The Great Debate UK

Geithner’s fudge won’t kill the euro zone debt Ouroboros

The frosty reception given to US Treasury Secretary Timothy Geithner at the ECOFIN meeting in Poland last week tells you all you need to know about what is wrong with the EU. The hostility was directed not at the feebleness of the advice he had to give, but at the right of an American passport-holder to offer any advice at all to the policymaking elite of Europe, who are so obviously capable of handling the crisis themselves without any outside assistance.

As far as I can tell, Geithner’s proposal amounts to leveraging the EFSF so that it can be inflated to a level sufficient to assure the markets that it has the resources to do the enormous job it has been given: bailing out Greece, Ireland, Portugal,  Spain, probably Italy and maybe even France at some point.

So, as ever, the American solution to the problem of excess leverage is… even more leverage. Financial wizardry is what Europe needs now – after all, it worked so well last time around… Risks? What risks? The additional borrowing will be guaranteed by the ECB, whose credit is cast-iron, so problem solved. Why did it take them so long to come up with an answer? If only it were so easy. Ask yourself: why is the ECB so creditworthy in the first place?

Not, in the final analysis, because its borrowing is backed by the governments of Greece or Portugal or Spain or Italy, nor even because it is backed by the Netherlands or Finland – however fiscally responsible they may be, they are simply too small to stand behind Europe’s central bank. In a crunch (and if we ever doubted that crunches happen, we know now that they do) even French support could be inadequate, given that it is currently running a sizeable budget deficit and faces a presidential election in a few months.

No: there are two meaningful levels of support that give the ECB its pristine credit status.

Firstly, the backing of the German government was, until recently, enough to preserve the ECB’s status as Son of Bundesbank. The trouble is that Germany itself has a debt-to-GDP ratio comparable to that of Britain, and the ratio would be a lot higher if it included commitments already made and about to be made to support weaker euro zone member governments. Moreover, even if they still have the capacity to do so, it is hard to see why the Germans would want to shoulder the bailout burden in this barely-camouflaged form when they are apparently so wary of entering into a more explicit transfer union (as they call the nightmare scenario of a Europe in which they are doomed to subsidise everyone else in perpetuity).

There is a second-level backstop for the ECB, and it is the one which I suspect will be called upon in the end. Although it is subject to all sorts of nominal restrictions on its freedom of action to reflect its multinational character, which have served to prevent it ever being free to behave like the Fed, the ECB is ultimately a central bank and, as such, it can always be given the green light to print Euros in whatever quantity is required to pay its debts or simply to cover the cost of more loans. The Geithner proposal amounts essentially to freeing the ECB from some of its existing constraints and preparing it to monetise Europe’s fiscal deficits, a policy similar to that which the Obama Administration itself has pursued vigorously so as to fund massive bailouts of Fannie Mae, Freddie Mac and other basket cases, with results that have been at best extremely mixed.

from The Great Debate:

China’s U.S. debt overhang needs Chinese cure

-- Wei Gu is a Reuters columnist. The opinions expressed are her own. --

When U.S. Treasury Secretary Timothy Geithner told students at Peking University that China's holdings of U.S. Treasury bonds were safe, his answer drew loud laughter from the audience.

Even economist and columnist Paul Krugman, who is often critical of U.S. economic policy, found himself defending America when he was repeatedly asked the same questions in China recently: Will you (U.S.) underwrite the value of China's holdings of U.S. government debt? Will you be prepared to pay a much higher rate of interest against the risk of high inflation and dollar depreciation?

This is a big change from two decades ago, when many Chinese felt the best way to preserve their savings was to convert yuan into dollars on the black market.

Dollars are still affectionately called "mei jin" in Chinese, which literally translates to "American gold", but they are now also referred to as toxic assets by many in China.

Last week's decline in U.S. bonds and the dollar after the sale of $100 billion in new U.S. Treasuries have made the Chinese even more concerned about the country's estimated $1.4 trillion of reserves parked in dollar-denominated assets.

The Chinese government wants to assuage rising domestic fury about the losses China faces on its $2 trillion foreign reserves, so the country's economists have come up with various options for Washington to "guarantee" the value of China's dollar holdings.

from The Great Debate:

Is the executive pay bubble popping?

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

Signs are it won't just be the salaries of bankers coming under fire.

An unusual array of forces are combining to make it very likely that top tier pay may be structurally falling, rather than simply taking a cyclical dip during a downturn.

Take it for granted that pay in the financial sector will fall. A combination of increased government ownership and a shrinking businesses taking fewer risks with other people's money will see to that.

But even if you cast arguments about a new mood of sobriety aside as humbug, government intervention and shareholder activism may combine to force down the share that top executives get of profits in businesses across the economy, even among companies not getting government handouts.

U.S. Treasury Secretary-designate Tim Geithner told Congress last week he would consider extending a $500,000 cap on the tax deductibility of executive pay to companies beyond those taking government bailout money.

"If confirmed, I would consider extending at least some of the TARP provisions and features of the $500,000 cap to U.S. companies generally as well as potentially imposing other rules beyond those potentially in effect," he wrote in reply to questions from Senator Carl Levin.

from The Great Debate:

First 100 Days: Obama and trade

-- Sean West is a Comparative Analytics analyst at the political risk consulting firm Eurasia Group. The views expressed are his own. --

Fear that President Barack Obama will backslide on America’s free trade commitments is misplaced—in fact, he may eventually expand America’s commitment to liberalization. His pledge to revisit the North American Free Trade Agreement (NAFTA) amidst an economic slump was one of his most widely discussed policy positions of the campaign season.

The economy—and, notably, unemployment—has gotten far worse since Obama derived political benefit from making the rhetorical connection between trade and job loss. Obama could use the magic policy window of his first 100 days to push through controversial but politically plausible anti-free trade measures. He will not do so—and if he does not do it now, he is unlikely to revisit it later.

If Obama is ever going to pound away at NAFTA it would in coming weeks. He is pushing this month for a comprehensive approach to saving or creating up to 4 million jobs in two years. If there was any real desire to rework NAFTA because it was thought responsible for job loss, it would make sense to address it now.

But Obama is unlikely to seek substantive change to NAFTA now or in the future because he recognizes the benefits of the agreement and knows that the U.S. has little room to maneuver in terms of renegotiation.

In fact, trying to “fix” NAFTA will more likely set off a firestorm with America’s neighbors than actually accomplish anything of substance.  Obama may be politically shrewd to have raised the issue, but he’s more pragmatic than protectionist.

The term “protectionist” is often thrown around incorrectly—and has inappropriately been attached to Obama. He is not a protectionist. Fears that he is should have been quashed with his selections of pro-market internationalists Timothy Geither, Larry Summers, and Ron Kirk for his economic and trade teams. But any one still left unconvinced should have taken solace in his recognition of the market’s “power to generate wealth and expand freedom” in his inaugural address. So rather than focus on misplaced pledges, what can be expected from Obama’s trade policy?