currency union

European Central Bank Chief Suggests Broader Rescue Is Possible

December 2, 2011 by NewsMaker Leave a Comment

In the run-up to a meeting of European leaders late next week, Mr. Draghi’s remarks seemed to be part of a larger effort by the bank and the region’s biggest economic powers — Germany and France — to lay the foundation for a broader rescue without seeming to compromise their principles.

Later in the day Thursday, the French president, Nicolas Sarkozy — acknowledging the region’s debt crisis — announced that he and the German chancellor, Angela Merkel, would meet in Paris on Monday “to make French-German propositions to guarantee the future of Europe.”

Last weekend, Germany and France began floating a plan to hold member nations of the euro currency union more financially accountable to their fellow members by giving European Union officials the power to vet and approve their national budgets. Euro zone agreement to such a proposal is seen as a possible precondition to increased financing by the central bank, to which Germany and France are the biggest contributors.

Mr. Draghi, in the manner of central bankers, made no explicit promises on Thursday. And the quid pro quo he offered governments was indirect. But his remarks illuminated how the bank might answer increasingly desperate calls for the bank to escalate its intervention in bond markets without violating its own mandate or alienating Germany, where opposition to a central bank bailout of Greece or Italy continues to run deep.

Speaking to the European Parliament in Brussels, Mr. Draghi stopped well short of offering a European version of the sort of large securities purchases that the United States Federal Reserve has used to try stimulating the American economy.

But he seemed to be saying that the bank would use its virtually unlimited resources to keep financial markets at bay, if government leaders in the euro region agreed to do their part by addressing the structural flaws that had allowed the debt problems of Greece to mutate into a threat to the global economy.

“What I believe our economic and monetary union needs is a new fiscal compact,” Mr. Draghi said. “It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union.”

After government leaders take steps to improve the way the euro area is managed, “other elements might follow,” Mr. Draghi said. European leaders will hold a summit meeting on Dec. 9, which is now seen as the latest deadline — there have been many during the nearly two-year debt struggle — for stemming the crisis.

Europe appeared to have bought a bit more time on Wednesday, when the Federal Reserve, the central bank and four other national central banks agreed to free up more dollar lending to European banks. But the stock market rally that followed that move did not carry over to Thursday — although successful government bond auctions in Spain and France did indicate at least a temporary calm in the debt storm.

By insisting that greater action would depend on rules to enforce spending discipline among euro members, Mr. Draghi might at least partly address German concerns that greater central bank action would reward countries that have mismanaged their finances and violate a prohibition against financing governments.

“Mr. Draghi appeared to be holding up the possibility of a greater degree of E.C.B. intervention if euro area governments were to commit, at next week’s key E.U. summit, to a tougher set of fiscal rules,” analysts at Barclays Capital said in a research note.

After insisting for weeks that the central bank is not authorized, under the European Union treaty, to bail out national governments, Mr. Draghi on Thursday hinted at how the treaty mandate might nonetheless let the central bank to do just that. He noted that the mandate required it to ensure price stability “in either direction.”

David Jolly contributed reporting from Paris.

Article source: http://feeds.nytimes.com/click.phdo?i=0a14c59de1c2ae35c0574c5564ba2d26

Filed Under: Business News Tagged With: angela merkel, currency union, precondition

Pressure Mounts for Urgent Action to Avert a Euro Zone Split

November 28, 2011 by NewsMaker Leave a Comment

The Organization for Economic Cooperation and Development said Monday that the euro crisis remained “a key risk to the world economy.” The research group, which is based in Paris, sharply cut its forecasts for wealthy Western countries and cautioned that growth in Europe could come to a standstill.

The warning came just hours after Moody’s Investors Service issued its own bleak report on Europe’s sovereign debt crisis. Moody’s, a leading credit rating agency, warned that the problems could lead multiple countries to default on their debts or exit the euro, which would threaten the credit standing of all 17 countries in the currency union.

Despite the gloomy predictions, stock indexes rose sharply in Europe and Asia, and were surging in Wall Street trading, and the euro strengthened, on hopes that European leaders were working on a new approach to resolve the crisis.

