MacroScope

There is no sovereign debt crisis in Europe

Evidence that Europe’s austerity policies are not working was in ample supply this morning. The euro zone as a whole is now in its longest recession since the start of monetary union. France has succumbed to the region’s retrenchment. Italy’s GDP slump is now the lengthiest on record. And Greece, still in depression, shrank another 5.3 percent in the first quarter.

To understand why this is happening, Brown University professor Mark Blyth says it is necessary to forget everything you think you know about the euro zone crisis. The monetary union’s troubles are not, as often depicted, the result of runaway spending by bloated, profligate states that are finally being forced to pay the piper. Instead, argues Blyth, it is merely a sequel to the U.S. financial meltdown that started, like its American counterpart, with dangerously-indebted risk-taking on the part of a super-sized banking sector.

In a new book entitled “Austerity: The history of a dangerous idea,” Blythe writes that sovereign budgets have come under strain primarily because taxpayers of various nations have been forced to shoulder the burden of failed banking systems.

The way austerity is being represented by both politicians and the media – as the payback for something called the ‘sovereign debt crisis,’ supposedly brought on by states that apparently ‘spent too much’ – is a quite fundamental misrepresentation of the facts. These problems, including the crisis in the bond markets, started with the banks and will end with the banks. The current mess is not a sovereign debt crisis generated by excessive spending for anyone except the Greeks. For everyone else, the problem is the banks that sovereigns have to take responsibility for, especially in the euro zone. That we call it a ‘sovereign debt crisis’ suggests a very interesting politics of ’bait and switch’ at play.

So why all the misunderstanding? Why has the crisis become conflated with a government debt problem in the public imagination? According to Blythe, this is a convenient way for Wall Street to again saddle the state with massive banking sector losses.

Why euro zone bond yield ‘convergence’ may be something to fear

 

Are European bond investors looking for love in all the wrong places?

The premium bankers demand to hold various types of euro zone debt over that of Germany has recently come down. In normal circumstances, this might suggest markets are no longer discriminating between the risks associated with different member countries’ bonds. But analysts say the recent convergence is based on a precarious belief of ECB action rather than any real improvement in economic fundamentals.

Spain and Italy still offer a comfortable premium over Germany. But a narrowing in yield spreads that is being driven by a fall in the funding costs of Spain and Italy, rather than by a rise in German yields, gives reason for pause.

According to Lyn Graham-Taylor, fixed income strategist at Rabobank:

The fact there is almost no movement from Germany and a huge movement in peripherals is indicative to us of this convergence for the wrong reason.

German ghost of inflations past haunting European stability: Posen

“Reality is sticky.” That was the core of Adam Posen’s message to German policymakers on their home turf, at a recent conference in Berlin.

What did the former UK Monetary Policy Committee member mean? Quite simply, that the types of structural economic changes that Germany has been pushing on the euro zone are not only destructive but also bound to fail, at least if history is any guide.

Posen, who now heads the Peterson Institute for International Economics in Washington, argued Germany’s imposition of austerity on Europe’s battered periphery is the product of an instinctive but misguided fear of an inflation “ghost” that has haunted the country since the hyperinflationary spurt of the Weimar Republic in the 1920s and 1930s. However, Posen offers a convincing account of modern economic history that shows inflation episodes are rather rare events associated with major political and institutional meltdown — and not always around the corner.

Abe’s European spring break: Japan stimulus sends euro zone yields to record lows

It wasn’t just the Nikkei. Euro zone government bonds rallied following Japan’s announcement of a massive new monetary stimulus. That sent yields on the debt of several euro zone countries to record lows on bets that Japanese investors might be switching out of Japanese government bonds into euro zone paper, or might soon do so.

The Bank of Japan on Thursday announced extraordinary stimulus steps to revive the world’s third-largest economy, vowing to inject about $1.4 trillion into the financial system in less than two years in a dose of shock therapy to end two decades of deflation.

Austrian, Dutch, French and Belgian borrowing costs over ten years fell to record lows as investors piled into euro zone debt offering a pick-up over Germany. The bond rally was led by 10- and 30-year maturities after the BOJ said it would double its holdings of long-term government bonds.

