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Friday, September 30, 2011

Some Friday afternoon polls...

Over at Open Europe, we admit to be poring over EU-related polls from the German-speaking world, like a German Commission offical over the Greek accounts.So here's some polling for a Friday afternoon.

A survey for Focus published today shows that 50% of Germans would be willing to exchange the euro and get the D-Mark back, while 48% preferred holding on to the euro. A year ago, 50% wanted to keep the euro, while 47% wanted a return to the D-mark.

Interestingly, 40% of the respondents stated that they were “sceptical” about Germany's EU membership - which seems like a surprisingly large share. 46% stated to have "personally" benefited from Germany’s EU membership, but, mirroring the "sceptic" share, a full 40% said that they had not personally benefited from Germany's membership.

Meanwhile, according to a survey conducted by the Austrian Gesellschaft für Europapolitik, only 37% of the Austrian people think Austria has benefited from the Single Currency, whereas 48% believe it hasn't been beneficial. While, in answer to the question: should the EU have a direct influence on national budgetary policy? 58% voted no, compared to 33% yes.

Additionally, 30% referred to a ‘United States of Europe’ as a ‘fitting model’ for the EU, while 50% disagreed.

A bit of a mixed bag then, but some clear signs of growing fears over the state of the eurozone in these core european electorates. Now the key question is, if and when this feeling will feed through to election results, we for one are waiting with bated breath.

How to lose support for EU free movement and alienate people

The European Commission just made it a lot more difficult to defend free movement in Europe. Free movement and open borders (two separate but related EU issues) are very difficult things to sell to the public, witness the Bombardier row (which had complicated causes, but partly flowed from competition rules designed to uphold free movement/the EU single market), the Danish restrictions on the Schengen agreement or the Lincolnshire strikes back in 2009.

In public opinion, free movement is usually bundled together with other complex issues such as immigration, the 'British jobs for British workers' debate, welfare and potential wage dumping. Economically, we would argue that free movement is on the whole beneficial, but politically, due to its society-changing potential, it's potentially explosive.

Therefore, free movement has to be treated with silk-gloves, with constant attention paid to national sensitivities. If Europe wants to keep it, national governments simply need to be given some discretion, within reason.

Clearly, this isn't something that the Commission understands. This week, the Commission threatened to take legal action against the UK's "right to reside" test on EU nationals, arguing that it violates EU law. Under UK rules, British citizens automatically qualify for benefits such as child benefit, child tax credit, state pension credit, jobseekers' allowance and unemployment support. But nationals from other countries have to pass a right to reside test before they can qualify for such benefits. The Commission argues that this practice indirectly discriminates against nationals of another member state, in turn breaching EU rules on social security co-ordination. The Commission insists that existing EU rules on who qualifies as a resident of a different member state are already strict enough to make sure that "only those persons who have actually moved their centre of interest to a member state (other than their own) are considered habitually resident there".

The Commission's statement was met with a barrage of criticism in the UK.

Employment Minister Chris Grayling said, "This is a very unwelcome development...I’m really surprised the European Commission has chosen to go into battle on this very sensitive issue, when there are clearly far more pressing problems to solve in Europe."

Work and Pensions Secretary Iain Duncan Smith wrote in the Telegraph:
"These new proposals pose a fundamental challenge to the UK's social contract. They could mean the British taxpayer paying out over £2 billion extra a year in benefits to people who have no connection to our country and who have never paid in a penny in tax. This threatens to break the vital link which should exist between taxpayers and their own Government."

"France, Germany and Denmark have all spoken out against the commission's insistence on issuing this week's provocative decision on benefit payments. This decision confirms the worry that the EU is pulling more areas of national competence into its fold. Yet these are decisions taken outside of national democratic processes by unelected and unaccountable institutions."
Given the recent statements from various prominent Labour party figures, apologising for "getting it wrong" on EU immigration, the Commission is likely to face more or less united UK opposition.

Even supporters of free movement will find it hard to see how the UK's "right to reside" tests are unreasonable. The Commission is now picking a fight with several EU countries, on the hugely sensitive issue of "welfare tourism" at a time when populist parties are on the rise across Europe.

Either the Commission backs down, or it risks facing a massive backlash.

As we've mentioned before, if the Commission wants to squash all public support for the EU, it's doing a pretty good job.

Forget about the crisis: The EU wants to put a man on the moon (well, at least a robot)

We'll resist the rather too obvious "EU officials are on another planet" jokes.

You might think that all available resources are going into saving the EU countries that stand on the verge of financial collapse. Well, there's always some cash left for vanity projects. Handelsblatt reported yesterday on a fairly unknown EU project aimed at getting to the moon by 2018.

Last year, the European Space Agency (ESA) awarded Astrium a contract worth €6.5 million, largely financed by Germany, to investigate the possibility of a landing at the Moon’s south pole.

To be fair, the ESA is not quite an EU agency, but gets 95.5% of its funding - which totals €4bn in 2011 - from EU member states (19.5% from the EU budget), and the rest from a handful other countries. The UK provides 6.6% of the ESA's overall funding, or €265.3 million.

The ESA quite clearly sees itself as representing "Europe" in this endeavour. This is ESA Director for "Human Spaceflight" Simonetta Di Pippo, who may well have watched the movie 2001: A Space Odyssey a few too many times:
“The Moon is the next natural goal on our common path to destinations further afield. Europe is actively and successfully present in these global projects, like ISS and exploration, which contribute to affirm our role as a modern, dynamic and innovation-driven continent.”
At least initially, it appears, we're looking at an unmanned mission to the moon, as Europe doesn't have "the technological capacity yet" to send living, breathing people, according to Michael Menking of Astrium. As Handelsblatt notes, the first European on the moon will therefore be a robot (will Herman Van Rompuy do?).

EADS (the European Aeronautic Defence and Space Company) is now conducting a “Lunar Lander Phase B1 study” whose “final result…will be a fully defined mission concept and a detailed design of the landing vehicle and Moon rover.” The rover is tasked with exploring the surface, while stationary instruments will record experimental data for an expected six to eight months. Just in case the Americans and Russians missed something...

The “Phase B1 study”, when completed, will lay out in a “Preliminary Systems Requirements Preview” an overall cost and a schedule so that a decision on full financing of the mission can be made at the next ESA Council Meeting, during the first half of 2012.

Following the decision, the ESA’s next step is to issue contracts for the development, construction and testing of the Lunar Lander. In other words, member states could soon see some pretty hefty space bills landing in their in-trays. Let's hope that this project doesn't face the same constant delays and cost over-runs, which have haunted that other great European space project, Galileo.

What about an actual EU man on the moon? When asked about it by Handelsblatt, ESA Director of Human Spaceflight, Thomas Reiter, answered optimistically “a return to the moon is an obvious target.” Hans Jörg Dittus, Executive Board member at the German Aerospace Center, is, however, less certain. “At the moment we don’t have the money in Europe” for manned spaceflight, he said.

No kiddin'!

Is this a worthwhile project that European taxpayers actually want to support? We have no idea - it could be. Maybe its a cunning plan dreamt up by certain EU leaders who would be quite keen on getting themselves on that shuttle if things go really sour...

Thursday, September 29, 2011

What’s a few hundred billion between friends…?

Below is the current status of the EFSF upgrade as ratified by national parliaments. A reminder that this is the vote on the package of measures agreed by Eurozone leaders back in July, and does not increase the overall size of the EFSF, merely its lending capacity (from €250bn to €440bn) and expands its scope, allowing it to buy government bonds, engage in precautionary lending and capitalise banks.

