Stumbling into disaster

I am just back from a conference in Berlin that was attended by finance officials from a number of euro zone countries.   I must admit that what I heard left me with an increased sense of foreboding on the future of the euro zone.     To no great surprise, officials from stronger countries made it clear their governments are willing to pay a significant price to save the euro zone – but not any price.   What worries me most is the emphasis on restoring “market discipline” given concerns for moral hazard, including the continued threat of debt restructuring.   (The sentiment behind Deauville has not gone away.)  While I have no trouble in understanding this position from likely net contributors under enhanced risk sharing arrangements, it is a recipe for Italy and Spain being driven from the bond markets.   The concern of stronger countries for their own creditworthiness under guarantee arrangements was also emphasised – and, again, is understandable.  

As has been pointed out before, the main message from “second-generation” currency crisis models is very relevant.    Concerns about the willingness of policy makers to bear the costs of protecting a currency peg — or avoiding default — leads to increased expectations of those events, raising the costs of avoiding them still further.   It is all too easy to fall into a self-fulfilling, bad-expectations equilibrium. 

So what is the way out?   Stronger countries need to lay out what institutional arrangements they require to support enhanced risk-sharing arrangements, including some substantial form of euro bonds.   For the medium-term, credible institutional discipline must replace market discipline.   The present mixed approach is not working.   In deciding whether to accede to arrangements that would significantly diminish fiscal/banking sovereignty, all countries must recognise the likely path under the present course.   It might be a bridge too far, but at least we should not stumble into disaster. 

43 thoughts on “Stumbling into disaster”

  1. Hi John
    Is there any economists who are influential in the likely solutions–and are they independent.? Or is it a straight power play.

  2. Spain is going to raise taxes in return for a year extension on meeting the deficit limit of. 3% of GDP.

    It was President Hollande’s mentor who forced Germany to accept the euro and it may require some variation of Merkozy to give German voters assurance that Germany itself isn’t alone in trying to save the currency.

    France has twin deficits and if it has not the will to get its house in order, Germany isn’t going to save everyone else, no matter how irrational that maybe.

    The following is a repost from the Kevin O’Rourke thread as the same key issue is covered:

    It is realistic to not expect a grand bargain.

    Even if the left of centre was to win the next German general election, I doubt that policy would be any different regarding mutualisation of debt.

    I doubt also that if Angela Merkel had been more active in promoting a solution of debt forgiveness and stronger firewalls that it would have changed the dynamic in Germany.

    Four years after Wall Street almost engineered a second Depression, a wealthy corporate raider with hidden wealth in tax havens such as the Cayman Islands, Switzerland and Ireland, is poised to take the White House bar a positive result from a demonisation campaign by the Obama campaign.

    Wonder how hard it is to sell health care reform in the US?

    In 1965, Canada spent 5.9% of its GDP on health care. The United States spent 5.7%. But around that time, Canada was transitioning to its current single-payer system. Over the next four decades, the growth of health care costs slowed in Canada while they accelerated in the United States. By 2009, Canada was spending 11% of its GDP on health care – –  and covering everyone. The United States was spending 17.4% of its GDP and leaving 45m uninsured.

    Whatever about a 20-year horizon in Europe, there can be little doubt that the next decade will be grim.

    German trade with the emerging economies is helping some EMU economies.

    In Ireland 10 years is too long to think about and today Minister Richard Bruton has announced a new manufacturing forum to give him some tips.

    Policy makers and experts are in fact clueless as to what to do.

    What would be too much to hope for until the wolf is outside the door, is a realistic assessment of the challenges.

    One option at least would be to live within our means.

  3. John,

    My intuition is that the EZ will continue to breakdown if not breakup. 1/8 Dutch persons are now in debt arrears with 27% in arrears for at least one of payments like – mort. , rent, utils. etc.

    IF the currency crisis models require an unlimited capacity yet Europe’s so called cores are starting to now feel a deep impact then I find that a difficult sell for their leaders. Especially with elections looming.

    It maybe that Germany has already decided a process of limiting the losses and is stalling to allow a retrenching. First done with Greece and even now the german regulator interceding to reduce scale of capital outflows from an italian subsidiary bank in Germany back to Italy. Disentanglement beginning?

  4. Also John: presume if they’re not already doing so Irish finance officials will be working on a post € environment?

  5. A lot of what we have done over the last few years has been more about choosing between disasters, and less about avoiding them. In Ireland, we have chosen the triple disasters of borderline unsustainable public debt, persistently high unemployment and foreign interference in our sovereign affairs in place of other disasters that threatened.

