Showing posts with label Italy. Show all posts
Showing posts with label Italy. Show all posts
Tuesday 20 December 2011
Europe's gutless collapse
By Reuven Brenner
The US and European financial crises have this in common: too much credit was advanced at too low prices to households in the United States and to governments in Europe. In the US, the recipients did not have either the collateral or the prospect of revenues to pay back creditors. In Europe, the governments, with their present institutions, cannot create enough taxed wealth to pay back the debt with their current institutions, taxes and regulations.
In both cases, the recipients of the loans either lied through their teeth or deluded themselves (and delusions can be powerful when they serve one's interests). In the case of mortgage recipients in the US, few did any due diligence about their future ability to pay or about the mortgage-backed bonds.
In Europe, the move toward the European Community and the euro started with lies (or delusions of German rescues). Recall that the Italians called 1987 the year of il sorpasso, since suddenly 18% was added to their gross domestic product (GDP). The politicians claimed that this number reflected part of their undeclared, unmeasured incomes.
Why 18%? Because this was the number that allowed Italy to conform to the European Community requirement of debt/GDP ratios. The European bureaucrats were aware of much undeclared incomes in Greece too. Eventually they sued the Greek government for the false national statistics.
The result? To this day in both countries some 30% of incomes are undeclared in a variety of imaginative ways, often hidden by these countries' intricate customs, traditions and systems of patronage.
The national governments will not have an easy time changing such deeply rooted arrangements. Too many complex taxes, too many regulations, and too much corruption "on the top" resulted in ingrained perceptions that governments are wasting the money and that the courts are unreliable, rationalizing the culture of tax evasion. Why should hard-working people pay taxes when politicians and the rich get away with murder?
As it is in private life, start relationships with lies and they are unlikely to last or to end well. No trust, no finance; diminished trust, finance at a higher price. It is not rocket science.
But if all this was known, why were lenders willing to advance massive amounts of loans to these irresponsible, unaccountable entities?
Whereas in the US the case can be made that it took some time until it dawned on some that things were going awry, in Europe's case the issues surrounding Italy and Greece were well known. It was no secret that the continent was divided into "junk countries" and others where the tribe - the German one - could be called on for sacrifices and fulfilling duties, as was the case after the reunification.
Who made the mistakes that led to offering the loans to these profligate entities, aggravating mispricing of credit around the world and failing to correct the errors?
After all, the rationale for capital markets is simple: when all parties are held accountable, they correct mispricing faster than any other institutions that supply capital. There are only two other main entities that supply capital in every society: families and governments. The first is unlikely to correct mistaken allocation faster because of emotions. The second is unlikely to correct mistakes faster than arms-length financial intermediaries because a wide variety of political considerations get in the way.
So what went wrong in the presumably accountable financial institutions? Improper fiscal, regulatory and monetary policies. When combined with political considerations, however, none were considered "mistakes" by large segments of academics, central bankers, and politicians.
China illustrates in an extreme way the main difficulty with the finding solutions, but it is not dissimilar to what now confronts Europe too.
Most people agree that communism, as once practiced in the Soviet Union and China, was a colossal mistake. Tens of millions of people were killed, generations were made miserable, and talents and resources became severely mismatched. How do you correct for such mistakes? What is the path from totalitarian societies to more open ones backed by rule of law and equality?
There are no unique answers. There are no theories, no models, since the countries do not have either the legal precedents or the personnel to create, interpret and enforce them. Governments may emulate a successful country, but that too can take a generation or two.
China bet on a strategy of keeping the monopoly of the communist party, but allowing part of its population to integrate with the West. To achieve this integration, they pegged their currency to the US dollar, thus allowing dollar prices to guide the drastic restructuring. What was the alternative? Since accounting, balance sheets, prices, costs under communism were all fiction, the new government needed an anchor, and dollar prices served as such anchor.
Since wages in China were much lower than in the US, employment and exports expanded quickly. The country rapidly accumulated trillions of dollar assets. The Fed's low interest rate policy from 2004 and on distorted China's massive flow of trade to the US and its purchasing of Treasuries.
