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Nobel Economics Prizewinner Paul Krugman on “The Euro Trap”

Posted on 5 Bealtaine, 2010 by NationalPlatform.Org

On Monday May 3rd, the Irish Times carried an article by Nobel Economics Prizewinner Paul Krugman on “The Euro Trap”. Its main contention was that the euro-realists and euro-sceptics who had warned against the dangers of abolishing national currencies to form an EU currency union were being proved right by current events.

The austerity being imposed on Greece so that it can repay what it owes to German, French and other banks could be alleviated if Greece had its own drachma to devalue, thus helping to restore its economic competitiveness and enabling its government to use its own money to encourage domestic demand. Exactly the same point is true of Ireland.

This article was first carried as an op-ed piece in the New York Times last week. Since then Krugman has written the following related pieces on his blog, which may be of interest.

http://krugman.blogs.nytimes.com/2010/05/04/default-devaluation-or-what/
The Conscience of a Liberal
Paul Krugman
Tuesday 4 May 2010
Default, Devaluation, Or What?

Is there anything more to say about Greece? Actually, I think so.

Observers like Charles Wyplosz, who point out that the adjustment being demanded of Greece is extraordinary and hard to see happening, are right. And yet .. one thing I haven’t seen pointed out sufficiently is that a debt restructuring, or even a complete cessation of debt service, wouldn’t do all that much to ease the burden.

Consider what Greece would get if it simply stopped paying any interest or principal on its debt. All it would have to do then is run a zero primary deficit – taking in as much in taxes as it spends on things other than interest on its debt. But here’s the thing: Greece is currently running a huge primary deficit – 8.5 percent of GDP in 2009. So even a complete debt default wouldn’t save Greece from the necessity of savage fiscal austerity.

It follows, then, that a debt restructuring wouldn’t help all that much – not unless you believe that getting forgiveness on much of Greece’s existing debt would make it possible to take on substantial new debt, which doesn’t seem very likely.

The point is that the only way to seriously reduce Greek pain would be to find a way to limit the costs of fiscal austerity to the Greek economy. And debt restructuring wouldn’t do that.

Devaluation would, if you could pull it off. I see that Vox has reposted the classic Eichengreen paper on why you can’t. I’ve already written that this argument, which I found extremely persuasive when first made, now seems to me less than watertight. But let me be a little more specific.

The way things are going, it looks quite possible that Greece will spiral into domestic as well as debt crisis, and be forced to take emergency measures. And that makes me think of Argentina in 2001. At the time, Argentina had the convertibility law, supposedly permanently pegging the peso to the dollar – and that was supposed to be irreversible for the same reasons the euro is supposed to be irreversible now. Namely, to repeal the law would require extensive legislative discussion, and any such discussion would set off destructive bank runs, hence there was no way to undo the fixed exchange rate.

But by late 2001 Argentina was a mess, with many emergency measures in place in an effort to contain the situation. These included the corralito, severe restrictions on bank withdrawals to contain bank runs – and one unintended consequence of all this was that the bank runs argument against suspending convertibility became moot.

Is it really impossible to see something similar happening in Greece? And if it does, might not other countries’ membership in the eurozone be called into question?

http://krugman.blogs.nytimes.com/2010/05/01/why-devalue/
The Conscience of a Liberal
Paul Krugman
Saturday 1 May 2010
Why Devalue?

As the debate over possible departures from the euro heats up, there seems to a lot of confusion over the possible uses of devaluation. The main argument I’m hearing goes like this: since Greece’s debt is in euros, devaluing won’t relieve the debt burden – so it won’t help.

But that’s missing the point. True, devaluation wouldn’t reduce the debt burden. But it would reduce the macroeconomic costs of fiscal austerity.

Think for a moment about Greece’s predicament now, even if it were to default on its debt. It’s running a huge primary deficit, so even if it were to stop paying any debt service it would be forced to slash spending and/or raise taxes, to the tune of 8 or 9 percent of GDP.

This would have a massively contractionary effect on the Greek economy, leading to a surge in unemployment (and a further fall in revenues, making even more belt-tightening necessary).

Now, if Greece had its own currency, it could try to offset this contraction with an expansionary monetary policy – including a devaluation to gain export competitiveness. As long as it’s in the euro, however, Greece can do nothing to limit the macroeconomic costs of fiscal contraction.

And that’s why a devaluation would help – it wouldn’t reduce the need for fiscal adjustment, but it would reduce the costs associated with fiscal adjustment. As I argued yesterday, this difference is an important reason why Britain, with a primary deficit as large as Greece’s, isn’t in anything like the same amount of trouble.

Or to put it another way, exchange rate flexibility doesn’t solve fiscal problems by itself – but it makes solving such problems much easier.

“The Euro Trap”
Paul Krugman
New York Times, Thursday 29 April; reproduced in the Irish Times, Monday 3 May

Right now everyone is focused on public debt, which can make it seem as if this is a simple story of governments that couldn’t control their spending. But that’s only part of the story for Greece, much less for Portugal, and not at all the story for Spain.

The fact is that three years ago none of the countries now in or near crisis seemed to be in deep fiscal trouble. […] And all of the countries were attracting large inflows of foreign capital, largely because markets believed that membership in the euro zone made Greek, Portuguese and Spanish bonds safe investments.

Then came the global financial crisis. Those inflows of capital dried up; revenues plunged and deficits soared; and membership in the euro, which had encouraged markets to love the crisis countries not wisely but too well, turned into a trap.

What’s the nature of the trap? During the years of easy money, wages and prices in the crisis countries rose much faster than in the rest of Europe. Now that the money is no longer rolling in, those countries need to get costs back in line.

But that’s a much harder thing to do now than it was when each European nation had its own currency.

Back then, costs could be brought in line by adjusting exchange rates … Now that Greece and Germany share the same currency … the only way to reduce Greek relative costs is through some combination of German inflation and Greek deflation. And since Germany won’t accept inflation, deflation it is.

The problem is that deflation – falling wages and prices – is always and everywhere a deeply painful process. It invariably involves a prolonged slump with high unemployment. And it also aggravates debt problems, both public and private, because incomes fall while the debt burden doesn’t.

