Following the influential work of Paul De Grauwe and Yuemei Ji, the idea that bond yield crises in the eurozone reflect liquidity (i.e. multiple equilibia) rather solvency has taken hold. (See, for example, Paul Krugman linking to a post by Joe Weisenthal.) The main evidence is the synchronised fall in yields when the ECB strengthened the LOLR regime with the annoucement of Outright Monetary Transactions (OMT), and also (indirectly) with the LTRO programme. This leads to the view that the tough fiscal adjustment programmes are not required for countries to regain creditworthiness. Here is Joe Weisenthal’s conclusion:
So we can trace the two peaks of Eurozone debt stress directly to two times the ECB intervened. Austerity has had nothing to do with the improvement in borrowing costs.
But is this account too simple? In one sense I would possibly go even further than De Grauwe and Li: in the context of monetary union, vulnerable countries will not be able to avoid the bad equilibrium without a credible LOLR. However, I also think it is important to recognise that what is fitfully emerging is a conditional LOLR. Countries will only get support if they are undergoing required adjustments (OMT description here). The announcement of OMT would then not help a country if investors believed it would not take the actions that would make it eligible. The LOLR and the adjustments are then both necessary to prevent or reverse the slide to a bad equilibrium.
Of course, it could still be argued that the explicit or implicit conditionality is inappropriately demanding (e.g., focusing too much on reductions in the actual deficit as opposed to the structural deficit). But given the regime as it is, the existence of OMT does not obviate the need for fiscal adjustments to steer clear of the bad equilibrium trap.
34 replies on “Drawing conclusions from the announcement of OMT”
Perhaps Wiesenthal is correct when he states that austerity has nothing to do with reduced borrowing costs…but for a different reason. Central banks flooding the world with various forms of liquidity has clearly worked, resulting in the lowest rates ever. This was demonstrated this past week when US junk Bond yields fell below 5%. I would venture that most sovereigns are a better bet than a lot of issuers of junk bonds..so the progression of downward yields on sovereigns is merely a reflection of the ongoing “hunt for yield”. But we may have reached the bottom…on Friday US 10yr hit 1.93% while the stock markets bounced ahead. So maybe normality is returning. OMT was a great bluff by Mario…but it may have outlived it’s usefulness. With the demise of Austerity in France, Italy and to a lesser extent Spain, how could the strict conditionality attached to OMT be enforced. Jens has already laid down the markers.
And today we see the unprecedented advice by a major British paper….”Spain is officially insolvent: get your money out while you still can”. Interesting times ahead?
Link to above..
You may have hit on something there, especially the introduction of Abenomics.
I find the de Grauw paper utterly unpersuasive when it gets to the point where it states that markets “gave the wrong signals”. Markets do what markets do and are invariably guided by sentiment. How else would they be guided? One way or the other, they cannot be bucked, to quote Margaret Thatcher, and the conclusion drawn in this blog contribution is correct unless some unknown sea change has occurred with regard to how markets operate.
it is a conditional LOLR but what is the exit strategy for the ECB if an OMT recipient country clearly makes all reasonable efforts to fulfill the obligations of that conditionality, but it becomes obvious to all that debt sustainability is not going to emerge as a result?
The ECB holds lots of short term debt at par or so, medium and long term bonds trade at a significant discount with high yields, but all funding needs are met by passing bonds to the ECB. they have said they are not willing to allow OMT states to significantly shorten their maturity profile.
The political tug-of-war, or see-saw, will continue, as currently in the case of France, and “market sentiment” will push it in one direction or the other.
Jeremy Warner seems to be recanting. Spain, after all, is not a minor country. It does, however, have nearly 400,000 UK ex-pats, most readers of the Telegraph.
On the Jeremy Warner blog entries, it would be interesting to be a fly on the wall (or in the cable wire) on the e-mail traffic between various IMF departments since people noticed the figures in the fiscal monitor on which he based the 1st column.
I should add, in case I seem to be entirely missing your point, that I cannot see OMT ever actually being triggered. Countries with any sense will do everything possible to avoid it. But that does not remove the possibility.
