Category Archives: Spain

Marshall’s latest

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REPEAT AFTER ME: THE USA DOES NOT HAVE A ‘GREECE PROBLEM’

By Marshall Auerback

To paraphrase Shakespeare, things are indeed rotten in the State of Denmark (and Germany, France, Italy, Greece, Spain, Portugal, and almost everywhere else in the euro zone). An entire continent appears determined to commit collective hara kiri (link), whilst the rest of the world is encouraged to draw precisely the wrong kinds of lessons from Europe’s self-imposed economic meltdown. So-called respectable policy makers continue to legitimize the continent’s fully-fledged embrace of austerity on the allegedly respectable grounds of “fiscal sustainability”.

The latest to pronounce on this matter is the Governor of the Bank of England, Mervyn King. This is a particularly sad, as the BOE – the Old Lady of Threadneedle Street – has actually played a uniquely constructive role amongst central banks in the area of financial services reform proposals. King, and his associate, Andrew Haldane, Executive Director for Financial Stability at the Bank of England, have been outspoken critics of “too big to fail” banks (link), and the asymmetric nature of banker compensation (“heads I win, tails the taxpayer loses”). This stands in marked contrast to America’s feckless triumvirate of Tim Geithner, Lawrence Summers, and Ben Bernanke, none of whom appears to have encountered a banker’s bonus that they didn’t like.

But when it comes to matters of “fiscal sustainability” King sounds no better than a court jester (or, at the very least, a member of President Obama’s National Commission on Fiscal Responsibility and Reform). In an interview with The Telegraph (link), the Bank of England Governor suggests that the US and UK – both sovereign issuers of their own currency – must deal with the challenges posed by their own fiscal deficits, lest a Greece scenario be far behind:

“It is absolutely vital, absolutely vital, for governments to get on top of this problem. We cannot afford to allow concerns about sovereign debt to spread into a wider crisis dealing with sovereign debt. Dealing with a banking crisis was bad enough. This would be worse.”

“A wider crisis dealing with sovereign debt”? Anybody’s internal BS detector ought to be flashing red when a policy maker makes sweeping statements like this. The Bank of England Governor substantially undermines his own credibility by failing to make 3 key distinctions:

1. There is a fundamental difference between debt held by the government and debt held in the non-government sector. All debt is not created equal. Private debt has to be serviced using the currency that the state issues.
2. Likewise, deficit critics, such as King, obfuscate reality when they fail to highlight the differences between the monetary arrangements of sovereign and non-sovereign nations, the latter facing a constraint comparable to private debt.
3. Related to point 2, there is a fundamental difference between public debt held in the currency of the sovereign government holding the debt and public debt held in a foreign currency. A government can never go insolvent in its own currency. If it is insolvent as a consequence of holdings of foreign debt then it should default and renegotiate the debt in its own currency. In those cases, the debtor has the power not the creditor.

Functionally, the euro dilemma is somewhat akin to the Latin American dilemma, such as countries like Argentina regularly experienced. The nations of the European Monetary Union have given up their monetary sovereignty by giving up their national currencies, and adopting a supranational one. By divorcing fiscal and monetary authorities, they have relinquished their public sector’s capacity to provide high levels of employment and output. Non-sovereign countries are limited in their ability to spend by taxation and bond revenues and this applies perfectly well to Greece, Portugal and even countries like Germany and France. Deficit spending in effect requires borrowing in a “foreign currency”, according to the dictates of private markets and the nation states are externally constrained.

King implicitly recognizes this fact, as he acknowledges the central design flaw at the heart of the European Monetary Union – “within the Euro Area it’s become very clear that there is a need for a fiscal union to make the Monetary Union work.”

This is undoubtedly correct: To eliminate this structural problem, the countries of the EMU must either leave the euro zone, or establish a supranational fiscal entity which can fulfill the role of a sovereign government to deficit spend and fill a declining private sector output gap. Otherwise, the euro zone nations remain trapped – forced to forgo spending to repay debt and service their interest payments via a market based system of finance.

But King then inexplicably extrapolates the problems of the euro zone which stem from this uniquely Euro design flaw and exploits it to support a neo-liberal philosophy fundamentally antithetical to fiscal freedom and full employment.

The Bank of England Governor – and others of his ilk – are misguided and disingenuous when they seek to draw broader conclusions from this uniquely euro zone related crisis. Think about Japan – they have had years of deflationary environments with rising public debt obligations and relatively large deficits to GDP. Have they defaulted? Have they even once struggled to pay the interest and settlement on maturity? Of course not, even when they experienced debt downgrades from the major ratings agencies throughout the 1990s.

Retaining the current bifurcated monetary/fiscal structure of the euro zone does leave the individual countries within the EMU in the death throes of debt deflation, barring a relaxation of the self-imposed fiscal constraints, or a substantial fall in the value of the euro (which will facilitate growth via the export sector, at the cost of significantly damaging America’s own export sector). This week’s €750bn rescue package will buy time, but will not address the insolvency at the core of the problem, and may well exacerbate it, given that the funding is predicated on the maintenance of a harsh austerity regime.

José Luis Rodríguez Zapatero, Spain’s Socialist prime minister, angered his trade union allies but cheered financial markets on Wednesday when he announced a surprise 5 per cent cut in civil service pay to accelerate cuts to the budget deficit.

The austerity drive – echoing moves by Ireland and Greece – followed intense pressure from Spain’s European neighbors, the International Monetary Fund on the spurious grounds that such cuts would establish “credibility” with the markets. Well, that wasn’t exactly a winning formula for success when tried before in East Asia during the 1997/98 financial crisis, and it is unlikely to be so again this time.

Indeed, in the current context, the European authorities are simply trying to localize the income deflation in the “PIIGS” through strong orchestrated IMF-style fiscal austerity, while seeking to prevent a strong downward spiral of the euro. But the contradiction in this policy is that a deflation in the “PIIGS” will simply spread to the other members of the euro zone with an effect essentially analogous to that of a competitive devaluation internationally.

