Well, that was the week that was, wasn’t it? It started with a cheerful, upbeat market response to both the impact of the ECB’s 3 year LTRO and the growing impression that Hungary was going to make some sort of “one-off” deal with the IMF, and ended near the depths of despair as S&P’s announced the downgrade of 9 Euro Area countries, while the EU Commission worked hard to reinforce the impression that it was about to launch legal proceedings that could even lead to the temporary suspension of Hungary from the EU. It was a time of bitter sweet experiences, which started with Tamás Fellegi (that’s him smiling in the photo below) heading off for his scheduled interview with Christine Lagarde. Then we learnt that the German economy had grown by a brisk 3% in 2011, only to have our hopes dashed by the clarification that most of the growth was in the first 9 months of the year, and in fact the country probably entered recession in the last quarter.
Just as we were recovering from that initial shock, Irish stockbrokers Goodbody poured even more cold water on our breakfast cornflakes by telling us that Ireland would probably need a second bailout, since economic performance in 2012 was likely to be below expectations, while prevailing financial conditions would make an early return to the financial markets virtually impossible. Our spirits were fleetingly brightened by the news that Spain had managed a successful bond auction, but the cork was just as swiftly rammed back into the bubbly bottle as it had been pulled out when we discovered that Italy had not, and that LCH Clearnet had promptly reacted by raising the margins on the country’s debt when posted as collateral.
On the other hand Thursday did give us another brief soothing interlude, as Mario Draghi reminded us of all the beneficial consequences of the recent 3 year LTRO (Long Term Repo Operation), and cheered our spirits by informing us that he was not lowering interest rates again at this stage due to the growing signs of stabilisation his technical staff had been able to identify. “According to some recent survey indicators, there are tentative signs of stabilization of economic activity at low levels,” he told the assembled journalists, although he did go on to warn that the debt crisis continued to pose “substantial downside risks” to the economic outlook and the ECB stood “ready to act” if need be.
Apart from the evidently weakening inflation, possibly the most important single indicator he will have had in mind in making the above statement would be the monthly PMI survey. The composite index (which combines manufacturing and services) shows economic activity contined to contract in December, but at a rather slower rate than in November, and in fact the rate of contraction in November was slower than the one recorded in October. So things are getting worse more slowly!
Despite the evident differences between countries in their rate of deterioration, the stabilisation pattern is pretty generally reproduced across the Euro Area. In Spain, for example, where services activity plummeted in November (at rates reminiscent of the last recession), the decline was significantly slower in December, although it was still, of course, a substantial decline.
The EU sentiment index has also fallen much more slowly in the last two months, indicating that confidence is not deteriorating as rapidly as it was.
And the widely followed German IFO Business Climate index has perked up slightly in the last couple of months.
So Mario Draghi is absolutely right, stabilisation is precisely what we see. But this is stabilisation during a decline, and there is little in these indicators to tell us which way the next move will be, and in fact the few forward looking components we have suggested things might be about to get worse rather than better, a point which was not lost on Markit’s Chief Economist, Chris Williamson, who said in his comment accompanying the monthly PMI report:
“The uplift in the Eurozone PMI in December does little to dispel fears of the region sliding back into recession. Despite the upturn, the fourth quarter saw the steepest contraction since the spring of 2009, and forward-looking indicators suggest that a further decline is on the cards for the first quarter of 2012. In particular, orders for goods and services continued to collapse, suggesting that output and employment will be cut as we move into the new year”.
Of course, as everyone is by now only too well aware, the week finished on a crescendo as S&P’s announced the widely anticipated downgrade of nine Euro Area countries. And just to ram the point home that something somewhere in the works wasn’t functioning as it should, at around the same time the talks on Greece’s Private Sector Involvment debt swap broke down.
That being said, surely pride of place in this extraordinarily agitated week must belong to Hungary, whose bleary eyed Prime Minister Viktor Orban can be seen in the photo below. It is early morning, and he probably hadn’t slept that well after learning that the IMF would defer to the EU on all matters relating to whether his country was in compliance with its Treaty obligations before taking any decisions on future loans.
As one country after another temporarily surrenders its right to an elected government to put itself in the hands of the technocrats (as Hungary did in 2009, before the election of the Orban government) I cannot help asking myself whether recent developments are mainly the result of the countries peculiar (and almost unique) history, or whether it is giving us an idea of the sort of thing we can expect to see if simple austerity as it is being practised all along Europe’s periphery doesn’t work out as planned. Certainly Mario Monti is alive to this possibility, as he said in an interview with Die Welt Online this week (German only I’m afraid), unless Europe’s policy is flexibilized it will be a case of “after me the populists”.
All Alive And Well On ECB Cool Aid?
Perhaps the main point to take to heart from the events of the last week is the way the recent ECB liquidity measures have apparently been able stabilised the debt crisis, at least for the time being, even while it is not clear that they will have the same success stabilising the deterioration in the respective real economies.
In a liquidity-providing operation which some have described as “unleashing a wall of money“, in the week before Christnas more than 500 EU banks borrowed a total of €489 billion in three-year loans – equivalent to roughly 5 per cent of eurozone gross domestic product and the largest amount ever provided in a single ECB liquidity operation. In fact only about €190 billion of this was new money, since the majority of the borrowing involved the consolidation of lending that had already been taking place on a shorter term basis.
Despite the size of the demand, and some relatively succesful bond auctions, much attention is still focusing on the way Eurozone banks’ overnight deposits with the European Central Bank have been rising in the wake of the move. In fact these themselves hit yet another all-time high last Thursday according to the ECB, with the quantity deposited hitting €489.906 billion, up from €470.632 billion the day before. This phenomenon has lead some analysts to suggest the operation may be a failure. Such a judgement would be a premature and erroneous in my humble opinion.
It’s The Real Economy, Stupid!
In order to assess the extent to which the recent ECB measures have succeeded we need to think about what the objectives really were. In the first place the bank clearly hoped the commercial banks would use some of the money borrowed to buy new issue government bonds in the primary market, and earn themselves a bit of “carry” (the difference between what it costs them to borrow from the central bank and what the bonds purchased pay) in the process. The much needed additional income will help them improve their bottom lines and allow them to accumulate some additional capital to help with their capital ratios. This has lead some observers, like Nomura’s Kevin Gaynor, to argue that the ECB is now doing overt (as opposed to covert) QE. In some senses this is surely the case, since the bank was already doing what some called QE by stealth way all the way back in 2009 (as Claus Vistesen argued here, and I argued here).
