Thursday, July 28, 2011

Enough is not enough

This summer is likely to be very hot as the temperature of financial markets is dangerously soaring. Rational arguments are here of no use; psychological factors are decisive like in any war. In fact, financial markets - big players like hedge funds and big banks - have decided to increase their pressure on sovereign debts of peripheral countries in the euro area with a view to make further profits on debt bonds.

A week ago, the European Council has agreed on a new rescue plan for Greece. It includes a new loan package, with a new loan of € 109 bn and € 50 bn of private contributions from banks and insurance companies as well as buyback of Greek bonds. For all new loans, interest rates will be 3,5% and repayments will be due in 15 up to 30 years. The novelty is that the Fund will buy back Greek bonds on secondary markets in exceptional circumstances and provide guarantees to Greek bonds if Greece were in selective default. The financial sector will contribute on a voluntary basis in multiple ways, either with bond exchange ( exchange of old bonds with new ones), roll over ( rescheduling of newly issued bonds over longer periods) or buy back ( purchase by Greek government of debt in private hands). In addition, there will be a task force to reactivate the Greek economy with structural Funds investments.

The accord was received positively by financial markets in Europe after the declarations of European and IMF leaders. The Greek crisis is apparently resolved but not at all. A rating agency, Fitch (the smallest among the three agencies) issued the term 'selective default' to invert the positive trend and nurture speculative attacks. It seems like if financial agents have ignored the scale of the loan package, the increased powers of the European bailout Fund which will be able to buy bonds on secondary markets, the favourable conditions which will apply to new loans, the purchase of Greek bonds held by domestic banks at a lower value. This creates a dangerous precedent: if the EU has accepted a partial default for Greece, this may also happen to Spain or Italy. This paves the way for a new cycle of speculation.

Indeed, the accord was meant to stop contagion to other countries such as Spain or Italy. However, their sovereign debts are still under pressure, especially Italy - the spread with German bonds widens, more than 300 points. With current growth and interest rates, debt service will increase 1,5 percentage point of GDP. This reflects long term, structural weaknesses of the Italian economy and the inadequacy of the political class in power, with wide corruption and scandals which certainly undermines the credibility of the country. Remember in 1992, after the attack against the lira by some hedge funds ( led by the famous raider, Soros who made a fortune with that operation), the Amato government had to ask for sacrifice to the Italian people as the country was about to collapse as it had to repay debt with interest rates soaring at 15%. Apparently, this lesson has not been learnt and Italian people are paying the consequences of the folly of a discredited political class, and of a single man who thinks to rule the country pursuing his own, narrow and controverted interests.

After the calm, the tempest may come in the next months. What went wrong? The EU accord on Greece is an important step forward but it came too late given current EU decision making rules. However, the real issue is that it does not build an effective economic governance to contrast speculative behaviour from banks and other agents. The European bailout fund has been increased up to € 450 billion but if Italy or Spain are under attack it will be insufficient to curb speculation. National governments do not need increase their current debt levels but the European Union which has no debt could borrow money at low interest rates. EU leaders know that the accord is not enough and will reconvene in September to agree on the way forward. The voluntary participation of the private sector is still to be further defined to avoid any moral hazard (if anything goes wrong, will States intervene again to save the banks?). In fact, EU leaders showed little enthusiasm to evolve toward a more federal management of the EU with the creation of eurobonds and stronger coordination of national fiscal policies. It is not too late to move in that direction if there is a common political will and awareness of risks and dangers of the current situation.

Friday, July 22, 2011

A clear vision for Europe

It is worthwhile mentioning also the document signed by five pro-European leaders - of which four left wing politicians- which calls for "a clear vision for Europe" articulated around five ideas: strengthened economic governance of the Euro; State guarantee of citizens; better international regulation of finance; more realistic objectives of debt reduction; European solidarity vis-à-vis highly indebted countries, including cancellation of part of the debt.

All these objectives should be pursued simultaneously, but require a shared vision and political will to undertake the reforms. It is nothing less than a vision for a regulated capitalism in Europe.

Sunday, July 17, 2011

A New Deal For Europe

The European project was engineered by a group of  farsighted statesmen - Schumann, Adenauer, De Gasperi and others - who were inspired by a vision of the United States of Europe and recognized that this idea could materialize only gradually by setting limited objectives, mobilizing the political will to achieve them and concluding treaties that required States to transfer competencies to supra-national institutions. This is how the post war European Steel and Coal Community was transformed into the European Union - step by step being conscious that each step was incomplete and would require further actions in due course.

