The euro crisis just got a whole lot worse

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With Europe plunging back into recession and unemployment soaring, Francois Hollande, the French president elect, is calling for growth objectives to be reprioritised over the chemotherapy of austerity.

Riot policemen lead away a protester holding a placard reading ‘Let’s get out of the Euro’ during May Day demonstrations in Neumuenster, Germany Photo: Reuters

Angela Merkel, the German Chancellor, has meanwhile continued to insist that on the contrary, Europe must persist with the hairshirt. What’s needed is political courage and creativity, not more billions thrown away in fiscal stimulus. Stick with the programme, she urges, as the anti-austerity backlash reaches the point of outright political insurrection.

Hollande and Merkel are, of course, both wrong. What Europe really needs is a return to free-floating sovereign currencies. Only then will Europe’s seemingly interminable debt crisis be lastingly resolved. All the rest is just so much prancing around the goalposts, or an attempt to make the fundamentally unworkable somehow work.

The latest eurozone data are truly shocking, much worse in its implications both for us and them than news last week of a double-dip recession in the UK.

Even in Germany, unemployment is now rising, with a lot more to come judging by the sharp deterioration in manufacturing confidence. For Spanish youth, unemployment has become a way of life, with more young people now out of a job (51.1pc) than in one. In contrast to the US, where the unemployment rate is falling, joblessness in the eurozone as a whole has now reached nearly 11pc. Against these eye-popping numbers, Britain might almost reasonably take pride in its still intolerable 8.3pc unemployment rate.

There is only one boom business in Spain these days – teaching English and German. No prizes for guessing where these students are heading.

Hollande’s opportunism in calling for a growth strategy he must know cannot be delivered looks like being answered only by intensifying recession. Maybe Mario Draghi, president of the European Central Bank, will surprise us after Thursday’s meeting with a rate cut and a eurozone-wide programme of quantitative easing. But even if he did, it wouldn’t fix the underlying problem, which is one of lost competitiveness manifested in ever more intractable levels of external indebtedness.

To think these problems can be solved either by fiscal austerity or, as advocated by Hollande and others, by its polar opposite of fiscal expansionism is to descend into fantasy.

By reinforcing the cycle, and thereby exacerbating the slump, fiscal austerity is proving self-defeating. Far from easing the problem of excessive indebtedness, it is only making it worse.

But it is equally absurd to believe that countries in the midst of a fiscal crisis can borrow their way back to growth. Who is going to lend with the certainty of a haircut or eurozone break-up to come?

I’ve been looking at the comparative numbers on fiscal consolidation, and they reveal some striking differences. The hairshirt prescribed for others is most assuredly not being donned by austerity’s cheerleader in chief, Germany.

In fact, German government consumption is continuing to rise quite strongly, even in real terms, and the fiscal squeeze pencilled in by Berlin for itself for the next three years is marginal compared with virtually everyone else. Germany is requiring others to adopt policies it has no intention of following itself. What’s so odd about that, you might ask?

Right to spend

Germany has earned the right to spend through years of prior restraint. It’s got no structural deficit to speak of and, in any case, isn’t that the way things are meant to work, with those capable of some fiscal expansionism compensating for the squeeze imposed by others?

All these things are true, but there is something faintly hypocritical about a country prescribing policy for others that it wouldn’t dream of imposing on itself. Germany’s supposed love of self-flagellation is actually something of a myth.

By the way, despite the rhetoric, Britain is hardly an outrider on austerity either. Now admittedly, the Coalition’s plans for fiscal consolidation have been somewhat derailed by economic stagnation. We were meant to be further along than we are. But in terms of what’s left to do, the UK is no more than middle of the pack.

On current plans, by contrast, the fiscal squeeze in the US, land of supposed fiscal expansionism, ratchets up substantially to something quite a bit bigger than what the UK has pencilled in for the next two years. It remains to be seen what effect that’s going to have on the American recovery. Will renewed growth melt away as surely as it did in early 2011, or is it self-sustaining this time?

Back in the eurozone, the stand-off between creditor and debtor nations shows few, if any, signs of meaningful resolution. During the recession of the early 1990s, there was a famous British Property Federation dinner at which the chairman introduced the then chief executive of Barclays Bank, Andrew Buxton, as “a man to whom we owe, er, more than we can ever repay”. It was a good joke, but it also neatly encapsulated what happens in all debt crises.

When the debtor borrows more than he can afford, the creditor will in the end always take a hit. The only thing left to talk about is how the burden is to be shared. The idea that you can force the debtor to repay by depriving him of his means of income is a logical absurdity, yet this is effectively what’s going on in the eurozone.

When such imbalances develop between countries, they are normally settled by devaluation, which provides a natural market mechanism both for restoring competitiveness in the debtor nation and establishing the correct level of burden sharing.

Least tortuous form of default

It’s default in all but name, but it is the least tortuous form of it.  Free-floating sovereign exchange rates also provide a natural check on the build-up of such imbalances in the first place.

The reason things got so out of hand in the eurozone is that investors assumed in lending to the periphery that they were effectively underwritten by the core, mistakenly as it turned out. Interest rates therefore converged on those of the most creditworthy, Germany, allowing an unrestrained credit boom to develop in the deficit nations.

None of this is going to be solved by austerity. For now, there is no majority in any eurozone country for leaving the single currency, but one thing is certain: nation states won’t allow themselves to be locked into permanent recession. Eventually, national solutions will be sought.

The whole thing is held together only by the fear that leaving will induce something even worse than the current austerity. This is not a formula for lasting monetary union.

By Jeremy Warner – Telegraph

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Euro, death approaching soon ?

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Death of a currency as eurogeddon approaches

It’s time to think what hitherto markets have regarded as unthinkable – that the euro really is on its last legs.

They need to wake up fast; it’s happening before their very eyes. In its current form, the single currency may always have been doomed, but it has been greatly helped on its way by an extraordinarily inept series of policy errors. Photo: AFP

 By Jeremy Warner, Associate editor – Telegraph

The defining moment was the fiasco over Wednesday’s bund auction, reinforced on Thursday by the spectacle of German sovereign bond yields rising above those of the UK.

If you are tempted to think this another vote of confidence by international investors in the UK, don’t. It’s actually got virtually nothing to do with us. Nor in truth does it have much to do with the idea that Germany will eventually get saddled with liability for periphery nation debts, thereby undermining its own creditworthiness.

No, what this is about is the markets starting to bet on what was previously a minority view – a complete collapse, or break-up, of the euro. Up until the past few days, it has remained just about possible to go along with the idea that ultimately Germany would bow to pressure and do whatever might be required to save the single currency.

The prevailing view was that the German Chancellor didn’t really mean what she was saying, or was only saying it to placate German voters. When finally she came to peer over the precipice, she would retreat from her hard line position and compromise. Self interest alone would force Germany to act.

But there comes a point in every crisis where the consensus suddenly shatters. That’s what has just occurred, and with good reason. In recent days, it has become plain as a pike staff that the lady’s not for turning.

This has caused remaining international confidence in the euro to evaporate, and even German bunds to lose their “risk free” status. The crisis is no longer confined to the sinners of the south. Suddenly, no-one wants to hold euro denominated assets of any variety, and that includes what had previously been thought the eurozone safe haven of German bunds.

Investors have gone on strike. The Americans are getting their money out as fast as they decently can. British banks have stopped lending to all but their safest eurozone counterparts, and even those have been denied access to dollar funding. The UK hardly has anything to boast of; it’s got its own legion of problems, many of them not so dissimilar to those of the eurozone periphery.