But before digging into all this a bit further, let’s go back to the issue of those growing overnight ECB deposits. For some observers the very size of these deposits constitutes evidence that the ECB 3 year LTRO isn’t working as anticipated.
This argument, as Danske Bank’s Senior Economist Frank Hansen argues, is misleading, since the volume of ECB deposits only give us a measure of aggregate excess liquidity across the Eurosystem, and doesn’t tell us anything about the distribution of that liquidity between countries or between banks.
“Does this mean that the operation has failed to stimulate government bond purchases? No, not really. If a bank uses money from the LTRO to buy government bonds (or any other paper) in the secondary market, the amount will still show up as a deposit at the ECB (now on behalf of the seller’s bank). If a bank buys government bonds in the primary market, the amount will also show up as bank deposits at the ECB if the government spends the receipts or places them at a private bank. Thus, the increase in deposits does not imply that the 36 months LTRO has failed to stimulate government bond purchases (or other trading for that matter)”.
So basically, if we think for a moment about maturing, and not new, additional issue, government bonds, then commercial banks along the periphery buying the replacement issue can allow their peers in the core to recover their investment, and park the money. The only way the money from these sort of bond transactions doesn’t show up as excess liquidity is if the national government concerned places the takings on deposit at the central bank, or if an investor takes the money they have recovered from a redemption out of the Eurosystem. The same goes for private bank debt, which often just moves from being a liability one bank has with another commercial bank in the Eurosystem to being a liability with the ECB. Naturally the bank that recovers its money may well then park the proceeds on deposit and hence it will show up as excess liquidity at the ECB.
So, while short term liquidity needs may be being catered for (at least up to 3 years), there may be a deeper phenomenon at work via the LTRO, whereby the core leaves the periphery. In fact that seems to be happening. The charts below (which were prepared by Citi Research) show the situation up to the end of October (latest data), and make clear that it is commercial banks on the periphery who are, in the main, making increased use of the ECB’s open market operations, while it is banks in core Europe who are using the deposit facility.
There is no reason to suppose that data post October will reveal any fundamental shift in tendency. Spanish banks, for example, increased their ECB borrowing from roughly €70 billion in September to €118 billion in December (nearly a €50 billion – or 75% – increase), while use of the deposit facility only went up from €9 billion to 15 billion, so the Spanish banking system clearly needs this liquidity.
Write-downs On The Liabilities Side?
Another area where the transfer of liquidity doesn’t show up as a change in aggregate excess liquidity is when banks offload their wholesale liabilities to other EuroArea banks and refund via the ECB. Here again, if they do it smartly, they can even earn a bit of “quasi carry” in the process, by buying back their debt at well below face value from those who are anxious to exit the periphery, and then refinancing at the ECB without writing down the underlying asset. This could be termed a liability “write down” (or a liability management exercise as the FT more euhpemistically puts it), and again the procedure earns the bank a nice bit of income which can subsequently be used to help the recapitalisation process.
Take the Portuguese Bank BPI (the country’s fourth largest), which is making public tender offers to buy back its debt. If all concerned tender their bonds to BPI, BPI will pay something short of €1.5bn cash to investors. Mortgages which were previously sitting in one of their SPVs will return to their balance sheet, and ECB money will now be on the other side financing them allowing significant profits (and capital) to be reported. In this particular tender the smallest discount is 35% and the largest is 65%. Investors may initially baulk at the offer, since they will nurse a heavy loss (equal, naturally, to BPI´s profit) but ultimately they will probably be only too happy to be able to walk away from Portugal, and with some cash in their pocket to boot, although Banco Santander bondholders weren’t too happy when they tried to do something similar last November with an offer which affected a third of its total outstanding “lower tier 2 capital” junior debt with call dates – on which the bank can opt to pay back the debt – ranging from March 2012 to September 2014. (update 21 January, in fact in the end Portugal’s PMI investors weren’t either happy to take the money or eager to walk away – see this report – but it wasn’t for want of trying on BPI’s part).
Iberian banks were already aware of the benefits of this kind of restructuring during the 2009-2010 liquidity wave, and went about quietly repurchasing their bonds (bank capital, securitizations, senior bonds) on a selective and private basis at a discount. Much of their reported profits in those years in fact came from either the ECB carry trade or this kind of transaction. So when we read that another Portuguese bank – Banco Espirito Santo – has just had €1 billion of debt guaranteed by the Portuguese state (a soverign which can’t itself go to the markets) it isn’t hard to imagine that the process going on in the background is something similar to that seen in the BPI case, and that the debt is being guaranteed so it can go over to the ECB to be posted as collateral.
The National Bank of Greece has been doing something similar. They recently offered to buy back some €1.5 billion in covered bonds and preferred securities, offering 70% of face value for the covered bonds and 45% for the preferred hybrids. As the bank itself says, “The purpose of the offers is to generate core Tier 1 capital for the group and to strengthen the quality of its capital base….The offers would generate a gain for the group.”
And Italian banks would seem to be doing something similar, since they issued around €40 billion in government backed bonds specifically to take to the ECB. The bonds are held by the banks themselves and stay on their books to maturity, their only purpose being to provide collateral for use at the ECB. In fact Italian banks took something like €116 billion from the LTRO, or almost 25% of the total. Perhaps this is why Unicredit CEO Federico Ghizzoni and other European top bankers met ECB officials in Frankfurt back in November, to discuss new rules for collateral.
In Spain securitised mortgages sitting on the balance sheets of the bank-owned Fondos de Titulizacion de Activos could also be recycled in this way (here’s a complete list, although note that these Funds are regulated by Spain’s CNMV and not the Bank of Spain, which is why their presence is relatively unknown and people are able to accurately say that the central bank has been very strict on SIVs, since they weren’t their responsibility). Here’s a link to an article (in Spanish unfortunately) which explains how Bankia are issuing cedulas they buy themselves, and retain for collateral posting at the ECB. They issued 3 billion euros worth in November, and are about to issue another 2 billion euros worth.
