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May 25, 2005
Pressure Buiding On The ECB?
You bet, say Edward at A Fistful of Euros (entering my list of favorite weblogs with a bullet) and Martin Wolf at the Financial Times (available by subscription only). From AFOE:
A right royal row is brewing at the ECB. Basically the old guard theorists of the ’one size fits all’ monetary policy are being challenged by more pragmatic observers of day to day realities...
In fact [European Central Bank chief economist Ottmar] Issing is really digging in. He provocatively gave this One Size Fits All speech on 20 May. His conclusions were as follows:
“Let me conclude with a citation. On the eve of the changeover, I wrote a commentary on diversity and monetary policy in the euro area. To the question whether a single one-size monetary policy could fit all parties involved – be they national entities, social partners or economic actors – my answer was: “One size must fit all”...
Obviously you have to ask whether Issing in now losing his grip on reality. Can one size fit all is a legitimate question, one size must fit all is not an adequate response, and one size *does* fit all seems to reflect a distorted vision of reality to say the least.
Meanwhile, Wolf concentrates on Italy, the member of the eurozone that he views as having the worst fit of all:
A number of economists argue that the European Central Bank is distorting the market by treating all eurozone sovereign liabilities as equally riskless. Even if the ECB does this only at the short end, the knowledge that it does so will affect the entire yield curve. The solution, suggest Willem Buiter of the London School of Economics and Ann Sibert of Birkbeck, in an unpublished note, is for the ECB to accept government debt as collateral only at market-determined discounts.
Whether this idea would make a big difference to prices in the market is unknowable. What is knowable, however, is that it makes little sense for anyone to treat the debt of all eurozone members as equivalent. Because of its size and status as a founder member of the European Union, Italy's predicament is the most significant. It is also highly revealing. What has happened since entry, as I noted last week ("A more dynamic eurozone is a necessity", May 17 2005), is the precise opposite of what was needed: declining productivity performance, deteriorating competitiveness, faltering growth and weakening fiscal discipline.
In its latest survey of Italy, the Organisation for Economic Co-operation and Development remarks: "It is somewhat ironic that Emu membership, by allowing sharply lower interest and exchange rates may, in effect, have relaxed the perceived need for structural adjustments on both supply and fiscal sides." It may be ironic, but it is also human - and potentially calamitous.
Here's an interesting picture, that doesn't exactly prove the point, but does illustrate the effect of the union on Italian risk premia:
Wolf's personal angel of moderation prompts this...
I do not wish to be misunderstood. So let me be clear. I am not saying that the eurozone will disintegrate, or that Italy is doomed to Argentina's fate either. I am saying that tough choices and tougher times do lie ahead. Only with radical structural reforms, the most disciplined wage behaviour and the greatest possible fiscal rigour can a country in Italy's predicament sustain stability and return to healthy growth.
... which is only a partial antidote to this:
Let us think the unthinkable: could the eurozone disintegrate? The answer is yes. Disappearance of the zone as a whole seems hugely unlikely, so long as the commitment to the European project survives. But the exit of one (or more) members, a sovereign default or both is not at all inconceivable...
Monetary union was not the easy option. It was the tough alternative to an inflationary bonfire of Italy's debt. If the country fails to rise to the challenge it confronts, a default or even a forced withdrawal from the eurozone is perfectly conceivable. Italy has willed the ends. It must now will the means.
UPDATE: I see that AFOE noticed the Martin Wolf article also.
May 25, 2005 in Europe | Permalink
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Comments
Posted by:
bernard godement |
May 25, 2005 at 12:24 PM
"It is somewhat ironic that Emu membership, by allowing sharply lower interest and exchange rates may"
I think this is a key point that often isn't considered enough: one of the advantages of the euro has been thought to be low interest rates from Italy, Spain, Greece, Portugal etc.
But sometimes this may be a mixed blessing. I mean you want to buy a nice sports car, you haven't got the resources to pay, and you don't have sufficient credit rating at the bank. So you go to your dad and ask him to be guarantor (or mum, I'm not sexist). This gets you the loan, and at a good interest rate, but it doesn't help you to pay it back (unless of course dad does the paying).
Now in many ways the Med Club countries have been in this situation.
The IMF is often criticised (in my view with insufficient grounds) for offering a rescue package, attached to a structural reforms swap. The recipient gets the money cheaper, but has to do something in return. Turkey would be a good example here.
Now this has been the EU weakness, these countries have gotten money on the cheap, but without giving anything in return.
So what seemed to be an advantage in fact may be a liability, as you get increasingly into debt.
And this isn't just sovereign debt, there is also private endebtedness to consider. The whole thing just distorts the economies.
I think I need to develop this a bit more and probably post it:).
Incidentally, and while I'm here Dave, I've just been reading the:
DIRECT INVESTMENT, RISING REAL WAGES
AND THE ABSORPTION OF EXCESS LABOR IN THE PERIPHERY
paper by Michael P. Dooley et al.
I have to say I really am impressed, above all by the intellectual quality of the reasoning. I'm not sure I agree with them, I need time to think about this, but I am impressed.
Equally you can see that here you have a mechanism where something is exchanged for something: China gets (indirectly) cheap interst rates, and the US gets cheap consumer products and a guaranteed long term return on investment. It sounds plausible, and much better than cheap money for Italy.
And between you and me and anyone else who might read this, going back to NR & BS in their collapse of Bretton Woods 2 paper where I found the reference to the other, the Roubini/Setser argument seems *much* weaker.
Think about the euro, about what we are saying here, then near term how the hell is the dollar going to fall?