    It may be that for many of those in stronger economies in Europe it is preferable to stride confidently (albeit with a show of reluctance) into the disaster of currency chaos than to embrace the disasters of permanent fiscal transfers, moral hazard and the destruction of German sovereignty.

  6. Ship deserts sinking rats? GerExit? BCT has a nasty there for us all to contemplate….

  7. The President of the German Constitutional Court Voßkuhle had the following question for the government officials at today’s hearing in Karlsruhe:
    Is the ESM a “systematically important bank”, which needs more and more money in the future to save the euro?

  8. @Frank G.
    Not sure why anyones’ head would explode. Anyone paying attention to this blog would already be aware that Greece was still actively issuing short maturity T bills, despite being locked out of longer maturity debt markets.

  9. @John Mch

    “To no great surprise, officials from stronger countries made it clear their governments are willing to pay a significant price to save the euro zone – but not any price. What worries me most is the emphasis on restoring “market discipline””

    Would you mind giving us a flavour of what sort of “officials” we are talking about here?

    Could you expand on “the emphasis on restoring “market discipline””?

  10. We stumbled into this disaster a long time ago. When we leave the eurozone we will be like pretty much every other country on the planet both now and throughout history. We’ll have our own currency and a modicum of control over our interest rates and we can get back to economics 101. Why is it that Irish policy makers still see a currency union as being in some way normal and desirable? Wake up! The world is sick and tired of this fiasco. The ridiculous eurozone and it’s interminable demise will not be regretted by anyone.

  11. Looks like all bets could be off….
    “Court President Andreas Vosskuhle announced at a public hearing on Tuesday that the court would undertake a “constitutionally sensible assessment” of the legal complaints that may go beyond normal procedures in weighing temporary injunctions. People who took part in the hearing said it could now take the court up to three months just to decide on whether to issue the injunction. It would then take considerably longer than that for it to reach its verdict on the substance of the complaint — whether Germany is handing over too much sovereignty to European authorities.” …Der Spiegal

  12. I don’t not fully understand the argument of net contributors that their solvency might be endangered if they agree to more, even full, fiscal risk sharing.

    In the long run, possibly, without fiscal rules and proper incentives.

    But for today, the aggregate numbers of the Euro area would matter. And they look better than in any large and advanced country of the world.

    Can sb. help me out?

  13. Thanks for the very interesting post. My only gripe is that you focus on “policy makers” willingness to bear the costs to keep all this alive. It seems more important now to focus on whether policy makers can and should keep the euro alive given all the problems. No institutional strucuture designed in Brussels will change the ugly reality that internal devaluation requires employees and employers at thousands of enterprises to sit down, trust each other, and agree to large scale wage cuts or increases from time to time if we are to avoid unemployment in the euro area. The many unemployed, bankrupt, and persons “in arrears” that you descirbe above are truly suffering due to the fixed currency (and lack of lender of last resort) at the national level. A sharp devaluation or appreciation of currencies relative to others would have instantly distributed the burden of adjustment qucikly and more evenly across the euro area. A national currency means you have a lender of last resort. But policy makers have locked us into this cumbersome single currency which seems to drive weaker nations ever weaker. So, rather than posit this battle as a fight between the creditor and debtor nations, it seems we are now at a stage where the key quesiton is: “Is the single currency right for the people of each nation in the euro area?” Policy makers can pretend they have the powers to decide the answer, but in reality they don’t, and makets can see this very clearly. We are now about to suffer one last battle where markets guess who will win: Can policy makers wrestle their personal dreams into perpetuity?, or, will enough voters rebel to topple the politicians who try to maintain this dream?

  14. @Seafoid
    Bank debt was so last year…………..

    This is much bigger then that.
    Its about juristiction and sovereignty.

    The only country in mainland Europe giving the bankers a few Kicks and not kick backs is Hungary.
    http://blogs.ft.com/beyond-brics/2012/07/10/hungarys-financial-transaction-tax-is-latest-snub-to-eu-and-imf/#ixzz20FGbcoLJ

    So we have a robust “debate” in Hungary about who has the authority to raise tax………..
    A fundemental debate in a world where IMF functionaires tell people to pay taxes to pay for exponential “sovergin debt” interest while make zero “contributions” to anyone or anything.

