Bad weather on the Spanish horizon?

The crushing defeat for the Spanish government in last weekend’s regional elections, along with the seemingly infinitely escalating situation in Greece, has seen concerns over the state of the Spanish economy rear their head once more.

Though we're generally far more positive about Spain than some of the other struggling eurozone economies (some of them are over the edge already so that's a no-brainer), in our recent paper looking at the situation in Portugal, we did warn of a potential ‘perfect storm’ (a combination of detrimental economic factors) which could push the Spanish economy towards needing a bailout.

Unfortunately, it does look like that storm could be brewing on the horizon, should the numerous factors which are hovering over the Spanish economy overlap or coincide.

Firstly, as was reported last week, these elections could reveal a raft of hidden debt (the FT suggested around €26.4bn) as the new regional heads of government attempt to establish exactly how big a problem they face – and blame any ensuing issues on the previous incumbents. Although not immediately dangerous given the size of the Spanish economy, this extra debt could cause Spain to miss it’s debt and deficit targets for the year – something they would surely be punished for by financial markets.

There’s also the rising political unrest due to high unemployment and austerity, particularly among young people. If this gathers pace, support for the government's reform programme could be put at risk despite having made large strides so far. Again it is likely that a let up in the economic adjustment currently underway would see the cost of borrowing increase – given that it’s already close to 6% its not a stretch to imagine that it might break the 7% threshold (beyond which debt is seen as unsustainable) under the 'perfect storm' scenario.

Then there is the ongoing spectre of ECB interest rate increases, which will hurt because of the massive levels of household debt and the high proportion of variable rate mortgages (making home owners with mortgages highly vulnerable to increases in interest rates), as well as the weak banking sector, which continues to look undercapitalised and remains heavily exposed to the bust real estate sector. Add to that the potential contagion from other parts of the eurozone which continue to struggle. Then combine all these factors and there is a potential economic storm brewing for Spain.

The biggest threats to long term prosperity in Spain continue to be the banking sector and potential ECB rate rises, which is why the government needs to step their banking reform programme up a notch (including building up capital reserves and deleveraging the entire sector), while developing a policy to counter interest rate rises by the ECB. Pushing the EU to come up with solutions that actually deal with the eurozone crisis rather than prolonging it (debt restructuring, combined with cash injections for banks for example), wouldn't hurt either.

Despite all this, the outlook for the Spanish economy is reasonably bright at the moment, especially bearing in mind how well it has withstood the Portugal crisis so far.

But there are far too many 'known unknowns' in Spain and across the eurozone to feel comfortable, suggesting that a storm could be ahead.

Learning the hard way

Zerohedge is taking a somewhat amusing look at calls in Germany last year for buying Greek government bonds, spearheaded by a campaign in Handelsblatt under the headline "We are buying Greek government bonds!"Amongst a range of prominent people explaining why government bonds is the right investment, the article featured Handelsblatt's own chief editor, Gabor Steingart, saying "to express my solidarity, I have ordered €5,000 worth of Greek government bonds."

Well, one year and hundreds of basis points later (the yields on Greek government bonds have soared from 9% last year to 17% this year, with prices moving in the opposite direction), investors who followed Handelsblatt's advice must feel somewhat jaded. Many have taken pretty hefty losses - unless they've dared to hold on to their bonds in the hope of better times. Hans-Werner Sinn, head of IFO Institute for Economic Research, put it well:

"It’s okay to be partial for Greece. But I cannot recommend buying Greek government bonds in good conscience. Instead, I would recommend vacationing in Greece. That way, you know you’ll get something in return for your money.”

Given the upcoming sale of Greek public assets, maybe Handelsblatt will run the headline 'We're buying Greek assets'...although we'd expect that they and many other investors are going to be a bit less bullish this time around (raising the interesting question of who will actually buy these Greek assets?)

The big three and the eurozone crisis

On Friday, the FT revealed that France is leading a majority group of eurozone governments in opposition to German demands that the permanent eurozone bailout mechanism include clear language providing for the inclusion of private bondholders in negotiations on any restructuring of government debt post-2013. This seems like a pretty dangerous game on France's part, but it also goes to show that the removal of Britain from the eurozone equation doesn't equal spontaneous Franco-German agreement.

If France isn't careful it could find itself as the only somewhat functioning economy representing and leading the Eurozone South, finding itself pitted against Germany and the Hawkish North more often than it might feel comfortable with.

But what does this mean for the wider political dynamics within the EU and for Britain?

While the huge financial implications the eurozone crisis has for Britain - not just its liabilities through the bailouts but also via the exposure of its banks to interconnected European financial markets - are beginning to sink in, the potential political outcomes for the UK's role in Europe are rarely considered with as much rigour.

With EU leaders no nearer a credible plan to fix the eurozone's economic mess, the political dynamics of the EU are in flux. It's clear that things can't remain the same, whatever happens over the next five to ten years in the eurozone.

Much of the analysis so far has been rather lazy, with commentators reaching for the "this is the beginning of a two-speed Europe" line, with the UK outside the 'eurozone core' and therefore in the 'slow lane'. However, while there may be an element of truth, these analyses seem unwilling to face up to the fact that the logical extension of this particular argument is that the UK should join the euro in order to maintain its influence in the EU - which no right-minded soul is prepared to even contemplate.

Even more importantly, it's clear for everyone to see that the "slow" and "fast" lanes in Europe are now defined by economics - that is by debt and deficits and by levels of competitiveness - rather than Treaty opt-outs or domestic constitutional measures, such as the UK's EU Bill. (Faced with numbers that are hard to ignore, people are being forced to re-define what they mean by a two-speed Europe - the more-often-than-not sound Economist, for example, which seems to have quietly dropped its narrative that institutional arrangements rather than economic fundamentals are the main fault lines in Europe).

Writing in the Mail a week or so ago, Iain Martin offered an alternative to the 'UK in the slow lane' hypothesis, suggesting the eurozone crisis presents "an historic leadership opportunity for David Cameron". The whole "Britain should lead in Europe" thesis has been done to death, but on substance, there is much reason, as well as a practical necessity, to believe that he is right - as we've been arguing for a while now.

Much of the logic that underpins those who have condemned the UK to life in the European slow lane's argument is that, by steering clear of plans for greater economic governance of the eurozone, Britain has pushed Germany into the arms of the French. This, the story runs, will lead to a more protectionist hardcore at the expense of Britain's more liberal economic interest.

Traditionally, Germany, to its advantage, has often been able to play British liberalism off against Gallic mercantilism. But, as we are beginning to see, forcing France and Germany together may start to reveal how many things that the two countries do not agree on.