But almost anything is going to look preferable to a currency which might soon be assigned to the dustbin of history. All of a sudden, the pound is the European default asset of choice.

What we are witnessing is awesome stuff – the death throes of a currency. And not just any old currency either, but what when it was launched was confidently expected to take its place alongside the dollar as one of the world’s major reserve currencies. That promise today looks to be in ruins.

Contingency planning is in progress throughout Europe. From the UK Treasury on Whitehall to the architectural monstrosity of the Bundesbank in Frankfurt, everyone is desperately trying to figure out precisely how bad the consequences might be.

What they are preparing for is the biggest mass default in history. There’s no orderly way of doing this. European finance and trade is too far integrated to allow for an easy unwinding of contracts. It’s going to be anarchy.

It’s worth stressing here that for the moment the contingency planning is confined to officialdom. This week, for instance, we’ve had the Financial Services Authority’s Andrew Bailey admit that he’s asked UK banks to plan for a disorderly breakup of the euro. He’d be failing in his duties if he hadn’t. Europe’s political elite, as ever several steps behind the reality, still regards the prospect as unimaginable.

They need to wake up fast; it’s happening before their very eyes. In its current form, the single currency may always have been doomed, but it has been greatly helped on its way by an extraordinarily inept series of policy errors.

First there was the disastrous suggestion from Angela Merkel and Nicolas Sarkozy that if Greece didn’t buckle under it might be chucked out. Markets reacted logically, which was to sell bonds in any country that looked vulnerable and chase “safe haven” assets, thereby making it much harder for governments to fund themselves.

The blunder was compounded by attempts to underpin confidence in the banking system by forcing banks to mark their sovereign debt to market. This may only have recognised the reality, but it also destroyed the concept of the “risk free asset”, forcing banks for the first time to apply capital to their sovereign debt exposures. Unsurprisingly, they stopped buying sovereign bonds, again making it harder for governments to fund themselves.

But perhaps the biggest sin of the lot was effectively to render all credit default swaps (a form of insurance against default) on sovereign debt essentially worthless, or void, by making the Greek default “voluntary”.

This has made it impossible to hedge against eurozone sovereign debt purchases, and thereby destroyed the market. Worse, it’s made investors believe that the euro cannot be trusted, that it’ll repeatedly find ways of reneging on contract. That’s the point of no return. This is no longer a serious currency.

Euro fallout is bad news for world economy

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Global Trends By Martin Khor

The IMF-World Bank meetings last week confirmed the global economy has entered the ‘danger zone’ of a new downturn and possibly recession. This time it could be more serious and prolonged than the 2008-2009 recession.

THE last two weeks have seen a clear downward shift in expectations on the global economy. The dominant view now is that the world has slipped into stagnation that may well become a recession.

Warnings that the economy had entered a “danger zone” generated the gloomy mood at the annual Washington gathering of the International Monetary Fund and World Bank, as well as the G20 finance ministers’ meeting.

Prominent economists are predicting the new crisis will be more serious and prolonged than the 2008-09 recession.

If the United States and its sub-prime mortgage mess was the immediate cause of the last recession, the epicentre this time is the European debt crisis.

The eurozone’s GNP grew by only 0.2% in the second quarter, and the European Commission predicts the rates will be 0.2% and 0.1% in the third and fourth quarters.

As the domino effect of contagion hit one European country after another (rather like how Asian countries were affected in 1998-99), European leaders have scrambled for a solution.

But none has worked so far.

In the Greek debt tragedy, the government has had to announce one painful austerity measure after another, but its economic condition continues to worsen and the social protests and strikes indicate the approach of the political breaking point.

The costs of austerity are already being seen (by the public at least) to outweigh the benefits.

Several British newspapers last week reported a set of big measures to tackle the European crisis was reportedly being worked on by unnamed European officials.

The centrepiece is a Greek debt default with creditors repaid only 50%, and two measures to cushion that shock – an injection of fresh capital into European banks that would suffer big losses from the default, and the boosting of the European bailout fund from 400-plus billion euros to almost two trillion euros to enable hundreds of billions of euros in new credit to countries like Italy and Spain to prevent them from becoming new debt-crisis economies.

However, this leaked news of a big Plan B was not confirmed by any policy maker, so its status or even existence is unknown.

Instead, the news out of Washington last week was of continued paralysis in European policy.

Greece this week is facing a new crunch time – waiting to see if the European institutions and IMF will approve the next bailout instalment of US$8 billion to service loans that are coming due, and what would happen if they do not. Would it be time then to declare a default?

Meanwhile, the US has its own budget deficit tug-of-war between the President and Congress and between Republicans and Democrats.

What this means is that Europe and the US are not able to make use of the policies (massive increases in government spending, interest rate cuts and pumping of money into the economy) that pulled them quickly out from the last recession.

Moreover, the coordination of policy actions among developed countries (and several developing countries as well, that also undertook fiscal stimulus policies) that fought the last recession no longer seems to exist, at least for now.

Thus the new global slowdown or recession is likely to last longer than the short 2008-09 recession.

The developing countries should thus prepare to face serious problems that will soon land on them.

We can expect a sharp fall in their exports as demand declines in the major economies.

Commodity prices are expected to climb down; they have already started to do so.

There may be a reversal of capital flows, as foreign funds return to their countries of origin.

The currencies of several developing countries are already declining and it may be the start of sharper falls.

It’s beginning to look like 2008 all over again.

But this time the developing countries are starting this downturn in a weaker state than in 2008, since they have not yet fully recovered from the last shock.

And as the downturn proceeds, there will be fewer cushions to blunt the effects or to enable a rapid recovery.

It is also clear that there is an absence of a global economic governance system, in which the developing countries can also participate in.

All countries are affected when the global economy goes into a tail spin.

Once again, the developing countries are not responsible for the new downturn, but they will have to absorb the ill effects.

Yet there is no forum in which they can put forward their views on how to lessen the effects of the crisis on them and what the developed countries should do.

As the new crisis unfolds, there will be renewed calls for reforms to the international financial and economic system.

This time there should be a more serious reform process, otherwise more crises can only be expected in the future.

Europe puts its head in sand over growth crisis

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By Alan Wheatley, Global Economics CorrespondentLONDON | Mon Sep 5, 2011

(Reuters) – Japanization is shorthand for slouching toward that country’s noxious mix of low growth and high debt. Euro zone governments will find it tough to keep the ugly new word out of their lexicon.

Concern is mounting over a deterioration in Europe’s long-term growth prospects that, unaddressed, will make it even harder to tackle the banking and debt problems underlying the current life-or-death struggle over the euro.

The financial crisis that has been rocking the global economy since 2008 has permanently reduced trend growth across the industrial world. The Organization for Economic Cooperation and Development in Paris reckons the potential output of its 34 member countries has dropped by about 2.5 percent.

“A lot of countries are going to take a permanent hit to their trend rate of growth. This is not an ordinary recession and so we’re not going to see countries bouncing back to pre-crisis rates of growth,” said Philip Whyte, a senior research fellow at the Center for European Reform, a London think-tank.

As firms have gone bust, capacity has been lost for good. With demand subdued, profitable companies are not replacing old plants.

And as high unemployment persists, skills atrophy. This weakens productivity and shuts people out of the job market for longer and longer periods — a danger stressed by Federal Reserve Chairman Ben Bernanke at the U.S. central bank’s Jackson Hole symposium last month.

