge reserves to protect against crises and could be net recipients of investment instead. When integrated financial markets work well, they offer investors higher returns, businesses cheaper finance and a better allocation of capital all around.

The problem is not that savings flowed from Germany to Europe’s periphery. It is that they funded property bubbles rather than productive investment. But the blame for that lies with herd-like investors, flawed banks and foolish governments, not the euro. After all, America, Britain, Iceland and other non-euro countries all had huge property bubbles too.

Granted, joining the euro did slash Irish interest rates, creating cheap borrowing that fuelled the boom. But at a macro level the Irish government could have tightened fiscal policy – in effect, run large budget surpluses. At a micro level, it could also have limited banks’ property lending – through higher, counter-cyclical capital requirements for instance – rather than encouraging it with tax breaks.

Ireland’s property bubble was particularly big. The value of its housing stock quadrupled in the decade to 2006, with construction swelling to an eighth of the economy. The price of a typical Dublin house shot up more than fivefold – and has since nearly halved. Such a property crash is inevitably painful. But it need not have led to a sovereign debt crisis. Ireland’s public debt was only 25 per cent of gross domestic product on the eve of the crisis, the lowest in the eurozone.

The government’s fatal mistake was stepping in to guarantee not just all the depositors of Irish banks but also all their bondholders. Now the bust banks’ huge losses are dragging down the Irish state with them. Had Britain’s recession worsened, the UK government might have ended up in a similar situation.

Only cheap finance from the European Central Bank has kept those bust Irish banks on life-support, until now. Outside the euro, Ireland would doubtless have suffered Iceland’s fate: its currency would have crashed and its central bank would have run short of foreign funds to keep its banks afloat. Far from precipitating the crisis, the euro has given Ireland vital breathing space. More’s the pity that the government has failed to make good use of it.

It is true that, outside the euro, Ireland would now enjoy a weaker currency. That could boost exports, and hence growth. But in very small open economies, devaluations tend to feed through rapidly into inflation, so the competitive boost might not have been that great. In any case, Ireland has already slashed wages and prices to restore competitiveness – in effect, an internal devaluation. And if it wished to cut unit labour costs further, it could reduce its high payroll taxes and replace the revenues with higher value added tax or a tax on land values.

Leaving the euro and reintroducing the punt is certainly not a solution, since Ireland would be incapable of repaying its euro-denominated debts in devalued punts. Nor, on its own, is an EU or International Monetary Fund “bail-out” – in practice, a loan at punitively high interest rates. That would merely postpone the crisis.

Irish taxpayers should not be bled dry to pay off investors – among them, European banks and American hedge funds – who gambled on lending to Irish banks. Instead those creditors should take a haircut, via a debt restructuring with the EU or IMF providing a bridging loan until Ireland has fixed its budget deficit. Ironically, it is Germany’s proposal that bondholders should lose out in future that brought this crisis to a head. It is such a good idea that it should be implemented now.

Don’t blame the euro for Ireland’s mess

This is a slightly longer version of an article that appeared in the FT.

Euro-phobes can scarcely contain their joy at the Irish crisis – proof positive, in their eyes, of the folly of the single currency. But while the euro-zone certainly needs reform, the notion that the euro is to blame for Ireland’s travails is simplistic.

Even many of the euro’s supporters now regret that in the boom years the single currency permitted huge capital flows from Germany and other surplus countries to Spain, Portugal, Greece, Ireland and other deficit countries. These imbalances, conventional wisdom has it, are unhealthy – and the EU is drafting new rules to limit them.

Yet enabling capital to flow from one member country to another without exchange-rate risk is a key advantage of the euro. If only this were possible globally, emerging economies would not feel compelled to accumulate huge reserves to protect themselves against crises – instead of being net lenders to rich countries, these fast-growing economies could be net recipients of investment funds. When integrated financial markets work well, they offer investors higher returns, businesses cheaper finance and a better allocation of capital all around.

The problem is not that savings flowed from Germany to Ireland and other economies on Europe’s periphery. It’s that they mostly funded property bubbles rather than productive investment. The blame for that lies with herd-like investors, flawed banks and foolish governments, not the euro. After all, America, Britain, Iceland and other non-euro countries all had huge property bubbles too.

Granted, joining the euro involved slashing interest rates in Ireland – and cheap borrowing helped fuel the property bubble. But at a macro level, the Irish government could have tightened fiscal policy – in effect, run large budget surpluses – to dampen the boom. At a micro level, it could have limited banks’ reckless property lending – through higher and counter-cyclical capital requirements, for instance – rather than encouraging it with tax breaks.

