Daniel Gros: Borrower, and Lender, Beware Post author By Philip Lane Post date March 9, 2011 His WSJ article is here. Categories In Bailout Tags ECB liquidity 11 Comments on Daniel Gros: Borrower, and Lender, Beware ← O’Rourke – thar sáile ar an mBád Bán → Ireland Once Again Among the Poorest Countries in Western Europe 11 replies on “Daniel Gros: Borrower, and Lender, Beware” It’s as well to know what people are saying about our troubles, so thanks to Philip Lane for linking to this, but I wasn’t impressed by the article itself. Those who have been following the story won’t learn much, while those who are not will be getting a poor introduction to the issues. Like many commentators, Daniel Gros conflates support to the banks and support to the state: “The ECB is, however, providing direct support to the euro zone’s troubled sovereigns via its normal monetary policy operations, which allow the banking systems of these countries to refinance themselves at the ECB’s benchmark rate of 1%.” And like many others, he confuses liquidity and solvency: “Without these injections of essentially free liquidity, both [Greece and Ireland] would have been insolvent a long time ago.” Of course there is some difficulty in distinguishing a liquidity problem from insolvency, but muddling the two concepts in this way is just lazy. Daniel Gros seems to feel that the ECB is doing Ireland some service by ensuring that the zombie banking farce continues. Maybe so, but the longer it goes on the more I doubt it. This link may work better. http://online.wsj.com/article/SB10001424052748704506004576174342907615806.html The argument advanced is all very well and could be characterised as a typical creditor country view. But it does not take an expert in either banking or economics to explain why this liquidity support is necessary, and why it will continue to be until the Greek and Irish banking systems are put back on an even keel. Investors – mainly German, French and UK banks – simply lost confidence in the Greek and Irish banking systems and pulled their funding. They had no reason to maintain it, and every encouragement to get out while the going was good, because the political debate in their countries (especially in Germany) went completely off the rails and many politicians, either through a lack of understanding (they overlooked the fact that these countries were part of a monetary union in which they were also participating) or electoral calculation, not alone did nothing to stop this development but actually egged it on. What goes around comes around! They now have the (ex-Celtic) tiger by the tail and cannot let go of it. All efforts are now being bent to keep two other tigers (Portugal and Spain) at a safe distance. Mr. Regling has recently confirmed this. This is not about economics but political relations within, as Delors has put it, a federation of nation states. States do not do sentiment (as the Icelanders found out). Nothing personal, just business. This predicament we are in – call it what you may, is about 40 years in the baking. Its what happens when the exponential plot line of debt growth goes above the linear plot line of aggregate economic growth. The situation becomes mathematically impossible to sustain absent a write-down of the debt load to a level that the aggregate change in economic activity (aka. some level of surplus) is available to pay off the principle so as to snuff out the debt growth. @ DOCM: Your correct. Its politics time: They have to figure out a way to legislate for an orderly winddown of the excessive debt loads. They are well aware of the predicament, but are fearful of what will happen. They may easily lose control. BpW Time for Karl Whelan’s 101 on liquidity and solvency? http://www.karlwhelan.com/Teaching/International%20Monetary/part3.pdf @ Brian Woods With regard to figuring out a way to legislate as you suggest, I am posting again a link to the suggestions of Professor Sinn of SiIFO, especially the following. “The report acknowledges that help without haircuts would be useful in a mere liquidity crisis resulting from dysfunctional markets. But haircuts in the case of a solvency crisis are indispensable for the stability of the European financial system itself. Thus, they form a key part of the group’s detailed proposal for a rescue mechanism that could serve as a blueprint for a new European financial governance system (see http://www.cesifo-group.de/DocDL/eeag_report_chap2_2011.pdf)”. http://www.project-syndicate.org/commentary/sinn36/English I am rather surprised that the well-thought out proposal in question has received so little attention. (It essentially proposes a form of Brady Bonds for insolvent countries of the Euro Area). However, having been an observer of the scene for some time now, the lack of understanding between economists, bankers, administrators and politicians increasingly reminds me of the old Monty Python skit where the pilots from various war-time aerodromes meet and are unable to communicate because they do not understand each other’s banter. Chapter 2 of CesIFO group also has some interesting things to say about Ireland including the suggestion that, with a bit of effort, we might have avoided becoming the guinea pig for the first (failed) (and only?) outing of the EFSF/EFSM. The key national question is whether we view Ireland as a future Argentina or a Finland? The problem of “banter” had better be overcome quick-time if the country is to give the right answer. @ Brian Woods I forgot to mention that I would agree with the view expressed by the group that the only way to impose budgetary discipline is to have the markets price sovereign risk correctly (something which they singularly failed to do from the inception of the euro until 2008). But this is not an argument for abandoning the efforts to strengthen the Stability Pact or introducing a Competitiveness Pact. If markets start pricing sovereign risk correctly, politicians will have even less room for manoeuvre and risk dealing with an ever more dissatisfied if spoiled electorate. Everything that persuades the last-mentioned of the fact that Father Christmas will not put their toys back in the pram is helpful. @DOMC: Much obliged for the info. “If markets start pricing sovereign risk correctly, politicians will have even less room for manoeuvre and risk dealing with an ever more dissatisfied if spoiled electorate. Everything that persuades the last-mentioned of the fact that Father Christmas will not put their toys back in the pram is helpful.” Yep! Thanks again. BpW @DOCM “However, having been an observer of the scene for some time now, the lack of understanding between economists, bankers, administrators and politicians increasingly reminds me of the old Monty Python skit where the pilots from various war-time aerodromes meet and are unable to communicate because they do not understand each other’s banter.” That’s because the economists all say different things, the bankers are being deliberately obtuse, the administrators have nothing to say anyway and the politicians are as baffled as anybody else. Daniel Gros has been making sense now for quite some time. As to the clarity of his writing – all high infants graduates can easly understand him. EZ policy makers, top ECB officials, and Irish politicians are another matter. Also from Polonius to Laertes and relevant to our relationship with the EU: “Those friends thou hast, and their adoption tried, Grapple them to thy soul with hoops of steel” I note that Daniel Gros is a guest on Saturday View on RTE Radio 1 just now. Comments are closed.