Apart from sapping animal spirits and forcing governments to raise taxes or cut spending, diminished growth closes off one route for lowering the high sovereign debt to gross domestic product ratios that have locked Greece, Ireland and Portugal out of the bond markets and are unnerving investors in Italian and Spanish debt.

Against this background, and with the scope for fiscal and monetary stimulus all but exhausted, politicians might be expected to grasp the nettle and push through reforms to improve the supply side of the economy — policies such as making it easier to hire and fire, promoting greater competition and investing more in training.

Far from it. Pier Carlo Padoan, the OECD’s chief economist, says he is less optimistic about the prospects for deep-seated change than he was at the start of the year.

“I see that measures are being announced. I would like to see them being implemented,” Padoan said.

With policy ammunition running desperately short, he said it was time for governments to overcome their squeamishness about confronting vested interests opposed to change. “This is a luxury that many countries cannot afford any more. The situation does not allow it.”

SOUTHERN DISCOMFORT

The vicious circle of rising debt and falling growth is made worse by the fact that those countries drowning in debt on the periphery of the euro zone are also the ones that have dragged their feet on freeing up their product and labor markets or modernizing their education systems.

“They’re going through some truly horrible times. I’m very worried about the whole southern European fringe, not just on an 18-month to 2-year view but looking out a decade or longer,” said Whyte with the Center for European Reform.

Germany, by contrast, derided a decade ago as the sick man of Europe, is being held up as a model, at least when it comes to jobs.

“The remarkable resilience of the German labor market in the last few years, where wage moderation and flexible time accounting shielded the economy from excessive job destruction, illustrates admirably the promise of well-structured reforms,” Jean-Claude Trichet, president of the European Central Bank, said approvingly in Jackson Hole.

How much are countries missing out by not pressing the reform button?

Padoan says Europe’s trend growth has fallen in recent years to an average of just 1.5 percent a year, but he says some members of the 17-nation euro zone could almost double that rate with a supply-side jolt.

Italy needs to liberalize its service sector, open up professions to new entrants and improve energy efficiency, Padoan said. Greece needs to do all that and overhaul its labor market and competition policy at the same time.

POOR ADVERT FOR FREE MARKETS

Germany, too, could grow faster still if it liberalized services, which would trigger increased investment.

These policy prescriptions are well worn. Leaders of the European Union enshrined them and a host of other reform goals in the 2000 Lisbon Agenda, which they promptly ignored. The pledges have since been repackaged as the Europe 2020 Strategy, but Whyte says the havoc wrought by the near-collapse of the international financial system will make politicians more wary than ever of the social disruption that reforms entail.

“The Great Financial Crisis hasn’t been a great advert for free-market capitalism,” said Whyte. His research outfit publishes a booklet this week exploring how Europe could take off by embracing innovation. But in this area, too, Whyte fears the political climate means policy is likely to be increasingly hijacked by incumbent firms hostile to competition from start-ups.

Europe is not doomed to go down Japan’s path of economic stagnation. Its potential growth rate is low but stronger than Japan’s — estimated by the Bank of Japan at just 0.5 percent a year because of a fast-shrinking working-age population.

But the specter of a renewed recession is a reminder for governments that, even if they can spirit away the euro zone’s currency and debt woes, they have still to find the elixir for growth.

“I’m not saying politicians will implement reform, but they should,” Padoan said. “Some politicians resist reform because they are captive to interest groups. Well, the price for those governments in terms of sustainable growth will be very high.”

(Reporting by Alan Wheatley; Editing by Ruth Pitchford)

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US no longer ‘AAA’, Eurozone the next?

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US no longer ‘AAA’

WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

STANDARD & Poor’s (S&P’s) had on Aug 5 cut the US long-term credit rating by a notch to AA-plus (from AAA). This unprecedented move reflected concerns about the US’s budget deficits and rising debt burden. It called the outlook “negative,” indicating that another downgrade is possible in the next 12-18 months.

According to S&P’s, the Aug 2 debt deal which cut spending by US$2.1 trillion, didn’t go far enough: “It’s going to take a deal about twice the size to stabilise the debt to GDP ratio.” It also stressed what it saw as the inability of the US political establishment to commit to an adequate and credible debt reduction plan: “The effectiveness, stability & predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” Moody’s Investors Service and Fitch Ratings haven’t followed S&P’s move causing a split rating. They had earlier (on Aug 2) affirmed their AAA credit ratings for the US, while warning that downgrades were possible, grading the outlook as negative. At the same time, China’s only rating agency (Dagong Global Credit Rating) downgraded the US from A-plus to A saying the deal won’t solve underlying US debt problems.

US downgrade

What does a rating downgrade mean? For the US, it will affect its borrowing costs eventually and immediately, investor opinion of US assets. According to Sifma (a US securities industry trade group), the downgrade could add up to 0.7 of 1 percentage point to US Treasury yields, thereby increasing funding costs for US public debt by some US$100bil. But the US dollar has a special position as the numeraire of global transactions; it is also a reserve currency, and often regarded as a safe haven in times of uncertainty. Ironically, in the recent sell-off in equities world-wide following the S&P’s downgrade, US government bonds was a big beneficiary. Its benchmark 10-year bond yields fell 21 basis points on Monday to 2.35%, the biggest one day drop since January 2009; by Wednesday, it was 2.14%, the lowest yield on record. Two year US Treasuries yield touched a record low of 0.23% and then, fell further to 0.184% on Wednesday. In the panic, Treasuries appear to be still the way to go.

With the downgrade, US no longer warrant the top-tier rating it enjoyed since 1941 (Moody has had a AAA on the US since 1917). At AA+, the US is still considered to have a “strong” ability to service its debt. Only Canada, Germany, France & UK still carry triple-A at S&P’s. The downgrade didn’t affect US short-term rating which remains at A-1+, the highest at S&P’s. In a follow through, S&P’s downgraded numerous government related enterprises (notably Fannie Mae and Freddie Mac which together hold more than one-half of US mortgages), 73 investment funds (fixed income funds, hedge funds, etc) and 10 insurance companies for their large holdings of Treasuries. But banks were spared on the implicit “too big to fail” policy of the government. Nevertheless, the US bond market retains widespread appeal. At more than US$35 trillion at end-March, this market is broad, liquid and deep. The Treasuries market alone has US$9.3 trillion debt outstanding. But in the end, the market decides. Consider Japan S&P’s downgraded it in 2002. Today, Japan is still able to borrow freely & cheaply. As of Aug 9, interest rate on Japan’s 10-year bonds stood at just 1.045% and 30-years, at below 2%. In practice, for the US, a double A-plus still works like a de facto triple-A.

 Market rebound: Traders work on the floor of the New York Stock Exchange on Thursday — AP

Immediate global sell-off

When markets opened following the weekend downgrade, a global panic sell-off in equities took over. There was a lot of fear and uncertainty in the markets, reflecting a confluence of three main factors:

● uncertainty about the US economy faltering, raising the risk of a double-dip recession;

● worries that the downgrade could further undermine US consumer confidence & business spending adding another layer of anxiety on the global economic outlook; and

● fear the euro-zone debt crisis will spin out of control, spooking investors.