Finance ministers from the euro zone were to meet Tuesday in Brussels to try to agree on how to increase the firepower of their bailout fund, and also hope to sign off on an €8 billion, or $10.7 billion, loan installment to prevent Greece from defaulting. A proposal for a Europe-wide solution to the crisis is expected before a summit meeting of European Union leaders on Dec. 9.

Concerns about the European crisis hung over a meeting Monday at the White House between President Barack Obama and three European leaders: José Manuel Barroso, the president of the European Commission; Catherine Ashton, the European foreign policy chief; and Herman Van Rompuy, the president of the European Council.

Those concerns also surfaced during a White House news briefing, when a questioner asked the press secretary, Jay Carney, whether the White House shared the view that “the euro is in a particularly perilous state, perhaps poised to collapse within days.”

Without going that far, Mr. Carney replied that “our position is and has been that it’s critical for Europe to move with force and decisiveness now, particularly with new governments coming into place in Italy, Greece and Spain.”

He added: “We continue to believe that this is a European issue, that Europe has the resources and capacity to deal with it and that they need to act decisively and conclusively to resolve this problem.”

In Brussels, European officials rejected suggestions that the euro was days away from breaking up, pointing out that countries have completed most of their bond issuance for this year, though they know the respite will only be a matter of weeks.

Belgium had to pay higher interest rates to borrow money in the markets on Monday, illustrating how the country’s failure to form a government has increased concerns about its ability to tackle its debts. The yield on 10-year bonds was 5.66 percent as opposed to 4.37 percent last month.

Concern also mounted regarding Italy, where borrowing rates skyrocketed at a bond auction Monday for the second consecutive business day. The interest rate Italy had to pay to get investors to part with their cash for 12-year issues soared to 7.20 percent, a full 2.7 percentage points higher than the previous similar auction.

There was alarm in several capitals Monday over French-German plans to create strict new budget rules for countries that use the common currency — something seen in Berlin as a precondition of further steps to save the euro zone.

On Sunday, France, Germany and Italy signaled they were ready to agree on new rules to enforce budget discipline in the euro zone, and to encourage more coordination of economic and fiscal policy.

On Monday the German Finance Ministry published comments from the finance minister, Wolfgang Schäuble, suggesting that this could be done by amending a protocol of the E.U. treaty, though officials said this would still need approval by all 27 E.U. members.

Article source: http://www.nytimes.com/2011/11/29/business/global/moodys-warns-of-escalating-dangers-from-europes-debt-crisis.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: bleak report, currency union, world economy

New Reports Warn of Escalating Dangers From Europe’s Debt Crisis

November 28, 2011 by NewsMaker Leave a Comment

The Organization for Economic Cooperation and Development said the euro crisis remained “a key risk to the world economy.” The Paris-based research group sharply cut its forecasts for wealthy Western countries and cautioned that growth in Europe could come to a standstill.

Europe’s politicians have so far moved too slowly to prevent the crisis from spreading, the organization said in a report . It warned that the problems that started in Greece almost two years ago would start to infect even rich European countries thought to have relatively solid public finances if leaders dallied, a development that would “massively escalate economic disruption.”

“We are concerned that policy-makers fail to see the urgency of taking decisive action to tackle the real and growing risks to the global economy,” the O.E.C.D.’s chief economist Pier Carlo Padoan said.

The warning came just hours after Moody’s Investors Service issued its own bleak report on Europe’s rapidly escalating sovereign debt crisis.

The credit agency warning that the problems may lead multiple countries to default on their debts or exit the euro, which would threaten the credit standing of all 17 countries in the currency union.

It also said that while European politicians have expressed their commitment to holding the euro together and preventing defaults, their actions to address the crisis only seem to be taking place “after a series of shocks” force their hand. As a result, more countries may be shut out of borrowing in financial markets “for a sustained period,” Moody’s said, raising the specter of additional public bailouts on top of the multi-billion euro lifelines currently supporting Greece, Ireland and Portugal.

“The probability of multiple defaults by euro-area countries is no longer negligible,” Moody’s said. “A series of defaults would also increase the likelihood of one or more members not simply defaulting, but also leaving the euro area.”

Despite the gloomy predictions, stocks rose sharply in Europe and Asia for the first time in more than a week, and the euro strengthened, on hopes that European leaders were working on a new approach to resolve the crisis.

