Tag Archives: Euro

Spain: predictable results in uncertain times

21 Nov

The most remarkable thing about yesterday’s election results in Spain is how unremarkable and predictable they were. For weeks, the opinion polls had been predicting that the incumbent Socialist government would be trounced and it duly was. The opposition Partido Popular (PP), lead by a seasoned PP politician, Mariano Rajoy, won 186 seats in the 350 seat assembly. The Socialist Party, the PSOE, won 110 seats. In terms of percentage of the vote, the PP’s victory was all the more striking: 44.62% of the vote for the PP, 28.73% of the vote for the PSOE. The scale of the PP’s victory was no doubt a reflection of the widespread disaffection with the governing Socialists. But beyond that, there was little in the results that indicated the scale of the economic and social crisis the country is facing. No new political formations have been thrown up by the crisis. The United Left party (IU) won 11 seats and 6.2% of the vote – not an insignificant result. But generally the smattering of small parties that won altogether 54 seats were an ideological mixture: left, right, Catalan and Basque nationalist. The Indignados movement, fueled by a widespread disenchantment with the ruling political class, did not prompt any mass withdrawal from the electoral process. Their slogan – They Don’t Represent Us! – did not seem to have much impact. The abstention rate was 28.3%: higher than in the two previous elections (2008 and 2004) but lower than in 2000.

Though unemployment stands at above 20% and the country’s ability to auction its bonds on the international market is looking shakier by the day, the prevailing sentiment in the course of the campaign was that of resignation. Rajoy himself did not propose any new ideas on how to tackle the crisis. His cryptic slogan that promised to transform Spain into the “Germany of the South” could be interpreted in a multitude of ways. His promises of fiscal rectitude and public sector reform was – in the absence of specificities – no more than a vague nod in the direction of both the markets and the EU. That an election at such a crucial time should throw up so few surprises is perhaps a fair reflection of how people are responding to the crisis. But in the case of Spain, it is surprising. After all, when the global financial crisis hit in 2008 Spain was performing well. Its government did not – contrary to Greece – run up large debts in the good times. Public borrowing was low as tax receipts from high growth rates ballooned. In 2007, its debt ratio was only 36% of GDP and from 1999 through to 2008 Spain ran a balanced budget on average i.e. its borrowing was equal to zero.

Spain’s problems today are in part the result of an asset price bubble. Whilst the government did not run up debts during the boom years, private borrowing in Spain rose rapidly as individuals were able to access credit easily via national and international channels. When the downturn struck, individuals found themselves saddled with extensive debts. Regional Spanish banks have also been left with a large number of bad loans, made to finance real estate projects that will never see the light of day. Repayment of these debts has cast a long shadow over the Spanish economy as spending power is squeezed and as banks refrain from financing the private sector.

However, this does not explain why the Spanish government is today struggling to find buyers for its bonds. That is to do with the common currency union. In a downturn, governments usually run up debts in order to pay for increases in welfare payments: with +20% unemployment in Spain, those payments are large but given Spain’s position at the beginning of the crisis it should be able to weather the storm. However, because of the common currency union, the use of automatic stabilizers is limited: Spanish government borrowing is judged not on its own terms as much as in terms of the wider dynamics of the Eurozone. The fact that these automatic stabilizers would have an inflationary effect which would reduce the debt burden in the longer term is also ruled out by the currency union. The disciplinary effect of monetary union is thus not neutral but specifically kicks in to restrain some policies rather than others. As already argued on The Current Moment, the effect is to structurally lock countries into internal adaptations through domestic wages and prices instead of adapting through a mixture of internal and external measures.

A measure of success for today’s protest movements should surely be whether or not they are able to challenge ruling orthodoxies in ways that impact upon electoral outcomes. The evidence from Spain is that up until now, protests have had no such impact.

