What are PGS doing?

What are Portugal, Greece and Spain doing about their fiscal positions?

Here's an account. It is rather incomplete, but it gives some insights. For simplicity, and because it is originally in Portuguese, I include the picture below in this post. The conclusion is that they are doing something, and except the unavoidable tax hikes, the reforms seem to be quite positive for productivity, savings and growth. Hopefully some of these reforms will be permanent...

I will also try to see if I can find the links to the Stability and Growth programmes that these countries submitted to the European Commission.

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(This is a late addition to the original post)

For another overview of the situation with the PIIGS, here's what The Economist has to say.

How to read exclusive articles on the FT's website

I've made a comment about this in a previous post, but I'll make a more thorough point about it now in this post, if for no other reason that I'll refer to this post each time I'll link anything to a FT article.

Many times when I link to the FT's website, the article will not seem to be accessible. A message will pop up saying that you need to subscribe to access that type of article or that you have reached your limit for the number of article that you can view for a specific period of time (generally 30 days).

So here's the disenchanted magic: If you use firefox for example, although you won't be able to see the title of the article inside the window, because it is covered by the error message, you can still see it on the top left-hand corner of the screen, as the title of the window. All you have to do is to copy the title of the relevant article into google and search for it. Among the results that you'll obtain you'll find what seems, by all accounts, to a link to the window you were just redirected from this website. The only difference is that the link from google works, where as the link from this blog, or for that sake from the FT's own website does not.

So there you go. That's the googly magic of FT articles!

It's so annoying I'm starting to get depressed...

I feel for European Integration, particularly the economic part of it. It never has any respite. It is constantly attacked from every corner. Today the Euro is attacked for being too weak as a result of the fiscal crisis. Yesterday it was accused of threatening European competitiveness because monetary policy was too strict thus causing exchange rates between the Dollar and the Euro to be too high. Before that the problem was that European currencies fluctuated too much among themselves, thus creating comercial tensions between the EU's member states. We are sklerotic, we are Byzantine and we are lazy. We don't innovate and we are too rigid. Now we are too flexible and soon we'll be extinct. It seems that the only time we were happy was during the "30 glorious" years after WWII. How ridiculous that support for Europe is dependent on economic growth. This crisis will pass as all others have and as the next ones will. The world will not fall apart, and the Eurozone won't desintegrate. The European Dream will survive, but nay sayers will always find an excuse to say that it is falling apart.

It's going to be painful,but European economies will pull through. Commentators are talking as if this was the first time we had to tighten our belts... Portugal had to be bailed out by the IMF in the 1980s. My country has a lot of problems, but we pulled through. There's no reason Greece, or any other country, won't. We'll fix our houses; Germany, France, the Benelux, Sweden and Finland will make sure of this. In some years we'll be fine. The Euro will be close to parity with the USA, and eventually inflation will calm down. We might even experience a little bit of an export led boom, and hopefully the weight of fiscal pressures will revive budget rationalisations about defence expenditure. Not withstanding my ideosincracies though, Gideon Rachman is depressed... and his is a pretty contagious sort of depression. On the other hand, there's always Liberation's Jean Quatremer, who at least is slightly more realistic about the cyclical nature of this pessimism. Charles Wyplosz also offers some comfort in this article from Bloomberg.

The Southern European Problem: Not Speculation, Not Just Fiscal Profligacy, but Structural inconsistencies

Wolfgang Munchau of the FT has a very good article published online last night, about the problems in the Eurozone, particularly in its southern members. (here's a little trick for accessing restricted news reports from the FT: Copy paste the title of the relevant article on google and click on the relevant link. For some reason this grants you access to otherwise restricted articles) It says that the problem is not speculative financial attacks on the debt of these countries, nor that it is just fiscal profligacy. It argues instead that the root problem is structural, and that there is a need for economic reform of the labour market, where wages are much above productivity. As a result these countries are not competitive vis à vis its northern neighbours.

I completely agree with it. But I need data to confirm this. I'll be updating this post.

What future for the Euro after the bail out?

5 very interesting articles from www.VoxEU.org :

"Greece: The start of a systemic crisis of the Eurozone?" by Paul De Grauwe, from Leuven

"Greek lessons", by Michael Burda and Stefan Gerlach, felows of CEPR

"European Stabilisation Mechanism: Promises, realities and principles", by Charles Wyplosz, CEPR fellow

"Financial Stability beyond Greece: Making the most out of the European Stabilisation Mechanism", by Daniel Gros and Thomas Mayer, CEPS and Deutsch Bank respectively

"How to deal with sovereign default in Europe: Towards a Euro(pean) Monetary Fund", by Daniel Gros and Thomas Mayer, CEPS and Deutsch Bank respectively

Worrying about structural reform in Europe (late post from 11/05/2010)

Now everyone calms down... Some insightful views on the EU and its economic future: Europe is unprepared for austerity, by FT's Gideon Rachman Markets rally runs out of steam, by the FT's Tony Barber, Ralph Atkins, David Oakley and Justine Lau "Le retour à l'équilibre des finances publiques est un impératif catégorique", an interview of Laurence Boone, by Jean Quatremer and finally, Project Europe 2030- Challenges and Opportunities, a report on the future of Europe by the Gonzalez Committee

Bailing out Greece: A great business deal!!