On Sunday, France, Germany and Italy signaled they were ready to agree on new rules to enforce budget discipline among the 17 nations that use the euro, and encourage more coordination of economic and fiscal policy.

Those efforts have so far been overshadowed by the failure of those countries to follow through on promises made back in July to bolster mechanisms to fight the euro crisis.

In particular, authorities have been slow to implement an expansion of the bailout fund, known as the European Financial Stability Facility, that was meant to raise money by issuing bonds backed by the stronger European countries and loan it to shakier countries facing high interest rates on their debt.

France last week bowed to pressure from Germany against the issuance of a common bond that would be backed by euro-zone countries, something investors said could help calm the crisis during the long time that it will take to expand the E.F.S.F.

Germany has also resisted calls to allow the European Central Bank to act as a lender of last resort to put out financial fires during the transition to a more federalist structure in the euro-zone.

The O.E.C.D. called on politicians to get the expanded bailout fund running as fast as possible, and said the E.C.B. must be allowed to step in more than it has to stem the crisis.

For now, the organization said it expects Europe’s leaders to do the right thing, and take sufficient action to avoid the type of defaults by European countries foreseen by Moody’s, as well as ward off both a sharp pullback in lending by spooked banks and the possibility of a wave of bank failures.

The Moody’s report came as anxiety intensified over Italy, whose borrowing costs have shot back above 7 percent in recent days despite promises by Mario Monti, the new prime minister, to enact a new austerity plan designed to reduce a mountain of debt.

Article source: http://feeds.nytimes.com/click.phdo?i=a841359a9c3c80849e30d7c9d3a272a9

Filed Under: Business News Tagged With: currency union, global economy, standstill

Debt Crisis in Europe Fuels Debate Over Bonds

August 15, 2011 by NewsMaker Leave a Comment

President Nicolas Sarkozy of France and Chancellor Angela Merkel of Germany are scheduled to meet in Paris on Tuesday but have vowed to avoid the issue of euro bonds altogether. Nonetheless, a number of analysts say that eventually they may have no choice if they want to keep Europe’s currency union from falling apart.

The euro bond concept is gaining traction among economists and other outside experts like George Soros, the billionaire investor, as a way of preventing borrowing costs for Italy and Spain from rising so much that the countries become insolvent, an event that could destroy the common currency.

Debt issued and backed by all 17 members of the euro zone, euro bond proponents say, would be regarded as ultrasafe by investors and could rival the market for United States Treasury securities.

The weaker euro members would benefit from the good standing of countries like Germany or Finland and pay lower interest rates to borrow than if left to face investors on their own.

“It may well be in order to calm markets right now,” said Jakob von Weizsäcker, an economist for the German state of Thuringia who has proposed a way to structure euro bonds so that countries would be encouraged to reduce their debt.

Data released Monday by the European Central Bank underlined how costly it would be to keep Italian and Spanish borrowing costs under control, and added urgency to the euro bond debate. Bond yields on Italian and Spanish debt, which recently rose above 6 percent, have fallen sharply since the central bank said it would start buying the bonds. The yield on Spanish 10-year bonds fell to 4.942 percent Monday, the lowest level in months. Italy’s benchmark yield was just below 5 percent.

But the central bank disclosed that it had spent 22 billion euros($31.8 billion) intervening in bond markets just last week to hold down Spanish and Italian bond yields. That compared with 74 billion euros the bank had spent in the previous 15 months, when it focused on the smaller markets for Greek, Portuguese and Irish bonds.

Euro bonds are a deeply controversial idea among both economists and ordinary Europeans. Critics said they would not solve the financial crisis and might create unbearable political tension instead. Voters in stronger countries would balk at assuming the obligations of less prudent members. Some critics argued that euro bonds would unfairly raise borrowing costs for countries like Germany, and, rather than protecting the euro, could lead to the breakup of the currency union.

“Euro bonds could trigger very strong anti-European movements,” said Clemens Fuest, a professor at Oxford. “It would be very hard to sell in Germany.”

The euro bonds debate reflects what is perhaps the central existential question facing Europeans: how much more central government and integration are they willing to accept to save the euro?