Already Ratified:
Belgium – 14th September
Cyprus - 29th September
Finland – 28th September
France – 8th September
Germany – 29th September
Greece – 27th September
Ireland - 22nd September
Italy – 15th September
Luxembourg – 15th September
Portugal – Government has rubber stamped the deal
Slovenia – 22nd September
Spain - 28th September

Yet to Ratify:
Austria - Parliament’s finance committee approved the EFSF bill yesterday, paving the way for a special session of the assembly to give final approval in a vote tomorrow.

Estonia - Parliament is due to ratify the EFSF bill later today after making amendments to local legislation required by a constitutional watchdog and opposition Social Democrats. Also proposed amendment which would require the Estonian parliament to give approval every time EFSF is used (seems unlikely to be accepted given that it would stir huge controversy with other countries).

Malta – Government officially proposed the bill yesterday, voting is due to take place early next week.

Netherlands - Parliament is scheduled to approve a supplementary budget, which includes the proposed EFSF changes, next week. Government will probably have to rely on the votes of the centre-left opposition as Geert Wilders' Freedom Party is likely to oppose the bill.

Slovakia - Voting is planned for October the 25th, but Prime Minister Iveta Radicova has said that she would like Parliament to vote on the plan by October 17th, possibly as early as the 11th. There have been some indications from the second-largest ruling party, Freedom and Solidarity (classic liberals), which had opposed the upgrades, that the ruling coalition was close to an agreement on approving the EFSF overhaul, but this is yet to be confirmed. The centre-left opposition has said it won't prop up the government if the coalition fails to come to an agreement but that it will vote in favour if the government comes to a united position.

It appears that there should be no major problems with passing the EFSF expansion through the remaining national legislatures, although the Slovakian situation is still uncertain.

This entire eposide serves as an important reminder that national democracy is still king, and, at the end, will determine the fate of the euro (markets, analysts, diplomats and government cabinets can squirm all they want).

The somewhat scary thing is that the series of EFSF votes is essentially a legacy issue. Markets have already set their eyes on the next big battle as European, and (increasingly concerned) global leaders, are mooting that the EFSF needs effective resources of €2 trillion (some suggest using ECB leveraging, which we consider a non-starter).

The political manoeuvring that has been/will be necessary to squeeze the relatively modest July measures through national parliaments (particularly Germany, Finland and Slovakia) will be tested to the limit if the Governments go back to national parliaments asking for a multi-trillion top-up - not least in Germany(see our earlier blog on today’s vote).

The markets know all this, which is why the whole situation remains so uncertain in spite of the apparent consensus among eurozone members...

The ECB's Italian Wishlist

It was Italy's worst kept secret. Everybody knew that the second austerity package hastily put together by the Italian government in August had been - let's say - 'inspired' by the ECB, despite several clumsy attempts to deny the existence of a letter containing a fully-fledged wish list set out in Frankfurt as a precondition to the ECB starting to buy Italian bonds.

With a bit of delay, the full text of the letter (the English version is available here) has eventually been disclosed by all the main Italian newspapers today, all of them curiously claiming that they had obtained it "in exclusive". After a quick reading, the first impression is that this letter may actually mark a watershed moment. In fact, the unquestionable resemblance between what the ECB urged the Italian government to do and what the Italian government ultimately did suggests that the letter is the first example of an independent EU institution effectively dictating fiscal policy to a member state - that it is the ECB just makes it all the more controversial.

Here are the most interesting excerpts,

Additional corrective fiscal measures are needed. We consider essential for the Italian authorities to front-load the measures adopted in the July 2011 package by at least one year. The aim should be to achieve...a balanced budget in 2013, mainly via expenditure cuts.

On this point, Italy has done its homework only in part. In fact, the second austerity package involves cuts to transfers of money to the local administrations, but the two 'flagship' measures initially envisaged to cut public expenditure (i.e. the abolition of provincial administrations and the halving of the number of MPs and Senators) have been kicked into the long grass of constitutional reform. As a result, most of the savings envisaged derive from tax hikes (e.g. the VAT increase from 20% to 21%).

It is possible to intervene further in the pension system, making more stringent the eligibility criteria for seniority pensions and rapidly aligning the retirement age of women in the private sector to that established for public employees.

Done, but the gradual alignment will only start in 2014 (meaning that it will be completed by 2026), due to staunch resistance from Lega Nord.

An automatic deficit reducing clause should be introduced stating that any slippages from deficit targets will be automatically compensated through horizontal cuts on discretionary expenditures.

Done, and it has turned out to be one of the most controversial aspects of Italy's second austerity package. In fact, the Italian government is planning to recover around €20 billion over the next three years from a reform of the tax and welfare system involving the abolition of hundreds of tax breaks currently into force. Failing that, the 'safeguard clause' demanded by the ECB would automatically be triggered, with all the consequences.

There is also a need to further reform the collective wage bargaining system allowing firm-level agreements to tailor wages and working conditions to firms' specific needs and increasing their relevance with respect to other layers of negotiations.

Done, despite protests from trade unions.

The letter also contains specific calls for liberalisation of the labour market (including breaking down the two-tier structure and greater privatisation), something that Italy needs badly if it is to return to growth (as we argued here and here), but is yet to make any clear headway on this topic.

Another interesting fact is what is not in the letter - monetary policy. In fact the letter itself highlights that these reforms are to "restore the confidence of investors" and underpin the "standing of [Italy's] sovereign signature". As we've noted before, the ECB has consistently argued that their bond market interventions have been based on ensuring effective transmission of monetary policy. The existence of the letter itself suggested that this was not the case, now it seems the content has fully confirmed that. It will, and should, raise questions about the independence of the ECB and the position it has taken up (but also been forced into) when it is dictating fiscal policy to a democratically elected government.

This letter shows beyond doubt that the thrust of Italy's second austerity package was effectively drawn up in Frankfurt, and not in Rome. Not quite the best birthday present for Berlusconi, who (believe it or not) turns 75 today...

A Pyrrhic Victory for Merkel?

The headlines tomorrow will say that the German Bundestag agreed to pass the expansion of the EFSF, and that Chancellor Merkel managed to get enough coalition votes to preserve her ‘Chancellor’s majority’; 315 in favour, 13 against and 2 abstentions. This meant she did not suffer the humiliation of having to rely on the votes of the opposition, which could have gone as far as bringing down her Government and triggering early elections.

So, indeed, a crisis has been averted and Merkel again showed signs of being a shrewd and canny operator (it was a while ago since we last saw such signs). She also displayed some pretty impressive expectation management skills, getting a bigger majority than many had anticipated.

However, the German public isn't exactly impressed. An opinion poll commissioned by Bild immediately after the vote hardly inspires confidence; only 6% of Germans believed that MPs understand exactly what it it is that they are deciding, while 47.5% did not believe they had an adequate overview of the situation.

There are still many questions to be answered and the road ahead remains uncertain. More than anything this demonstrates how the eurozone crisis has constantly frustrated politicians’ attempts to bring it under control by mutating rapidly while they are still dealing with its previous stages. Here we had the slightly absurd situation where the Bundestag was considering measures agreed by European leaders back in July to boost the EFSF’s bailout guarantees to €440bn, (Germany’s share will increase from €123bn to €211bn), while earlier this week it was reported that Eurozone and global leaders were in negotiations to increase the size of the EFSF to €2 trillion, possibly using a leverage scheme through the ECB.