This note was posted as a comment on the FT, Brussels Blog at http://blogs.ft.com/brusselsblog/2010/05/mother-of-all-rescue-plans-buys-europe-time-but-can-it-work/#comments:

"Germany is all “abuzzing” about the costs of bailing out “lazy” Greeks. But how much did it cost Germany to bail out Greece? Well apparently letting Greece scare the markets and then bailing it out is a good business model. As it turns out, Germany made at least a €8.6Bn profit off it. May be even as much as €25.4Bn. How? Let’s see:

The cost of bailing out Greece was €22.4 Bn over 3 years, according to Der Spiegel. (http://www.spiegel.de/international/europe/0,1518,693579,00.html)

However this saved German banks from a balance sheet hole of as much as €33Bn, due to their exposure to Greek sovereign debt. (http://www.spiegel.de/international/europe/0,1518,693579,00.html)

It also turns out that a weak Euro, caused by Greek fiscal profligacy probably helped German exports. It is hard to say by how much, but given that exports had grown by 1% on average over the last year or so, and that they grew by 21% in March, I have generously considered that 14.81Bn out of the total 85.6Bn of German Export may have been caused by the low value of the Euro. (http://www.ft.com/cms/s/0/f6e35528-5c1f-11df-95f9-00144feab49a.html ) Finally it seems that the DAXX regained all the losses it incurred last week. (http://markets.ft.com/ft/tearsheets/performance.asp?s=569857&ss=WSODIssue)

So I propose two estimates of the German economic profit from rescuing Greece:

If you think that my estimated effect of the low Euro is exaggerated, which it probably is, then at worse, the bail out saved German banks from incurring those losses. As such Germany made an economic profit of as much as €8.6Bn from saving Greece.

None the less the low value of the Euro must have had some impact on Germany’s. Although the effect might not have been as high as to account for a whole €14.8 Bn worth of added exports, I guess one could establish that as a decent ceiling of how good the devalued Euro might have been for Germany. If that’s so, then we have to accept that Germany might have made a total of up to €25.4Bn from rescuing Greece.

Not such a bad deal after all… "

uau!! €500Bn is a lot of money!!

As Jean Quatremer (notice the reference to the IMF) of Liberation writes the Eu revolutionized itself last night, by creating the puffiest safety cushion on earth:

Markets rally on €750bn EU bail-out - FT

EU Crafts $962 Billion Show of Force to Halt Crisis - Bloomberg

EU Turns to 'Nuclear Option' to Halt Euro Speculation - Der Spiegel

“Mother of all rescue plans” buys Europe time - but can it work? - Tony Barber from Brussels Blog at the FT

Wolfgang Muchau of the FT joins his colleague on a gloomy analysis of the Fiscal package. He makes two interesting points. One about fiscal union and another about national economic reform:

On the first he says that "this deal is going to be ineffective beyond the very short term, unless it is followed up by substantive reforms – the introduction of a single European bond, an agenda to co-ordinate economic reforms with specific relevance for the monetary union, policies to reduce economic imbalances, much tighter supervision of fiscal policies that kick in well before budgets have already been announced, and, in my view also a kernel of a fiscal union – in essence all the things over which the EU has been, and still is, in denial."

I guess I must take issue with this. It As I have shown in this post, there is already a single European Bond, which has existed in theory since 1988. The ECOFIN already is a forum for coordinating economic reforms, and it is expected to be revamped by the commissions' proposals to be presented in two days. This will probably see the implementation of tighter supervision.

I agree that this is not tantamount to fiscal Union, but it leads the way for it, under enhanced cooperation.

Regarding to economic reform, Mr Munchau says that "the private sector [in Portugal is and in Spain ]massively indebted. The prices of assets that serve as collateral are still falling. The Spanish government, as guarantor of the banking sector, will be lumbered with rising debts at a time of stagnating economic growth. We should remember that solvency is not primarily related to financial markets’ willingness to lend. That’s liquidity. You are solvent when you can stabilise your debt as a proportion of income. Southern Europe’s solvency position is thus unaffected by the billions."

