Opinion

The Great Debate

from Breakingviews:

Applying corporate finance to nations

By Rob Cox

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

It is generally accepted on Wall Street that breaking up bloated and unwieldy companies is a good thing. Division makes them easier to manage, more accountable and allows them to deliver greater value to their many constituents. On the eve of Scotland’s historic vote on independence, it’s worth considering whether the same logic might also be applied to nations.

Scotland will vote on Thursday whether to spin itself off from the United Kingdom. Catalonia is planning a similar, but not legally binding referendum on leaving Spain in November. If both go their own way, other European nations could end up splitting into smaller new political units.

There are few precedents, at least in the developed world, for them to emulate. The history of corporate finance may provide some useful insight. Of course, it is hard to imagine any legislator anywhere in the world exhorting voters to stake their futures to a Wall Street construct. But the philosophical underpinnings to breaking up companies and countries share many similarities.

In the corporate world, the logic starts with the premise that these actions will, first and foremost, benefit shareholders. The gains include allowing management to focus on what it is best at and improving the ability of the organization to respond to the needs of customers and the marketplace. These can outweigh the economies of scale that companies often hope to extract from greater size.

from John Lloyd:

If Prince Charles becomes King Charles, will his kingdom leave him?

Prince Charles, the Prince of Wales and Duchess of Cornwall Camilla arrive for the second day of the Royal Ascot horse racing festival at Ascot, southern England

Could Prince Charles finally get his crown? And if he does, could it mean the end of the United Kingdom?

Abdication in favor of the younger generation seems to be something of a trend in Europe -- if two cases can be considered a trend. Queen Beatrix of the Netherlands abdicated last year so that her son, Willem-Alexander, could bring some youth and vitality to the largely ceremonial role.

More recently, King Juan Carlos, widely credited with having assisted the end of the Franco dictatorship in Spain in 1975 and with puncturing a rather feeble coup attempt in 1981, vacated the throne in favor of his son, Felipe. The announcement was followed by large demonstrations calling for an end to the monarchy entirely, with Cayo Lara, leader of the United Left Coalition, quoted as saying, "We are not subjects, we are citizens."

from Nicholas Wapshott:

No, austerity did not work

There have been a lot of sighs of relief in Europe lately, where countries like Britain and Spain, long in recession, have finally started to grow. Not by much, nor for long. But such is the political imperative to suggest that all the misery of fiscally tight economic policies was worth the pain that there are tentative claims the worst is now over and, ipso facto, austerity worked.

Hold on a minute. Growth is good. Growth is what allows countries to pay down their national debt by increasing economic activity, putting the unemployed to work and making people prosperous enough to pay taxes. But gross domestic product growth alone is not enough to provide adequate sustained prosperity if it does not also lead to significant job growth.

Take Spain, which has just emerged from two years of recession by posting a third quarter growth rate of 0.1 percent. Technically the Spanish slump is over. But a glance at their job figures shows the country has a long way to go before it can genuinely say it has escaped the diminishing effects of austerity -- in the form of tight fiscal policies, public spending cuts and labor and entitlement reforms -- imposed indirectly by Germany through the European Union.

The year ahead in the euro zone: Lower risks, same problems

Financial conditions in the euro zone have significantly improved since the summer, when euro zone risks peaked because of German policymakers’ open consideration of a Greek exit, and the sovereign spreads of Italy and Spain reached new heights. The day before European Central Bank President Mario Draghi’s famous speech in London in which he announced that the ECB would do “whatever it takes” to save the euro, bond yields in Spain and Italy were at 7.75 percent and 6.75 percent, respectively, and rising. When the ECB announced its outright monetary transactions (OMT) bond-buying program, the euro zone was at risk of a collapse.

Since then, risks have abated significantly, thanks to a number of factors:

    The ECB’s OMT has been incredibly successful in reducing the risks of breakup, redenomination and a liquidity/rollover crisis in the public debt markets of Spain and Italy. Although the ECB has yet to spend a single additional euro to buy the bonds of Spain and Italy, both short-term and longer-term sovereign spreads against German bonds have fallen substantially. Following a number of political and legal hurdles, the successful operational start of the European Stability Mechanism (ESM) rescue fund provides the euro zone with another €500 billion of official resources to backstop banks and sovereigns in the euro zone periphery, on top of the leftover funds of its predecessor, the European Financial Stability Facility (EFSF). Realizing that a monetary union is not viable without deeper integration, euro zone leaders have proposed a banking union, a fiscal union, an economic union and, eventually, a political union. The last is necessary to resolve any issue of democratic legitimacy that might result from national states transferring power from national governments to EU- or euro zone-wide institutions. This transfer of power also would have to involve the creation of such institutions to ensure solidarity and risk-sharing are developed in the banking, fiscal and economic unions. The open talk in the summer by some German authorities about an exit option for Greece has turned into a tentative willingness to prevent and postpone such an exit. There are several reasons for this. First, Greece has done some austerity and reforms in spite of a deepening recession, and the current coalition is holding up. Second, an orderly exit of Greece is impossible until Spain and Italy are successfully isolated. Such an exit would lead to massive contagion, which would hurt not only the euro zone periphery but also the core, given extensive trade and financial links. Third, an economic disaster in Greece would be damaging to the CDU Party’s chances of winning the German elections. Thus, even when Greece inevitably underperforms on its policy commitments, Germany and the troika (the IMF, EU and ECB) will hold their noses and keep the funds flowing as long as the current coalition holds up.

