Wolfgang Münchau: Politics will bedevil resolving the euro crisis Post author By John McHale Post date April 3, 2011 Wolfgang Münchau has an interesting take on the bailout/default debate that is relevant to recent posts (see here). Categories In Bailout Tags Default, ESM 19 Comments on Wolfgang Münchau: Politics will bedevil resolving the euro crisis ← What Irish Bond Prices are Saying → A couple of links 19 replies on “Wolfgang Münchau: Politics will bedevil resolving the euro crisis” I do not think Munchau is right. His argumentation, although supposedly talking about politics, is mechanistic in the extreme. Brian O’Hanlon has argued eloquently on the other thread that the market view of sovereign and corporate debt has irrevocably changed. Again, as a layman observer in this area, I do not see how this can be true. I post again the fascinating charts in the Voxeu summary of the Sinn proposal which seems to underpin much of what has emerged as the ESM http://www.voxeu.org/index.php?q=node/6199 What they demonstrate is a return to the status quo ante with regard to the the introduction of the euro but with a notable improvement for Belgium and Italy. This would reflect what is happening on the ground i.e. increased economic integration at the centre. Italy, for example, has surpassed France in terms of industrial production (if I am not mistaken) and Germany, interestingly, has overtaken France as an exporter of agricultural products. Put simply, the markets got it wrong up until the 2008 crash with regard to sovereign risk in the euro area which at least keeps open the possibility that they are now also getting wrong by way of reaction, a point made by another contributor. It is, apparently, a well known phenomenon. @ DOCM Do I take it (also from what you are saying on the previous thread) that you feel Ireland and others will probably become insolvent but some mechanism will be found to prevent this from torpedoing the ESM ? The interesting part from an Irish perspective in the FT article- “That would imply that Greece, Ireland and eventually Portugal will remain under the safety umbrella for a long time. Existing loan programmes will be replaced by new ones. The time for repayments will be lengthened; interest rates will be cut; the day of reckoning postponed. Eventually, the ESM, with the help of the ECB, will have accumulated the entire debt of these countries and there will be no private creditors left to be bailed in. If, or rather when, the system implodes, the ESM’s shareholders will pay the entire bill. Or they, too, will default.” “If, or rather when, the system implodes,” seems to be a bit ott. I wonder what he means by a long time. Don’t short De La Rue then Ceteris. That route is more likely than implosion. I’m curious, what exactly is the APR on the bailout when we include the cost of paying non-guaranteed bondholders as an initial down payment? Let us imagine for the sake of argument that Wolfgang is right and that ultimately states like Ireland end up being in debt to the ESM alone. Let us then imagine that at that stage Ireland had managed to get back to primary surplus (again, just for the sake of argument). What would happen then? And what would be the consequences? Kevin, I presume the Eurocrats would then be claiming crisis resolution and looking for an exit mechanism to refinance the sovereign and “guaranteed” banks debt in private markets at similar rates. Ireland would then be a highly leveraged economy vulnerable to any downturn but with with a primary and current a/c balance. But would private investors be willing to take that bet and take the EU/ESM/ECB out of their trade. Personally, I doubt it. Private markets would probably want to see a reduction of the debt burden to give them a margin of safety against any downturn. @ Paul Quigley My answer would be that if, and as John McHale has now suggested, the new government accepts that its liberty of action is confined – as Colm McCarthy has already pointed out – to the additional budgetary retrenchment and reform structural measures it can undertake, there is a sporting chance that Ireland can exit the EFSF and avoid the ESM. It is a matter of political will, not economics. For the moment, there is little sign of that political will or even recognition that such action is necessary either in the government or among the general population. Indeed, there has been some slippage rather than any acceptance of the case for further efforts. Maybe the detailed examination of the MoU and the sight of the Troika hesitating about whether or not to sign the next quarterly cheque may have the desired impact. On the broader point with regard to the ESM, it is a vessel well worth torpedoing. It is a misshapen concept, just like the EFSF, which reflects zig zag domestic German economic and political decisions rather than an answer to the problems confronting the euro. It has also failed to reassure German voters as the disastrous electoral showing of both the CDU-CSU and the FDP has confirmed. Coincidentally, Colm O’Rourke has opened another thread on the issue of competitiveness and imbalances. A large element of the problems confronting Europe stem from the skewed economic policies followed first by Schroeder (with Steinmeier as his right-hand man), then Merkel-Schroeder in a grand coalition and now Merkel in coalition with the FDP. These boiled down to the effective suppression of internal demand and an over-reliance on exports. Steinmeier, as