Here I must agree with it, but according to the general argument this is a problem intrinsic to the Eurozone. Because there is only one interest rate for all 16 countries, it cannot effectively target everyone. As a result the rates are too low to contain inflation in Portugal and Spain and too high for Germany and the Benelux. However there's a problem with this argument, it completely disregards the fact, that banks as intermediators should price debt better than they do in Portugal and Spain. Just because they can borrow cheaply, it does not mean that they cannot lend more expensively. My guess is that this has been possible in Portugal because a lot of people were guaranteed to pay their debts because so many people work for the state. In Spain the mechanism must have had something to do with the economic growth and the real estate boom. However this conjuncture has been changed and with the reforms to be implemented, it should change even more. As unemployment increases, as civil servants' salaries are frozen and as other such austerity measures are implemented (please stop hiring new civil servants!!) banks should start to price risk at a higher rate and thus the cost of borrowing should increase, thus increasing the rate of savings in countries like Portugal and Spain. More over it should also force them to move their money abroad, to less risky investments. This is of course if publicly owned banks don't loan at lower rates than those of the market for political and electoral reasons. The hope is that this won't lead to a debt deflationary crisis.

Before I go though, here's the council communiqué from last night about the fund/Financial Stability Facility in question. As you can see it is sparse on details and qualitative clarity. It is very clear quantitatively though!

What do you think?

The European Commission can Contract Debt on behalf of the whole of the EU!!

I am godsmacked by my own ignorance! I had no idea about this but apparently the European Commission has been able to contract debt on behalf of all of its member states since 1988. This is heavily regulated, but has been brought forward as a reform channel now that the EU needs to set up an emergency fund to calm down the markets.

I came across it on this article by Mr Anthony Barber from the FT.

After researching a bit, these are the relevant sources that I found:

The relevant press release, which among other things gives info on the debt:

"The EC has carried out three euro bond issues since last year to finance a first instalment of €2 billion for Hungary (disbursed early December 2008), a second instalment also to Hungary and also of €2 billion (disbursed late March) as well as a first instalment of €1 billion to Latvia (paid in February). The last issue, placed on 17 March and due on 7 November 2014 (5-year maturity), was priced 3.25%."(implemented to help Hungary and Latvia).

Council Regulation (EC) No 332/2002 of 18 February 2002 reforming the original 1988 regulation, forbiding its application to the Eurozone countries but allowing its use to non €zone countries. Also extending the fund to 25 Billion.

The original Council Regulation (EEC) No 1969/88 of 24 June 1988 establishing a single facility providing medium-term financial assistance for Member States' balances of payments.

More details on the implications soon to come, but for the time being I can think of this:

If the finance ministers intend to use this debt facility as a channel for dealing with and calming debt markets, then they will face 1 obvious hurdle and 2 potential problems. The obvious problem is that the regulation is very clear. This debt facility only applies to NON EUROZONE countries. At the very least they will have to pass another regulation by the end of the night in order to get it to also apply to Eurozone countries. Then there's the fact that I haven't et checked whether there's anything written about it in the Maastricht, Amsterdam, Nice or Lisbon treaty, that also specifies the scope of this regulation. If so it is an enormous problem, tantamount to requiring EU constitutional reform, which takes ages. Finally it is possible that the ECB may play a role in this and as such it would be interesting to see what obstacles it would pose to the expansion of this subreptitious European Monetary/Debt Fund.

Eurozone inevitably an Optimum Currency Area (OCA)?

I posted the following comment on Prof. Krugman's blog for the New York Times. What do you think?

"

Prof. Krugman,

As you say the arguments on the shortcomings of European EMU as an OCA have been known ever since the early 1990s. If a group of economies are very open and trade in differentiated products, then as they are exposed to asymmetric shocks, they must have flexible wages and prices, high labour mobility, or alternatively, there must be some form of homogeneity and/or solidarity to ensure that transfers from one country to another balance the asymmetric shock. Otherwise one group of countries benefits from the union at the detriment of another. This is simple enough and it is what is taught in every decent manual on the economics of the EU. Moreover, it is easy to see how France and Germany might initially have benefitted from Greece's fiscal crisis. After all a cheaper € makes for more competitive exports.

What no one seems to focus a tremendous amount is on the merits of the Euro. First of all, the public and the commentators seem to have forgotten about all the exchange rate crises of the 1970s-1990s. Increased trade interdependencies expose EU member states to each other's bad governance, forcing to create arrangements to protect themselves from each other. The ERMs and the EMS were the first attempts at dealing with this issue, but proved incomplete at best, leading to the creation of the €. If the latter was to disappear, then we'd be back to the early 1990s.

Finally, speaking as a Portuguese and as a social scientist I must also admit that the euro also presents a welcomed pressure for necessary economic reform. By creating a tighter system of monitoring between the member states, it divulges more information about the quality of their performance. If for the € to work, it requires a strengthening of internal monitoring and if this increases the pressures for rationalisation of policy making and reform, then I can only conclude that the € is positive for its less efficient member states.