Look at the response of US/Europe spreads today. This is only partly the FOMC minutes. German ten year bonds touched a historic all time low. The two are interconnected, and this is going to affect Greenspan.
Posted by:
edward |
May 25, 2005 at 12:37 PM
"This graph says with 100% certainty that neither Italy nor Portugal will leave EMU".
Well this is where, ehem, we get into the rather tricky problem of Sovereign Default. Obviously if they had to pay what they had borrowed in euros at 100% of face value, it would be impossible.
But if they leave, and I go further than Martin Wolfe, I really see no long run way out, (this is Argentina 1998) they won't pay back in Euros if they can help it, but in Lira mark II which will be trading at (say) 3 to the euro. Then will come the hassle, and years of disputes, but then I guess Italian politicians (like their Argentinian counterparts) are used to that kind of wrangling. In fact they are probably experts:
Look at this post I put on Bonobo yesterday about the difficulties Eurostat is having just getting basic information of government spending and the deficit.
http://bonoboathome.blogspot.com/2005/05/lies-damn-lies-and-italian-government.html
We aren't there yet, but it may well (and on my view will) come. The first indication will probably be a return to noticeable sovereign spreads. Once that just starts to happen then the negative circle could become vicious very quickly IMHO.
Incidentally Bernard, I am most certainly not anti EU. I just think the euro has been a bad decision, and if the EU has a crisis on Monday it won't be because the French vote no (if indeed they do) but because they vote no and France uses the euro as a currency.
Posted by:
edward |
May 25, 2005 at 01:27 PM
Edward,
my point about 100% sure is not the principal, it's the interest: think about the extra current expenditure to service a debt that would occur at 600-800 extra basis points. That is nightmare personified to any treasury department. In fact, to a certain extent, you could argue that keeping one's debt in a hard currency (euro) rather than a weak currency ( new lira) means that the cost to the debtor is tilted towards late in the future compared to having to pay huge interest immediately.
Now on spreads, some have said that perhaps the ECB should differentiate between various sovereign debts, but I honestly don't see how they could do that: a central bank that takes its cue from (sometimes) volatile markets is in my view a recipe for disaster and vicious circle. I agree though Idon't see the solution that current spreads aren't wholly informative of reality.
On whether the Euro was a bad decision, I beg to disagree. The Euro is an economic AND a political project.
Politically, it is in part an answer to the strategic uncertainties born out of the collapse of the East block and the re=unification of Germany. It anchors Western Europe together and maybe later on Eastern Europe as well and that is a good thing. Do remember always that WWII only finished 60 years ago.
Economic wise, the situation prior to the Euro was that countries such as France took monetary policy from the Bundesbank = and that was tailored with germany and no one else in mind = or, if they did not, suffered grave consequences in terms of spreads and exchange rate stability. The present situation is not ideal perhaps, but all countries except Gemany now have a policy that is actually somewhat closer to their needs, and enjoy interest rates that are very low indeed. I hate to think where the French economy would be right now if the long term spread was 200 bp as it was prior to 1992. For me, the Euro is a great progress, it is incomplete and I want this continent to unify institutions.
Posted by:
bernard godement |
May 26, 2005 at 10:01 AM
Back from a trip. I won't comment on pressure on the ECB as it is rather obvious. There is an amusing point to make in relation to the graph in your post. This graph says with 100% certainty that neither Italy nor Portugal will leave EMU. The cost to their Treasury departments would be rather substantial.
The same can be said of a number of other countries. Some small countries could see an interest in leaving but that would not deal a death blow to EMU. Which leaves Germany and France. Germany will never do so as it would then be profoundly ostracised politically and subject to containment strategies. Besides, they are profoundly European in a way that many Anglo=Saxons seem to find difficult to grasp.
The remarks above lay to rest the first solution to the one-size-fits-all problem (which is of course a real problem) and show that the current thoughts agitated by some on markets are a poor disguise for what has always been hostility to the unification of Europe (and, yes, before some scathingly reply, there is a section of French opinion which is very anti=european, but it is very much smaller than the coming no vote number).
This leaves us with the second solution to the problem, namely a coordination of fiscal policy in the zone and, later on, hopefully, the possibility to actually choose a fiscal/monetary policy mix, which is not the case right now. The situation now is unsatisfactory: when Germany decides to reform and tighten fiscal policy, monetary policy is not there to pick up the slack as it would be in the US for instance.
I might add that a unification of fiscal policy and a re=distribution mecanism whithin the zone might help assuage cyclical diversities, but then I would be dreaming in the short run. In the long run though, I may not be dreaming that much.
Now, reform. It is a fact of political life that most Western Europeans are seriously opposed to reform of the welfare state that has brought them so many benefits. I personally have been hearing the story of how Europe is condemned to abandon most of its welfare state for the past 20 years at least. So far, my compatriots are still alive. We certainly recognise that we will be dead in the long run but can't help notice that so will every one. The political reality is that the social compact is still very alive in countries such as France and that attempts at changing it in Germany are a demonstrated recipe to political doom.
Another certainty is that so=called cheap imports = as in Chinese imports = do threaten industries in welfare Europe as they do in non=welfare US. The point is quite simply that redistribution cum welfare and manufacturing vulnerability are likely independent of each other. There simply are manufacturing activities that highly developed cuntries have no business being in: should France manufacture T=shirts (it does not) or should it manufacture nuclear plants (to evoque a subject that seems dear to your heart)? The answer seems obvious and what relation it might have with how France chooses to treat its poor and disadvantaged, I honestly don't know. Like it or not, we like to extend a caring hand.