How long, for example, can the two countries share the same currency while France runs deficits to pay for its generous pension system (plans to raise the retirement age to 62 resulted in mass protests) and Germany saves and raises its retirement age (which since 2007 is being phased in at 67)? The Franco-German alliance remains strong but there are also some deep disagreements between the two countries on economic policy (on the role of central banks, spending and deficits etc) that were pretty much swept under the carpet when the Single Currency was forged. If times get worse, expect more flare-ups.

It is hard to see how remaining 'excluded' from these kinds of rather uncomfortable questions will damage Britain's influence in the wider EU. And with many countries reconsidering a rush into the single currency, which they seemed destined for not so long ago, there is nothing inevitable about Europe's future political make-up. On the contrary, the current uncertainty in Europe has opened up space for those who believe in a better way forward for the EU to make their case.

That being said, the UK cannot make its voice heard if it doesn't say anything.

The Great EU debt write off?

Over on Conservative Home Steve Baker highlights a new paper from two professors at ESCP Europe Business School, which demonstrates the huge level of interconnectivity between the debt problems of different EU economies. The paper suggests that countries should cancel out or write off debt which they owe each other.

Before:

After:


Clearly the diagrams above highlight the huge interconnectivity between EU countries and highlights why a long term solution needs to be found as soon as possible. In reality, as the authors of the paper admit, a pure debt write off is not really a viable option. Although these exposures are amalgamated to the country to country level, in actual fact much of the exposure will be through financial sectors and private enterprise, meaning trying to impose a massive write off would cause havoc in these areas. It is still an interesting exercise which should help drive home what is at stake in eurozone debt crisis.

Is Christine the answer?

With it being a relatively slow news day, much of the economic and political commentariat has focussed on who ought to and/or has a chance of replacing Dominique Strauss-Kahn as IMF chief. Everyone seems to have an opinion on this; there have been some sensible suggestions, and some totally left-field ones, such as Martin Kettle’s pitch for Peter Mandelson.

Much of the debate has centred around the issue of whether he or she ought to be European, or whether it was time for an emerging economy to take over the helm of the IMF, with China, Brazil and Turkey all pushing for a non-EU IMF chief. Allister Heath made a good point in his City AM column:

“the European-led IMF was always perfectly happy to force much harsher policies on emerging countries. These days, however, it is the Asian and other emerging nations that have put their houses in order and Europe and the US that continue to spend money they don’t have.”

However, as we know, Europe tends to prefer the status quo (regardless of whether the status quo is actually a good thing) and France’s finance minister Christine Lagarde has emerged as a clear favourite.

So is she the right person for the job?

We're sceptical. Yes, she speaks polished English, more Oxford than the typical thick French statesman's accent, which in combination with her background at US financial firms, give her some street cred in the anglo-saxon world (which is enough for the BBC to love her). And she has done a relatively good job in keeping the French economy stable. However, she's nonetheless firmly wedded to what can be described as the ‘bailout consensus’ and state intervetion which as we have pointed out multiple times is a blind alley, and there are plenty of people out there who seem to agree.

FAZ’s Heike Göbel today slams Lagarde’s statist outlook, and argues Germany ought to be supporting a more a more market-friendly voice:

“Lagarde is rooted in the French tradition, that when in doubt, one ought to argue for more coordination rather than for more competition. She is the advocate in chief for unbridled state assistance, and does not want private creditors to participate in the rescue of insolvent eurozone countries."

The Indy’s Sean O’Grady concurs:

“Impressive as she is, the French finance minister is… too steeped in the EU establishment and too much part of the French elite to be able to abandon the euro as an article of faith. For a clear-headed, dispassionate Singaporean, let us say, the decision on recommending that Greece leaves the euro would be a much less traumatic affair. And even if that were not the case, we might still be better off with someone for whom the idea that they are a Sarko crony could never stray into our minds. So while it is true that Ms Lagarde knows the eurozone's funny little ways, she might also be more blind to its failings.”

In fact, the IMF would probably benefit from having someone from outside of the eurozone’s political elite, not least since large parts of this elite - as we have documented - consistently failed to grasp how the single currency would work in practice, and has mis-judged the crisis ever since it broke.

Ultimately, whether this person is European or not is actually of secondary importance.

The Self Preservation Society

AKA the ECB...

There’s been a lot of handbags between the ECB and EU leaders this week, after some leading EU politicians admitted that there could be some form of debt restructuring of Greek debt. Both Olli Rehn, EU Economics Commissioner, and Jean-Claude Juncker , Prime Minister of Luxembourg, suggested that there could be an extension of loans given to Greece (although its not clear whether this would just involve the official loans or private sector loans as well).

Needless to say, this did not sit well with the ECB, particularly ECB board member Jurgen Stark. After suggesting that any form of restructuring would be a catastrophe, Stark also accused “vested interests in the US and the UK” of undermining the economic adjustment programme in Greece. He also issued what seemed somewhat like a veiled threat, saying that the ECB may not accept Greek bonds as collateral for ECB lending to banks after a restructuring – a move which would probably push Greek banks into bankruptcy.

At first glance it is surprising just how removed the ECB is from the views of the rest of Europe (as we've argued for some time, restructuring is probably inevitable - an increaing number of people are coming around to this view). But ultimately, the ECB's posturing simply comes down to self interest. The ECB is holding masses of Greek bonds (we’d reckon around €60bn in nominal value) in addition to €140bn in state related collateral it has accepted from Greek banks. This €200bn exposure to Greece then presents the potential for large losses for the ECB under a Greek restructuring.

You may ask: why does the ECB care? It’s backed by eurozone governments, and therefore taxpayers, so they will ultimately foot the bill.

True – and another unfortunate potential hidden cost for eurozone taxpayers – but going cap in hand to eurozone governments to ask to be recapitalised after these losses would be incredibly humiliating for the ECB. It would also give eurozone leaders huge leverage over the ECB on future economic decisions and policy. The only other choice for the ECB is even worse though - printing money to cover its losses. This would mean abandoning its raison d’être (price stability) instead going down a path that could lead to pretty scary levels of inflation.

Arguing anything other than staying the course would therefore probably have dire consequences for the ECB, highlighting the impossible situation it’s managed to get itself into.

Some common sense from the Commission

Here's an encouraging proposal:

As we reported in our press summary yesterday, the European Commission has announced plans to revise its Byzantine state aid rules, potentially making life a bit easier for local and regional authorities. Currently, local bodies have to comply with the EU's jungle of rules, designed to ensure fair competition on the Single Market, even when subsidising or contracting out small projects such as swimming pools, playgrounds or crèches - which is just silly (and which adds unnecessary costs for taxpayers).