[…]

All this is exactly what the euro-sceptics feared. Giving up the ability to adjust exchange rates, they warned, would invite future crises. And it has.

So what will happen to the euro? Until recently, most analysts, myself included, considered a euro breakup basically impossible … But if the crisis countries are forced into default, they’ll probably face severe bank runs anyway, forcing them into emergency measures like temporary restrictions on bank withdrawals. This would open the door to euro exit.

So is the euro itself in danger? In a word, yes. If European leaders don’t start acting much more forcefully, providing Greece with enough help … a chain reaction that starts with a Greek default and ends up wreaking much wider havoc looks all too possible.

[…] What the crisis really demonstrates, however, is the dangers of putting yourself in a policy straitjacket. When they joined the euro, the governments of Greece, Portugal and Spain denied themselves the ability to do some bad things, like printing too much money; but they also denied themselves the ability to respond flexibly to events.

And when crisis strikes, governments need to be able to act. That’s what the architects of the euro forgot […]

Filed under: EU Economy, Euro / Monetary Union | Tagged: , , , , , | Leave a comment »

Greek Bail-Out Crisis

Posted on 3 Bealtaine, 2010 by NationalPlatform.Org

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7591027/Greek-aid-in-doubt-as-German-professors-prepare-court-challenge.html
Greek aid in doubt as German professors prepare court challenge
Ambrose Evans-Pritchard
The Daily Telegraph
15 Apr 2010

A quartet of German professors is to preparing to challenge the EU-IMF rescue for Greece at Germany’s constitutional court as soon as the mechanism is activated, claiming that it violates the ‘no-bail-out’ clause of the EU Treaties.

http://www.ft.com/cms/s/0/461663a0-5613-11df-b835-00144feab49a.html
Europe’s choice is to integrate or disintegrate
Wolfgang Münchau
Financial Times
Monday 3 May 2010

The aim of the rescue package agreed for Greece cannot conceivably have been to prevent a default… the numbers do not add up. The main purpose I can detect is to reverse the rise in Greek bond yields and stop contagion.

[…]

A debt restructuring will eventually be necessary, however, because Greece’s debt to gross domestic product ratio is going to rise from its current 125 per cent to about 140-150 per cent during the adjustment period. Without restructuring, Greece will end up austere, compliant, and crippled.

The decision to take Greece out of the capital markets for three years will prevent immediate ruin but has only a marginal impact on the country’s future solvency. The underlying assumption of the agreement is that Greece can sustain austerity beyond the time horizon of the accord, without falling into a black hole. The latter is particularly optimistic. Standard & Poor’s, the rating agency, last week estimated that Greece would not return to its 2009 level of nominal GDP until 2017.

[…]

On my estimate, the total size of a liquidity backstop for Greece, Portugal, Spain, Ireland and possibly Italy could add up to somewhere between €500bn ($665bn, £435bn) and €1,000bn. All those countries are facing increases in interest rates at a time when they are either in recession or just limping out of one. The private sector in some of those countries is simply not viable at those higher rates.

…three things are required if the eurozone is to survive in the medium term: a crisis resolution system, better fiscal policy co-ordination, and policies to reduce intra-eurozone imbalances. But this is only the minimum necessary to get through the next few years. Beyond that, the eurozone will almost certainly need both an embryonic fiscal union and a single European bond.

I used to think that such constructions would be desirable, albeit politically unrealistic. Now I believe they are without alternative, as the experiment of a monetary union without political union has failed. The EU is thus about to confront a historic choice between integration and disintegration.

Germany can be relied on to resist every one of those measures. In the meantime, European leaders will treat each new crisis with the only instrument they have available: an injection of borrowed liquidity. But this instrument has a finite lifespan. If it is not blocked by popular unrest, it will be blocked by constitutional lawyers.

… There can really be no doubt about what the “no bail-out” rule was intended to mean. It meant that Greece should not be supported. The EU had to resort to some unseemly legal trickery to argue that advancing junior loans at a massive scale to an effectively insolvent country does not constitute a bail-out…

So what is the endgame of the eurozone’s multiple crises? For Greece it will be debt restructuring, a polite term for negotiated default. The broader outcome is more difficult to predict: it will either be deep reform of the system or a break-up.

Filed under: EU Economy, Euro / Monetary Union | Tagged: , | Leave a comment »

The real costs of eurozone membership

Posted on 28 Aibreán, 2010 by NationalPlatform.Org

The article below from the Financial Times points to the lack of public debate across the EU on the real implications of the 1992 Maastricht Treaty’s proposal to abolish national currencies and replace them with the euro.

In Ireland’s 1992 referendum on the Maastricht Treaty the main thrust of public debate was on the Abortion Protocol attached to that Treaty.

There was virtually no discussion of the economics involved, apart from the fact that it would make it easier for Irish tourists to go on holiday on the continent and that it would give us permanently low German-level interest rates! The latter in due course helped impel our early-2000s borrowing binge.

The article mentions Professor Albrecht Schachtschneider and his colleagues, who launched a constitutional challenge to Germany’s ratification of the Maastricht Treaty at the time. This led to the Court’s well-known Brunner judgement, which laid down the constitutional principles governing Germany’s adherence to Economic and Monetary Union.

My colleagues and I had the pleasure of welcoming Professor Schachtschneider when he came to Ireland last September to show solidarity with those urging a No vote to the Lisbon Treaty.

We wish him and his colleagues every success if they now take action in the German Constitutional Court against the breach of the EU Treaties which a financial bail-out of Greece or any other EU State in face of the current bond-market crisis would constitute.

http://www.ft.com/cms/s/0/bff9757a-522d-11df-8b09-00144feab49a.html
Greek crisis begets a German backlash
David Marsh
Financial Times
Wednesday 28 April 2010
(The writer is senior adviser to Soditic-CBIP LLP, chairman of SCCO International and author of “The Euro – The Politics of the New Global Currency”)

When Josef Joffe, then foreign editor of the German daily Süddeutsche Zeitung, wrote a 4,000-word essay in December 1997 attacking the planned formation of the European single currency, he published it first in English, in the New York Review of Books. “Never in the history of democracy have so few debated so little about so momentous a transformation in the lives of men and women,” noted Mr Joffe. As if to confirm his point, the article appeared in an abridged German translation in the Süddeutsche Zeitung more than a month later, unobtrusively buried in a weekend supplement.