The European Union is the largest economic bloc in the world right now. This is why it is so critical that Europeans get out of the EMU straightjacket and allow government deficit spending to do its job. Anything else will entail a deflationary trap, no matter how the euro zone’s policy makers initially try to localize the deflation. And the deflation is almost certain to spread outward, if sovereign states such as the US or UK absorb the wrong lessons from Greece, as Mr., King and his fellow deficit-phobes in the US are aggressively advocating.

There are two direct contagion vectors off the fiscal retrenchment being imposed on the periphery countries of the euro zone.

First, to the banking systems of the periphery and the core nations, as private loan defaults spread on domestic private income deflation induced by the fiscal retrenchment. Second, to the core nations that export to the PIIGS and run export led growth strategies. So 30-40% of Germany’s exports go to Greece, Italy, Ireland, Portugal and Spain directly, another 30% to the rest of Europe.

These are far from trivial feedback loops, and of course, the third contagion vector is to rest of world growth as domestic private income deflation combined with a maxi euro devaluation means exporters to the euro zone, and competitors with euro zone firms in global tradable product markets, are going to see top line revenue growth dry up before year end.

Let’s repeat this for the 100th time: the US government, the Japanese Government, or the UK government, amongst others, do NOT face a Greek style constraint – they can just credit bank accounts for interest and repayment in the same fashion as if they were buying some helmets for the military or some pencils for a government school. True, individual American states do face a fiscal crisis (much like the EMU nations) as users of the dollar, which is why some 48 out of 50 now face fiscal crises (a problem that could easily be alleviated were the US Federal Government to undertake a comprehensive system of revenue sharing on a per capita basis with the various individual states). But, if any “lesson” is to be learned from Greece, Ireland, or any other euro zone nation, it is not the one that Mr. King is seeking to impart. Rather, it is the futility of imposing arbitrary limits on fiscal policy devoid of economic context. Unfortunately, few are recognizing the latter point. The prevailing “lesson” being drawn from the Greek experience, therefore, will almost certainly lead the US, and the UK, to the same miserable economic outcome along with higher deficits in the process. As they say in Europe, “Finanzkapital uber alles”.

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EU Daily, China, and Fed swap lines

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The euro remains under the cross currents of deflation driven further by the austerity measures that make it stronger.

And portfolio shifting out of euro mainly into dollars and gold out of fears of disintegration and restructuring that are making it weaker.

The latter is currently the stronger force as evidenced by the falling euro and rising price of gold, especially when priced in euro.

It may even be a case of allowing ‘insiders’ to get out and leave the public institutions like banks holding the bag at the point of restructuring at the expense of the remaining shareholders.

The deflation forces are evident in the falling commodity prices, declining equity values, and declining term structures of rates outside of the euro zone, where the politics of fiscal austerity also seem to be getting the upper hand as the world goes the way of Japan.

And each passing day provides more evidence that ultra low overnight rates from central banks are in fact deflationary, probably through the income and cost channels, which allows governments to have a much lower level of taxation for a given level of government spending (higher deficits) to sustain optimal levels of output and employment.

Unfortunately they firmly believe the opposite and continue with their deflationary, overly tight fiscal policies.

And talk coming out of China about ‘monetary easing’ tells me they see reason to be very concerned about their growth as well.

So it looks like the two external threats to the US economy, the euro zone and China, are indeed happening as feared.

Last, on a reread and after discussion, the new Fed swap lines look to be both unsecured and containing rollover language that reads as the foreign central banks being able to roll over their loans in perpetuity meaning they are not loans but one way fiscal transfers from the US to foreign central banks, as repayment is strictly voluntary.

EU Daily

Zapatero Said Sarkozy Threatened to Leave Euro, El Pais Says
ECB’s Trichet Dismisses Inflation Fears
ECB’s Tumpel Says Inflation to Be Fought ‘Without Compromise’
Volcker Sees Euro ‘Disintegration’ Risk From Greece
Trichet Says ECB Plans Time Deposits to Sterilize Buys
ECB Will Give ‘Sterilization’ Details Next Week
Quaden Says Market Reaction to Greece Was Excessive
German Cities’ Deficits to Hit Record in 2010, Rundschau Says
ECB Pares Spanish, Italian Bond Purchases, AFME Says
Constancio Says ECB Will Give Details on Sterilization Soon
Spain’s Core Inflation Turns Negative for First Time

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Goodhart Says Greek Deal May Collapse as Crisis Tests Euro

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I like the way he puts it below:

“…if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Goodhart Says Greek Deal May Collapse as Crisis Tests Euro

By Svenja O’Donnell and Andrea Catherwood

May 4 (Bloomberg) — Greece’s bailout “might collapse” and the nation’s debt crisis makes it “hard to see” how the euro will survive in its current form, former Bank of England policy makerCharles Goodhart said.

“If this financing deal should collapse, and it might for one reason or another, then there would be a question of what the Greeks could possibly do,” Goodhart said in an interview with Bloomberg Television in London today. “Default would be totally disastrous for them and leaving the euro would equally be disastrous.”

Euro-region ministers on May 2 agreed to a 110 billion-euro ($145 billion) bailout with the International Monetary Fund to prevent a Greek default, after investor concern sparked a rout in Portuguese and Spanish bonds last week and sent stock markets tumbling. The Greek crisis shows the need for more integration within the euro as a common currency, Goodhart said.

“It’s very hard to see how this is going survive this particular test,” he said. “The euro system has either got to have much more integration or parts of it will fall by the wayside.”

Standard & Poor’s last week cut Greece’s credit rating to the junk level of BB+, lowered Spain’s grade by one level to AA and downgraded Portugal by two steps to A-. Greece has now agreed to budget-cutting measures worth 13 percent of gross domestic product.