That something like this may be happening, with the ECB “buying into” public and private Euro Periphery debt while investors are discretely getting out is suggested by this report in Bloomberg:
The euro is losing the relationship with riskier assets that underpinned the currency in 2011 as the deepening sovereign debt crisis reduces the creditworthiness of even the biggest economies in the region. The 17-nation currency has fallen 8.7 percent against the dollar since October, while the Standard & Poor’s 500 Index has gained 3.4 percent, and the correlation between the two dropped to 58 percent from a record 91 percent in November, according to data compiled by Bloomberg. The euro had moved almost in lockstep with investments linked to growth, including stocks and the Australian dollar, since January 2011.
This decoupling is taking place as European Central Bank President Mario Draghi cuts interest rates and promises banks unlimited cash for three years to rein in soaring borrowing costs for governments… Strategists also anticipate more losses as the US economy improves while the euro zone shrinks, driving international investors away from the region’s assets.
So if the first two objectives were to help the struggling sovereigns, and enable the commercial banks to refinance their debt, then to some extent these objectives have been met. But what about the third objective, moving credit on the periphery to get the real economy moving again? Well, here the ECB’s measures are likely to have far less effect, and indeed what effect they do have may be in some way a mixed blessing, since the banks seem far more worried about demonstrating they have an adequate level of core capital than they are about participating in solutions to real economy problems.
Credit Crunch Is NOT Uniform
To understand why this simply increasing aggregate liquidity doesn’t necessarily help individual countries, it is important to realise that credit conditions in the Euro Area member countries are not uniform (a much more detailed exposition of this point can be found in this earlier post). In countries like Germany, Finland and the Netherlands, credit is more or less freely available, even if demand for it is limited – German corporates are awash with cash, and it has been a long, long time since German households were digging their way into debt.
In France and Italy, banks are drawing in their horns, but credit is a long way from being frozen.
Although in France, the rate of new loan generation in the private sector has been sliding since mid summer, especially if you look at the thin black line in the chart below (Bank of France), which shows the rate of change on a three monthly rather than an annual basis.
A similar position can be seen in the case of home mortgages.
Now in the French case, given that the private sector is not heavily overindebted, unemployment is not excessively high, and a demand for credit from solvent clients exists, it is quite possible that the ECB measures can help stabilise the situation, and put a brake on the implosion.
On the periphery, however, where populations are heavily endebted either directly, or via their sovereigns, where the economy isn’t functioning properly, and unemployment is high and rising, the problem isn’t only the unavailability of credit, but also the shortage of solvent clients who actually want to leverage themselves.
Day Of The Living Dead?
For increased liquidity to mean that credit becomes expansionary for the real economy again, it is the banks themselves who need to deleverage (and not simply write down their liability side), by disposing of the large volume of continually restructured but basically non-performing credit they have on their books. Behind the credit crunch in these countries lies a problem of massive economic structural distortion, produce by the lending and borrowing boom during the “good” years. What is needed is what Joseph Schumpeter referred to as a process of “creative destruction”, whereby some enterprises die so that others can be born, and naturally some loans are written off, despite the fact this has unpleasant effects on bank profitability and capital ratios. To really get credit moving again in some of these periphery economies, a large chunk of loans need to be written down, and support needs to be offered by the sovereign to enable this to occur.
Unfortunately the ECB’s liquidity provision could have precisely a perverse effect in this context, as it may well enable those who should die to stay alive. Commercial banks, at the discretion of their central bank, may now package straighforward bilateral commercial loans to present as collateral at the ECB. This measure, which in theory was intended to enable the banks to extend “good credit” may now enable them to restructure and keep on their balance sheet loans that should really be classified as “impaired” and somehow resolved.
In the case of Spain, for example, in addition to the properties they have acquired, banks still have oustanding loans of over €300 billion to developers on their books according to Bank of Spain data. The majority of these loans are not classified as either non-performing or sub-standard, and are hence considered to be “good” (I will refrain from saying “excellent”). In principle there is no reason why a significant number of these “good” loans cannot be packaged in some way or other to serve as collateral to be posted at the ECB. Naturally this takes some of the pressure off Economy Minister Luis de Guindos to establish a bad bank, since for the time being the ECB can, in part, serve this purpose for him. And if the banks write down their liability side a bit, then this may also help him with the €50 billion or so he estimates will be needed for bank recapitalisation. No wonder he feels the amount of public money needed will be minimal! The only real downside on this is that foreign investors may well be dumping Spain, while the country (which still runs a current account deficit) continues to have an external financing requirement.
None of this is either uniquivocally good, or unequivocally bad, it depends. What the liquidity move will do is buy the banks time to sweat out some capital onto their balance sheets, and make them better able to withstand more of those dreaded “stress tests” (assuming, that is, that the European Banking Authority allows some “wiggle room” to enable them to keep maintaining their risky sovereign debt holdings). What it won’t do is help put the real economy straight, or allow the banks to get back to what some would consider is their basic task which is guaranteeing a normal supply of credit to the economy.
Working Against The Clock
All of which brings us nicely back to those horrid S&P downgrades. According to S&P’s own literature, the dowgrades were prompted by a number of concerns:
Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone. In our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.
If we look at the list of 5 issues they identify, the recent 3 year LTRO may do something to help ease the first two of their concerns, especially in core countries as far as credit conditions go, and at the short end in terms of peripheral sovereign debt spreads, but it will do virtually nothing to resolve the other key issues, and it will not alter the course of the crisis in the longer term. In other words it is not a game changer, even though it will buy time.
But time is – if we look over to Hungary – something we will eventually run out of. Handing over the adminsitration of one country after another to a group of approved technocrats may well work for a while, but it won’t work forever. One day or another, if the measures taken don’t work, Mario Monti will be replaced by the populists, and a new chapter in European history will open. At the present time the policy emphasis on fiscal rectitude and structural reforms, to the neglect of the deep competitiveness and imbalance problems which exist within the Euro Area, is leading us all to no good place. A quick glance over in the direction of Hungary might suggest to us what that place could look like.