The episode illustrates past barriers to plain speaking about economic and monetary union (EMU). Many ordinary Germans always feared the euro would be less stable than the D-Mark. Yet, reflecting postwar belief that German interests ineluctably overlapped with Europe’s, there was little discussion of the risks. This went beyond Germany. One senior Dutch central banker, now retired, says most European governments – including his own – agreed the Maastricht treaty 20 years ago without understanding what they had signed into law.

In April 1998, Germany’s parliament voted through the euro with only minimal opposition. Now, the German-in-the-street is making up for lost time…

There is an air of déjà vu… four German professors who launched an unsuccessful anti-euro lawsuit at the constitutional court in 1998, are preparing fresh legal action. Their claims of infringements to the EMU rules, in particular over the “no bail-out clause” preventing joint payment of weaker states’ debts, have a much greater chance of success this time.

As Greece approaches a possible debt restructuring and even a euro exit, questions are due on why warning signals went ignored that weaker eurozone countries were building up unsustainable borrowings…

[…]

Inadequate discussion of the eurozone’s problems has been particularly acute on the issue of whether monetary union required political union. Both the Bundesbank and Helmut Kohl, the former German chancellor, suggested in 1991 that without political union, EMU would eventually fail… In 2006 Otmar Issing, former chief economist at the Bundesbank and then the ECB, said monetary union “can work and survive … without fully fledged political union”. Now Mr Issing says: “In the 1990s many economists – I was among them – warned that starting monetary union without having established a political union was putting the cart before the horse.”

Leading German figures never explained that large deficits in countries such as Greece would eventually impinge on Germany’s own finances. Germany, the main surplus country, has inevitably become the largest creditor of the eurozone’s heavily indebted peripheral nations. As Mr Issing said in 1999, the no bail-out clause was meant to prevent the “negative external effects of national misbehaviour” from spilling over elsewhere. In fact, German taxpayers will have to pay for Greece: directly, through emergency government loans; indirectly, through supporting German banks that will be hit by a Greek debt restructuring; or, conceivably, both.

This is one of many costly facts about monetary union now bursting disagreeably to the surface.

Filed under: EU Economy, Euro / Monetary Union | Tagged: , | Leave a comment »

FT: Greece is Europe’s very own subprime crisis

Posted on 27 Aibreán, 2010 by NationalPlatform.Org

This is going to be the most important week in the 11-year history of the euro-currency, according to Financial Times associate editor Wolfgang Munchau in the article below.

A Greek default on its debts now looks virtually inevitable, the only question being when.

The Irish Government has agreed to contribute €480 million to the joint EU/IMF bail-out for Greece aimed at staving off this default. The opposition Fine Gael and Labour parties promise to back the Government in this.

If Greece defaults, Irish taxpayers will never get all of this money back.

The 11 EU countries that have not adopted the euro – the UK, Sweden and Denmark amongst them – are being asked to contribute only to the IMF part of the loan to Greece, viz. 15 billion euros out of a promised total of 45 billion. The 16 eurozone members, including Ireland, promise to lend the other 30 billion.

A question: will Ireland be expected to contribute to both the IMF part and the EU part of this Greek loan, thus giving dollops of money from two sources to Greece, in contrast to the 11 EU Members States which have not adopted the euro?

http://www.ft.com/cms/s/0/47b429f4-5091-11df-bc86-00144feab49a.html
Greece is Europe’s very own subprime crisis
Wolfgang Münchau
Financial Times
Monday 25 April 2010

[…] Some parliamentarians… argue that the best solution would be for Greece to leave the eurozone and rejoin later. On this point, they are supported by large parts of the country’s legal and economic establishment.

Their argument is full of legal hypocrisy. Those who make it pretend to care deeply about the strict fulfilment of the Maastricht Treaty’s “no bail-out” clause. Yet they see no problem in advocating a breach of European law by proposing a Greek exit from the eurozone. Under existing law Greece cannot be pushed out. In fact Greece cannot leave the eurozone voluntarily, without having to leave the EU as well. In any case, it is smarter for Greece to default inside the eurozone than outside. So what happens if the Bundestag blocks the aid? Greece will simply default, and this will put several German and French banks that hold large chunks of Greek sovereign and private debt at risk.

[…]

Just as unhappy families are unhappy in their own distinct ways, Portugal is different from Greece. But its problems are no less severe. The problem in Portugal is not the state sector. Portugal’s gross public sector debt is projected by the EU to be about 85 per cent of gross domestic product by the end of this year. This is high, but not exceptionally so. On my calculations, using data from the World Bank, Portugal’s external debt-to-GDP ratio, including public and private sectors, is a staggering 233 per cent – the government at 74 per cent and the private sector 159 per cent. The net international investment position is about minus 100 per cent of GDP – the amount by which Portugal’s financial assets abroad are outweighed by assets owned by foreigners in Portugal. The current account deficit is projected to remain at just under 10 per cent of GDP. This is an acute private sector crisis. And like Greece and Spain, Portugal has lost competitiveness against the eurozone average of some 15 to 25 per cent during its first decade in the eurozone…

Filed under: EU Economy, Euro / Monetary Union | Tagged: , , , | Leave a comment »

For Your Information: Ireland, EU, Eurozone, Banks & Economy – News & Analysis

Posted on 26 Eanáir, 2010 by NationalPlatform.Org

Ghosts of debt and jobs will haunt economy
The Irish Times – Tuesday, December 29, 2009
http://www.irishtimes.com/newspaper/opinion/2009/1229/1224261354227.html
Morgan Kelly
OPINION : By 2015, Iceland will almost certainly be a lot better off than Ireland because it dealt decisively with its banks.

For grand corruption, though, we will have to look to Nama. By allowing the banks to dictate the terms of their bailout, the bank rescue was turned into the most lucrative and audacious Tiger Kidnapping in the history of the State, with the difference that, like the sheriff in Blazing Saddles, the bankers held themselves hostage.

Bad banks like Nama were tried on a large scale in the early 1930s in the US, Austria and Germany; and proved to be profoundly corrupt and corrupting institutions, whose primary purpose was to funnel money to politically connected businesses. The German bank is best remembered for setting up what we would now call a special purpose vehicle to fund the presidential election campaign of the odious Paul Hindenberg.