In Germany, the answer so far is that euro bonds go too far toward a so-called transfer union where the rich and solvent subsidize the poor. Asked about the issue, Mrs. Merkel’s office said she endorsed a statement by the finance minister, Wolfgang Schäuble, who told the newsmagazine Der Spiegel that he ruled out euro bonds as long as countries pursued their own fiscal policies.

Different interest rates are needed to provide “incentives and sanctions, in order to enforce solid fiscal policy,” Mr. Schäuble told Der Spiegel. “Without such solidity there is no foundation for a common currency.”

Steffen Seibert, a German government spokesman, said Monday that euro bonds were not on the agenda for the meeting between Mr. Sarkozy and Mrs. Merkel. “The German government has said on numerous occasions that it does not believe euro bonds make sense, and that’s why they will not play any role at tomorrow’s meeting,” Mr. Seibert said, according to Reuters.

Article source: http://feeds.nytimes.com/click.phdo?i=1918336a41df6493aad12b320f288bfb

Filed Under: Business News Tagged With: billionaire, currency union, thuringia

Italy Moves to Rein In Short-Selling Amid Market Jitters

July 11, 2011 by NewsMaker Leave a Comment

The step came as European Union officials met in Brussels to wrestle with threats to the currency union, even as wider discussions stalled over a second bailout for Greece.

Amid the continued uncertainty, the euro declined more than 1 percent against the dollar, to $1.4058, and the Euro Stoxx 50 index of euro zone blue chips was down around 2.4 percent in afternoon trading. Trading in Standard Poor’s 500 index futures suggested Wall Street stocks would decline at the opening bell.

Germany sought to soothe the latest jitters ahead of the talks in Brussels.

Angela Merkel, the German chancellor, said she spoke Sunday with Prime Minister Silvio Berlusconi about the Italian situation, The Associated Press reported from Berlin. Italy needs to send a “very important signal” by approving an austerity budget, Mrs. Merkel said, and she has “firm confidence” that the Italian government will do so. Mrs. Merkel also called on the European ministers to sort out the Greek aid “in very, very short order,” the AP reported.

Consob, the Italian market watchdog, took its step on short-selling after Milan banking shares fell heavily last week. Investors were unnerved in part by signs of a growing divide between Mr. Berlusconi and the finance minister, Giulio Tremonti, who has been praised for his handling of the economy during the financial crisis and for maintaining control of the budget deficit.

In a statement, Consob said the measures were similar to those already in force in Germany. Under the new rules, short sellers must show their hands when they have a net short position of 0.2 percent holding of a company’s capital. They also must notify the market each time they obtain 0.1 percent more.

In a short sale, an investor sells a borrowed security in the hope of repurchasing it later at a lower price, pocketing the difference as profit.

The FTSE Italia All-Share index has fallen about 7 percent this year. It was down more than 3 percent in afternoon trading.

The trading curbs were enacted as top European Union officials met in Brussels ahead of an afternoon meeting of finance ministers from the euro area, which is expected to focus on how to resolve Greece’s troubles.

A spokesman for Herman Van Rompuy, president of the European Council, denied that the morning meeting would cover the state of Italy’s finances, which many investors consider increasingly precarious. But another official, who requested anonymity because he was not authorized to speak publicly, said Italy would probably be on the agenda.

For Italy, the cost of debt financing rose last week, though it is still well below the levels faced by Greece. The spread between the yield on the Italian 10-year bond and the German equivalent widened on Friday to 2.36 percentage points, the most since the introduction of the euro.

Italy’s cost of borrowing for 10 years is now about 5.27 percent.

The euro zone has been shaken by the fiscal troubles of Greece, Portugal and Ireland, though their economies are relatively small. The Italian economy is more than twice the size of the combined economies of those three countries. If investors were to drive Italy’s borrowing costs to unsustainable levels, it could imperil the entire European monetary union.

Even without Italy, European officials have a big task in the coming days. They have reached an impasse of sorts on whether to include the private sector in a second Greek bailout, which is considered essential to controlling the crisis that has so far been limited to the smaller economies on the Continent.