@John mch, docm
The Paul De Grauwe and Yuemei Ji paper is a revisionist romp. It attempts to let certain groups of participants in the decision making process off the hook, by dumping all the blame on a cheap and easy target. “influential”? – I suppose it tries to cover a lot of arses, so it will have been ‘popular’.
The authors begin with an assumption that widening spreads equal a request from the markets to apply austerity. If an asset manager sells a bond thereby placing upward pressure on its spread he is doing so because he either thinks there is inflationary pressure sufficient to depreciate the currency it is denominated in (not relevant in the case of the Euro spreads considered here) or he has come to think there is a higher probability of default.
Nowhere there, is there a request for the state to increase austerity.
I might sell a bond because I have worked out economic fundamentals place higher default risk on the bond, and that likely policy responses (austerity is in vogue at the moment, but there could be others, see Japan for example) probably will not make much difference to that predicted path.
This assumption that market participants and analysts are right wing cocaine addled Chicago worshipers as Paul Krugman once suggested, is not a sound foundation.
“The next question that arises is whether the judgement of the market (measured by the spreads) about how much austerity each country should apply was the correct one.”
The interpretation that higher spreads should be responded to with proportionately more austerity was one made by democratically elected domestic politicians in the main, who chose which economic punditry to follow and which to ignore, not buyers and sellers of bonds.
“There are essentially two theories that can be invoked to answer this question. According to the first theory, the surging spreads observed from 2010 to the middle of 2012 were the result of deteriorating fundamentals (e.g. domestic government debt, external debt, competitiveness, etc.). Thus, the market was just a messenger of bad news. Its judgement should then be respected.”
So far, so sensible, but wait…
“The implication of that theory is that the only way these spreads can go down is by improving the fundamentals, mainly by austerity programs aimed at reducing government budget deficits and debts.”
Oh. I presume the authors will not be attempting to manage a bond portfolio anytime soon. If they did, they might discover their counterparts are not so naive – they will be aware that bond spreads can move an enormous amount on things like Central Bank Intervention, and will be constantly watching out for signs it might occur.
“Another theory, while accepting that fundamentals matter, recognises that collective movements of fear and panic can have dramatic effects on spreads. These movements can drive the spreads away from underlying fundamentals, very much like in the stock markets prices can be gripped by a bubble pushing them far away from underlying fundamentals.”
Is that really just a “theory”?
Note “fear and panic cited here, no mention of exuberance – of the type that distorted EZ bond yields in spite of fundamentals for a decade under EMU. Why is it disallowed to consider that compression’s reversal to be anything other than “fear” or “panic”?
This bit seems remarkable for the fact they find it anything other than obvious, they have noticed that when the ECB “intervened” or “rigged” via the OMT announcement, the spreads that it brought in the most were those that had previously blown out the most. If I’ve missed something please let me know what it is.
“We find a surprising phenomenon. The initial spread (i.e. in 2012Q2) explains almost all the subsequent variation in the spreads. Thus the country with the largest initial spread (Greece) experienced the largest subsequent decline; the country with the second largest initial spread (Portugal) experienced the second largest subsequent decline, etc. In fact the points lie almost exactly on a straight line going through the origin. The regression equation indicates that 97% of the variation in the spreads is accounted for by the initial spread. Thus it appears that the only variable that matters to explain the size of the decline in the spreads since the ECB announced its determination to be the lender of last resort is the initial level of the spread. Countries whose spread had climbed the most prior to the ECB announcement experienced the strongest decline in their spreads – a remarkable feature. ”
“In previous research (De Grauwe and Ji 2012) we provided evidence that prior to the regime shift made possible by the ECB a large part of the surges in the spreads were the results of market sentiments of fear and panic that had driven the spreads away from their underlying fundamentals. Figure 2 tends to confirm this.”
Why are widening spreads not viewed as equally possibly a reflection of actual fundamentals as the market corrects from its long and inappropriate compression of the spreads during the Great Moderation and EMU ‘convergence’?
Then they move on to the fact that post OMT announcement, debt / GDP ratios have not reduced and try to argue that because spreads have compressed (because of a very significant ECB policy change) at a time when debt/GDP has worsened, this is evidence the market widening those spreads in the first place was unrelated to economic fundamentals – it was all just ‘panic’.