Bad banks do not just happen to be corrupt and anti-democratic institutions, it is what they are designed to be. Effectively, bad banks give governments the power to choose which of a country’s most powerful oligarchs will be forced into bankruptcy, and which will be resuscitated to emerge even more powerful than before.

Nama will get to pick which of the fattest hogs of Irish development will be sliced up and fed, at taxpayer expense, to better connected hogs (remember that Nama has been allocated at least €6.5 billion, considerably more than the Government saved by draconian budget cuts, to “lend” to favoured clients).

While Nama may have momentous political consequences, it has already failed economically: the Irish banks are still zombies, reliant on transfusions of European Central Bank funding to survive until losses on mortgages and business loans finally wipe them out. In the next few months we will discover if the State bankrupts itself by nationalising the banks; or if it has the intelligence to free itself from bank losses by turning the foreign creditors of banks into their owners, as Iceland has just done with Kaupthing bank.

It is ironic that by 2015, having devalued its currency and dealt decisively with its banks, Iceland will almost certainly be a lot better off than Ireland.

Why the eurozone has a tough decade to come
Financial Times – January 6 2010
http://www.ft.com/cms/s/0/54cc3b20-fa62-11de-beed-00144feab49a.html
Martin Wolf

What would have happened during the financial crisis if the euro had not existed? The short answer is that there would have been currency crises among its members. The currencies of Greece, Ireland, Italy, Portugal and Spain would surely have fallen sharply against the old D-Mark. That is the outcome the creators of the eurozone wished to avoid. They have been successful. But, if the exchange rate cannot adjust, something else must instead. That “something else” is the economies of peripheral eurozone member countries. They are locked into competitive disinflation against Germany, the world’s foremost exporter of very high-quality manufactures. I wish them luck.
[…]
Where does that leave peripheral countries today? In structural recession, is the answer. At some point, they have to slash fiscal deficits. Without monetary or exchange rate offsets, that seems sure to worsen the recession already caused by the collapse in their bubble-fuelled private spending. Worse, in the boom years, these countries lost competitiveness within the eurozone. That was also inherent in the system. The interest rates set by the European Central Bank, aimed at balancing supply and demand in the zone, were too low for bubble-fuelled countries. With inflation in sectors producing non-tradeables relatively high, real interest rates were also relatively low in these countries. A loss of external competitiveness and strong domestic demand expanded external deficits. These generated the demand needed by core countries with excess capacity. To add insult to injury, since the core country is highly competitive globally and the eurozone has a robust external position and a sound currency, the euro itself has soared in value.

This leaves peripheral countries in a trap: they cannot readily generate an external surplus; they cannot easily restart private sector borrowing; and they cannot easily sustain present fiscal deficits. Mass emigration would be a possibility, but surely not a recommendation. Mass immigration of wealthy foreigners, to live in now-cheap properties, would be far better. Yet, at worst, a lengthy slump might be needed to grind out a reduction in nominal prices and wages. Ireland seems to have accepted such a future. Spain and Greece have not. Moreover, the affected country would also suffer debt deflation: with falling nominal prices and wages, the real burden of debt denominated in euros will rise. A wave of defaults – private and even public – threaten.

The crisis in the eurozone’s periphery is not an accident: it is inherent in the system. The weaker members have to find an escape from the trap they are in. They will receive little help: the zone has no willing spender of last resort; and the euro itself is also very strong. But they must succeed. When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters.

Are we about to see the end of the much-vaunted eurozone?
The Observer – Sunday 3 January 2010
http://www.guardian.co.uk/commentisfree/2010/jan/03/peter-oborne-end-of-eurozone
Peter Oborne
In putting financial considerations before social ones, the governments of Europe have ensured that things can only get worse

It is nearly 20 years since the Conservative chancellor of the exchequer Norman Lamont made his notorious remark that unemployment was a “price worth paying” for the restoration of economic stability. Lamont was at once condemned for his comments, made at the height of Britain’s ill-fated membership of the Exchange Rate Mechanism. The progressive left universally denounced him as arrogant, brutal and out of touch. And yet, only two decades later, the European left has made the identical calculation. The imposition of the euro, and the rigid economic policy a single currency implies, is having socially catastrophic effects across much of Europe on a scale that dwarfs Britain’s suffering in the 1990s.

Consider the facts. In Spain, unemployment has already reached a gut-wrenching 19.3%. But unemployment for those between 16-24 is a catastrophic 42%. In Greece, youth unemployment is 25%, in Ireland 28.4% and Italy 26.9%. Marginal eurozone countries such as Greece, Spain and Ireland are not just in recession. They are in depression – and so long as they remain inside the euro there is no exit.

Before their decision to abandon economic sovereignty and sign up to the euro, policymakers had a tried and tested response to the kind of global setback of the last two years – depreciate the currency and loosen fiscal and monetary policy[…] But inside the euro, individual countries are stripped of the ability to manage their own economies. That is why the global recession has been far, far more devastating for some eurozone members than would otherwise have been the case – in just the same way that membership of the ERM inflicted wholly unnecessary damage on the British economy in the early 1990s.

The European single currency amounts to an experiment in social and economic engineering on a scale only very rarely before encountered in world history. The great question is whether it will work. There is a universal belief among the European political and economic elite that the euro will continue, no matter how much damage it inflicts or how many jobs it costs.
[…]
I believe that this heartless analysis is mistaken, and that the eurozone will in due course collapse (as Karl Marx might well have remarked) under the weight of its own contradictions. Economically, the euro can be spotted a mile off: it is a classic bankers’ ramp. It is designed to do all the things that bankers have historically wanted: create efficient markets, drive down the cost of labour, impose price stability, eliminate trade barriers, confound national boundaries and maximise corporate profits. Bankers don’t care much about youth unemployment in Madrid or home repossessions in Lisbon or riots on the streets of Athens. They worry about the bottom line and the euro has been very good for the bottom line, with stock markets up by an obscene 50% over the last eight months.

