Friday, June 29, 2012

The Way Out?

European leaders have agreed on a new plan, which will allow the bailout funds (ESM and EFSF) to inject capital directly into troubled banks, conditional upon the establishment of a new EU banking supervision authority. The markets are pleased, for the moment. Of course the markets have been pleased before, and the euphoria has been short-lived. There are some reasons for optimism this time, however. Since Merkel has ruled out mutualization of debt for the time being (actually, in her words, for as long as she lives), this was the only option available that would not lead to imminent meltdown. Furthermore, there seems to be a consensus that the ECB can support banks via the ESM, an indirect route, but not directly. The ECB seemed to have recognized the need but worried about the legality, which has now been clarified. So this could hold things together for awhile.

Of course, this solution does not remedy the structural imbalances, that is, the fact that the southern tier countries, and even France, import more from the stronger economies than they export. With no devaluation option available in the short term to remedy this, and no willingness of private lenders to finance the resulting current account deficits, the only option is for the deficitary economies to contract sufficiently to reduce their demand for imports. (Increased productivity in the south is another remedy, but increasing productivity takes time, so is not a short-term solution.) The results of this contraction in Greece and Spain have been devastating, with very high unemployment, reduced social spending, etc. How much more of this can be tolerated is of course anyone's guess.

But saving the banks--distasteful as it is to many people to have to save banks whose irresponsible lending during the boom years is at the heart of the crisis--was the first necessity, and this has now been taken care of. I think the European banking system was fairly close to seizing up, so this was really an emergency measure. Let's hope the implementation proceeds smoothly and quickly.

As I discussed earlier, the banks, in protecting themselves against the risks of sudden stops in short-term financing, have largely stopped borrowing across borders. This means that the European financial system is no longer delivering one of the chief benefits that the euro had promised: the ability to move capital from countries where there is too much of it to countries that could make productive use of more. This is unfortunate. But after a period of healing, normal capital flows could resume, but with the tighter controls on bank lending promised by the new supervisory mechanism. There will still be booms and busts, of course, as long as there are human beings, but perhaps--perhaps--the damage can be limited next time. In any case, I'm feeling slightly more optimistic today than I did yesterday. The European agreement, plus the major, major Supreme Court decision in the US, are signs that the tsunami have bad news may have begun to recede.


bert said...

I may be allowing Francois Hollande's complete failure to inspire anything in me other than faintly nauseated contempt to skew my analysis. But I'd be interested if you share this take:

Hollande came into this summit pushing the "growth agenda", a small, soggy caramel pudding insignificant enough for Merkel to be happy to nod it through.
This precooked conclusion was held hostage by the Italians, in a fractious faceoff to which Hollande was essentially an observer. France under Hollande is now a passenger, and next week we get a report from the Cours des Comptes, which very serious people claim will be the cue for very serious fiscal retrenchment. Are we entirely confident it won't be the trigger for something rather scarier?

Art Goldhammer said...

Not sure what your point is, Bert. If you're saying that Hollande is trying to have his cake and eat it too--calling for stimulus while in fact reducing government expenditures--yes, I think that is exactly what he's doing. He wants the stimulus to come from elsewhere. And it should, since France has for some years been in current account deficit with its Eurozone trade partners. In the US, massive fiscal transfers are necessary to maintain the single currency, and Europe must eventually do the same thing. This is not happening yet, and Hollande can't make it happen. But that's not his fault. It's the fault of the euro system design. So contempt for Hollande is unwarranted. His contradictions are inherent in his dual position: as steward of the French state budget, he must ensure that French borrowing costs do not rise and therefore retrench as the markets insist; as a co-equal leader in Eurozone governance, he must advocate for his (correct) analysis that transfers from surplus to deficit states are necessary to keep the system afloat. Those transfers can take place via private lending, public lending, or public "gifts," if there is to be convergence of Eurozone economies toward a more sustainable set of wage and productivity differentials than currently exists.

FrédéricLN said...

I agree on most of the analysis. Slight difference on "the only option is for the deficitary economies to contract sufficiently to reduce their demand for imports." -> I would write "or, to make enough progress to increase their export to demanding countries".

I have some difficulty with the way of thinking "exporting Germany needs importing countries". Well, strong basket ball teams need weaker opponents in order to be ranked first. And this advocate for a salaries sharing system and common regulations, as exist. But it should not push the loosing teams to go on the same way, train the same way and go on scoring badly.

The € system, as it was until 2010, was an incitation to non-cooperative behavior, take the money and run (not only Greece, but also Chirac's and Sarkozy's France did that). The only limit was national debt, the "no bailout" clause. What will happen if the limit is abolished? More cooperation, or less? I fear it will be less.

bert said...