But, under the new rules, the Commission would lower the threshold on public procurement rules which - or so we hope - would let local authorities off the hook for public tenders for small-scale public services. As the competent EU Commissioner for Competition, Joaquin Almunia, put it.

"Our state aid rules currently apply also to local services organised by very small municipalities. It seems quite obvious to me that among these services, there are some that will have little impact on trade between member states and little potential to distort competition. I think that we need to adjust our scrutiny here and focus it on the cases that have a clear impact on the single market."

That makes sense. An official quoted over on Euractiv was even blunter:

"Most people [in DG Competition], they are not happy having to deal with a state aid complaint against a Dresden swimming pool. To be honest, it's more a pain in the ass than anything else, because they know very well that these matters should not be dealt with in Brussels."

The Commission says it wants to revise the regime in November (which it can do without asking member states or MEPs, since the EU has exclusive powers over this area). This is exactly the type of common sense that we want to see from Brussels.

But we need more of it - much, much more.

Incidentally, Open Europe will soon publish a list of examples of EU laws and measures that we feel should be revised on similar grounds. So watch this space.)

Is the ESM another €700bn bazooka pointed in the wrong direction?

We’ve just got our hands on the draft treaty establishing the European Stability Mechanism (ESM), which comes into force in 2013 and is the follow up to the original eurozone bailout packages - dubbed the €750bn bazooka back in 2010.

As expected, the ESM will have an effective lending capacity of €500bn, but to maintain a Triple-A rating it needs to be backed up by €700bn in capital – pretty huge figures. This means that Germany will be on the hook for guaranteeing €190bn! We can’t imagine German taxpayers will be too happy about having that potential liability hanging over their heads for the next 12 years (at which point the fund will be reassessed). Moreover, given the structure of the fund, €80bn in capital must be paid in initially, meaning Germany has to pay in €4.3bn per year for the next five years – this could even increase if someone – yes we’re looking at Greece – puts in an early request for funding.

We were also wondering what would happen if one of the countries – this time we’re looking at all of the PIIGS – was unable to cover its share of the fund. The draft treaty seems slightly contradictory. First it states:

“The liability of each ESM Members shall be limited, in all circumstances, to its portion of the authorized capital at its issue price. No ESM Member shall be liable, by reason of its membership, for obligations of the ESM. The obligations of ESM Members to contribute to capital in accordance with this Treaty are not affected if such ESM Member becomes eligible for or is receiving financial assistance from ESM.”

This would suggest that no country would be forced to shoulder anyone else’s burden. However, it later adds:

“If an ESM Member fails to meet the required payment under a capital call…a revised increased capital call shall be made to all ESM Members with a view to ensuring that the ESM receives the total amount of paid-in capital needed.”

So in actual fact, if one or more members failed to put up their share, all the other members will be asked to cover it (with the expectation of getting it back, but, as we're beginning to see, that’s far from guaranteed in the eurozone crisis).

The treaty also contains some tough conditions for investors. First, ESM loans will be senior to all other loans except the IMF, which we expected. Second, the disbursement of any financial aid from the ESM will require “adequate and proportionate” private sector involvement (read debt restructuring or at least rescheduling) and thirdly, all eurozone government bonds issued post July 2013 must include a standardised form of Collective Action Clauses - which stop a small minority of bondholders holding up any restructuring deal by waiting for better terms.

Although this is intended to help shift the burden from taxpayers (a good thing in principle), giving investors such substantial warning is likely to turn the market for some European sovereign debt into a ghost town. Why buy new debt when you're being explicitly told that you're first in the firing line?

How this will help wean Ireland, Portgual and especially Greece off their current ECB and EU bailouts is far from clear and could turn the ESM into a self-fulfilling bailout fund.

As the conditions for bondholder involvement highlight, the ESM might eventually bring a necessary eurozone debt restructuring to fruition but by that point the write downs will need to be huge and such a large amount of the debt of peripheral countries will be owned by the taxpayer that the private sector burden will still end up being minimal.

*** Update 11am 20 May 2011:
Writing in the FT Quentin Peel suggests that the latest version of the treaty does not stipulate that ESM loans will be senior to private creditors. Having reviewed the version we have it looks as if its still mentioned in the preamble but not the body of the treaty, so it is possible that it could be removed, which would be big news. But since negotiations are ongoing its not completely clear whether it will be removed or not. We'll keep you posted on the situation...

Ouch!!!

Usually mild mannered Swedish politicians have certainly displayed an unusual willingness to communicate strong opinions on European political issues of late. After some forthright comments on twitter from foreign minister Carl Bildt on Lybia recently, we now have finance minister Anders Borg eviscerating Gordon Brown’s reputation and lingering chances of becoming the new head of the IMF.

Speaking to Jeff Randall on Sky News, Borg said:

“It would be difficult to have a person that is so responsible for the fiscal crisis in the UK at the helm of the IMF… a country with a 10% deficit is I think a little bit problematic… the IMF today is very much about restoring fiscal responsibility”

Borg went on to tell Svenska Dagbladet that:

“He has been one of those who has argued for the deficit politics that we now see the results of. It would be odd to argue for him.”

For Gordon Brown, the self-styled saviour of the world, that has got to hurt. Nevertheless, it's refreshing to hear politicians who are not afraid of speaking their mind.

Half Time score on EU short selling regulation: Common sense 1, Poltical motives 1

Pardon for this uncharacteristically jargon-heavy blog-post...

Following our event on the proposed EU regulation of short selling in March, we expressed our concerns that political motives were trumping common financial sense at that point in the negotiations (based on the European Parliament’s proposal). It looked as if certain EU politicans had got one over on the markets (or so the politicans would like to present it) with a proposed ban on uncovered credit default swaps (CDS) and extending a ban on naked short selling to the sovereign debt markets.

Now, having examined the latest proposal to come out of the recent meeting of EU finance ministers, its looks as if the common sense is slowly gaining some ground back.

For starters, they’ve left CDS largely alone, apart from a clause which allows CDS activities to be temporarily banned in exceptional circumstances if all national regulators agree (which gives the FSA an effective veto).

The proposal still bans naked short selling (as it was ultimately designed to do), including sovereign debt, but this can be rescinded if it is seen to harm liquidity in sovereign debt markets. Interestingly, short selling of sovereign debt is allowed if it is seen as hedging against a corresponding long position. The European Securities Market Authority (ESMA) is mostly given a coordination role, it can attempt to rescind or extend the ban on an EU-wide basis but, again, it requires the consent of national authorities to do so.