Should we divorce the euro?
The Sunday Business Post – 10 January 2010
http://www.sbpost.ie/commentandanalysis/should-we-divorce-the-euro-46642.html
David McWilliams

Joining a currency union is the economic equivalent of a marriage. If a country decides to give up its currency and get into bed with another currency, it would seem ludicrous to entertain this move without being sure that the union was suitable. As we all know, there is a difference between fancying someone and making the thing last.

To avoid single currency arrangements going sour, there is also a ‘matchmaker’ in economic theory. The economic matchmaker goes by the typically incomprehensible name of the ‘optimal currency area theory’. This theory is a checklist of economic attributes which need to line up in order for a monetary union to work.

For a currency union to work for a country, the most important thing is that the country trades overwhelmingly with the other members of the monetary union.

This ensures that all the countries in the union move roughly in the same economic cycle. It is also important that the structures of the respective economies are broadly similar, so that one country doesn’t experience a huge boom, while the rest are just motoring along nicely.

Having similar structures in banking and housing, for example, will imply that a country should not suffer a monumental bust, while the others are merely experiencing a normal recession. Equally, it is important that there is significant movement of people within the currency union – like there is in the US between its states – so that, if a country does slump, its citizens can move to find work in another member country.

In general, for a currency union to work, there should also be a single fiscal policy so that, when one area of the currency slumps, the rest of the union’s taxes go some way to ease the problems in the region in difficulty. This is how the currency unions in the US, Canada and Australia work.

Guess what? None of these attributes was in place when Ireland joined the EU economic and monetary union (EMU) and the euro. So it is clear that we didn’t join for economic reasons. So why did we join? It seems that we were too insecure to behave logically and this national insecurity – particularly among our senior mandarins – prevented us from having a debate.
[…]
The reason we should ask these questions is that it is clear the euro has been a disaster for Ireland, and will ensure our slump lasts considerably longer than it has to. When we look at other countries, we see that, of the three entrants into the then EEC in 1973,we are the only ones using the euro. However, we trade less with other eurozone countries than either Denmark or Britain.

The Irish Credit Bubble
University College Dublin Centre for Economic Research Working Papers Series – WP09/32 – December 2009
http://www.ucd.ie/t4cms/wp09.32.pdf
Google Cache (Web Page)
Morgan Kelly

While NAMA is intended to repair, for now, the damage to the asset side of Irish bank balance sheets from developer loans, their liability side appears unsustainable. The aggressive expansion of Irish bank lending was funded mostly in international wholesale markets, where Irish banks were able to borrow at low rates. From being almost entirely funded by domestic deposits in 1997, by 2008 over half of Irish bank lending was funded by wholesale borrowers through bonds and inter-bank borrowing. This well of easy credit has now run dry. In the words of Bank of England Governor Mervyn King: “But the age of innocence—when banks lent to each other unsecured for three months or longer at only a slight premium to expected policy rates—will not quickly, or ever, return.” As foreign lenders have become nervous of Irish banks, their place has increasingly been taken by borrowing from the European Central Bank and short-term borrowing in the inter-bank market. Payments from NAMA will allow Irish banks to reduce their borrowing by a trivial amount.

Without continued government guarantees of their borrowing and, more problematically, continued ECB forbearance, the operations of the Irish banks do not appear viable.
[…]
By pushing itself close to, and quite possibly beyond, the limits of its fiscal capacity, the Irish state has succeeded in rescuing Irish banks from their losses on developer loans. Despite this, these banks remain as zombies entirely reliant on continued Irish government guarantees and ECB forbearance, and committed solely to reducing their own debts.

While bank capital levels are, probably, adequate for the markedly smaller scale of their future lending, we will see below that even fairly modest losses on their mortgage portfolios will be sufficient to wipe out most or all of that capital. Having exhausted its resources in rescuing the Irish banks from the first wave of developer losses, the Irish state can do nothing but watch as the second wave of mortgage defaults sweeps in and drowns them. In other words, it is starting to appear that the Irish banking system is too big to save. As mortgage losses crystallise, the Irish government’s ill conceived project of insulating bank bond-holders from any losses on their investments is sliding beyond the means of its taxpayers.

The mounting losses of its banking system are facing the Irish state with a stark choice. It can attempt a NAMA II for mortgage losses that will end in a bond market strike or a sovereign default. Or it can, probably with the assistance of the IMF and EU, organise a resolution that shares property losses with bank creditors through a partial debt for equity swap. It is easy for governments everywhere to forget that their states are not wholly controlled subsidiaries of their banks but separate entities; and a resolution that transfers bank losses from the Irish taxpayer to bank bond holders will leave Ireland with a low level of debt that, even after several years of deficits, it can easily afford.

Filed under: EU Economy, Euro / Monetary Union, Irish Economy | Tagged: , , , , , , , , , | Leave a comment »

Daily Telegraph: Will Germany deliver on the Faustian bargain that created monetary union?

Posted on 28 Feabhra, 2009 by NationalPlatform.Org

DAILY TELEGRAPH
Monday 23.2.08

If Der Spiegel is correct, the German finance ministry is drafting rescue plans to prevent default on the edges of the eurozone leading to a full-blown collapse of Europe’s monetary system.

By Ambrose Evans-Pritchard

This is an entirely appropriate policy in economic terms. One dreads to think what would happen if the world’s twin reserve currency were to disintegrate at this stage.

But what about the solemn pledge to voters by Germany’s political elites – promiscuously given over the years – that monetary union would never leave them on the hook for the debts of half Europe?

The vast imbalances that have been allowed to build up under the seductive protection of EMU leave German taxpayers facing bail-out liabilities that exceed the cost of reparations after the First World War in proportional terms.

The political ground has not been prepared for this. EMU was foisted on the German people without a referendum, in the face of deep public scepticism and scathing criticisms by the professoriat. This failure to secure a mandate for such a revolutionary undertaking is coming back to haunt them.

Berlin is at last having to deliver on the Faustian bargain made by Germany’s political class when it swapped the D-Mark for French acquiescence in reunification. It must either go the whole way towards EMU fiscal union and take responsibility for Italy’s public debt (111pc of GDP by next year), Austria’s loans to Eastern Europe (70pc of GDP), the adventures of Ireland’s ‘Canary Dwarf’ (€400bn or so in liabilities), and Spain’s housing collapse (1m unsold homes), or jeopardize its half-century investment in the political order of post-war Europe. Letting EMU fail at this stage would have far higher costs than never having launched the project in the first place.