‘Appalling Deflation’

“If the current bailout is put in place, it will be enough to meet their immediate financing problems not only this year but for the next year or two,” Goodhart said. “The problem is that it doesn’t meet their adjustment problems. It doesn’t deal with the problem the Greeks, in part from having too large a deficit and too large a debt ratio, are very uncompetitive and if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Greek 10-year bonds yielded 8.7 percent, about 566 basis points more than German bunds, as of 11:32 a.m. in London. That spread is down from as high as 800 basis points last week, the biggest gap since the euro’s introduction 11 years ago.

Should the deal fail, Greece “might do a kind of dual currency in which they use their scarce euros to meet their external commitments and in the meantime use an internal IOU, rather as Californian and some of the Argentinian states did, in order to meet their internal commitments” Goodhart said. “It would be a dual currency and the internal currency would fluctuate compared to the euro.”

Such an exercise would be “very messy,’ he added.

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The USA is broke and something needs to be done NOW

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Yet Another ‘Innocent Fraud’ Attack On Social Security And Medicare

The Future of Public Debt

By John Mauldin

For the rest of this letter, and probably next week as well, we are going to look at a paper from the Bank of International Settlements, often thought of as the central bankers’ central bank. This paper was written by Stephen G. Cecchetti, M. S. Mohanty, and Fabrizio Zampolli. ( http://www.bis.org/publ/work300.pdf?noframes=1)

The paper looks at fiscal policy in a number of countries and, when combined with the implications of age-related spending (public pensions and health care), determines where levels of debt in terms of GDP are going. The authors don’t mince words. They write at the beginning:

“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable.

Solvency is never the issue with non convertible currencies/ floating exchange rates. The risk is entirely inflation, yet I’ve never seen a manuscript critical of deficit spending that seriously looks at the inflation issue apart from solvency concerns.

Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.”

The negative consequences are always due to the moves presumed necessary to reduce deficits, not deficit spending per se.

Drastic measures is not language you typically see in an economic paper from the BIS. But the picture they paint for the 12 countries they cover is one for which drastic measures is well-warranted.

That would mean a hyper inflation scare, not solvency fear mongering.

I am going to quote extensively from the paper, as I want their words to speak for themselves, and I’ll add some color and explanation as needed. Also, all emphasis is mine.

“The politics of public debt vary by country. In some, seared by unpleasant experience, there is a culture of frugality. In others, however, profligate official spending is commonplace. In recent years, consolidation has been successful on a number of occasions. But fiscal restraint tends to deliver stable debt;

Stable public debt means stable non govt nominal savings with economies that require expanding net financial assets to support expanding credit structures and offset institutional demand leakages.

rarely does it produce substantial reductions. And, most critically, swings from deficits to surpluses have tended to come along with either falling nominal interest rates, rising real growth, or both. Today, interest rates are exceptionally low and the growth outlook for advanced economies is modest at best. This leads us to conclude that the question is when markets will start putting pressure on governments, not if.

Govts with non convertible currency/floating fx are not subject to pressure from markets with regards to funding or interest rates.

“When, in the absence of fiscal actions, will investors start demanding a much higher compensation for the risk of holding the increasingly large amounts of public debt that authorities are going to issue to finance their extravagant ways?

Investors have to take what’s offered, or exit the currency by selling it so someone else. And floating exchange rates continuously express the indifference levels

In some countries, unstable debt dynamics, in which higher debt levels lead to higher interest rates, which then lead to even higher debt levels, are already clearly on the horizon.

Only countries such as the euro zone members who are not the issuer of the euro, but users of the euro. They are analogous to us states in that regard, and are credit sensitive entities.

“It follows that the fiscal problems currently faced by industrial countries need to be tackled relatively soon and resolutely.

Agreed, except fiscal drag needs to be removed to restore private sector output and employment. They have this backwards.

Failure to do so will raise the chance of an unexpected and abrupt rise in government bond yields at medium and long maturities, which would put the nascent economic recovery at risk.

Like Japan? Triple the ‘debt’ of the US with a 1.3% 10 year note? And never a hint of missing a payment. And Japan, the US, UK, etc. all have the same institutional structure.

It will also complicate the task of central banks in controlling inflation in the immediate future and might ultimately threaten the credibility of present monetary policy arrangements.

Yes, inflation is the potential risk, which is mainly a political risk. People don’t like inflation and will topple a govt over it. But there is no economic evidence that inflation is a negative for growth and employment.

“While fiscal problems need to be tackled soon, how to do that without seriously jeopardising the incipient economic recovery is the current key challenge for fiscal authorities.”

Yes, exactly. Because they have it wrong. The fiscal problem that has to be tackled soon is that it’s too tight, as evidenced by the high rates of unemployment.

They start by dealing with the growth in fiscal (government) deficits and the growth in debt. The US has exploded from a fiscal deficit of 2.8% to 10.4% today, with only a small 1.3% reduction for 2011 projected. Debt will explode (the correct word!) from 62% of GDP to an estimated 100% of GDP by the end of 2011.

Yes, and not nearly enough, as unemployment is projected to still be over 9%, and core inflation is what is considered to be dangerously low.

Remember that Rogoff and Reinhart show that when the ratio of debt to GDP rises above 90%, there seems to be a reduction of about 1% in GDP. The authors of this paper, and others, suggest that this might come from the cost of the public debt crowding out productive private investment.

Can be true for fixed exchange rate regimes/convertible currency, but not true for today’s non convertible currency and floating fx regimes. And today, deficits generally rise due to slowdowns that drive up transfer payments and cut revenues ‘automatically’ (automatic stabilizers) so it’s no mystery that rising deficits are associated with slowing economies, but the causation is the reverse RR imply.

Think about that for a moment. We are on an almost certain path to a debt level of 100% of GDP in less than two years. If trend growth has been a yearly rise of 3.5% in GDP, then we are reducing that growth to 2.5% at best. And 2.5% trend GDP growth will NOT get us back to full employment. We are locking in high unemployment for a very long time, and just when some one million people will soon be falling off the extended unemployment compensation rolls.