The transparency rules are still included, stating that any investor with a significant net short position in shares must disclose it to regulators and to the markets if above a certain threshold. Importantly, this has been watered down in reference to sovereign debt so that no public disclosure is necessary. Public disclosure of short positions isn't uncomplicated but ultimately its impact will depend on the exact threshold levels and the format in which it is disclosed, both details which are yet to be announced.

Clearly, the Council's proposal is better than what some countries, such as France, had pushed for, particularly in relation to sovereign debt. It looks as if, at least in this round of the negotiations, the common sense approach - not least in terms of avoiding cutting off sources of liquidity for struggling eurozone countries - has been taken to heart. However, the negotiations are far from over, with the European Parliament still pushing for its far tougher proposal.

Member states and MEPs will now have to try to find a compromise between their respective proposals (with some member states no doubt using those negotiations trying to win back concessions that they horse-traded away - that's the nature of co-decision and Qualified Majority Voting).

So while this is pretty good news, it's only the half-time score.

True Finns continue to rise

Last week, the True Finns announced that it could not participate in a Coalition government that supported the bail-out of Portugal, its opposition to which was a key plank of the party's election manifesto. Announcing the decision, True Finns leader Timo Soini said, "It would have been nice to be part of the government but you cannot betray yourself."

Soini may have passed up on power, but his decision seems to have gone down well with voters. In an opinion poll carried out at the end of last week - when it had already become clear that the True Finns would not join the government due to the Portugal bail-out - the party got 22.4%, beating its election score by over 2% and making it the biggest party for the first time. It is trailed by the National Coalition Party on 20.6%, the Social Democrats on 18.6% and the Centre Party on 14.4%.

At this rate - particularly if the eurozone continues to deteriorate, requiring more bail-outs - Soini could become absolutely lethal in four years' time. It's that tension again, inherent in the eurozone structure - political ambition vs national democracy vs. economics...

On a separate note - irrespective of what we think of the True Finns - there's an interesting contrast here to a certain UK party, which, upon joining a Coalition government as a junior partner dropped from 23% at the election to 18% just over a month later and falling even lower this year.

What's the point then?

This is a pretty interesting comment from the Chief Operating Officer of the EU's diplomatic service (the EEAS), David O'Sullivan. In an interview with EUobserver, he said:

"At the end of the day, it's the member states that decide whether they want to speak with one voice, and there are moments when there are divergences. The High Representative [Baroness Catherine Ashton] has difficulty expressing a common European view if one doesn't exist...It is our hope that [the EEAS] will facilitate this process...We cannot at the end of the day change fundamental disagreements between member states."

Well put. As we've consistently argued, institutions cannot replace real policies - particularly in foreign affairs where it's clear that the EU remains a bloc of 27 national policies, which occassionally find common ground.

But his begs the question: what's the added value of the EEAS in the first place? If Ashton and the EEAS don't have the power to act in the absence of a common position shared by all 27 member states - a rare occurence indeed - is it then really worth spending hundreds of millions of taxpayers' money every year (€464 million only in 2011) to run a giant "facilitator"?

Given the criticism Ashton is facing (Only two weeks ago, Belgian Foreign Minister Steven Vanackere openly criticised her inability to get EU governments to agree on any of the most sensitive issues - not least the upheavals in North Africa and the Middle East - during her first year in the job), we wonder if the good Baroness isn't starting to ask herself that question as well, despite some good talk.

Still dodging the question: The Commission Responds To Our Aid Report (Part 2)

As promised, here is Part 2, which focusses on the Commission's second response to our two-part series on EU aid - this time our report looking specifically at the EU's approach in North Africa and the Middle East, the follow up to our briefing on the EU external aid budget taken as a whole.

In our previous post we noted that the Commission completely failed to engage with the main recommendation in our earlier report - that national contributions to aid funding should be made voluntary - and suggested why it chose to dodge the question. But in this post we'll take up some of the more detailed points raised by the Commission's two responses, which you can read in full here and here.

Firstly, there's the issue of 'budget support'. Over the last ten years, the EU has been increasingly relying on delivering its aid in the form of 'budget support', meaning that the money is transferred directly to the treasuries of recipient countries, rather than being committed for individual projects. Budget support can be either 'general' or 'sector-specific'. In 2009, 35% of the money allocated via the EU's Neighbourhood Policy (ENP) was in the form of sector budget support.

The Commission says in its response to our aid report that it "provides budget support only to certain governments in the developing world that meet minimum conditions of governance and good administration."

However, the Commission then fails to explain how Ben Ali’s Tunisia and Mubarak’s Egypt – where people took to the streets to protest against these regimes’ autocratic and corrupt rule – were able to fulfil the Commission’s criteria on transparency, democracy and good governance, given that in 2009 alone they were allocated €61.3 million and €107.7 million respectively in direct budget support funding by the EU.

The Commission writes:

“It goes without saying that in a number of countries…the EU has often felt frustrated by the lack of political reforms, stifling of civil society, and violation of human rights or dominance of the state…However, the serious shortcomings of a government do not justify isolating a population, punishing its youth and leaving it only in the hands of despots or dictators.”

But this still does not explain the Commission's history of dealing directly with illegitimate regimes via budget support, rather interacting with civil society groups.

To be fair, the Commission insists that it “has funded civil society to a large extent,” for example via the European Instrument for Democracy and Human Rights (EIDHR). However, we can’t help noting that €141 million to develop 14 projects in the EU’s Southern neighbourhood between 2007-2010 is dwarfed by the direct support to now discredited regimes in the area. The Commission's Annual Action Programmes show that, over the same period, a total €394 million in the form of budget support was committed to Egypt alone.

Secondly, the Commission has defended its financial and auditing controls, saying, in particular, that:

"In order to achieve clarity about the outcomes of aid in a certain country or in a particular sector like health or education, the European Commission contracts a higher level evaluation to carry out an examination across a number of projects and programmes."

However, the Commission’s response to our report on EU aid to North Africa and the Middle East shows something went very badly wrong in the evaluation of a €40 million project in the Occupied Palestinian Territories. Between 2006 and 2007, the Commission allocated €40 million to pay for power sold to local electricity companies operating in the area, with the aim of ensuring Palestinians received uninterrupted power supplies. In our report, we cite from an independent evaluation of the EU’s MEDA II funding programme for Mediterranean countries carried out by a network of European audit firms - an evaluation contracted by the Commission.

The evaluation raises two important concerns. Firstly, the auditors write, “We do not have the documentation to record disbursements” - in other words, the auditors had no idea where the cash went. Secondly, they note that

“by providing meta-level support, in the form of payment of invoices for power sold to the local electricity companies, the European Commission is not directly engaging in issues of who pays what for their electricity at a retail/consumer level. Funds generated at that level could be used to subsidise any element of the operations in West Bank and Gaza, including activities which might further destabilise the area.”

