October 7, 2024

Economix Blog: Simon Johnson: Introducing the Latin Euro

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Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a director of Salute Capital Management Ltd. Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and former chief economist at the International Monetary Fund.

The verdict is now in. Traditional German values lost and the Latin perspective won. Germany fought hard over many years to include “no bailout” clauses in the Maastricht Treaty (the founding document of the euro currency area) and to limit the rights of the European Central Bank to lend directly to national governments.

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But last week, the bank’s governing council – over German objections – authorized the purchase of unlimited quantities of short-term national debts and effectively erased any traditional Germanic restrictions on its operations.

The finding this week by the German Constitutional Court that intra-European financial rescue funds are consistent with German law is just icing on this cake, as far as those who support bailouts are concerned.

With this critical defeat at the E.C.B., Germany is forced to concede two points. First, without the possibility of large-scale central-bank purchases of government debt for countries such as Spain and Italy, the euro area was set to collapse.

And second, that “one nation, one vote” really does rule at the E.C.B.; Germany has around one-quarter of the population of the euro area (81 million of a total of around 333 million), but only 1 vote of 17 on the bank’s governing council – and apparently no veto.

The balance of power and decision-making has shifted toward the troubled periphery of Europe. The “soft money” wing of the euro area is in the ascendancy.

This is not the end of the crisis but rather the next stage. The fact that the European Central Bank is willing to purchase unlimited debt from highly indebted nations should not make anyone jump for joy. The previous rule forbidding this was in place for good reason; the German government did not want investors to feel they could lend freely to any euro-area nation and then be bailed out by Germany.

Now investors know they can be bailed out by Germans, both directly through fiscal transfers and through credit provided by the European Central Bank. How does that affect the incentives of borrowers to be careful?

Prime Minister Mariano Rajoy of Spain has now opened the next front in the intra-European credit struggle. Despite the announcement of E.C.B. support, Mr. Rajoy remains elusive regarding whether he would seek the money.

His main concern is that the E.C.B. is insisting that the International Monetary Fund, along with the European Union commission and perhaps the central bank itself, negotiate an austerity program with any nation that needs funds. Such an austerity program is the “conditionality” that the E.C.B. had to assert would exist in order to justify the large bailouts they are promising.

So the battleground moves from whether the European Central Bank can bail out nations to whether austerity programs should be required for bailouts. The peripheral countries will fight this issue tooth and nail, and they will win.

Unemployment in Spain is now around 24.6 percent; in Greece it is 24.4 percent (with unemployment for those 14 to 24 at 55 percent). Both Portugal and Ireland have made progress with their austerity programs, but they are not growing, and their debts remain very large (gross general government debt is projected by the I.M.F.’s Fiscal Monitor to be 115 percent of gross domestic product next year in Portugal and 118 percent of G.D.P. in Ireland).

The current Italian government is well regarded, but large political battles loom, and it is also burdened with big debts (to reach 124 percent of G.D.P. in 2013).

At the same time, European countries outside the euro – including Britain, Sweden, Poland and Norway – are all seen as faring much better.

The Germans will be increasingly drawn toward one plausible conclusion: perhaps the euro area is simply the wrong system. If tough austerity programs do not wrest nations free from high unemployment and overindebtedness, then how are they to get back on the path to growth?

If a one-time devaluation could help release nations from their troubles rather more quickly, perhaps Germany should instead acknowledge – or insist – that the single currency is a failed exchange-rate regime.

The European Central Bank is now fighting for its survival as an organization. Its president, Mario Draghi, and his colleagues have stretched the rule book in order to open the money spigots to purchase troubled nations’ debts. The leaders of troubled nations will fight hard to get all they can with as few promises in return as possible. Elected officials must do this, or they will lose elections.

Europe has strong institutions, including good property rights and vibrant democracy. An independent central bank was long seen as an important manifestation of such institutions. But powerful interests have shifted toward wanting easy credit above all else. And the more the E.C.B. provides such credit, the more powerful those voices on the periphery will become.