Explaining the strong Euro

31 Oct

As Europe’s sovereign debt crisis rages on, it is easy to forget about the Euro. In the midst of the crisis, the currency itself is holding up remarkably well. Andrew Watt,  over at Social Europe, has asked how it is possible that the currency – which many are predicting will soon disappear under the pressure of its own internal contradictions – is actually comparatively strong. He noted that the currencies weakened most by the crisis are the US dollar and the UK pound. The Eurozone’s sovereign debt problems have affected the value of the Euro but mainly in a way that has seen it depreciate against “safe haven” currencies such as the Swiss Franc. It has not so far depreciated significantly against the pound or the dollar. This may change, given the impact of the ECB’s decision over a year ago to start buying up the government bonds of countries like Greece. Deutsche Bank predicts that against the dollar the Euro will over the next 12 months depreciate from 1.38 $ per Euro to 1.25 $/Euro. Significant as that may be, it is also noteworthy for the EU’s current starting point, which is relatively strong against the dollar.

Watt correctly pointed to the European Central Bank as key to the Euro’s movements. One big difference between the Bank of England and the Federal Reserve in the US and the ECB in Frankfurt has been the practice of quantitative easing by the British and US central banks. One intention behind printing money is to depreciate the currency (by putting more dollars and pounds in circulation) and thus stimulate exports. The UK pound lost 1% of its value against the Euro after Mervyn King, director of the Bank of England, announced another 75 billion pounds of quantitative easing.

There is another way of looking at this same issue. A feature of the ECB is its peculiar exposure to political pressures. In some respects, it seems entirely immune from any such pressure. The ECB has maintained its hawkish policy on inflation, raising rates when all other comparable economies are cutting theirs. In 2011, the ECB has raised interest rates twice. With rates relatively higher in Europe, the pressure upwards on the Euro is maintained. It may seem absurd that as the Eurozone as whole struggles to avoid recession the outgoing ECB director congratulates himself on keeping inflation low. Trichet, in an article in Die Spiegel, earlier this year, was dubbed “the German Frenchman”. Over on the FT’s Alphaville blog, much is made of the ECB’s insulation from political pressures. As Joseph Cotterill quite rightly notes, the ECB is not here to save the world. Those expecting the ECB to transform itself into the Eurozone’s political saviour will be disappointed.

But to say that the ECB is entirely insulated from political pressure is wrong. Rather, its exposure to such pressures is selective. The decision by Trichet in May 2010 to start buying up the sovereign bonds of embattled European economies prompted the departure of then German board member and head of the German Bundesbank, Axel Weber. This decision, which saw the ECB go beyond the terms of its mandate, was widely seen as evidence of French pressure. The ECB’s role is thus far from politically neutral. Its actions reflect the specific configuration of the European Union’s supposedly supranational institutions. Formally independent from member states, these institutions are heavily shaped by the outlooks and preferences of national executives and national officials. At the same time, they are very far removed from events on the ground and from the concrete interests of majorities within EU member states. The ECB’s actions reflect the varied interests of Europe’s governments but not those of its people.

Guest Post: Europe and Democratic Funding

27 Oct

Editors’ Note: The European banking crisis continues to unsettle markets, and to raise serious doubts about not just the economic but also political future of current European institutions. As our guest post today by Anush Kapadia points out, underlying the turmoil is the achingly familiar ‘democratic deficit’ problem, but this time present in a new form. The basic democratic challenge this time reaches beyond the question of the EU’s institutional structure to the question of how its member states, and supranational institutions, relate to (financial) markets. As Kapadia points out, this democratic challenge, though it has special characteristics in the European case, is a general one facing any state seeking funding yet also seeking to retain enough autonomy to remain under the control of its citizens.

Europe and Democratic Funding

Anush Kapadia

The European crisis is one of legitimacy, not of the European project per se but of the financial fundamentals of moderns states. The lopsided nature of the European project merely serves to highlight the potentially undemocratic side of the financial undergirding of state power. It also foreshadows a potential solution to the problem.

It is not hard to notice that while scorn is routinely reserved for the unelected Eurocrats who want to squash national sovereignty, very little seems to be said about the legitimacy of unelected markets dictating terms to sovereign states. Morality, it seems, is on the side of the creditor: sovereigns, like us ordinary folk, should pay their debts.

But sovereigns, like people, have a responsibility to maintain their own autonomy to the extent they can. When governments fund themselves in ways that put their sovereignty at risk, they are abrogating their democratic duty. This is the double-edged nature of government borrowing: democracy can be aided by the flexibility and liquidity of marketing government debt, but beyond a point debt turns to poison.

So how can democratic states take advantage of the bond markets without being consumed by them?

