Tuesday, May 31, 2011

Sometimes you can't have both: democracy and the euro

There is a fundamental tension between democracy and the euro that is playing itself out in the South of Europe today. Daniel Oliveira of the Portuguese newspaper Expresso wrote this week that Portugal is being treated like a colony by the North, where the wishes of the people are being steamrolled, and the democratic and constitutional rule of law is being disregarded.

There is some truth in that statement, now that Portugal's public finances have reached a breaking point. The same is true for Greece. But it isn't the entire truth. The other half is that Portuguese and Greek voters supported joining the euro, which they probably shouldn't have done. They wanted to join, but not pay the price in terms of budget restraint, which means they were not being honest with themselves or the rest of the EU about what they really wanted.  They could have easily joined a different kind of euro with no negative implications for their democracy, one that did not insist so urgently on tough budget criteria. But that is an entirely different universe from the one in which we live, and it is unlikely that a 'soft euro' would have been a success. A euro without Germany or France? Unlikely. They saw it as necessary as a matter of pride and status, of really belonging to Europe. Now, instead of pride and belonging, they have disgrace, humiliation, and relegation to third-rate status within the EU. They are far behind the emerging markets of Eastern Europe and will stay there for a long time.

In theory, what the Portuguese will have to accept is that getting democracy back as quickly as possible means leaving the euro. That is not an easy way out either. The Portuguese government owes a lot of money in euros. Once Portugal re-introduces a national currency that devalues, the value of the national debt compared to the government's ability to pay with debased currency will skyrocket. Portugal will have no choice but to default on its debt. International investors will turn their backs on the country until yet another political leader is elected who wants to satisfy international financiers. And the problem will be back.

The European Commission has always been a strong proponent of countries joining the euro as quickly as possible. In the case of Southern Europe, they encouraged willing governments. In Eastern Europe, which largely was not desperate to join, the Commission resorted to ugly and ill-advised threats to cut EU funding to national governments in April 2004. They, in turn, having just shed Soviet imperial rule, rejected those threats as outrageous, illegal and undemocratic. The Commission's policy toward rapid euro accession needs to be thown out the window re-thought, at least as long as we have the kind of euro we have, which is for the foreseeable future. Without fiscal transfers; without an economic government for Europe, it cannot work. The euro, and the consequences of membership, do not exist in a vacuum.

It isn't the tension between the euro and democracy per se that is playing itself out, but that the colliding wishes, interests and values of certain euro member states make democracy and the euro incompatible. Either everyone adopts the same culture and values, or someone's democracy has to die. Europe has already decided what limits on democracy are compatible with euro zone membership.

So, Portugal and Greece, what will it be? Democracy or the euro?

You can't have both.

Wednesday, May 25, 2011

Declaring Greece Bankrupt

In bankruptcy, putting someone into administration means assigning them a guardian who makes financial decisions on that person's behalf. It's a final step when you admit that the person who is bankrupt is incapable of doing it personally. Assets are sold, income set aside for debt repayment, and in some cases, a portion of the debt is forgiven. That has nothing to do with administration per se, but the heightened sense of trust in the administrator's handling of the bankrupt individual's financial affairs makes such deals possible if they are wanted.

This morning, the Financial Times reported that Europe is considering a proposal to couple the sale of state assets with an administrative panel that would do two things: ensure that the sales actually take place; and ensure that the proceeds are used to pay down the debt. The sales will take place on state-owned companies, such as utilities and ports. Ironically, the sales will cut further into the revenues of the Greek state looking into the future, but that is a challenge that all European countries face. It is a separate question of whether privatisation of utilities is a good thing to do (indeed its merit is debatable in principle, regardless of the country involved), but Athens has precious few options left.

Somewhere in the last while I came across a proposal from a global institution I will not name until I find the reference which proposed establishing a formalised bankruptcy procedure for countries. Someone within the EU has clearly suggested such a thing on an ad hoc basis for Greece. But Portugal is certainly up next.

If this proposal bears fruit, Greece may be declared bankrupt in some official way soon, setting a pattern for other countries. They will avoid using that name. Going into administration sounds so much more neutral. But the reality is the same.

