Sunday, November 27, 2011

Why euro bonds won't work

Euro bonds won't work without a political authority that backs them up. We have seen over the last week that the EU has no intention of establishing such a government either. The point of bonds is that they are repaid, and without a decisive body to decide who is going to repay those bonds, the message to markets is clear: no one will.

Germany proposed more strongly this last week one way to solve this problem, which is to elaborate in more detail the termination of economic sovereignty for countries that require assistance in exchange for approving euro bonds...a position that attracted the derision of the country's national conscience and premier philosopher, Jurgen Habermas. Habermas rightly points out that the new imposition of central control from Brussels and Berlin contradicts the democracy that the EU is supposed to stand for, and warns that the damage to democracy could last for a century, if not longer.

Germany sees all of this nastiness as necessary to convince the world that it has it's 'problem' under control and that bonds can be issued without placing a higher burden on the German economy. The payers will be located in Greece, Portugal, Italy and Spain.  But without a European government to back the bonds, there is no guarantee. Indeed, these economies are nearly guaranteed under the current rules to contract for at least several more years. They will not be paying anything substantial back.

Which brings us back to why the bonds won't work. Pound for pound, the United States is worse off financially than Europe is, (and has problems governing itself financially, as we saw this last week in the failure of talks to manage the country's finances), but it is still a better financial bet for international investors than Europe. The main reason is that bondholders know not only who is responsible for US debt, but can hope that whoever wins the next elections can make a definitive policy on how to move forward.

As long as Europe's powerful countries hold on to their idea of sovereignty, euro bonds cannot work. And as long as they believe that 'all countries are equal, but some are more equal than others', it positively shouldn't.

Sunday, November 13, 2011

Poland, the new member states and the financial crisis

I am getting seriously tired of referring to countries that entered the EU in 2004 as the new member states. There has to be a better way.

The point of this post, however, is to consider an interview with Lech Walesa on the financial crisis. Desi Anwar interviewed Walesa in 2010 and got to hear two key things from him: that Poland weathered the crisis fairly well because it didn't engage in the same kinds of banking practices as in the West, and that dealing with the crisis requires strong international cooperation.

One could add to the list of reasons why Poland is not the source of speculation: it isn't in the euro, and it has had robust public finances. Part of the consequence, however, was a strong emigration of Poles to other countries during the lean years, due to the lack of economic opportunity at home. Austerity has its costs as well.

Friday, November 11, 2011

Authority, the public and the euro

Within the last 24 hours, Italy and Greece have gotten new heads of government. One is a former central banker. The other a former European Commissioner. Both favour the TINA approach to dealing with the euro zone crisis, that there is no alternative to those countries accepting their obligations, repaying their debts and staying within the euro zone.

There is merit in that approach, but only if the Greeks and Italians are fully on board with the changes that would have to happen. Those who work for the state, receive a pension, or have a contract with the public sector would have to be willing and able to live with far less income, however that is required. Private sector wages would have to decline. All of this would be required to ratchet back the expenses of the state, and to ratchet back the cost of production for export products. These dual measures are required to start reducing borrowing, reducing payouts, and earning more money. 

This means that Greece, Italy and Portugal must accept, if they go down this path, that the next generation is a lost one. Most of them will become poorer. The achievements they have made will be diminished. The lie of their prosperity, built on a bubble paid for by bondholders, will be exposed for the sham it is.

These are harsh words, and there are equally harsh words that can be pointed at the bondholders who lent their money to these countries. They are equally at fault for being so reckless and delusional in investing in countries like these without the recipients using that money as an investment in future productive income. That is the only kind of investment that the private sector should be undertaking. The worst part of all this is that we not only need to ask the pointed question of what kind of crack that asset managers at hedge funds were smoking when they treated these countries as equals of more productive countries, but why the other investment managers we expect to be more prudent were doing precisely the same. Pension fund managers and insurance managers were part of this as well.

If Greece, Portugal and even other countries were required to default on part of their debt, it would finally force creditor countries to start doing more than treating Southern Europe as the evil shadow of irresponsibility, recklessness and demise. It would force them to face questions about why they were the first in line with the money to give these countries.

Those are answers that voters in creditor countries should be demanding. Why is economic decision-making in the financial centres of Europe so irresponsible? A departure of Greece from the euro zone, as painful as it may be to begin with, would ultimately benefit both it and the euro zone. An important impact would be making euro zone membership more compatible with economic objectives again, as would be aligning membership with democratice choice. But the pressure it puts on financial centres will force some hard questions about why Europe's rich countries thought that their own economic welfare depended on speculation in a bubble in financial instruments, even if they were in government debt. What all of this has in common is that a short, sharp downturn could force a return to realistic assessments--of political motivations and political choices, not just in Greece, but everywhere in the EU. 

The new leadership of Italy and Greece is based on the premise that political authority can force a country to embrace low inflation and public borrowing. Chile has done that fairly successfully, but only through a military dictatorship. This will be the first attempt at such authoritarianism inside democracies. I almost wrote functioning democracies, but that is giving the countries too much credit at the present time.

This is a social science experiment of great proportions, the likes of which have not been seen for a very long time. Can you use public power to change who a people are and what they want?

We shall see.

Tuesday, November 1, 2011

Greece and Europe: hardball over default

Europe's creditor and debtor countries are playing hardball over how to handle the Greek crisis. And it matters, because Greece is only the beginning. What is decided here will set precedents. A couple of points are worth underlining from the events of the past week.

First, the EU has made some progress, but it is mostly in agreeing on haircuts on Greek debt. This was something that had to happen, and it is positive, but it only applies to banks, and those banks are being paid with taxpayer money to compensate for the loss, at least in part. If pension funds, hedge funds, or individuals hold Greek bonds, they still can claim 100%. A real solution needs to be more radical.

Second, the increase in the EFSF, the bailout fund, is modest and inadequate unless it is leveraged, and it doesn't look like anyone is biting yet. Neither China nor Brazil seem keen on pouring that kind of money into Europe.

Third, there have been wide-ranging discussions about establishing a European Minister of Finance. It might become a reality, but it is unlikely that this individual would have any real power. The EU has very little tax revenue, nor will it have much. It is only intended to put the screws to Greece. But you don't really need a new Commissioner for that.

Fourth,the very limited deal that has been struck now looks to unravel. The summit itself was delayed, revolved around France and Germany, and now seems to be put in question by a Greek referendum on the deal that is being offered. We will have to wait and see whether Greeks accept the terms of the deal, which would still impose hardship for a long time on the country, but just about be payable, or whether they say Oxi (no).

Greece really does have a choice. Should the people say Oxi, it would be best for Europe to do the dignified thing and deal with the consequences as best they can, rather than doing what they usually do, which is browbeat the country until it votes as it 'was supposed to'.