    The goverment or the Central bank…..
    Our Goverment gave executive control to the Central Bank without a fight that fateful day when the nice Mr Honohan came on the radio ….to ……become political baby…..but for who ?

    We are a sad bunch.
    That have no concept of divisions of power even.
    Not even the illusion remains in Ireland.
    Which could be a good thing ….. if we had people who understood principles.
    Which we Don’t.

    Fifth commandment of the communist manifesto
    5.Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.

  15. @Seafoid
    Bank debt was so last year…………..

    This is much bigger then that.
    Its about juristiction and sovereignty.

    The only country in mainland Europe giving the bankers a few Kicks and not kick backs is Hungary.
    http://blogs.ft.com/beyond-brics/2012/07/10/hungarys-financial-transaction-tax-is-latest-snub-to-eu-and-imf/#ixzz20FGbcoLJ

    So we have a robust “debate” in Hungary about who has the authority to raise tax………..
    A fundemental debate in a world where IMF functionaires tell people to pay taxes to pay for exponential “sovergin debt” interest while make zero “contributions” to anyone or anything.

    The goverment or the Central bank…..
    Our Goverment gave executive control to the Central Bank without a fight that fateful day when the nice Mr Honohan came on the radio ….to ……become political baby…..but for who ?

    We are a sad bunch.
    That have no concept of divisions of power even.
    Not even the illusion remains in Ireland.
    Which could be a good thing ….. if we had people who understood principles.
    Which we Don’t.

    Fifth commandment of the communist manifesto
    5.Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.

  16. @Albert
    Well I have never been to Hungary but the one response to Krugs article is

    “What a biased article! Hungary a so called “a police state”…This is disgusting propaganda.

    Check in your own back yard, before pointing fingers to others. Even under the Nobel peace prize winner Obama, the USA keeps the Guantanamo prison camp operational. The inmates are kept locked up for years, without even being officially charged, without going through a court of law.

    Extrajudicial killings are business as usual for the USA, and “collateral damage” of murdering civilians is also part of everyday business.

    Finally, the NSA collects all communications of US citizens, without a court’s permission.
    Mr. Krugman, it is you who lives in a fascist police state, not the Hungarians.

    Come on man – grow up a bit.
    This is the New York times baby.

    You are not the type of guy who picks up Time magazine waiting for the Doctor are you ?
    I prefer to pick up woman’s world or something.
    At least I can compare my breast size to the rest of the girls.
    While Time and the New York times ?
    What can you do with that stuff unless you have diarrhoea or something.

    I have news for you mate.
    Krug and the rest are propagandists.
    They are not meant to be taken seriously.
    The man is a joke.

  17. Err Dork. My backyard is somewhere in this fair troika land. Your ravings and roilings here are getting worse and worse. Chillax.

  18. Stumbling into disaster, blindfolded, chained to a ball of debt, infection developed over the ankle where it chafes, holding a rosary beads and praying to St Jude while mumbling about a return to the markets.

  19. @Albert
    The central bankers have lost credibility.
    They claim to somehow protect the currency when they have destroyed it.

    Many of were screaming to vapourise the entire bank bond market back in the day to protect the currency and………

    Instead what did they do ?
    They loaded on fraudulent debt on the middle class and then expected them to pay extra tax on the sov debt they created to bail out the bank bonds………causing a breakdown in the money system.
    As you can’t tax people with no money…. which means the money loses credibility….

    They will blame goverments for printing to peserve the medium of exchange …. you wait for it now……..anytime soon.

    Many of us have enough.
    Honoghan became a political agent that morning.
    Thats not acceptable.

    (All to save credit deposits over and above the payments system.
    If I have over 100,000 savings I don’t spend it day to day – it does not affect the tax system much if it goes away like.)

    What right has he as much as I loath rather then truely hate FF.

    There is no division of powers.
    Central banks do collateral
    Goverments do money issuance and tax.
    That how it was supposed to work.

    It is time to dump the central bank system in my opinion as all it does is socialise wildcat banking.
    The 20th century has been characterised by a series of terrible wars as the cartel have extended their power over the globe.

    Let the bastards go back to free banking and let goverments print interest free notes and we will see how they get on out in the real world.

    Treasuries should now officially divorce themselves from these pump and dump operators.
    Credit everybody with a equal amount of goverment money in a non bank account and take the leverage power away from the banks.

  20. So, when this goes tits up and Ireland defaults, under what jurisdiction is our debt? Will our debt be sold at cents on the dollar to hedge funds who will pursue us through international courts as Argentina is still experiencing?