“First, while the spreads declined, the debt-to-GDP ratio continued to increase in all countries after the ECB announcement. Second, the change in the debt-to-GDP ratio is a poor predictor of the declines in the spreads. Thus the decline in the spreads observed since the ECB announcement appears to be unrelated to the changes of the debt-to-GDP ratios. If anything, the fundamentalist school of thinking would have predicted that as the debt-to-GDP ratios increased in all countries, spreads should have increased rather than decline.”
Do the authors really think there is a significant sector of the market that thought the ECB policy change last year was trivial in respect of bond prices as compared to comparatively unsurprising worsening of debt/GDP ratios?
Apparently so – because only three people predicted it could happen as one of the authors cites himself (not thousands of others, obviously:
“From the previous discussion one can conclude that a large component of the movements of the spreads since 2010 was driven by market sentiments. These market sentiments of fear and panic first drove the spreads away from their fundamentals. Later as the market sentiments improved thanks to the announcement of the ECB, these spreads declined spectacularly. This was predicted in De Grauwe (2011), Wolf (2011) and Wyplosz (2011).”
The conclusions. ~Two of the tree are noteworthy:
“Three conclusions can be drawn from the previous analysis.
•Since the start of the debt crisis financial markets have provided wrong signals; led by fear and panic, they pushed the spreads to artificially high levels and forced cash-strapped nations into intense austerity that produced great suffering.
Actually, no. The financial markets have provided mixed accuracy of signals. They were right about Greece’s unsustainable debt position when politicians and officials were trotting out rubbish about the markets merely panicking and losing sight of fundamentals etc etc (anyone remember Lorenzo Bini Smaghi?), they were right that Ireland had lost all track of what liabilities it had signed itself up for, and how do these researchers know the market’s suspicions about Spain are wrong?
” •Financial markets did not signal northern countries to stimulate their economies, thus introducing a deflationary bias that lead to the double-dip recession.”
This has me a bit puzzled. What market signal has the market failed to give, that it reasonably could and should have, in light of the pressures on it from QE, a liquidity trap and central bank action to suppress yields everywhere, deleveraging etc – which would have given a clear sign it wanted the Northern countries to stimulate their economies?
I agree that putting it terms of the markets demanding austerity is not particularly useful. As you say, investors perceived default risk and sold and bought accordingly. But I think De Grauwe’s earlier comparison of the UK and Spain, an analysis echoed by Martin Wolf, provided a very useful way to highlight the susceptibility of individual countries to self fulfilling bad expectational equilibria when you don’t have your own money-printing central bank. Although the ECB has defended OMT in terms of fixing the monetary transmission mechanism to ease complaints of stepping beyond their mandate, I’m sure they recognise that the problem is more fundamental than that, with the eurozone potentially becoming a default machine. This also is why I flinch at the calls of Mr. Mody, Mr Buiter and others to apply a low default trigger. It is hard to see the euro surviving the seemingly inevitable resulting extreme fragility given the apparent ease of falling into the bad equilibrium. I know many of our contributors would welcome this; but I can’t see how it is the best course given what I think is the significant odds that these multiplie equilibria exist.
On your earlier question about how OMT is supposed to work, I must admit it is something of a black box to me as well, and am surprised investors have taken as much comfort as they seem to have given the lack of detail. Presumably the idea is that the availability of OMT is meant to reduce fears of a liquidity freeze up, allowing countries to roll over debt to market investors across the full range of maturities. But I would think it would only be effective in preventing a bad equilibrium if it is believed that the ECB would support shorter term issues even when a country cannot issue at longer maturities. Of course, the ECB will not be working alone but in tandem with the ESM (and probably the IMF), which will be applying a debt sustainability analysis. A critical element will continue to be that the (perceived) debt restructuring trigger is not set too low.
I’m not clear why a country running a primary surplus in the depths of a recession should be concerned about a bad equilibrium as the result of default. Supposedly, we willl be running a primary surplus next year.
Jeremy is obviously feeling the heat. Smoke, fire etc..
The key word here from Grauwe and Ji is ‘seems.’