leader of the opposition, has now seen the error of his ways and is a virulent critic of Merkel. This is hardly surprising. This prompts me to provide a link to the Terra Nova think-tank which shows what the left in France think of German policy. http://www.tnova.fr/note/partenariat-terra-nova-lib-ration-investir-dans-notre-avenir What has amazed me as I have followed developments is not the actions that Germany has taken – all were perfectly legitimate – but that other countries agreed to them, no doubt seduced by the political arguments in respect of Enlargement. Nothing underlines this more than the fact that both Germany and Austria were able to avail of the full gamut of restrictions on free movement of labour negotiated in that context and will not open up their labour markets until 1 May of this year! In the meantime, Germany has been able to steal a march both in terms of transferring investment to the new Member States and of availing of emigrant labour on the basis of considerations decided by it, not the EU. However, the die is now cast. The economic conditions for the centre to plough ahead without worrying too much about the peripheral countries – which include the UK – now seem to exist as will probably be confirmed by a rate rise by the ECB on Thursday. On balance, this is a good development as the imbalances generated by mistaken German policies seem to be righting themselves. All of the above brings me back full circle to my opening paragraph. Ireland is on her own and on the horns of a peculiarly sharp dilemma. @Kevin O’Rourke Just think “can”, then think “road”. Next try to think “can and road”. Then think of a randomly chosen action. The action is only permitted to be something frequently done in football – there is a directive on this somewhere. You are flirting here with the dangerously anti-European concept of thinking things through. If you have such urges again just say to yourself “there is the can and there is the road, we must perform our dutiful action. That is our plan. There is no other plan”. Saves me from repeating myself. 🙂 Here’s one thing Münchau didn’t mention. It has been suggested that the rules of the ESM (at least as announced late last year) are going to greatly increase the EU’s control over an EZ member state’s restructuring. So given the political will to stymie any post-2012 restructuring by Ireland, our EU partners may also have the legal means to do so. Under the circumstances, that would be a particularly dangerous bit of sovereignty for Ireland to lose. On the political-will side, Münchau mentions LBS’ opposition to ESM defaults, but he could also have mentioned France. I seem to recall that last year the French reluctantly agreed to a form of words which countenanced default inside the ESM, then came out loudly insisting that it would never happen. Also, in the case of Ireland the odds have to be more than fair that the ECB will still be holding not only Irish sovereign debt but also armfuls of our banks’ debt, collateralised against the sovereign, in 2013. Unlike Mr. Münchau, I don’t claim to know what will happen. I will say that it seems unwise to assume that the worst that can happen if we keep working the bailout is that we default our way back to solvency in 2013 while the ESM holds our hand. On the contrary, the situation seems to have all the makings of a protracted disaster. The EU could well faff and faff and faff for years, dribbling out term extensions and other minimal measures to keep the pot off the boil while blocking any proper resolution. It will all be our fault, after all – we took the money promising to reduce our debt, then failed to do so! Therefore most EZ voters will be happy to hear the pips squeak, as Jagdip Singh put it, for quite some time. @ DOCM That seems well asembled. As you describe them, the German policies seem to have been analogous those pursued in China. Repression of interest rates has been used to transform worker’s savings into cheap investment capital for the export businesses of the elite. The presence of a big new chunk of citizens from the former communist regime probably facilitated German policy. I think you might agree that traditional notions of left and right can often be misleading in analysis of today’s golobal economy. ‘Maybe the detailed examination of the MoU and the sight of the Troika hesitating about whether or not to sign the next quarterly cheque may have the desired impact’ How soon can we expect to be shown the instruments of torture ? 🙂 Of course Germany believes that ESM requires a treaty change. Not because sovereign default is currently banned inside the Eurozone – it’s not – but because EFSF/EFSM/ESM-style bailout mechanisms are. Presumably the ESM’s manacles on sovereign default would require approval too. What will happen if ESM doesn’t go out to ratification as a treaty change after all? Possibly little will change – perhaps everyone will carry on, pretending that the ESM complies with the European treaties, or perhaps it will be a long time before Ireland gets close to having a primary surplus, and in the meantime no Irish government will want to risk unilateral default even if there are no legal obstacles. IANAL. @all Rumours from Washington …. http://www.spiegel.de/international/europe/0,1518,754864,00.html Time for Ireland to get real – and restructure its debt! That ECB blue pill won’t work …. Our government got a mandate from the electorate to restructure Ireland’s