Ireland’s property bubble was particularly big. The value of all the houses in the country quadrupled in the ten years to June 2006 and construction swelled to an eighth of the economy. The price of a typical Dublin house shot up more than fivefold – and has since nearly halved. Such a property crash is inevitably painful. But it need not have led to a sovereign debt crisis. Ireland’s public debt was only 25% of GDP on the eve of the crisis, the lowest in the euro-zone.

The government’s fatal mistake was stepping in to guarantee not just all the depositors of Irish banks but also all their bondholders. Now the bust banks’ huge losses are dragging down the Irish state with them. Had Britain’s recession worsened, the UK government might have ended up in a similar situation.

Only cheap finance from the European Central Bank has kept those bust banks on life support, until now. Outside the euro, Ireland would doubtless have suffered Iceland’s fate: its currency would have crashed and its central bank would have run short of foreign funds to keep its banks afloat. Far from precipitating the crisis, the euro has given Ireland vital breathing space. More’s the pity that the government has failed to make good use of it.

It’s true that, outside the euro, Ireland would doubtless now enjoy a weaker currency. That could boost exports and hence growth. But in very small open economies, devaluations tend to feed through rapidly into inflation, so the competitive boost might not have been that great. In any case, Ireland has already slashed wages and prices to restore competitiveness – in effect, an internal devaluation. And if it wished to cut unit labour costs further, it could reduce its high payroll taxes and replace the revenues with higher VAT or a tax on land values.

Leaving the euro and reintroducing the punt is certainly not a solution, since Ireland would be incapable of repaying its euro-denominated debts in devalued punts. Nor, on its own, is an EU or IMF “bailout” – in fact, a loan at punitively high interest rates. That would merely postpone what is now a  solvency crisis.

Irish taxpayers should not be bled dry to pay off investors – among them, European banks and American hedge funds – who took a punt on lending to Irish banks. Those creditors should take a haircut (or lose their shirts).The way forward is a debt restructuring – a polite word for an orderly default – with the EU and/or IMF providing a bridging loan until Ireland has eliminated its budget deficit. Ironically, it is Germany’s proposal that bondholders should take a haircut in future that has brought matters to a head. It’s such a good idea that it should be implemented now.

Thought of the day: Ireland

I spent a fantastic weekend in Kilkenny, at Kilkenomics, Ireland’s first economics (and comedy) festival. Despite (and because of) the crisis, it was a sell-out. Congrats to Richard Cook and David McWilliams for putting on a superb event, hopefully the first of many.

The Irish government now appears to be in talks with the EU about a possible bailout, but politicians don’t want to lose face by accepting help.

Despite the huge housing bubble and now bust, it needn’t have come to this, as I explain in Aftershock: Reshaping the World Economy After the Crisis.

The Irish government had very small debts going in to the crisis.

Its crucial mistake was guaranteeing the creditors of its bust banks.

Now it’s bust too.

An EU/IMF bailout without restructuring the banks’/government debt is not the solution.

Irish taxpayers would be bled dry to pay off investors who took a punt on lending to Irish banks.

Those creditors should take a haircut (or lose their shirts).

The way forward is debt restructuring/default, with either the EU/IMF providing a bridging loan until Ireland has eliminated its budget deficit.

How to make the euro work better

Excellent piece by Peter Sutherland in today’s FT:

An honourable tradition of the European Union is that of turning a crisis into an opportunity…

The past three months have provided painful lessons to the leaders of the eurozone about the design flaws of the single European currency…

Without the single currency, Europe would be an economic wasteland. The cost of not having the euro would have been far greater over the past two years than the cost of having it has been over the past three months. Competitive devaluations of national currencies after the financial crisis of 2008 would have led to economic chaos incomparably worse than the turbulence we are now experiencing. The eurozone’s leaders recognise this. The task that confronts them is to ensure that the eurozone functions in such a way that the risk of disintegration is minimised and its potential advantages are exploited to the utmost…

The original system of governance for the European single currency was intellectually and politically schizophrenic. On the one hand, it represented the culmination of 40 years of integration, based on the obvious inadequacy of national procedures to confront continental and global challenges. On the other hand, it was concerned with preserving absolute national sovereignty in fiscal, budgetary and macroeconomic matters…

Their common membership of the single European currency entails a measure of economic sovereignty-sharing between, for example, Germany and Greece. This will not disappear because there are no political structures to manage and reflect their shared sovereignty…

Recent experience points to a more binding surveillance of national economic, not merely budgetary, policies. A natural counterpart would be enhanced macroeconomic co-ordination within the eurozone. Even within the single European market, national economic policies have substantial repercussions for that country’s neighbours. That the eurozone has been so reluctant to set up mechanisms for managing this interdependence is a tribute to the fetish of national sovereignty rather than a reflection of reality…

Germany has every interest in playing its traditional central role in that process, not merely as a good neighbour in Europe, but as a matter of pressing national interest.

A useful antidote to the euro panic and hostility.