Thanks for the reply. Sorry if I wasn't clear. My view is that the euro-level stimulus is a sideshow. Which I believe is your view, too.

Is there a Hollande plan for European macroeconomic management conceived and justified around the principle of fiscal transfer? If so, I must have missed it. What I see is a lot of waffle about stimulus, plenty of handwaving about deficits, and a deep-dyed resistance to taking on entrenched client groups.

I'm enjoying your claim that when the French cannot balance their current account the shortfall *should* be made up by others. You could borrow a slogan from Lillian Bettencourt: "Because I'm worth it". I'm no Bundesbank headbanger but I have to say that in the current environment that sounds like an enormously convenient soft solution. How pleasing to reach it via the route of high principle.

Art Goldhammer said...

FrédéricLN, yes, I've amended the post to reflect your objections. Indeed, increasing productivity in the low-productivity countries is the long-run solution, but it takes time and cannot work overnight. And cutting wages in order to increase competitiveness is not only very difficult but also counterproductive, because it reduces income and tax revenue, compounding budgetary problems.

Art Goldhammer said...

Bert, you neglect the fact that Germany is the chief beneficiary of the current account deficits run by others. German unemployment would not be as low as it is if French, Spaniards, Italians, etc., were not buying Audis and Mercedes. And they won't, unless German surpluses are recycled. For a while they WERE recycled via loans to the PIGS. No longer. So another transfer mechanism must be found. Moralizing about supposed German virtues does not change the national accounting identities.

bert said...

Hello, Frédéric.
Commiserations on the election.
Last time we were on the same thread I posted a polite reply to you, but far too late and you almost certainly won't have seen it. Not that it matters ... nice to see you again.

FrédéricLN said...

On the post itself: a more pessimistic view, by Olivier Berruyer

On your reply, Art:

yes, "cutting wages in order to increase competitiveness is not only very difficult but also counterproductive" (socially, first, and social coherence is important). It may be the case that some countries increased wages an aberrant way during the last 5 or 10 years, and have to come back on this — I did not check. Anyway France is not in such a situation. I (and we at MoDem) would certainly not advocate for cuts in wages.

yes, "increasing productivity … takes time and cannot work overnight." Yes but… perhaps no. Perhaps there is more light on this side that you would expect. At least my own small theory is that the assets bubble of the years 2002 to 2008 vastly undermined productivity, in the broadest meaning of the word: decision-makers at all levels were pushed to bet on assets instead of betting on creativity, innovation, service, productivity, customer satisfaction and so on.

Decision-makers at all levels do include the single factory worker: many of them took every opportunity of leaving their job (plans de départs volontaires, that worked "very well") with a bunch of banknotes, and dedicated their energy to improving their home or creating "auto-entrepreneurs" small businesses in the same field - "les entreprises de jardinage" (garden services?) are in a boom. It's nice, it's great, I'm not sure it was in all cases for the best interest of national competitiveness.

More briefly said:

1) our economy was anesthetized buy the assets bubble (real estate bubble, debt bubble), as the Spanish one has been anesthetized during the XVIth Century by the New World gold;

2) I hope that the (upcoming) end of this assets bubble will automatically recommit "Main Street" workers and executives to improve their businesses (l'économie réelle), and that the backlog since 2002 will be caught in 2-3 years from now.

3) I fear that political decisions intending to save the system as it is, only delay recovery.

FrédéricLN said...

bert: thank you! I just went there, saw your comment indeed, and answered. I often write too sharply (because I'm not fluent in English, but I also do so in French), but I appreciate very much the point of the discussion: what of Keynesianism is to be saved and transferred into the new economy.

Btw, I take part to a working party on the topic, you may find the argument interesting: (a video in French) and

(to prevent a question: yes, the people there are rather Caucasian, male, 45 y old+, Parisian and bear diplomas; but come from quite all French political currents).

bert said...

Art, sounds to me like yourself and Martin Wolf are on much the same page. You won't need reminding of one of his main conclusions. To build a system based around dumping your deficits in the lap of the German taxpayer risks choosing to become a new mezzogiorno. I think Frédéric is right about focussing on competitiveness. In particular, it brings the missing part of your model - markets outside the eurozone - into play.

The dynamic whereby the regions that have been hardest hit have been forced into procyclical crisis measures has been immensely damaging though, and if fiscal transfer can restore a bit of balance to that situation it'd be most welcome. The response of the Irish to last night's deal is worth a close look.

In the shorter term, France has managed a current account deficit for a while now. There must be stuff around the house you could sell. And are you sure the future of Europe depends on your neighbour buying that Audi?