The Great Debate

The reaction to this weekend’s European Union bailout deal for Cyprus has gone from initial shock to rather predictable condemnation. “Europe botches another rescue,” ran the headline on an editorial in the Financial Times. “It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying ‘time to stage a run on your banks,’ ” Paul Krugman, the economist and New York Times columnist wrote on his blog.

As widely reported, the deal has an important claw-back component: a one-time tax on the deposits of everyone who has a bank account in Cyprus ‑ Cypriots and foreigners alike ‑ aimed at raising 5.8 billion euros of the total rescue package of 17 billion euros. It’s always possible that the hyper-alarmist scenario of a pan-European bank run actually takes place, although by Monday afternoon, even jittery stock markets across Europe were starting to grow calmer, as EU officials insisted that the Cyprus deal was exceptional.

In fact, there are two compelling reasons why the EU actually has gotten this one right. The first is that Cyprus for years ranked highly on international lists of opaque tax havens, as it reinvented itself in the 1990s as the offshore banking center of choice for Russians. Under growing international pressure, and in order to join the EU in 2004, Cyprus eventually abolished its offshore tax regime and put in place a residence-based one with some clear oversight.

Still, the suspicions about Cypriot banks linger on. Last November, the German foreign-intelligence agency reportedly warned that any EU bailout funds for Cyprus could simply end up in the pockets of Russian oligarchs, according to the newsweekly Der Spiegel. The German agency estimated the amount of Russian money in Cypriot banks at $26 billion – substantially more than the total EU bailout package. Indeed, one Russian businessman, Dmitry Rybolovlev, owns almost 10 percent of Bank of Cyprus, the island’s biggest. (The Bank of Cyprus is also one of the two banks whose soured loans to Greece sparked the crisis in the first place.) Cyprus remains on an Organization for Economic Cooperation and Development “gray” list of countries that have made progress to meeting international standards but have not yet been judged squeaky-clean. (So, too, does Luxembourg, which was the one country supporting Cyprus’s objections in the weekend negotiations).

Under these circumstances, simply cutting Cyprus a check for the equivalent of more than half its annual gross domestic product with no strings attached would be politically incoherent. France and Germany for years have railed about the dangers of offshore tax centers, and have pushed their colleagues around the world at G8, G20 and other meetings to clamp down on abuses and harmful tax competition. The notion of “moral hazard” was much bandied about during the 2007-08 financial crisis, although in the end few were punished. But not to ask for a contribution from the Cypriots themselves would undermine their tough line on tax havens and what the French and German leaders have called the need for a “moralization” of finance.

There is an increasing probability that financial markets will respond negatively to the unfolding economic and political drama unfolding across Europe. So far, the European Central Bank has pumped out cash and calmed the nerves of investors, but it needs to do more. A cut in interest rates by the ECB is crucial to contribute to a revival of growth across the euro zone. On its own, however, that is not enough. Europe’s political authorities need to counter the increasingly widespread perception that they lack the will to confront the zone’s economic ailments and promote a clear path to growth – austerity policies alone will not work.

The situation has become far more serious now that the crisis has moved from the zone’s periphery to its major economies: Spain shows no signs of emerging from prolonged negative growth, Italy is now facing mounting difficulties and France is sliding into recession.

Overall, looking across the euro zone, the jobless data best illustrates the pain of this crisis. The latest statistics from Eurostat show unemployment across the 17-nation euro zone at 11.9percent; 19 million people are out of work. The rates in Greece and Spain are 27 percent and 26.2 percent, respectively, and in both countries the rate for youth unemployment exceeds 55 percent. In Portugal and in Ireland, where major efforts are being made to overcome acute difficulties, the jobless rates are, nevertheless, 17.6 percent and 14.7 percent, respectively. The rate in Cyprus has shot up from 9.9 percent to 14.7 percent over the last year. In Italy, the rate is over 11.5 percent, while in France it now stands at 10.6 percent.

Four years ago world leaders, meeting in the G20 crisis session, agreed they would all work to move from recession to growth and prosperity.  They agreed to a global growth compact to be delivered by combining national growth targets with coordinated global interventions. It didn’t happen. After the $1 trillion stimulus of 2009, fiscal consolidation became the established order of the day, and so year after year millions have continued to endure unemployment and lower living standards.

Only now are there signs that the long-overdue shift in national macro-economic policies may be taking place. The new Japanese government is backing up a “minimum inflation target” with a multi-billion-dollar stimulus designed to create 600,000 jobs. In what some call the “reverse Volcker moment,” Ben Bernanke has become the first head of a central bank for decades to announce he will target a 6 percent level of unemployment alongside his inflation objective. And the new governor of the Bank of England, Mark Carney, has told us that “when policy rates are stuck at the zero lower bound, there could not be a more favorable case for Nominal GDP targeting.” Side by side with this shift in policy, in every area but the Euro, there is also policy progress in China. It may look from the outside as if November’s Communist Party Congress simply re-announced their all-too-familiar but undelivered wish to re-balance the economy from exports to domestic consumption, but this time the promise has been accompanied by a time-specific commitment: to double average domestic income per head by 2020.

The intellectual case for change is obvious. A chronic shortage of demand has developed for two reasons. First, as the IMF announced at the end of 2012, the adverse impact of fiscal consolidation on employment and demand has been greater than many people expected. Secondly, the effectiveness of quantitative easing has almost certainly started to wane. As former BBC chief Gavyn Davies has put it, “the supply potential of the economy is in danger of becoming dependent on, or ‘endogenous to,’ the weakness of domestic demand. …With demand constrained in this way for such a lengthy period of time, supply potential is beginning to downsize to fit the low level of demand.” It is a new equilibrium that can be reversed only by boosting demand.