There are seldom soundbite explanations for significant economic trends and when the Italian treasury had a successful auction in the aftermath of the general election, Draghi’s OMT was a factor but as Fiatluxjnr has highlighted above, the investment in risky assets as fund managers are forced to show some returns, is no longer the news it was when Franklin Templeton bought Irish bonds.
The FT reports that data released on Friday by the Japanese finance ministry showed that Japanese investors bought Y204bn more of foreign bonds than they sold in the week to April 27, then extended the buying to a net Y310bn the following week, a week in which they also became net buyers of foreign stocks.
PSI (and/or bank creditor haircuts if that’s a big part of the problem).
Any form of OSI is verboten.
I think OMT can just be viewed as a way for the ESM/ECB to do for sovereign debt what has already been done for bank recap debt (in Greece, Spain, Cyprus ex-Laiki/BoC). The source of funds is a keyboard, not the capital markets. The liability to pay back and eliminate this newly created money is still entirely with the sovereign that receives the funds.
Ireland has about 90bn of privately held sovereign debt standing in line ahead of any official debt, if the debt sustainability threshold ever crosses the magic number.
Perhaps ‘austerity’ is not austerity at all. Inflation was always the great tool of fiscal correction. The borrowed amount loses value over time – a relatively painless counter to over-borrowing – while the higher interest rates attached to inflation-time borrowing is countered by an extra economic ‘demand’ as consumers buy before prices increase. At the moment, within the policy framework of ‘very-low (or zero) inflation’, a big chunk of ‘demand’ has been sidelined. Add in the excessive borrowing levels, resulting in a ‘savings’ phase, and you get the under-active economy we have.
If the approach was to cut ‘interest rates on loans’ (not just ‘interest rates’), then, at least, that which a small bit of inflation used to counter would be countered. How do you cut interest rates on consumer loans (and government loans) in a commercial banking world: The mechanism is within the power of the central banks (lenders of last resort) working with governments. 1) New government borrowing to be direct from ECB (including fresh borrowing to replace maturing bonds); 2) Leading to increased pressure on depositors to invest in other areas, including business investment,; 3) Policies to bring clarity to borrowers (including loan write-offs + low interest); 4) A greater government intervention in jobs strategy.
None of this has anything to do with austerity. The tax base has dried up , somewhat, following the economic shock. The tax base, as designed, is per the babycham glass, i.e. broad at the top, narrowing down, so that a 15% drop in GDP led to a 25% drop in tax take. If austerity means a ‘correction’ while maintaining the existing tax/GDP ratio, then so what. If austerity means a ‘correction’ to some aspects of excessive government programmes, then there are two sides to that debate. If austerity means increasing the overall tax % (which is not happening), then that IS austerity.
The big elephant in the room is the banking debt loaded on to the government. The big elephant solution re this is to wait until AibBoiPtsb turn the corner, then match up future gains straight against AngloNationwide losses. One will fully counter the other. With that load lifted, everything else lifts.
Right, so Greece’s decline in spreads has nothing to do with having half its debt written off? And the multi-year austerity program that has seen it move to a primary surplus? And that many of the austerity measures are long-run in their outcome? (Pension changes, for example).
Clearly it is not necessary to have a horse at all, because the cart moved down that hill all by itself…
I am puzzled why you ignore those class of models that suggest austerity and a fixed exchange rate lead to an under-employment equilibrium/depression. I would venture that the markets know that one absolutely necessary condition for solvency is the prospect of some economic growth. Credible policies, austere or, more probably, otherwise, require embedded/rational expectations of growth. That’s a big part of the US story: they were able to borrow, despite much hysteria in some quarters about being the next Greece, partly because markets expected growth to resume, as it has. And now the fiscal deficit is magically shrinking, far more rapidly that the commentariat seem to realise. The same is about to happen to the UK.
Once the markets sniffed the austerity game is over, yields started to fall in Ireland and elsewhere. Yes, the markets got there a long time before the Germans but we all got there in the end. I venture that if the EU had followed your fiscal council recommendations – even more austerity even more quickly – we would still have double digit bond yields.
