Flashman Letters

EZ crisis and historical trilemmas | vox

http://www.voxeu.org/article/ez-crisis-and-historical-trilemmas

The implicit national government backstop was really only credible because of the international commitment to the European integration project. It was that commitment that led markets to believe that – in spite of the no bailout provisions of the Maastricht Treaty – there were almost no limits to the amount to which debt levels could accumulate both in the private and the public sector. When governments turned round, in particular after the Deauville meeting of Chancellor Merkel and President Sarkozy in October 2010 and demanded a haircut for Greek creditors (or Private Sector Involvement, PSI), the yields immediately diverged. Deauville undid the framework of solidarity that the EU treaties seemed to have created.

When the democratic/popular backlash occurs, it takes the form of rejection of international/cross-border political commitment mechanism. Voters are surprisingly discerning. Opinion poll data shows a major increase in hostility to the EU in peripheral countries, but with no corresponding unpopularity of the common currency. Hostility to the EU is also evident in parliamentary elections results in Greece and Italy.

The trilemmas are worse in the recent context because of the absence of an escape clause. In the absence of an exchange-rate option, there is a need for greater debt reduction, but that raises a politically awkward question of the distribution of losses between the private and the public sector.

The result is reminiscent of the interwar political debate about whether (mostly American) private creditors or (mostly European) official reparations creditors should have priority in the payment of German debts. What made the interwar slump so intractable was that it was not just a financial issue, but also a crisis of democracy, of social stability, and of the international political system. In the interwar period, increased social tension as a consequence of increased unemployment and of widespread bankruptcy made normal democratic politics impossible. Domestic political pressure also became a source of heightened international tension.

That is true in today’s Europe. Democracy has become a central target of complaints by the European elite. Luxembourg Prime Minister Jean-Claude Juncker and former euro group chair stated that it wasn’t that European leaders didn’t know what the right policies were; but that they didn’t know how to be re-elected after they had implemented them. The 2013 Cyprus crisis and its resolution exposed two new dimensions to the clashes over Europe’s debt and bank crisis. The discussion of a levy on bank deposits, and whether small customers should be exempted, puts class conflict at centre stage. The question of foreign, and especially Russian, depositors – along with the proximity to Syria - makes the incident into an international relations problem.

Supranational commitments however do not change the problems posed by the adjustment requirement, and the asymmetric character of crisis adjustment is more apparent in the modern era (and in the interwar experience) than it was under the classic gold standard. A design that intentionally excluded a contingent clause made the system at first apparently more robust, but aggravated the eventual adjustment issue. That is why the initial crisis may not have been so acute as some of the gold standard sudden stops, but the recovery or bounce back is painfully slow and protracted. The instability is increased by the heightened complexity and length of credit chains, and by the fact of the mediation of credits through small country banking centres.

Spanish Bad Loans Soar To New Record High | Zero Hedge

http://www.zerohedge.com/news/2013-10-18/spanish-bad-loans-soar-new-record-high

Despite the onslaught of confidence-inspiring flim-flam from leadership in Europe and a Spanish Prime Minister (and finance minister) desperate to distract with "soft" survey based data, the hard numbers keep coming in and keep getting worse and worse. The latest, seemingly confirming the IMF's fearsome forecast that European banks face massive loan losses in the coming years, is Spain's loan delinquency rate. Bad loans across Spanish banks amounted to $247 billion in August - a new record-breaking 12.12% of all loans outstanding (now 30% higher than any previous crisis in the history of Spain). Credit creation continues to implode with a 12.3% plunge in total loans outstanding but of course, none of that matters (for now), as Spanish bond spreads (and yields) press back towards pre-crisis lows...

Richard O'Connell
+34 666 24 1104

Private and public debt in crises: 1870 to now

http://www.voxeu.org/article/private-and-public-debt-crises-1870-now

Some observers – often with great conviction – see the European crisis through the lens of public finance (Alessandrini et al. 2012). They see the key source of the problem as the inherent inability of past governments (many in the periphery, and possibly soon even some in the core) to live within their means. For these observers, stricter fiscal rules – a ‘better Maastricht’ – are what would have saved the day, and what will now be required to prevent another crisis down the road.

Others argue that we should worry about private borrowing the most. According to this perspective, the crisis in Europe (setting aside the blatantly misleading public accounting in Greece) is the result of credit booms and housing bubbles that emanated from the private sector, and which were fueled by private cross-border lending flows. When the bubbles eventually burst, the public sector was forced to absorb the direct costs of banking losses and/or the much larger indirect costs of extreme cyclical deficits, picking up the pieces as best it could to prevent the economy from going into a tailspin. In other words, the surge in public debt is merely an epiphenomenon.

Yet, to a large degree, the debate over these narratives has proceeded with scant reference to empirical evidence from macroeconomic history.

In new research (Jordà, Schularick, and Taylor 2013) we fill this gap by studying the co-evolution of public- and private-sector debt in 17 advanced countries since 1870. Using new methods combined with a comprehensive set of macroeconomic controls, and a consistent chronology of business cycles and financial crises, we present the first systematic study of the joint dynamics of public and private debt over the modern business cycle.