As expected, the Budestag witnessed a feisty debate, with plenty of accusations flying around as to who was to blame. This however disguised the fact that of the five parties, only the left-wing ‘die Linke’ was wholly opposed to the EFSF expansion (on the grounds that it was a bailout for banks and not citizens), while the coalition CDU/CSU and FDP parties argued for it begrudgingly, and the opposition SDP and Green Party argued the measures did not go far enough. The unifying factor was a feeling that Germany had done very well out of membership of both the EU and the Eurozone, and that it had a responsibility to ensure stability and support struggling members.

However, how far this solidarity should go, and what institutional form it should take provoked the most disagreement. Let's remember that today's vote was mainly about exanding the scope of the EFSF - to allow it to buy govenrment bonds, precautionary lending and capitilse banks - it did also increase the lending capacity to €440bn (as it was originally meant to be) but did not push the size of the fund any further - as many have recently been calling for.

What became clear during the debate is that Merkel used up a lot of political capital persuading coalition MPs, who railed against fiscal irresponsibility, and transfers of debt between member states to vote for the expansion. It was also evident that for many this was a line in the sand; they would accept the expansion of the bailout fund, but no additional measures. The FDP’s Rainer Brüderle, former Minister for the Economy insisted that:
“The rescue mechanism must not be allowed to become an investment bank… Germany must fulfil commitments under Lisbon treaty but in future structural changes must be enacted to prevent unfair transfers”
Brüderle also raised the spectre of hyperinflation, something the FDP in particular are very concerned about. Germany’s finance minister Wolfgang Schäuble said that “the whole of Europe depends on Germany’s economic stability”, and about the tough conditions that Greece must meet in order to receive the next tranche of bailout funds. However not all coalition MPs were satisfied, with CDU dissenter Klaus-Peter Willsch arguing that “you can't fight debt with debt”, although the muted applause was an early indication not enough of his colleagues were prepared to back him in the vote.

The arguments adopted by the opposition were fascinating, in that they argued that the crisis had been exacerbated by the Government’s unwillingness to work with other European states. The SPD’s Peer Steinbrück argued Germans had lost faith in the Government because of its lack of leadership, while the Greens went even further, with senior Green politician Jürgen Trittin arguing that:
“Germany has a responsibility to Europe which it cannot renege on… the Government’s insular and eurosceptic tendencies have prolonged the crisis… Barroso was right [in his State of the Union speech yesterday] that the European Commission is Europe's economic Government, we need strong democratic EU institutions in this globalised era.”
His party colleague Priska Hinz argued that:
“We need more budgetary co-ordination, a Financial Transaction Tax, Eurobonds and if treaty changes are necessary to accomplish this then we'll campaign for them.”
So while the vote was easily passed by a 523 votes in favour and 85 against (with 3 abstentions), the preceding debate clearly demonstrated serious differences between the coalition parties, and to a lesser degree within them. Here are some key issues to look out for in the German debate:
  • The issue of Eurobonds, enthusiastically backed by the opposition is an absolute no-go area for the coalition parties - but backed by the Greens and SPD that currently lead in the polls (illustrating how public euro discontent still is to filter through to party politics).
  • Merkel needs to decide whether to revise the complex and flawed second Greek bailout, meaning there are still key battles that have yet to be fought within parties, between them, with other European partners and some of Europe’s largest financial institutions.
  • The future role of the ECB will be crucial, specifically whether Germany can accept an expanded mandate for the bank, particularly through a larger bond buying programme, and whether the EFSF’s firepower will be increased by leveraging it through the ECB.
In other words, still plenty to play for...

Wednesday, September 28, 2011

Hague hits back on the Euro

The Spectator’s James Forsyth has conducted an extended interview with Foreign Secretary, William Hague, which contains a lot of interesting points, not least about the ongoing Eurozone crisis, the future direction of the EU, coalition politics on Europe and finally his future job prospects…

The central theme of the section of the interview relevant to Europe is one of vindication, in particular regarding Hague’s campaign to keep Britain out the Euro when he was party leader, even if this was widely mocked at the time. Hague does not mince his words, describing the euro as:
"A kind of historical monument to collective folly… a burning building with no exits”
Hague clearly thinks that many of the current problems stem from the fact that the rules were fudged to allow the struggling countries to become members in the first place. Nonetheless, to his credit, he does not indulge in gloating or triumphalism but is quick to acknowledge that the eurozone’s troubles also threaten Britain’s national interest, and Britain should not hope for the break-up of the single currency, saying:
“We are very concerned about what would happen if the euro broke up and so despite all our opposition to it… we must support [the Eurozone]”.
Significantly, his “no exits” line means he does not advocate a default by any of the struggling economies, arguing instead that the Greeks, Portuguese and possibly even Italians “will have to accept some very big changes in what happens in their country” (which indicates having to adopt further austerity measures), while crucially, he says that the Germans will “have to accept that they are going to subsidise those countries for a long time to come really, for the rest of their lifetimes.” This is clearly not going to be acceptable to the Germans, as proved by their refusal to countenance expanding the EFSF even further, for example by allowing it to be leveraged through the ECB.

Worryingly, however, Hague does not elaborate on what would happen if these conditions were unable to be met, and says that if the Eurozone countries are unable to meet a six week deadline set by George Osborne to push through measures already agreed to try and protect the Euro, “then we’ll be even more worried”, which even if honest, hardly inspires confidence.

Away from the apocalyptic narrative surrounding the Eurozone, Hague indicated that in terms of broader UK-EU relations, he still believes that:
“The EU does have too much power, I haven’t changed that view from being in government, in fact if anything being in government has reinforced that view and there should be powers that are returned to this country”
However he refuses to be drawn on what he is going to do about this, giving a rather vague answer that it would have to be discussed within the coalition. James Forsyth concludes that “Hague seems to see bringing back powers as very much a second term issue”, reinforced by Hague’s assertion that Europe could be one of the dividing lines between the coalition parties put forward at the next election. Here we would argue that there is no excuse for inaction on repatriating powers and EU reform, and the Government must try to build a consensus on this issue, even if this means Conservative and Liberal Democrat backbenchers having to make some compromises on their respective Eurosceptic/Europhile beliefs.

Finally on a lighter note, at the end of the interview, Hague insisted that whatever he may turn to in the future, replacing Cathy Ashton as the European Union’s external affairs commissioner is most definitely not on his agenda, insisting that “any job I have in the future will not be in the European Union”.

Does Labour have an EU policy?

The Labour Party conference has provided a belated opportunity to focus on the opposition party’s policies, and our interest naturally gravitated towards what Eds Milliband and Balls would have to say on the UK’s relations with the EU, and crucially their views on the burning issue of the eurozone crisis.

An early indication of Labour’s attitude towards the EU in opposition came from Lord Maurice Glassman (pictured), tasked by Miliband to develop a new intellectual framework for the Labour Party. Glassman’s ‘Blue Labour’ critique took aim at many targets (with no quarter given), including the EU, in particular its dominating legalistic institutions (a criticism we share) and the free movement of people and capital (which we think on the whole has benefited the people of Europe).

Ed Miliband, Ed Balls and other key Labour players have been busy developing this argument at party conference, in particular emphasising they had been wrong to allow unhindered access to the UK’s labour market to the eastern Europe accession countries in 2004. In an interview with Sky News, Miliband said: “We got it wrong in a number of respects, including underestimating the level of immigration from Poland, which had a big effect on people in Britain”, while Hazel Blears claimed that Eastern Europeans claiming generous UK benefits “creates a real sense of grievance and justifiably so” (even if research has shown immigrants are less likely than natives to receive state benefits or tax credits).