Firefighting in the euro zone

Money markets largely braved Cyprus’s bailout saga last week, but figures showing liquidity conditions are tightening suggest sentiment may not be as resilient the next time around.

Data from CrossBorder Capital, an independent financial firm that specialises in analysing global liquidity flows, shows the euro zone saw its biggest capital outflow in March since late 2011 – around the time the ECB injected liquidity into the financial system.

Financial institutions and governments took a net $175 billion worth of bonds and stocks, on an annualised basis, out of the euro zone in March – the biggest outflow since $201.4 billion in December 2011, according to the data.

Europe’s ‘democratic deficit’ evident in Cyprus bailout arrangement

The problem of a “democratic deficit” that might arise from the process of European integration has always been high on policymakers’ minds. The term even has its own Wikipedia entry.

As Cypriots waited patiently in line for banks to reopen after being shuttered for two weeks, the issue was brought to light with particular clarity, since the country’s bailout is widely seen as being imposed on it by richer, more powerful states, particularly Germany.

Luxembourg has accused the Germans of trying to impose “hegemony” on the euro zone.  The country, whose banking system, like Cyprus’, is very large relative to the economy’s tiny size, fears that similarly harsh treatment could be imposed on its depositors.

Is Slovenia the next shoe to drop?

The Cypriot saga has thrown the spotlight on Slovenia, which is also a small euro zone country struggling with an over-burdened banking sector.

Slovenia’s mostly state-owned banks are nursing some 7 billion euros of bad loans, equal to about 20 percent of GDP, underpinning persistent speculation that the country might have to follow other vulnerable euro zone countries in seeking a bailout.

According to Standard Bank’s head of emerging market research Tim Ash:

The latest crisis in the euro zone, this time in Cyprus, continues to raise questions as to possible contagion effects throughout the region, and in particular which economies could be next.

Priceless: The unfathomable cost of too big to fail

Just how big is the benefit that too-big-to-fail banks receive from their implicit taxpayer backing? Federal Reserve Chairman Ben Bernanke debated just that question with Massachusetts senator Elizabeth Warren during a recent hearing of the Senate Banking Committee. Warren cited a Bloomberg study based on estimates from the International Monetary Fund that found the subsidy, in the form of lower borrowing costs, amounts to some $83 billion a year.

Bernanke, who has argued Dodd-Frank financial reforms have made it easier for regulators to shut down troubled institutions, questioned the study’s validity.

“That’s one study Senator, you don’t know if that’s an accurate number.”

100-years of solitude in the euro zone

The euro zone slipped deeper into recession than economists expected in the fourth quarter of 2012 as Germany and France– the region’s two largest economies – shrank 0.6 percent and 0.3 percent respectively on a quarterly basis.

The data is a reminder of the plight still facing the euro zone as it struggles to shake off a three-year debt crisis, which the region has sought to fight with harsh, growth-crimping austerity.

The European Central Bank’s promise to buy the bonds of struggling sovereigns has spurred investors back into those markets and helped reduce borrowing costs. While one trillion euros of cheap funding made available to banks in late 2011 and early 2012 also gave investors greater confidence, the benefits of such policies have yet to translate into improvements in the real economy.

Irish setback

We’ve been saying for some time that while the immediate heat may be off the euro zone, therein lies a danger – that policymakers will relax their efforts to remould the bloc into a tougher structure that can withstand future crises, and possibly even allow this crisis to flare back into life.

Exhibit A has been the apparent backsliding on what we thought was a concrete plan to allow the euro zone rescue funds to recapitalize banks directly from next year, thereby removing the onus on highly indebted governments to do so. Over the weekend we got Exhibit B courtesy of a Reuters exclusive.

We reported that the European Central Bank had rejected Ireland’s solution to avoid the crippling cost of servicing money borrowed to rescue its failed banking system – debt servicing would amount to around 3 billion euros a year for the next 10 years. Dublin wanted to convert the promissory note into long-term bonds. The ECB decided last week that that crossed its red line of monetary financing.