Key long-run trends

Figure 1 shows the evolution of public debt (general consolidated government debt) and private credit (bank loans to the non-financial sector) in advanced economies since 1870. The figure conveys two key messages. First, although public debt ratios had climbed from the late 1970s until the mid-1990s, they had declined toward their historical peacetime average prior to the global financial crisis of 2008. Second, in a break with historical patterns, private credit maintained a fairly stable relationship with GDP until the 1970s, and then surged to unprecedented levels in the decades that followed and right up to the outbreak of the crisis. The implications of this increasing financialisation in Western economies are profound, and have become an active area of investigation. The takeaway is clear – in looking for the proximate cause of the crisis, prima facie evidence favors private-sector borrowing over public-sector debt.

European energy fact of the day

http://marginalrevolution.com/marginalrevolution/2013/10/european-energy-fact-of-the-day.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+marginalrevolution%2Ffeed+%28Marginal+Revolution%29

…utilities have suffered vast losses in asset valuation. Their market capitalisation has fallen over €500 billion in five years. That is more than European bank shares lost in the same period.

The full article from The Economist is here, interesting throughout. The article starts with this paradox:

On June 16th something very peculiar happened in Germany’s electricity market. The wholesale price of electricity fell to minus €100 per megawatt hour (MWh). That is, generating companies were having to pay the managers of the grid to take their electricity. It was a bright, breezy Sunday. Demand was low. Between 2pm and 3pm, solar and wind generators produced 28.9 gigawatts (GW) of power, more than half the total. The grid at that time could not cope with more than 45GW without becoming unstable. At the peak, total generation was over 51GW; so prices went negative to encourage cutbacks and protect the grid from overloading.

The trouble is that power plants using nuclear fuel or brown coal are designed to run full blast and cannot easily reduce production, whereas the extra energy from solar and wind power is free. So the burden of adjustment fell on gas-fired and hard-coal power plants, whose output plummeted to only about 10% of capacity.

One implication is that solar and wind receive implicit subsidies from coal and gas plants, through the medium of a backstopped power supply, and those subsidies will be harder to maintain as solar and wind become more important and the installed base of non-renewables weakens.

Unsustainable Social Security Promises: Spain vs. U.S.

http://globaleconomicanalysis.blogspot.fr/2013/10/unsustainable-social-security-promises.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+MishsGlobalEconomicTrendAnalysis+ (Mish's+Global+Economic+Trend+Analysis)

Given that eight million people age 65 and 16.7 million workers cannot sustain the current pension, imagine what will happen in the coming decades as the differential goes back even closer.

Pensions today promise Social Security payments of 100% of the average wage in the last 25 years for those with 37 years of Social Security contributions. Such payments are absolutely unsustainable. The relative income of pensioners relative to the average income of the society will sink (without massive tax looting of active workers).

Immigration could partially alleviate the problem, making the demographic transition somewhat smoother, but if new rights accrue to future pensions, immigration only delays the problem. In any case, it might be a good idea to allow free immigration to Spain in exchange for not accrue rights to Social Security.

The most important practical advice to draw from the above chart is simple: save and invest. If you trust your retirement to politicians, you will end up poor and feeling cheated.

Feds reviewed only one bid for Obamacare website design

http://m.washingtonexaminer.com/article/2537194#.UlvHPWwQRGk.twitter

Germany’s Complacency Problem

http://tablet.fuw.ch/article/germanys-complacency-problem/

can’t count the number of times over the summer I was told that the eerie silence of those putatively responsible for addressing these issues was due to the impending German elections. The radical reforms needed to decisively address these problems were toxic to German voters. The election had to take place before new policy initiatives could be rolled out.

This was always naïve. Mrs. Merkel is not about to pull a rabbit out of her hat. Rather, she was always going to stay the course. Her temperament is perfectly attuned to that of her public. She is content with the status quo, just as the German public is content. It is not her way to accept, much less offer, radical changes in policy strategy. The IMF has just told her that the growth of German GDP should accelerate further to 1.4% in 2014. Southern Europe may be suffering, but who is to say that a little suffering is bad for the soul?

A little suffering may not be bad for the soul, but it is bad for stability. There is still the possibility that high unemployment and continuing recession may result in a sudden vote of no confidence in the Greek or Italian government. Portugal and Ireland may fail in their efforts to regain bond market access. A big bank failure in Italy or Spain might alarm investors. Complacent Germans evidently believe that the status quo is tenable. In fact, any number of untoward events could upset the applecart. At that point, the crisis will be back with a vengeance.

Mrs. Merkel and other German leaders could in principle take steps to shatter the prevailing sense of complacency. They could drive home that the risks are very real. They could emphasize that just because the euro has survived a difficult five years is no guarantee that it will survive five more, absent fundamental policy reforms.