Nothing that a sufficient tax cut won’t cure. There is a screaming shortage of aggregate demand that’s easily restored by a simple fiscal adjustment- tax cut and/or spending increase.

Government transfer payments of some type now make up more than 20% of all household income. That is set up to fall rather significantly over the year ahead unless unemployment payments are extended beyond the current 99 weeks. There seems to be little desire in Congress for such a measure. That will be a significant headwind to consumer spending.

Yes, backwards policy. They need to work to restore demand, not reduce it.

My first proposal is for a full payroll tax (fica) holiday, for example.

Government debt-to-GDP for Britain will double from 47% in 2007 to 94% in 2011 and rise 10% a year unless serious fiscal measures are taken.

Or unless the economy rebounds. In that case the deficit comes down and the danger is they let it fall too far as happens with every cycle.

Greece’s level will swell from 104% to 130%,

Yes, and they are credit sensitive like the US states.
This is ponzi.
Ponzi is when you must borrow to pay maturing debt

The US, UK, Japan, etc. Have no borrowing imperative to pay debt, the way Greece does.
They make all payments the same way- they just mark up numbers on their computers at their own central banks:

(SCOTT PELLEY) Is that tax money that the Fed is spending?
(CHAIRMAN BERNANKE) It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Bernanke didn’t call china to beg for a loan or check with the IRS to see if they could bring in some quick cash. He just changed numbers up with his computer.

so the US and Britain are working hard to catch up to Greece, a dubious race indeed.

Confused!

Spain is set to rise from 42% to 74% and “only” 5% a year thereafter; but their economy is in recession, so GDP is shrinking and unemployment is 20%. Portugal? 71% to 97% in the next two years, and there is almost no way Portugal can grow its way out of its problems.

Yes, they are in Ponzi

Japan will end 2011 with a debt ratio of 204% and growing by 9% a year. They are taking almost all the savings of the country into government bonds, crowding out productive private capital.

Nothing is crowded out with non convertible currency and floating fx. Banks have no shortage of yen lending power. The yen the govt net spends can be thought of as the yen that buy the jgb’s (japan govt bonds)

Reinhart and Rogoff, with whom you should by now be familiar, note that three years after a typical banking crisis the absolute level of public debt is 86% higher, but in many cases of severe crisis the debt could grow by as much as 300%. Ireland has more than tripled its debt in just five years.

Ireland is in Ponzi as they are users of the euro.

The BIS continues:

“We doubt that the current crisis will be typical in its impact on deficits and debt. The reason is that, in many countries, employment and growth are unlikely to return to their pre-crisis levels in the foreseeable future. As a result, unemployment and other benefits will need to be paid for several years, and high levels of public investment might also have to be maintained.

“The permanent loss of potential output caused by the crisis also means that government revenues may have to be permanently lower in many countries. Between 2007 and 2009, the ratio of government revenue to GDP fell by 2-4 percentage points in Ireland, Spain, the United States and the United Kingdom.

Again, failure to recognize the critical differences between issuers and users of the currency.

It is difficult to know how much of this will be reversed as the recovery progresses. Experience tells us that the longer households and firms are unemployed and underemployed, as well as the longer they are cut off from credit markets, the bigger the shadow economy becomes.”

Yes, responsible fiscal policy would not have let demand fall this far. The US should have had a full payroll tax holiday no later than sept 08, and most of the damage to the real economy would have been avoided.

We are going to skip a few sections and jump to the heart of their debt projections. Again, I am going to quote extensively, and my comments will be in brackets [].Note that these graphs are in color and are easier to read in color (but not too difficult if you are printing it out). Also, I usually summarize, but this is important. I want you to get the full impact. Then I will make some closing observations.

The Future Public Debt Trajectory

“We now turn to a set of 30-year projections for the path of the debt/GDP ratio in a dozen major industrial economies (Austria, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Portugal, Spain, the United Kingdom and the United States). We choose a 30-year horizon with a view to capturing the large unfunded liabilities stemming from future age-related expenditure without making overly strong assumptions about the future path of fiscal policy (which is unlikely to be constant). In our baseline case, we assume that government total revenue and non-age-related primary spending remain a constant percentage of GDP at the 2011 level as projected by the OECD. Using the CBO and European Commission projections for age-related spending, we then proceed to generate a path for total primary government spending and the primary balance over the next 30 years. Throughout the projection period, the real interest rate that determines the cost of funding is assumed to remain constant at its 1998-2007 average, and potential real GDP growth is set to the OECD-estimated post-crisis rate.

[That makes these estimates quite conservative, as growth-rate estimates by the OECD are well on the optimistic side.]

Yes, future liabilities are always quoted in isolation from future demand leakages including growth of reserves in pension funds, insurance companies, corps, foreign govts, etc.

And they are always used to imply solvency issues. No actual calculations are ever done regarding inflation.

Debt Projections

“From this exercise, we are able to come to a number of conclusions. First, in our baseline scenario, conventionally computed deficits will rise precipitously. Unless the stance of fiscal policy changes, or age-related spending is cut, by 2020 the primary deficit/GDP ratio will rise to 13% in Ireland; 8-10% in Japan, Spain, the United Kingdom and the United States; [Wow!] and 3-7% in Austria, Germany, Greece, the Netherlands and Portugal. Only in Italy do these policy settings keep the primary deficits relatively well contained – a consequence of the fact that the country entered the crisis with a nearly balanced budget and did not implement any real stimulus over the past several years.

Yes, this is big trouble for the solvency of the euro zone members, but not the rest.

“But the main point of this exercise is the impact that this will have on debt. The results plotted as the red line in Graph 4 [below] show that, in the baseline scenario, debt/GDP ratios rise rapidly in the next decade, exceeding 300% of GDP in Japan; 200% in the United Kingdom; and 150% in Belgium, France, Ireland, Greece, Italy and the United States. And, as is clear from the slope of the line, without a change in policy, the path is unstable. This is confirmed by the projected interest rate paths, again in our baseline scenario. Graph 5 [below] shows the fraction absorbed by interest payments in each of these countries.From around 5% today, these numbers rise to over 10% in all cases, and as high as 27% in the United Kingdom.

