Daniel Gros on bailouts and euro

Gros has two relevant pieces on Vox: here and here

29 replies on “Daniel Gros on bailouts and euro”

The “bailout” should be looked at only in terms of short term cash flow as obviously in the case of Ireland default is inevitable unless something is done about the euro.

Look in 2010 we’ve had 10% export growth and zero GDP growth. Do you think we are going to get that export growth again next year, not a chance. There are too many competitors in this space such as Poland and I just don’t think Irelands plants and cost base could flawlessly expand by another 15% in the current climate. This is just wishful thinking. We will lucky to get 5% growth in exports.

Given that 6.5 bn are to be taken from the economy in tax increases and spending cuts the 5% growth in exports will translate into a DECLINE IN GDP of 1.5% assuming a GDP multiplier of 1. Assuming that payments to Senior bond holders are more or less outside the country I think we can safely that this cash is on a multiplier of 0 and paying them is the equivalent in GDP terms of a bonfire.

At the end of the year we will end up with a debt/GDP ratio of 120%+ and again the largest fiscal deficit percentage rise of all the PIIGS.

If you were a bond-holder in that situtation you really would want to sell long term paper as Daniel Gros has made clear. In essence the “bailout” has just inflated and delayed the problem.

The government just has to look as the bailout in clear cash flow terms. If in any given quarter they are expected to pay out more to the bondholders/ECB than they will recieve from the Trokia they there best stratergy is to default. In the shorter term keep taking the cash from them provided the terms arent too onerous and pay off the short-term bonds and keep the country going with the cash.

All that happened last year is that short-term senior bonds due last year were paid off with ECB cash as the banks cashed in their junk bonds, government or otherwise, with the ECB.

As I have said on this site before all that is happening is that the market is trying to establish the floor the ECB is putting on Irish Gilts and bank-bonds. In the real world all this paper would quite rightly be classified as junk.

At the moment the bailout says “short term bonds (1-2) years are O.K because they have been underwritten by the ECB , given the risk they are probably worth 90% of face” And “long term bonds, unless something radical is done shit they are worth 40% of face”


I am not saying that every policymaker in the eurozone is hopeless. There are a few exceptions. My point is that the system is überfordert, unable to cope. The first, and most important, is a tendency to repeat the same mistakes. The biggest of these is the repeated attempt to address solvency problems through liquidity policies.

What triggered last week’s panic was the sudden realisation by investors that, with an interest rate of 6 per cent and an ongoing no-default guarantee to bank bondholders, Ireland is insolvent.

The second is a lack of political co-ordination

The third is a breakdown of communication

A fourth aspect is a tendency by governments to blame investors when something goes wrong, rather than solve the problem

Fifth is the tendency to blame each other

Finally, a sixth aspect is the tendency to appeal to a deus ex machina when all else fails. That would be the European Central Bank.

This is kind of proposal that Ireland needs to promote at a Europen level.
He does make a number of key points.

The State must be saved before the banks.
“In the Spanish case, the problem stems from the banks. Nobody can know with certainty how large their losses will be in the end. But this uncertainty drags down the entire country. The banks must thus be sacrificed if the sovereign wants to stay afloat.”
Eichengreens bright red line is gaining traction.

The second major point is that he wants to assign the elements of the “Big bang” to where it should be assigned.
* The ECB stabilises the banking system, and
* The EFSF/ESM (the fiscal authorities) take care of the financing needs of governments.

The proposal to seniors to convert from Senior to subordinated also makes sense.

“The State must be saved before the banks”

It is so bleedingly obvious. If the wound continues to fester you can multiply the financial losses of the banks several times .

@Richard Tol [v. good stuff here]

“… The banks must thus be sacrificed if the sovereign wants to stay afloat. Holders of bonds of the banks most exposed to the real estate bust would thus be offered a debt for equity swap. The Spanish government would then be free of further large contingent liabilities, and should have no problems servicing its present debt of around 60% of GDP.
The accounting losses for the holders of Spanish bank bonds might again be limited if the bonds are transformed into subordinated debt with the same face value of the bonds. For holders of the bonds which do not mark to market the accounting losses could then be taken over a longer period. Spanish banks would not be forced into fire sales, and patient investors might limit their losses if the Spanish real-estate sector does recover.
The same should have been done in Ireland. But at this point it would require first the (new) Irish government to renege on the guarantee given by the old one. This will lead to legal problems and would formally be equivalent to a default, but it would restore the solvency of the Irish government, so that no haircut would be needed on Irish government debt. The debt-for-equity swap (as with GDP warrants) allows investors to participate in the upside that would materialise if the assets of the Irish banks and Spanish cajas are really worth as much as the banks and their regulators maintain.
Core governments would of course have to stand ready to recapitalise those of their banks with the highest exposure to the peripheral debt to be restructured.” …… “Restructuring will become virtually impossible once the Greek and Irish programs have run their course.” Daniel Gros