Further to the post directly above yours, did Irish spreads narrow because the market sniffed the end of the austerity or because the market sniffed that the debt might be restructured to the point of sustainability & fiscal policy has brought us to the within reach of primary surplus.
Does it have anything to do at all with economic growth?
You are correct though on the UK and US- both these are on the cusp of a recovery but then they are well governed states in stark contrast to the chaotic and capricious rule of the Prussian hegemom.
I wouldn’t have put you down as a free luncher. The idea that there is a free lunch has come in different forms over the last few years. Those asserting the expansionary fiscal contraction idea believe that discretionary fiscal adjustments actually improve growth, allowing you to improve the deficit and growth performance at the same time.
Your idea by contrast fits with the idea of self-defeating fiscal adjustment: in this case slower adjustment again leads to a better fiscal (and/or creditworthiness) performance and faster growth.
The self-defeating idea has come in various forms. The strongest form says that slower discretionary adjustments lead to faster improvement in the primary deficit. The primary deficit has been improving despite multiple drags on growth in addition to the austerity measures.
A second form claims that discretionary adjustments do not lead to improvements in the debt to GDP ratio. If the overall deficit multiplier is greater than 1 (unlikely in the Irish case given the openness of the economy) and the starting debt to GDP ratio is high enough, the debt to GDP ratio will rise in the short term. But today’s adjustment will have a positive effect on the debt to GDP ratio over the medium term. This is usefully discussed in a recent IMF paper (Eyraud and Weber, 2013).
The third form is the one you invoke: more discretionary adjustment actually damages creditworthiness. The fall in yields from close to 15 percent in mid 2011 to below 4 percent today – all at a time of significant fiscal adjustment – makes it quite a stretch that the fiscal adjustment has damaged creditworthiness. It should be said that the fall in yields also probably reflects an interaction between the successful record in implementing adjustments with the emerging conditional lender of last resort arrangements at the eurozone level. Your argument appears to be that the dramatic improvement in creditworthiness has been due to a belief that austerity will be abandoned. This seems fanciful to me. But readers will make up their own minds.
What intrigues me is the idea that “discretionary fiscal adjustments” can be factored in to any economic model without any further information is to their make-up. Adjustments that improve overall productivity can fairly readily be distinguished from those that simply involve borrowing money — or raising taxes – to enable expenditures to continue as before, if at a reduced level. Concentration on these would certain help to avoid a “bad equilibrium”.
There are innumerable examples of the failure to make the necessary radical changes required. A recent one, for example, is the shooting down purely for reasons of political tactics of the very sensible idea of an extra free school year for infants funded by a reduction, if not abolition, of the universal character of children’s allowances.
Either the real debate on such issues begins, including unpicking the extraordinary level of unjustified transfer payments generated by decades of clientilist politics, or the present slow deterioration in the economy will continue.
@ John McHale
I think you know that is not what I said nor meant. You hide behind your models and correlate falling yields with austerity to imply causation. And in the process reveal a model that says yields are a simple, probably linear or log linear, function of (mostly) austerity and (a little bit of) LOLR.
My equally simple model (not mine actually, I think somebody else thought of it 80 years ago) posits under employment equilibrium, caused by the current policy mix. Solvency has now been restored with an equilibrium rate of unemployment of 14%.
We remain one growth slowdown away from default, given current policies.
One could say that bond yields have dropped with the prospect of OMT despite the threat of more associated austerity and not because of it. Investors could care less whether a country ends up resembling Sweden or Somalia as long as the bond market never collapses, which the promise of OMT seemingly guarantees.
The alternative explanation is that the prospect of a backstopping of debt via OMT is attractive to markets because they believe that the accompanying austerity will make the debt less risky, this reduced risk being because the economic fundamentals of the country in question will necessarily improve. However given the beating the ECB (or is it the Harvard) consensus on austerity has taken in the last six months this is not a debate that belongs in economics any more. Not credible, never was, the IMF no longer buys it and its main proponents face years of being ignored by everyone except the ECB, Olli Rehn and fellow travelers.
Now I agree that you could fill in the background of OMT a little more, the ECB’s sort of half offer to be a real central bank is definitely predicated on the recipient country doing what is the best interests of Germany and the ECB. This seems to belong in a different discussion though – about how the shared interests of the ECB and the creditor nations in the Eurozone have made a proper response to the global financial crisis impossible.
