Tuesday, 29 November 2011

Fast track union changes will not help


France and Germany are pushing on with fast-track treaty changes, trying to find the loopholes that will allow the Euro-zone to impose German-style budget discipline on the other member countries without being bogged down by democratic procedure.

Presumably it means that the ECB subsequently will be allowed to act like a central bank. Or at least one hopes.

I  have come to believe that Germany still does not get it. The German policy is consistent, but wrong. The method for budget discipline now being pushed is just an ├╝ber-version of the tragically mis-named “Growth and Stability Pact” (PSG), Germany’s contribution to the euro from 1997.

Already back then, economists pointed out, that the PSG would be procyclical. It means that a country typically runs a (bigger) budget deficit in a period of slow or negative growth. The PSG was then intended to impose cut-backs on countries already having economic problems. It would deepen the problems, hence causing even bigger cyclical swings on the country in question.

We all know that the PSG was largely ignored – even by Germany, when it found it necessary.

It is correct that budget discipline and a manageable government debt are necessary for long term stability. But it will not work to impose deflationary policies on the other Euro-zone countries, when growth is desperately needed to in order to grow out of the deficit situation.

In order to balance the European economy, Germany needs to support the weaker Euro members with long term loans to the most needy and by adding to domestic German demand.

I agree with the German vision that it is better to have an economy based on producing things people actually need. But structural changes cannot be introduced quickly. Greece and Portugal will probably never be efficient producers of reliable hairdryers, much less advanced tool machines and industrial robots. Such changes take years, and in the meantime economic growth will be depressed.

So here is a yardstick by which you can measure the various ideas being touted in the press. It is good news if it brings us closer towards one of following:
  • Long-term loans to the countries in problems
  • Stimulation of demand in the countries that can afford it
  • Co-ordination of economic policies to stimulate demand
  • Help to structural development where needed
  • ECB to assume the role of a real central bank.

If a new policy idea or international agreement does not bring us closer to any of those elements, it is either bad news or quite simply irrelevant.

Whether this will end in a deep depression (as the OECD warned yesterday) or a long period of slow growth, nobody knows yet. But if the scale tips towards the depression outcome, Germany will suffer more than believed today. Ouch!

Friday, 25 November 2011


12 reasons for the markets to be paranoid

I cannot really find anything interesting in today's news. So let me instead use some space to summarise my views on why it is so difficult to operate in today's markets.

I have on earlier occasions expressed that at no other point in my career have I had to dig that deep in remote corners of my memory to find tools that can help me to understand. Yesterday one had to dig into the conditions for European government bond auctions (French primary dealers must bid at the OAT auctions, German primary dealers can abstain from Bund auctions if they like).

The day before yesterday one had to understand the unique American tradition of planning government expenditure programs over 10 years - which means that one cannot really count on anything. Last week we had to go over the ECB's charter to understand whether a modification of the charter also requires changes to the Lisbon treaty. And so on.

But we take a deep breath and list the factors that currently have conspired to ruin our night's sleep:

  1. A secular reversal of a 15-year trend where households in many countries have increased their financial leverage significantly
  2. A normal cyclical slowdown in the cyclical upturn that began in 2009
  3. Government austerity programs across Europe, beginning in 2010
  4. Additional public sector cut-backs in 2011
  5. A dramatic reassessment of the price of risk - and perhaps even a new understanding of risk
  6. Europe's central bank does not have the necessary authority to conduct a monetary policy that can effectively help us out of the pinch
  7. European banks have opposed a recapitalisation and are now zombies, are forced to reduce their balance sheets dramatically now (remember Japan!). The U.S. banks are still struggling with the aftermath of the Sub-Prime crisis
  8. Strong ideological determination in Germany to use the opportunity to shape important aspects of European political cooperation after the German model
  9. Southern European countries, which for years have opposed productivity-enhancing reforms and general budgetary discipline
  10. Maximum increase in the number of retirees (born 1945-50) putting pressure on state finances independently of the financial markets
  11. Large institutional investors are still forced to abide by the rating firms' views, even if these views are deeply compromised
  12. China's growing influence on world economy and the derived effects when even China has "slow" growth


I could probably find a few more. It is not necessary. There is already plenty.

My biggest problem is not really that the situation is complex. It is that the vast majority of communications in the financial sector has been shortened to a point that it can also be read by people with profound attention deficits.