On the eurozone crisis, shadow Chancellor Ed Balls somewhat bizarrely argued (15 mins in) that Greece, the country at the centre of the problems did not have a debt problem:
“The crisis in Greece is fundamentally caused by the euro, an assumption about the interest rate which has turned out not to prevail… its not a crisis caused by debt, it’s caused by a liquidity crisis caused by a global financial crisis and a failure of the eurozone to act.”
While we certainly echo that the euro is a major problem, Balls appeared somewhat confused on the nature of this crisis. In fact, he may well find himself in a minority of one if he genuinely believes Greece is facing a liquidity rather than a solvency crisis. The markets (and increasing numbers of eurozone policymakers) know that Greece cannot sustain its debt burden in the long term, and are waiting for the inevitable default, something Balls did not mention.

Finally, in terms of gauging Labour’s general approach to EU issues in opposition, Miliband broadly backed the coalition government’s approach, saying that:
"We want a Europe that works for people in this country and I think that's the most important thing… let's get stuck in, let's engage and let's get Europe to grow. That's the priority, not referenda or constitutional changes or any of that stuff.”
While the reflection and internal debate is very welcome, as the Spectator’s Coffee House blog notes, “despite the interventions from Miliband and Balls, the party is bereft of a policy in this area”. And anyone wanting to get an idea of the Labour party's vision for Europe would have been disappointed by Miliband’s leader’s speech this afternoon, which barely referenced the EU or the eurozone. In fairness, Labour's Shadow Europe Minister Wayne David did say some encouraging things at a recent Open Europe event on EU justice and home affairs, which suggested he would press the Government on this issue, although again, he was vague on what specifically a Labour government would do. David has recently also gone pretty hard on the proposed increases to the EU budget.

Needless to say, given the crucial and fast-moving nature of events currently unfolding in Europe, it is vital we have an opposition that sharpens its focus and is able to hold the government to account.

We have a feeling that it's in the area of free movement of people and workers that Labour could face it's greatest temptation to move in a more populist direction...

Tuesday, September 27, 2011

Increasing the EFSF: A view from Europe

Comments on the rumours that Eurozone leaders are considering to top up the EFSF in order to combat the eurocrisis, and even including the ECB in it, seem to be all over the place. However, apart from the IMF, no one seems to be rather supportive of the idea.

German Finance Minister Wolfgang Schäuble seemed to reject the proposal over the weekend, saying “We won’t come to grips with economies deleveraging by having governments and central banks throwing – literally – even more money at the problem. You simply cannot fight fire with fire.” Christian Lindner, the Secretary-General of junior coalition partners FDP, called on the German Chancellor, Angela Merkel, to rule out “very quickly that there are no changes to the rules for EFSF” via the backdoor.

Jens Weidmann, head of the Bundesbank, warned that this would entail a disguised way of funding states through the ECB, and called it a “dangerous path” while questioning whether “financing states is a task for banks.”

Finnish Prime Minister Jyrki Katainen and his Dutch counterpart Mark Rutte both came out against increasing member states contributions. Dutch Prime-Minister Mark Rutte yesterday said during a joint press conference with Katainen that news about further increasing the EFSF is based on “rumours” and “speculation”. He added, “There are no plans in the Netherlands and, as far as I know, in Finland to increase the amount of money we put into the EFSF.” For his part, Katainen doubted there would be support for the move in Finland, saying “obviously it won’t be met positively.”

On Spain’s public broadcaster TVE, Spanish Economy Minister Elena Salgado also insisted that increasing the EFSF to €2 trillion “is not on the table and has not been discussed,” stressing the need for “some verbal discipline.”

David Beers, Head of Standard & Poor's sovereign rating group, suggested that the plan could have “potential credit implications in different ways,” hinting that it could lead to sovereign downgrades in the eurozone. He added, “We're getting to a point where the guarantee approach of the sort that the EFSF highlights is running out of road.”

Head of the IMF’s Europe department Antonio Borges on Friday said that there are growing expectations of more expansionary policy in the eurozone and that the IMF "would be very supportive of that." Borges did, however, say that the idea to "leverage the EFSF to the hilt...is not serious in our view."

Clearly, a consensus is yet to emerge...

Update 13:45 - Eurozone governments don’t really look to be on the same page. In contradiction with Salgado’s comments, Austrian Finance Minister Maria Fekter has reportedly said that plans to leverage the EFSF will be discussed at next week’s meeting of eurozone finance ministers. The FT’s live eurozone blog also suggests the issue will be a topic of discussion.

A non-starter?

In today's City AM, we give our take on the idea that was floated over the weekend to top up the EFSF, using the fire power of the ECB:
THERE was quite a bit of excitement in the media and financial markets over the weekend. The hot news was that Eurozone leaders, on the sidelines of the G20 summit, forged a new grand scheme to save the embattled euro. The plan, we were told by some, would be announced “within days”. Alas, details are still thin on the ground and talk of an imminent deal looks wide of the mark. So what’s the fuss about? The key proposal would see the Eurozone’s undersized bailout fund, the European Financial Stability Facility (EFSF) topped up through a complicated scheme involving the balance sheet of the European Central Bank (ECB). This would increase the fund’s lending capacity to around €2 trillion, allowing it to contain a Greek default, by providing a much needed backstop to Italy and Spain, as well as covering the recapitalisation needs of Europe’s banks. EFSF funds would be used to cover the first 20 per cent of any losses the ECB makes on purchases of government bonds or the recapitalisation of European banks. The proposal gets good marks for creative thinking, acknowledging that an orderly Greek default is the preferred option and attempting to address Europe’s unhealthy banking system. Unfortunately, the proposal is also a non-starter.

Firstly, the plan would require a radical reworking of the EFSF framework, since it is not designed to be leveraged or be subordinate to the ECB in terms of covering losses. Remember, following a deal agreed in July, most of these countries are still scrambling to get a more moderate boost to the EFSF past national parliaments, which are becoming increasingly resistant to what they see as a potential blank cheque.

Secondly, using the ECB’s balance sheet to top up the EFSF would further expose the former to even more risky debt. As of August this year, the ECB was leveraged around 25 times with an exposure of around €510bn to the peripheral Eurozone economies – with much of this debt being of very dubious quality. It faces potentially hefty write-downs should a Eurozone country actually default (it remains unclear how these losses would be covered).

In theory, the ECB has an unlimited capacity to lend, and can even do so to some extent without triggering inflation, due to control over future money supply. But this is where politics kick in. By effectively merging its balance sheet with that of a government-run institution, the EFSF, the ECB would fully enter the domain of fiscal policy. This is critical for a number of reasons. The ECB’s freedom to act without political influence affords it the trust of financial markets, and allows it to effectively transmit monetary policy, including managing inflation expectations. It was on this premise that the single currency was sold to the German electorate in the 1990s – the ECB was going to be the heir to the trusted Bundesbank. As former European Commission President Jacques Delors once famously observed, “Not all Germans believe in God, but all Germans believe in the Bundesbank”. In contrast, a growing number of Germans now view the ECB with growing suspicion, as was seen in the dramatic resignation last month of Juergen Stark, the German representative on the ECB’s executive board, allegedly over the bank’s decision to start buying Italian and Spanish government bonds. One step further, and German support for the entire euro project could start to diminish.