Specifically, they could argue that the risks can be adequately addressed only by creating an full-fledged banking union – not just a single supervisor empowered to require European banks to raise adequate capital, but also a common deposit insurance scheme and a jointly-funded resolution mechanism – along with a jointly-funded pan-European unemployment insurance fund. The banking union would break the «diabolic loop» between banking problems and sovereign debt problems. The jointly-funded unemployment insurance fund would provide for limited transfers from low to high unemployment regions, like those which operate in the United States.

The question is how to make the case. German leaders could start by observing that the common presumption that Germany will be a net contributor to these mechanisms is far from assured. Just because the German economy has been performing handsomely in the past is no guarantee that it will do so in the future. The country’s low investment rate and ageing infrastructure do not bode well for the future of productivity growth. The highest rated German university, according to the Shanghai Rankings, is the Technical University of Munich at number 50, which is not particularly impressive. The country’s sustainable energy policy is a logistical nightmare that, going forward, will weigh down German firms’ export competitiveness.

Above all, there are Germany’s dreadful demographics. Germany’s population is already shrinking. The fertility rate has dropped to fewer than 1.5 children per woman. The country is now taking steps to raise fertility rates, giving tax breaks for families with children and stay-at-home mothers. But whether encouraging mothers to stay at home rather than work is the best way of growing the labor force is dubious. And even the best-laid plans for raising fertility will impact the growth of the labor force only after 20 or more years.

Fagor entra en preconcurso con una deuda de 1.000 millones - and plans to create new capacity in France and Poland.

http://www.expansion.com/2013/10/16/empresas/industria/1381921099.html

Con el objetivo de lograr la recuperación y crecimiento, Fagor acordó invertir 20 millones de euros en inversiones en el negocio de Cocción, vinculadas a sus nuevas plataformas de inducción en las fábricas de Orleans (Francia) y Mondragón, y en su nueva plataforma para cocinas en Polonia.

Why the senate was more reasonable

http://m.washingtonpost.com/blogs/monkey-cage/wp/2013/10/16/deal-making-in-a-polarized-congress/

First, the final deal brokered by Senate leaders Harry Reid and Mitch McConnell (and ultimately swallowed by Speaker John Boehner) drives home the impact of blame avoidance in propelling parties to the bargaining table. Congressional deals, in short, are possible even in the absence of an ideological sweet spot of policy agreement shared by the parties. When the consequences of stalemate are deemed unacceptable, anticipation (or evidence) of being blamed for extreme outcomes drives partisans to the table. Given the heterogeneity of states in comparison to most congressional districts, Senate Republicans proved more electorally vulnerable to a damaged party brand name than their House colleagues. No surprise then that the deal took shape in the Senate. It took devastating poll results to weaken House GOP leaders’ resolve, ultimately collapsing when the clock ran out on their futile efforts to legislate without Democratic votes.

Richard O'Connell
+34 666 24 1104

The Mother of All Natural Experiments in Global Political Economy | Daniel W. Drezner

http://drezner.foreignpolicy.com/posts/2013/10/16/the_mother_of_all_natural_experiments_in_global_political_economy

o here we are. Despite repeated own-goals, study after study after study after study after studyshows that even after 2008, the United States remains the undisputed financial hegemon. But will this latest episode trigger a concerted effort to reduce the reliance upon the United States? Let's go back to Landler:That does not mean a brush with default will not have long-term damaging consequences for the United States. Even if China continues to buy Treasury bonds, economists said, it may opt for those with shorter maturities, which would drive up long-term interest rates in the United States, hurting home buyers and owners of small businesses.The sour taste from the budget impasse will also motivate the Chinese to intensify their efforts to deepen their own debt markets. Already, China has negotiated swaps for its currency, the renminbi, with the European Central Bank and other institutions, a step toward making the currency convertible and, someday, a rival to the dollar and euro.“This gives them a kick in the pants to do it,” said Kenneth S. Rogoff, professor of public policy and economics at Harvard and a former chief economist of the International Monetary Fund.Any decline in the status of the dollar will be gradual, said Mr. Rogoff, who pointed to the erosion of the British pound sterling over several decades as a precedent. But, he said, “Memories are long: you do this once, you do this twice, and people start to think.”At the time, U.S. policy during the Asian financial crisis seemed to reinforce views that the United States was the world's benevolent hegemon. As the next decade demonstrated, however, U.S.-enforced policies in the Pacific Rim caused countries in that region to adopt policies designed to reduce their reliance on the United States and international financial institutions. Thanks to the Mongolian clusterf**k that Ted Cruz, John Boehner, and some other economic know-nothings in the U.S. Congress have perpetuated, the next decade of global political economy will provide an excellent natural experiment to see whether there will be any form of economic balancing against the United States. Realists have been advocating predicting balancing behavioragain and again and again since the end of the Cold War. It hasn't come to pass -- the benefits of U.S.-centered globalization have been too good for most countries. Now we're gonna see whether incipient U.S. rivals will start making the necessary down payments to act on their increasingly justified complaints.   

Richard O'Connell
+34 666 24 1104