The Commission is now dismissing this evaluation, saying that a separate international audit firm “was able to confirm that all claims submitted for payment were eligible.” Extraordinarily, the Commission goes on to explain that

“The evaluators [the ones we quote in our report] were given access to the Commission's financial records system for contracts in the external relations field. It is therefore difficult to say why they could not find this data which was available for them…The comments quoted in the report were made by independent evaluators based on incomplete information.”

But here's the thing, the Commission actually signed off the evaluation, saying that it provided “credible and substantiated findings and conclusions”. The Commission is contradicting itself in so many ways that it's almost an achievement. What's clear is that this example inspires little confidence in the auditing and monitoring systems that the Commission claims are at the heart of its efforts to "identify the results of its aid".

Another issue we raise in both our reports concerns a €10 million grant given to the Italian Interior Ministry to train Libyan 'law enforcement authorities' and prepare them better to tackle illegal migration to Italy and other Southern EU member states. The project's expected results included: "Special units trained/able to gather intelligence information by debriefing the illegal migrants detected"; and "technical equipment provided to improve the operational capacity of the relevant Libyan agencies in charge of border and migration management, search and rescue operations, investigation."

The Commission argues that "retrospectively this spending was particularly pertinent given the current situation in the Southern borders of the EU." We're suprised the Commission is willing to defend training Gaddafi's 'authorities' for any purpose - especially given Gaddafi's resort to effectively blackmailing the EU on migration issues.

Also on Libya, the Commission says "contrary to what is stated in the Open Europe report, the EU has never 'opened' an association agreement with Libya." In fact, we said, "in 2008, the EU opened negotiations on a possible association agreement with Libya" and we make it very clear that talks were suspended. The point is that the talks were opened as late as 2008.

The Commission also fails to come up with an adequate defence of why it chooses to fund so many cultural projects and initiatives in Mediterranean countries whose added value remains, according to us and the Netherlands' Europe Minister, dubious. In the response to our aid report, we read that “cultural and creative industries, as well as cultural tourism, create jobs and economic growth on an important scale.” This may be true, but then the Commission should at least try to explain how this applies to, for example, the €22,500 for a Europe Day Concert or the €9,500 German folk band concert, both in Jordan - in addition to a range of other projects promoting European culture.

Finally, we note that, as was the case with our earlier aid report, the Commission has decided not to engage with some of the key suggestions we make, including: making aid to Mediterranean countries voluntary and granting the EU’s Southern neighbours full market access, which would involve lifting tariff quotas on agricultural products and scrapping the EU’s complex rules of origin.

A real shame that once again the Commission has chosen to avoid the real issues in this hugely important area. Instead, it opted for a response riddled with contradictons and inconsistencies - which largely served to vindicate our conclusions rather than refute them.

As much as we like being vindicated, we would prefer if the Commission instead engaged in a grown-up discussion about how we can better target EU aid. Everyone would gain from that, not least the world's poor.

Spring cleaning

The EU has today released its spring forecast, which updates last autumn’s economic forecasts for EU (and related) countries.

Despite our (relatively) chirpy title it’s far from happy reading.

The EU now expects Greek debt to reach 157.7% of GDP in 2011 and 166.1% in 2012. We can’t help but think that this backs up our (and many others') claim that the bailout has been a complete failure in Greece (combine this with talk of a second bailout only a year after the first and they’re almost making our point for us).

It’s not just Greece either. Irish debt is expected to reach 112% this year and 117.9% next. While Portugal’s debt is forecast to hit 101.7% by the end of the year and go on to 107.4% in 2012. Only a few months ago Portugal’s debt was expected to be around 82% this year, that’s a whopping 20% increase in only a few months!

All in all the figures and the report make fairly grim reading. Over the past year we have seen these sets of figures continuously revised upwards, yet the EU and the ECB continue to maintain that the adjustment programmes they’ve laid out for these countries are achievable and are having a substantial impact.

We think it’s about time the EU started accepting the reality of its own figures and added a debt restructuring to its tools for cleaning up the eurozone debt crisis this spring.

The EP brings us breaking news...

Don't ever say that the European Parliament is out of touch with the popular mood around Europe. In a press release today, the EP informs us that there are "Differing views on the road out of the debt crisis"!

If the picture's a little to small, you can read the EP's in depth analysis right here.

The Commission responds to our aid report (Part 1)

The strong reaction to our report on EU external aid, particularly in the Netherlands, has prompted the European Commission to issue a 14 page rebuttal. Without rehashing the Commission's entire response, which you can read here, we think it's important to highlight some of the contradictions within it and also where it seems to have completely missed the point.

We call this part 1 because the Commission has also issued a response to our report which specifically addresses EU aid to North Africa and the Middle East. We'll take a closer look at that later on (in part 2).

So here goes...

The EU's aid budget is designed to do several different things at once: it is used for programmes that most people would understand as "development" funding, aimed at poor countries in sub-Saharan Africa and Central Asia; it is used for programmes in the EU's neighbourhood including countries in Eastern Europe, the Middle East and North Africa; it is used for 'pre-accession' funding to help supposedly future members of the EU make the grade; and some of it is also passed on to other multilateral aid donors such as the World Bank and the United Nations.

The central conclusion of our report is that national contributions to EU aid spending should be made voluntary. This would not only increase accountability to national governments, and by extension European taxpayers, but also necessitate a thorough debate about whether the EU should really be attempting so many different things with its aid spending (many of which we argue national governments could do on their own - member states are perfectly capable of donating money to the UN and World Bank without the EU's help).

It's behind this complexity that the fundamental problems of the EU's aid budget lie, which the Commission's responses to our criticism demonstrate. The mixed objectives lead to some pretty blatant contradictions and prevent a sensible discussion about the specific problems with the component parts.

Firstly, in our report we note that, in 2009, only 46% of the Commission's 'Official Development Assistance' (ODA) was spent in lower income countries, illustrating a lack of poverty focus. The reason for this is because, although some of the EU's aid programmes are geared explicitly at poorer countries, a large amount of EU aid is spent on neighbouring countries.

The Commission says our figure of 46% is "misleading", since no lower income country "is eligible for the neighbourhood funding, ENPI [Eastern Europe, Middle East, and North Africa] or IPA [Turkey and the Balkans], which represents a sizable portion of EU aid."