All this took its toll. Stock markets plunged around the world with funds flowing into havens, such as gold (up 60% since 2010, surpassing US$1,800 a troy ounce), Swiss francs (up 24% against euro and 32% on US dollar over the past year) and ironically, US Treasuries. In Asia, markets closed at their lowest levels in about a year. Key benchmarks in Hong Kong, Seoul, Mumbai and Sydney skidded for the fifth consecutive day. Shares in China, Taiwan and South Korea plunged sharply before recovering some ground. All closed nearly 4% lower on Monday. In Hong Kong, the Hang Seng Index had its worst day since the 2008 financial crisis, falling another 5.6% on Tuesday; it had fallen by 16.7% in the past six sessions, or more than 20% from its recent peak. South Korea’s Kospi was down 3.6% and Indonesia’s main stock exchange fell 3%. At its close, the KL Bursa lost another 1.7% on Aug 9 (-1.8% on Aug 8). Japan’s Nikkei fell 2.2% to its weakest level since the March earthquake. India’s Bombay stock index declined 1.6%, its fifth drop in a row.

The Dow Jones Industrial Average (DJIA) recovered 1.5% on Tuesday after a record 635 point fall (-5.5%) in sell-offs on Monday. The German DAX closed further down 5% and the Paris CAC 4.7% lower while the FTSE 100 in London fell another 3.4%. The Stoxx Europe 600 index ended 1.4% higher following a 4.1% slide on Monday, although underlying sentiment remained extremely fragile. The VIX which tracks stock market volatility, reached its highest since the initial Greek debt crisis in May 2010. It rose 20% to 38.5 on Monday afternoon and then to 40.5 on Tuesday, reflecting extreme fear and emotional trading. It measures the price investors pay for protective options on the S&P’s 500 index. After Monday’s sharp share-price drop and the previous week’s poor performance, China and Hong Kong aren’t the only markets at or near bear territory. Stocks in Germany & France are now down more than 20% (definition of a bear market), from highs reached in the previous year. India’s benchmark Bombay Sensex is down 20%, and Japan’s Nikkei is off 16.5%.

A day after US stocks received a boost from the Fed to keep interest rates low until 2013, markets in the US and Europe resumed their plunge on Wednesday. The fear: politicians across the Atlantic won’t be able to manage the significant headwinds buffeting the US & European economies. Woes were focused on France, where its bank stocks plunged amid worries it may lose its triple-A status. The Paris CAC-40 index fell 5.4%. In the US, the DJIA was down 4.62% (-520 points) wiping out Tuesday’s surge. The Fed had run out of bullets. Asian stocks advanced Wednesday with sentiment helped by a strong Wall Street rebound. However, gains in most markets lacked the passion observed on the way down. Hong Kong was up 2.3%, South Korea, 0.3% and Taiwan, 3.3%. All three were still down more than 10% so far in August. Japan was up 1.1%, Australia, 2.6% and China, 0.9%. But Stoxx Europe 600 was down 3.7%. Expectations are for the markets to remain choppy. On Thursday, most Asian markets were back in negative territory. But Europe closed stronger (up about 3%) and the DJIA surged by 4% (+423 points).

European contagion

Italy and Spain, the euro-zone’s third and fourth largest economies, have a combined GDP of nearly 2.7 trillion euros, about 30% of the eurozone total. For nearly two years, the European Union (EU) has been trying to stem the unfolding debt crisis. The July 21 Greek bailout bought some time not much to ward off further contagion. The European Central Bank’s (ECB) decision on Aug 7 to buy Italian and Spanish debt represents a watershed in EU’s continuing battle against turning ECB into the lender of last resort. The ECB has insisted the main responsibility to act lies with national governments. Given worries of a new bout of contagion sweeping European and global markets, ECB defended the new intervention as restoring the “normal functioning of markets through a better transmission of monetary policy.” ECB’s continued bond-buying brought benchmark Spanish borrowing costs for 10-year bonds down to 5.019% on Tuesday, close to their lows for the year. Italian 10-year bond yields also fell to a one month low of 5.143%. Both countries’ yields had approached 6.5% last week a level that eventually escalated to push Greece, Ireland & Portugal into bail-outs. Analysts estimate ECB could have bought up to 10 billion euros, a small fraction relative to the size of Spain & Italy’s debt markets. Italy’s debt alone is 1.8 trillion euros.

Market sentiment aside, the purchases did little to change the fundamental backdrop in Europe where economic growth has slowed even in the “core” nations of Germany & France. Signs of stress remain despite the positive market reactions to ECB’s decision. Deposits at ECB, for example, hit a 2011 high of 145 billion euros on Monday, reflecting banks’ reluctance to lend inter-bank preferring the safety of ECB. There is a limit to how deeply ECB can be drawn into the fiscal misadventures of its members. Concerns are mounting on the French economy because of its high debt levels (85% of GDP, already above the US & rising) and weak growth prospects. Germany, in much better shape, isn’t immune either. Already, the cost of insuring German bonds against default using credit-default swaps (CDSs) rose above 85 basis points, higher than insuring UK bonds for the first time on Tuesday, despite the London riots. There is growing concern the new austerity measures in Italy & Spain will slacken their struggling economies, plagued also by social unrest.

What’s wrong with the US economy?

The recession ended two years ago. The stumbling recovery may turn out to be the worst ever. Most indicators are not reassuring unemployment at 9.1% is still too high and jobs creation too slow; GDP growth is faltering, income growth continues lagging behind; household wealth is falling; banks are not lending enough; and consumer expectations have not been positive. In the last eight recoveries, lost jobs were regained within two years of recession’s end. This recovery is still seven million jobs below peak employment in 2008 and about two million fewer than if unemployment was held below 8%. The US economy will remain lacklustre for some years because of heavy household debt, a financial system deeply scared by mortgages, and a dysfunctional political establishment. Heavy household debt and a dismal job market have hurt consumers’ confidence, further dampening their willingness to spend. The only bright spot is exports, reflecting the weak US dollar and still booming emerging economies. Unexpectedly, the pace of growth in US services fell in July to its lowest level since February 2010. Taken alongside disappointing manufacturing data, the services sector showed-up an economy with weak hopes of a rebound in the second half of this year, after an anaemic first half. According to Harvard’s Martin Feldstein, “This economy is really balanced on the edge. There is now a 50% chance that we could slide into a new recession.” Even Prof Larry Summers now concedes: “The odds of the economy going back into recession are at least one in three.”

The US problem is more a job and growth deficit than an excessive budget deficit. The diagnosis of the run-up in debt out of control spending by the Federal government, is exaggerated. Indeed, the “cure” of severe spending cuts is likely to make recovery more difficult. The real problem lies in the fall-off in tax revenue. From 20% of GDP in 1998-2001, tax revenue has fallen steadily: averaging just 17% of GDP from 2002-08 and then, to below 15% in 2009-10. About 50% of the rise in deficit was due to the downturn because of “automatic stabilisers”, reflecting cyclical revenue falls and higher spending to assist the unemployed and other transfers to help the poor. They contribute to demand and assist to “stabilise” the economy.

The US rating downgrade is a warning bell. On present trend, its debt burden is unsustainable and the US political system seems unable to reverse it. To do so, it needs faster growth can’t cut its way to growth. What’s required is tax reform and a will to restore revenues back to the 20% of GDP trend; a prospect most Republicans have castigated. At issue is not the US government’s capacity to service its debt, John Kay of the Financial Times pointed out. It is the “willingness of the government to repay.” If sovereign borrowers meet their obligations, it is only because “they want to.”

● Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching & promoting the public interest. Feedback is most welcome; email: starbizweek@thestar.com.my.