“Seeing that the status quo is untenable, countries are embarking on fiscal consolidation plans. In the United States, the aim is to bring the total federal budget deficit down from 11% to 4% of GDP by 2015. In the United Kingdom, the consolidation plan envisages reducing budget deficits by 1.3 percentage points of GDP each year from 2010 to 2013 (see eg OECD (2009a)).

Why would anyone who understood actual monetary operations want to increase fiscal drag with elevated unemployment and excess capacity .

“To examine the long-run implications of a gradual fiscal adjustment similar to the ones being proposed, we project the debt ratio assuming that the primary balance improves by 1 percentage point of GDP in each year for five years starting in 2012. The results are presented as the green line in Graph 4. Although such an adjustment path would slow the rate of debt accumulation compared with our baseline scenario, it would leave several major industrial economies with substantial debt ratios in the next decade.

“This suggests that consolidations along the lines currently being discussed will not be sufficient to ensure that debt levels remain within reasonable bounds over the next several decades.

“An alternative to traditional spending cuts and revenue increases is to change the promises that are as yet unmet. Here, that means embarking on the politically treacherous task of cutting future age-related liabilities.

Here we go- this is too often the ‘hidden agenda’

It’s all about cutting social security and medicare.

Who would have thought!!!

Yes, the euro zone’s institutional arrangements that make member govt spending revenue constrained have it on the road to collapse, maybe very soon, and for reasons other than long term liabilities.

The rest of the world doesn’t have that issue, as govt spending is not revenue constrained, and the risk to prosperity is acting as if we all have the same revenue constraints as the euro zone.

With this possibility in mind, we construct a third scenario that combines gradual fiscal improvement with a freezing of age-related spending-to-GDP at the projected level for 2011. The blue line in Graph 4 shows the consequences of this draconian policy. Given its severity, the result is no surprise: what was a rising debt/GDP ratio reverses course and starts heading down in Austria, Germany and the Netherlands. In several others, the policy yields a significant slowdown in debt accumulation. Interestingly, in France, Ireland, the United Kingdom and the United States, even this policy is not sufficient to bring rising debt under control.

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Greece CAN go it alone

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Greece CAN Go it Alone
Yesterday at 5:00pm
By Marshall Auerback and Warren Mosler

Greece can successfully issue and place new debt at low interest rates. The trick is to insert a provision stating that in the event of default, the bearer on demand can use those defaulted securities to pay Greek government taxes. This makes it immediately obvious to investors that those new securities are ‘money good’ and will ultimately redeem for face value for as long as the Greek government levies and enforces taxes. This would not only allow Greece to fund itself at low interest rates, but it would also serve as an example for the rest of the euro zone, and thereby ease the funding pressures on the entire region.

We recognize, of course, that this proposal would also introduce a ‘moral hazard’ issue. This newly found funding freedom, if abused, could be highly inflationary and further weaken the euro. In fact, the reason the ECB is prohibited from buying national government debt is to allow ‘market discipline’ to limit member nation fiscal expansion by the threat of default. When that threat is removed, bad behavior is rewarded, as the country that deficit spends the most wins, in an accelerating and inflationary race to the bottom.
It is comparable to a situation where a nation like the US, for example, did not have national insurance regulation. In this kind of circumstance, the individual states got into a race to the bottom, where the state with the laxest standards stood to attract the most insurance companies, forcing each State to either lower standards or see its tax base flee. And it tends to end badly with AIG style collapses.

Additionally, the ECB or the Economic Council of Finance Ministers (ECOFIN) effectively loses the means to enforce their austerity demands and keep them from being reversed once it’s known they’ve taken the position that it’s too risky to let any one nation fail.

What Europe’s policy makers would like to do is find a way to isolate Greece and mitigate the contagion effect, while maintaining the market discipline that comes from the member nations being the credit sensitive entities they are today; hence, the mooted “shock and awe” proposals now being leaked, which did engender an 8% jump in the Greek stock market on Thursday.

But these proposals don’t really get to the nub of the problem. Any major package weakens the others who have to fund it in the market place, because the other member nations are also revenue dependent, credit sensitive entities. Much like the US States, they do not control central bank operations, and must have good funds in their accounts or their checks will bounce.

The euro zone nations are all still in a bind, and their mandated austerity measures mean they don’t keep up with a world recovery. And Greek financial restructuring that reduces outstanding debt reduces outstanding euro financial assets, strengthening the euro, and further weakening output and employment, while at the same time the legitimization of restructuring risk weakens the credit worthiness of all the member nations.

It does not appear that the markets have fully discounted the ramifications of a Greek default. If you use a Chapter 11 bankruptcy analogy, large parts of the country would be shut down and the “company” (i.e. Greece Inc) could spend only its tax revenues. But the implied spending cuts represent a further substantial cut in aggregate demand and decreased revenues, in a most un-virtuous spiral that ends only with an increase in exports or privation driven revolt.

The ability of Greece to use the funds from the rescue package as a means to extinguish Greek state liabilities would improve their financial ratios and stave off financial collapse, at least on a short term basis, with the side effect of a downward spiral in output and employment, while the sovereign risk concerns are concurrently transmitted to Spain, Portugal, Ireland, Italy, and beyond. Those sovereign difficulties also morph into a full-scale private banking crisis which can quickly extend to bank runs at the branch level.

