The expression “a descent into farce” is meant to describe a terminal condition – where things have become as ridiculous (or whatever pejorative term you desire) as they can get. I think the Euro elites are carving out new grounds that will require some new terminology. Their latest iteration – the second Cyprus bailout deal – is about as bad as it gets. You would think anyway. But given the capacity to outdo themselves with incompetence and sheer bastardry, I will await further developments before I consider the latest action to be the terminal condition. It almost beggars belief that highly paid and obviously self-important senior officials (such as the Dutch Finance Minister who is the head of the Eurogroup of Finance Ministers) could in one breath say one outlandlishly stupid remark to the media and then, in the next breath, repudiate that statement with another equally nonsensical statement that flies in the face of fact and practice. So if anyone out there wants to speculate on “What comes after farce?” please let us know. The problem is that as a slapstick comedy this rates among the best except in this case, millions are unemployed. But it goes further with the Cyprus fiasco – and the Dutchman’s hints of a new model forming. First, the unemployed and poor are bearing the risks of a failed capitalist economy. But now, the consumers are being forced to take losses. Where the hell are all the capitalists? Probably wining and dining with their Euro elite mates in Brussels.
A while ago – the next best thing in the Eurozone, which was going to solve the crisis – was the European Stability Mechanism (ESM). That has about €700 billion in its coffers and I understood was designed to rescue ailing Eurozone banks and prevent the necessary funds appearing as new debt on the books of the relevant member-state governments.
Well forget about that. The latest bailout – or bail-in model – as the jargon goes – is that in the Eurozone, the following behaviour will be observed. Private savers will trundle down to their friendly corner bank and open saving accounts as a way of risk managing their future.
At some point, due to the mismanagement of the bank managers (who are all paid massive incomes), or the mismanagement of the aggregate (monetary and fiscal) policy framework
The EU Observer reported yesterday (March 25, 2013) that – Euro chief spooks markets with Cyprus comments.
Apparently, the Dutch Finance minister, who chairs the Eurogroup (the Finance Ministers’ group) said after the Cyprus bailout was announced that it was a “template for future eurozone bank re-structurings”.
He was quoted as saying:
If there is a risk in a bank, our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself? … If the bank can’t do it, then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders …
So ultimately the model of capitalism that is evolving in the minds of these characters is one where not only a the risks privatised and the losses socialised but now a broader concept – the consumer pays for the losses of the company they deal with.
One of the concepts that students learn in introductory microeconomics is – consumer sovereignty. It is one of the key building blocks of the neo-classical claim that markets are efficient and guide resources to their highest value use.
Consumers reveal their preferences by “voting” with their dollars and know best. The concept informs a lot of policy design with respect to social transfers (in-kind are alleged to be inferior to cash etc).
As I noted the other day, studies in behavioural economics have shown fairly convincingly that consumers are not rational in the way economists think.
Daniel Kahneman (1994) assessed that the body of work in this field has demonstrated that:
… people are myopic in their decisions, may lack skill in predicting their future tastes, and can be led to erroneous choices by fallible memory and incorrect evaluation of past experiences.
[REFERENCE: Kahneman, D. (1994) 'New Challenges to the Rationality Assumption', Journal of Institutional and Theoretical Economics, 150/1, 18-36]
There is also the long-standing issue of supply-manipulation of the demand-side of markets – via advertising etc. The hard-core claim that advertising is just information which helps consumer sovereignty. The reality is nothing of the sort.
But the point is that the whole neo-classical economic model, which drives current policy, rests on propositions such as consumer sovereignty being a reliable description of how the markets work and what drives efficiency.
In that sense, it is extraordinary that the elites are now attacking the consumers that their “model” eulogises.
The practical import of the Finance Minister’s comments were that the financial markets dropped the Euro somewhat but the broader signal cannot be misunderstood.
Why would anyone who wanted to protect their savings invest in any Euro-denominated banks in nations that are vulnerable to economic misery?
In fact, why would anyone want to save in Euros per se.