Well, that really was the week that was, wasn’t it. It’s over, let it go, there’s another one coming just around the corner, and my initial impression is that it is unlikely to be a quieter or more relaxing one.
On one level, Friday’s news was not really surprising. The French rating downgrade was a shock foretold. As was the breakdown in talks between private investors and the Greek government about a voluntary participation in a debt writedown. A proposition that was unrealistic to start with has been rejected. We should not feign surprise.And yet both events are important because they show us the mechanism behind this year’s likely unfolding of events. The eurozone has fallen into a spiral of downgrades, falling economic output, rising debt and further downgrades. A recession has just started. Greece is now likely to default on most of its debts and may even have to leave the eurozone. When that happens, the spotlight will fall immediately on Portugal, and the next contagious round of downgrades will begin.
Wolfgang Munchau, Financial Times, Sunday 15 January 2012.
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January 16th, 2012 at 6:00 pm
“As one country after another temporarily surrenders its right to an elected government to put itself in the hands of the technocrats ”
Can we please put an end to this nonsense? In most countries I know of, governments are NOT elected but appointed by the head of state and confirmed by a vote of confidence of parliament. And as the pertinent constitutions do not provide for an “elected government”, there is no “right to an elected government” that could be surrendered.
Governments have changed before without general elections, both in the countries involved now and in others (e.g. in Germany when the Free Democrats switched allegiance) – and in fact there are constitutions which specifically provide for such happening.
It is a parody of ridiculous proportions when people who do not even grant other nations the right to have a constitution as they damn well please suggest these nations surrendered rights which never existed.
January 16th, 2012 at 6:08 pm
I think you are quibbling Oliver. My legal language may not have been the most technically adequate – I am an economist not a lawyer – but the point still stands: the clock is ticking, the technocrats (Brussels’n all) have a limited amount of time, then come the populists, and with them bankruptcy, default and disorder.
January 16th, 2012 at 6:11 pm
I disagree. Because with your comment, you suggest a lack of mandate of these governments and in doing so, you are hindering their authority to act yourself.
January 16th, 2012 at 6:13 pm
Put another way, democratic governments are normally associated with parties. Maybe that is a mistake, I wouldn’t know, but which parties are governing in Italy, or in Greece?
And while Mario Monti and Lucas Papedemos are going about their lawful business, what exactly are the political parties in these countries getting up to? I am sure they are not being idle. Will the Troika find that Greece despite all Mr Papedemos’s good intentions the country has not met the targets set when they carry out their next inspection?
January 16th, 2012 at 6:17 pm
Oliver, I am not quibbling the authority of mandate. I am asking whether the policies they are applying will work, and if they don’t work (as I suspect), then what happens next?
But actually, this isn’t the point of this article at all. The real point I am making is that, while the 3 year ECB LTRO may help sovereigns finance and bring down spreads, and banks earn money to help recapitalise, it won’t get credit flowing smoothly on the periphery, and this is one of the reasons Papedemos and Monti will fail, as Standard and Poor’s recognise.
January 16th, 2012 at 6:50 pm
Well, on the one hand, you state you are afraid of what might happen if populists take over – on the other, you adopt their argumentations almost verbatim. This argument of “unelected governments” is all over the place when the goal is precisely to undermine any attempt at doing something about the situation.
What S&P clearly does not recognize is that they’re actively interfering with the process on more than one level. Their claim that they were just analyzing fails already on the level that their analysis can’t be really very thorough if they do not recognize feedback mechanisms in the market driven by their ratings. They are actively interfering with the process. But then again, they might be very content with that – they never were given so much attention and never had so much influence before the crisis.
January 16th, 2012 at 7:01 pm
“This argument of “unelected governments” is all over the place when the goal is precisely to undermine any attempt at doing something about the situation”.
How do you know that is the goal? Do you think all commentary on the Monti and Papademos governments is being coordinated to reach a given objective? Where is the “control room” where these goals are collectively hammered out?
Incidentally, do you think the 3 year LTRO will get credit moving on the periphery?
January 16th, 2012 at 7:46 pm
Did I say these arguments were centrally organized? It’s the very nature of populism that they try to provide “easy arguments” and copying from one another is as easy as it gets. Look across the web, into the various forums, you’ll find the argument about “unelected governments” all over the place when it comes to attacking the EU with nationalist-populist argumentation.
As for the LTRO, as you noted yourself, markets seemed to respond pretty positively – of course, the S&P decision killed a lot of that again. At worst, it would have given some time. I find it ironic that analysts talk on end about domestic politics in the crisis nations but completely ignore domestic politics in the more affluent nations. Even if she wanted, Angela Merkel couldn’t convince her electorate to make any more investments into stabilization of the Euro unless she can convince the public that the money would be well-spent and not wasted into some of the financial black holes still existing – which is why one way or the other, she cannot proceed without firmly entrenching fiscal discipline. Personally, despite being German, I’m all for Germany and the ECB doing some bold steps, even if they mean significant investments now, with side aims both to thwart speculation against the Euro and to demonstrate that the EU isn’t just a community for sunny days. But I also know the poll results in Germany which show quite clearly that the larger part of my compatriots is not in favour of such steps – which is why some convincing needs to be done.
January 16th, 2012 at 8:41 pm
[...] – An incredibly thorough summary of last week. [...]
January 17th, 2012 at 12:05 am
Edward, thanks for the excellent article.
I share your concern about ‘unelected governments’. In a democracy people elect their leaders (indirectly through legislative elections and, in the case of France, directly throuh presidential election, thanks to Charles de Gaulle), but also, and perhaps more importantly, people know that they can throw them out at the next election… and they often do.
The side effect, or possibly the purpose, of ‘technocratic governments’ is to disconnect governmental authority from electoral accountability. (And, incidently, the best exemples of Europe’s 20th-century technocratic governments are Nazi Germany and Soviet Russia).
When mainstream political parties, blinded by their european nationalism, surrender their rôle to non-elect bureaucrats, they force citizens to turn to ‘populist’ parties (these days, everybody who does not agree with Brussels seem to be a populist). Thus I concur to your conclusion that the failure of policies imposed by the ECB and the EC, which is, I believe, as probable than you seem to think, will inevitably lead to the progress of these ‘populist’.