John, that argument is long over for everyone who did not invest personal or political credibility in the European component of the global financial crisis being one of national fiscal irresponsibility.
@ Tull: “You are correct though on the UK and US- both these are on the cusp of a recovery but then they are well governed states in stark contrast to the chaotic and capricious rule of the Prussian hegemon.”
Tull, I beg to differ with you in the states of the US and UK economies. Whatever about the UK, the US has ‘enjoyed’ faux growth for over a decade. Just keep a clear head here. The US is well governed? Nope. Look again – v-carefully!
Your characterization of D-land v-unhelpful. Its simply not correct.
Thinking about the austeritarian idea. Aggregate economic growth will (increase or resume) if;-
Y = C + G + I + Nx
So, Y increases by 1 if one variable on the RHS also increases by 1, provided the other variables remain unchanged. There are several other variable combos which give an increase in Y. This is all fine and dandy, but …
Each of those variables on the RHS are not independent of each other. They are closely interlinked in quite complex ways. Also, their proportionate contributions to Y are far from equal. So, if G is ‘forced’ down – variable (or variables) goes up to compensate? Advocates of austerity => growth seem somewhat short on the explanation of what variable(s) will actually increase in order to compensate for decrease in incomes, wages and government transfers. Oh! – they mean Nx will increase – substantially? Or that I will increase, even if companies and individuals are busy repairing their respective balance sheets? Must be C then. But, C is somewhat dependent on … … Oh sh*t! Not to worry – the theory says it will work, in spite of the empirical evidence to the contrary. Quite!
@ Prof McHale: Good or bad equilibria? How does one select which? These are contentious, argumentative value claims. Stick with refutable knowledge claims. Its a lot easier.
“One could say that bond yields have dropped with the prospect of OMT despite the threat of more associated austerity and not because of it. ”
Or both… imagine if there was more than one cause. How many ideological positions would that ruin?
Isn’t it likely that sovereign bond yields have dropped for the afflicted for a combination of reasons that include (a) austerity, (b) prospect of less austerity, (c) prospect of OMT, (d) the hunt for yield. How much weight to attach to each component is anybody’s guess.
Apparently the markets are happy that following G7 meeting European politicians are going to ease up on austerity.
So it seems that less austerity will please markets.
Until markets figure out that less “austerity” means more supply. Then the problems begin.
By the way, which markets would those be? I expect stock markets to be delighted…
It depends on the rate of supply. If rollover risk is removed, in particular. What will not be acceptable I reckon is attempts to fund bank bailouts in big lumpy issuances…
Big lumpy bank recaps and borrowing to fund a fiscal stimulus would frighten the horses.
The precious and semi precious metals community while not being paragons of virtue usually throw up ideas worth considering.
Abenomics is working on the ground in NAFTA, MB has removed the “diesel” premium on its GLK (SUV) series vehicles with a price reduction of 8% + or -. Hyundai’s style is also being seriously cramped. US$1 is now JYen102 as the Yen continues to depreciate. The pressure intensifies on Germany and France to shift even more manufacturing resources to low cost and productive countries such as China Brazil, Mexico, Indonesia and others. At the moment even the US looks low cost to Germans.
As Europe and the US continue to stagnate they will rethink their ability to compete with Asia. At some point the towel will be thrown in by the EU and US and the world will divide along EU, NAFTA, Russia, parts of Africa, South/Central America against the hyper competitive ROW.
Japan is becoming a major irritant for the US and Germany who will do everything in their power to ensure Japan does not succeed at their expense.
The need to stop the corporate tax hemorrhages out of the US and EU will lead to collateral damage that will not avoid Ireland. This will be further strengthened by transfer tracking driven by the “War on Terror”.
The uncomfortable thought is that Germany the EZ linchpin is coming under increasing competitive stress. What does this mean for Ireland which has more than enough on its plate. A question that should be asked is why manufacturing resources are fleeing overseas with unemployment rates at record highs in the EU.
