A Flea in the Fur of the Beast

“Death, fire, and burglary make all men equals.” —Dickens

Tag: european debt crisis

Krugman declares Cyprus FUBAR

by pdxblake

This is pretty astounding stuff (here’s a reminder of the definition of FUBAR):

At this point the Cyprus situation is pretty clear — and clarity does not bring reassurance. In fact, it looks as if Cyprus has managed to combine in one place everything that has gone wrong elsewhere.

1. Runaway banking. Cyprus has a huge banking system — assets around 8 times GDP — based on a business model of attracting offshore money with high rates and good opportunities for tax avoidance/evasion.
2. Big domestic real estate bubble, Spain or Ireland-sized. Not yet fully deflated, which means lots more losses to come.
3. Massive overvaluation, with Cypriot prices and costs having risen much more than in the rest of the euro area.
In the end this probably comes, in some version, to what it should have been from the start — a big haircut on deposits over 100,000.

More available in the full post.

I jumped the gun and gave credit where credit was not due

by pdxblake

Remember when I said something nice about Martin Feldstein?  Ok, he’s back to being wrong, but not as wrong as the Bundesbank (ht Business Insider):

focusing potential ECB purchases on the sovereign debt of those countries with high interest rates would have serious adverse effects. It would reduce pressure on the governments of Italy, Spain, and other high-interest countries to make the politically difficult decisions that are needed to cut long-term fiscal deficits. Spain needs to exercise greater control over its regional governments’ budgets, while Italy needs to shrink the size of its public sector. An ECB policy that artificially reduces their sovereign borrowing costs would make these steps even more politically difficult.

Feldstein is arguing economic policy based on a “morality” argument where debt and deficits are bad and should be discouraged, and by doing anything, the scofflaws are just being encouraged.

Where this goes wrong is that the Spanish and Italian bond yields are rising more as a result of the refusal of the central bank (the ECB) to defend the Eurozone, something which the ECB has now pledged to do, subject to approval of the Bundesbank, the German central bank.

The poor governance of the Eurozone with the Bundesbank having implicit veto power over the ECB’s policy will continue to inhibit dealing with the crisis.  There are plenty of times to worry about deficits, but not when the integrity of the Eurozone is in doubt.  Then, you must focus solely on saving it (if you want to save it), by any means necessary.

Paul Krugman, Martin Feldstein agree on something (not here, in Europe)

by pdxblake

Martin Feldstein, a conservative economist, argues (ht Mark Thoma) that a rapid fall in the value of the euro can “save Spain”.  His argument, which applies for all the peripheral countries including Italy and Greece is that:

“The increase in peripheral country net exports would also raise their gross domestic product and so reverse their recessions that were caused by higher taxes and cuts in government spending. That would make it politically easier to achieve the needed fiscal consolidations. And shifting from recession to growth would raise business incomes and employment, reducing the volume of bad loans and mortgage defaults now hurting the banks.

Furthermore, the devaluation in the euro, which is already happening could be sped up by looser monetary policy:

“The decline of the euro can therefore occur without specific action by the European Central Bank. But a further shift by the ECB toward a looser monetary policy would speed the euro’s decline.”

Feldstein worked in the Bush Administration, so you would expect me to stick in a big “but” here, but no, I agree, and so too does Paul Krugman who wrote that:

Think of Spain as facing a three-level problem. The topmost level is the problem of the banks; set that aside for now. Below that is the problem of sovereign debt. What makes the debt problem so serious, however, is the underlying problem of competitiveness: Spain needs to increase exports to make up for the jobs lost when its housing bubble burst. And it faces years of a highly depressed economy until costs have fallen enough relative to the rest of Europe to achieve the needed gain in competitiveness.

The issue of competitiveness basically comes down to the fact that it had a huge real estate bubble which inflated prices in the country until 2007 and then, since Spain has no control over its own monetary policy or the value of its currency, it was unable to make the changes the way most countries do: looser monetary policy which stimulates the economy and a devalued currency, which adds stimulus by making exports more competitive.