debt. It chose to instead take the medicine given by our previous government . So say goodbye to democracy and hello to government by the banks, for the banks, we’re now a bit like those satellite states of the former USSR, those letters updating to ECB… http://wp.me/pBbF3-ej http://www.efinancialnews.com/story/2011-04-04/europe-patches-bailout-mechanisms?mod=sectionheadlines-home-IB It would appear the risk of contagion is disappearing with the new ESM purpose of keeping countries such as Ireland on the minimum of life support. It would also appear penal austerity is the new medicine handed out by the IMF/ECB. Our own government has caved in to accepting its new role. The problem is this socialism of the banking sector has a democratic deficit. Politically and economically and democratically it has been shown in the movement among the Arab countries towards democracy, there is ironically a corresponding movement away from democracy to some form of ECB/IMF socialism. When we’ll rejoin the free world of democracy and free capitalism is anybody’s guess:) @Colm Brazel “It would appear the risk of contagion is disappearing with the new ESM purpose of keeping countries such as Ireland on the minimum of life support.” It would seem so. An article in the Economist has the same slant. Also Der Spiegel saying the IMF is urging Greece to restructure. Economist- “This newspaper has argued that Greece, Ireland and Portugal need their debt burdens cut sooner rather than later. That case is stronger than ever, not only because today’s approach is failing but because the risks of restructuring are falling. The spectre of contagion is receding. Spain, whose bond yields have fallen and whose spreads with Germany have tightened, has distanced itself from Portugal. Behind the scenes, sovereign-debt specialists are devising ways to minimise the impact of an “orderly restructuring” on banks. Most banks in the core of the euro zone can withstand a hit from the three small peripherals. The big obstacle is not technical but political. Since many at Europe’s core, particularly the ECB, remain implacably opposed to debt restructuring, the pressure has to come from elsewhere—not least from the peripheral economies themselves. Ireland’s new government is talking about forcing the senior bondholders of its bust banks to take a hit. Greece should stop pretending that it can bear its current debt burden and push for restructuring. But the best hope lies with the IMF. Its economists have the most experience of debt crises. Some privately acknowledge that debt restructuring is ultimately inevitable. It is time the Fund’s top brass said so publicly and, by refusing to lend more without a deal on debt, pushed Europe’s pusillanimous politicians into doing the right thing. ” Are we approaching the end game sooner than anticipated? @ Colm & Ceteris Let’s see if I’ve got this right. By 2013 we can imagine a position where EZ (all EU?) countries have signed up to the ESM. This will include, ‘what to do if banks fail’, including bond restructuring or ‘bail-ins’ whichever term is most useful. Everyone, including the financial markets is happy, as we all know where we stand, and the bond markets can get on with things, buying bonds with the new deal factored in. In the meantime, Ireland as a stand out, will have paid off, through the sovereign all the once-private bonds of all the banks that have fallen due up to this date. There will be a figure on this known unto the Central Bank and who else? Us, the citizens, or are we mushrooms? Anyway, it will be a very large number. This means that Irish citizens and tax-paying entities (and a lesser extent the Greeks because the Greeks don’t have so much of a banking crisis), are expected to fork out in full for bank bonds, while all other EZ (EU?) citizens have more of a co-responsibility situation, where all players pay. Is that right? So the issue arises, that as the ECB (a free standing entity we’re told), has told M M. Noonan that Ireland cannot touch senior bonds even though Ireland wishes to and these are not guaranteed by the state, we alone are carrying the can. This seems manifestly unfair. If the state does actually carry on down the road of successfully not defaulting, what options might there be within Europe to rectify this injustice? I am glad to see that the article include “Euro crisis” in itś title. The sooner most pundits in Ireland realise that Ireland is dealing with a “Euro crisis” the quicker most people will realise that Ireland has to tackle itś own problems and forge strong bi-lateral links in and out of the Euro Zone area. The diverse politics of Europe also means that the likelihod of a benficial coherent strategy emerging from the ECB is very unlikely. However in fairness to politics and politicians: everyone has to admit we are currently relying on them to clean up the mess which the bankers have left us with. Under the current circumstances I would rather have accountable politicians managing bank accounts, mortgages and credit in Ireland rather than the dodgy imcompetent bankers who either got us into this mess or who may be waiting in the “wings “to “swoop down” when the “remaining scraps” look a bit tastier . @DOCM Re your last sentence : “Ireland is on her own and on the horns of a peculiarly sharp dilemma” IMHO you are absolutely spot on. I also posted a comment on Colm McCarthyś Sindo article which you may be interested in reading. Best…L Comments are closed.