IMF – Lagarde’s Challenges

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Raghuram Rajan

CHICAGO – Now that the dust has settled over the selection of the International Monetary Fund’s managing director, the IMF can return to its core business of managing crises. Christine Lagarde, a competent and well-regarded technocrat, will have her hands full with three important challenges.

The first, and probably easiest, challenge is to restore the IMF’s public image. While the criminal case against Dominique Strauss-Kahn on sexual-assault charges now seems highly uncertain, the ensuing press focus on the IMF suggests an uncontrolled international bureaucracy with unlimited expense accounts, dominated by men with little sense of restraint.

Fortunately, the truth is more prosaic. Top IMF staff face strict limits on their allowable business expenses (no $3,000 per night hotel rooms, despite reports in the press), and are generally underpaid relative to private-sector executives with similar skills and experience.

The IMF, like many organizations where workers spend long trips together, has its share of intra-office romances. But the environment is professional, and not hostile to women. A previous incident in which Strauss-Kahn was let off lightly for an improper relationship with a subordinate clearly suggests that the Fund needs brighter lines for acceptable behavior and tougher punishment for transgressions. But other organizations have dealt with similar issues; the IMF needs to make the necessary changes, and, equally important, get the message out that the DSK incident was an aberration, not the tip of the proverbial iceberg.

Mess in Europe The second, and perhaps most difficult, challenge facing Lagarde, is the mess in Europe, where the IMF has become overly entangled in eurozone politics. Typically, the IMF assesses whether a country, after undertaking reasonable belt-tightening measures, can service its debt – and lends only when it is satisfied that it can. The entire objective of IMF lending is to help finance the country while it makes adjustments and regains access to private borrowing. This also means that a country with too much debt should renegotiate it down before getting help from the IMF, thereby avoiding an unsustainable repayment burden.

Perhaps swayed by promises of eurozone financial support (and Europe’s desire to prevent default-fueled financial contagion from spreading to countries like Spain and possibly Italy), the IMF took a rosier view of debt sustainability in countries like Greece than it has in emerging markets. But this has not “helped” such countries, for the availability of soft credit from the eurozone or the Fund only enables a greater accumulation of debt.

Ultimately, debt can be repaid only if a country produces more than it spends. And the higher the debt, the less likely it is that the country will be able to achieve the mix of belt-tightening and growth that would enable it to generate the necessary surpluses. Delayed restructuring eventually means more painful restructuring – after many years of lost growth.

If troubled eurozone countries, especially Spain, start growing rapidly again, there is still a “muddle-through” outcome that might work. With too-big-to-save countries like Spain in the clear, the debt of highly-indebted peripheral countries like Greece could be written down through interest waivers, maturity extensions, and debt exchanges. The eurozone – and the European Union – could survive its fiscal crisis intact.

Significant haircut But having failed to insist on an up-front restructuring, the IMF will face problems. With private investors reluctant to lend more or even to roll over existing debt, the bulk of Greek debt at the time of any restructuring (or whatever it is euphemistically called) will be from the official sector. How the resulting losses imposed on debt holders will be divided between the various eurozone institutions and the IMF is anyone’s guess. For the first time in its history, the Fund might have to take a significant “haircut” on its loans, and it will have to prepare its non-European shareholders for it.

 Being independentA greater dilemma will emerge if the muddle-through strategy does not seem to be working. At some point, the IMF’s strategy, which should be focused on the distressed country’s citizens and its creditors, should depart from that of the eurozone, which is more willing to sacrifice individual countries’ interests for the larger interest of the monetary union. Lagarde’s challenge will be to chart a strategy for the IMF that is independent of the eurozone’s strategy, even though she has been intimately involved in formulating the latter.

The third challenge for Lagarde concerns the circumstances of her election. It is not inconceivable that a number of emerging-market countries will get into trouble in the next few years. Will the Fund require the tough policy changes it has demanded of countries in the past, or will Lagarde’s need to show that she is not biased towards Europe mean that future IMF interventions will become more expansive and less demanding? A kinder, gentler Fund is in no one’s interest, least of all the distressed countries and the world’s taxpayers.

Finally, there is a challenge that seems to be pressing, but is not. In her campaign for the position, Lagarde emphasized the need for diversity among the IMF’s top management. But what is really needed is the selection and promotion of the best people, regardless of national origin, sex, or race.

Clearly, the IMF’s existing culture and history will bias its selection and promotion of staff towards a certain type of person (for example, holders of PhDs from US universities). That commonality in backgrounds among IMF personnel allows the Fund to move fast in country rescues, not wasting time in endless debate. In the long run, more diversity is needed. But if it is attempted too quickly, in order to paper over the fact that a European is in charge once again, the Fund risks jeopardizing its key strength.

The IMF is perhaps the central global multilateral economic institution at a time when such institutions are needed more than ever. Lagarde arrives to lead it at a difficult time. We all have a stake in her success.

Raghuram Rajan, a former IMF chief economist, is a professor at the University of Chicago’s Booth School of Business.

US dollar cracking at the seams

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WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

MY last columns dealt with the international monetary system (IMS), specifically why the world monetary order is in disorder, and why free movement of capital underpinning the IMS is increasingly being challenged.

Today’s column concerns the basic anchor of the IMS the reserve currency role of the US dollar and why it will give way to rapidly rising pressures towards multipolarity, that is, the concurrent pulling of forces emanating from more than two growth centres.

In 20 years, the World Bank expects the newly emerging BRIIKs (Brazil, Russia, India, Indonesia and Korea) to join China as new drivers of growth towards a multipolar world. Today, none of their currencies is used for reserve accumulation, invoicing or exchange rate anchor. The status quo remains centred on the US dollar. But change is in the air. In 1991, the G3 (US, euro-zone and Japan) accounted for 49% of world trade, and the BRIICKs (BRIIKs plus China) only 9%. By 2010, the G3′s share had fallen to 29%, while the BRIICKs’ share rose beyond 30%. Without doubt, the post-war structure dominated by advanced nations is in the midst of fundamental change. Globalisation and the rapid growth of the emerging market economies (EMEs) are bound to translate into greater global economic power. It’s just a matter of time.

Multipolarity

We are witnessing the cracking of the global institutions created in 1945. They are still unadjusted to the growing weight of the EMEs, reflecting reluctance by the United States and euro-zone to come to terms with a world they no longer dominate. It is also a manifestation of uneasiness in China, India and Brazil that the management of their domestic economy, long the jurisdiction of internal prerogative, now matters to the rest of the world.

This is understandable. The founding of the Bretton Woods institutions (IMF and World Bank) after the devastation of the Great Depression and WWII set in motion an era of stability at a time when the US was unchallenged in the global economy. In international finance, this post-war order began to fall apart in the 1970s as the US economy floundered, the dollar tanked, Europe was rebuilt and Japan asserted itself.

The move towards multipolarism was, however, interrupted in the 1980s and 1990s by the Soviet Union’s collapse, the euro-zone’s indigestion after swallowing a re-united Germany, and the Asian currency crisis. The US was thrust into the forefront to lead. But, the home-made US financial crisis in the 2000s in the face of rapidly rising EMEs, brought the era of US dominance to an end.

Yet, neither the US, euro-zone nor China has the capacity and clout to manage global problems. Happily, the G-20 came along to replace the G7, stumbling on to a mutually beneficial co-operation. Prof Barry Eichengreen‘s reference in history of another scenario is scary: “The decades following WWI were marked by the inability of rising or declining powers to stabilise the world economy or create functioning global institutions; the result was the Great Depression & WWII.”