Given these developments, the risk of a Greek exit in 2013 has been significantly reduced, even if the risk of an eventual Greek exit from the euro zone is still high, close to 50 percent by my estimation. Meanwhile, the narrowing of Spanish and Italian sovereign spreads has significantly diminished the risk that either country will fully lose market access and be forced to undergo a full troika bailout like Greece, Portugal and Ireland. Both Spain and Italy may in 2013 opt for a memorandum of understanding (MoU) that opens the taps of ESM and OMT support, but such official financing would inspire confidence as it would not be associated with rising, unsustainable spreads and a loss of market access.

While there is a much lower likelihood of disorderly events in the euro zone, there are still significant obstacles to deeper integration, as well as country-specific economic and political vulnerabilities. The biggest obstacle to the formation of a banking, fiscal, economic and political union is that Germany is pushing back against the time line for action, with the initial skirmish on ECB supervision of euro zone banks. This backpedaling reflects deep German skepticism on whether the resolution of the euro zone crisis requires a move toward greater union. Without a more credible commitment to austerity and reforms from euro zone periphery countries, lurching forward would imply that risk-sharing will turn into a large, long-term transfer union, which is unacceptable to Germany and the core. Thus, Germany will do whatever is necessary to delay the integration process, at least until after elections in fall 2013.

Decisive euro action is needed at the G20 summit

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.

Europe’s Lehman moment

By Jeffry A. Frieden
The opinions expressed are his own.

Europe is in the midst of its variant of the great debt crisis that hit the United States in 2008. Fears abound that if things go wrong, the continent will face its own “Lehman moment” – a recurrence of the sheer panic that hit American and world markets after the collapse of Lehman Brothers in October 2008. How did Europe arrive at this dire strait? What are its options? What is likely to happen?

Europe is retracing steps Americans took a couple of years ago. Between 2001 and 2007 the United States went on a consumption spree, and financed it by borrowing trillions of dollars from abroad. Some of the money went to cover a Federal fiscal deficit that developed after the Bush tax cuts of 2001 and 2003; much of it went to fund a boom in the country’s housing market. Eventually the boom became a bubble and the bubble burst; when it did, it brought down the nation’s major financial institutions – and very nearly the rest of the world economy. The United States is now left to pick up the pieces in the aftermath of its own debt crisis.

Europe’s debtors went through much the same kind of borrowing cycle. For a decade, a group of countries on the edge of the Euro zone borrowed massively from Northern European banks and investors. In Spain, Portugal, and Ireland, most of the borrowed money flooded into the overheated housing market. “At the height of the building boom,” Menzie Chinn and I write in our new book, Lost Decades: The Making of America’s Debt Crisis and the Long Recovery:

from MacroScope:

Europe’s over-achievers and their fall from grace

Ireland's fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.

Take a look first at the progress of  PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the  same point) Ireland is far and away the biggest loser. Portugal is basically where it was.

Scary

But now take the rebasing back to roughly the time that the euro zone came together.  First, it shows that Ireland's fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years' misery. But it is front loaded.

Euro zone medicine not working on banks

Fear of lending to banks is rising again in Europe, as even a 750 billion euro zone rescue package proves not enough to stem fears that the banking system will prove the weak link when southern European nations can’t meet their obligations.

Strikingly many European and British banks are now being forced to pay more to borrow money in the interbank markets than before the joint European Union, International Monetary Fund and European Central Bank package was announced two weekends ago.

That deal, which should insulate highly indebted countries such as Greece, Spain and Portugal from funding pressure for the next two years or so, was effective in driving down the extra interest those countries had to pay to borrow as compared to Germany. Tellingly, it was less effective, even counter-productive, in restoring calm to the markets in which banks fund their short-term borrowing needs.

Watch banks for clues on Greece

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

As odd as it sounds, concerns about the effects of a euro zone sovereign crisis on Europe’s still poorly capitalized banks may prove to be the tipping point that leads to a swifter bailout of Greece.

While discussion of contagion may seem very 2008, the problems with Greece, which faces a huge fiscal deficit, are becoming tougher for euro zone authorities to leave uninsured.

from MacroScope:

Political economy and the euro

The reality of  'political economy'  is something that irritates many economists -- the "purists", if you like. The political element is impossible to model;  it often flies in the face of  textbook economics;  and democratic decision-making and backroom horse trading can be notoriously difficult to predict and painfully slow.  And political economy is all pervasive in 2010 -- Barack Obama's proposals to rein in the banks is rooted in public outrage; reading China's monetary and currency policies is like Kremlinology; capital curbs being introduced in Brazil and elsewhere aim to prevent market overshoot; and British budgetary policies are becoming the political football ahead of this spring's UK election. The list is long, the outcomes uncertain, the market risk high.

But nowhere is this more apparent than in well-worn arguments over the validity and future of Europe's single currency -- the new milennium's posterchild for political economy.

For many, the euro simply should never have happened --  it thumbed a nose at the belief that all things good come from free financial markets; it removed monetary safety valves for member countries out of sync with their bigger neighbours and put the cart before the horse with monetary union ahead of fiscal policy integration. But the sheer political determination to finish the European's single market project, stop beggar-thy-neighbour currency devaluations and face down erratic currency trading meant the  currency was born and has thrived for 11 years.

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