Tuesday, May 24, 2011

Italy and the euro

Following up on my last post about Greece, and why a Marshall Plan is unlikely to work, I want to share an excellent piece of work by Edward Hugh at Credit Writedowns, who makes a strong case for Italy's bleak future in the euro zone.  His take is that Italy simply lacks the productivity to earn what's required to pay its debt down. The points here can be applied to other countries as well.

In short: structural adjustment programmes that lower unit labour costs are required. That's what living with the euro means.

A Marshall Plan for Greece?

Yes, you heard that right. The idea for a Marshall Plan for Greece comes from Michael Diekmann, head of the Allianz Insurance Group. It would differ from the original Marshall Plan that financed the re-industrialisation of Western Europe in that Greece isn't an industrialised country.

And therefore, Diekmann is not only calling for a Greek Marshall Plan, but for the massive transfer of manufacturing from Western Europe to Greece. That way, he argues, the Greeks would have an economy into which the money could be productively invested.

There is a point in what he's saying from an economic standpoint, but does anyone think that this is going to happen? It could, if protectionism in the EU's more established economies wasn't running rampant. It's better to spend loads of cash to keep Opel German than allow production to close and shift to places like Greece. Then there is also the point that shifting production can also be counterproductive. Volkswagen shifted production outside of Germany during the 1990s and 2000s, drawn by low wage rates, but poor productivity ate up the expected savings.

One part of what made the Marshall Plan so successful in West Germany was the iron determination of the population to work, the sometimes overlooked fact that despite the devastation of World War II that Germany emerged with 50% of its industry (including heavy industry) still intact, that German companies were incredibly well-connected with one another, and that banks had their hands in many of these companies as shareholders or major lenders or both. The result was that the portion of the Marshall Plan funds that were invested in West Germany were invested in a country that had an above-average chances of putting it to good use. The French had the planning capacity of the state, the links between the Ministry of Finance and the country's banks, which then organised what would be produced and what would not. The Brits had a high degree of planning and public ownership well after the war that wasn't really relaxed for quite a while, and which functioned.

But Greece doesn't function, precisely because of the Greeks. Unless it becomes an effective colony of Germany, to the point of changing who the Greeks are, Diekman's Marshall Plan, as noble as it is, won't work.

Character is everything.  Diekmann's suggestion does serve a purpose, for it points to what stands in the way of making it effective: old-style protectionism in the EU's established economies, and a lack of willpower in Greece.

Monday, May 23, 2011

Default, deception and European debt

Europe has economic and political problems that just won't quit. There is a stench of desperation in the air that has gotten so strong that the President of the EU Council, Herman van Rompuy, has effectively told heads of government to STFU, lest they freak out the markets and send investors fleeing unnecessarily. On the contrary, Europe is suffering from a deep psychosis.

It's unlikely to make much difference unless there are real reasons for investors to think that Europe has its act together. And Europe doesn't. Standard and Poors has already downgraded bonds from Greece and Portugal to within a breath of junk bond status earlier this year. Those bonds, as well as those of Spain and Italy, are under renewed pressure as S&P considers a further downgrade of Italy.

The only question that anyone cares about, but that the politicians haven't accepted yet, is which of these countries will default on their debt this year, and by how much. If no default were likely, the problem would take care of itself. Imagine raking in the high interest payments on debt that you just bought for a big discount. The markets aren't buying it. Literally and figuratively.

Europe, with the exception of the ECB, (For its part, the ECB is demanding that the Greeks and everyone else pay in full, and that Europe reject any talk  of default, under whatever deceptive label it might come .) sent a strong message last week that it wants to let Greece default without actually calling it a default. A partial default is called a restructuring and is pretty common. But no one wants to say that. Talk started to circulate of 'soft restructuring', as if this would make an difference to anyone. When it was clear that it wouldn't, European finance ministers started talk of 're-profiling' the debt, which did nothing but slap a new label on an old plan. Last week, realising that someone would have to do something, the EU Council asked banks holding bonds from these countries not to ask for the money back.