The European architects generated the necessary political will by drawing on the memory on WWII and the massive human losses, the cold war and the potential benefits of economic integration. The process of European integration fed on its economic success with a sustained increase of trade among EU countries and important institutional developments. As the Soviet Union collapsed,  it received a powerful boost from the German reunification. Germany recognized that it could be reunited only in the context of closer European integration and it accepted to pay the price for it. The European project culminated in the Maastricht Treaty and the creation of the euro. 

The European political establishment recognized at the time  that the euro was incomplete as it had a European central bank but not a central Treasury. Its architects, notably Jacques Delors, were aware of that deficiency, but member States were reluctant to transfer sovereignty over their public finances. They believed , however, that when needed, the political will could be mobilized to move towards to a "transfer Union". But the whole conception of the euro was based on the idea that financial markets were self regulated and that their excesses could be corrected, so the rules were designed for introducing fiscal discipline in State budgets. But most problems came from the private sector as interest rate convergence within the euro area led to economic divergence: lower interest rates in 'peripheral' countries fueled house bubbles, while Germany had to introduce financial rigor in order to cope with the burden of reunification. Essentially, it adopted "beggar thy neighbor policies"  whereby it transferred deflationary effects to the other countries.  

Without the boost of German reunification and the enlargement, the financial crisis has generated a process of disintegration. This happened after the collapse of Lehman Brothers and the US authorities had to guarantee that no other important financial institution would be allowed to fail. German chancellor Merkel insisted that there should be no EU guarantee to address any systemic risk  in the financial sector and that each state had to care for its own institutions. This was the root of today's euro crisis.

The financial crisis  forced European States to guarantee for its own credit and this put into question the creditworthiness of European government bonds. As a result risk premiums widened (and continue to do so) putting national public finances on unsustainable strain. This has created a two speed Europe with debtor countries sinking under the weight of their debts and surplus countries forging ahead. As the largest creditor, Germany can dictate the terms of the assistance on the debtor countries and  push them towards insolvency. Meanwhile, Germany has benefited from the euro crisis which has depressed the exchange rate and  boosted its competitiveness further.

From the main driver of European integration, Germany has become the main opponent  of a "transfer Union". Now, the political establishment defends the status quo, and anyone who considers it unacceptable or unsustainable  is seen as anti-European  As heavily indebted countries are pushed towards insolvency with the help of  rating agencies, the 'deus ex machina' of financial markets, nationalism is rising in most European countries, for example the true Finns party in Finland who reached 20% in last elections. 

The status quo scenario is no longer sustainable. The two speed Europe is driving member States further apart. Greece seems to be heading  towards a default situation, but it should at least be conducted in an orderly manner While some contagion seems difficult to avoid - whatever happens to Greece is likely to spread to Portugal and Ireland's financial position is becoming unsustainable too with the recent downgrading. Defaults by the most exposed countries would affect banks and pension funds in both the core and the periphery.   In order to arrest and revert this  inexorable (at least it seems so) process,  bold solutions need to be envisaged. 

The answer is more Europe, not less. This would mean strengthening the euro area, which would require, as suggested by Jean Claude Juncker, president of the Ecofin and Eurogroup councils of finance ministers, and Giulio Tremonti, Italian finance minister, to convert a share of national debt into EU bonds through a voluntary process of enhanced cooperation. They proposed that these bonds could be traded globally and attract surpluses from the central banks of emerging economies and sovereign funds. These financial inflows could strengthen the euro area and stimulate growth and cohesion without fiscal transfers between member States.

The Amato-Verhofstadt proposal, endorsed by several Socialist and Liberal-Democrat leaders ( FT 3 July) differs in the sense that the EU bonds could be held by the EU itself,  therefore the debt would be ring-fenced from rating agencies and the interest rate could be decided by Eurogroup finance ministers. It cold thus help curb speculation and allow governments to govern.

This proposal is inspired by the Roosevelt bond which financed the 'New Deal' of the 30s and the former president of the European Commission proposed in 1993 to match the common currency with common EU bonds. Europe does not have a federal fiscal policy, but EU bonds, according to the Amato-Verhofstadt proposal do not need new institutions, but they could be held by the existing European financial stability facility - the fund which allowed the loan package to Greece, Portugal and Ireland together with the IMF- which could then co-finance projects with the European Investment Bank. 

As they put in their plan, "bonds are not printing money. They are not deficit finance. they do not need fiscal transfers between States. Net bond issues would see new inflows of funds to finance recovery, rather than austerity". European leaders are urged to recognise this case, "both to stabilise the euro and deliver a New Deal for Europe". The plan is sound enough to generate political will and to mobilise a pro-European majority around the idea that the European solution is better than national ones.