Our suggestion will rescue Greece and the entire euro zone from the dangers of national government insolvencies, and turn the euro zone policy maker’s attention 180 degrees, back to their traditional role of containing the potential moral hazard issue of excessive deficit spending by the national governments through the Stability and Growth Pact. If the member states ultimately decide that the Stability and Growth Pact ratios need to be changed, that’s their decision. But the SGP represents the euro zone’s “national budget”, precisely designed to prevent the hyperinflationary outcome that the “race to the bottom” could potentially create. At the very least, our proposal will mitigate the deflationary impact of markets disciplining credit sensitive national governments and halting the potential spread of global financial contagion, without being inflationary.

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SOVS Update

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It’s all moving very quickly now.

The US 10 year is down over 25 bp from the highs, US stocks are leveling off as the dollar is looking up, hurting foreign earning translations as are rising risks of more serious trouble in the euro zone.

It’s also becoming more apparent that the austerity measures do not ‘fix’ anything but instead slow growth and cause the automatic stabilizers to keep the national gov. deficits high and growing, causing further credit deterioration.

While higher deficits are the answer for growth, at the same time they reduce already deteriorating creditworthiness.

The question is now whether the deficits get large enough to support the needed GDP growth that might restore credit worthiness before the loss of credit worthiness causes widespread defaults.

On Thu, Apr 22, 2010 at 6:35 AM, wrote:
EU release of budget deficit estimates for 2009 which were revised higher hurting the peripherals

Ref Entity 5y$ COD 5y/10y Coupon

Germany 35-39 1.5 4/5 25x
France 59-64 4 3/5 25x
Netherland 37-41 2 3/5 25x
Finland 26-30 1.5 3/5 25x
Norway 17-20 0.5 2/4 25x
Denmark 35-40 1.5 3/5 25x

Belgium 68-73 4.5 2/4 100x
Austria 66-70 4.5 2/4 100x
Sweden 36-40 2 3/5 100x

Greece 545-585 85 -120/-85 100x
Portugal 268-278 45.5 -22/-15 100x
Spain 178-188 23 -8/-3 100x
Italy 148-153 17.5 -1/3 100x
Ireland 175-180 24.5 -3/3 100x

USA €’s 38-41 0 2/4 25x
Switzerland 45-55 0 2/5 25x
UK 73-76 2 1/3 100x

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ECB monetizing or not ?

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>   
>   (email exchange)
>   
>   On Thu, Apr 15, 2010 at 3:29 PM, John wrote:
>   
>   Warren, I can’t tell from this article if the European Central Bank is
>   issuing new currency in exchange for national government bonds or not?
>   

This in fact is a very good article.

Yes, the ECB is funding its banks, and yes, they do accept the securities of the member nations as collateral.

However that funding is full recourse. If the bonds default the banks that own the securities take the loss.

The reason a bank funds its securities and other assets at the Central Bank is price. Banks fund themselves where they
are charged the lowest rates. And the Central Bank, the ECB in this case, sets the interbank lending rate by offering funds at its
target interest rate, as well as by paying something near it’s target rate on excess funds in the banking system. That is, through its various ‘intervention mechanisms’ the ECB effectively provides a bid and an offer for interbank funds.

In the banking system, however, loans ‘create’ deposits as a matter of accounting, so the total ‘available funds’ are always equal to the total funding needs of the banking system, plus or minus what are called ‘operating factors’ which are relatively small. These include changes in cash in circulation, uncleared checks, changes in various gov. account balances, etc.

This all means the banking system as a whole needs little if any net funding from the ECB. However, any one bank might need substantial funding from the ECB should other banks be keeping excess funds at the ECB. So what is happening is that banks who are having difficulty funding themselves at competitive rates immediately use the ECB for funding by posting ‘acceptable collateral’ to fund at that lower rate.

One reason a bank can’t get ‘competitive funding’ in the market place is its inability to attract depositors, generally due to risk perceptions. While bank deposits are insured, they are insured only by the national govts, which means Greek bank deposits are insured by Greece. So as Greek and other national govt. solvency comes into question, depositors tend to avoid those institutions, which drives them to fund at the ECB. (actually via their national cb’s who have accounts at the ECB, which is functionally the same as funding at the ECB)

As with most of today’s banking systems, liabilities are generally available in virtually unlimited quantities, and therefore regulation falls entirely on bank assets and capital considerations. As long as national govt securities are considered ‘qualifying assets’ and banks are allowed to secure funding via insured deposits of one form or another and the return on equity is competitive there is no numerical limit to how much the banking system can finance.

So in that sense the EU is in fact financially supporting unlimited credit expansion of the national govts. They know this, but don’t like it, as the moral hazard issue is extreme. Left alone, it becomes a race to the bottom where the national govt with the most deficit spending ‘wins’ in real terms even as the value of the euro falls towards 0. When the national govts were making ‘good faith efforts’ to contain deficits, allowing counter cyclical increases through ‘automatic stabilizers’ and not proactive increases, it all held together. However what Greece and others appear to have done is ‘call the bluff’ with outsize and growing deficits and debt to gdp levels, threatening the start (continuation?) of this ‘race to the bottom’ if they are allowed to continue.

The question then becomes how to limit the banking system’s ability to finance unlimited national govt. deficit spending. Hence talk of Greek securities not being accepted at the ECB. Other limits include the threat of downgraded bonds forcing banks to write down their capital and threaten their solvency. And once the banking system reaches ‘hard limits’ to what they can fund a system that’s already/necessarily a form ‘ponzi’ faces a collapse.

The other problem is that when the euro was on the way up due to portfolio shifts out of the dollar, many of those buyers of euro had to own national govt paper, as their is nothing equiv. to US Treasury securities or JGB’s, for example. That helped fund the national govs at lower rates during that period. That portfolio shifting has largely come to an end, making national govt funding more problematic.