Brian Woods Snr: Says:
May 13th, 2013 at 7:55 am
@ MH: “A question that should be asked is why manufacturing resources are fleeing overseas with unemployment rates at record highs in the EU.”
The short answer (and quite inadequate) is, its NeoLiberal time – again! Big gov bad. Small gov better. No gov best of all. If the sociopaths in charge of modern manufacturing enterprises (cf: William Martin Murphy for an Irish examplar) need a larger ’surplus’ to re-invest in the financial sector (where lo or no reg => more), then they go. If they decide to return, its with robots instead of sentient folk. You could write a thesis on this.
This behaviour eventuates with economies dependent on services (usually low paid for majority of earners – with few, if any ‘benefits’). Fine, except that low paid folk are not big demanders of consumer goods. Even Henry Ford was able to figure that one out. So you give them credit-lines – with nice juicy interest rates – and those obscene charges. That gives the low-waged a virtual increase in income – for a while, and then its Sh*tsville time – and here we are. Nice ville? Depends I suppose.
This poor outcome is skirted over by the NeoLiberal theorists and their sychophantic (political) supporters. It really is a significant political problem which can only be can-kicked so far, for so long. Ordinary folk need food and fuel. But our NeoLiberal economic theorists have this nifty notion that the incomes to purchase necessaries will (like heavenly manna) – just arrive! But how? Ah! They are a bit short on the explanation, but that is no impediment. They can prove that less => more. And dopey folk are seduced. Welcome to Sh*tsville US, UK and parts of EU! Nice ville?
The US deficit is falling because of rising cyclical revenues and spending cuts. Pentagon contracts tumbled 52% in April from a month earlier as across-the-board federal budget cuts took hold — it’s not called austerity but payroll tax rises for all workers and personal tax rises for rich people are also taking effect.
It’s unlikely that the US can avoid a new normal of long-term lower growth than in postwar decades, while Eurozone stagnation is more certain. Real US GDP rose an average of 3.4% per year from 1960 through 2007.
Real growth rate in six European countries (Spain, UK, Netherlands, France, Germany, Italy) has been slower in each successive decade (on average) since the 1960s; the drop between the 1960s and the noughties was a staggering 54 percentage points. The US, which is shown for contrast, saw fairly steady growth from the 1970s to the 1990s before dropping off this century.
According to Eurostat data released in April, the Eurozone’s (17 countries) fiscal deficit rate and debt rate as a percentage of GDP (gross domestic product) in 2012 averaged 3.7% and 90.6%, respectively. The US deficit was 7.0% of 2012 GDP and the debt GDP ratio was 106%.
Gillian Tett of the FT reports: “Late last month, the International Monetary Fund published its World Economic Outlook, in which a tiny chart (on page 5) shows that American household debt, as a proportion of income, declined from 130% in 2007 to 105% at the end of 2012. In the same period, Eurozone household debt has risen from 100% to almost 110%. Historically, Europeans always had a lower debt ratio than Americans, but those two lines have now crossed. It is a stark contrast to the pattern in 2000, say, when the ratio was only 80% in the Eurozone — and 90% in America.”
In the Fortune Global 500 of 2011, there were 160 European firms and 133 American; Nestlé of Switzerland was the world’s most profitable company.
Germany has over 1,300 so-called Hidden Champions – – medium-sized mainly family-owned firms that account for 25% of exports and are defined as world leaders in their niche sectors. The number is a multiple of every other country’s total including US, China and Japan. Austria and Switzerland also have disproportionate shares.
According to The New York Times, the share of American adults with jobs has barely changed since 2010, hovering between 58.2% and 58.7%. This employment-to-population ratio stood at 58.6% in April 2013. That is about four percentage points lower than the employment rate before the recession, a difference of roughly 10m jobs. According to the Labor Department, workers 25 to 34 years old are the only age group with lower average wages in early 2013 than in 2000.
Eurozone unemployment was at a rate of 12.1% in March; the US official rate was 7.5%. Gavyn Davies in the FT says today on the US rate: “…large numbers of people have left the labour force altogether as the recession has dragged on, and this probably means that the official unemployment rate is no longer acting as a consistent measuring rod for the amount of slack in the labour market.”