I thought the argument presented in this Bloomberg Op Ed (March 26, 2013) – Cyprus Shows Trust in ECB Is Misplaced – went to th nub of the problem, even if the analysis was flawed.
The author challenges the statements made by the ECB last year that it would do anything that was required to save the European banking system. The Cyprus affair shows that the ECB is unwilling to fulfill its role as the central monetary authority.
It prefers to jeopardise financial stability to maintain its membership of the Troika, an ideological consortium of over-paid and largely unaccountable elites.
From a systemic perspective, Cyprus is tiny and the ECB would not blink if it recapitalised the capital-inadequate banks in one keystroke.
The preferred re-capitalisation, within the ambit of the Eurozone, would have been for the Cypriot government to have nationalised the banks and then for the ECB to ensure that the funds the government put into these banks were available. There are a number of ways this could have been done within the Lisbon rules.
Obviously, the better solution remains for the nation to exit the Eurozone and start using its currency sovereignty to restore health to a (nationalised) banking system. I will come back to that later.
As to the rescue-within-the-Eurozone approach, I thus disagree with the Bloomberg conclusion that the ECB doesn’t have the capacity to save the EMU.
The Bloomberg Op Ed says:
… the ECB can use to support euro-area countries is outright monetary transactions, the bond-buying program that it detailed in September. This facility has yet to be used, but its mere existence has caused borrowing costs for peripheral euro-area countries to fall significantly.
Thus recognising the capacity of the ECB to fix government debt yields at whatever level it sees fit.
But then, as if there is some logical connection, the Bloomberg Op Ed says:
Despite this renewed confidence in euro-area government debt, recent events in Cyprus have highlighted the bond-buying program’s limitations — it can alleviate stress in the sovereign-bond markets, but that’s about it. Even if Cyprus met all the conditions to use the facility, that wouldn’t help the country avoid a banking and economic collapse.
Which is a false conclusion. While the conditions for use of the OMT are ridiculous – that is, a nation has to be killing growth and jobs through fiscal austerity before it will be given help in this way – there is no doubt that the ECB could bankroll growth-supporting deficits if it so choosed.
Apparently the “investors should have seen the limitations of the ECB’s intervention tools before the Cyprus bailout disaster” because even though “sovereign borrowing costs have fallen” it remains the fact that:
… as the real economy is concerned, most indicators released from a euro-area country in the past six months have been worse than the last. This goes not just for the weak countries but also for core countries, such as Germany.
Which is not a statement about the capacity of the ECB. Rather it reflects on the ideology of the ECB and its role as part of the Troika. The Eurozone could have exited the downturn not long after it began if the ECB had have used its “fiscal” capacity correctly. The continued real contration is not because the ECB cannot stimulate the economy it is just that it won’t.
The conditions it places on the nations to maintain low bond yields are killing growth. It would be far better, given the deliberate absence of a credible fiscal authority in the EMU, for the ECB to tell the markets that it will fund any deficit as long as the deficits are creating employment and stimulating national income growth.
Beyond that point, the support would stop. Which is, of-course, just what a currency-issuing national government would do if its economy was in trouble. It would ensure that the deficit-spending was focused in areas most in need of demand stimulus. It would also ensure that its banking system was credible.
The ECB is operating in some sort of half-way house. It knows it has to operate in secondary markets to keep bond yields low and it knows it has to ensure banks have sufficient reserves. All functions that a sensible central bank would adopt as core business.
However, then it uses its obvious “fiscal capacity” to undo that monetary work. Illogical behaviour and only explainable once you realise that the ECB is an ideological player in the game.
The Bloomberg Op Ed then claimed that the ECB cannot reduce “political risk”:
Even if the ECB’s two special rescue mechanisms succeed in improving and stabilizing the financial and economic environment of a euro country in crisis, these tools are powerless to address political risk in the euro area. That’s a significant weakness, because political risk has repeatedly come to the forefront of this crisis, as elected politicians seek to protect their own country’s interests in negotiations over who will end up paying for the imbalances that have developed in a fundamentally flawed monetary union.