Barroso and Draghi yield huge powers (esp. the previous Goldman Sachs boy) but have never, and will never fight an election. This is most dangerous.
I have believed for some time that the stubborn madness, the arrogance and the sheer stupidity of the european nationalists were slowly killing the Europen idea and ideals. Sadly, this seems more and more true.
January 17th, 2012 at 12:10 am
Edward, your article was about money (lots of it). I wonder what will happen in 3 year time, when the banks find out that they must return the ca. 500 bn to the ECB. Hopefully, we can discard dodgy collateral, sovereign bankruptcies, housing bubbles remains and other niceties to assume that they will happily give the money back *rubis sur l’ongle*.
What happens if they don’t?
January 17th, 2012 at 6:37 am
@Perplexed in Montreal
“In a democracy people elect their leaders (indirectly through legislative elections and, in the case of France, directly throuh presidential election, thanks to Charles de Gaulle), but also, and perhaps more importantly, people know that they can throw them out at the next election… and they often do.”
Nothing is any different about the supposedly “unelected” governments – the legislative gave them their confidence and both the legislative can revoke said confidence as can the people revoke their confidence into the legislative come election time.
“Barroso and Draghi yield huge powers (esp. the previous Goldman Sachs boy) but have never, and will never fight an election. This is most dangerous.”
What is dangerous is people attacking the constitution of individual countries in a time of crisis – THAT is precisely how dictatorships came into power. As for these two, Barroso received a vote of confidence from the EP – which is as much as most heads of government can claim. The EP has, in the past, rejected Commissions.
January 17th, 2012 at 10:10 am
Well, it looks like we’ve exhausted all the options except for doing it right!
January 17th, 2012 at 10:23 am
Perplexed:
“When mainstream political parties, blinded by their european nationalism, surrender their rôle to non-elect bureaucrats,…..”
To some extent I think the issue is even simpler. Mainstream political parties depend on votes, and it is hard to get these when you are nonstop and continually making unpopular cuts, and people see no light at the end of the tunnel.
During this crisis, and apart from the Baltics, I think I am right in saying, no government that has implemented deep cuts has been returned to power in the next election.
In Southern Europe where you have the added problem of clientelism (political parties have very few members, and you win support based on patronage), not being able to build a new airport or offer a lot of jobs to would be voters going into an election offers a serious structural problem.
I think, as in the 1930s (the economic problems show some structural similarity), democracy is at risk, and Hungary is a warning signal. Mariano Rajoy is basically a moderate politician, and is doing everything Brussels asks of him at this point. But his situation in his own party is vulnerable, there are plenty who would just love to stick a knife in his back, and naturally José Maria Aznar would make the perfect Spanish Viktor Orban.
January 17th, 2012 at 10:27 am
Perplexed,
“Edward, your article was about money (lots of it). I wonder what will happen in 3 year time, when the banks find out that they must return the ca. 500 bn to the ECB”.
This is easy, the ECB can re-lend and extend. I think the ECB, the commercial banks and Euro Area sovereigns are now all locked together in one and the same boat, and no one of them can sink without the rest going down. So assuming the Euro is still with us 3 years from now, the bank will have no alternative but to renew. It wouldn’t surprise me to see even a 10 year LTRO at some point to enable banks to buy longer term debt.
The thing which can upset the apple cart here is (as we are discussing) the return of populism on the periphery, as people get tired of high unemployment, constant cuts, and no growth.
January 17th, 2012 at 12:01 pm
Nothing is any different about the supposedly “unelected” governments – the legislative gave them their confidence and both the legislative can revoke said confidence as can the people revoke their confidence into the legislative come election time.
But the voters haven’t given them their confidence. We vote to determine our governments. The idea that we vote just to determine the composition of parliament which then chooses the government is just a legal fiction, even though it follows the literal wording of the constitutions.
You cannot go back to the old ways of a real power of parliament to choose the government without a backlash. The peoples will not give up the power to elect their government they have gained by convention without a fight, even if that means voting in the populists.
Well, on the one hand, you state you are afraid of what might happen if populists take over – on the other, you adopt their argumentations almost verbatim.
Unfortunately those demanding radical steps need not be wrong in understanding the problems a nation faces. In fact they usually are right. A populist demanding solutions to problems that don’t exist is a figure of ridicule, not a dangerous populist.
January 17th, 2012 at 3:55 pm
Well Alex, looking back over the history Europe’s debt crisis, European Central Bank Executive Board member Lorenzo Bini Smaghi once invoked Winston Churchill’s famous quip, “You can always count on Americans to do the right thing — after they’ve tried everything else.” Europeans too, he assured his audience would also get it right, eventually. We have to hope he was right, don’t we, although I personally am not convinced that the list of wrong options has been completely exhausted, yet.
January 17th, 2012 at 5:32 pm
@The other Oliver
“But the voters haven’t given them their confidence. We vote to determine our governments. The idea that we vote just to determine the composition of parliament which then chooses the government is just a legal fiction, even though it follows the literal wording of the constitutions.”
Sorry to say, but the one producing legal fiction here is you. Not just that, it is pure and utter fiction. And that this is the case would have been clearly visible to anyone who rather than just claiming to do so would actually do his homework and research what the people of Italy are, in fact, used to. If you did that, you would have found this:
http://en.wikipedia.org/wiki/List_of_Prime_Ministers_of_Italy (Might have to wait until the Wikipedia blackout is over – or hurry to preempt it)
As the list clearly shows, the people if Italy are USED to not having one, but two, three or even FOUR “prime ministers” per legislature. That the prime minister changes without general election is not the exception in Italy, it is actually quite common.
The list should also answer Edward’s question as to what party should be said to rule or whether government is not usually defined by a party – in fact, with Carlo Azeglio Ciampi
and Lamberto Dini, Italy already had TWO prime ministers considered technically independent and leading technocratic governments during the Nineties. Ciampi, incidentally, was later elected president – he was the predecessor of the incumbent president, elected in the first round with two-thirds majority.
What we have here thus is not a deficiency in democracy in Italy, but rather a deficiency of knowledge about Italy of the critics, paired with a projection of one’s own experiences from one’s home country to foreign nations – a very dangerous exercise that has precious little to do with defending democracy.
