Tuesday, January 25, 2011

One month to go for Ireland

The government of Ireland has collapsed. Green Party members withdrew from the coalition on the weekend, leaving the Fianna Fail to effectively govern alone as a caretaker government. March 11 elections have been moved up to February 25. Greens woke up to the prospect of losing core voters angry at their party supporting the bailout of bankers whilst cutbacks are imposed on the general population.

Ireland must pass a budget to receive funding from the IMF, and IMF funding is part of the financial package that Europe put together to save countries like Ireland: the European Financial Stability Fund. Fianna Fail may succeed in garnering support form the opposition, particularly its main rival, Fianna Gail.

Fianna Fail, a big-L Liberal party (which in Europe means pro-market), and Fianna Gail, a centre-right Christian party are not that far apart and could succeed in pulling together for a gesture of national unity. Fianna Fail was in power when the financial crisis started and bears the stigma of letting the Irish economy collapse, (albeit under a different Tioseach (head of government)). The infighting within the party has already started. A grand coalition or a minority government would stabilise the country, but at the cost of failing to address needed reforms and a rethinking of how extensively Ireland subsidises its banks.

At stake is Ireland's understanding of what it holds to be right, especially what the state's role in the modern Irish economy is, and why the bankers are so (un)deserving of state aid. What is to be done? Who should benefit and who should pay? Will Ireland regain some of its independence from the banks, as it once regained from England, or will it chose to uphold subsidies for the country's richest institutions?

It will likely come down to a visceral, gut decision on the part of the Irish electorate--on how they see the relationship between banks, the state, and the people.

Saturday, January 22, 2011

Regimes of European Integration nominated for prize

I'm pleased to announce that Oxford University Press has nominated my most recent book on financial market regulation in Europe: The Regimes of European Integration:  constructing governance of the single market, for a prestigious prize.

The UACES Best Book Prize is ‘for the book that has made the most substantial and original contribution to knowledge in the area of European Studies in 2010’. Eligible books are from four disciplines: politics, economics, sociology and law. Only publishers may nominate. UACES is the University Association for Contemporary European Studies, the premier academic association in this field. The winner will be announced at the Annual UACES meeting, 5-7 September 2011 at Robinson College, University of Cambridge. I am grateful for the confidence that Oxford has shown in my work.

The book shows how national understandings of company and stock market collapses shaped financial market regulation nationally and ultimately in Europe. It advances our theoretical and empirical understanding of what makes regulatory governance beyond the national level possible, and what form it is likely to take. It's findings are the departure point for my next book on global financial market regulation.


Friday, January 21, 2011

The Pain in Spain

has been bad enough these past three years without the curse of being associated with Portugal. The Spanish may have floated their economy on a credit-fuelled real estate boom during the last decade, but they have managed to fulfil the budget criteria for EMU membership for most of that time. Whereas Italy, Greece and Portugal only managed to enter the single currency with what was generously depicted as creative accounting, Spain demonstrated the steel and determination to bring down inflation, reduce unemployment and keep public finances on an even keel.You can read more about it here, in my book. It's only problem was moving too quickly to be sustainable.

Spain's principal problem is that international investors and European politicians don't distinguish between Spain and Portugal. When the original list of member states was being drawn up in 1998, Spain almost didn't make the cut despite doing its homework because of Portuguese problems rather than questions of its own merit. And the same problem is happening today. No one is entirely sure what toxic ooze lurks within the depths of Spain's mammoth banks, but there are good reasons to view Spain and Portugal differently. The most important is the political will and capacity of the Spanish to sort out inflation and public finances.

Today, late on a Friday evening, the Spanish government contacted me directly to let me know about a new statistical website they are setting up to inform people about their performance. The fact that there is a Portuguese election on Sunday is no accident in my estimation, and the Spanish are reacting appropriately. No matter what happens, election results have a way of unmasking the true face of public opinion and public demands. Portugal is going through the most unpleasant period of its young democratic history, and the resentment and frustration against discipline that contributes to Portugal's status as the poorer of the Iberian sisters is likely to be confirmed. That will typically lead to investor sell-offs and capital flight.

Spain's legitimate interest now is to convince investors as best it can that Spain is not Portugal. That is not only a good thing for Spain, but a good thing for Europe if it succeeds. That message needs reinforcement from other European governments, who must make a clear distinction between Spain and its western neighbour and underline that it's based on facts and a reputation for discipline. Spain will fight the good fight, but it will need help to deter an attack.

Or the first run on a major euro zone country will not be far off.

A new leader for European Securities Regulation

A Dutchman, Steven Maijoor, has been selected to head ESMA, Europe's Securities and Market's Authority, for the next five years. Maijoor brings with him his experience as the head regulator of the Dutch Financial Markets Authority, the AFM, and was selected by the Board of Directors, comprised of regulators from the 27 member states of the EU.