We’ve seen such a dynamic operate time and again around the world. When strong regional governments are fighting for resources against national governments, there is a tendency for regions to accumulate large debts, then demand new bailouts at the national level. These battles often end in runaway inflation, messy defaults or both (think Argentina many times or Russia in the 1990s).

The European Central Bank has handed the euro zone’s peripheral governments a great victory at the expense of those who hoped to keep the euro area a solvent, “hard currency” zone through disciplined public finance.

It may be difficult to imagine that wealthy European nations could follow the tragic path to inflation and defaults seen for so long in Latin America. Yet with each “step forward” in this euro crisis, Europe moves further along that same route.

Article source: http://economix.blogs.nytimes.com/2012/09/13/introducing-the-latin-euro/?partner=rss&emc=rss

DealBook: Société Générale Profit Falls 31% in Third Quarter

The bank Société Générale said it would increase its reserves.Jacques Brinon/Associated PressThe bank Société Générale said it would increase its reserves.

PARIS — Société Générale said on Tuesday that its third-quarter net profit fell by nearly a third, weighed down by the cost of writing down its exposure to Greece.

The French bank said profit in the three months ended Sept. 30 fell 31 percent, to 622 million euros ($856 million), from the period a year earlier. Revenue rose 4 percent, to 6.5 billion euros, bolstered by a gain booked on a decline in the value of the bank’s own debt; excluding that one-time gain, revenue fell 10.6 percent.

The bank, based in Paris, said it was marking down 333 million euros of its Greek sovereign debt holdings on a pretax basis, equivalent to a 60 percent write-down, bringing its treatment of the holdings closer into line with its global peers.

Société Générale also said it had reduced its sovereign risk exposure to Greece, Italy, Ireland, Portugal and Spain to 3.4 billion euros by the end of October.

Financial institutions across Europe are recognizing losses on their holdings of Greek bonds as it becomes obvious that the country will never pay off its debts in full. On Tuesday, Munich Re, a German insurance group, said it had written down the value of its Greek bonds by 933 million euros this year.

Munich Re’s loss on Greek debt coincided with insurance losses related to the March earthquake and tsunami in Japan and Hurricane Irene in the United States, cutting its profit for the third quarter 62 percent, to 290 million euros.

BNP Paribas, the largest French bank, announced last week that it was marking down its Greek exposure by 60 percent and reducing its holdings of European sovereign debt, a move that cut its third-quarter profit 72 percent.

Jon Peace, an analyst with Nomura International in London, noted in a report that most of Société Générale’s reported net profit resulted from the 542 million euros the bank booked on its own debt. Considering that large one-time gain and the bank’s need to reduce leverage, he said, “we suspect the market will retain some caution.”

Société Générale’s shares rose 8.8 percent on Tuesday morning in Paris. For the year, the stock is down 53 percent.

Revenue from its core corporate and investment banking activities dropped almost 37 percent, to 1.2 billion euros, the result of “a challenging environment in the debt markets, with very weak activity in the primary market especially in Europe, and the effects of the European sovereign debt crisis on secondary markets.”

Frederic Oudéa, Société Générale’s chief executive, said in the statement that the third-quarter results “demonstrated the group’s resilience: the profit-generating capacity of the core businesses is robust.”

He also said there would be “a significant decline” in bonus pay this year.

Because of the regulatory requirement that banks strengthen their capital buffers, the bank said it would not pay a dividend for 2011. The third-quarter profit and the retaining of the dividend provision helped the bank to increase its core Tier 1 ratio to 9.5 percent on Sept. 30, from 8.5 percent on Dec. 31, 2010. That leaves it with the need to raise another 2.1 billion euros of capital, a sum the bank said it would cover through its own resources by the end of June 2012.

All the major French banks have said they hope to raise their capital ratios by trimming their balance sheets, rather than by raising additional equity.

Jack Ewing contributed reporting from Frankfurt.

Article source: http://feeds.nytimes.com/click.phdo?i=c22a4e0b249e3908631626f80a79b581