One could make the point that if the Chinese Communist Party opened up its domestic financial markets more rapidly, dispersing power and allowing entrepreneurship to thrive, the financing of the housing bubble could have been significantly mitigated, if not avoided, even with the pegged currency. Was the US able to use its negotiating powers at the time to force China to open its domestic markets more quickly? I believe so - though this option wasn't pursued.
The main point though of the above example is not to regret some foregone opportunity but to show that there are no models describing either how exactly countries should correct their political mistakes or how other countries should react while countries go through such transitions. There are no roadmaps and general theories for successful transformation: using negotiating power matters.
The European crisis
The financing of profligate, unaccountable governments, sanctioned by rating agencies and the Bank of International Settlement in Basel as being "riskless", brought us to the present situation. The solution for the eurozone required a drastic change in domestic policies cajoled by the European Union. After all, the EU knew all along about the extensive black and grey markets and the intricate patronage. Solutions were known too: simplified taxes, simplified regulations, more accountable governments.
Note that these solutions have very little to do with financial markets. They are a matter of political leadership. The political and financial institutions of China, Italy, Greece, and so forth shaped intricate institutions and habits and will not be altered because some economist or politician disapproves of it or devises some new technical models. Changing these is a matter of political leadership.
Unfortunately, such leadership is today nowhere in sight. If it does not emerge, bankruptcy, a distant second best, will bring about the changes. It is a distant second best because it could involve an extremely disorganized process, whose political outcome is unpredictable. What could then be done now while we wait for the Club Med countries to put their houses in order?
Since the European banks are at the center of the present crises, the best solution would be to emulate what happened in the US banking system in the 1990s. Namely, let them raise money by selling their loan book.
Banks would be much smaller. Ownership of non-investment grade loans would be much more dispersed. If the US banks could diminish their ownership of such loans from 80% in 1994 of their assets to 20% by 2009 (the balance distributed in a variety of collateralized loan obligations), there is no particular reason why Europe cannot achieve the same in much shorter time.
No need to implement a myriad of regulations. Disgorging debts from the zombie banks would also mitigate the much discussed "too large" or "too interconnected" to fail issue. Pension funds, insurance companies, and sovereign funds could offer the capital for such purchases.
But this takes guts, which are lacking in both Europe and the US. Yet again, I sound like Machiavelli waiting for his prince who never came.
Let's hope that he will emerge in 2012.
Reuven Brenner holds the Repap Chair at McGill University's Desautels Faculty of Management. The article draws on his books Labyrinths of Prosperity and Force of Finance.
Tuesday 15 November 2011
Germany has benefitted from the Euro and should protect it.
There is only one alternative to the euro's survival: catastrophe
Little Englanders – and blinkered Germans – need to wake up to the implications of a fractured eurozone
It is hard not to have the gravest of forebodings about the
European and British economies, and about the future of Europe itself.
Nobody would start from here – an ill-designed single currency
interacting with an insupportable burden of private debt created by
oversized, undercapitalised banks. And it's as much a problem in the US
and China as in Europe. There are only least bad ways forward: none
good. This is a crisis in contemporary capitalism as much as a crisis of
Europe's monetary regime and governance. It needs to be seen in those
terms.
But so saturated is British commentary in jingoistic Euro-scepticism that Europe's travails are portrayed as proof positive that it is European visionary delusions rather than contemporary capitalism that is at fault. Greece, and indeed Ireland and even Italy, are urged to get out of the euro, for the euro to be smashed and for the entire EU project to be abandoned. This is the route to prosperity and wellbeing – with no trace of self knowledge as British trade performance deteriorates even after a monumental devaluation while our economy is still years away from recovering to 2008 levels of peak output. That is Europe's fault, or so runs the line – not the fault of our dysfunctional economic structures and policies.
However, Britain's interest is unambiguous: it lies in the survival of the euro. There is too much easy talk about countries leaving. Last week, financial policy committee member Robert Jenkins spelled out the consequences for Britain and for Europe of Greece now quitting the euro. There would be seismic bank runs in Ireland, Portugal, Spain and even Italy as citizens and companies, fearing the same could happen to them, moved their cash out of their countries. Weaker banks, tottering from losses in Greece, would fold. The European Central Bank would be overwhelmed. The European economy would slump – and Britain with it.