The weakening euro and rising oil prices raises the risk of ‘inflation’ flooding in through the import and export channels. With a weak economy and national govt credit worthiness particularly sensitive to rising interest rates, the ECB may find itself in a bind, as it will tend to favor rate hikes as prices firm, yet recognize rate hikes could cause a financial collapse. And should a govt like Greece be allowed to default the next realization could be that Greek depositors will take losses, and, therefore, the entire euro deposit insurance lose credibility, causing depositors to take their funds elsewhere. But where? To national govt. or corporate debt? The problem is there is nowhere to go but actual cash, which has been happening. Selling euro for dollars and other currencies is also happening, weakening the euro, but that doesn’t reduce the quantity of euro deposits, even as it drives the currency down, though the ‘value’ of total deposits does decrease as the currency falls.

It’s all getting very ugly as it all threatens the value of the euro. The only scenario that theoretically helps the value of the euro is a national govt default, which does eliminate the euro denominated financial assets of that nation, but of course can trigger a euro wide deflationary debt collapse. The ‘support’ scenarios all weaken the euro as they support the expansion of euro denominated financial assets, to the point of triggering the inflationary ‘race to the bottom’ of accelerating debt expansion.

Bottom line, it’s all an ‘unstable equilibrium’ as we used to say in engineering classes 40 years ago, that could accelerate in either direction. My proposal for annual ECB distributions to member nations on a per capita basis reverses those dynamics, but it’s not even a distant consideration.

Where are ‘market forces’ taking the euro? Low enough to increase net exports sufficiently to supply the needed net euro financial assets to the euro zone, which will come from a drop in net financial assets of the rest of world net importing from the euro zone. This, too, can be a long, ugly ride.

As a final note, the IMF gets its euros from the euro zone, so using the IMF changes nothing.

Comments welcome!

The Next Global Problem: Portugal

By Peter Boone and Simon Johnson

Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a principal in Salute Capital Management Ltd. Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of 13 Bankers.

April 15 (NYT) — The bailout of Greece, while still not fully consummated, has brought an eerie calm in European financial markets.

It is, for sure, a huge bailout by historical standards. With the planned addition of International Monetary Fund money, the Greeks will receive 18 percent of their gross domestic product in one year at preferential interest rates. This equals 4,000 euros per person, and will be spent in roughly 11 months.

Despite this eye-popping sum, the bailout does nothing to resolve the many problems that persist. Indeed, it probably makes the euro zone a much more dangerous place for the next few years.

Next on the radar will be Portugal. This nation has largely missed the spotlight, if only because Greece spiraled downward. But both are economically on the verge of bankruptcy, and they each look far riskier than Argentina did back in 2001 when it succumbed to default.

Portugal spent too much over the last several years, building its debt up to 78 percent of G.D.P. at the end of 2009 (compared with Greece’s 114 percent of G.D.P. and Argentina’s 62 percent of G.D.P. at default). The debt has been largely financed by foreigners, and as with Greece, the country has not paid interest outright, but instead refinances its interest payments each year by issuing new debt. By 2012 Portugal’s debt-to-G.D.P. ratio should reach 108 percent of G.D.P. if the country meets its planned budget deficit targets. At some point financial markets will simply refuse to finance this Ponzi game.

The main problem that Portugal faces, like Greece, Ireland and Spain, is that it is stuck with a highly overvalued exchange rate when it is in need of far-reaching fiscal adjustment.

For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012. With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment. The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess.

Neither Greek nor Portuguese political leaders are prepared to make the needed cuts. The Greeks have announced minor budget changes, and are now holding out for their 45 billion euro package while implicitly threatening a messy default on the rest of Europe if they do not get what they want — and when they want it.

The Portuguese are not even discussing serious cuts. In their 2010 budget, they plan a budget deficit of 8.3 percent of G.D.P., roughly equal to the 2009 budget deficit (9.4 percent). They are waiting and hoping that they may grow out of this mess — but such growth could come only from an amazing global economic boom.

While these nations delay, the European Union with its bailout programs — assisted by Jean-Claude Trichet’s European Central Bank — provides financing. The governments issue bonds; European commercial banks buy them and then deposit these at the European Central Bank as collateral for freshly printed money. The bank has become the silent facilitator of profligate spending in the euro zone.

Last week the European Central Bank had a chance to dismantle this doom machine when the board of governors announced new rules for determining what debts could be used as collateral at the central bank.

Some anticipated the central bank might plan to tighten the rules gradually, thereby preventing the Greek government from issuing too many new bonds that could be financed at the bank. But the bank did not do that. In fact, the bank’s governors did the opposite: they made it even easier for Greece, Portugal and any other nation to borrow in 2011 and beyond. Indeed, under the new lax rules you need only to convince one rating agency (and we all know how easy that is) that your debt is not junk in order to get financing from the European Central Bank.

Today, despite the clear dangers and huge debts, all three rating agencies are surely scared to take the politically charged step of declaring that Greek debt is junk. They are similarly afraid to touch Portugal.

So what next for Portugal?

Pity the serious Portuguese politician who argues that fiscal probity calls for early belt-tightening. The European Union, the European Central Bank and the Greeks have all proven that the euro zone nations have no threshold for pain, and European Union money will be there for anyone who wants it. The Portuguese politicians can do nothing but wait for the situation to get worse, and then demand their bailout package, too. No doubt Greece will be back next year for more. And the nations that “foolishly” already started their austerity, such as Ireland and Italy, must surely be wondering whether they too should take the less austere path.

There seems to be no logic in the system, but perhaps there is a logical outcome.

Europe will eventually grow tired of bailing out its weaker countries. The Germans will probably pull that plug first. The longer we wait to see fiscal probity established, at the European Central Bank and the European Union, and within each nation, the more debt will be built up, and the more dangerous the situation will get.

When the plug is finally pulled, at least one nation will end up in a painful default; unfortunately, the way we are heading, the problems could be even more widespread.

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European Retail Sales Decline Most in Nine Months

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‘market forces’ are driving national deficits higher via automatic stabilizers which drives the euro lower to the point exports rise sufficiently to turn the tide, but that needs to happen before the rising deficits result in defaults.