This is precisely our point. Much of the Commission's aid budget is spent in neighbouring countries, which are relatively wealthy in global terms. But, crucially, this is still counted by the Commission as 'development aid', or ODA, in its official figures (we have explained the logic of the figures and the concept of ODA in greater detail here).

The 46% figure is, therefore, not misleading but merely illustrates the mixed priorities of the EU's aid budget. The real question is whether the Commission's aid is pursuing the right aims and how much money should be allocated to each of them. But the Commission's refusal to acknowledge the logic of its own position makes a debate on the real issues incredibly difficult.

The Commission points out that one of its aid programmes, the European Development Fund (EDF), sees 85% of its funding spent in lower income countries. In fact, this is a point we make ourselves in the report. The EDF also happens to be the only part of the EU's aid budget that is based on voluntary contributions from national governments rather than from mandatory contributions to the central EU budget. According to the UK's Department for International Development (DfID), the UK is able to "drive much better performance" with the EDF, precisely because the UK's contribution to it is voluntary. Sadly, the Commission chooses not to address this point.

Secondly, the Commission also takes exception to our statement that "geographical proximity and ties with former colonies continue to determine the destination of much of the Commission's foreign aid". The Commission claims this is "simply false", which is quite frankly a bizarre accusation since the Commission's response also contains the following defence of neighbourhood spending:

"The EU has a real interest in fighting poverty on the EU's borders, for example in Northern Africa and Central and Eastern Europe, where poverty breeds insecurity and illegal migration. Only by helping these countries create stable democracies with economic chances for its citizens will we address the root causes of these problems, which are of interest to us all."

"The case of Turkey must therefore be understood under this light and in particular of its efforts to transform its economy as it continues the process towards accession to the EU: Turkey is indeed the biggest recipient of EU funds due to its status of candidate countries to the EU."

The Commission's impassioned defence of EU aid funding to countries on Europe's borders patently shows that "geographical proximity" plays a strong determining factor in EU aid. Our point here is that when it comes to "fighting poverty", targeting the world's poorest countries seems a better place to start. Funding for neighbouring countries might have a role to play but, again, it is a question of degree and what the EU is trying to achieve (we look at this in closer detail here).

However, most importantly and revealingly, despite going to the lengths of a 14 page response, the Commission has completely failed to engage with our main recommendation: that national contributions to EU aid spending should be made voluntary.

There is a legitimate discussion to be had about whether the Commission is simply funding countries that the member states would be helping anyway – what officials in Brussels describe as the ‘division of labour’. But, on the back of our report, the UK’s Development Minister Andrew Mitchell has called on the EU’s aid to be far more “targeted at the poorest people”, while the Netherlands’ Europe Minister Ben Knapen has suggested, “We need to help our neighbours, that is in our interest. But such assistance must be reconsidered, especially when it comes to the significant assistance to candidate countries such as Turkey.”

If, as the Commission says, member states would spend the same amount of money on their neighbours anyway, why not relinquish control and make national contributions to EU aid spending voluntary? We would soon find out who is right.

Why is the Commission so reluctant to move to a voluntary-funded model? The answer, one suspects, is that it would result in far less money heading to Brussels and because it goes to the root of the EU's current modus operandi, of accumulating power at the expense of member states. People might even start to question whether other areas of the EU budget might be better funded nationally rather than via Brussels: the Common Agricultural Policy, or regional spending within the Union, perhaps?

It is, above all, the Commission's silence on this crucial point that speaks volumes.

Deja Vu

The EU looks set to celebrate the one year anniversary of the Greek bailout by... giving it another bailout.

The fact that a second bailout for Greece is even being considered almost defies belief. Greece’s credit rating got downgraded again yesterday by S&P, solidifying its position as junk and highlighting the fact that a debt restructuring is by almost all accounts, except the EU powers that be, unavoidable. On top of this, there is also talk of further relaxing the original rescue conditions and reducing the interest rate. At some point one has to ask, to what end?

Not only has the EU failed to grasp the public opinion spreading across Europe (no more bailouts), they’ve also completely lost sight of the end game – finding a solution to the eurozone crisis.

Both the Greek and Irish bailouts failed to achieve anything, except maybe buying time as BBC’s Stephanie Flanders suggests (that’s some expensive time by the way). Both countries have seen their cost of borrowing skyrocket and continue to have massive debt and deficit levels. Furthermore, Greece has ultimately failed to meet the conditions laid down in the first bailout agreement, rewarding it with another bailout as well as relaxing those conditions seems to supercharge the moral hazard created by the original bailout. Combine this with the ongoing resistance to imposing losses on bondholders and it becomes clear just what perverse incentives these actions could be creating.

Relaxing the bailout conditions doesn’t really help anyone, least of all Greece, because the deficit/debt cutting and labour market reforms are vitally important for the future of the Greek economy. Some relief might sound good right now but ultimately these reforms will need to be made if Greece is ever to have a chance of becoming competitive again.

It’s becoming increasingly clear that eurozone leaders are just trying to put off dealing with the situation until 2013, when the new permanent bailout fund (ESM) comes into force, for both political (its after some important core eurozone elections) and economic (Germany thinks its banks will be in better shape then) reasons. Reaching that date seems to be the new end above all else, no matter the cost (restructuring will only get more costly as debt continues to increase) or the futility of their actions.

Unfortunately, we feel like we've made all these arguments before, but at least we feel less alone this time... ( for example see here, here and here but there are countless others)

The EU and the Mediterranean: Good Neighbours?

As a follow-up to our much discussed report on the EU's external aid policy, on Sunday we published a new briefing looking at the effectiveness of EU assistance to North Africa and the Middle East. The EU's funding effort towards its Southern neighbours has so far been remarkable: more than €13 billion committed between 1995 and 2013. Not exactly peanuts.

Hence, in the light of recent events across the area, a few questions arise. Couldn't the EU have achieved more in return in terms of democratic reforms and political stability in the Mediterranean region? Was all of EU money well spent? What have the real benefits been for these countries?

In our briefing, we suggest some possible answers. First of all, in its relations with Mediterranean countries, the EU has privileged political stability over democracy, by developing close ties with autocratic regimes such as Egypt and Tunisia, and sometimes providing them with direct aid funding. The Commission has consistently increased its funding commitments to these countries despite noting limited or no progress in terms of democratic reforms and human rights in its own policy assessments.

This links to one of the EU's most frequent mistakes: adopting a 'one-size-fits-all approach' - the European Neighbourhood Policy in this specific case - for groups of countries which have very little in common. In fact, unlike former Soviet states, countries in North Africa and the Middle East have no chance whatsoever of joining the EU in future. Therefore, in the absence of the 'golden carrot' of EU membership, they have little or no incentive to go beyond those superficial reforms sufficient to persuade the Commission to keep its funding tap open.