Wednesday, July 6, 2011

Democracy is at stake, not just the euro

Prof. Sen argues  rightly that it is not just the euro but Europe's democracy which is at stake ("The Guardian" (June 22, 2011). He writes : "Europe has led the world in the practice of democracy. It is therefore worrying that the dangers to democratic governance today, coming through the back door of financial priority, are not receiving the attention they should. There are profound issues to be faced about how Europe's democratic governance could be undermined by the hugely heightened role of financial institutions and rating agencies, which now lord it freely over parts of Europe's political terrain." 
His comment is highly pertinent.  We know from the Greek experience, the rating agencies act like a 'deus ex machina'- of course, they don't hold the truth but they behave as if they were right; they just act to make things happen as they want. This is an aggression against democratically elected governments and their people; if we cannot regulate them, they should be prosecuted, given their record of economic disasters !
In the same vein, G.Amato and Guy Verhofstadt  (FT 3 July) point out that 'Europe is losing a war between its elected governments and unelected rating agencies. Governments are trying to govern, but the rating agencies still rule". The issue is how to govern rather than let the rating agencies rule. This is why Europe needs an ambitious plan to tackle the debt crisis by strengthening existing institutions and creating solidarity among its members.  
In 1941, while they were prisoners on the Italian island of Ventotene, Altiero Spinelli, Eugenio Colorni and Ernesto Rossi wrote the famous Ventotene Manifesto where they called for a 'free and unite Europe'.  The Milan Declaration which followed in 1943, was the  founding act of the European Federalist Movement .  The Manifesto encouraged a federation of European states, which was meant to keep the countries of Europe close, thus preventing war. We should not forget that people gave their lives for freedom and justice. This is why we should fight and resist against the  financial and economic powers which are undermining the bases of our democracies.  We know historically what this meant for Europe!

See Sen's article : It isn't just the euro. Europe's democracy itself is at stake

Sunday, July 3, 2011

Reimagining Capitalism

The Nation, a US left wing monthly magazine asked an interesting question : if one had to reinvent American capitalism what should be changes  to make it less destructive and dominant, more focused on what people really need for fulfilling their lives? The question was put to a list of selected public thinkers, activists as well as influential people from business and finance.  The answers were a provocative sample of smart ideas as well as proposals to reform capitalism. But as W.Greiner, the Nation's editor (27 June) points out *, " the problem, of course, is that none of these ideas have any traction in regular politics. Both parties are locked in small-minded brawls, unable to think creatively or even to tell the truth about our historic economic crisis". 

The focus of many answers was on 'big government', not capitalism as such. The US political debate is imprisoned between Republicans who want less government and democrats who think that regulation will fix all problems. Despite a so-called recovery, the economic pathologies generated by unbound capitalism persist: falling wages and mass unemployment,  deepening inequality and the steady destruction of the broad middle class. The political system in the US and Europe alike does not have an answer for any of these.  W.Greiner notes : " at some point, it will become obvious that our economy will not truly recover until American capitalism is refashioned, stripped of its self-aggrandizing excesses and made to serve the interests of society rather than the other way around. As our commentators observe, this will require deep structural change, not simply new policies. Their essential approach is to reach into the guts of corporate capitalism and fix the wiring. That means changing both rules and operating values. It involves democratizing reforms that will compel business and finance to share decision-making and distribute rewards more fairly"

Among the proposals outlined for designing a new economy,  I'll focus on three main broad ideas.  The first one is to find an alternative to the profit maximizing corporate model and to declare their public mission as a primary goal above shareholder interests. This would require new corporate accountability vis-à-vis citizens and an independent watchdog to supervise that corporations are fulfilling their goals. Furthermore, it implies employee ownership plans  to make corporations more responsible. 

The second one is not new- it consists of a tax to fight against financial speculation, which is known as the Tobin tax.  This would help to downsize Wall Street and other financial centres by discouraging reckless behaviour and raise funds for public use. Other related ideas include  " publicly owned state banks as a way to create the underpinnings of truly local economies across the country" and to protect pension savings  from wall Street.  Moreover,  investors who meet sustainability objectives should get  financial incentives. 

Third idea: how to give a decent job to everyone. There is no economic demand more urgent than putting people back to work.  This has worked in past times when the government created jobs through big federal programs and became an “employer of last resort” . This is a social emergency - billions of dollars can be deployed for sustaining wars in several parts of the world, so why not for creating jobs to build a cohesive society!

Can we reform capitalism in a moral sense?  The endless search for profit is incompatible with the pursuit of general interest and common good. If we just assume that capitalism is not based on profit maximization, then we are talking about a different system. In fact,  the 'Nation' is imagining something which does not resemble to  modern capitalism. Someone called it "inclusive capitalism"  but whatever it is called it implies a fundamental redistribution of power and resources, which requires in turn a stronger government that will put an end to maldistribution of wealth through its tax and spending programs. Government has to recover its economic levers that were abandoned in the era of deregulation which led to intolerable inequalities. Let's call it socialism of a new type.