Greece's fight is our own. But what is being asked of Greece's new interim prime minister, Lucas Papademos, is impossible. Unemployment is 18.4%. The schedule of its foreign loan repayments over the next five years beggars belief. On the other hand, Greek capitalism, a network of family oligarchs rigging Greek markets and leading a society in which tax evasion is morally and socially acceptable, is in acute need of reform. Europe could have been organised around floating exchange rates rather than a single currency, but the vast overhang of private debt alongside crocked banks demands similar medicine.
And while staying in the euro is in the interest of Greece – and Italy – it is in the rest of Europe's interest too. But there has to be a quid pro quo for all the pain that such severe austerity involves. Private and public debt needs to be radically lowered; and in a world of little growth there are only two routes. Either it has to be forgiven by their creditors, or there has to be inflation. If the eurozone can deliver neither, its future is in question.
In July and, again, in October, the EU signalled it understood what needed to be done and moved towards it – a combination of decisive debt forgiveness, the creation of a European Monetary Fund, substantially financed by Germany and which could bail out stricken banks and even governments, and the empowerment of the European Central Bank to go beyond supplying emergency cash on crisis terms. Instead, it could act as a lender of last resort everywhere in the eurozone.
The system could potentially be put in place fast; the right sentiments have been uttered – but after each summit Germany has consistently blocked making the money flow. It has said no to the European Central Bank operating as a lender of last resort across the eurozone; no to creating a genuine European Monetary Fund on the scale needed; no to the creation of single euro bonds. Ireland, Greece and Italy are all doing their part. Germany must now do its – or the euro will buckle.
Germany's phobias are well-known – inflation and then slump led to Hitler. What's more, the German constitutional court has ruled that the EU is a Staatenbund (a group of states). This means that Germany can only constitutionally make fiscal transfers to other members if each one is agreed by the German parliament. But phobias and constitutional courts cannot trump the agonising choice facing Germany and Europe.
Germany profits richly from the way the eurozone is organised. It is the only country in Europe whose share of world trade has risen over the past 10 years. But it enjoys the same exchange rate as much weaker exporters such as Greece or Spain – a huge boon. Even Britain, with our much vaunted floating exchange rate, has seen our share of world trade fall by a third over the same period.
Germany now has to accept its part of the bargain. The choice must be confronted. One option to secure the euro's future is via widespread debt forgiveness and fiscal transfers backed by Germany; the only other route out is inflation.
Here I make a modest proposal. Instead of delivering purposeless lectures from the sidelines about the need for action while he prepares to blame Europe for the ongoing British stagnation, for which he is primarily responsible, David Cameron should make the intervention of his life. He should travel to Germany and make a speech in German – however embarrassing – spelling out the choices. If Germany is unprepared to accept them, he should argue that the least bad option is not for Greece to leave the euro – but for Germany, whose economy is strong enough to take the shock, to do so.
He should say that while it was right for Britain not to join the single currency as it was previously constructed, if Germany were to act responsibly, Britain would peg sterling to a reformed euro and in the long run even consider joining the regime. Moreover, Britain would do this either way, he could argue – eventually joining a single currency in which Germany accepted its responsibilities or a single currency without Germany.
Such a speech – which, of course, will never be made – would create turmoil in Germany. It fears isolation in Europe even more than it fears inflation. It prizes the undervaluation of its exports priced in euro. It would force its leadership to recognise that there are other potential ways of organising our continent other than around German preoccupations – and perhaps trigger the change in German policy that is needed. It would change the rules of the game at a stroke, and show that Britain is a European force with which to be reckoned. But Cameron is trapped into Little England isolationism. And Little Englanders, along with moralistic and blinkered Germans, threaten to sink both the idea of Europe – and its economy.
But so saturated is British commentary in jingoistic Euro-scepticism that Europe's travails are portrayed as proof positive that it is European visionary delusions rather than contemporary capitalism that is at fault. Greece, and indeed Ireland and even Italy, are urged to get out of the euro, for the euro to be smashed and for the entire EU project to be abandoned. This is the route to prosperity and wellbeing – with no trace of self knowledge as British trade performance deteriorates even after a monumental devaluation while our economy is still years away from recovering to 2008 levels of peak output. That is Europe's fault, or so runs the line – not the fault of our dysfunctional economic structures and policies.