This is something that has started to dawn on top EU officials. At the end of February, EU Enlargement Commissioner Štefan Füle told MEPs,

Many of us fell prey to the assumption that authoritarian regimes were a guarantee of stability in the [Mediterranean] region. This was not even Realpolitik. It was, at best, short-termism – and the kind of short-termism that makes the long term ever more difficult to build.

Similarly, in an op-ed published by several European papers yesterday, European Council President Herman Van Rompuy admitted,

In the past, we haven’t always respected our own values by giving priority to the interest in regional stability and even accepting regimes which weren’t democratic in order to counter the risk of fanatic dictatorships.

Neither have closer relations with the EU helped to boost Mediterranean countries' prosperity via increased trade. On the contrary, the EU's Southern neighbours have seen their annual trade deficit with the EU soar from €530 million in 2006 to €20.4 billion in 2010. In addition, Mediterranean countries still have to face tariff quotas on their exports of agricultural products to the EU and - with the exception of Tunisia, Algeria and Morocco - remain subject to the EU's over-complicated system of 'rules of origin'.

There are also examples of poor monitoring. €40m was handed out in the Palestinian territories in 2006 and 2007 with no “documentation to record disbursements”, according to an audit by ADE, a Belgian consultancy hired by the Commission. “We simply don’t know where the funds went to because there was no evidence of how they were spent,” said Tanguy de Biolley, a director of ADE, to the Sunday Times.

Making aid to Mediterranean countries voluntary, removing barriers to trade and adopting strategies tailored to each one of the EU's partners could all help boost the effectiveness of the EU's Neighbourhood Policy in the Mediterranean and ensure that European taxpayers get better value for their money.

It is good to see the likes of Van Rompuy and Füle willing to admit there are problems, but what is really needed is a thorough debate about what role the EU should play in development funding. Tinkering with existing policies won't solve the deep-seated confusions and contradictions present in the EU's approach.

Greece considering eurozone exit?

Breaking news from Der Spiegel online suggesting that Greece is considering leaving the eurozone. According to the article a secret emergency meeting of eurozone finance ministers have been called.

From the article:

SPIEGEL ONLINE has obtained information from German government sources knowledgeable of the situation in Athens indicating that Papandreou's government is considering abandoning the euro and reintroducing its own currency.

Alarmed by Athens' intentions, the European Commission has called a crisis meeting in Luxembourg on Friday night. In addition to Greece's possible exit from the currency union, a speedy restructuring of the country's debt also features on the agenda. One year after the Greek crisis broke out, the development represents a potentially existential turning point for the European monetary union -- regardless which variant is ultimately decided upon for dealing with Greece's massive troubles.

Obviously, if there is any truth to the rumour, this is a huge turn of events. We’re still sceptical since it seems a bit out of the blue, but plenty of big events have been so we’re definitely still waiting with bated breath for more details. What's clear is that in the long-term, there's no way that Greece could have sustainable economic growth inside the Single Currency (it would need permanent subsidies).

The euro has already started dropping on the news, suggesting it may have started filtering through to the markets.

The commission and the German government have also issued responses denying the rumours - unsurprsingly quick off the draw for once.

If they were to leave, especially with such short notice and lack of planning, the fallout wouldn’t be short of financial chaos. Expect massive bank runs in Greece, money flowing away from the euro, a huge Greek devaluation probably leading to a default due to the massive increase in Greek debt. In the long-term, it may be inevitable, however. What was that we’ve been saying about having a plan in place for such an occurrence…?

EU snoozes and loses Latin American trade?

While the EU wastes time and effort with internal squabbles, is anyone paying attention to its external trade agenda?

Well, to be fair, the Commission has done some decent things in this area lately - the South Korea Free Trade Agreement for one. But a recent report from the United Nations Economic Commission for Latin America and the Caribbean (CEPAL in Spanish) should be cause for concern. It reveals that, if predicted growth targets continue, China is tipped to overtake the EU as Latin America and the Caribbean’s second biggest trading partner in 2014.

According to CEPAL, in 1990, Latin America’s exports to the EU reached 25%, while imports from the EU were 20%. In 2009, this exchange had reduced dramatically to 14% for both exports and imports.

In recognition of this downward trend, last year the EU, under the rotating Spanish Presidency, relaunched negotiations for an EU-Mercosur Association Agreement. An EU-Mercosur deal would pave the way for a new phase in regional trade relations, with the creation of one of the world’s largest free trade zone, boasting a population of 750 million.

Latin America is a key growth market. Mercosur countries’ economies have shown resilience in the face of the international economic crisis, after initial difficulties, the economies are now bouncing back and are expected to grow between 7.5% - 9.5% this year. As their economies grow, so does their negotiating position in international fora. In contrast, the eurozone’s entrenched economic difficulties weaken the EU’s hand. As member states’ austerity measures reduce demand within the bloc, the EU desperately needs to bolster its trade relationship with other export markets.

Negotiations are expected to conclude on 8 July, however, whether or not a deal can be struck remains to be seen. Not unexpectedly, negotiations are tough as both sides must agree to major reciprocal concessions on trade – with focus on industrial products, agriculture and intellectual property rights. A report by the Commission’s Joint Research Centre, conveniently leaked to Reuters this week, claims that European farmers could lose more than €3bn in annual revenue by 2020 and up to 33,000 farm jobs if the current draft EU-Mercosur trade deal is approved. The Reuters article does note at the end, however, that the current deal would bring general net benefits of €4.5bn to both regions.

As the EU’s role in the world becomes ever more faded, it’s more necessary than ever that EU leaders lift their heads out of the sand and focus more energy on trading with the world. The EU cannot afford to snooze and lose Latin America’s trade.

You call that austerity?

We imagine that will be the response by many in Athens and Dublin to the conditions which have been announced along with the €78bn bailout deal for Portugal. Jose Socrates, the caretaker Portuguese PM, was almost boasting on TV last night about how much more favourable the terms were for Portugal compared to Greece and Ireland. In the cold light of day though, most of the details we’ve seen so far focus on what won’t happen rather than what will, raising the question: Where are the necessary savings actually going to come from? That should be slightly concerning for taxpayers across the EU.

The point that has attracted most attention is the easing of the deficit cutting programme. But in actual fact the targeted cut is higher than before, given the change in the level of the deficit.

