The Great Debate UK

The death of the euro is greatly exaggerated

-Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own.-

The Governor of the ECB, Jean-Claude Trichet has raised interest rates by 0.25 percentage points – and quite right too. For us in the UK, blaming rising prices on temporary disturbances in the world’s commodity markets is a figleaf to hide the fact that we are actually embarking on a partial default-by-inflation. For Europe, it is a different story. For one thing, the Germany-Austria-Netherlands bloc is, if not booming, at least chugging along at a highly respectable rate, and as the ECB Governor said today in response to a question about the impact of the rate rise on Portugal, his job is to set interest rates for the Eurozone as a whole, not just for the benefit of one of its smallest and weakest members.

Sovereign bailouts are becoming routine and, for the media, a standard part of the ritual is to question whether the euro zone can survive these crises. There is one highly relevant question, however, which seems rarely if ever to be discussed.

Quite simply, it is not in my view a question of whether the euro zone can survive, but rather of what we mean by the death of the euro zone or, maybe, how it can be killed off without inflicting near-fatal damage in its death-throes.

First, as I have said before, the European Monetary Union is emphatically not threatened by a ClubMed walkout. Not only could it survive, it might even thrive if its weaker members quit. But, however much Germany may wish them to go, Greece, Portugal, Ireland, Spain, Italy would be crazy to leave individually or en masse. On the contrary, they have every incentive to stay because, however painful the austerity measures imposed on them by Brussels and/or Frankfurt and/or the IMF in Washington, the reality of life outside the euro zone would be far worse. Imagine having to relaunch your own currency when you are still burdened by massive foreign currency denominated debts – unless of course, you have defaulted, which would make the relaunch even more problematic. In the end, exiting the euro zone would mean every bit as much austerity as staying in, with the light at the end of the tunnel seeming even further away than it does now.

Of course, for the German Bloc, the voluntary or involuntary departure of the ClubMed countries would be a very mixed blessing. In the long run, it would allow them to look forward to preserving the euro as a hard currency, the true successor to the Deutschmark, with the prospect of welcoming into the fold at some future date the more responsible East European countries like Estonia, Poland, Czech Republic, Slovakia and others (and possibly one or two Nordics, maybe eventually Britain too). But in the short run, and especially if they were leaving involuntarily, the departing PIGS would almost certainly default on the enormous loans made to them by banks in Germany and its immediate neighbours, and possibly also on their debts to non-bank creditors in the euro zone, including the big German multinationals.

So if it is likely to be so costly to expel the insolvent member countries, what about the alternative of Germany itself quitting and leaving the PIGS to wallow in their own fiscal mess?

“Always a borrower, never a lender be”

-Laurence Copeland is professor of finance at Cardiff University Business School. The opinions expressed are his own and do not constitute investment advice. -

The first chapter of the Eurozone crisis story has ended as expected, with the Germans (and Dutch and Austrians) left to foot the bill, repeating the pattern we have seen in the last couple of years, at the micro and macro level: savers bailing out borrowers, the solvent rescuing the insolvent, the responsible minority rescuing the feckless majority from the consequences of their irresponsibility. No wonder banks don’t want to lend and firms don’t want to invest.

Apart from the injustice, the really damaging aspect is the message it sends out loud and clear about the way modern Western democracies operate. The younger generation will be noting the lesson — even if David Willetts, the Minister for Universities, is not — that those who work and save must bear the burden of carrying those who do neither, because nowadays the welfare state operates at all levels: personal, national, global.

The choice is, as they say, a no-brainer.  Shakespeare’s Polonius needs updating: “Always a borrower, never a lender be”.

This state of affairs is not something sudden, but rather the culmination of at least half a century of evolution, as the dynamics of democracy led us from a society based on the principle that nobody should be disadvantaged by accident of birth or chance, which was agreed in all Western countries by the end of World War Two, to the current consensus that nobody should be disadvantaged by indolence or fecklessness.

With its corrosive and cumulative effect on the will to work and save, it is a philosophy which local governments could never have afforded to embrace –- so they had to be bankrolled by central government. Now that central governments in turn are going bankrupt under the burden, they are left to scour the world for a sugar-daddy willing to bail them out, like a struggling Premier League football club looking for a billionaire with money to burn.

Is the re-pricing in stocks and oil complete?

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The better tone in stock indices and oil prices that has appeared this week begs the question as to whether the bout of re-pricing is complete.

The correction lower was arguably necessary to allow for the fact that the fiscal repair process which has started in parts of the Eurozone and will soon spread to the UK and then to the US next year will cap growth prospects for the industrialised world.

The likelihood that most countries in the industrialised world will see growth in the region of 1 percent and 3 percent this year did not sit comfortably with the exuberance of the recent rallies in assets such as oil and stocks.

The rally in the WTI oil contract took it from $33.98 /b in February last year to a high of $86.84 /b in April 2010.  While a re-pricing was probably unavoidable, it must be said that the economic news, particularly in the US, is not too bad.  Recent US economic data has been sufficiently robust to allow some forecasters to draw the conclusion that the US recovery is now self-sustaining.

The Federal Reserve recently increased its growth forecast for this year to 3.45 percent.  Stronger growth should undermine fears of contagion from the Eurozone debt crisis and will likely allow for a relaxation in some of the market’s indicators of risk and bring further bargain hunters into stock markets and into oil.

This may bring a little support into the near-term outlook for commodities.  That said the reprieve from bad news on the European debt crisis may be short-lived.  On top of that, it is likely that a strong USD will continue to weigh on the prices of dollar denominated commodities.