The EZ rate may also be understated.
The broad measure of US employment (U-6) including discouraged workers and involuntary part-timers was 13.9% in April – -one of the highest levels since 1994.
Michael Greenstone and Adam Looney of the Brookings Institution said in 2012: “When we consider all working-age men, including those who are not working, the real earnings of the median male have actually declined by 19% since 1970. This means that the median man in 2010 earned as much as the median man did in 1964 — nearly a half century ago. Men with less education face an even bleaker picture; earnings for the median man with a high school diploma and no further schooling fell by 41% from 1970 to 2010.”
The EZ faces a long period of low growth; the US picture is murkier.
The pre-US recession employment creation rate was down from the previous two decades. The declining job creation from employer business startups (firms with employees) reflects a declining firm startup rate [pdf]. The startup rate of firms has declined from as high as 12% to 13% (as a percentage of all firms) in the 1980s to 7% or 8% in recent years. There has been no discernible trend in the average size of a new firm.
@yoganmahew (I just copy and paste)
Did they teach you nothing at summer indoctrination camp? I have a principle, you have an ideological position, she is a fanatic, they are European Commissioners.
There is not too much room for argument here, we can reasonably disagree about the exact weighting of factors that market participants thought reduced the risk in holding government debt but not their order of significance. It was the mere fact of the ECB taking action (or promising to, in the case of OMT) that meant there was a reverse in sentiment at all.
So our investor had some combination of the following explanations in mind when they started being less appalled at the idea of holding GIPSI government bonds, in order of diminishing significance.
(a) The ECB would definitely step in if a country could no longer sell government debt (and LTRO held off the possibility of banks bringing their sovereigns down).
(b) The various funding measures/potential of funding were a sign of short term monetary loosening and provided opportunities for speculation.
(c) The ECB offers signaled a change in policy from net austerity and possibly long term monetary loosening that might encourage economic growth.
(d) The additional austerity that OMT might require would be good for medium term economic growth.
(e) Belief that the policies required by the additional austerity required by OMT offered opportunities for profit (privatizations, cheap assets)
Factors (c) and (d) are contradictory and the actualite of Eurozone wide fiscal tightening (unemployment, negative growth, political chaos) means that position (d) is definitely more faith than reason based. It is also hard to believe that anyone in their right mind thought that if OMT came with even more more added demand choking meausures that would somehow improve debt sustainability absent the ECB’s guarantees.
I know that John McHale has a more sophisticated view of the operation of European debt markets (and institutional politics) than I do but the facts in this matter seem too gross to argue about. The Fiscal Council’s aggressive position on debt still baffles me, it seems to play politically into the hands of the most reactionary element in the German bloc and European Institutions while being increasingly at odds with the empirical results and theoretical consensus on the policies required for an economic recovery from the particular kind of economic crisis the Eurozone has marched itself into.
Here is a market participants view…
“1. Sentiment towards eurozone peripheral sovereign debt remains remarkably benign despite the severity of the economic downturns across the region and the recent sell-off in core government bond markets. Central bank policy action continues to hold down Spanish and Italian borrowing costs even though the sustainability of the rally is being increasingly called into question. Despite evident tensions within Mr Letta’s new coalition government and extremely bleak economic conditions, the resilience of Italy’s sovereign bond market remains undiminished. However, demand at Spanish and Italian auctions has been somewhat lacklustre of late. Today’s Italian sale was reflective of this trend but still a solid auction, with yields coming in further and the Treasury hitting the top end of its target.
2. There’s a growing acknowledgement on the part of many market participants that Spanish and Italian bond prices have become far too detached from fundamentals. Yet just because the rally appears way overdone doesn’t mean that it’s about to go into reverse. The “reach for yield” continues unabated and Spanish and Italian debt markets are among the biggest beneficiaries of this dramatic shift in investment behaviour. Yet there’s an inescapable sense that peripheral government bond markets are due for a correction – the timing and the abruptness of it being a matter of debate.” …..from the guardian blog
So it seems the “hunt for yield” outweighs fundamentals.
Could it also be the fact that the markets see the concept of a “conditional LOLR” as a contradiction in terms?