And it is not just Spain, but all the peripheral countries that had recessions in excess of Germany’s since that country has defacto control of the monetary policy for the whole Eurozone and by and large makes changes to suit its own economy’s needs, the rest of the Eurozone be damned.  That has created a cascade of problems from Greece with various cop outs for why those countries deserved what they got (Ireland had to bite the bullet in taking on bank liabilities as sovereign debt to win confidence with the markets, Greece lied to get into the Euro and spends too much, Portugal was, well, I’m not sure what the reason they would give why Portugal deserved to get thrown into the fire).

However, the cases of Italy and Spain present different challenges.  They are, for one, much larger.  Spain is about 8% of the Eurozone European Union’s economy, Italy is about 12% so between them they represent one-fifth of the Eurozone European Union’s economy.  Italy also has a $2.6 trillion bond market, the third largest in the world.  If it melted down it would cause much greater chaos than the already large impact of the Greek tragedy.

These countries entered the Great Recession in relatively good shape: Spain had a surplus and even now Italy has a small primary (i.e. before interest payments on the debt) deficit even though Italy has a lot of debt.  So the moralizing is not as easy for why these countries deserve the fate of Greece, Ireland (?) and Portugal (??).  Even Germany’s Finance Minister who is wrong on basically everything said that Spain’s debt is not unsustainable, although he resorted to just saying markets were wrong (ignoring the root problem of inaction on a European level to end crisis of confidence in European debt markets that requires ECB action).

So, at the end of the day, we have two economists who agree on very little agreeing that the main issue in Europe is a lack of competitiveness in Southern European countries, and that devaluation (aided by monetary policy) could help speed up the devaluation by loosening monetary policy.  They largely agree, I think, that the ECB has to buy Spanish and Italian bonds to prevent the spikes in interest rates we see now, although I think they would disagree on whether the ECB should target higher rates of inflation in Germany and how the Eurozone will ultimately prevent future crises. However, now, the case is in for why the ECB must act is pretty well resolved, except within the ECB and the German Finance Ministry, which is why the crisis will continue to live another day.

UPDATE: The ECB President Mario Draghi is saying:


This presumably (unless it is just another head fake) is the ECB acknowledging, at last, what everyone else has realized for quite a long time.

Europe is trying the same policies that failed in Greece

by pdxblake

Economist Tim Duy reflects about the lack of any sense of urgency from Europe to deal with the crisis (ht Economist’s View):

Consider where we are at today. Greece once again is making the headlines, as it is increasingly evident that they have made virtually no progress on the last bailout package, and will therefore need another. This should have come as no surprise; it was increasingly politically impossible to engage in additional austerity with the Greek economy plummeting into the abyss. But bailout fatigue will finally hit this time, as there appears to be no more appetite to limp Greece along. Evan Ambrose-Pritchard argues that Germany is leading the drive to finally force Greece out of the Eurozone. Ambrose rightly places at least some, if not the lion’s share, of the blame for this outcome at the feet of the Troika [ECB, IMF and the European Commission]

The big problem in Europe is that the European Central Bank has refused to make any concessions in terms of allowing higher inflation in Germany to ease the deflation in the periphery (Portugal, Ireland, Italy, Greece and Spain, or the PIIGS), something I addressed in an earlier post.  It has also refused to buy these countries’ bonds in a quantitative easing type of program to stimulate the European economy and send a signal that they will support Eurozone countries’ economies even if it raises inflation a bit in Germany, something that is essential for bondholders who are increasingly unwilling to hold Spanish and Italian bonds.  Spanish bonds now trade at yields above the 7% threshold that led Portugal, Ireland and Greece to seek a bailout, with Italian bonds only slightly below.

And the prescription from the Troika is the same.  As Duy explains:

And make no mistake, European policymakers have learned nothing from the Greek experience. One gets the sense that policymakers think the prescription was correct, but that the patient was simply unwilling to take the medicine. Where Greece failed, Spain will succeed, or at least so it is hoped.

So, as before, the beatings will continue until morale improves and the European crisis is no closer to being solved.

UPDATE: With the latest comments from Mario Draghi, President of the ECB, Tim Duy thinks he has blinked…maybe.