A definite shift is taking place, driven by the rising power of the emerging BRIICKs, together representing more than one-half of global growth in 14 years. According to the World Bank report, Multipolarity: The New Global Economy, the EMEs will grow at 4.7% per annum up until 2025, which is double the rate of the advanced nations (2.3%). The implications are far-reaching:

• the balance of global growth and investment will shift to the EMEs;

• this shift will lead to boosts in investment flows to nations driving global growth, with a significant rise in cross-border M&As, and a changing corporate landscape where established multinationals will largely be absent;

• a new IMS will gradually evolve, displacing the US$ as the world’s main reserve currency by 2025;

• the euro and the RMB (renmimbi, China’s currency) will establish themselves on an equal footing in a new “multi-currency” monetary system;

• the euro is the most credible rival to the US$; “its status is poised to expand provided the euro can successfully overcome sovereign debt crisis currently faced by some member countries and can avoid moral hazard problems associated with bailouts within the European Union;”

• the rising role (and internationalising) of the RMB should “resolve the disparity between China’s growing economic strength on the global stage and its heavy reliance on foreign currencies;” and

• the transition will happen gradually

At no time in modern history have so many EMEs been at the forefront of an evolving multipolar economic system.

A strong US dollar a delusion

The US dollar is the reserve currency. This refers to its use by foreign central banks and governments as part of their international reserves. This role, combined with its widespread use as a medium of exchange (transactions and settlement vehicle), a standard of measurement (unit of account) and a store of value (method of holding wealth), has given rise to the key currency status of the US dollar. For these reasons, the US serves as world banker.

This was not planned. It just evolved since it met various needs of foreign official institutions and foreign private parties more effectively than any alternative could. Many of the reasons for the use of US dollar by official and private parties are the same. However, the aims of the two users need not always coincide. If the US dollar’s role as reserve currency was terminated, its use by private traders and institutions would most likely remain, perhaps even stronger. The wheels of commerce keep turning. The role of the US dollar as world banker remains relevant.

It is a long-standing tradition for the US Treasury to favour a strong US dollar. The US Fed has no say since it is outside its purview of fighting inflation and unemployment.

The exchange rate is just another price. The price of the US dollar relative to other currencies is determined in the market, and not under the control of anyone. An increase in demand for US dollar or a reduction in its supply strengthens the US dollar. Lower demand and increased supply will weaken the US dollar.

A strong US dollar is not always good. It depends on what causes it to strengthen; if the cause is rising productivity or innovation, that’s good. But in an economy struggling to grow and to create more jobs, a strong US dollar is not so desirable. A weak dollar means goods are cheaper relative to foreign goods; it stimulates exports and reduces imports. Foreign goods get more expansive but more US jobs are created.

At this time, US is better off with a weak dollar. Strangely, most politicians thinks it’s desirable for the US dollar to weaken only against one currency, the renminbi. The US Congress routinely bashes China for not weakening the US dollar enough. Indeed, a fall in the value of the US dollar against all currencies would help the US even more. Yet, in the next breath, the same Congress wants the US dollar to be strong. This delusion just won’t go away. They are like failed dieters who talk earnestly about healthy living while eating a chocolate doughnut.

The US dollar isn’t going anywhere. It is not about to be replaced anytime soon. The only dangers are (i) reckless US mismanagement giving rise to chronic inflation (or deflation if the exit of QE2, the second round of quantitative easing, is not well handled), which is implausible; and (ii) US budget deficits run out of control; outright debt default is far-fetched. Mark Twain once responded to accounts of his ill health by saying “reports of my death are greatly exaggerated”. He might well have referred to the US dollar. For the moment, the patient is stable, external symptoms notwithstanding. But there will be grounds for worry if he doesn’t commit to a healthier lifestyle.

The euro and renminbi

Today, the US dollar faces growing competition in the global currency space. The serious contender is the euro, which has gained ground as a currency goods are invoiced and as official reserves held. Nevertheless, share of reserves held in US dollar remains well over double the share held in euros; US$ share did fall from 71% in 2000 to 67% in 2005 and 62% in 2009, while euro’s share rose from 24% in 2005 to more than 27% in 2009. In terms of global forex, the US$ market turns over US$3.5 trillion daily, more than double that in euros. But the US dollar share of the market fell from 45% in 2001 to 42% in 2010. Euro capital markets are of comparable depth and liquidity as the US dollar’s, and the euro-zone and US economies are roughly the same size.

Events since 2008 have shaken faith in the US financial markets. But the banking crisis and its economic fallout are a trans-Atlantic affair. Continuing euro bailouts is a sign the old continent is not much safer than the US. Worried savers may still sleep better with US$ under their pillow. So for the euro, it’s going to be a long haul.

The sheer dynamism of China and the globalisation of its corporations and banks will propel the renminbi to a greater international role. It can become a global settlement currency this year. China has made good progress, signing currency swaps with more central banks. The issuance of renminbi-denominated bonds is actively promoted. Renminbi offshore deposits in Hong Kong (to top 1 trillion renminbi by year-end) are rising rapidly, and offshore renminbi trading will expand beyond Hong Kong.

But with the undervalued exchange rate, an asymmetry in settlement has arisen. Foreign importers are reluctant to settle in renminbi, while foreign exporters are glad to do so. In the end, success at internationalising the renminbi depends on the pace China liberalises the capital account.

The problem lies in speculative capital flows aimed at profiting from arbitrage. Capital controls remain as China’s last line of defence against hot’ money inflows. Its policy continues to encourage non-residents to hold more renminbi and renminbi-denominated assets. The sequencing of policy adjustments remains critical as China moves forward. The road ahead is going to be bumpy.

Policies co-ordination

By 2025, the World Bank’s best bet is the emergence of a multipolar world centered around the US dollar, euro and renminbi. A world supported by the likelihood US, euro-zone & China will constitute the three major “growth poles” by then. They would provide stimulus to other nations through expanding trade, finance and technology transfers, which in turn creates international demand for their currencies. Already, private investment inflows into EMEs are expected at US$1.04 trillion this year (mainly to China) against US$990bil in 2010 and US$640bil in 2009.

Inherent in this shift is rising competition among them, which is real. This is bound to create situations of potential conflict, which can exact a heavy toll on global financial markets and growth. This calls for workable mechanisms to strengthen policy co-ordination across the major growth poles in particular. This is critical in reducing risks of political and economic instability.

In the recent crisis, the G-20 was able to pick low-hanging fruits by managing the re-alignment of macro-economic policies aimed at generally common objectives to get out of recession and to rebuild financial systems. In today’s world, shifts in policy co-ordination will be increasingly towards more politically sensitive domestic fiscal and monetary and exchange rate policies. Also, the interests of the least developed countries (LDCs) have to be safeguarded against pressures accompanying the transition to a multipolar order.

Against the backdrop of the tragic earthquakes and tsunami that hit Japan, the political turmoil of the Arab spring’ gripping much of Middle East and North Africa (MENA), and growing uncertainties emanating from euro-zone sovereign debt crisis, global growth remains at sub-par this year with high unemployment, and rising inflation in the EMEs and LDCs. This calls for building confidence and promoting investments to boost productivity and create jobs to absorb the large pool of youth in MENA in particular. The LDCs and MENA nations are heavily dependent on external demand for growth. Aid and technical assistance have the ability to cushion adjustments as they adapt in the transition process.

According to the World Bank: “It is also critical that major developed economies and EMEs simultaneously craft policies that are mindful of the growing interdependency associated with the increasing presence of developing economies on the global stage and leverage such interdependency to derive closer international cooperation and prosperity worldwide.”