January 17th, 2012 at 6:44 pm
“As the list clearly shows, the people if Italy are USED to not having one, but two, three or even FOUR “prime ministers” per legislature. That the prime minister changes without general election is not the exception in Italy, it is actually quite common”.
On this we are all agreed, this situation is normal not only in Italy but in a number of other countries.
“The list should also answer Edward’s question as to what party should be said to rule or whether government is not usually defined by a party – in fact, with Carlo Azeglio Ciampi
and Lamberto Dini, Italy already had TWO prime ministers considered technically independent and leading technocratic governments during the Nineties.”
I don’t think I ever said that Italy had never had technocratic governments, that is not the issue I am raising. The issue I am raising is the general and widepread recourse to technocratic governments across Europe WITH POLICIES THAT WON’T WORK.
None other than Mario Monti himselff warned of exactly this problem in an interview in the Financial Times on Monday. Unless he receives help (from Germany in particular) to bring down the interest on Italy’s debt there could be a “powerful backlash among voters”, he warned. This mirrors his “after me the populists” warning issued in an interview with Die Welt Online on Friday.
“Rome”, Monti said, “would push the German government to realise it was in “its own enlightened self-interest”… to lend more of its fiscal weight to lowering borrowing costs of Italy and other highly indebted governments. The single currency had brought “huge benefits …and maybe [to] Germany even more than others,”.
“The stance could put Mr Monti, whose appointment to replace Silvio Berlusconi was cheered by German chancellor Angela Merkel, on a collision course with Berlin. Ms Merkel has been reluctant to take more aggressive action to lower Italy’s euro-era high borrowing costs, such as supporting commonly-backed “eurobonds” or increasing the size of the eurozone’s rescue funds”.
“Mr Monti insisted insisted his government was cutting expenditure “for the good of future generations of Italians” and not at the behest of Berlin. In return for that fiscal discipline “there has to be a visible improvement somewhere else,” he said. “In a country like Italy now, the ‘somewhere else’ can only be interest rates.””
The views expressed here about what is wrong with the way things are being done at this point are Mario Monti’s not mine. I am just pointing out that even the technocratic leader himself is aware of the danger.
I agree there is a history (and even a tradition) in Italy of having technocratic governments in time of crisis, but the thing about the Ciampi and the Dini governments is that they were able to show results (even if in neither case did they last much more than a year). This is what is worrying Monti, he won’t be able to show much in a year (the visible improvement he mentions), only recession and a call for more sacrifices. It is not clear how long Italian society will be willing to go on cutting and cutting basic services without some kind of kick back – remember, after reducing the deficit to zero they have to apply the “debt brake” and reduce their outsanding debt back to 60%. This is going to be very painful, and I don’t see it being doable without a restucturing, any more than I see Greece still having 120% debt to GDP in 2020 being a plausible story.
You may disagree, and think all this is doable, but please try to see the logic of what I am arguing, which I think is at least consistent, and not simply a question of ignorance.
January 17th, 2012 at 8:47 pm
Edward:
Trying to read the tea leaves, it is also quite possible that a disordered ‘credit event’ (e.g. a Greek bankruptcy) terminates the efforts of the ECB to sustain a largely zombified financial system through LTRO. Even the ECB cannot fight the laws of gravity for ever.
Regarding the Churchillian comment “You can always count on Americans to do the right thing — after they’ve tried everything else.” , I would add that of Charles de Gaulle, uttered at about the same time :”Americans will do all the silly things you can think of, and even those you can’t”. My conviction is that the euro is the disease, not the patient. Unfortunately at this stage, only the ‘populist’ dare claim so in public. Meanwhile, mainstream parties continue their exercise in creativity of these silly things. Churchill and de Gaulle would probably not approve.
January 17th, 2012 at 8:54 pm
Edward:
Trying to read the tea leaves, it is also quite possible that a disordered ‘credit event’ (e.g. a Greek bankruptcy) terminates the efforts of the ECB to sustain a largely zombified financial system. Even the ECB cannot fight the laws of gravity for ever.
Regarding the Churchillian comment “You can always count on Americans to do the right thing — after they’ve tried everything else.” , I would add that of Charles de Gaulle, uttered at about the same time :”Americans will do all the silly things you can think of, and even those you can’t”. My conviction is that the euro is the disease, not the patient. Unfortunately at this stage, only the ‘populist’ dare claim so in public, while mainstream parties continue their exercise in creativity of these silly things. Churchill and de Gaulle would probably have not approved.
I believe a quick (and painful) demise of the Euro through a Greek accident or anything similar would be better than a long (and even more painful) agony. The toxic brew of inadequate policies will eventually lead to dangerous popular reactions. The longer we wait, the more likely they become.
January 17th, 2012 at 9:42 pm
Perplexed, I understand your perplexity, but I think there is a lot of mileage left in the thing, even if it is completely dysfunctional.
Perhaps the choice countries are being offered is a bit like how you would prefer to be executed, through a swift beheading or via a slower Garott-Vil. Most are choosing the latter course even though it is definitely more painful. But then, either way you are dead, at least for some good while, and this is the issue.
This is why I once compared the Euro to Dr Stangelove’s Doomsday machine, it was built to explode, and to explode too if you ever tried to dismantle the thing.
But to take another example from another part of the globe, I personally think that Japan will eventually end up bankrupt, but they’ve been kicking the can along for the best part of 20 years now, and they still are a long way from being done, and my feeling is that the combined resources of the Euro Zone have just as much fire power as Japan has.
The reason for the Japan analogy is not that Japan is on a gold standard or something, although it is structurally unable to devalue its currency, but that the ECB is steadily being turned into a second BoJ, with interest rates permanently now stuck near the zero bound.
I think it will be the populism that finally undoes the thing, which is why I think Hungary is so important (oh, I know, Hungary isn’t in the Euro some stickler will say, but it does have rapidly ageing population – like Japan which isn’t in the Euro either), and it has all those horrid forex loans which mean they can’t flexibilise the currency (like the Southern Europeans).
I think Greece will reach a deal with the bondholders (at least in extremis), even though the protection of the “official sector” loans means there is no way that this makes their debt sustainable.