Why does Europe think that banks and other institutional financial investors would hold on to such a crappy investment? It's the state equivalent of a sub-prime mortgage. Sooner or later, you want to get rid of it. The less confidence you have in the ability of the borrower, the sooner you want to sell. And if it isn't clear by now, holding on to that debt in the hope that it will be repaid, or at least that markets will re-invest in it at some point out of speculation, is hoping that a new economic bubble will wash the problems away. Or at least onto someone else's balance sheet.

That is a really bad idea. It's like a serious alcoholic who's trying to hide the booze bottles rather than admit having a problem and taking on the pain and responsibility of rehab. But lies and delusion don't make a problem go away. They prolong the disease and the agony. And everyone turns their backs on you.

Under these conditions, when Europe is deliberately trying to mislead the world about the depth of its problems, there are serious reasons to object to Europe insisting on its right to head the IMF. It wants to hold on to its prestige and power by birthright rather than merit, a point that is both legitimate and gaining steam internationally. It's like the town drunk, insisting on running the liquor store. Unless Europe shows a change of heart, that is another really bad idea. Europe hasn't hit bottom yet, and still thinks its in control.

It's time to take away the keys.

Tuesday, May 17, 2011


Draghi is confirmed as the ECB President.

Given what has gone on elsewhere in euroland, that was the easiest decision to make.

A conspiracy theorist's dream

Is Dominique Strauss-Kahn the victim of a sinister, diabolical plot? Is Europe being brought to its knees by dark forces pulling strings in the shadows? Who would have the motive and the means? Can it really be a coincidence that the man responsible for bringing Europe together to rescue the EU's economic basket cases was locked up as a monster just days before Europe's heads of government were to meet to work out a deal for Greece?

Conspiracy theorists have ample material to let their imaginations run wild this week.

If the allegations against DSK are true, then the greatest tragedy of this story will be a personal one: the woman who was apparently attacked in the Sofitel on the weekend. We shouldn't forget that.

But it can be said that two groups stand to gain from this absence of IMF support for Europe. The first are the currency speculators, who stand to make a lot of money if the euro zone fails, or becomes smaller. The second are emerging market countries, who are already questioning the notion that a European should succeed DSK as the head of the IMF. Not only will DSK likely leave, but the second in command as well, American John Lipsky.

A number of names have already been floated, from Turkey, South Africa, Singapore and India. The most important of these emerging markets is China, which has strengthened its influence in Europe by lending the money that others--European creditor countries, American investment companies, and the IMF--are not.

Now, the idea that the euro zone could collapse or could become smaller depends on creditor countries like Germany taking an unrealistically tough line with debtor countries like Greece and Portugal. Until DSK's departure from the scene, it was hoped that he would be able to make a deal possible. The EU's finance ministers are finishing up a two-day meeting, and appear to have reached an impasse.

Monday, May 16, 2011

DSK, the IMF and Europe

This weekend brought a WTF moment from New York that will be bad for Europe, regardless of how the trial turns out.

DSK, Dominique Strauss-Kahn, has been arrested on allegations of attempted rape at the Sofitel in NYC. Since he heads the IMF, folks are now speculating whether it will impair the IMF's ability to play its role in the Euro crisis.

You would think it need not, but the euro zone fund is complex. One-third of the money is provided by the IMF, and Finland reluctantly agreed at the end of last week to support financial aid for Portugal if the IMF is totally happy with the deficit reduction measures that the country's government is implementing.

What DSK's effective departure does is open up a power play for the top role of the fund. With that contest comes an opportunity to upset the existing status quo, and to set new priorities within the fund. You can bet that various camps within the IMF are assessing each other's strengths, thinking of whom they can best work with, securing alliances, hatching plots and so on. 

Europe can only lose from this. In a tradition dating back to the original Bretton Woods agreements of the 1940s, America heads the World Bank and Europe heads the IMF. Both institutions have been reformed to  increase the representation of emerging markets within them, but the effects this will have on the institutional leadership have never been tested. Europe can only get weaker from here on in. It would be revolutionary if a non-European were to take the helm of the IMF. It is inevitable, however, that the opinions of the BRIC countries in particular will carry more weight from this morning onward. America should not be too smug either. The new constellation of interests is somewhat more critical of American public borrowing practices than pre-crisis.