The political risk would dissipate to the normal to and fro of politics if unemployment was reduced, growth restored, pensions secured and bank deposits safe.
The political crisis that will continue to widen is all their own doing.
Anyway, after briefing the journalists about the Cyprus bail-in, sometime later in the day, maybe after a few more wines,this – Statement by the Eurogroup President on Cyprus – was issued.
Presumably this was after his mates realised the gaffe he had made in disclosing the discussions of the group to the media, and hence, the public:
Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday.
Macro-economic adjustment programmes are tailor-made to the situation of the country concerned and no models or templates are used.
Which of-course was not only a humuliating about-face but also a bald-faced lie.
The nations are in trouble for two major reasons:
1. The uniform monetary policy (common interest rate) may not be optimal across all nations given how disparate their economies are. That is a popular view and is used to point out the fact that all the hot money surged into Spain and Ireland because interest rates were too low there.
I have some sympathy with that view but, in general, do not consider monetary policy to be an effective counter-stabilisation tool. When I say (above) that the ECB has the capacity to address the crisis I am not inferring this would come through interest rate adjustments. I am referring to its capacity as currency-issuer and the way it could fund government deficits. That is what I call its “fiscal capacity”.
It would be far better if that capacity was shared with a federal treasury institution but that it not likely to happen in the European context because it would require all nations, including Germany, to cede macro policy to a body, preferably elected by all of Europe as a federal government.
2. The lack of currency sovereignty and the fixed exchange rate constraints that membership of the Eurozone entails has been further exacerbated by the fiscal rules that are imposed on all nations by the Stability and Growth Pact and more recently by the Fiscal Compact mentality.
There is not a tailor-made macro policy for Greece, Germany etc. It remains that large economies such as Germany and France have violated the fiscal rules and pressured the authorities to turn a blind eye when seeking to apply the nonsensical Excessive Deficit Mechanism.
But what would be needed now is for the EU to allow nations such as Greece, Spain, Ireland, Portugal, Belgium, France, Italy etc to expand their deficits by several percentage points of GDP. The expansion required would be different in each case. That is what a “tailor-made” macroeconomic policy would look like.
What the Finance Minister was really saying is that the Troika reserves the right to dream up different ways of wrecking any specific nation, depending on what comes into the mind of the Germans, in between Wolfgang Schäuble’s Sudoku games.
There was an interesting 2011 paper published in the Cyprus Economic Policy Review – The Banking System in Cyprus: Time to Rethink the Business Model? – the author Constantinos Stephanou, being a Senior Financial Economist at the World Bank, who was at the time on secondment at the Financial Stability Board.
The paper noted that:
Cyprus has a large banking system compared to its economy (total assets of 896% of Gross Domestic Product or GDP in 2010), relative to the average for the EU and the Eurozone (357% and 334% respectively in 2009).
The ECB publishes its – EU Banking Structures 2010 – the last publication being in September 2010.
It provides detailed information about the size of banks and other interesting financial data.
The following Table is constructed using data in that publication and shows the total assets of credit institutions in Europe as a percentage of GDP (a measure of the size of the economy).
It is clear that since 2005 the size of the banking sector in Cyprus has grown rapidly but not all that differently to say the United Kingdom or Ireland.
And certainly, this growth was very evident at the time Cyprus joined the Eurozone in 2008.
There has also been a lot of talk about the number of Cypriots employed in banking – as if almost all the population is in some way working in a bank.
The most recent detailed labour force statistics available from Cyprus are the – Labour Statistics 2011 – publication.
The following Table shows the proportions of employment by main industry sector in relation to total employment (WRT is wholesale and retail trade).
Finally, it is overwhelmingly obvious that Cyprus should not have entered the Eurozone in 2008 and should withdraw immediately. It had two things going for it in the last few years – a financial sector and tourism.
The former will be destroyed by the decisions taken yesterday. No-one in their right mind would seek to put their savings, much less their “laundered” cash, in a Cypriot bank after the actions by the Troika.
