Vox Clamans

Draghi comments from London have risen high expectations from global markets. Basically, he said that ECB would do whatever it takes  to save the euro by any means. This needs to be interpreted since ECB powers are limited by the EU Treaty. Maybe we should understand that it would go beyond its remit by anticipating the June European Council decision, which gave the power to the ECB to purchase directly bonds in euro-zone members.

The reaction of markets was positive as Spanish and Italian bond yields were brought down, but still remain high. But just after the hawks of the Bundesbank warned against any intervention of the ECB, markets retrenched immediately. The German conservative newspaper, Die Welt, said that Mario Draghi, is the "Trojan horse of the indebted South, who wants to transfer resources from the rich and productive North to the continental South". 

Markets are not driven by moral sentiments. The finance world is neither a land of sudden and lasting miracles. The recent speculative attacks - concerted between the most powerful US and European banks - aimed to test the resilience of most exposed countries of the euro-zone and to bet on the inability of  EU institutions and national governments to set out an effective strategy to counteract them. Lately, Europe has given its worst image: after the announcement of unanimously agreed measures to tackle the euro crisis at the June council, some countries put in question the agreement with contradictory declarations with the sole consequence of feeding international speculation in a growing political decay. The perfect storm ! 

Under these conditions, the final assault to the crumbling fortress of the euro-zone was to be expected. In his statement, Mario Draghi has warned against the risk of disintegration and  explained that the ECB was ready to mobilize all the instruments at its disposal  to stop speculation. The (temporary) retrenchment does not mean that speculators will surrender, but they know that they will have to deal with a genuine federal institution which is determined to defend the euro-zone at any cost. But it cannot remain alone in this final battle and governments should,  without any ambiguity, play their role, for example by bringing additional resources into the European financial stability fund, and then into the European Stability Mechanism (ESM) which will enter into force in September 2012.

Progressively, the ECB will have to turn in a sort of Federal Reserve. Economists are divided over its performance on managing the crisis in the US economy. Some argue that its policy of 'quantitative easing' (easy credit) inflated the bubble while others believe that the Fed's interest rate cuts since the bubble burst have been a success as they prevented a much more severe recession. Others think that the Fed has merely postponed the day of reckoning. 

Ch. Kindleberger, a famous economist who wrote a history of financial crises, in "Manias, Panics and crashes " (1978)  believed that , in certain conditions, markets needed help from a lender of last resort. He understood both the danger of inaction by such a lender and the “moral hazard” that its mere existence can create, by encouraging investors to be reckless in the belief that they will be bailed out if all goes wrong. Thus, he argued, a “lender of last resort should exist, but its presence should be doubted.” It should always come to the rescue, but “always leave it uncertain whether the rescue will arrive in time or at all, so as to instil caution.” this is precisely what we need in Europe, not just a firefighter.

The price of offshore finance

Studies on inequality focused mainly on income and failed to capture the missing wealth due to tax evasion, which means that global inequality is much higher than accounted so far .  A recent research  on the" price of offshore" - carried out by James Henry, the former chief economist of Mc Kinsey based on data from the World Bank, IMF, central banks, UN and the Bank of International Settlements - has estimated for the first time the private financial wealth deposited in tax havens. In fact, there are very few studies on private wealth, despite the wealth of information. The report  estimates that the global super rich people have hidden at least 21 trillion dollars in tax havens, which is equivalent to the  combined GDP of the US and Japan. However, this estimation is conservative as it takes into account only private financial wealth and leaves aside real estate, yachts and other non-financial assets. 