(The views expressed by former British prime minister Gordon Brown are the author’s own and not those of Reuters)

The good news is that Europe is no longer going the way of Greece. The sad news is that it is threatening to go the way of Japan.

After years of hesitation punctuated by panic, Europe has finally accepted the compelling logic that a single currency needs a lender of last resort. Pro-euro voters in the Netherlands have clearly been impressed as the President of the European Central Bank (ECB), Mario Draghi, braved the scowl of the ever-cautious Bundesbank and led his ECB directors to a pledge of unlimited – if conditional – short-dated bond-buying to avert another currency crisis.

The European crisis is no longer a European crisis. It is now everyone’s. Unless Monday’s G20 summit in Mexico coordinates a concerted global action plan right now, we face a global slowdown that will also have a deep impact on the U.S. presidential election and even on China’s transition to a new leadership. This is the last chance.

The standard, but often empty, language of summit communiqués will simply not do when the euro area is finally approaching its own day of reckoning. Whichever way the Greeks vote in Sunday’s election, a chaotic exit from the euro is becoming more likely: Its tax revenues are collapsing, not rising as promised. Unable to regain access to markets, Portugal and Ireland will soon have to ask for their second IMF programs. Sadly Italy – and potentially even France – may soon follow Spain in needing finance as the European recession deepens. Even German banks, which are some of the most highly leveraged, are not immune from needing more capital.

At G8 and G20 summits, world leaders have tended to be mere spectators as Europe has gone from one failed intervention to another. Now they must move decisively as they did in 2009. They must not leave Mexico without agreeing to support a big European firewall to stop contagion. And they must construct a global growth initiative for East and West.

If the euro really is on the verge of collapse, as many pundits are now proclaiming, how come it is still so highly valued against other currencies, including the U.S. dollar?

That may sound like a crazy question, given the euro’s much-publicized decline over the past couple of weeks. It has been dropping as the possibility grows that Greece may seek to pull out of the 17-nation currency union following parliamentary elections there in mid-June. That scenario of a “Grexit” has spooked financial markets and pushed governments and business around Europe to draw up contingency plans.

Yet looked at from a longer perspective than last week, the euro is in fact still pretty expensive. On foreign exchange markets, one euro today buys about $1.25. That’s more than 6 percent above the $1.17 rate in January 1999, when the euro was first introduced as an accounting currency. Back then, it got off to a weaker start even than Facebook’s IPO and quickly fell below parity to the dollar. On Jan. 1, 2002, when euro notes and coins were introduced into general circulation, one euro bought just 90 U.S. cents. It then dropped to a low point of 86 cents in March of that year. That’s 30 percent below where it is today. This chart from the ECB website shows the full picture since the euro’s introduction:

His political allies wrote him off as a lightweight, “a pedal-boat captain in a storm” as one memorably put it. European leaders, including Germany’s Angela Merkel, have gone out of their way to avoid him, and the markets have been unimpressed by his declaration, to the City of London, that “I am not dangerous.”

Yet with opinion polls in France unanimously predicting that François Hollande will be elected president on Sunday, this is a good time to be asking just how bad his presidency really would be for France, for Europe and for the markets.

If he does win, will he be able to inspire confidence and rebuild and renovate the fragile economy, with its heavy debt, stagnant growth and rising unemployment? Or will he preside over its rapid descent into Greek- or Spanish-style chaos, as Nicolas Sarkozy, the incumbent at the Elysée Palace, keeps warning?

The Law of Diminishing Returns  states that a continuing push towards a given goal tends to  decline in effectiveness after a certain amount of effort has been expended. If this weren't the case, Usain Bolt would be able to run the mile in  less than 2-1/2 minutes.

From an economic standpoint, this law now seems to be fully in force in Greece. The latest jobs figures from the twice-bailed out euro zone country paint a bleak numerical picture of the impact of unrelenting austerity in ordinary Greeks, regardless of whether it was self-inflicted or not. To wit:

More than one in five Greeks is unemployed.

There are more young people without a job than with one.

The record 1.08 million people  without work in January was a  47 percent tumble  in a year.

By Carlo De Benedetti
The opinions expressed are his own.

In a magnificent book published a few years ago Cormac McCarthy imagines a man and a child, father and son, pushing a shopping cart containing what little they have left, along a back road somewhere in America. Ten years earlier the world was destroyed by a nameless catastrophe that turned it into a dark, cold place without life.

There is no history and there is no future. But there is an objective: to head south toward the sea. Mythical places, only vaguely perceived, where there might be salvation. The father is getting older and is ever more weary. But he has the child with him. And he has his objective. He wants to take him southward to the sea. Toward a future that may still be possible.

Today, is the western economy, in particular the Italian economy, that world destroyed by an Apocalypse? Are we pushing that cart, containing the few things we have left, toward a mythical sea of which we know nothing, or even what it is like or where it is?

By Bethany McLean
The opinions expressed are her own.

There were a lot of things that were supposed to save Europe from potential financial Armageddon. Chief among them is the EFSF, or European Financial Stability Facility.

In the spring of 2010, European finance ministers announced the facility’s formation with great fanfare. In its inaugural report, Standard & Poor's described the EFSF as the “cornerstone of the EU’s strategy to restore financial stability to the euro zone  sovereign debt market.”  The facility itself said in an October 2011 date presentation that its mission is to “safeguard financial stability in Europe.”

That of course hasn’t happened. And the evidence suggests that the EFSF may have only exacerbated the problems.