Chronicle of a predictable crisis (new episode)


While Eurogroupe Finance Ministers will, at long last, meet to finalise – under severe market pressure – the details of a comprehensive intervention mechanism applicable to the Eurozone as a whole, it is appropriate to analyse how the latest episode in the financial crisis has suddenly reached a critical momentum, spreading rapidly throughout world financial markets.


Try as they may to shift responsibility onto “speculators” as the cause of so-called irrational fluctuations in currencies, Government securities and their derivatives or, alternatively, onto the Rating Agencies, the politicians have only themselves to blame because it is to their own actions - often delayed or poorly thought through – that these disturbances should be attributed.


Indeed, the handling of the Greek crisis has been mainly “reactive” to market movements and always calibrated to meet the minimum requirements dictated by the specific fears being expressed, delaying at every turn – mainly for internal political reasons – any attempt to reach a comprehensive structural solution to the problems of managing the Economic and Monetary Union.


In two previous papers1 I drew attention to the fact that the structure of the Greek bail out contained implicitly all the necessary ingredients to encourage financial operators to test once again the true degree of solidarity that was supposed to exist among EMU Members.


The main weakness – quite obvious for an informed observer – was the bilateral character –even if coordinated – of the assistance provided to Greece by Eurozone members. Not only did these bilateral loans prolong as well as reinforce uncertainties because, in some countries - in particular Germany -, they were subject to a parliamentary procedure but, furthermore, it was clear that the mechanism was not repeatable, should the crisis contaminate the capacity of other EMU Members to refinance themselves under normal conditions.


The demonstration of the accuracy of this analysis has just been given by the fact that, only yesterday, the extraordinary summit of EMU heads of State in Brussels has mandated the implementation of a permanent intervention framework, the broad outlines of which Ministers of Finance are supposed to agree prior to the opening of markets on Monday.


But the choice of bilateral loans for Greece had further drawbacks:


It increased the indebtedness of the other 15 EMU Members at the same time as Germany and France arrogantly reminded their partners of their duty to return promptly within the strict budgetary limits defined by the Stability and Growth Pact (For Portugal this implies an effort of € 800 million for 2010, reducing commensurately its ability to achieve its budget deficit reduction target).

 It also meant fixing an interest rate arbitrarily at 5%. a level that avoided the challenge of containing an element of subsidy (forbidden by German Law). This level of interest rate was highly contentious: it meant that it left a profit for all lenders able to raise funds cheaper while exposing others to a loss ( though compensated by a very dubious equalisation scheme); but even more damaging was the fact that it put into jeopardy the very concept of support for Greece as the latter was in effect “subsidizing” its creditors. It is hardly surprising that a key element of the protests by Greek citizens focussed on this glaring lack of solidarity. A traditional Community loan – passed through at cost – would have eliminated all these problems. (As I write, I learn that a €70 billion Community Facility is being under discussion by Finance Ministers in a new example of “too little too late!”).


Even if the Eurogroupe agrees on a credible plan, it will not necessarily be sufficient to stop a further deterioration of the current episode of the financial crisis.


Indeed, as was the case after the Lehman failure, it is once again the financial sector that is in the eye of the storm, but this time the risks are far greater, at least in Europe. Then, the “subprime” crisis induced the freezing of the interbank market but Central Banks and Governments had the necessary resources to substitute for it. This resulted in a massive transfer of indebtedness from the financial towards the public sector. Now, it is precisely the Government securities, issued to finance bank rescue operations and general economic stimulus plans, which have been accumulating on bank balance sheets (encouraged by the apparently riskless arbitrage opportunities deriving from cheap and unlimited supply of liquidity by Central Banks) that are becoming the main source of fragility and systemic risk.


Furthermore, finding themselves compelled to submit to rigorous budgetary discipline imposed in particular by France and Germany and endorsed by the ECB, it is clear that EMU Governments, having reached and often exceeded the limits of prudent indebtedness, are in no condition to come a second time to the rescue of their banks. One can conclude that the correction of budgetary deficits can only take place through deep cuts in public spending as well as through tax increases, repeating, but in the opposite direction, the errors of a “pro-cyclical” policies. The economic consequences can only lead to a renewed recession and further weakness of the financial sector.


Over the last two years, I have on many occasions drawn attention to the unstable equilibrium between the deflationary and inflationary pressures prevailing in the economic environment. The apparently orthodox appeals (with the notable exception of Gordon Brown) for budgetary discipline leads me to believe that the odds favour falling into a depression (the worst possible scenario) as compared with the lesser dangers of an inflationary spiral.


Despite encouraging signs of renewed growth in emerging countries as well as in the United States, such an outcome in Europe has a high probability of contaminating the rest of the world, as feared by a growing number of commentators interviewed in the media. Indeed, any real weakness of the Euro – that should still be considered strong at present levels – would seriously jeopardise the capacity of the United States to boost its exports and consequently the strategy on which American recovery is based. That is why the events in Europe took such a toll in the US markets last week.  In such a scenario, all ingredients would be in place for reviving protectionist measures that, so far, the world has thankfully more or less avoided.


No! Ladies and Gentlemen, you who run our European politics should not blame speculators for our current problems but rather your own indecision, inconstancies and contradictions. It is the future of the Euro – and consequently of the European Union itself – that is in your hands. You do not have the right to destroy the efforts of fifty years of European integration because you lack the necessary political will.


1 “Chronicle of a predicable crisis” dated April 9th and “Flash: le sauvetage de la Grèce” dated April 12th.

09:41 Écrit par Paul N. Goldschmidt 13 Ave. Victoria 1000 Bruxelles dans Général | Lien permanent | Commentaires (0) |  Facebook |

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