Euro Update (11)- Expanding the EFSF, Inflation and Berlusconi

Contrarily to what this post’s title might imply, since the Portuguese debt auction a little more than a week ago, not much of significance has happened in Europe. A look at the main websites focused on reporting EU news, shows that the main headlines focus on the “hum-drum” daily business of governing the Union (with sports packages and other such things making the headlines). The buzz about Euro’s imminent bankruptcy that has periodically characterised the news reports for the last year is no where to be found. We are in the typical period of in between important decisions. This will probably be the case until at least January 31, at which time a General Affairs Council of Ministers of the EU meeting might bring about more discussion on the future of the EFSF. This will be closely followed by the ECB’s Governing Council Meeting on February 3rd and by a meeting of the Council of the EU the day after. So although the second half of January should be pretty calm, expect a turbulent early February.
For the time being the news are very discreet, and what can be found are quiet references to the problems to come, which are the first two topics listed in the title.

Expanding the EFSF

The main problem facing the Eurozone at the moment is the possibility that Spain may be brought to its knees in the sequence of a Portuguese assistance package. If that were the case, the EFSF’s size would take a hit, which would jeopardise the ability of the Eurozone to make any use of it. Therefore, Member states considered, in vain, increasing the size of the EFSF at this week’s meeting of the Council of Ministers for Economic and Financial Affairs of the EU.

At the same time, the ECB has been less than cheery about having to intervene in international debt markets to purchase sovereign debt, in order to lower the yields. Things are getting so bad or both strained member states and the ECB that there are now proposals floating around for “Trichet Bonds” in the image of the US Treasury’s “Brady Bonds” to Latin America (which by the way, depending on the accounting feasibility might not be a bad idea at all). This has then brought forth a discussion about whether the EFSF should see its scope expanded qualitatively as well, by allowing it to purchase sovereign bonds on the secondary market, so as to alleviate some of the pressure that the ECB has been exposed to under the present sovereign debt crisis. It is particularly important in light of fears that if these potentially toxic purchases are forced onto the ECB for much longer, it may effectively become a “Bad Bank”.

Of course the German government, who will have to foot the majority of the bill if the EFSF is expanded, isn’t particularly fond of the idea, while others are. At the same time, the popularity of the minority party(FDP) in the German governmental coalition has seen its electoral support take a hit in recent surveys, while the Greens and the SPD, who have declared their support for “European solutions to European Problems”, are experiencing a resurgence. Whether that support is ideological or opportunistic is a matter of debate. However, it is becoming clear that the Eurozone bailouts may lead to a breaking up of the German coalition government.
On the other hand, the German Government seems to be holding its line that “everything is fine for now“, that “there’s no need to intervene, for the moment“, that “nothing needs to be done yet” and that “currently everything is fine”. In my humble opinion this is total a complete denial of reality and completely lacks foresight, as it fails to prepare for the inevitable.

More interestingly, Germany seems to not have enjoyed Barroso taking initiative in his proposal of this improvement of the EFSF. It kind of makes one wonder what they think his job description is. Anyway, here’s what the German press (Financial Times Deutschland, centre-right Frankfurter Allgemeine Zeitung, business daily Handelsblatt, center-left Süddeutsche Zeitung and the left leaning Die Tageszeitung [political affiliations according to Der Spiegel) had to say about it. Nonetheless, this week’s Eco-Fin meeting seems to have sparked some discussion, which is good. If both qualitative and quantitative reforms of the EFSF were undertaken it would be very good, but I’ll be satisfied if even a single one is adopted by the Council of the EU meeting early next month, although I doubt it. May be March is a more realistic date. By then I suppose everybody will have gone through another round of debt auctions, with Portugal facing even more pressure (Note that Portuguese Bonds are issued either on the second or on the third Wednesday of every month[see beginning of last paragraph of page 1).

I actually think it’s a good idea… We’ll have to do it anyway, so why not do it now, before the fire is at the gates, and before the elections get to close. Conservativism for conservativism’s sake makes no sense. Hopefully the discussions aren’t just rumours, and will be fruitful. Apparently the contention seems to be about timing. According to this article from the FT, the Commission and the member states want to do it fast, sometime in the next two weeks, while Germany wants to wait longer in order to get a more comprehensive agreement. Whether more time would lead to more agreement is arguable though.

Inflation – Oil and Wages

Going back to the ECB, inflation seems to be on the rise in the EU, mostly due to a rise in oil prices. The WSJ’s EU blog, Real Time Brussels, has a very interesting post where it summarizes a study by Ernst and Young forecasting the damage to the EU if the price stays at its level or if it rises. According to that forecast, the damage is significant in growth losses.

On the other hand, German inflation is on the rise too, as is to be expected. As the low exchange rates brought about by the instability in the Eurozone periphery stimulate the German export sector, it increases German firms’ revenues and pushes wages upwards. There are two non-exclusive solutions to this problem, which both require that the German government take action. First, if the German government finds interest rates too low, then it should put its electorability where its mouth is and increase taxes on credit transactions (loans). After all if Germany wants the cost of borrowing to rise in order to stem inflation, it can always increase it through marginal taxes. Secondly, they can simply accept a federal Europe, with an enlarged budget, able to take on the borrowing costs of its members. By doing this it relieves the pressure on the ECB, at the same time as it is forced to accept a rise in the taxes of its citizens, which in and of itself would be equivalent (+ or- ) to the first solution.

The irony thus seems to be that the present German hesitation will come back to bite it eventually.

Either way, these two issues have led to the resurgence of inflationary fears in the heart of Bundesbank President Axel Weber. These grumblings have been loud enough to be ehard in Princeton by Paul Krugman who offers a very good review of the problem for the periphery countries if the ECB starts prioritizing the disinflation needs of richer countries at the detriment of the periphery. .

Berlusconi is yet again investigated

I don’t know how many times Berlusconi has been investigated. Someone must have a list somewhere. The latest is not a matter of influence, Mafia or money laundering. Here the Italian Prime Minister may have innovated in the slimmest of ways. He may have had sex with a minor. Anyway, if this analysis by the Economist is at all telling, it’ll be difficult to prove there was any transaction or sexual intercourse between the prime minister and the young girl and as far as abuse of power is cocerned, it will take a lot of effort to get parliament to support any such accusation. Anyway, as the British say, “They don’t do dull in Italy…”Source: Evening Standard, Monday 18 January 2011, page 15.

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