Some officials now believe that any bailout plan involving a substantial but voluntary contribution from private investors in Greek debt would be declared a selective default by the bond rating agencies Moody’s, Standard Poor’s and Fitch. The officials’ objectives of achieving a private sector contribution that is voluntary and substantial — but which is not judged a selective default — may not be possible.

If voluntary steps would cause such an event, these officials say, then more radical options may as well be considered, including requiring banks and other private investors to take part.

Article source: http://feeds.nytimes.com/click.phdo?i=dd06b49b7471bf4b2e73638b8ee1eeee

Filed Under: Business News Tagged With: currency union, index futures, short position

Economix: Why France Wants to Run the I.M.F.

June 2, 2011 by NewsMaker Leave a Comment

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Andrew Harrer/Bloomberg News

Just a few years ago, euro-zone countries were at the forefront of those saying that the International Monetary Fund had lost its relevance and should be downsized. French authorities regarded the I.M.F. as so marginal that President Nicolas Sarkozy was happy to put forward the name of a potential rival, Dominique Strauss-Kahn, as a candidate for its managing director, in fall 2007.

Today the French government is working overtime to make sure that a Sarkozy loyalist, the leader of his economic team — Finance Minister Christine Lagarde — becomes the next managing director. Why do France and other euro-zone countries now care so much about who runs the I.M.F.?

The euro currency union has a serious problem, to be sure, with the likes of Greece, Ireland and Portugal, but it is beyond bizarre that these countries are borrowing from the I.M.F., which typically lends hard currency to countries that have balance-of-payments crises — they have been importing more than they were exporting, while the private-sector capital inflows (typically loans of some kind) that financed this current account deficit have dried up.

Greece has a current account deficit, but its money, the euro, is one of the world’s hardest currencies — a reserve currency in which central banks and private business keep their rainy-day funds (as are dollars, yen, Swiss francs and, perhaps, British pounds). The euro zone as a whole does not have a current account deficit.

I vividly recall discussions with euro-zone authorities in 2007 — when I was chief economist at the I.M.F. — in which they argued that current-account imbalances within the euro zone had no meaning and were not the business of the I.M.F.

Their argument was that the I.M.F. was not concerned with payment imbalances between the various American states (all, of course, using the dollar), and it should likewise back away from discussing the fact that some euro-zone countries, like Germany and the Netherlands, had large surpluses in their current accounts while Greece, Spain and others had big deficits.

Those euro-zone treasury and central bank officials had a point. After all, if one deficit country got into trouble, it could be helped out by other members of the currency union. As the euro is a reserve currency — and a highly regarded one; for example, it remains strong relative to the dollar — the I.M.F. is now essentially lending euros to the euro zone through its various bailout programs.

Does this make sense?

No, unless you understand that the goal of these various bailouts is to ensure that German and French taxpayers do not realize the full extent of their losses or appreciate the ways in which their banks have been mismanaged.

Take the most generous interpretation of I.M.F. lending to Greece: that it is like the Troubled Asset Relief Program in the United States, in the sense that a great deal of money will be laid out but all or most of it will be repaid in nominal terms.

Such lending could just as easily be made by other euro-zone countries, from current resources or by borrowing in the markets. Germany, for example, has plenty of fiscal credibility and issues some of the lowest-risk sovereign debt available. But even if all the money lent to Greece in this fashion were repaid, this would look bad — to German voters (and to French voters, because France would have to lend, too).

Such loans are much more risky than commonly supposed. The I.M.F. does eventually get its money back nominally, but not always in real terms (adjusted for inflation) and not on a risk-adjusted basis (that is, the interest rate charged does not include proper compensation for the risks being taken). There is a very real possibility that some or all of the monies lent will not be paid back in the foreseeable future.

The I.M.F., which is, in this regard, essentially a credit union owned by 187 countries — with voting based on ownership shares that reflect relative economic size. The European Union owns about 30 percent of the I.M.F., so 70 percent of any money at risk belongs to other countries: about 17 percent to the United States, 7 percent to Japan, 35 percent to emerging-market nations and the rest to other countries.

The managing director of the I.M.F. is the impresario of any bailout and oversees the big decisions that must be negotiated with all significant stakeholders. This leaves enormous scope for discretion.