The alleged bail-out options include “bilateral bonds” where big brother countries agree to shoulder the credit risk for siblings, (who vouches for Italy and Spain?), or some form of EU bond.

[…]

For now, the bail-out talk has cowed speculators. The euro has rallied after weeks of sharp descent against the dollar. Credit default swaps (CDS) on Irish debt have fallen back below the red alert level of 400 basis points. But it has not been lost on the markets that Germany’s own CDS spreads have risen to a record 86. Are traders starting to ask whether Berlin is in a fit state to rescue anybody?

The German economy contracted at an 8.4pc annual rate in the fourth quarter as exports to Eastern Europe, Club Med, and the Anglo-sphere collapsed.

[…]

Last week chief economist Jurgen Stark attempted to head off the bail-out plans, reminding Berlin last week that rescues are prohibited by EU law. This is not strictly true – Article 100.2 allows aid in “exceptional circumstances” – but it gives powerful cover to anybody wishing to oppose the Steinbruck policy.

But whatever the legal theory, the political reality is that 700,000 Germans are going to lose their jobs this year as unemployment rises to 4.3m (IFO Institute). Voters are not going to look kindly on any party seen to divert German savings to Ireland or Club Med.

Architects of EMU were well aware that a one-size-fits-all monetary policy for vastly disparate nations would create serious tensions over time. They gambled that this would work to their advantage. The EU would be forced to create new machinery to safeguard its investment in the euro. It would be a “beneficial crisis”, bringing about the great leap forward to full union.

We are about to find out if they were right.

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⁂ European Central Bank capitulating in face of crisis

Posted on 28 Feabhra, 2009 by NationalPlatform.Org

Two similar articles from newspapers on the political Right and Left forwarded for your information by Anthony Coughlan:

TELEGRAPH
Tuesday 24.2.09

ECB faces mutiny from national bank governors as recession deepens
– The European Central Bank is capitulating.

By Ambrose Evans-Pritchard

For months the ECB held sternly to the high ground of orthodoxy as the US, Japanese, British, Canadian, Swiss and Swedish central banks slashed rates towards zero and embraced quantitative easing, but a confluence of fast-moving events is now forcing it to move.

The credit default swaps that measure bankruptcy risk on the debts of Ireland, Austria and a clutch of Latin Bloc states have vaulted to dangerous levels. In the case of Ireland, the slump is spilling on to the streets. Some 120,000 marched through Dublin over the weekend to protest austerity measures.

The slow fuse on Eastern Europe’s banking crisis has detonated, leaving Austrian, Belgian, Italian and other West European banks with $1.5 trillion (£1 trillion) in exposure.

It is happening just as industrial output collapses in the eurozone’s core states. Germany’s economy contracted at 8.4pc annualised in the fourth quarter. ECB president Jean-Claude Trichet said on Monday that “a process of negative feedback” has set in where the banks and the real economy are pulling each other down in a self-reinforcing spiral. Eurozone credit is contracting. Banks are rationing credit as deleveraging gathers pace.

Rob Carnell, global strategist at ING, said the ECB has been painfully slow to acknowledge the global deflation tsunami sweeping across Europe.

“It seems divorced from reality. It is clearly nonsense to talk about inflation now: it has been negative on average for six months. The eurozone purchasing managers’ index has fallen twice as fast as in the US, so the ECB should be acting even faster than the Fed,” he said.

Mr Trichet said the ECB has increased its balance sheet by ¤600bn (£525bn) since the Lehman collapse in September. The bank is providing “unlimited liquidity” in exchange for a wide range of collateral, including mortgage bonds issued for the sole purpose of extracting ECB funds.

But the ECB’s leading voices have adamantly refused to contemplate going to the next stage: buying bonds and other assets with “printed money”. They see that as the Primrose path to hell. This week the tone has abruptly changed, suggesting that a majority of the 16 national bank governors on the ECB council are having second thoughts.

The apparent ring-leader is Cypriot member Anastasios Orphanides, a former Fed official and a world authority on deflation traps. He said on Monday that the ECB may have to go beyond “zero-bound” rates and revealed that an “internal discussion” was under way.

Italy’s Mario Draghi is in the “activist-easing” camp. “The experience in the US in the 1930s and Japan in the 1990s suggests that it is necessary to fight, in the early phases of the crisis, the tendency for real interest rates to rise,” he said.

Finland’s Erkki Liikanen is of the same opinion. “We are facing the worst financial crisis in our time. It is important not to exclude, ex ante, any measures.”

Julian Callow from Barclays Capital said 10 ECB governors are now doves.

This amounts to a mutiny against the Bundesbank-dominated executive in Frankurt. It is no great surprise. They have to answer to their democracies. The plot is thickening.

The Euro, an Illusory Shield against the Crisis ?

L’Humanite, Paris , Thursday 19 February 2009,

by Isabelle Metral (Translated)

Most political leaders of euro-zone countries make it sound as though the single currency has shown its capacity to play a protective role as the financial crisis sweeps across the Old Continent. So much so that today, even the staunchest of the Euro-sceptics (the British, Icelanders, Swedes, or Danes) are supposed to have suddenly realized the advantages of joining the euro…

The claim was made by Joaquin Almunia, European commissioner for economic and monetary affairs, on Tuesday last.

The EU leader’s statement actually betrays a growing concern in the face of signals showing increasing divergences between the different regions or countries of the euro zone. These divergences might eventually lead some countries to consider opting out of the single currency.

The crisis shows up the very serious defects in the original conception of the euro.

Entirely obsessed as they were with the stability criteria put forward by financial markets, those that championed its creation in 1999 were aiming first at a “strong euro” in the hope of luring as much capital as possible to the European market.

Hence the curb on public spending (with the Maastricht treaty), the pressure on wages through the deregulation of labour markets that diminished labour’s negotiating power. “The euro has brought war over exchange rates to an end, but it has exacerbated competition over prices,” rightly claimed Jean-Paul Fitoussi, president of the Observatoire français des conjonctures économiques

Today, the deepening crisis and the effect of the competition between states that sink deeper and deeper into debt have the additional effect – a refinement on the earlier stages – of bringing the pressure of competition to bear on the States’ capacity to meet their debts (in treasury bonds).