A former banker, Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome at starbiz@thestar.com.my

They can try to ‘delay and pray’ but the euro is running out of time!

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As a doomsayer from the start, who has written several times on the subject, I have recently been reluctant to burden my readers with more jeremiads about the euro.

‘Why is the euro in crisis? Because it was fundamentally flawed at its inception’ Photo: GETTY

But fasten your seatbelts. Here I go again. My excuse is that this crisis keeps surprising the unwary. There is so much to say that I will have to have several bites.

Before we can find solutions, which I will discuss at a later date, first the causes. Why is the euro in crisis? Because it was fundamentally flawed at its inception. Only good luck, strong economic growth and enlightened economic management could keep it together. In fact, the eurozone has had to suffer the opposite of all three.

Giving up sovereign currencies is a serious challenge. Exchange rates act as a safety valve. When you remove them, the pressure either has to be reduced or it will find some other way out. In a fixed exchange rate system, such as the ERM, currency speculation could and did break the system. Advocates of the euro project drew comfort from the fact that, by contrast, a full monetary union is immune from such attacks.

It was recognised that economic and financial pressure might still find an outlet as countries which diverged from the core had to face higher bond yields. But this would be a good thing. The prospect of it should serve to restrain them. It wasn’t imagined, though, that strain in the bond markets could threaten the stability of the euro itself.

Failurres

Four things went wrong. The first two were private sector failures. First, far from reacting to their newly shackled state, Spain and Ireland went on a private sector spending spree. (Meanwhile, in Greece the government led the bonanza.) Second, in all these cases, the bond markets were hopeless at foreseeing possible difficulties and imposed bond yields only marginally higher than on Germany. Accordingly, they provided no restraint at all.

The third and fourth were failures of government. The authorities presided over an extremely shaky banking system, acutely vulnerable to shocks. And their policies over many years resulted in a high government debt to GDP ratio, not only in the peripheral countries, but also in the supposedly solid core. In common with almost everyone else, the European authorities grossly underestimated the possibility of sovereign default as a realistic threat and market worry, and underestimated its capacity to cause a full scale banking crisis.

The fact that the political elite ploughed on with the euro project was the result of profound arrogance. Where possible, electorates would be denied the chance to say whether they approved of the euro and other aspects of integration. Where they had to have their say, they would be compelled to go on voting until they said “yes”. The current crisis has the same roots. The project’s difficult economics would be overcome by the politics. The Brussels establishment would ensure that everything turned out all right.

But it hasn’t. Now the economics threaten to overwhelm the politics. Greece’s sovereign indebtedness is so high that it is impossible to see how it can honour its debts without outside help (ie. gifts). And the economy will go on contracting for years. There will have to be “an event”. The only issues are when this will happen; who will pick up the tab; and what it will be called.

Nonmenclature

This being the European Union, nomenclature is extremely important. Of course it won’t be called a default – I doubt it will be called anything beginning with “de”. Bad things begin with de – like decline and defeat. It will be called something beginning with “re”. Good things begin with “re”, including rebirth and renewal – and restructuring and reprofiling. But default it will be.

Who picks up the tab is important because the bill could seriously undermine some banks. Remarkably this threat includes the ECB itself because it has taken on a large amount of Greek debt. The rows over the bill are likely to delay any sort of solution and to poison the atmosphere between member states. Meanwhile, the fate of the European banking system will be hanging by a thread.

This is why the “when” issue is so important. The current approach is to try to stave off the event until things get better. You will notice that this bears a striking similarity to the sophisticated strategy adopted by British banks in the face of dud commercial property loans, namely “delay and pray”. Mr Micawber had the same idea but expressed it differently.

So even though the markets cannot cause the euro to break up by exchange rate pressure, they can cause an internal financial crisis worse than any currency panic. The prospect, or the reality, of such a crisis could yet cause some European leaders to precipitate the end of the euro as we know it.

By Roger Bootle  who is managing director of Capital Economics and economic adviser to Deloitte.

Europe’s Job From Hell

Madman Is Wanted to Fill Europe’s Job From Hell

by Matthew Lynn

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Feb. 23 (Bloomberg) — It comes with a nice office and a grand title. You would probably have a pretty generous expense account. And there may well be a lucrative consulting gig with Goldman Sachs Group Inc. when it is all over.

Even so, you would have to be bordering on insanity to accept the role of European Central Bank president when Jean- Claude Trichet steps down in October this year.

It’s the job from hell. The euro crisis is getting worse. You will be asked to achieve the impossible. You will have zero independence. And the chances are that you will wind up being remembered as the person who presided over one of the biggest monetary failures in history.

That’s hardly an appealing prospect.

When Axel Weber unexpectedly resigned as Bundesbank president this month, the favorite to take over from the usually calm and confident Trichet was suddenly out of the running.

The field is now wide open. Mario Draghi, the Bank of Italy governor, has been installed by the bookmakers as most likely to get the job. He is followed by Erkki Liikanen, the Finnish central banker, who is now at odds of 2-1, followed by Luxembourg’s Yves Mersch, and Dutchman Nout Wellink. An outsider at 20-1 is another German, Klaus Regling, the head of Europe’s bailout fund. It could even be another Frenchman — Xavier Musca, the economics adviser to French President Nicolas Sarkozy, has been mentioned as a possibility.

Euro Mess

Yet surely any job would be preferable to running the ECB. Greek finance minister, for example. Or running the public relations unit for BP Plc on the Gulf coast. Either would be better than trying to sort out the mess the euro has become.

Here’s why.

First, the crisis ebbs and flows. But the only real fix is for the economies of the 17 members to converge, and there is no sign of that. Germany is booming, and the peripheral countries are slumped in recession. The German economy will expand 2.3 percent this year, according to the government. By contrast, the Greek economy shrank 1.4 percent in the fourth quarter alone. From a year earlier, its economy contracted 6.6 percent.

The difference in growth rates between Germany and the worst performing countries is now close to nine percentage points. In effect, the imbalances are widening — and that means the crisis is becoming more severe.

Inflation Lurks

Second, the new ECB president will be asked to achieve the impossible. The central bank is mandated to keep consumer-price increases at just below 2 percent. In January, the euro area’s inflation rate was already 2.4 percent. Thomas Straubhaar, director of the Hamburg Institute of International Economics, says German inflation will reach 4 percent by the end of 2012. Price pressures are growing everywhere, and at some point the ECB will have to act.

That will plunge the struggling nations into a depression. What happens to an economy that has already contracted more than 6 percent in the past year when you boost interest rates? You create a full-blown depression — 1931 will seem mild by comparison. They will burn your effigy in Athens and Dublin. You can’t maintain price stability and rescue the peripheral nations, but that’s what you will be asked to do.

Three, the bank’s independence is about to be compromised. The euro area’s leaders will struggle to keep the single currency together. They have invested too much capital in this project to let it fail. They will come up with a dozen plans and trillions of euros in rescue packages. The chances of the ECB maintaining its independence during that process are zero.

Let Inflation Rip

If you need to print money to keep the euro intact, you will have to turn on the presses. If you have to prop up bankrupt banks, the euros will have to be made available. If you need to cut interest rates and let inflation rip, you will have to ignore your mandate for price stability. The ECB president will end up having to do what French and German politicians tell him, regardless of whether it makes any economic sense.