This links with another crucial question: who, exactly, is in charge? The advantage of using the ECB as lender of last resort for the Eurozone is that it can act quickly without seeking a democratic mandate from voters, which is a slow process. Combined with its capacity to massively expand its balance sheet, this is one of the reasons why the ECB is, in theory, the one institution that can move markets. But since it hinges on EFSF loans, the proposal discussed over the weekend would presumably still be subject to approval by each member state (and various national parliaments), meaning that we would be stuck with the same political bottlenecks as now.

There are also, it should be said, familiar economic risks involved. Leveraging the EFSF’s lending capacity, which is mostly backed by six triple-A states, could negatively impact on the credit ratings of the member states, most notably France (through contingent liabilities). This could lead to a vicious circle, with the rating of the EFSF suffering a corresponding blow.

Not much of a surprise then, that politicians and central bankers in triple-A countries have lined up to criticise this proposal, with Bundesbank president Jens Weidmann saying: “If [the EFSF were to finance government bond purchases] through the central bank, it would be monetary state financing. Whether you do it directly or whether you do it via the detour of a special purpose vehicle makes no difference economically.”

What’s positive about the apparent change in mood over the weekend is that Eurozone leaders are beginning to realise that without a restructuring of Greece’s, and possibly some other country’s debts, and proper recapitalisation of European banks, there’s absolutely no way out of this crisis. But proposals need to be rooted in political, legal and economic reality. Otherwise, the huge gap between what markets demand or expect, and what politicians can deliver, will grow ever wider – and the rollercoaster ride will continue.

Friday, September 23, 2011


A tasty development coming out of tiny Malta today – the Maltese government plans to ask for collateral on its loans to Greece.

Maltese Finance Minister Tonio Fenech said:
“I can confirm that at a recent meeting of the Eurogroup in Poland, Malta officially requested to be treated like Finland where it comes to collateral. All member states should be treated the same and we are insisting on this.”
So, also Malta is now echoing recent calls for equality in the eurozone as well. Many involved in the negotiations might be irked by this late call from a country with such a small contribution. However, in all fairness to Malta their contribution does amount to around 6.5% of their GDP, so clearly not a pittance to them. That more countries are coming out of the woodwork against this collateral deal just highlights how rushed and poorly thought out the second Greek bailout is.

As for what form the collateral deal will take – shockingly – no new developments. This, despite eurozone leaders saying we would have an agreement in one week, two weeks ago. Currently, it looks as if some collateral arrangement will be made available to all but it is likely to be so complex and costly that only those who have to accept it due to domestic constraints (Finland because of a deal with its parliament, Austria and Netherlands because of the growing Eurosceptic parties and Malta for, well, possibly for actual economic reasons) will choose to.

More meetings to come for sure - although it seems that this issue has taken a backseat to the topics of looming Greek default and financial market meltdown. Not that we can blame the eurozone leaders for that, it’s just, when you have so many balls in the air, one is bound to drop. Unfortunately if unexpected, that would mean disaster for the global economy.

Actually, come to think of it, we can and do blame eurozone leaders for that since they should have dealt with this problem head on a long time ago.

Thursday, September 22, 2011

Guilty Men's lessons from the past

In this week's Spectator, Peter Oborne and Frances Weaver trail their forthcoming book, "Guilty Men", which, judging by today's article, does a comprehensive job of lampooning the UK's pro-euro lobby. It will certainly make uncomfortable reading for those, including Mr Clegg, who still claim that "no one could see this coming".

The opening paragraph is the premise on which they make their argument:
"Very rarely in political history has any faction or movement enjoyed such a complete and crushing victory as the Conservative Eurosceptics. The field is theirs. They were not merely right about the single currency, the greatest economic issue of our age — they were right for the right reasons. They foresaw with lucid, prophetic accuracy exactly how and why the euro would bring with it financial devastation and social collapse."
There were of course those on the Labour side who made similar arguments but Oborne and Weaver hold no punches, especially when it comes to institutions of the establishment such as the FT and the BBC (We made our own attempt to highlight the folly of the pro-euro arguments in "They said it" last year):
"Even as late as May 2008, when the fatal booms in Ireland and elsewhere were very obviously beginning to falter, the paper retained its faith: ‘European monetary union is a bumble bee that has taken flight,’ asserted the newspaper’s leader column. ‘However improbable the celestial design, it has succeeded in real life.’ For a paper with the FT’s pretensions to authority in financial matters, its coverage of the single currency can be regarded as nothing short of a disaster."
Oborne and Weaver's research illustrates just how far the 'EU ideal' had permeated much of the political and media establishment - to the extent that those who disagreed where dismissed as "cranks".
"As Rod Liddle, then editor of the Radio 4’s Today programme, said: ‘The whole ethos of the BBC and all the staff was that Eurosceptics were xenophobes and there was an end to it. The euro would come up at a meeting and everybody would just burst out laughing about the Eurosceptics.’ Liddle recalls one meeting with a very senior figure at the BBC to deal with Eurosceptic complaints of bias. ‘Rod, the thing you have to understand is that these people are mad. They are mad.’"
And, in this respect, there is also an important warning for the future:
"One urgent lesson concerns the BBC. The corporation’s twisted coverage of the European Union is a serious problem, because the economic collapse of the eurozone means that a new treaty may be needed very soon — plunging the EU right back into the heart of our national politics."
We would perhaps add that the EU is already at the heart of national politics, something of which we're now reminded daily. Regardless, with the flaws of the eurozone now plain for all to see, more open-mindedness than in the past is a necessity when it comes to future debates about the best model for European cooperation, as well as UK's relationship with Europe - which faces a defining period in the coming years.

Blind faith is no longer an option.

Contrasting the ECB and the ESRB

With the IMF Global Financial Stability Report released yesterday, the debate over the recapitalisation of European banks has kicked off again. Previously, it had just been the IMF trading blows with eurozone leaders (including the ECB), with the former pushing for a substantial recapitalisation of the European banking sector and the latter resisting and insisting that banks are perfectly healthy, citing the stress test results in their defence. However, yesterday the European Systemic Risk Board entered the fray – a more interesting development than it may seem.

The ESRB press release argued:
“Supervisors should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities, taking also into account the need for transparent and consistent valuation of sovereign exposures. If necessary, this could benefit from the possibility for the European Financial Stability Facility to lend to governments in order to recapitalise banks, including in non-programme countries.”
Essentially, the ESRM is calling for a recapitalisation of European banks, after banks had marked their holdings of sovereign debt to market prices.

Many may ask why exactly the thoughts of this new and still obscure institution may change such a heavyweight debt. Well, the reason is that the ESRB is headed by the President of the ECB Jean-Claude Trichet and incudes all the heads of European National Central Banks. It does include plenty of other members from various EU bodies (see here for a full list) but the members of the ECB board do control 18 out of 36 votes. Add to this the member from the European Commission and the likelihood that heads of other European bodies should follow the line laid down by eurozone leaders and it would be expected that the ESRB would side with eurozone leaders rather than the IMF in this debate.

Jean-Claude Trichet has previously said that, “There is no liquidity or collateral shortage for the European banking system," and has reiterated that there is no funding crisis in the European banking sector as well as that banks do not need new capital injections. It’s also interesting since Eurozone leaders have continued to reject the need for banks to mark-to-market on sovereign debt and defended their accounting procedures against an attached from the International Accounting Standards Board recently.

All in all it seems surprising to us that a board filled with influential European leaders and officials would break so clearly with the official line that has been touted by eurozone leaders in recent months. It is clearly a welcome return to reality in some sense, but also raises questions about the growing disputes bubbling underneath the surface of European institutions on how the solve the eurozone crisis.

