Following last week’s developments, commentators have reached for their podia clamouring to the leadership to do something. I shall highlight three interesting contributions in the FT, from Larry Summers, Wolfgang Munchau and Gideon Rachman. The discussion deals with the issues of debt repurchases, interest rate decreases and the logic and relative benefits of fiscal union.
The first one was an opinion piece by Larry Summers who claims the EU has to stop doing 3 things, find it’s solidarity and implement it via a string of policies incorporating at least 5 elements.
Stop Talking about private sector default
The first of his 3 warnings are against fomenting Market uncertainty by ending European political talks of default, or restructuring. He points to the American experience with Lehman Brothers and reminds us of the pitfalls of such a myopic populist and disorderly approach:”US policymakers were applauded for about 12 hours for their willingness to let Lehman go bankrupt. The adverse consequences of the shattering effect that had on confidence are still being felt now”. The second warning he makes is about the huge political consequences that the present economic crisis might have. He explicitly draws a comparison between the austerity programmes of Portugal, Greece and Ireland, with post WWI German war reparations and their role in feeding the radicalism that allowed Hitler to gain power. His last warning is about externalities, when he reminds (Germany) that sovereigns do not exist in financial isolation from one another: “Third, whether or not a country is solvent depends not just on its debt burdens and its commitment to strong domestic policies, but on the broader economic context. Liquidity problems left unattended become confidence problems. Debtors who are credibly highly solvent at interest rates close to or below their nominal growth rates are likely to become insolvent at higher interest rates, putting further pressure on rates and exacerbating solvency worries in a vicious cycle”.
Lighten the Burden and Support Sovereign Bond Repurchases
His 5 policy advices can be described as the “carrot package, in that they offer positive incentives for countries (potentially) at risk for them to implement growth enhancing policies. First, the EU/IMF loans should not be offered at a premium. The argument he gives is that if no the EU is commited to avoiding default, that risk should be null and signalled as such to the markets. Secondly, countries at risk (read Spain, Italy and may be even Belgium) should be allowed not to contribute to the EFSF or the Greek loan facility. The logic seems to be that it will decrease their debt, by decreasing their liabilities. The third proposal is that The EU retract itself from it’s talk of default by committing itself to a no-default policy towards large financial institutions. Fourthly, he argues that countries pursuing sound policies should be able to buy guarantees (Eurobonds anyone?). Finally, he recommends that the issue of private debt should be dealt with through repurchases, so long as they are at a low enough value.
Fast pace of events
Mr Summers’ piece concludes with a warning that events are moving fast and that much like a contagion to Italy might have seemed unrealistic his proposals might also loose their radicalism in the presence of looming catastrophic events. This is a line taken up by Mr Munchau, a personal favourite of this blog. I won’t lean over too much over his last contribution, other than to say that it’s a point I’ve pained to make for more than six months now. I would however highlight two things. First, his chronology of his own beliefs: “Five years ago, I was among those who argued that the probability of a collapse of the eurozone was close to zero. Last year, I wrote it was no longer trivial, but small. The odds have risen steadily since, not because of the crisis itself, but the political response. I now would put the odds of a break-up of the eurozone at 50:50. This is not because I doubt the pledge by the European Council to do whatever it takes to save the euro but because I fear it has left things too late.”
I would like to take this opportunity to reiterate his structured view of the crisis as described in his previous two posts. In the first post he argued, more confidently than he sounds now, that the Eurozone core would not let the Eurozone periphery sink. Instead, they would continue to bail them out. However, the cost of doing so would be for the periphery to give up some fiscal policy sovereignty. In order for this to be acceptable, it would have to be mutual and equal agreement, also applicable to the core. This would then lead to the creation of a Eurozone finance minister, a centralised banking resolution fund and a further step in European integration of labour market policies as well as the creation of Eurobonds. In the second post he goes on about the legal issues around this process of further fiscal integration and the role of article 136 of TFEU. Mr Munchau argues that this article “allows members of the monetary union to establish eurozone-specific institutions to improve the co-ordination of their policies while remaining under the legal umbrella of the EU”. I checked and here is what I got
“In order to ensure the proper functioning of economic and monetary union, and in accordance with the relevant provisions of the Treaties, the Council shall, in accordance with the relevant procedure from among those referred to in Articles 121 and 126, with the exception of the procedure set out in Article 126(14), adopt measures specific to those Member States whose currency is the euro(a) adopt measures specific to those Member States whose currency is the euro and (b) to set out economic policy guidelines for them, while ensuring that they are compatible with those adopted for the whole of the Union and are kept under surveillance.”
Of course even a cursory reading of the treaty immediately shows the problem of this argument. Articles 123 and 125 are particularly tricky. The first states that:
Article 123)1.”Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.
2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.”
Whilst the second states that:
Article 125)1.”The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakingsof another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”
Of course as these would effectively have the first part actually forbids the creation of the EFSF as a EU institution. That’s the reason it is a private company registered in Luxembourg. That way it complies with the exception described in article 123)2. Article 125 however, forbids the purchase of debt directly from the sovereign issuer, but it seems to leave some wiggle room for secondary market interventions.
Finally, Mr Munchau goes on to argue that the way to do this is by framing the question in a manner that it cannot be rejected by the core’s voters.
” Whether electorates and their parliaments will accept a fiscal union will depend on their perceptions of the available alternatives. Clearly, there is a difference if your perceived choice is one between integration or a break-up, or whether it is simply between more integration or less integration. The political process will hinge on these perceptions “
It’s all very reminiscent of prospect theory…
However, Mr Munchau colleague at the FT, Mr Rachman, seems to disagree. He presents a very anglo-saxon perspective which inherently vindicates the UK’s choice to remain out of the Eurozone by arguing that it was a bad idea to start with. In his words, the argument in favour of fiscal and political union “is a profound misdiagnosis of the crisis”. Although I don’t immediately agree with that view, I’m not necessarily closed to listening to its arguments.However, whatever those arguments are, they must address the question of how we would deal with the problems that the Euro solved. How would a return to national currencies avoid the exchange rate crises of the 1980s and 1990s. Unfortunately, Mr Rachman throws demagogery onto our eyes. When he claims that “the real problem is political and cultural. There is not a strong enough common political identity in Europe to support the single currency”, he forgets that both Ireland, Portugal, Spain, Italy and Greece had referenda in order to determine whether they should join the Eurozone. It might not be the most popular of issues now, but the single currency was certainly popular until recently.
Because he doesn’t answer my questions, I can’t really agree with Mr Rachman. Moreover, while I think in the same pan-European line of Mr Munchau, I’m not quite sure his legal argument, about the potential role of article 123, was really well thought through. I do however share his concerns that events may be about to accelerate beyond the ability of European leaders to keep up. I also sympathise with his disappointment at Mrs Merkel. I suppose we all sympathise, even her mentor ex-Chancellor Kohl.