On Thu, Apr 8, 2010 at 6:04 AM, La-Toya Elizee wrote:

European Retail Sales Decline Most in Nine Months

Revamped ECB Lending Rules May Cause Greece Pain

German Factory Orders Unchanged After January Jump

French Trade Deficit Widened in February on Imports

Capital flight squeezes Greek banks

Italy needs deep reform, say employers

Spain’s Industrial Output Falls More Than Expected in February

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Euro finance ministers to agree on Greek aid: source

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Without an interest rate and a credible quantity pledged, the agreement is grossly deficient.

The way Greece obtains funding is by offering ever higher rates until there is a taker.

So let’s say they offer securities at 5%, then 6, then 7, then 10, then 15, then 20 with no takers. How high do they go before they tell the EU group they have failed to obtain funding?
And then what rate does the EU charge them if they agree?

The process makes no sense.

The way to do it is for the EU group to offer funding at some rate, giving Greece some amount of time to try to find a better rate.

Euro finance ministers to agree on Greek aid: source

By Jan Strupczewski

March 13 (Reuters) — Euro zone finance ministers are likely to agree on Monday on a mechanism for aiding Greece financially, if it is required, but will leave out any sums until Athens asks for them, an EU source said on Saturday.

Policymakers have been debating possible financial support for the heavily-indebted European Union member state for more than a month, but have provided only words of support. Germany, key to any deal, has resisted appeals to promise aid.

British newspaper The Guardian on Saturday quoted sources as saying Monday’s meeting of the currency zone’s 16 finance ministers would agree to make aid of up to 25 billion euros available.

But a senior EU source with knowledge of preparations for Monday’s meeting told Reuters no numbers were likely at this stage.

“I think we should be able to agree on principles of a euro area facility for coordinated assistance. The European Commission and the Eurogroup task force would have the mandate to finalize the work,” the source said.

“It would be the principles and parameters of a facility or mechanism, which then could be activated if needed and requested.

He said no figure had been agreed.

“You would have a framework mechanism and you would have blank spaces for the numbers because there has been no request (from Greece) yet,” the source said.

Greece has announced steps to reduce its budget deficit this year to 8.7 percent of GDP from 12.7 percent in 2009, triggering street protests and strikes but also reducing market concern over whether the country would be able to service its debt.

That helped Athens sell its bonds with ease on debt markets earlier this month, but policymakers are still searching for ways of making its cost of borrowing — still far above that of other Europeans — more sustainable.

They are also concerned that the problems in Greece could undermine confidence in the euro and spread to other heavily indebted eurozone countries such as Portugal or Spain.

CUTBACKS

The EU source said that among the instruments considered to help Greece were both bilateral loans and loan guarantees.

“The preparations have been done under the Eurogroup by member states and the Commission. The Commission has done much of the technical work,” the source said.

“The aim of the exercise so far has been to do the technical preparations, so that the political decision could be possible on Monday. Germany holds the key at the moment.”

Polls show that public opinion in Europe’s biggest economy Germany is strongly opposed to bailing out Greece, which has for years provided unreliable statistics about the true size of its deficit and debt, breaking EU budget rules.

In a move that is likely to alleviate German concerns about spending money on Greece, the Commission has said it would soon make a proposal for stronger economic cooperation between euro zone countries and tighter surveillance of their performance.

French Economy Minister Christine Lagarde told the Wall Street Journal she believed Greece’s austerity moves were behind the improvement in its situation on markets and negated the need for a bailout.

“”There is no such thing as a bailout plan which would have been approved, agreed or otherwise, because there is no need for such a thing,” she said.

But she added that “technical experts” at the EU have been working on a contingency plan, so that if the need arose “all we would have to do is press the button.”

The Guardian quoted a senior official at the European, the EU executive, official as saying the euro zone members had agreed on “coordinated bilateral contributions” in the form of loans or loan guarantees if Athens was unable to refinance its debts and called on the EU for help.

The agreement has been tailored to avoid breaking the rules governing the operation of the euro currency which bar a bailout for a country on the brink of bankruptcy, and to avoid a challenge by Germany’s supreme court, the official said.

A German ministry spokesman said he could not believe the newspaper’s report on the bailout plan was correct.

“We are not aware that this is being planned,” he said, adding that Greece had not requested any aid. “Greece is implementing its (savings) program and we expect that it will manage it alone.”

(Additional reporting by Tim Pearce in London, Pete Harrison in Brussels and Volker Warkentin in Berlin, Writing by Sarah Marsh and Jan Strupczewski; Editing by Patrick Graham)

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Eurozone downward spiral continues

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Looks to me to be getting more desperate with increasing rhetorical nonsense.

Higher deficits due to falling revenues and rising transfer payments simultaneously weaken both the euro and national govt credit worthiness in a race against time.

And any budget cuts will only further cut aggregate demand and output, cut already falling tax revenues,
and increase unemployment and transfer payments, adding to deficits and further eroding creditworthiness.

The only hope is for a quick enough recovery that brings down deficits through exports, or, evern more unlikely, through domestic credit expansion, before the rapidly deteriorating national govt credit worthiness results in systemic failure of the payments system.

The ramifications of a banking sytem where deposits are guaranteed only by the national govts as yet
to make front page discussion, but nonetheless this structural flaw remains an ongoing source of system
risk capable of shutting down the entire euro payments system.

My proposal for an immediate and annual distribution of 1 trillion euro from the ECB to the national govts on a per capita basis will end the crisis and provide the framework for the national govt credit worthiness needed to reverse current downward spiral.

And not only does it not introduce moral hazard risk, it does the reverse by allowing
for withholding of future payments for non compliance of EU mandates.

Germany’s IG Metall, Employers Agree on Pay, Job Security

German States’ Budget Deficit Increases, Handelsblatt Reports

France’s Lagarde Sees ‘Fragile, Painstaking’ Economic Recovery

Isae Raises Italy’s 2010 Growth Forecast to 1% on Exports

Premier Insists Spain’s Economic Recovery Is Near but Offers Few Details

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