The research was promoted by the British NGO, Tax Justice Network , which opposes tax havens since "they are heightening inequality and poverty, corroding democracy, distorting markets, undermining financial and other regulation and curbing economic growth, accelerating capital flight from poor countries, and promoting corruption and crime around the world". The existence of countries without any fiscal transparency is indeed one of the causes of global poverty and the growing inequality between the rich and the poor. These resources are diverted from productive use, investment and labour and therefore have a negative effect on the financing of public goods such as infrastructure and education, especially in times of recession. This vicious circle creates a sort of 'black hole in the world economy" with terrible consequences on the lives of billions of citizen

According to the report, the leading 50 banks - of which primarily Credit Suisse, Ubs and Goldman Sachs- have transferred, at the end of 2010,  mores than 12 trillion of cross border investments on behalf of individuals, large corporations or foundations controlled by the super rich. This network of financial intermediaries explains the rapid growth of off shore finance.  

If the deposits were taxed at 30% a minimum gain of 3%, governments could collect 180 billion dollars ( 280 billion on the basis of a higher estimation of 32 trillion), more or less what the OECD countries allocate to aid to developing countries. This is without any doubt a concrete way to help getting out from the Great Depression. 

Regulation is not enough

After the crash of 2008, governments had to bail out their banks for having taken excessive risks. Some were too big to fail, let aside the exception of Lehman Brothers, the fourth largest US bank.  But in the aftermath of the crisis, they continued their business as usual activity.  Nouriel Roubini points out that" the incentives of the banks are still to cheat or to do things that are immoral and the only way to avoid that is to break-up this financial supermarket " 

The Barclay's  case is just another example of immoral behavior. Together with other European and US banks, they manipulated the Libor - the average (estimated) interest rate which serves as a benchmark for inter-bank and private transactions which represent today around 500 trillion dollars- as well as the Euribor, the equivalent for the euro area. The financial impact is quite significant: billions of profits for the banks, additional charges for businesses and citizens. 

How could these crimes happen ? Regulators were distracted, or complacent but did not ignore the fact. Bankers have disregarded basic financial rules without any effective control and supervision. Now, investigations are under way in the US and Europe which could eventually lead to arrest bank managers and traders. 'Class actions' (collective judiciary actions) have been launched against the banks, but these legal battles will probably take years.

The issue is whether there is any effective regulation which could stop banks from cheating on interest rates, building 'ponzi schemes' or laundering dirty money. There are no limits to their criminal fantasy. Global rules are necessary but they have to be enforced vigorously with severe sanctions. Leading by example is one way forward: powerful bankers who committed criminal acts should go to jail. We need to create the right incentives to reform the international financial system and put an end to Adam Smith's 'vile maxim of the masters of mankind" - "all for ourselves and nothing for other people". 

Sign the petition: http://www.avaaz.org/en/bankers_behind_bars_f/?fp

Europe should fight the recession

The European summit (28-29 June 2012) - the 19th held in an attempt to resolve Europe's economic woes- has met its expectations on short term measures to fight speculation but has fallen short  on growth measures. As one commentator said, one more summit but "the crisis rolls on". 

The most concrete outcome is the possibility for the European Financial Stability Fund (and then the new European Stability Mechanism) to intervene directly in banks . This is meant to respond to Spain's concern about soaring spread. The significance of this measure should calm the markets since banks will be bailed out collectively by all members of the eurozone and that losses will be shared in proportion to the size of each country (which means in theory that even Greek tax payers could participate in the rescue of Spanish banks!). As part of the agreement, there will be a “single supervisory mechanism involving the ECB”. That means that the ECB may intervene eventually as lender of last resort if funds from the EFSF dry out to deal with future banking crises. The agreement will be finalized by the end of the year to sort details out, so no direct aid to banks will be granted by then. In the meantime, the Spanish debt will increase by EUR 100 billion as a result of the bailout of Spanish banks and put the country at risk of default .

The second important decision is the "compact for growth and jobs" to complement the 'fiscal compact".  If we think about a big plan for Europe's recovery', we are simply wrong. The Council has come up with a plan of EUR 120 billion (equivalent to around 1% of EU GNI)  for fast-acting growth measures. The only concrete measure is an increase of EIB"s capital of EUR 10 billion - which means that its overall lending capacity will increase by EUR 60 billion. Project bonds will be launched as a pilot phase, to bring "additional investments  of up to EUR 4.5 billion for pilot projects in key transport, energy and broadband infrastructure ". The remaining funds come from Structural Funds which have already been allocated to the member States and which should be redeployed to support growth and jobs especially in lagging regions. 