Plausible – but politically extremely difficult …………[Core NO to increase in bail-out fund … and NO NO NO to a Euro-BOnd (which must happen at some stage imho) …

Item 1 on Agenda of next Irish Government: Banks … and send ‘Big Bang Casey’ as part of the negotiating team (-; When a Traveller from Southhill can win a European title – the Irish are far from finished (-;

“Restructuring will become virtually impossible once the Greek and Irish programs have run their course.” Daniel Gros

to be sure to be sure ……

What a disaster. The fact that we have 16 separate bond issuers within the same currency is the problem. Each country is isolated. At the first hint of weakness, the bond piranha’s swarm in. None are unable to devalue. We are all trapped in the train-wreck which is the Euro. Our problems can only become calamitous the longer we dither on the key measures necessary to save the country.

We have been backed into a corner and our only realistic choice now is to default on the bank guarantee. Leave the banks go and concentrate on quickly establishing our own currency. The situation is akin to war and people will have to cope.

This budget should be rejected by the Dail. The 19 billion of the Pension fund should immediately be directed towards the purchase of precious metals, especially silver. This is the only possible hedge as far as I can see. Silver will go to $100 eventually and possible a lot higher and when this happens the game is up for the banks.

JPM, et al are sitting on vast naked short positions, on silver especially. Popular demand for silver coin and bullion is battering at the door of the banking citadel. The battle for silver is as much a political issue as an investment opportunity. When COMEX is shown to be insolvent, the jig is up. There will emerge a de facto Gold Standard and Ireland needs to position itself to benefit from this new order. The pension fund could not be directed toward a better end. We need to act quickly. Time is not on our side.

The Labour Party are talking about a new State bank. This is a good idea. It needs to be set up and to start lending as quickly as possible (even before the Euro drama plays out to its inevitable conclusion). Even before our new currency emerges credit can be lent to institutions, businesses, Government depts through the EFT mechanism. Wage earners can access goods and services through the exclusive use of card technology thus avoiding the Euro clearing system.

The loans carry interest and this returns to the Bank as a dividend which the Government can use to fund most of its expenditures. Re-payed loans are recycled into the economy and provided fiduciary discipline prevails inflation is avoided.

The important aspect of this State bank is that the money is not lent at interest to the Government by private banks as is the current practice but rather are lent directly into the economy by the State bank. by-passing the Cartel. The loans monetize the productivity of the nation. This is what backs the currency. Money supply can be restored to levels appropriate for the economy. The National Debt is eliminated. The economy grows. What Ireland needs is credit circulating in the economy. We have suffered a 50% reduction in the money supply in society and this will get worse. The only institution that can provide the necessary liquidity is this State bank.

The IMF/EU bailout constitutes a rape of our country. We need leadership that will reject this budget, default on the banks loans, get into metals and start a new currency with a State lending institution at its head.

@ Mokabaybob : “… should immediately be directed towards the purchase of precious metals, especially silver. This is the only possible hedge as far as I can see. Silver will go to $100 eventually and possible a lot higher and when this happens the game is up for the banks.”

Very interesting. Regrettably your correct, and you may get a bit of a roasting for proposing this. Just watch the price of crude as well: over $ 85! Global liquid fossil fuel production has plateaued out for the last 5 years – bobbling about within a 5% band: This is being completely ignored, for the moment anyhow. Stagnating supply ensures economic activity will shrink!

Who will want to extend credit if they are confident it will not/cannot, be repaid? I would support a silver-based currency. Gold would indeed be better, but physical gold is in short supply. Maybe for higher denominations.



Great to see this one eventually ON AGENDA …. two levels, and can be done. When is another matter – the Nein Nein Nein from core to be expected ….