Ms. Lagarde, or any managing director, could directly influence the terms of I.M.F. involvement — and based on her negotiating position to date within the euro zone, we can presume she will lean toward more money, easier terms and, above, all no losses for the banks that made foolish loans.

Increasingly, it looks as though the euro-zone leadership, under French guidance, will go for the full-bailout option, in which all Greek debt is bought by the I.M.F., the European Central Bank and other euro-zone entities. This debt will be held to maturity — and any creditor who did not yet sell will be made whole (those who have already sold at a loss are out of luck).

This course of action will be expensive, in terms of nominal outlays and in real risk-adjusted terms, because whatever terms Greece gets must also be offered to Ireland and Portugal. The I.M.F. may need to raise more capital or, more likely, tap its credit lines from member governments. (To be clear, the full bailout is painful for the debtor countries; their fiscal adjustments will involve spending cuts, tax increases and asset sales.)

The Europeans greatly fear their own “Lehman moment,” in which any attempt to impose even moderate losses on creditors will cause chaos throughout the financial system. The French and Germans fought hard against increasing capital requirements under Basel III and the results of various European banking stress tests have been completely noncredible — particularly because they did not take into account serious sovereign-debt default scenarios.

The French want to sway decision-making at the I.M.F. in order to use money from the United States, Japan and poorer countries to conceal from their own electorate that the euro-zone structure has led all its members into fiscal jeopardy: some borrowed heavily; others let their banks lend irresponsibly and thus created a large contingent liability.

The best way to hide the true cost is to have other people’s taxpayers foot the bill, preferably with the least possible transparency. Thus, euro-zone politicians have a lot at stake, and look for Ms. Lagarde to run the I.M.F.

Article source: http://feeds.nytimes.com/click.phdo?i=5023fdfe63c29ccb371f8e3a3011e514

Filed Under: Economy News Tagged With: currency union, current account deficit, dominique strauss kahn

German Finance Minister Cites Risks in Greek Default

May 27, 2011 by NewsMaker Leave a Comment

But Mr. Schäuble’s comments left room for a less radical solution in which Greece might be given more time to pay its debts.

“There is no experience with what happens when a country inside a currency union becomes insolvent,” Mr. Schäuble said in an interview published Thursday in the German newspaper Handelsblatt.

European leaders have begun to discuss openly the possibility of extending the payback period for Greek debt, despite fierce opposition to that idea from the European Central Bank. Mr. Schäuble’s comments were interpreted by some as a sign that he had moved closer to the central bank’s view.

“We believe that today’s interview is key for markets in that it shows that politicians in charge of the matter in Germany, namely Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble, remain opposed to a rescheduling for the time being,” analysts at Barclays Capital wrote in a note.

But a Finance Ministry official, who was not authorized to speak publicly, said that Mr. Schäuble stood by comments he made days earlier, in which he appeared to entertain stretching Greece’s bond payments.

In an interview published Sunday in the German daily Bild, Mr. Schäuble said an extension of Greek debt payments would be possible only if it could be done without causing private investors to withdraw their money from the country.

Mr. Schäuble and other European leaders have grown impatient with the pace of Greek efforts to sell state assets, improve tax collection and make the economy more competitive. They are trying to maintain pressure on Greek leaders, while acknowledging that they may have to deal with the possibility that Greece cannot meet all its obligations.

In an interview published this week by Der Spiegel, the German magazine, Prime Minister Jean-Claude Juncker of Luxembourg, who oversees regular gatherings of euro zone finance and economic ministers, said that a so-called soft restructuring might be considered, but only after Greece had completed a tough overhaul.

“It would be the last step in a very long process,” Mr. Juncker said.

On Thursday, he warned that Greece might not meet requirements to receive the next installment of aid from the International Monetary Fund, Bloomberg News reported. His comments were interpreted as further pressure on Greece to act more boldly.

“I’m skeptical about Greece,” Otmar Issing, a former member of the European Central Bank’s executive board, said on Thursday, according to Bloomberg News. “Greece is not just illiquid, it’s insolvent.”

Peter Bofinger, an economist who advises the German government, said on Wednesday in Hamburg that Greece’s creditors would need to accept a 40 percent cut in the value of the country’s bonds, and swap them for bonds issued jointly by euro zone members.