Indeed, if euro zone countries are united by the single currency and the European Central Bank, the rates at which they get loans, and the conditions attached to them, vary from one country to the next. Before the crisis, the spreads remained quite limited. But with the plunge into recession, and the gigantic assistance granted by the various states through bank bail-outs or economic stimulus plans, this is no longer true.

Spain and Ireland, for instance, which until a short time ago, were still praised as models of economic success by pro-marketers in Brussels and elsewhere, are now going through a period of fierce turbulence. As a result, they are at a disadvantage on financial markets and find it difficult to raise money.

Sovereign loans in the euro- one consequently tend to be widely spread. The risk premiums demanded from the frailest countries are soaring, unlike those demanded of Germany, which is still considered an exemplary borrower. The benchmark rate for German (Bund) loans over 10 years last Monday stood at 2.98%, much lower than that of France (3.50%), or of Spain (4.13%) or, above all, of Greece (5.47%).

The over-rated credit rating agencies were not slow in down-grading Madrid and Athens. Downgrading a state amounts to casting suspicion on its ability to pay back its debts as settled, in the best conditions.

In such circumstances, some countries that are strangled by the service of an increasingly heavy debt might be tempted simply to leave the euro ship. To ease the stranglehold, they might try devaluing their restored national currency as a last resource, in order to boost their exports.

This prospect has made the fortune of the managers of the Intrade site where, for the last few months, it has been possible to bet on one or several of the sixteen euro-zone countries opting out of the euro. The contract expires at the end of 2010.

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The weakness of Euro membership for Ireland

Posted on 29 Eanáir, 2009 by NationalPlatform.Org

(1.)
http://newsweaver.ie/bloxhamresearch/e_article001314795.cfm?x=bf0GvBb,bcgrvNVl
Bloxham Morning Note
Wednesday, January 14, 2009
Company/Economic News
Strategy – Lex pointing out Ireland’s weakness

The weakness of Euro membership for Ireland is highlighted into today’s Lex column. With the UK doing what is needed to adjust to the new economic reality and devaluing its currency, Ireland is unable to devalue its currency to restore competitiveness. Therefore Lex points out that wages in Ireland will need to fall, something which is exceptionally difficult to achieve. While the Euro zone has provided us with the buffer of a central banking guarantee, the downside pain is in a loss of competitiveness against our nearest neighbour, the UK.

Published by Bloxham
Copyright © 2008 Bloxham. All rights reserved.

(2.)
specials.ft.com/cgi-bin/Common/FTToday/nph-todayEdition.cgi?latest=BACK1_LON
The Financial Times
THE LEX COLUMN
Wednesday January 14 2009
Eurozones of pain

The Irish must be feeling green, and so too the Spanish, Greeks and Portuguese. Over the past week, all four countries’ debt ratings have been placed on review for downgrade.
Dublin, Madrid, Athens and Lisbon may bat away such warnings with reassuring noises about how they will put their financial houses in order – even if they, meanwhile, suffer higher borrowing costs. What they cannot dismiss so easily, however, is the solution to their troubles: deflation.
The potential downgrades are only a manifestation of a deeper problem: a loss of competitiveness. That is largely why the Irish, Greek, Spanish and Portuguese trade deficits are so large and their economies slowing so fast. It has been a long decline. Euro membership lowered borrowing costs, but unleashed a credit boom and a rise in prices – most obviously in housing but also in wages.
Ireland shows the problem writ large. Since 2000, its relative wage costs have risen by 20 percentage points versus Germany. (Greek wage costs have risen by about 5 points.) Export performance has been further hurt by the weakening currencies of two of its major trading partners, the
US and the UK. That is why Brian Lenihan, the Irish finance minister, lashed out at the UK, saying the pound’s fall had caused Ireland “immense problems”. The quick solution would be for Ireland to devalue too. As a euro member, it cannot. Instead it has to deflate.
Germany managed this at the start of the millennium. But as its trading partners were inflating at the time, German prices only had to rise at a slower rate for relative wages to fall. Today, with inflation falling everywhere, that path is not open to uncompetitive eurozone countries.
Instead, wages have to fall in absolute terms. That is immensely painful. It is also politically unpalatable; democracies generally don’t “do” wage deflation. Even East Asian countries, with their more flexible labour markets, did not manage it during the 1997 crisis – or at least not without political change.
The Irish referendum this autumn on the European Constitution may well be an explosive vote.

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Help Ireland or it will exit euro, economist warns

Posted on 29 Eanáir, 2009 by NationalPlatform.Org

http://www.telegraph.co.uk/finance/globalbusiness/4285331/Help-Ireland-or-it-will-exit-euro-economist-warns.html
Daily Telegraph

Help Ireland or it will exit euro, economist warns
A leading Irish economist has called on Dublin to threaten withdrawal from the euro unless Europe’s big powers do more to rescue Ireland’s economy.

By Ambrose Evans-Pritchard
19 Jan 2009

David McWilliams, a former official at the Irish central bank, has said that Ireland could withdraw from the euro if they are not given more help Photo: Rex Features
“This is war: countries have to defend themselves,” said David McWilliams, a former official at the Irish central bank.
“It is essential that we go to Europe and say we have a serious problem. We say, either we default or we pull out of Europe,” he told RTE radio.
“If Ireland continues hurtling down this road, which is close to default, the whole of Europe will be badly affected. The credibility of the euro will be badly affected. Then Spain might default, Italy and Greece,” he said.
Mr McWilliams, a former UBS director and now prominent broadcaster, has broken the ultimate taboo by evoking threats to precipitate an EMU crisis, which would risk a chain reaction across the eurozone’s southern belt, where yield spreads on state bonds are already flashing warning signals. The comments reflect growing bitterness in Dublin over the way the country has been treated after voting against the EU’s Lisbon Treaty.
“If we have a single currency there are obligations and responsibilities on both sides. The idea that Germany and France can just hang us out to dry, as has been the talk in the last couple of days should not be taken lying down,” he said.
Mr McWilliams cited the example of New York’s threat to default in 1975. President Gerald Ford “blinked” at the 11th hour and backed a bail-out to prevent broader damage.
As yet, there is no public support for withdrawal from the euro. A Quantum poll published by the Irish Independent yesterday found that 97pc reject such a radical move. Three-quarters are in favour of a national government, an idea floated by Unilever’s ex-chief Niall Fitzgerald.
“The economic disaster we are facing is unlike anything which has happened in my lifetime. It is a national crisis and needs a government of national unity,” Mr Fitzgerald said.
Mr McWilliams said EMU was preventing Irish recovery. “The only way we can win this war is by becoming, once again, an export country. We can do what we are doing now, which is to reduce our wages, throw more people on the dole and suffer a long contraction. The other model is what the British are doing. Britain is letting sterling fall so that the problem becomes someone else’s. But we, of course, have ruled this out by our euro membership.
“We are paying twice for the euro: once on the exchange rate and once more on the interest rate,” he said.
“By keeping with the current policy, the state is ensuring that Ireland turns itself into a large debt-repayment machine. Is this the sort of strategy to win wars? ” he said.