Who do you think will succeed Jean-Claude? The Goths have already ‘vetoed’ Axel …. for historical reasons.


When are the next German and French elections? Strauss-Kahn in Elysee and a Grand Coaliton in Germany would help ….

@D O’D,

Sarko is gearing up for a second term from May 2012. DSK will only jump from the IMF if he is handed the Socialist party nomination on a plate. Mss Aubry and Royal have other ideas – as do a host of other rmale political pygmies. Frau Merkel doesn’t have to meet her federal voters until Sep. 2013, but there are numerous lander elections next year.

@ DoD

I read somewhere that there was going to be a lot of shifting of tectonic plates before Christmas. Pension funds and insurance cos across Europe are taking a big hit with Italian, Spanish, Portuguese, Irish and Belgian yield spreads where they are at the moment. So this is much bigger than just a Mullingar issue.

@Paul Hunt

Ta. September 2013 …. Oh Dear – think Yeats summed up this ‘lock-out’ long time ago. We would be well sunk by then …….. & EuroBond would need a Grand Coalition in Germany imho ….

May 2012 …. still too far off ………

So EU will go for a ‘bigger bail-out fund’ .some time ‘soon’………….. which essentially pushes us into no-man’s land if we have to wait to 2013 … and the conflationist trap is closed.


‘‘We prefer the term ‘hysterity’ to describe the sentiment that the citizens of the richest economies in the world are somehow having to tighten their belts, but are mostly failing to do so in any convincing way,” O’Hagan said.

‘‘As long as that is the case, as long as the West lives far beyond its means, with a disjoint between expectations and reality, and a crowding out by government of the economy, growth in the US and Europe will remain challenged,” he added.


O’Hagan said there were three possible ways out of the current crisis: a meaningful austerity programme, inflation, or default. In the absence of austerity or inflation, which is anathema to the ECB – he sees the state of ‘‘hysterity’’ in Europe as inevitably leading to some form of default.


… so this is much bigger than a Mullingar issue.’

When tectonic plates collide one may expect volcanic eruptions, earthquakes, tsunamis, ash clouds, and casualties (of which we are(may be) one) ….

Speaking of Mullingar and Kilgarvan – Bloomberg are (seriously) reporting that Jackie Healy-Rae might bring down the Euro … maybe it is Yeats’ 1913 back again from some parallel universe ….

” and a crowding out by government of the economy, growth in the US and Europe will remain challenged,” he added.”

Alternatively the permagrowth horse has been flogged to death. US corporates have $3 trillion in cash waiting on the sidelines and they don’t want to invest. There is only so much sales effort that a country can take. Short of a return back to Victorian inequality levels where’s the growth going to come from ? Reducing the minimum wage in Ireland to €2.50 won’t get any votes.

I heard 2 respectable economists say today that emerging Asia will grow faster than Europe and North America for the next 20 years. Really ? And who is going to buy their stuff ?

@ Ahura Mazda


On Wednesday, the Fed went ahead and launched a second programme of quantitative easing, or QE2, to use its ubiquitous nickname. It will spend another $600bn on buying Treasury bonds. By increasing the demand for the bonds, this should push up their price, and hence push down their yield, or effective interest rate. As they are buying the bonds with money that they have created, this should by orthodox monetary theory be directly inflationary. Such an action is only imaginable, then, in desperate circumstances.

I input the key words into the wrong search engine on the FT site and got the following fascinating result

“No equities were found for only imaginable in desperate”

Well seafoid you can look at it from any view you want

View 1: Bunch of bankrupt whingers complaining they are suffering austerity when in fact even left wing newspapers in the UK are shocked at the antics of the kleptocrats here

View 2: The permegrowth economy has hit its limits…… So we can only grow again after we have shrunk properly! So in effect what went on before was some kind of ‘peak lifestyle’ or above peak lifestyle

View 3: Maybe those people in the growing economies will have their day in the sun…. Who says they have to produce for our consumption, trade between developing nations is increasing dramatically. The world is full of countries who were once rich

I thought the bond guy put my view as to whats happening here much better than i could.


It’s strange that Ciaran O’Hagan doesn’t seem to think that sorting out the European banking system is part of the solution to Europe’s woes, don’t you think?

These recommendations for more austerity come from a member of the fraternity of bond traders, who, through their track record, have collectively shown that they are unable to price risk and therefore are incompetent. If employees in a normal industry screwed up the way bond traders have in the last 10 years, they would be fired. Not so in banking.