So many people now have their lives and careers on the line keeping things from crashing that I think you underestimate how far they will all eventually really be prepared to go. The days when a few Bundesbank people at the ECB or even the German constitutional court could throw a spanner in the works are now long gone. The pressures on everyone, including those in Washington and on Wall Street are enormous, so this can certainly run a good while yet. At least that is the conclusion I have come to.
January 17th, 2012 at 9:48 pm
On the other hand Perplexed:
“The toxic brew of inadequate policies will eventually lead to dangerous popular reactions. The longer we wait, the more likely they become”.
You are right that this is the greatest danger. Simple can kicking by the ECB (as I said, why not a 10 year LTRO for 10 year bonds, and who knows, a 25 year one to help finance outstanding mortgages) cannot solve the underlying structural economic problems. In the end loans have to be paid back, unless you restructure, and yes we can do some more of that, but if the banks keep having to “sweat capital” to avoid sovereigns assuming debt, good fresh credit will become harder and harder to come by.
So the most likely outcome, imho, is a long semi-depression on Europe’s periphery. As historical experience from the 1930s shows, this kind of depression can easily produce political instability and unruly outcomes. Thus, my fear is that the very instrument the idealists created to bring Europe together may well end up destroying it.
January 17th, 2012 at 9:54 pm
(And, incidently, the best exemples of Europe’s 20th-century technocratic governments are Nazi Germany and Soviet Russia).
Nonsense. Two ideological movements if there ever there.
the best example of Europe’s 20th century technocratic government were unelected technocrats Winston Churchill and Clement Attlee wresting power from popular elected premier Chamberlain.
I wonder if Edward would call this abolition of democracy too, as in: “In the year 1940 war-time Britain abolished its democratic elected government and replaced it with unelected persons with dictatorial power.”
Monti, on the the other hand, still has to bring any laws through parliament.
January 17th, 2012 at 10:00 pm
by the way, what’s with the “Massen”? Germany wasn’t downgraded, you know. A slight whiff of germanophobia?
And S&P has all along hardly shown any judgement. we are talking about the agency after all who just stamped AAA on any and all ABS. And even now they are hardly scouts, but more camp followers, following conventional wisdom wherever it leads.
And it is not helpful to just mash the “periphery” together. Italy,m a country with a primary surplus, could well in some years balance it’s budget. The situation in other periphery countries is quite different.
January 17th, 2012 at 10:06 pm
>oh, I know, Hungary isn’t in the Euro some stickler will say, but it does have rapidly ageing population – like Japan which isn’t in the Euro either>
You are obsessed with that, aren’t you? And then you try to shoehorn everything into it.
And to stickle: Hungary is indeed not in the Euro and acquired it’s current populist, if not authoritarian government all of it’s own. Or do you want to argue that Orban(!) is a technocrat?
January 17th, 2012 at 10:12 pm
Edward,
“So many people now have their lives and careers on the line keeping things from crashing that I think you underestimate how far they will all eventually really be prepared to go. ”
How true (and depressing). They have gone a very long way already, with a remarkable record that they can be proud of (the quasi destruction of Greek economy, the garot slowly squeezing around the Spanish one, et al.).
On the other hand (and that is my optimistic side), consider that the Soviet Union collapsed almost overnight. One day something looks indestructible, the following day it’s gone.
Because Japan has a very strong internal and social coherence (as well as being able to rely on itself for financing its deficit), it probably can endure very strong shocks without falling apart. From this point of view, the EMU (and the EU) look probably more similar to late 1980s Soviet Union (but, again, that is my optimistic side, and I might be wrong).
But the longer the mess goes on, the higher the odds of unpleasant things. Your assessment of the symbolic importance of the Hungary situation is, I believe, spot on.
January 17th, 2012 at 10:53 pm
IM:
Technocrat (my loose translation): “minister, or high-level civil servant, for whom prevail the technical conception of a problem, to the detriment of human and social consequences”.
Looks like a perfect fit to Nazi and Soviet regimes to me. The Nazi death camps, where six million people died, were built and organized scientifically to that purpose, like a huge scale evil engineering project. Ideology defines the objective (in the Nazi case, their nauseous obsession with the purity of the human race). Technocracy provides the method to go there (Death trains and death camps), You are confusing end and means. I believe that, given the chance, most ideologues can become technocrats. That’s because they don’t care about the human factor.
And I’m afraid the european nationalism is an ideology by itself…
January 17th, 2012 at 11:31 pm
Something funny happened to Hungary.
Our populist friend has been in power for quite a while, and has for quite a while taken, shall we say, debatable decisions. Brussels vaguely protested along, without seeming to care too much.
But when Orban decided to put limits to the independance of the central bank, all euro-hell went loose, complete with a series of frightful threats. The limitation of the power of unelected officials is serious stuff that can’t be ignored ! Stop the IMF ! Cancel the funding !
Could it be that the eurocrats fear that some day they too will loose their unelected freedom at the hands of a nasty populist? One almost feel some pity for Orban, who was nicely authoritarian-ing himself, until he committed a dreadful mistake: the capital, ultimate & terrible crime of attacking an Independent Central Bank.
January 17th, 2012 at 11:56 pm
“Our populist friend has been in power for quite a while, and has for quite a while taken, shall we say, debatable decisions. Brussels vaguely protested along, without seeming to care too much.
But when Orban decided to put limits to the independance of the central bank, all euro-hell went loose, complete with a series of frightful threats. The limitation of the power of unelected officials is serious stuff that can’t be ignored ! Stop the IMF ! Cancel the funding !”
“In power for quite a while…” yeah. He was confirmed as prime minister by parliament in mid-2010″ The new constitution was not passed until spring 2011 with the most significant changes not being effective until the start of this year. Quite a while my a**.
It is this becoming effective at the start of this year that has triggered the more aggressive sanctions. The issue with the central bank is one out of many in them.
If Brussels had pre-empted his actions, you’d slung even more mud. You can hardly start punitive action before someone has done anything, and even Orban needs a while to pass his laws. It has been made quite clear to him from the get-go that he will be watched carefully, and dragging him in front of the Court of Justice would be the logical consequence if he was deemed noncompliant. (In this vein were the demands for changes in the media legislation a year ago) Such a step, however, requires thorough documentation so that you can provide evidence of the breaches. Unlike you, the Court of Justice will not deem mudslinging and wild accusations as sufficient to establish guilt.
