Sunday, 19 December 2010

The euro crisis: Endgame or not?

Two wellknown economists, Nouriel Roubini and Tim Congdon offer their takes of what will happen to the euro. Not unsurprisingly, their views differ somewhat. Nourine has described himself as the most europhile economist on his side of the Atlantic, while Congdon on the other hand is quite critical with regard to the euro.


Thus, in addition to an orderly resolution regime for banks, Europe must also implement early orderly restructurings of distressed sovereigns' public debt. Waiting until 2013 to implement these restructurings, as German Chancellor Angela Merkel proposes, will destroy confidence, as it implies a much larger haircut on residual private claims on sovereign borrowers.
Orderly market-based restructurings via exchange offers need to occur in 2011. Such exchange offers can limit private creditors' losses if they are done early. That way, formal haircuts on the face value of debt can be avoided via new bonds that include only a maturity extension and an interest-rate cap that is set below today's unsustainable market rates. Waiting to restructure unsustainable debts would only lead to disorderly workouts and severe haircuts for some private creditors.
Finally, Europe needs policies that restore competitiveness and growth to the eurozone's periphery, where GDP is either still contracting (Greece, Spain, and Ireland) or barely growing (Italy and Portugal). Without growth, it will be difficult to stabilize public and private debts and deficits as a share of GDP—the most important indicator of fiscal sustainability. Moreover, without growth, the social and political backlash against painful belt-tightening will eventually undermine austerity and reform.
Unfortunately, fiscal austerity and structural reforms are—at least in the short run—recessionary and deflationary. So other policies are needed to restore growth. The ECB should pursue a much looser monetary policy to jump-start growth, with a weaker euro to help boost the periphery's competitiveness. In addition, Germany should delay its fiscal consolidation; if anything, it should cut taxes for a couple of years to boost its own growth and—via trade—that of the periphery.
In the next few months, it will become clear whether European policymakers can compromise and implement reforms that dampen the threat of a eurozone breakup. Either the EU moves in the direction of a more stable equilibrium of closer integration, or the risk of an unstable and disorderly breakup scenario will rise significantly.

Read the whole piece here.


Many commentators and officials seem to think that the creation of a large inter- and cross-governmental financing facility for troubled nations is the answer. Well, that may be the answer to something, but – by itself – it will do nothing to boost Eurozone activity. For that the priority has to be faster growth of Eurozone M3, about which the ECB appears to have given no thought whatever. Given that policy-making is in chaos, market participants have to take pre-emptive action in case the Eurozone does break up. Everyone knows that the European Union has been able to cope – by the extension of blanket guarantees to governments and banks – with the crises in the small PIGS (i.e., Portugal, Ireland and Greece), precisely because they are small. But Germany and France cannot give blanket guarantees to the governments and banking systems of Spain and/or Italy, now precisely because Spain and Italy are large (the extension of guarantees to countries as big as Spain and Italy would – obviously – affect the creditworthiness of Germany and France).
So we appear to be reaching some sort of endgame. The final rupture is likely to see the ECB in Frankfurt telling a national central bank that it will have to refuse requests for help from that nation’s government and/or banking system. In this context, it is interesting that the ECB has recently taken action to boost its capital base.
Anyhow the latest ECB weekly return shows a sharp and resumed rise in lending to the commercial banking systems. These new loans – very probably, although not certainly – are loans to PIGs banks that are running out of cash. If a trend is unsustainable, it will stop. No one knows the exact date of the Eurozone’s breakup. Nevertheless, unless a big boom gets under way soon, the Eurozone will break up in 2011. A big boom would follow the deliberate large-scale monetisation of public deficits/debt, but the Germans are wholly opposed to that, and it is impossible to see rapid and effective agreement on scale, instrument and method by the relevant authorities in the Eurozone.

Link to Dr. Congdon´s article.

I would not bet on it, but I think Congdon might be closer to the truth.

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