Banking today is an industry wholly subsidised by the taxpayer. Banks have an inflated risk appetite because they know they will be bailed out at the end of the day.

And the response of this seasoned banker to problems that started with, and have been made worse by, the banking industry is to increase the pain for the average citizen. Unbelieveable!

All this illustrates perfrectly the famous quote by Upton Sinclair:

It is difficult to get a man to understand something when his job depends on him not understanding it.

@ Seafóid,

I guess if countries are looking at severe deflation, then a little bit of easing might go a long way. This is the case for a number of PIIGS. There are many ways you could structure QE. The PIIGS are carrying too much debt. What use is the ECB to these countries if they can’t gain the benefit of low interest rates?

The type of QE programme I’d like to see in the EZ is zero interest loans to sovereigns with principal being repaid at 3/4% p.a. (Really, this is an obsure means of debt forgiveness). To me, this is the best way of avoiding default. As ‘principal’ payments would be made, I think this should help limit inflation. The current IMF-EU rescue of Ireland only buys time, a proper PIIGS solution should strengthen the euro.


An interesting article in the Telegraph by a former deputy governor of the BOE

‘Although for the present, banks and sovereigns can turn to the European Central Bank for funding, the ECB is wary of being drawn into providing fiscal transfers through the back door (by buying sovereign and bank debt which will in time be written down).’

If they keep buying our bonds the problem could be solved.


Maybe the emerging Asian economies will grow for 20 years. Maybe India will be the third largest economy by 2020. Maybe the fact it hasn’t grown consistently over 20 years since the 17th century is irrelevant. Maybe all of the peasants in Uttar Pradesh will become entrepreneurs and Bombay will expand to a population of 80 million. I don’t get the feeling that the guys doing the trades have much insight.

As far as I can see it is all about finding patterns in data and trying to extend them into infinity.

Same with China. How good is the party in making economic decisions ?

I thought this was fascinating


Jeremy Siegel, professor of economics at the Wharton School in Philadelphia, produced a model, in his The Future for Investors, that suggested that westerners’ comfort in retirement was almost wholly dependent on productivity growth in the developing world. If the developing world keeps raising productivity at 6 per cent per year, then the US could meet the needs of its ageing population while barely raising the retirement age from 62. If, however, developing world productivity growth stalls completely, then the US retirement age by 2050 will have to rise to 77.

How likely is it that Indian and Chinese workers will allow capital to cream off all of their productivity gains ?

@ CP and AM

QE would solve a lot of problems but it shows up a total failure of the market to price risk efficiently.

@BPW/ Mokabaybob
There is 5 times as much physical gold as there is silver – due to the use of silver in industrial products (cell phones etc) – so silver is undervalued in relation to gold by about 5 times right now – BTW when do JPM have to cover their shorts?
Max keiser has a viral campaign – and it seems he is getting some publicity in the “respectable” press

“Restructuring will become virtually impossible once the Greek and Irish programs have run their course.” Daniel Gros

There’s also an even simpler problem: ESM puts national restructuring in the hands of an EU procedure – and it puts that EU procedure in the hands of the EU, which may be almost as terrified of restructuring in 2013 as it is now, or maybe more, should we somehow get there without a crisis first. Thus from 2013 the EU may have both the means and motivation to stymie restructuring by obstructive behaviour, short of an EU exit for the defaulting country.


… now way do the reformed lemmings around here wait for 2013 on restructuring … then we join the sovereign defaulters/restructuring [Greece; Portugal; (italy?)] from a position of abject weakness …..

similar to Spain our problems related mainly [we fix deficit in a pragmatic manner] to banks and property bubble ……… so we might tune into the SpanishEconomy blog ….. and see how the wind drifts …………. and a continuous eye on Frankfurt/Brussels re “überfordert“ and the coping classes. Lovely word that “überfordert“ ……. so poetic that Poor Werther must have used it ……

Any Spaniards around …. ?

I saw on the FT recently that any sign of a return to decent oil demand and the oil price is likely to go back up above 150 usd . Which surely would dent the growth prospects of even the emerging Asian economies. India was badly placed in 2008 when the oil price went north – the gu’mint subsidises petrol for the masses and the bill went through the roof.

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