Eurocrat unions on the warpath...again

This in from PA:
A union for eurocrats is on the warpath over plans for a 40-hour week -
claiming the move would hit the balance between work and home life.

Some of the best-paid civil servants in the world are being asked to
agree to work another two and a half hours a week as a cost-saving
measure in the midst of mounting pressure from national governments to
cut the EU administrative budget.

Number-crunchers in Brussels say putting in the modest extra hours will
save EU taxpayers one billion euros a year (GBP870 million).

But one of the staff unions representing workers with pay and conditions
which are the envy of national civil servants across Europe is refusing
to negotiate on the increase.

All civil servants in the main EU institutions - European Commission,
European Parliament and EU Council of Ministers - enjoy the same scale
of pay and perks.

And many senior staff work long hours, despite the official norm of 37
and a half hours per week.

Now the Equipe d'Union Syndicale, the European Parliament's joint trade
union, has sent round a message rejecting the call for longer hours.

A group of union officials put their names to a letter declaring: "The
unions and staff associations replied to this proposal with a
categorical 'Niet!'"

They say working a 40-hour week would have a "very negative impact on
reconciliation of working and home life".

The statement adds: "The attractiveness of the European civil service
would deteriorate."

European Parliament staff already have Fridays off in the weeks when
European Parliament plenary sessions are held.

And most staff finish at lunchtime on Fridays the rest of the time.

But some insisted today that staff put in long hours, far in excess of
the official 37 and a half hour week.

On the other hand they can operate a flexi-time system, balancing short
days by working longer hours another day.

And they enjoy time off in lieu for hours over 37 and a half per week -
even in senior management positions.

But Conservative leader in the European Parliament Martin Callanan
insisted today that those fighting the change should "get real", in the
midst of the economic cutbacks being suffered across Europe.

"Public sector staff the world over are facing cutbacks and wage
freezes," he said.

"But here in Brussels they seem to think they live in an economic
microclimate where money grows on trees and the world owes them a very
comfortable living."

He added: "The Brussels pen-pushers, just like many of the politicians
here, just don't seem to get it when it comes to the economy. Austerity
measures are being taken everywhere, but somehow they think the EU is

"They need to get real and start to talk to us about how they can help
Europe out of this crisis."
It would have been absolutely hilarious had it not for the fact that the is EU facing its worst crisis to date, with falling living standards and redundancies now a fact of life for people across Europe.

As we've noted before, it's almost as if these people go out of the way to be unpopular with ordinary citizens.

Wednesday, September 21, 2011

ECB easing…

No, not the quantitative kind (not yet anyway), it is in fact the easing of the ECB’s collateral requirements, possibly substantially. The ECB has today released a few updated rules for its general documentation on collateral requirements (to come into force at the start of 2012).
The most important change is as follows (emphasis ours):
The Eurosystem has abolished the eligibility requirement (Sections and that debt instruments issued by credit institutions, other than covered bank bonds, are only eligible if they are admitted to trading on a regulated market. At the same time, the Eurosystem risk control measures for marketable assets (Section 6.4.2) have been amended. Specifically, the Eurosystem has reduced the limit for the use of unsecured debt instruments issued by a credit institution or by any other entity with which the credit institution has close links. Such assets may only be used as collateral to the extent that the value assigned does not exceed 5% of the total value of collateral submitted (instead of 10%, as previously stipulated).”
Essentially, the ECB has said it will accept debt instruments as collateral (in return for loans) even if there is no clearly regulated market for these instruments. It’s not initially clear exactly what instruments the ECB has in mind, but we have a few ideas, some of which would mark this as a substantial move by the ECB.

First off, the obvious ones are certain types of asset-backed-securities which banks have been holding onto since the financial crisis due to lack of market or demand for them. Secondly, it could be that this would allow the ECB to accept defaulted Greek debt, although this seems like a long shot since it would run counter to other direct provisions in the ECB’s collateral guidelines – this debate is likely to heat up over the next few days so we’ll keep you posted. There’s also the issue of some €30bn in Greek state backed bank bonds which the ECB had previously been wary of accepting as collateral, by some accounts – these would now likely be eligible (although given that Greek banks are now tapping the ELA, this is probably far less relevant).

In any case it will probably allow the ECB to accept further unmarketable assets and assign them a fairly arbitrary value based on its own determination. This will further add to the opacity and risk of the ECB’s balance sheet and allow for a transfer of risk away from the private sector onto the taxpayer-backed books of the ECB.

It's also interesting that the ECB saw the need to ease collateral requirements, since ECB President Jean-Claude Trichet has recently reiterated numerous times that he believes there is an abundance of collateral in the eurozone available for ECB liquidity operations.

The fallout from this ECB decision is far from clear as of yet, but it has the potential to be an important change and we’re sure it’s not the last we’ll hear about it.

Tuesday, September 20, 2011

Enhanced cooperation and the EFSF

We came across an interesting proposal today on Business Insider - that EFSF members could use the process of 'enhanced cooperation' to overcome their difficulties agreeing on the second Greek bailout (Finnish collateral demands) and ratifying the expanded role of the EFSF. We've sent a response through to Business Insider, suggesting that this isn't possible becasue the EFSF falls outside the EU treaties, to which enhanced cooperation applies. Unfortunately, there are no easy ways out of this situation.

(Enhanced cooperation - a procedure which allows at least 9 EU member states to push ahead with integration even if others decline to be involved.)

See below for our full response (we'd recommend reading the BI article as well):

The EFSF is not part of the EU Treaties and is a separate special purpose vehicle; therefore enhanced cooperation cannot apply to it. Since it is not technically an EU institution it does not fall into the jurisdiction of rules or procedures such as enhanced cooperation. The articles of incorporation for the EFSF highlight that it is a “public limited liability company” based in Luxembourg, not a formal EU body or institution.

This was an intentional move by eurozone countries to avoid a treaty renegotiation when setting up the EFSF, which would have been massively time consuming and may have failed to be approved. The EFSF grew from the intergovernmental loans given to Greece under the first bailout (although the two are still separate), therefore its basis has always been intergovernmental and not part of the EU Treaties.

The first part of the preamble to the EFSF Framework distinguishes between the change to EU Treaties required to establish the EFSM (the other €60bn temporary fund) and the setup of the EFSF, which did not require EU treaty change.

In addition, the UK didn’t have to approve the creation of the EFSF, since it was not inside the EU treaties. However, the European Stability Mechanism (ESM), the permanent bailout fund, is inside the Treaties and its creation does require UK approval (see here) and the UK also had a vote on the EFSM. It is clearly confusing since both the EFSM and the ESM are part of EU Treaties but the EFSF is not; but the distinction is clear.

It also seems fairly clear in the framework of the EFSF (Article 10, part 5, page 17) that any decisions on disbursing funds or adjusting the mechanism must be made unanimously. The only way around this would be for all the members of the EFSF to unanimously agree to allow Finland to step out of its share of guarantees but, as the current debate shows, the likes of Austria, the Netherlands and Germany would not let Finland excuse itself while they have to take on a new burden for political reasons.

All in all it seems clear that this enhanced cooperation way out is not plausible for the expansion of the EFSF or for the release of the second Greek bailout.

"The EU wants to solve the problems caused by centralisation by further centralisation"

If you think that Europe's toughest economic hawks sit in Frankfurt or dwell within Ifo - the flagship German econmic institute - think again. In fact, the German hawks have nothing on some economists and politicians in Slovakia - the tiger of Central Europe.