The issue is whether this package of measures which will enter into force this year is sufficient to combat the recession in Europe. The answer is clearly no. In fact, the reaction of markets has been vigorous and spreads of Italian and Spanish bonds are soaring again dangerously. It is understandable that one summit could not resolve all issues on the table and that time is needed to coordinate these measures with other international partners. 

In fact,  the main lesson drawn from this summit is that European leaders have a deep misunderstanding of the economic crisis and about the policies which are necessary to tackle it. Economic history has taught us about success and failures of policies to end the crisis between the two world wars. Maybe they should get more inspired.

But, just one note of optimism. The foundations for the creation of a nucleus of a European federal State have been laid down. this means a more collective leadership for Europe. The United Kingdom, the most virulent opponent of this project has proposed a referendum on which British people should decide whether to stay in the European Union or not. It would be wrong to say that Germany has surrendered: its natural destiny is linked to a federal government of Europe. This is part of the solution to the crisis, not the problem. 

P.S: today, the Eurogroup will meet to flesh out the political promises of the EU council. It will obviously focus on Spain which has offered more sacrifices to get better bailout conditions. Will this calm the wrath of the God market? Personally I doubt.

We need a Federal Act

Europe has to choose between a federal Union or disintegration. The Spinelli group has proposed a Federal Act 30 years after the Single Act, which translates into 12 key elements including a banking union, a fiscal union, a social union and a political union. This has been explained by the Spinelli group during its shadow Council on the same day of the European Council of 28 June.

Inter-governmentalism has failed and led to an economic disaster  due to the absence of a vision and project for Europe.

Let's be inspired by the words of Altiero Spinelli: 

 “It will be the moment of new action and it will be the moment 

  for new men: the moment for a free and united Europe”

The Krugman-Layard Manifesto

In their manifesto, Krugman and Layard (FT June 28) argue that when private spending falls short, government spending should sustain demand. Typically, partisans of austerity use two arguments: the first is the confidence argument insofar budget cuts keep interests low and help economic recovery; the second argument is is that output is constrained on the supply-side. If these arguments are wrong, it means that governments are imposing massive suffering to people  without addressing the real causes of the crisis. 

Critics would argue that the money to finance this plan is not available.  All peripheral countries need more than a trillion euro to repay their debt and cover current deficits, without counting bank recapitalization for Spanish banks (100 billion euro). Greece is probably an exception with a net borrowing of 10 per cent of its gross domestic product. For the other so-called peripheral countries, the net borrowing is more moderate (3% for Italy, 5% for Portugal). The market fundamentalist view is that high interest bonds signal a high risk of non repayment. But what about mutualizing European debt or creating safety nets to prevent even higher interest rates? The problem is not the debt of individual countries but European economic governance which is flawed.

The adoption of Keynesian measures by the New deal led to increases in wages, social benefits and public works programmes which materialized into lower unemployment and higher growth. The austerity measures introduced subsequently by Hoover caused a prolonged recession of the US economy as a result of wrong policies.The rise in output during 1940-42 was also due to higher spending, especially in defence. Of course, this is not desirable today, but the idea of boosting demand through  (civil) public programmes - provided that they are efficient economically and socially- remains valid. 

It is odd to consider Latvia as a super-model for the rest of the EU. The country suffered from overheating in 2008 as a result of credit expansion. The introduction of austerity measures, in the form of internal devaluation, which was deemed equitable (!) led to a dramatic fall in output and labour mobility. Is this efficient by any means? If Latvia - as well as the other two Baltic States- have lower deficits and higher growth rates does not indicate that they are undergoing economic recovery. One cannot judge economic performance by just one year and derive firm conclusions about the quality of economic policy. No country has recovered steadily as a result of austerity policies. 

This is just ideology, not economic sense.