But go on with your “unelected” accusations, they are particularly ridiculous when trying to contrast them with someone who was just as much confirmed by parliament as any commissioner in Brussels.
The fact is that you will come up with any ridiculous excuse to sling mud and are willing to even use to someone’s detriment that they actually abide by proper procedure and law.
It is not surprising consequentially that you say “One could almost feel some pity for Orban” – or any other populist. Given that you happily use their methods, you are of one mind.
January 18th, 2012 at 10:02 am
@Perplexed in Montreal
You say that Soviets and Nazis were examples of [unelected] technocrats but it seems very likely that [early] Soviets and Nazis were actually both very popular and populist: in other words, technocrats of today are equivalent to Weimar Germany politicians, and the populists to come might, unfortunately, be similar to Soviets and Nazis, which is a problem.
In Italy, for example, the story was this:
Berlusconi was losing popularity by the day, both beacause personal scandals and because he was forced by the crisis to rise taxes, wich was the opposite of his promises. Opposition parties called for his resignation.
At this point Monti was proposed as a successor by the italian president. Berlusconi agreed and resigned.
When Monti had to appoint his new government, he explicitly asked main political parties to propose “high profile” political personalities for the government, in order to legitimize it. Both sides starkly refused.
What I understand from this is that both parties don’t want to be in power now, because they would be forced to make the same umpopular policies that Monti is doing (since they don’t want to make extreme policies like leaving the euro or declare bankruptcy). I think that most Italians would agree with my interpretation.
Thus the problem is not wether Monti is democratically legitimated (in my opinion he is, for the reasons Oliver stated above), the problem is that the Italian government, elected or not, is no more able to make a policy that reflects the expectations of Italians.
Also, I realize that on this blog and on other sites the idea that the Euro should break is very popular.
I too believe that for some countries (like Italy where I live) this could be a solution: we redenominate our debt in “new liras”, then print a lot of new liras, so we have a bankruptcy through devaluation and improved competitiveness through devaluation.
This, however, would be a “beggar thy neighbour” strategy, as non italian creditors like German banks could suffer a lot, and also the “competitiveness through devaluation” is a form of mercantilism.
Thus is very likely that other european countries would retaliate either by devaluing themselves and/or by protectionist measures, such as import tariffs.
Thus we would have big time trade wars in Europe, were most countries are both big exporters and big importers, and I think this would be a really big problem.
Note that, in some sense, trade wars through currency devaluation could solve the problem, because if everyone devalues the real value of nominal debt falls; but this could be accomplished much faster by the ECB by simply printing more euros, which I think would be the best, and less painful, solution.
So when I read that you would favour a EU without the euro, where every nation elects a “populist” government (that is very likely to use mercantilist and “blame the foreigner” policy), I have to say: be careful to what you wish for.
January 18th, 2012 at 2:50 pm
Random :
I agree with your conclusion that a fall in real value of the debt (through inflation) is the less painful solution to the debt problem. Whether the ECB will go along is unsure. Also, the debt problem is not the root issue: competitivity divergence between Northern Europe and the rest of EMU is the problem, I believe.
Regarding your last paragraph, I certainly do not wish populist governments anywhere. I simply state that populist governments usually occur when mainstream political parties are unable, or unwilling, to solve a country problem. Populist governments are not a cure. They are a late-stage symptom of the disease.
January 18th, 2012 at 5:11 pm
[...] The Massendowngrade Effect [...]
January 19th, 2012 at 7:59 pm
Here’s another example of what I am getting at from the Financial Times today. Greek’s bailout is wobbling, but it isn’t only wobbling becuase private bondholders are quibbling about the size of the coupon they will get on the new bonds, it is wobbling because the IMF are not convinced that the pace of reforms will make the debt projections on which the bailout is based feasible.
And why are the reforms going slowly? Because the politicians are positioning for an election. This is a very narrow line the EU and the IMF are walking, and they only have so much time.
Now for the FT:
*******************************************
European officials are hoping the Greek debt restructuring deal will be completed by Monday, in time for it to be signed off at a meeting of eurozone finance ministers in Brussels.
But there are growing signs the Greek government could be in for another tough negotiation with international lenders once the deal is completed.
Mission chiefs for the European Central Bank, International Monetary Fund and European Commission are due in Athens on Friday, and European officials said there is mounting concern that Mr Papademos’s government has made little progress in implementing reforms asked for by bail-out creditors since taking office in November.
One senior European official said concern has risen to such an extent that some northern creditor countries are again pushing for the EC to take over implementation of the Greek reform plan within the Greek government, something the commission is resisting.
“The Greeks have to take responsibility to run their own country,” said the official, adding that because of yet more slippage in the reform programme and increasingly pessimistic economic numbers, Athens will likely have to go through another round of austerity measures before a second €130bn bail-out is finalised, which is expected to come next month.
“They will have to take some prior actions before the second programme begins.”
Greece has missed an upwardly revised budget deficit target of 9.5 per cent of gross domestic product for 2010 because of overspending and poor revenue collection as the country sank deeper into recession.
Mr Venizelos has said the economy contracted by more than 6 per cent last year on top of 4.8 per cent in 2010. Another year of recession is forecast before Greece can look forward to a modest recovery.
But with an election due in April, senior politicians have been positioning themselves for the campaign rather than pushing through unpopular reforms.
Mr Papademos, a former ECB vice-president, has found himself undermined by senior socialist politicians preparing for a party leadership contest in March, conservatives who oppose some European Union-IMF measures and rightwingers backing vested interest groups.
January 23rd, 2012 at 1:00 pm
[...] and there is no simple rule from a central bank which can produce new credit (although see my Masssendowngrade Effect post for more detailed explanation about bank “liability management”, and how this interferes [...]
January 23rd, 2012 at 2:36 pm
[...] and there is no elementary order from a executive bank that can furnish new credit (although see my Masssendowngrade Effect post for some-more minute reason about bank “liability management”, and how this interferes [...]