  21. Are there any more drastic steps that could prevent us from stumbling into disaster as the thread title says.

    THis is a comment in the telegraph today on one of Ambrose Evans Pritchards articles:

    http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100018516/china-exports-yet-more-excess-capacity-to-crippled-west/#disqus_thread

    “BUT if the West does not stage a promising recovery soon, it will raise the spectre of import restrictions/taxes. It won’t be long before legislators again consider the attractions of protectionism as they did in US a couple of years ago. But if anything, it may be Europe, or rather the South that may militate for action.

    Aside from the immediate concern of Greece and Spain, the uncertainty cloaking the next few years is wide and bewildering. We simply don’t know – and Ambrose is quite right to flag up the slightly forgotten deflation risk. Timely article.”

  22. @ Inscrutable

    All Irish government debt is governed by Irish law. Zerohedge made a bit of a fool of himself last year by arguing otherwise.

  23. @ Inscrutable

    Actually, I think some people on here made fools of themselves by arguin otherwise as well. They don’t post round these parts anymore post-referendum…

  24. Is IRL Govt policy something more elaborate that,
    “what goes t*ts up, must go t*ts down” ?

  25. The yield on the Spanish 10-year bond closed at 6.8% on Tuesday compared with 1.32% for the equivalent German bund. Nevertheless, as a ratio of GDP, Germany and France had higher debt servicing levels than Spain in 2011 and in the period 1990-2000, Italy’s debt servicing ratio was more than twice the level it was in 2011.

    Deutsche Bank calculates that in 2011 Italian debt servicing costs were at 4.8%.

    http://www.finfacts.ie/irishfinancenews/article_1024606.shtml

  26. What will be will be. It has been clear for soem time that euro break-up is still firmly within the range of possibilities.

    This emphasises the need for contingency plans as pointed out by Prof Kevin O’Rourke.

  27. Johnny Foreigner got it in one. Who ever believed that a state could run its economy without a monetary policy! Its like driving from Dublin to Cork without a sterring wheel. Disaster was inevitable. The longer we delay the more painful it will be when the inevitable happens. We made the change to the euro ten years or so ago. Its time to make the change back. The template is there.

  28. @BEB

    The ink was barely dry on voters’ ballot papers when the referendum was seen for what it truly was – a colossal wasted opportunity to send Europe a serious wake up call.

    With virtually ever heart beat since the basis on which the no campaign fought the referendum has been proven accurate most notably the assertion that the ESM pot would be empty when the country requires it (as it will), Mr Ganly suggested this time after time but was rebuffed in addition he also fought the campaign on the basis that the most important issue facing the EZ was the unsustainable bank balance sheet positions the Zone now finds itself lumbered with and what do you know, the last month it seems as of nothing else has been discussed. Ireland voting NO would in my view have the Irish bank debt debacle being treated as is the Spanish i.e. now, and not having to wait at the back of the line as the more roudy boys to the front are dealt with and when our time comes to be likely told, sorry you’re just too compliant and slow and the pot is empty. Great.

    So not for the first time I’d suggest your view of the world is slight at odds with the reality on the ground. Wise up.

  29. The European Banking Authority released a report to day identifying Bankia and 6 Greek banks as ‘the only ones’ not meeting recapitalization target of 9%. The sample (and correct me here) embraced 27 banks. Hard to ‘credit’ there is so much health in the banking sector.

  30. The world is beginning to assess the EZ prospects of survival realistically. The recent summit consensus is unravelling hourly. The Euro is dropping below USD 1.22 with the next support level at USD 1.19. If this erosion continues the periphery will thrive and so will Germany to the point of overheating with accompanying high inflation. Germany’s worst fears realised as the rest of the EZ countries cling to low ECB rates and a low Euro like drowning men clutch straws.

  31. I saw an interview with Sheila Colleen Bair on news TV a few days ago that provided food for thought. She is an ex Chairman of the FDIC and ahighly respected and knowledgable woman. She sees the flight from unstable banks on the periphery turning from a slow motion flight to a stampede. The usual questions of bank liquidity problems vs. failed banks and the EZ inability to distinguish between the two was raised.

    Her conclusion was that without a Euro wide credible deposit insurance scheme and closing of failed banks the resulting bank runs will end up at the doors of banks in Germany, France, GB, Austria and the US within a few months. She sees the now ‘stable’ European core banks as being dangerously exposed to the periphery.

    If I remember correctly I saw this on European CNBC.

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