The answer from creditor-morality is simple: don’t borrow beyond your means. And there is truth in this homily. The problem of course is that the very extent of ones means is subject to the judgment of the self-same creditor. To a large degree, solvency is in the eye of the creditor.

For any economic unit, the pattern of cash inflows rarely maps perfectly on to the pattern of cash outflows. Individual cash (dis)hoarding can of course mitigate this mismatch; what we call “banking” is merely the socialization of this liquidity-matching function: units with excess inflow lend to units facing outflow constraints via the intermediation of a bank. If the matching process stops, a borrowing unit’s cash commitments can swamp its cash inflows: the unit is dead. If your creditors stop rolling over your debt, the music stops very quickly indeed.

Prudence dictates that the unit steer clear of such peril. Yet when faced with myriad constraints, units will load up on credit if that dimension is eased. The market price of the unit’s debt is meant to be an indicator of proximity to peril. Yet as we have seen, this indicator is notoriously fickle: one day the unit is extremely creditworthy, the next day it’s bust.

Now especially if the economic unit is a democratic state, it has a solemn duty to avoid such peril. This means that it has a solemn duty to avoid fickle funding. And this in turn means avoiding the bond market beyond the point of prudence.

This is exactly what Europe has been groping towards, willy nilly. It is precisely because Europe lacks a common fiscal authority that it is seeking this solution. In so doing, it foreshadows a more democratic method of state funding.

Most see Europe as an unfinished federal project and indeed weak on that score. What they miss is that Europe is a new experiment in interstate relations, not a slow-motion rerun of US history. The people of Europe do not want to be part of a federal state. This is axiomatic; it renders the nation-state analogy for Europe nugatory. Our imaginations are constrained by this nation-state frame.

This national impossibility is what ultimately ties the hands of the ECB as an effective lender of last resort; its paranoid ideology is merely icing on the cake. A prudent lender of last resort mitigates the fickle nature of market funding by stabilizing the credit system as a whole when the market mood inevitably turns. This function can only perform its stabilizing work if it has credibility; it has credibility because it is backed by a fiscal authority.

Thus if the ECB were to act as an adequate lender of last resort in this crisis, it would implicitly call into being the absent European fiscal authority. And this cannot happen because the European people don’t want it. The Bundestag is merely the institutional expression of this desire. Of course, if the ECB acts as a lender of last resort in this crisis without at least implicitly calling into being a common fiscal leviathan, the ECB itself will take the place of the impaired sovereigns as the target for the markets. A lender of last resort without fiscal backing is not credible; the markets will gnaw away at it until implicit backing is made explicit. The assets that the ECB purchases will lose value to the point where the ECB’s own balance sheet will start to look shaky; the Euro itself would start to melt away.

Hence all the machinations around the EFSF (recent summit statement here). One can see how this institution might be the kernel of a common fiscal authority, at least in its borrowing power if not (yet) its taxation power. And that’s what the fight is about now. The Germans want to keep it small and limited so that it won’t prefigure some kind of common fiscal mechanism, but if it’s too small it’s not credible enough to function as a lender of last resort.

So no ECB, no EFSF. And the markets are completely roiled. Where oh where can a distress sovereign go for funding? China.

Well, not literally, but certainly figuratively. With the ECB and EFSF hamstrung because of the latent common fiscality they imply, Eurocrats have to find another set of balance sheets with spare capacity. This is where the special-purpose-investment-vehicle (SPIV) solution enters the fray.

Without getting into the details, there are two current plans to bolster the capacity of the EFSF (ignoring the somewhat loopy French plan to turn it into a bank): make it an insurance company or make it a kind of collateralized debt obligation (remember those?). There might be some combination of these solutions, but the latter is the one to focus on.

Floating a SPIV by the EFSF means that the latter would create and underwrite an entity that would issue highly-rated bonds; the proceeds of this sale would be used to buy encumbered sovereign debt. (Note: The same structure was used to by mortgages; the resulting securities were thus called mortgage-backed securities. The same tranche structure is envisioned here so that private money take come in and take the more risky elements of the vehicle). And who are the potential sources of funding for this vehicle? Sovereign wealth funds and other “international public investors.” The patient, institutional capital, in other words, not the fickle market money.