Peter Gonda, an economist at the Conservative Institute of M. R. Štefánik and lecturer of economics at the Comenius University in Bratislava, wrote today:
"The euro rests on an inappropriate understanding of EU integration. The common market requires real competition and the absence of barriers to free exchange. Not centrally managed harmonisation of terms and a common currency. The irony is that the EU wants to solve the problems caused by centralisation by further centralisation. The debt crisis in the Eurozone is an excuse to pursue fiscal and political union. The Slovakian parliament could reject the EFSF 2, which is an instrument for supporting moral hazard and fiscal irresponsibility at taxpayers’ expense. Slovakia should consider leaving the Eurozone or the EU altogether should the EU bring further problems in terms of freedom and prosperity for our country."

Monday, September 19, 2011

Changing mood?

Once upon a time, the so-called 'Franco-German axis' was seen as the single currency's indestructible bulwark. And if one stopped at the passionate statements made by German Chancellor Angela Merkel and French President Nicolas Sarkozy over the past few days, one might think that nothing has changed, and France and Germany are still capable of doing 'whatever it takes' to keep the euro afloat.

However, the big question is for how long the change of mood among both countries' populations can be ignored by the respective governments. The case of Germany has been abundantly documented on this blog (see here, here, and here) - with Merkel's ruling coalition incurring an embarrassing series of electoral defeats, polls showing rising opposition to multi-billion euro bailouts and even the first-ever protest taking place outside the ECB's headquarters in Frankfurt.

But it looks like the attitude towards the eurozone crisis is now changing in France as well. Leaving aside Front National leader Marine Le Pen's calls to "let the euro die its natural death", a growing number of people seem to be realising that their government may actually be throwing money into a bottomless pit in its effort to save Greece from an inevitable default.

This is true for both academics and public alike. In today's Le Figaro, French Professor Édouard Tétreau pulls no punches when he stresses the need to "drop Greece in order to save Europe," arguing,
"We know that, unless Greece becomes Orthodox - with its finances - or is put under tutelage, the money lent and given to this country will never be paid back...France has already voted two bailout plans for Greece in two years, coming with a cost of more than €30 billion – the equivalent of what is raised from income taxes in France in seven months. Who would agree, in our country, to work seven months to subsidise the lifestyle of people who are unable to pay their own taxes? By subsidising this organised robbery, we are not doing Greece, or Europe, a favour." *
Strong words indeed, but it's even more interesting to see that the French haven't exactly reacted well to their parliament's ratification of the second Greek bailout. In fact, an opinion poll conducted by France's Institute of Public Opinion (IFOP) shows that 30% of respondents are "completely" (tout à fait) hostile to France's decision to contribute €15 billion to the second Greek bailout, with a further 38% describing themselves as "rather" (plutôt) hostile - making up an impressive 68% 'anti-second Greek bailout' front. Of the remaining 32%, only a tiny 5% "completely" agree with their government's choice. One must not forget that France was forced to adopt a €12 billion austerity package for 2011-2012 last month.

It's too premature to say to what extent this gradual change of public mood could erode the Franco-German axis from within. In addition, both the French Socialists and the German Social-Democrats seem on course to win the next general elections, and both of them are far more pro-EU integration than the current governments. (How increasingly sceptic publics and potentially more pro-integration governments will mix is also an interesting question.)

However, given the current pace of events (the French will vote next year, and the Germans in 2013) public hostility towards euro bailouts might have grown so great that not even the most fervent euro-federalists can ignore the writing on the wall.

* Tétreau's op-ed carries the headline, "Greece: The barrel of the Danaids" - which will certainly delight fans of ancient Greek mythology. In fact, the Danaids were condemned by Zeus to fill in with water an ever-draining barrel whose bottom had been pierced on purpose...

Friday, September 16, 2011

Empty threats by the IMF?

There has been a lot of back and forth over the past week or two regarding the next tranche of funding due to be paid out under the original Greek bailout. The EU and the IMF were originally due to pay out €8bn to Greece (€5.8bn and €2.2bn respectively) by the end of September. However, eurozone finance ministers announced today that this would be delayed until the start of October (with the funds being released around the 15 October). Most reports suggest that Greece has enough money to last until mid-October, so this is cutting it mighty close to say the least.

But what are the chances of the funds not being dispersed?

We saw Christine Lagarde, Head of the IMF, yesterday calling for greater budget cuts in Greece and firmer implementation of the previously agreed bailout conditions. We’ve seen the EU/IMF/ECB review team leave Greece to allow the government more time to implement some necessary austerity measures and we’ve also heard a plethora of comments by leaders and politicians across the eurozone suggesting that if Greece doesn’t pay, the funds will be withheld. This would suggest there is some significant risk of the money not being paid out.

However, behind the scenes this seems unlikely. We saw a similar situation in the early summer with the previous tranche which led to the second bailout being agreed. The diversion this time around is less substantial to some extent, since the IMF cannot complain that long term funding is not assured as it helped sculpt the second bailout agreement (in reality we all know that Greece will default and the second bailout will not be enough but we’re viewing it from the perspective of the EU/IMF). Greece has already agreed to levy a new property and solidarity tax, which, estimates suggest, should cover any budget gaps for the rest of the year. Again in reality this means little from a country which already fails to collect taxes efficiently (particularly property taxes), but seems to be enough to appease European officials, who already look keen to complete the review and disperse the funds.

So the Eurozone part of the funds look likely to be paid out. The IMF is holding out, but in reality this is probably more of a negotiating strategy to gain more concessions, than a full blown stand-off over the solvency of the country (although clearly the IMF is losing patience with Greece - see it’s hesitance over getting involved in the second bailout). Even if the IMF did not release its share, the EU could still pay out its portion or even cover the IMF’s. The Greek Central bank could also pump liquidity into the banking system using the Emergency Liquidity assistance (ELA), which be used to buy up some short term Greek government debt, so there are still some options.

In any case, a few weeks is probably too short a time frame for both the EU and the IMF to plan for an orderly Greek default - and both accept a disorderly default would be incredibly painful.

There are plenty of other factors flying around which could precipitate the Greek default (collapse of the banking sector, wider social problems etc), but at this moment in time it does not look like the EU or IMF not dispersing bailout funds will be one of them (we obviously agree Greece will default, but just that it looks likely that they will receive the next tranche of funds). Whether these funds will be on time or enough to hold Greece over until the next tranche in December remains to be seen…

I need a dollar...

Five central banks, including the Bank of England (BoE) and the European Central Bank (ECB), announced yesterday that they would provide unlimited three month dollar loans to their banking sectors. Although we've been fairly critical of the ECB during this crisis, we've often maintained that many of its actions were taken out of its hands by the lack of action on the part of eurozone leaders. This is a prime example of such a situation.

The decision won't change any of the underlying problems in the European banking sector - many banks still need to be recapitalised, some need to consolidate and deleverage and they all need to fully realise and account for potential losses from the eurozone crisis. That said there are also unlikely to be many negative side effects from this dollar provision, especially since the likes of the ECB were already providing unlimited liquidity anyway.

Below are a few of our thoughts on the issue (specifically in reference to the ECB's role):
- The mechanism is the same as the standard lending practices but in dollars, so the credit risk is the same as normal liquidity provision but with some small additional foreign exchange risk, however this should be priced into the lending rate to banks and (probably) into the collateral requirements.

-It doesn't count as monetisation as it is directly replacing the dollar funding lost from the hesitancy of the money market funds in the US who used to provide these loans to banks. In very recent times the collateral used was widely accepted on the market so there is less to worry about in terms of quality.