For the moment, the immediate impact will certainly be that the IMF, as it deals with Portugal, will be in the process of transforming itself after a long period of pushing for internal reform. This is less likely to be a naked power struggle and more likely to be one that is done in secret. But DSK is politically finished, his parting has sped up something that has been in the works for years.

This means that Portugal will become the first test of what the new IMF is transforming into. What will it demand? Will it be harder? Or will it be lenient, considering that the Chinese have been lending money when other sources dried up, and are now more powerful in the IMF?

This case will not be the last, for it is now clear to all European leaders that Greece will default on its debt this fall. They've been talking about how to deal with this.

It's time to watch both the IMF and national governments very closely indeed.

Tuesday, May 10, 2011

Finland, Portugal and the future of the euro

European Commissioner Olli Rehn warned Finland today that it would cause a 'Portuguese Lehman' if it refused to back emergency funds for Portugal. The term is a bit off, as Lehman was private company, but the message is on target.

Then, as now, an important financial player will go bust without further assistance. If it goes bust, the contagion to other markets will be fast and hard. Portugal can be allowed to fail as a state just as Lehman was allowed to fail as a bank. But does Europe want that?

In concrete terms, if Portugal fails, there may be serious consequences for Spain. It's not the only country that would be hurt, but it is the most vulnerable. And when financial markets smell blood, the sense of weakness can become a self-fulfilling prophesy.

Germany blocks the ECB

Jean-Claude Trichet, the President of the ECB, has a term of office that extends into October and cannot be renewed under the existing rules. And yet, Europe cannot agree on a replacement.

Let me rephrase that. Germany cannot bring itself to support the candidate that everyone else seems to have agreed on. This is despite the fact that the Chancellor herself has praised the candidate, his policies and his credentials. Mario Draghi is the current Chair of the Financial Stability Board, the global body responsible for ensuring that there will not be another financial crisis. In terms of policy, Draghi brings everything to the table the Germans want. He is clear on the question of whether the ECB should continue to purchase bonds from bankrupt eurozone governments as Trichet has reluctantly done. He says the ECB wouldn't do that on his watch. He would be tough on inflation. What more can Germany want?

That is the question. Germany seems to want to teach Europe a lesson. Not just the 'deficit sinners' who will be cast into the fire, but France and Italy as well. The level of hysteria in the German press and in German politics against foreigners is breathtaking. They're not only mad at the so-called PIIGS, they're mad at the ECB as well. And that is run by a Frenchman.  Chancellor Merkel wanted a German candidate, Bundesbank President Axel Weber, to be the next head of the ECB. He withdrew from the running after citing opposition from Europe and from within the Bank itself to his intent to run a tight ship. And it seems in her eyes, the German chanting for European blood could only be appeased by a Teutonic captain at the helm of the ECB.

There is a saying coined by Carl Jung that what you resist persists. In the context of German hysteria, the Weber Affair blew up because it had to. Weber came across outside Germany as arrogant and contemptful of his European colleagues, echoing what Europe hates about Germany most. Only 10 years ago, Germany was an economic basket case. It flouted the rules that it demanded be applied to others. It defied the application of economic penalties in the mid-2000s when it passed one emergency budget after another. Now that it is back on track, it is screaming for obedience and punishment according to terms it would never accept for itself. 

Germany has been rightly criticised for a lack of sensibility in how it deals with its European neighbours. One might argue that there is little the German government could do in the face of such domestic revulsion for Europe. Except for one thing. Merkel forgets that Germany has been here before and chose European cooperation rather than an all-out War of the Roses. In 1991, Merkel's mentor, Chancellor Helmut Kohl, conceded minor points to the hysterical politicians who wanted to torpedo EMU. But he insisted that you had to compromise in Europe, that Germany actually had to get on with its neighbours. Germany's past, he argued, demanded that. 

Germany is at the verge of destroying Europe. It may not in the end, but it is making it weaker every day.