Since these new investors have very deep pockets and have their eye on the very long-term (some of them are sovereigns themselves after all), they are not subject to the same incentives as normal players in the bond market. The latter tend to be highly-leverage and work on the narrowest of margins. Having drastically underpriced sovereign risk, the fickle money markets are now drastically overpricing it; yesterday’s promise of growth has turned in today’s demand for austerity. Long-term investors look at long-term value rather than short-term prices; think Buffet rather than Bear. These investors would typically hold the bonds to maturity and can ride out short-term fluctuations because of their deep pockets. And at the moment they are getting a deal.

The absence of a common fiscal authority in Europe has lead to a credibility crisis at its heart. Most see the solution to this as an aping of the history of the nation-state: “build a fisc already!”, this position screams. But that way is closed to Europe. They are charting a new history.

Because of these constraints, the Europeans are finding that another route to stability is in effect to de-marketize some portion of their sovereign debt and place it with buy-and-hold institutions. What we might consider is that Europe’s ex post crisis response might be a way of insulating democratic states from the fickle markets ex ante.

The analogy with bank funding is clear: part of the problem with banks leading up to the crisis was that they were funding in highly liquid markets at ever-shorter maturities and in ever-greater proportions. This made them vulnerable to a run; subprime burst the bubble and the inevitable run followed. What is the proposed solution? Mandatory funding durations imposed by the regulators: long-term assets ought to be funded by long-term liabilities to the extent possible.

The state is a long-term asset, our long-term asset. It needs a funding structure adequate to its long-term democratic duties. A state simply cannot legitimately allow itself to be bossed around by the markets. This means that the state (and the banks it underwrites) should not be allowed to fund in fickle markets beyond a certain point; no matter how cheap and liquid this funding appears, the cycle will turn and austerity will result.

The East Asians learned this after their crisis and responded with cash hoarding. But this is globally suboptimal: banking was invented so that we wouldn’t all have to keep our cash under our mattresses. Better lend it out to those who need it; if we are long-term savers, we can afford to lock it up for a while.

That’s what pension funds do; that’s what sovereign wealth funds do. We know that how we fund our governments matters for its legitimacy, but our democratic common sense ties only taxation to representation. Yet the structure of state borrowing is equally critical. It is to this patient structure of funding that Europe’s experiment now turns, at least at the critical margin. There might be a lesson in there for all of us.

“Contagion”, market pessimism and democracy

19 Sep

As European finance ministers last week converged on Wrocław in Poland for a meeting of the economic and finance grouping of EU member states, the so-called ECOFIN meeting, many analysts and commentators were talking more openly about the modalities of a Greek default. This is still vehemently denied by most governments in Europe, not least by the government in Athens, but it is worth considering how exactly it should be done.

The first question is which should come first for Greece: exit from the Euro or default on its debts (thanks to Klaus Giesen for first raising this). Looking at the commentary in the financial press, most assume that a default will come first, either by necessity or simply because defaulting might not automatically mean Greece has to leave the Euro. In its weekend edition, the Financial Times considered the option of a Greek default, followed by a more favourable assessment by private creditors of its growth outlook paving the way for Greece’s return to international loan markets. It seems also clear that default would come first, simply because of the difficulties of preparing to introduce a new currency without anyone finding out. Were it to emerge that Greece was secretly printing a new Drachma somewhere, there would be a run on its banks and any existing loans would dry up.

If a default occurred, and this put a stop to the money currently entering Greece via the European Central Bank and the IMF, the government would be unable to pay its everyday bills. It would not have enough money to pay its civil servants or to meet its welfare obligations to its citizens. At the same time, Greece’s banks are heavily exposed to its own government’s debt: a default would leave the banks high and dry. In this respect, the economy would grind to a halt. Greece would be left with two options: exit the Euro and begin issuing its own currency in order that it can start paying its own bills and recapitalize its banks; or sit in limbo, hoping that some kind of help will come from outside, whilst on the ground in Greece the cash economy gives way to a temporary bartering arrangement and the creation of quasi-currencies in the search for some kind of medium of exchange.

Putting all this into some perspective, and if we remember that Greece’s economy accounts for only a tiny proportion (less than 3%) of the overall Eurozone economy, the most likely scenario would be for Greece to default and – assuming that wasn’t enough to convince private creditors that it could return to growth in the medium term – it would exit the Euro but in a way that saw it tided over by loans from the EU. The difficult period between default and a new currency winning some kind of international credibility could be made easier by help from other European governments.