Four, you will probably end up presiding over the dismemberment of the euro. This is an eight-year term. Whoever gets the job will still be there in 2019. It is hard to see the single currency surviving that long without one or more countries leaving. The pressures within the system are too great to be contained. Who wants to be remembered as the person who presided over one of the great monetary failures in history?

They will probably find someone to take the job. There’s always someone who wants a promotion.

But Axel Weber was a candidate of stature, just what the ECB needs. He walked away from the gig. The other candidates are now taking a good hard look at the job description.

(Matthew Lynn is a Bloomberg News columnist and the author of “Bust,” a book on the Greek debt crisis. The opinions expressed are his own.)

China supports Euro, Offers to buy Greek debts

China’s premier, Wen Jiabao, pledges support for euro

The country vows it will not reduce its holdings of European government bonds, and will double trade with Greece

• Reuters
• The Guardian, Monday 4 October 2010
• Article history

Chinese prime minister Wen Jiabao, addresses the Greek parliament in Athens yesterday. Photograph: Petros Giannakouris/AP

China pledged to support a stable euro and not reduce its holdings of European government bonds, in an effort to deflect criticism of its foreign exchange policy ahead of this week’s EU-China summit.

Chinese premier Wen Jiabao, who is at loggerheads with the United States over the yuan and likely to face similar complaints during his tour of European countries emphasised China’s willingness to cooperate with the EU.

“I have made clear that China supports a stable euro,” he said during a visit to Greece at the start of a one-week European tour. “We will not reduce the holdings of European bonds in our foreign exchange portfolio.”

Wen, who offered on Saturday to buy an unspecified amount of Greek government bonds when debt-laden Athens resumes issuing, said he was glad Greece was starting to emerge from the shadows of its debt crisis. Wen vowed to double trade with Greece to $8bn (£5bn) within five years and provide a $5bn credit line to Greek shipowners buying Chinese-built vessels.

China has said it needs to diversify its foreign currency holdings and has bought Spanish government bonds. Chinese state entities have been conservative about investing in foreign financial markets and the Chinese government faces domestic criticism over losses incurred from the global financial crisis.

At the height of the European debt crisis this year, Chinese officials, concerned that the crisis could hurt the global economy, pressed European officials to restore confidence in the euro. But Beijing has rejected discussion of its foreign exchange policy. It even blocked an attempt by G20 leaders in June to praise its decision to allow greater flexibility in the yuan’s exchange rate.

Ahead of a China-EU summit on 6 October, Wen urged the bloc to recognise China as a market economy, making it less vulnerable to anti-dumping charges under WTO rules. In exchange, China offered to boost copyright protection and widen bilateral trade.

“China commits to improving the investment environment, to intensify copyright protection, widen bilateral trade and upgrade technology cooperation,” he said in his speech in Greece’s parliament through an interpreter.

But despite its growth, China remains an emerging economy, Wen said. “The basic reality of China, such as a huge population, a weak economic base, and unbalanced growth has not radically changed,” Wen told parliament.

“Per capita GDP is just one eighth of Greece’s and the percentage of population below the poverty line is three times that of Greece. China continues to be an emerging country.”

Wen and his Greek counterpart George Papandreou said in a joint statement the world’s nations need to coordinate economic policies for global recovery to find a sure footing. “Global economic recovery is a journey with many turns and a full exit from it requires joint efforts,” Wen said yesterday. He made no comments on the yuan. On Saturday he said he was willing to work with the EU to confront the financial crisis and reform the international financial system.

He said he was confident Greece was on track to exit a debt crisis that shook the euro and said China wanted to boost cooperation with Greece, which faces its worst recession in decades.

“Greece is China’s best friend in the EU,” Wen said at a meeting with Greek opposition leader Antonis Samaras. Bilateral trade volume should double to $8 billion euros a year in 2015 with Greek traditional exports, such as olive oil, increasing.

“A few months ago, [we] signed an agreement to purchase 290 tonnes of Greek olive oil,” Wen said. “Last night, for the first time in my life, I dipped a bite of bread in olive oil. It tasted very good.”

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China offers to buy Greek debt

Prime minister Wen Jiabao says his country will support Greece and rest of euro zone to overcome financial crisis. Last Modified: 03 Oct 2010 16:23 GMT http://www.youtube.com/v/ZN7DFPVz0qw

Gerald Tan reports on the significance of China’s proposal to buyout Greece’s debt China has offered to buy Greek government bonds, in a show of support for the country whose debt burden pushed the euro zone into a crisis. Wen Jiabao, the Chinese prime minister, made the offer on Saturday at the start of a two-day visit to Greece, his first stop in a European tour. During talks with George Papandreou, the Greek prime minister, Wen said China would double its trade ties with Greece over the next five years, underscoring Beijing’s use of economic strength to win friends. “China will undertake a great effort to support euro zone countries and Greece to overcome the crisis,” Wen said. In addition to seeing economic opportunities in Greece, China’s support of a struggling European country may also help deflect international criticism of its trade policies and its refusal to let its yuan currency appreciate sharply. ‘Full market status’ Wen said during the visit that China will address European concerns over its investment rules and copyright violations, but wants the EU to relax remaining trade barriers with Beijing in return. Speaking at Greece’s parliament, he urged the EU to recognise China’s “full market economy status” and relax restrictions on high-tech exports. “I have repeatedly said that China supports a strong euro and will not reduce the number of European bond holdings from its foreign exchange reserves,” he said. Wen sought to ease European concern that overseas companies operating in China face licensing rule restraints that give local competitors an unfair advantage. He said China would “strengthen dialogue” with the EU and was committed to continue “improving investment, confronting issues of intellectual copyright protection, expanding bilateral commerce and upgrading cooperation in technology.” Wen did not specify how much Greek debt China would be willing to buy or which Chinese entities would buy the bonds. Chinese state entities have been generally conservative about investing in foreign financial markets and the Chinese government faces domestic political criticism over losses incurred by these entities during the global financial crisis. China has a lot to gain from getting a foothold into Europe, Vagelis Agapitos, an economist in Athens specialising in investment, said. “They [China] get a bargain in terms of buying into strategic industries, such as the port authorities, the railways and the logistic centre, which is important for the export of Chinese goods,” Agapitos told Al Jazeera. High borrowing cost A senior Greek government official said Wen made clear his offer concerned buying bonds only when the country returned to markets. Greece, which is currently funded through a 110 billion euro ($150 billion) EU/IMF bailout, is only issuing short-term treasury bills for the time being. Since the true scale of its debt burden emerged late last year, investors have shunned its bonds. The yield they demand to hold 10-year Greek debt has shot up to 10 per cent, compared with just 2.3 per cent for similar bonds from the euro zone’s biggest economy Germany, making it too expensive for Greece to seek long-term funding in international markets. It has said it wants to return to markets some time next year to sell longer-term debt. “There is domestic pressure [in Greece] not to sell itself cheaply, but there is also quite significant international pressure regarding the total debt, which is at 120 per cent of the GDP, and rising,” Agapitos said. “This needs to go down in order to avoid debt restructuring which would be disastrous, not only for Greece but also for the European Union as a whole,” he said. China, at loggerheads with the US over the yuan and likely to face similar complaints during this European tour, emphasised its willingness to co-operate with the 27-nation EU on financial issues. “China is prepared, hand in hand with the EU, as passengers in the same boat, to strengthen co-operation … to confront the financial crisis,” Wen said. “I believe that we can undertake a genuine effort to promote the reform of the international financial system and strengthen its supervision,” he said.

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