It seems that European integration happens through trial and error along a fairly clear integrationist path. As with any other polity, decision makers tweak and fine tune the machine. When each monetary mechanism failed after another, the argument for the € became more and more credible. Now that the consequences of the shortcomings of the Stability and Growth Pact have been brought to light, the structure will be kept with enhanced powers and institutional support, and my guess is that sooner rather than later there will be a certain amount of fiscal powers transferred to Brussels in order to fulfil the OCA.

On the USA though, by the standard of its time the country would not have been seen as any more homogenous than the Hapsburg Empire, with all its religions and languages (English, German, French). Moreover until the Civil War most Americans considered themselves first and foremost Virginians, New Yorkers, etc, and only after that Americans. Yet the dollar, fragile though it may have been, existed before the 1870s. The EU in that sense is not very different from the early USA or India, although we do not have a military threat as a catalyst for integration.

Before I conclude, I would like to add that the issue of labour mobility is limited first and foremost by language diversity. This however seems to be a decreasing problem as the vast majority of Europeans are now adopting English as their second language, thus making it the continent's "lingua Franca". This should solve the issue of labour mobility in the next 2 to 3 generations.

To conclude, just because the €zone is not an OCA, it is not automatically undesirable. Moreover just because it is now a second best option, it does not mean that it will not become a first best option in the future, as labour mobility will increase and as geographical automatic stabilizers will start to play a bigger role "

Readings on the Debt and EU-USA integration

Friday - 07/05/2010

Some interesting readings from www.VOXEU.org:

"Greece, Portugal and Spain: Lessons from Argentina", by Domingo Cavallo, Joaquín Cottani

"What will happen if Greece defaults? Insights from theory and reality", by Eduardo Borensztein, Ugo Panizza

"Untapping the EU-US trade potential: Taking the Transatlantic Economic Council forward", by Lucian Cernat, Bertin Martens -----

Debt markets in the next two weeks

This article is extremely insightful. However I must disagree with the analogy between Greece and Bear Stearns. This is inappropriate because Greece is getting bailed out, Bear Stearns wasn’t. If anything Greece should be compared to Morgan Stanley who was bailed out.

Moreover, the contagion to Portugal, Spain, Ireland and Italy is similar but on a much smaller scale. When Bear Stern filed for bankruptcy, the devastation was enormous because suddenly reputation was worthless. Therefore markets were unable to know who was in a good financial position and who wasn’t. Bad money crowded out good money which almost brought trading to a halt. In the present situation however markets know that Northern Europe’s credit is good. The doubt is as to whether all of Southern Europe is worse off than its northern neighbours and if so by how much.

Thus reactions are probably extremely exaggerated. Greece cooked its books for some years until it was impossible to hide the mess any longer. Portugal, Spain, Ireland and Italy for all we know have been honest in their reporting. Now of course no one is in a great place right now. Portugal has a private debt to GDP ration above 200% and requires some very fundamental changes in the way its economy works. Spain is going through 20% unemployment rates. Ireland has the EU’s largest deficit this year. So the fundamentals are not quite there, and in the long run it is both predictable and good that the financial markets are putting some pressure on these countries to fix their economies.

I would venture the guess that asymmetries of information between the governments and their lenders are causing the latter to exaggerate the extent of risk that they are exposed to. They are also increasing the effect of rumours and gossip in trading, such as Morgan Stanley's Joachim Fels' argument that the Euro-area is at risk. If this is the case, then things should either get much better or much worse for Portugal, Spain and Italy in the next 2 weeks. On May 12 data pertaining to the first quarter of 2010 about the national accounts of Portugal and the preliminary Italian and Spanish GDP values will be published. On May 19, the Spanish national accounts data will be published and the next day Italy will publish its latest industrial turnover figures.

The dissemination of this information should decrease the asymmetries of information and give a better idea of how solvent these countries are. Of course whether the new data will be favourable to the reporting nations is completely unknown. If it is, sovereign debt yields should shrink. If isn’t, then there might be yet another run on their debts and on the Euro. If the latter occurs, I would expect the ECB to start purchasing national debt on the secondary market in order to limit contagion. This should lower the prices of national debt, while maintaining some institutional pressure on EU member states to reform. All that the ECB has to do is to warn that in the absence of reform it will dump suspicious sovereign debt on the markets, causing a fairly predictable increase in their price.

Until then the markets should continue to behave a bit nervously, at least for another week, unless something new happens, like some oil shock, a or some freak revolution in Greece. Moreover, they will probably go a bit bonkers with the fact that there wont be a clear cut majority in Westminster. The Greek parliament could fail to approve EU/IMF assistance, or the upcoming summit of the council leaders could be either very successful or very unsuccessful in drafting plans for dealing with fiscal problems and reforming the Stability and Growth Pact (Hopefully they'll come up with decent plans for the EMF rather than for an actual European rating agency). Finally some rating agency might downgrade one of these countries yet again. What do you think?