What makes this orderly default and exit from the Eurozone unlikely? Everything hangs on the problem of what analysts are calling “contagion”. In fact, contagion is the wrong word. The problem is simply that if Greece’s default were to work in Greece’s favour, it would make it seem attractive for other crisis-stricken countries like Spain, Portugal or Italy to follow, raising the prospect of a mass default that would be incredibly expensive for those banks exposed to government debt in those countries. But if Greece’s default were to be a complete mess, that would also spook the markets, making it seem as if there was no alternative to keeping the Eurozone together, putting the spotlight on the political problems faced by Merkel, Sarkozy and others. So for a Greek default, both success and failure would cause problems: damned if you do, damned if you don’t.

Much of the concern about the Eurozone thus rests on the nebulous idea of “contagion”, a term which gains its force from its implication that events can develop randomly and in unexpected ways, a little like the spread of an epidemic. In fact, there are strong reasons to suppose that a Greek default and/or exit from the Eurozone could be contained. Greece is not Italy or Spain. The underlying basis of these economies is quite different, with the fundamentals in Italy in particular being much stronger.

What prevails in contemporary analysis is as much an overwhelming pessimism with the ability of democratically elected representatives to tackle contemporary economic problems as it is a clear-headed assessment of economic fundamentals. It is this lack of faith in democracy that is making the Eurozone crisis so intractable, not the objective and relentless laws of the markets.

Le Monde Diplomatique article on anti-social Europe

26 Aug

The English edition of Le Monde Diplomatique has published an article on the Eurozone crisis by one of The Current Moment editors.


Le Monde diplomatique
English edition
The article develops and expands on themes familiar to Current Moment readers: the anti-social origins of ‘Social Europe’; the way the present-day EU was built on the ruins of the post-war Keynesian consensus; the zero-sum competition between Eurozone members that exacerbated the asymmetries within the Eurozone; the preference of national governments in Europe for external rules and norms that serve to distance leaders from their own power and decisions. As the crisis develops, the EU’s anti-social roots are further institutionalized and political responsibility for the crisis is lost in the myriad of summits, committees and pacts that have accompanied it from the beginning.

Can the European Central Bank really save the Eurozone?

10 Aug

The Belgian economist, Paul de Grauwe, has been calling for some time for a comprehensive reform of the Eurozone’s institutions. Contagion, he argues, is inevitable in a currency union that lacks adequate political power. There is no way out of the Eurozone crisis other than more political union. It would appear de Grauwe has the ear of European Central Bank chief, Jean-Claude Trichet: over the weekend the ECB started buying up Spanish and Italian government bonds, at rates low than those being offered by the market. Another step towards the ECB acting as a lender of last resort.

De Grauwe’s account of the crisis is simple and compelling. He argues that government bond markets in a currency union like the Euro are “inherently fragile”. They are basically issuing debt in a currency the value of which they have no real control over. Greece, Spain, and Italy all issue their debt in Euros and yet they do not control the value of the Euro in the same way that the UK or Switzerland control the value of the Pound and the Swiss Franc. Governments in London and Bern can, in extremis, force their central banks to print more money. There will always, in theory, be enough money to pay back bondholders. In the Eurozone, there is no such guarantee as the ECB is not a lender of last resort. And this makes the Eurozone inherently fragile. In practice, the ECB has been buying bonds of crisis-struck member states but it has done so as an exception, not as the rule.

De Grauwe’s recommendation is then simply to give the ECB responsibility as lender of last resort in the government bond markets of Eurozone member states. This should put a stop to contagion, according to de Grauwe. But will it? Defaults have occurred in the past in countries that both issue their own currency and have control over their national central banks. Why should the Eurozone be any different?

De Grauwe’s analysis supposes that there is an institutional quick fix to the Eurozone’s problems. This is akin to suggestions made in the US, covered in the Current Moment, about resolving the debt burden via low interest rates and some easy money provided by the US Federal Reserve. Two problems stand out here. The first is that the problem the Eurozone faces is not an institutional one but it is the inability of some Eurozone member states to return to growth. Until national income in troubled Eurozone member states grows faster than state expenditure, or until a realistic prospect of this arrives onto the horizon, the debt crisis will continue. The European Central Bank, even as lender of last resort and notwithstanding the esteem with which central bankers are held today in macro-economic circles, cannot restore profitability to national economies of the Eurozone.