However, Britain's interest is unambiguous: it lies in the survival of the euro. There is too much easy talk about countries leaving. Last week, financial policy committee member Robert Jenkins spelled out the consequences for Britain and for Europe of Greece now quitting the euro. There would be seismic bank runs in Ireland, Portugal, Spain and even Italy as citizens and companies, fearing the same could happen to them, moved their cash out of their countries. Weaker banks, tottering from losses in Greece, would fold. The European Central Bank would be overwhelmed. The European economy would slump – and Britain with it.
Greece's fight is our own. But what is being asked of Greece's new interim prime minister, Lucas Papademos, is impossible. Unemployment is 18.4%. The schedule of its foreign loan repayments over the next five years beggars belief. On the other hand, Greek capitalism, a network of family oligarchs rigging Greek markets and leading a society in which tax evasion is morally and socially acceptable, is in acute need of reform. Europe could have been organised around floating exchange rates rather than a single currency, but the vast overhang of private debt alongside crocked banks demands similar medicine.
And while staying in the euro is in the interest of Greece – and Italy – it is in the rest of Europe's interest too. But there has to be a quid pro quo for all the pain that such severe austerity involves. Private and public debt needs to be radically lowered; and in a world of little growth there are only two routes. Either it has to be forgiven by their creditors, or there has to be inflation. If the eurozone can deliver neither, its future is in question.
In July and, again, in October, the EU signalled it understood what needed to be done and moved towards it – a combination of decisive debt forgiveness, the creation of a European Monetary Fund, substantially financed by Germany and which could bail out stricken banks and even governments, and the empowerment of the European Central Bank to go beyond supplying emergency cash on crisis terms. Instead, it could act as a lender of last resort everywhere in the eurozone.
The system could potentially be put in place fast; the right sentiments have been uttered – but after each summit Germany has consistently blocked making the money flow. It has said no to the European Central Bank operating as a lender of last resort across the eurozone; no to creating a genuine European Monetary Fund on the scale needed; no to the creation of single euro bonds. Ireland, Greece and Italy are all doing their part. Germany must now do its – or the euro will buckle.
Germany's phobias are well-known – inflation and then slump led to Hitler. What's more, the German constitutional court has ruled that the EU is a Staatenbund (a group of states). This means that Germany can only constitutionally make fiscal transfers to other members if each one is agreed by the German parliament. But phobias and constitutional courts cannot trump the agonising choice facing Germany and Europe.
Germany profits richly from the way the eurozone is organised. It is the only country in Europe whose share of world trade has risen over the past 10 years. But it enjoys the same exchange rate as much weaker exporters such as Greece or Spain – a huge boon. Even Britain, with our much vaunted floating exchange rate, has seen our share of world trade fall by a third over the same period.
Germany now has to accept its part of the bargain. The choice must be confronted. One option to secure the euro's future is via widespread debt forgiveness and fiscal transfers backed by Germany; the only other route out is inflation.
Here I make a modest proposal. Instead of delivering purposeless lectures from the sidelines about the need for action while he prepares to blame Europe for the ongoing British stagnation, for which he is primarily responsible, David Cameron should make the intervention of his life. He should travel to Germany and make a speech in German – however embarrassing – spelling out the choices. If Germany is unprepared to accept them, he should argue that the least bad option is not for Greece to leave the euro – but for Germany, whose economy is strong enough to take the shock, to do so.
He should say that while it was right for Britain not to join the single currency as it was previously constructed, if Germany were to act responsibly, Britain would peg sterling to a reformed euro and in the long run even consider joining the regime. Moreover, Britain would do this either way, he could argue – eventually joining a single currency in which Germany accepted its responsibilities or a single currency without Germany.
Such a speech – which, of course, will never be made – would create turmoil in Germany. It fears isolation in Europe even more than it fears inflation. It prizes the undervaluation of its exports priced in euro. It would force its leadership to recognise that there are other potential ways of organising our continent other than around German preoccupations – and perhaps trigger the change in German policy that is needed. It would change the rules of the game at a stroke, and show that Britain is a European force with which to be reckoned. But Cameron is trapped into Little England isolationism. And Little Englanders, along with moralistic and blinkered Germans, threaten to sink both the idea of Europe – and its economy.
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