Maijoor takes over the most powerful of the three European Supervisory Authorities in financial market regulation, alongside the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA). ESMA, EBA and EIOPA serve together as the European System of Financial Supervisors and play an important role in the European Systemic Risk Board.

Portugal's Road to Nowhere

Portugal is holding presidential elections on Sunday. The centre-right incumbent, Anibal Cavaco Silva, is running for a second and final term in office. He was elected in 2006 with a razor-thin majority of less than 51%. Now, as in 2006, the political left is represented by a spectrum of candidates. One of three things could happen. Silva could benefit from the divided left and be elected again; he could fail to secure 50% of the vote and there will be a run-off election between the two most popular candidates; or he will win by a comfortable margin. The polls suggest he will do better than last time and be re-elected in the first round. The main contender on the political left, Manuel Alegre, has no chance of winning.

A good number of Portuguese voters are protesting budget cuts that the Portuguese government is carrying out to reassure investors, or supporting those protests. This is not a time when the social democrats can profit from the disappointment they have in public policy. They hold the office of Prime Minister, and are associated more directly with budget management than the President is.

There's nowhere left to go.

Wednesday, January 12, 2011

Trichet and the Politicians

An addition to my previous post helps put the relationship between the ECB and the politicians further in perspective, lest their be any doubt or misconception about Trichet's preferences. Ultimately, he expects the euro zone's member states to consolidate their finances on their own. He made that clear last Friday when he said that the ECB cannot replace the 'irresponsibility' of national governments, at least not indefinitely, to manage their fiscal affairs prudently. But necessity is winning the day for the moment.

The Rise of General Trichet

The writing is on the wall for Europe's political leaders this week, and so far they have done nothing. The consequence of this is that the ECB is taking over areas of policy out of necessity.

It is not as if the warnings have not been made. One after the other this week and last, the key economists who played a role in establishing the euro have warned that the Stability Facility is woefully inadequate and in need of support. Willem Buiter warned last Friday that the war to defend the euro was running out of ammunition because the Facility was too small. Today, on Wednesday, European Commission President Manuel Barroso, made the plea for member state governments to funnel more resources into the fund. Ottmar Issing underlined yesterday, in contrast, that no solution would ever be sufficient unless euro zone member states addressed the need to impose budget discipline on all of its members. Meanwhile, Jean-Claude Trichet, President of the ECB, confirms that the European Central Bank will continue to purchase government bonds for the foreseeable future from countries that cannot place them on the market to avert even greater catastrophe. 

In the meantime, Germany is denying that it needs to do anything, bondholders are denying they will have to take a haircut, Portugal is pretending that markets have confidence in its bonds, and Greece is pretending it will not default on its debt this year. This is reckless denial on a catastrophic scale. Economists may not always be right, they may not agree, and they are rarely popular, but in this case, Europe's political leaders would do well to listen to the list of choices they have at their disposal. 

An ominous warning in Buiter's statement to the press was that if the governments of the euro zone could not sufficiently fund the Facility, the ammunition to fight the war would have to come from elsewhere. For unless the euro zone admits defeat and ejects its weakest member states, or admits that they are bankrupt, someone will have to fight the war that the politicians haven't been willing to wage on their own behalfs.

Enter Trichet. Under his leadership, the ECB is purchasing government bonds from the euro zone's weakest member states. The Bank is far from happy about doing this, but sees no alternative for the time being. As the politicians fight one another and refuse to face the enemy, it is up to the bank to save Europe.

Trichet's position today resonates with the historical development of his own country of origin. The French Fifth Republic was the creation of General De Gaulle, a necessity for a country that lay in political shambles in the 1950s and could not govern itself. It required strong, centralised political authority that ordinary politicians were incapable of providing. That was not so much a statement of De Gaulle's authoritarian character as of France's polarised, fragmented political class that was allowing the country to collapse without his intervention.

Trichet's position is not the same as De Gaulle's, but his potential importance is at least as great, and arguably, immensely greater. In a world where the greatest challenges to public welfare are economic, and where decisions have to be made to harden and mobilise the country to keep it strong, the ECB is the only institution with the overview and the means to act where politicians have failed. And Trichet is the General.

There has been some speculation about what will happen when Trichet's existing term of office ends in late 2011. His term cannot be renewed under the terms of EU law. There await blistering divisions within Europe about what candidate should replace him. Nothing less will be at stake than what kind of single currency survives 2012.

But. The member states of the EU are busy negotiating changes to the Treaties to allow the Stability Facility to be funded. They could, and should amend it as well to allow Trichet's reappointment if he were prepared to serve on, at least until the crisis is over and calmer political temperaments prevail. In a highly polarised environment, that is probably the best thing that could happen to Europe.

Saturday, January 8, 2011

China and the Euro

Savvy observers have noticed that China is the new big investor in Europe. Chinese money is flowing into European sovereign debt and into European companies. This is part of a diversification strategy for the Chinese, who have been shifting some of their assets out of the US dollar and into assets. This trend will be uneven over the next year, but if Europe plays its cards right, it stands to benefit greatly.