- The concerns surrounding the withdrawal of lending to UK and European banks are not directly based on the banks health for the most part, but mostly the lack of eurozone leaders' ability to deal with the crisis and the fall in growth across Europe. Exactly the type of situation where central banks should intervene for liquidity purposes. (There is obviously some concern over these banks' exposure to the debt crisis, but that does not fully account for the complete lack of funding while also does not often directly affect the quality of collateral they can offer for dollar lending).

- It is essentially only an extension of the existing facility. The ECB was already offering unlimited weekly loans, now it has just extended this to 3 months. This offers added security and reduces the cost of continuously rolling over the short term funding.

- If they didn't receive this funding in dollars the banks would probably have borrowed in euros and arranged foreign exchange swaps to gain dollars. Essentially, it looks to us as if the ECB is basically taking on the exchange rate risk for the banks. This is a fairly small price to pay (and may be covered in the lending rates as mentioned above) and is much easier for the central banks to manage, especially with their direct lines with the Fed, than individual banks.

- One issue is that it removes the stigma of borrowing dollars from the ECB's one week funding mechanism. This could have a negative impact to some extent as it increases moral hazard as it may encourage banks to borrow more regularly from the ECB.

- Could become problematic if the ECB has no exit strategy. The lending rate needs to be high enough so that when some semblance of market confidence returns, the banks go back to borrowing from elsewhere and don't stay reliant on the ECB. (This mechanism was used and wound down again in 2008 and early 2010, so there is at least some precedent that it can be used temporarily).

- It is likely that most of the BoE lending will go to UK banks, or the UK arms of global banks, so unlikely that the UK will be directly funding European banks - a concern expressed by some. In any case, its a global coordination and would have been hard for the UK to avoid no matter its position in Europe, its also likely that this role would fall onto central banks when you have a global financial system with numerous heavily used currencies (and one key reserve currency).
All in all, the introduction of this mechanism doesn't change much, particularly in terms of the risks for the ECB. Any underlying problems can mostly be traced back to issues with the existing unlimited liquidity provision by the ECB, but that is a whole other story...

Coalition all over the place on the eurozone

Irony alert.

Ken Clarke - former UK Chancellor, now Justice Secretary in the Coalition - went on Newnsnight last night, taking a swipe at politicians in the eurozone and the US.

Clarke said :
"The main thing I take from this crisis is unfortunately the political leadership in the USA and large parts of Western Europe have been totally overwhelmed by the dimensions of the crisis, not able to cope...You have paralysis in Washington, and paralysis in large parts of Europe because they are incapable of agreeing and everybody is fighting short-term politics. I do not think the British government comes out of it too badly when you make the comparison."
Incapable of agreeing, eh?

In contrast, the Coalition has a coherent view of what the eurozone should do...not.

This is what Clarke (who once said, “The reality of the euro has exposed the absurdity of many anti-European scares while increasing the public thirst for information. Public opinion is already
changing […] as people can see the success of the new currency on the mainland"), told Newsnight:
"I think the euro will survive... What the eurozone needs is fiscal discipline, that's what the eurozone needs. It doesn't need the same level of tax, it doesn't need the same level of spending. Governments can decide that for themselves whether they are high tax, high spend, or low tax, low spend. But discipline, fiscal discipline, controlling of deficits... we agreed it when I was chancellor and the Germans led the way in breaking it."
It's hard to interpret this in any other way than that Clarke thinks that adherence to the original Stability & Growth pact will cut it. In other words, in terms of the institutional set-up, the status quo, with some tweaks is pretty much sufficient. Eurobonds - which would inevitably have to involve more German (or at least centralised) fiscal control as quid pro quo - are not necessary, for example ('same level of spending').

PA reports that Osborne "is understood to sympathise with Mr Clarke's sentiments", which confuses us. This morning, Osborne told a conference thus,

"Crucially, my European colleagues need to accept the remorseless logic of monetary union that leads from a single currency to greater fiscal integration."

And last month he wrote in the Telegraph,

"Solutions such as eurobonds now require serious consideration if investors are to be convinced about the long-term future of the currency."

We're sorry, but this is something quite different to what Clarke is calling for. Osborne clearly signals the need for more fiscal integration, including possibly eurobonds - which in fact could undermine fiscal discipline due moral hazard, but could potentially compensate for some economic divergences within the eurozone, depending on how you implement them.

On his part, Nick Clegg said last month
"Countries like the UK should not see ourselves as spectators, watching from the wings, triumphalist, complacent, as if Europe's economic woes are a eurozone problem, rather than a problem for all of us - as if it is enough to put your own house in order, but then stand by and let the neighbourhood crumble."
He went on to say that though it isn't his role to "predict",
"On the one hand, some people, including senior members of the previous UK government [hello Jack Straw], are predicting collapse and doing so with short-sighted relish, given it would do lasting damage to the UK economy. On the other hand, some people are now arguing that only complete fiscal union can work...I expect – as is usually the case – things will end up somewhere in between these extremes."
So, on eurozone survival:

Clarke: More fiscal discipline by sticking to existing rules
Osborne: Existing rules are not enough - greater fiscal integration is inevitable
Clegg: Somewhere between fiscal union and break-up (while UK cannot watch from the sidelines while the house burns, meaning participating in bailouts?)

What was that about being incapable of agreeing? Something tells us that the Coalition would not have fared much better had it been running German eurozone policy...

Thursday, September 15, 2011

The statement that said nothing - and yet meant everything

Last night, German Chancellor Angela Merkel, French President Nicolas Sarkozy and Greek PM George Papandreou held another one of those crunch-time talks, as the fate of the euro balanced on a knife's edge. Amid reports that Greece is falling well short of meeting its austerity targets, markets feared an imminent Greek default, with the risk that the country would have to leave the eurozone altogether. Following IMF/ECB/EU pressure last week, Greek PM Papandreou announced new austerity measures, including a property tax and further cuts in public sector jobs.

But the jitters remained. As ever, it's one thing to announce new measures, a completely different thing to implement them in a way that actually results in savings - and even with these new cuts, Greece's situation looks rather hopeless, and a default inevitable.

So what to make of yesterday's statement by Sakrozy and Merkel? Well, this was the thrust of it:
The Chancellor and the President are convinced that the future of Greece is in the eurozone. The implementation bailout deal obligations is essential for the Greek economy to return to sustainable and balanced growth. The Greek Prime Minister has confirmed the absolute commitment of his government to take all necessary measures to implement the obligations in their entirety. Greece's successful adoption of the measures will strengthen the stability of the eurozone.
Absolutely nothing new in there. But as we argued yesterday on Newsnight, there appears to be an implicit guarantee that, even though Greece is falling short of its commitments in reality and will be unable to reduce its debt mountain by its own strength alone, Germany and France will stand behind the country - at least for now. The charade over impossible austerity targets will continue - to appease increasingly restless parliaments in Triple A countries - but Greece will receive the next tranche of EU/IMF money, worth some €8bn (needed for it to avoid immediate bankruptcy).

The statement may also be a nod in the direction of the IMF, whose officials remain unconvinced. It'll now be very difficult for the IMF to refuse to unlock the next tranche of aid to Greece, following EU/ECB/IMF evaluations that will resume next week. Olli Rehn today also effectively confirmed that Greece will receive the next tranche.

Behind the scenes, meanwhile, finance ministries continue to scramble for some sort of 'solution' to the Greek problem, with an orderly default sailing up the wish list as one of the few realistic alternatives. As ever, buying time is the only strategy. Very uncomfortable questions about Greece's future inside the eurozone remain.