One idea that has been gaining favor among economics specialists is a pact in which holders of Greek bonds would agree to be paid back more slowly to avoid greater losses if Greece defaulted. Such an agreement would be complicated but possible, legal specialists say.

The European Central Bank, which is the largest holder of Greek debt, has refused to consider such solutions.

Article source: http://www.nytimes.com/2011/05/27/business/global/27euro.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: barclays capital, currency union, german magazine

In Europe, Rifts Widen Over Greece

May 24, 2011 by NewsMaker Leave a Comment

Gloomy investors on Monday drove down Europe’s stock indexes by about 2 percent, while the euro fell nearly 1 percent against the dollar, touching a two-month low.

Meanwhile, yields rose on 10-year Spanish and Italian bonds, reflecting a market perception that the risks are rising that those two indebted nations might be following the downward spiral of Greece. Greek 10-year bonds reached a record 16.8 percent as investors demanded a high premium for holding them.

On Wall Street, major stock indexes were also down more than 1 percent, in part over the uncertainties in Europe.

The markets seem to reflect the growing discord within the 17-member euro zone currency union, barely a year after European governments came together with a 750 billion euro ($1 trillion) safety net for debtor-nation members. Tensions also remain over whether to restructure Greece’s debt and force bondholders to take losses.

It is clear that the bailout package and the austerity terms imposed on Greece have deepened its recession and added to its already substantial debt burden. The debate now is whether making more cuts and recharging a program to privatize many formerly government-run agencies and social services in Greece will be enough to persuade a reluctant Europe to lend the country another 60 billion euros.

“It looks like a real unraveling — everyone is taking their own position and as a result cooperation has become an impossibility,” said Paul De Grauwe, an economist in Brussels who advises the president of the European Commission, José Manuel Barroso.

The discord has become increasingly apparent since Greece’s financial decision makers were summoned to secret talks at a Luxembourg castle by their currency partners this month.

The Greeks probably knew that a tongue-lashing over the country’s stumbling financial overhaul effort was coming. What they probably did not expect was that beleaguered Spain and Italy, as opposed to economically robust Germany, would take the lead in upbraiding them.

The meeting, on May 6, showed that the disagreements in the euro zone were not just between richer northern countries like Germany and the less wealthy south.

Struggling countries like Spain and Italy fret that any Greek failure on spending cuts might cause investors to conclude that those two countries have no better growth prospects than Greece — even as their own austerity programs cause social and political unrest.

On Monday, the bond market seemed to fulfill Spain and Italy’s worst fears about being lumped in with Greece’s as a poor investment risk and the perception that the cuts meant to ease those countries’ debts will instead mire them deeper in recession.

Ten-year yields for Italian bonds edged up to 4.8 percent on Monday, from 4.7 percent last week. Rates for Spain’s comparable bonds rose to 5.5 percent, up from 5.2 percent. Euro zone unity has always been a challenge to maintain, given the member countries’ contrasting histories and cultures. That it should be crumbling barely a year after European governments agreed to a rescue package underscores the difficulty in translating grand policy ideals into workable achievements.

And that it is Spain and Italy now stressing the necessity of austerity — not Germany or the European Central Bank — is further evidence that bond market investors continue to be the most powerful voice in this debate, Mr. De Grauwe said.

Southern countries, he said, are afraid of contagion from Greece’s woes. “But history shows us that you cannot cut deficits in the midst of a recession.”

For Spain, devastating local election losses on Sunday by the governing Socialist Party created worries that Madrid’s plan to cut its budget deficit might founder. It had planned to reduce the deficit to 6 percent of gross domestic product this year in the face of a 20 percent unemployment rate.

Many Spaniards have now taken to the streets in protests organized through social media. (Spain’s deficit was 9.24 percent of gross domestic product in 2010.)

Article source: http://www.nytimes.com/2011/05/24/business/global/24iht-euro24.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: currency union, downward spiral, euro zone

Economic View: Euro vs. Invasion of the Zombie Banks

April 16, 2011 by NewsMaker Leave a Comment

In Ireland, there has been a “silent bank run” on financial institutions for much of the last year. In February, for instance, Irish private sector deposits dropped at an annual rate of 9.8 percent. That’s largely because some depositors doubt the commitment of the Irish government to the euro. They fear that they will wake up one morning to frozen bank accounts, followed by the conversion of their euro deposits into a lesser-valued new Irish currency. Pre-emptively, the depositors send their money outside Ireland, where it still represents safe euros or perhaps sterling, accessible by bank transfers and A.T.M. cards.