Previous 2010 estimate and 2011 target: 7.3% and 4.6% = change of 2.7%

New 2010 estimate and 2011 target: 9.1% and 5.9% = change of 3.2%

Most observers, including us, didn’t expect Portugal to be able to achieve its original level of cuts, let alone a higher level - especially when combined with lower growth prospects. That was before we even found out what was not going to be cut…

According to Socrates the conditions will not include cuts to: minimum wages, public sector pay, education spending and healthcare. In addition, there will be no additional public sector job cuts and the retirement age will not be increased. That is a huge list of things that will be left untouched, especially since savings of 3.2% of GDP are expected.

So, seriously, where is the money coming from?

Well, there are expected to be some, limited, cuts to higher scale state pensions as well as a decrease in the amount and duration of unemployment benefit. There is also a plan to raise VAT on electricity. In terms of increasing revenue, there was talk of privatising €5.3bn in public assets but not Caixa Geral de Depositos, the largest credit institution, which was widely expected to be sold to raise funds. So all in all not exactly an earth-shattering plan for saving 3.2% of GDP.

To be fair, there are more details and plans to be announced but considering what has already been taken off the table we’re not overly optimistic.

Admittedly, too much austerity would definitely be bad for the economy and finding the right balance is a hard line to tread. But for those of us who already believe the bailouts to be a waste of money, since they won’t solve any of the long term problems, these kinds of conditions are almost just adding insult to injury.

Is Turkey going cold on EU membership?

As Europe limps along economically and struggles to speak with a single voice on… well almost anything, and at a time when the EU's two flagship projects - free movement and the single currency - are coming under massive strains, the contrast between the bloc and perennial candidate country Turkey could not be starker.

In 2010, the EU-27’s GDP grew by 1.8%, while in comparison, Turkey’s GDP grew by 8.2% over the same period (and by a phenomenal 150% since 2003), with steady growth of 4.6% projected for 2011. In parallel to its strong economic performance, Turkey is also becoming increasingly self-assertive on the world stage, most notably when, together with Brazil, it took the diplomatic initiative over the Iranian nuclear programme last year.

It now seems as if the increasingly confident Turks are turning against the idea of EU membership. Only 38% expressed support for the idea last year, compared with 73% in 2004. That's a spectacular drop.

Should this be of concern to the EU? Most definitely.

Irrespective of the pro and cons of Turkey joining the EU, Brussels' approach to this issue really represents the worst of all worlds. By constantly sending mixed signals about whether or not Turkey is in fact welcome - the EU risks antagonising a country that it really needs on side. Do you really want to tick off a country that is up and coming, possessing a huge market (that Europe's struggling economy desperately needs) - and whose geo-strategic importance is second to none?

France in particular, but also to some extent Germany, have not exactly encouraged the country's attempt to gain full EU membership despite the fact that Turkey has been an official candidate country since 1999 and in accession talks since 2005. You'd forgive Turks for feeling insulted by being messed around by the EU. This is now reflected in Turkish public opinion.

The problem with the EU's mixed-signals approach is that it could push Ankara in to the arms of far less pleasant countries, such as Iran. That would be a spectacular own goal for Europe.

It is also possible that full EU membership is becoming less appealing for the Turks for other reasons. A union in which debt is being past around and several countries are on the dole - and control over a country's political and economic future is partly in other peoples' hands - just isn't that attractive. While many in Europe are worried they would end up having to subsidise Turks, the idea of being asked to bail out troubled eurozone members (least of all Greece!), can hardly be appealing to the Turks either.

But there's another side to this which is often overlooked. Just as the EU has in the past acted as a driving force behind modernisation and reform in Turkey (albeit with mixed results), so Turkey could contribute to some badly needed reforms in the EU. An EU which has Turkey as a full member simply would have to withdraw from some crucial policy areas where it has over-stepped its mark in the past. Justice and Home affairs for example, where EU integration has made some quantum leaps over the last few years. Or the Common Agricultural Policy, which would probably implode if Turkey were to join, or the Structural Funds, or the excessive use of Qualified Majority Voting (as Turkey would instantly become the most powerful country in the Council of Ministers due to its size). In other words, Turkey's size and composition could in fact be a strong argument in favour of the country joining - at least for those of us who want to see some real and radical EU reform.

In fact, the UK of all member states ought to consider the strategic benefits of using the issue to build momentum for institutional reform within the EU. The EU could also draw lessons from Turkey’s dynamic economic performance which will be crucial to the continent’s future prosperity, especially in the context of Europe’s looming demographic crisis. Clearly, there are significant problems with the Turkish candidature that would have to be overcome, from the Cyprus issue to the status of the Kurdish minority, so it is important not to jump the gun here.

But for politicians - in the UK and beyond - ruling out the prospect of Turkey of tomorrow joining the EU of tomorrow would be a pretty serious mistake.

From tomato sauce with pasta to Honorary German

Bild, Germany’s largest newspaper, yesterday came out in support of Mario Draghi’s candidacy for the role of ECB President, proclaiming him to be a “Honorary German Citizen”.

Clearly they don’t do things by halves…

In February Bild screamed "Mamma Mia!" over the thought of an Italian running the German currency. They claimed: “For Italians, inflation is a way of life, like tomato sauce with pasta.”

We’d expect that it won’t be too long until Merkel publicly comes out in support of Draghi (given that neither Sarkozy nor Bild would have supported him without her private approval).

To be honest, he’s been the only real candidate for a while – in terms of both skills and personality – but the fact that it took so long for an established professional, and the right man for the job, to overcome the massive stereotypes in Europe might say something about so-called EU unity… the picture doesn’t help either.

Lessons from Europe

Last week, Open Europe participated in a discussion in Washington DC hosted by the Heritage Foundation, looking at the debt and deficit spiral haunting both the US and Europe. The discussion can be viewed here.

In a note published last week, in tandem with the Heritage Foundation’s Sally McNamara and J.D. Foster, we also outlined ten economic lessons from Europe. We noted,

The primary lesson from the Eurozone sovereign debt crisis is that running large deficits and accumulating debt with no indication of changing will always translate into higher interest payments and likely higher interest rates, meaning more tax revenue will be consumed just paying for past fiscal sins. Greece, Ireland, and Portugal are now facing interest rates of 13 percent, 10 percent, and 9 percent, respectively, and still face the very real possibility of defaulting.

The U.S. is on dangerous ground by not tackling its current and future deficits with enough urgency. The Obama Administration seems to be relying on markets continuing to provide it with near unlimited liquidity at reasonable rates. But this cannot last forever. Even absent a fiscal correction, interest rates are widely expected to rise substantially in the next few years as the global economy rebounds. For example, the Administration forecasts a rise in the 10-year Treasury rate of 230 basis points. Add in the ongoing deficits, and investors will eventually give the United States the Irish treatment, raising the cost of borrowing much more.

Read the full note here.