Filed under: EU Economy, Euro / Monetary Union, Irish Economy | Tagged: , , , , , | Leave a comment »

[25/08/2005] Has the Euro GOT a future?

Posted on 25 Lúnasa, 2005 by NationalPlatform.Org 
THE TIMES, London, Thursday 25 August 2005

A hard truth: the future of the single currency is now far beyond our Ken

Anatole Kaletsky (Economics Correspondent)

THERE WAS a time when Kenneth Clarke's admission that "the euro has been a
failure" might have dominated the headlines for weeks. It might even have
changed the course of Britain's history. Had Mr Clarke been prescient enough
15 years ago to recognise the fatal flaws in the single currency project,
the Tories might have been spared the humiliation of Black Wednesday and the
suicidal infighting over the Maastricht treaty; they might still be
governing the country.

If the ex-Chancellor had humbly admitted five years ago that he had been
wrong about the euro, he would surely now be the Leader of the Opposition
and the Conservatives might be vying for power with Labour in a hung
parliament. By this week, however, Mr Clarke's public confession about the
failure of the euro was as irrelevant to the future as Macbeth's final
soliloquy comparing himself to "a walking shadow, a poor player who that
struts and frets his hour upon the stage and then is heard no more".

But while Mr Clarke's regrets about the euro may no longer be of any
interest in Britain, they remind us of something extremely significant about
the wider world beyond. The euro has been enjoying a political honeymoon in
the four years since it was introduced. While the Europe's economic
performance has gone from bad to worse almost since the day when the euro
was launched in January 1999, no respectable politician has ever dared to
blame the euro or criticise the single currency project in any way. This
taboo has now been lifted.

In Italy, Silvio Berlusconi has consciously encouraged an anti-euro movement
designed to blame Italy's problems on Romano Prodi, the man who took Italy
into the single currency, who happens to be his main political opponent in
the forthcoming general elections. In the Netherlands, France and Germany,
the euro has started to be blamed for inflation, economic instability and
unemployment - and while some of these charges may not be intellectually
sustainable, nobody can dispute that the European Central Bank has performed
poorly, certainly in comparison with the US Federal Reserve Board, the Bank
of England, the Bank of Japan or the emasculated German Bundesbank.

Why does all this matter? Because the euro, like any other paper currency,
is just an illusion; its power to command people's lives and motivate effort
depends entirely on a suspension of disbelief. People must not only think
that these elaborately printed but worthless bits of paper will be
exchangeable for valuable goods and services. They must also believe that
their intrinsically worthless paper money will continue to be honoured for
the indefinite future by the whole world. That belief, in turn, rests
ultimately on the faith that the value of paper money will be upheld by a
government with the right and the ability to levy taxes on a wealthy nation.

But if the EU is not going to evolve towards a full-scale political union
who exactly is going to guarantee the value of the euro? And if the
membership of the eurozone is never even going to be equivalent to
membership of the EU, with Britain, Sweden, Denmark and other EU countries
remaining outside, then why should a government, whether it is Italy or
Germany, that finds it inconvenient to use the euro not simply opt out and
re-create its own national currency?

The sudden emergence of questions such as this does not necessarily mean
that the eurozone will fall apart or even that the euro will completely
cease to exist, but it does mean that such possibilities may soon be
seriously considered. And if investors ever start to worry about the
long-term viability of the single currency project, scenarios for the total
collapse of the euro will suddenly come into view.

The most plausible such scenario is Italy withdrawing from the euro, under
pressure from mounting unemployment, a weak economy and imploding public
finances, exactly the same combination of pressures that forced Italy out of
the ERM in 1992. If the possibility of Italian withdrawal were ever taken
seriously by the markets, foreign holders of Italy's E:1,500 billion public
debt would face enormous losses, since the Italian Government would simply
convert its bonds into "new lire" and would legally get away with this
conversion.

In fact, such are the financial risks of Italian withdrawal to the European
financial system, that the Italian Government may now be in a position to
blackmail the European Central Bank into reducing interest rates and
devaluing the euro simply by threatening to withdraw. Such an easing by the
ECB would actually be a rational response to the present economic problems
throughout the eurozone. But this is where a multinational monetary
institution would face a fatal problem.

If the ECB were seen as capitulating to Italian blackmail, the euro's
survival would face a new and even more serious threat: a collapse of public
confidence in Germany and the Netherlands, where populist politicians would
start blaming their countries' economic problems on the weakness of the ECB.
Right-wing German and Dutch politicians might well start demanding a
stronger currency - and threaten to leave the euro if the ECB continued to
accommodate Italy's "inflationary" demands.

It is possible to imagine a situation where the Germans and Dutch were
demanding a tighter policy to punish Italy while Italians were demanded an
easier policy to keep their economy afloat - with both sides threatening to
leave the euro if their demands were not met. The game would then really be
up for the euro and the ECB.

A break-up of the euro seems highly improbable in the next year or two. But
anybody who still believes that such a break-up is impossible should bear in
mind the lessons from the break-up of the ERM, the sterling, franc and lira
devaluations of the 1960s, the collapse of the dollar-based Bretton Woods
system in the early 1970s and the prewar abandonment of the gold standard.
In confrontations between politics and financial markets, events can move
straight from "impossible" to "inevitable" without ever passing through
improbable.

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