-Edward Hugh (Don’t Shoot the Messenger)
European newspapers are once more full this weekend of statements by Angela Merkel that she ain’t goin’ to no debt share, oh no, no, no, no, while Spain trembles on the precipice and Greece dangles in the balance.
The latest story to go the rounds is that even if Greece should turn out to be unwilling to leave in the last resort, Spain will show no such reluctance. Pure tommy rot. Spain has been a long term recipient of European aid in a way which creates a kind of Stockholm dependency, and I have heard absolutely no influential voice here calling for withdrawal. Naturally, there is no shortage of warnings that if the country doesn’t pick its ideas up, then it could end up, like Greece, getting thrown out of the common currency club. But, as I keep emphasising, the sheer cost of such a move for the remaining participants would rapidly turn the whole dream into a nightmare. So why go to all that trouble, if you can keep them in for a tenth of the additional cost? Certainly, ever since Germany’s leaders shied away from paying the price of breaking out and going back to the Deutsche Mark they have effectively been groggy and pinned up against the ropes, vulnerable to any swinging hook that might come their way, as young contenders like Greece’s Alexis Tsipras have now discovered to their advantage.
But if voices for early exit are lacking in either Greece or Spain, this is not the case in Italy. The latest to make the point that Italy could leave was former Prime Minister Silvio Berlusconi, who only this weekend posted an appeal to the ECB on his party website urging the central bank to engage in what he calls “money printing” (personally I’m not sure he understands what is and what isn’t printing). If the central bank doesn’t become a “lender of last resort,” he said, then Italy should say “ciao, euro,” adding that in the absence of such a move the “Bank of Italy could print either “euros or our own currency”. It seems it isn’t only the Greeks who may be considering making irregular use of the facility known as ELA.
Naturally this is not the first time that Berlusconi – who may be without power but is not without influence – has made such threats, and in fact both Italy’s right and its left have long had reservations about belonging to the monetary union, blaming the centre, and in particular the centre left politician Romano Prodi, for taking the country in. If anti-austerity resentment continues to fester in the country as seems to be happening, then it is not hard to imagine a coalition of the “unwilling” could be formed (Berlusconi’s “polo”, the Lega del Norte, Beppe Grillo’s five star movement and possibly IdV) in order to force an exit. Italy, it should be remembered, is much closer to budget surplus than either of the other two aforementioned countries, and the current account surplus is rapidly closing. In addition the country has a large domestic savings base from which it could finance itself.
At the moment all this talk is largely that, talk and demagogic rhetoric, but it should be remembered that in this case the threat is not an entirely empty one.
Meanwhile, as one world leader after another advises the encircled Mariano Rajoy to head for bailout, it isn’t clear to me that the cost of such an operation is really doable using existing resources. The much vaunted European Stability Mechanism is scheduled to come into operation on July 9th, with a firepower of 500 billion Euros, but a quick back of the envelope calculation suggests that Spain’s needs (for a total Greece-type bailout) would be significantly larger. There is bank recapitalisation (say 150 billion to 200 billion euros as a conservative lower-end estimate), the creation of a “bad bank” to ring fence problematic property assets (another 300 billion euros using the same criteria), and then the country would need another 300 billion to 400 billion (at least) to take the sovereign out of the markets for the next 3 years. Previously I think everyone (including myself) had been hoping that the country could get away with just an injection of money to recapitalise banks, but unless the legacy property assets and developer loans are taken off balance sheet and the banks enabled to deleverage accordingly, then there is no hope of credit flowing in a way which would facilitate economic recovery.
Finally, all that much publicised international investor flight has left Spain’s banks as the only potential purchaser for maturing sovereign bonds and new issue. They have made a heroic effort to date, but the situation has now become unsustainable; hence the need to take the country out of the markets entirely. The numbers are certainly large, yet otherwise, well, there but for the grace of God go all of us.
Don’t Push the Emergency Button
-by Ed Dolan (Ed Dolan’s Econ Blog)
There is so much being written about the euro crisis that it is hard to single anything out, but a comment by Robert Zoellick in the FT on Friday was the most thought-provoking thing I read on the topic this week. Zoellick writes that it is time for Europe to “break the glass,” by which he means that the ECB and those who stand behind it must get ready to offer unlimited assistance to Eurozone banks, including those with poor collateral and those that are flirting with insolvency. What struck me in particular is his comment that governments will have to guarantee bank deposits and “probably other liabilities.” Otherwise the rot will spread from the financial to the corporate sector with catastrophic, instead of merely ruinous, consequences.
He may well be right, yet an unlimited state guarantee for the unsecured nondeposit liabilities of banks is a truly terrible idea. It is right to compare it to pushing the emergency button behind the broken glass–the one you know will activate the sprinkler system, ruin your furniture, your carpets, and your Picassos, and be better only than letting your entire house burn down. Even if shareholders are entirely wiped out (and there is no guarantee that will happen–Bankia shareholders are facing a big hit, but not a full wipeout), guaranteeing unsecured nondeposit liabilities would create the worst kind of moral hazard.
Regulation unsupported by market discipline is never going to achieve a stable financial system, not in Europe and not in America. In theory, retail depositors who investigated the soundness of banks before handing over their money could be part of the solution, but in practice, that is both politically and behaviorally unrealistic. Shareholders already provide some element of market discipline, but that alone has not proved enough, as Alan Greenspan found to his “shocked disbelief.” Where is the discipline to come from, then? It has to come from unsecured nondeposit creditors. If they can be sure it is safe to hand over their funds without regard to the risks that banks take with them, there is simply nothing left of market discipline. Without that vital leg, the stool will fall, and, after being set upright at great expense, it will fall again.
Will the Central Banking Revolution Start in Turkey?
-Emre Deliveli (The Kapalı Çarşı: Emre Deliveli’s blog on the Turkish economy)
I will be attending a very interesting conference in Istanbul tomorrow and Tuesday. “Financial and Macroeconomic Stability: Challenges Ahead“, organized by the Central Banks of Turkey, Brazil and Finland, has got me thinking:
The unorthodox monetary policy measures of the CBT have made a big impact in Turkey, but their reach could even be wider.
The Bank has effectively ditched the official policy rate, the weekly repo, in favor of the effective funding rate, which is the weighted average of the lending rate of the Bank’s various lending facilities. The CBT notes that this change provides itself with the necessary flexibility to respond to the uncertain global environment and volatile capital flows.
As students of economics know very well, there is no free lunch: This flexibility has come at a huge cost, as banks cannot project their funding costs even in the very short-run. As a result, banks on the Istanbul Stock Exchange have been lagging behind, and the ISE is not dominated by financials anymore.
The uncertainty created by this policy has also hit market activity. Trading in government bonds is as low as in 2009, when the economy had hit bottom. There is anecdotal evidence that a similar story holds in the FX market.
More importantly, the CBT is the first major central bank that has taken unorthodoxy to such extremes. There is a lot of talk by monetary policy experts that the global crisis has brought conventional central banking to an end. Many contend inflation targeting should be abandoned, some even going as far as to claim that central bank independence is not a good idea anymore.
However, there have not been major modifications to monetary policy yet, barring the Fed’s quantitative easing and the ECB’s LTRO. If the CBT’s “experiment” is successful, other central banks may follow, making bold changes to their own monetary policy frameworks.