The second problem is a political one. De Grauwe has nothing to say about the political implications of transforming the ECB into a lender of last resort. Some are beginning to wonder about the democratic quality of these developments but generally it is considered an afterthought to a more pressing set of institutional questions. This repeats the patterns of the past: innovations at the EU level are subsequently presented to domestic populations as a fait accompli, to be given a stamp of approval by voters. Why this should work now, when previous efforts to do the same failed miserably, is anyone’s guess. The Eurozone’s debt crisis, if resolved, is likely to be followed by a political crisis as the EU scrambles to find legitimacy for its new powers.

The Euro and transnational capital

1 Aug

We have argued before that one of the mysteries of the ongoing Eurozone crisis is how doggedly attached member state governments are to its survival. For all of its manifest weaknesses, the Euro lives on. One suggestion made by a reader of The Current Moment was that lying behind the Euro’s longevity in the face of crisis was the interest of transnationalized European capital. The Euro has made it possible for dynamic European capitalists to exploit low wage opportunities in diverse parts of the Eurozone, resulting in a transnationalized capitalist class that today benefits greatly from the Euro.

It is worth seeing whether the figures support this. Generally, the effects of a currency union on foreign direct investment (FDI) can go both ways. It can reduce the need for such investment as the incentive of setting up a whole operation in another country in order to be able to sell goods in that domestic market is lower. Lower cross-border transaction costs mean that FDI will be replaced by trade. However, it can also boost FDI by making the spread of production processes across borders easier and cheaper. Specific cost gains can be made by locating parts of production in one place that has lower wage costs for that particular activity.

How this has played out in the Eurozone is not clear. Estimates vary, suggesting that intra-Euro FDI flows have increased as a result of the Euro’s introduction by between 14% and 36% (European Commission report, EMU@10, p35). Other studies have found that the link between the introduction of the Euro and FDI flows is much weaker. A paper co-written by Geneva-based economist Richard Baldwin and a number of colleagues on the trade and FDI effects of the Euro makes some interesting points. It notes that the “stars” of FDI within the Eurozone are by far Germany and France, both in terms of outward and inward FDI. This runs against the notion that FDI is driven by Northern European capitalists seeking profit opportunities in low wage parts of the Eurozone. It is, in fact, difficult to know where these low wage parts might be. Countries such as Ireland, Spain, Portugal and Greece were all characterized by above-average increases in wages since the introduction of the Euro – something likely to put off, not encourage, outside investors.

Baldwin et al also note that 70% of all intra-Eurozone FDI flows for the period 1999-2003 were from or to Luxembourg, a result driven by the peculiarities of Luxembourg both in terms of taxes and transparency and unrelated to the Euro as such. Looking specifically at the German case, there is little evidence of German FDI having been driven by the exploitation of lower-wage Eurozone economies. Most of the out-sourcing of production that has occurred has taken place in those EU members outside of the Eurozone, namely in Central and Eastern Europe and further afield. Other German FDI activity has tended to be flagship merger and acquisition deals, of the kind seen in the telecoms sector, driven more by stock market patterns than by the creation of a currency union.

There are other economic benefits from the introduction of the Euro. Trade effects for instance have been important. It would still seem though that the desire to preserve the Eurozone at all costs appears – from the perspective of a private investor or a German-based CEO – quixotic. Greece after all only represents 3% of the Eurozone’s total GDP. Why keep it within the Eurozone if its membership risks spreading contagion to other much larger member states? In answering this question, the economic gain from the Euro is important but not decisive. More critical is the role the Euro plays in the wider world of macro-economic policymaking in Europe.

For Eurozone members, the Euro is not just a currency, it’s a way of making decisions. It involves the Eurogroup and its attendant committees and officials, the European Central Bank and all national central banks of the Eurozone and the meetings of all EU member finance ministers in ECOFIN. This kind of integrated decision-making has become the dominant way in which macroeconomic policy is both practiced and understood today in Europe, by core and peripheral economies within the Eurozone. This, more than the economic benefits of monetary union, explain the Euro’s survival so far in the face of crisis.

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