The Chinese are not looking at Europe with rose-tinted glasses, but there are reasons to be optimistic about the future of the Chinese-European relationship from an economic standpoint. The return on investment in Europe depends on how quickly and how strongly Europe can manage economic revival. This means restructuring the European economy so that it is producing competitive products and services, getting unemployment back down, and with it, consumption back up. This is the job of the EU's Europe 2020 programme, which I will leave to another day. It also means sorting out the problems of the euro zone with higher degrees of stability than are presently found in America. Relative performance is the key. If Europe succeeds at getting its economic house in order more quickly and thoroughly than America does, it will be the first and biggest benefactor of the crisis' biggest winner. Both China, as the country that has gained most from the crisis, followed by Europe, will emerge much stronger.

Timing, Generals, and the Euro

At the beginning of the new year, thoughts return to time. We think of what has passed over the last year and look to the year ahead.

But what is more intriguing than time is timing. Why does a crisis erupt when it does and not sooner or later? Why do the successive stages of a speculative attack on the euro take place when they do?

They say many things about fighting a war. One of them is that it is hard to wait and not know when the next battle will be or from what direction it will come. Some insight can be gained by considering the following factors.

First, an awful lot of money is required to wage a successful speculative attack on a large country in the euro zone. Since financial speculators are dispersed, they require a means of deciding whether and when to place their resources on  a particular country, a direction, and an outcome. Just as in the horse races, the better your prediction, the better the payoff. Unlike the horse races, the target a speculator is trying to hit is determined not only by the target country but by the market as a whole. This is not an entirely anonymous and invisible market, but one that is dominated by a variety of financial institutions looking for opportunities for profit, and hoping that other market participants will prove them right.

That means that there must be a tipping point at which some trigger leads the first of the speculators to stick their necks out and the rest of them to follow until the rush becomes unstoppable. The question is, what is that tipping point? One thing that has emerged from the history of the financial crisis to date is that quarterly company reports are windows of time during which financial markets pay close attention to the way the wind is blowing. This makes sense from their perspective. When businesses slump, so do government finances, either because public finances will remain generally weak, or because catastrophic failures, which means the failure of a key company with knock-on effects for the rest of the economy may tempt the government to respond with costly, debt-fuelled state intervention that the market will eventually flee from.

The ebb and flow of reporting season, four times per year, is therefore central to whether investors are presented with a focal point that can lead to crisis. The full-blown financial crisis was triggered by quarterly reports on financial institutions. Attention has spread to the wider economy as well, in search of signs from strategic economic sectors.

What we need to watch and understand better is when and under what conditions the markets actually turn, when and how they can be held at bay, and what that deterrence is likely to cost (and what form it can take) if it is to be effective. Deterrence is a notoriously difficult thing to observe. If it works correctly, there is no battle.

However, it is possible to detect how public authorities marshall resources and how they position them. The EU heads of government are currently debating treaty changes that will allow the long-term establishment of the EFSF, and possibly bonds that use the EFSF as collateral to leverage even further funds. This is a risky move that I will return to in another post.

For the moment, it should suffice to say that using the funds available to the EU through the EFSF will not be enough. The EU will have to deploy those funds strategically when the time is right and where they are needed. That requires clear political authority that can be exercised within hours, if not minutes. Currently this authority is lacking in Europe. The Heads of Government must convene to fight whilst the enemy is overrunning them. There are no generals in command.

If Europe wants to defend the euro, that will have to change.

Sunday, January 2, 2011

Estonia and EMU

Estonia is joining the euro zone today. One might wonder why a country would join the single currency when it's been under such fire this year. But Estonia is a model of what official EMU policy requires of national economic policy. The country won't have any problems with EMU membership, as it requires no adjustment. It therefore can only gain in opening up the country more fully for business and aiding consumers as well with more transparent pricing and lower financial transaction costs.

Saturday, January 1, 2011

The Politics of EMU Survival

EMU has been through a lot in 2010. As we start 2011, it is worth considering the following points on how Europe has responded:

EMU may lack an accompanying political union that various political architects called for when the currency union was established, but it was political solidarity that kept the single currency together in the darkest hours of 2010.

2010 showed us that political solidarity does not have to rest on a common sense of identity and purpose, at least in the sense that everyone has to like it. The acrimony, bellyaching and arm-twisting that accompanied Europe's collective action in 2010 belie that. Some will support a specific form of cooperation because they believe it is right. Others will do so because they believe it is necessary, even if it is far from their ideal preferences. Indeed, it seems that all European governments felt the hot breath of necessity on the back of their necks last year, compelling them to do things they really didn't want to.

Under conditions like that, nearly anything could happen. EMU may very well survive the year, but not as it once was.