This flight of capital reflects a centuries-old economic principle known as Gresham’s Law, sometimes expressed casually as “bad money drives out good money.” In this context, if two assets — euros inside and outside Ireland — are not equal in value in the eyes of the marketplace, sooner or later the legally fixed price parity will fall apart.

If enough depositors fear frozen accounts, the banks will be emptied out, and they also will require additional government bailouts, on top of the bailouts for the bad real estate loans. The banks come to resemble empty shells, conduits for public aid but shrinking and unprofitable as businesses — and, to a large extent, that is already the case in Ireland. Portugal is moving in this same direction, toward being a land inhabited by zombie banks.

It’s the zombie banks that doom the current European bailout plans. On any single day, or even for a year or two, an economy can survive with zombie banks, but over time functional domestic banks are needed to allocate credit.

As it stands, European Union emergency facilities are marking time by lending more money to the fiscally troubled nations in the currency union. But these loans do not reverse the logic of Gresham’s Law. For instance on its longer-term notes, Portugal is already paying yields in the range of 8 to 10 percent, and yet the Portuguese economy is shrinking. The Portuguese are digging deeper into debt, and confidence in the banking system and the fortitude of the Portuguese government is dwindling.

At this late point there’s probably no way to escape the mess by cutting government spending in the troubled countries. This year Ireland has a budget deficit of more than 30 percent of G.D.P., whereas in Portugal it is 8.6 percent. Even the best economic reforms can take many years to pay off with concrete results, and with zombie banks a turnaround is even harder and perhaps impossible. Most important, immense government spending cuts are often unpopular and so investors wonder whether an ailing country’s political system will see it through. The confidence problem remains.

A second option is a giant write-down of current debts, combined with national bailouts to the creditor banks. For instance, taking this approach, the Merkel government in Germany might acknowledge the status quo isn’t working and speedily recapitalize the German banking system, while letting Ireland, Portugal and others off the hook for some of the money. It’s easy to see why this policy isn’t popular in Germany, and indeed, for years German politicians promised to their voters that such an outcome would never happen.

Another dramatic way out is for Ireland, Portugal or some other country to break from the euro and create a new and lesser-valued domestic currency, while also defaulting on some debts. Any such breakaway country would incur the wrath of the European Union and also might have trouble borrowing on international capital markets. There will be no easy exit path from the euro. Still, taking this approach, a resolution of some kind would be in place, no subsequent devaluation of bank deposits would be expected and the new lower-valued currency would improve growth. Also, the troubled countries already cannot borrow at workable interest rates.

There would be an associated problem, however: if any one euro zone country were to start exiting the euro, there would be bank runs on the other fiscally ailing countries. The richer European Union nations know this, and so they are toiling to keep everyone on board. But that conciliatory approach creates a new set of problems because any nation with an exit strategy suddenly has enormous leverage. Ireland or Portugal need only imply that without more aid it will be forced to leave the euro zone and bring down the proverbial house of cards. In both countries, aid agreements already are seen as a “work in progress,” and it’s not clear that the subsequent renegotiations have any end in sight, because an ailing country can always ask for a better deal the following year.

ALL of the ways forward look ugly but, sooner or later, some variation of at least one of them is likely. Unfortunately, they all share the property of lowering European bank values, whipsawing currencies, hurting business confidence and possibly ending the European Union as an effective institution for collective decisions. That’s all because the euro, in retrospect, appears to have been a misguided attempt to equalize the values for some very unequal assets, namely the bank deposits of strong countries and those of weak countries.

To track the risk of a new financial crisis, focus on whether the troubled euro zone economies are seeing bank runs and capital flight. Then comes a fundamental question about human nature, namely: Why do we so often postpone admitting that short-run patches simply aren’t going to work?

Tyler Cowen is a professor of economics at George Mason University.

Article source: http://www.nytimes.com/2011/04/17/business/17view.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: currency union, depositors, financial institutions