The other source of growth, given the government is unable to promote domestic growth because it is in the SGP straitjacket, is Tourism. But Tourism is an one of those activities that comes after food and the basics.
At present, there is negative growth in the Eurozone and that has persisted more or less for 5 years. This is not a short-lived downturn. This is a chronic stagnation engineered with skill by the Euro leaders.
Export (tourism) growth cannot hope to boom under these circumstances. The other option (the Iceland approach) would be to enjoy some relative price advantage via a depreciated currency to boost tourism. That option is also prevented under the Eurozone arrangement.
So Cyprus will now wallow in increasing stagnation. The young will seek to migrate to better lands (where?) and unemployment will continue to rise.
As I noted last week in the blog – Troika Technical Manual: How to wreck (another) country? – when it entered the Eurozone its unemployment rate was 3.7 per cent. Since then it has risen to around 12 per cent and will exceed 14 per cent by the end of this year.
The austerity that is now being imposed on it and the destruction of its banking sector will ensure that it keeps rising.
I know the responses will focus on the “costs” of depreciation. As I have noted several times in other cases, while it is certain the currency will depreciate, that process will be finite and involve real income losses for sure to the extent that people rely on imported goods and services.
But the lower exchange rate brings benefits to the export sectors – especially sensitive sectors such as Tourism. I have read in comments that this view is a neo-classical one and how is it that a Modern Monetary Theory (MMT) proponent would be spouting neo-classical dogma.
The idea that making something relatively cheaper boosts the willingness of people to purchase it is not the intellectual property of neo-classical economists. Yes, income effects typically dominate (which is something that is typically denied by neo-classicists) but relative price effects also operate. Yes, with lags. Yes, with less certainty than we might like. Yes, with distributional effects.
But it remains the fact that Cyprus would witness a boost in exports with a lower exchange rate of some quantum, whereas under current arrangements they have not way of tapping that unless they scorch the living standards of their workforce and even then, productivity growth would also slump and negate much of those relative price effects.
The most important point though is that the nation need not rely on net exports to get themselves out of the hole that joining the Euro created. With a fully sovereign government it could ensure its financial system is stable and pursue domestic policy initiatives to bring down its unemployment rate.
That has to be the best option for the nation now. Not painless by any means. Not somewhat fraught. But the path out of the mess is identifiable under the exit option and the tools known and available.
Under the status quo, there is no identifiable growth path and only a stagnant oblivion awaits them.
The unfolding nature of the crisis has been amazing to bear witness to. The ideological straitjacket that policy is operating in has forced the Euro leaders to innovate. The problem is that their innovations have gone from bad to worse.
They do not even understand their own logic.
Anyway, my train is about to reach Sydney so that will be it.
Greed of music promoters
Last night, I had tickets to the Sixto Rodriguez concert at the Enmore Theatre, in Sydney. The tickets were over $A80. I had been looking forward to the concert since December when we bought the tickets. He was a favourite of mine back in the early 1970s when he was obscure. I like these obscure geniuses!
Anyway, I arrived at the theatre in Sydney only to find out that the tickets were “standing room”. That is, the promoters these days rip out the seating in the theatre and cram as many people in as they can but still charge patrons the price that would normally elicit a seated position in the auditorium.
The night before I had seen Shuggie Otis (another obscure genius) in Melbourne at the wonderful Hamer Hall for the same sort of price and enjoyed a very comfortable seat with excellent sound.
So despite really wanting to see Rodriguez live I decided not to be herded like cattle by these greedy promoters. I disposed of the ticket and caught the train home to Newcastle. I would recommend no-one goes to the Enmore Theatre in Sydney before checking that you actually are paying for a seat.
The standing room entry they were selling for $80 wasn’t worth $20.
CPSU Campaign to Protect Public Services
Despite my claims that I would be giving this presentation yesterday – in fact, the presentation is later today. There was a major mix-up in the respective diary entries.
Come along and give the union your support. Grass roots action is needed to change the direction of policy.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.