Financial Crisis Part II

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

Hollywood would never allow a record-breaking disaster movie to go without a sequel. The same seems to be true of the 2008 banking crisis.

In the end, the Greeks are going to get some kind of bailout – of that, we can be absolutely certain, because European policymakers are afraid that Greece could be Europe’s Lehman-AIG.

The resistance of the German Government has been undermined by the dawning realisation that a Greek default would be a major blow to its own banks, which own around 45bn Euros of Greek sovereign debt. Taken on its own, I suspect that would not be enough to persuade Frau Merkel to brave the wrath of her electorate on behalf of the Greeks, but the clincher is the fear that the contagion could spread.

It turns out that, for the last ten years, the German banks have been accumulating a vast stock of the riskiest sovereign debt in Europe – encouraged no doubt by the assurances enshrined in the banking regulatory framework that one Eurozone member country’s debt is as safe as another, so that they may now have nearly a trillion euros of bonds issued by Spain and Portugal alone.

If bailing out Greece can prevent Iberian default, it could be dressed up as a bargain for all concerned.

In short, the so-called sovereign debt crisis is actually a European banking crisis. Germany is unwilling to bail out the Greeks, but it feels it has no choice but to bail out its own banks.

What’s next in EMU after Greece deal?

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The European Union has finally agreed that an Economic and Monetary Union member country in serious fiscal difficulties will be able to receive bi-lateral assistance from its Eurozone partners as well as draw support from the International Monetary Fund.

Following weeks of discord, it had become politically important that there be a show of unity on how to deal with fiscally errant members.

In this sense the announcement of an agreement was an important step in the right direction.  The proof of the pudding is in the eating, however.

Greece still has to sell a significant amount of debt in the open market this spring and the EU will be hoping that Greece, never mind Portugal or Spain, will not have to tap its EMU partners for a loan.

Greek bond spreads tightened in response to news of the support mechanism, though the initial move in the longer end of the curve was half-hearted with the 10 year still yielding over 300 bps over bunds.

Similarly while the euro performed well after the announcement, EUR/USD has only retraced a small part of its recent falls.   The Greek debt office will almost certainly have to announce another bond sale in the coming weeks.

Is a queue forming at the EU’s fiscal soup kitchen?

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

Back in the prehistory of the euro zone, I wrote an article in the Times trying to work out how the game currently being played out in Europe would end.

Re-reading it, I think on balance I stand by my 1997 forecast.

Of course, back then it seemed far more likely that the major default threat would come from Italy or Belgium – Greece wasn’t even a member (and seemed unlikely at that stage to be admitted), but otherwise the endgame still looks the same to me.

The situation is as follows. Greece’s national debt is over 110 percent of its GDP, a figure which is growing by 12 percent or more every year (we cannot be sure, because there is widespread suspicion that the government is understating its deficit).

Given that Latin American countries have been often defaulted with far lower levels of debt, the markets are worried – which is hardly surprising, since Eurozone members are in exactly the same situation as third-world countries borrowing in dollars.

It cannot be emphasised enough that, at least in principle, the euro is nobody’s domestic currency, in the sense that no national government or central bank has the right to print it in order to repay its debts. Printing euros is the sole prerogative of the European Central Bank and its governing council, made up of representatives of all the euro zone member countries.

A tough spring in store for the pound

- Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The pound has started the year on a negative note.  Ongoing concerns over the budget deficit, an impending general election, the prospect that the Bank of England (BoE) may yet increase quantitative easing (QE) and a drop in consumer confidence are all clouding the outlook.

That said, sterling has already paid a high price for its weak fundamentals.  In 2009 EUR/GBP averaged 0.8909, this is 17 percent higher than its average in the 12 months leading to the Northern Rock crisis and 35 percent above the average rate between 2000-07.

A lot of bad news is in the price but a sustained sterling recovery is unlikely until there are concrete signs of resolution to the UK’s deficit problem.

In the midst of the deficit concerns, the government is still too uncertain about the prospects for economic growth to stiffen its commitment to austerity and, according to opinion polls, the opposition is not enjoying a decent enough lead to ensure it of election success.

This has left the pound worried by the possibility that this spring’s general election may produce a hung parliament and sensitive to the brutal suggestion from Pimco that if Labour return to power the UK may suffer a credit downgrade.

On a more positive note, the UK most likely emerged from recession in Q4.  This is hardly a cause for celebration, however, since most major economies emerged in Q2 or in Q3.

from The Great Debate:

A chink of light for the euro zone

-- James Saft is a Reuters columnist. The opinions expressed are his own --

Even without a huge fiscal boost or a hell-for-leather central bank, Europe could have a recovery, albeit a tepid one, on the cards by the end of the year.

Recent forward looking economic data is still grim, but hides within it the seeds of a rebound, as the absolutely brutal fall in manufacturing over the past six months burns itself out.

The euro zone's economic situation is still dire and it still faces outsized risks; its banking system must deleverage and has the potential for disastrous losses while it remains unclear who in the world exactly is going to be buying enough goods to stoke a sustained recovery.

But nothing goes in the same direction forever, and absent a health or banking disaster it is reasonable to expect positive surprises from demand as the year wears on.

As those who are betting on a recovery are generally backing U.S. growth, that surprise when it comes could give a nice boost to European markets.

"There is good convincing evidence that the inventory cycle in the euro area is turning favorably," said Aurelio Maccario, chief euro zone economist at UniCredit Group.