Germany should be careful what it ‘allows’

The German Magazine Der Spiegel ran a story over the weekend (January 3, 2015) – Austritt aus der Währungsunion: Bundesregierung hält Ausscheiden Griechenlands aus dem Euro für verkraftbar (Exit from the Monetary Union: Federal government considers Greece’s exit from the euro is manageable). This so-called “radical change of position” is presumably designed to impart external pressure on the Greek democratic process, which is about to elect a new national government presumably on January 25, 2015. The claim is that the German government is prepared to make Greece expendable because it thinks it has shored up the rest of the Eurozone so that what happens to Greece is immaterial. I think Germany should be careful what it ‘allows’.

According to the latest polling (January 3, 2015) provided by Parapolitika, Syriza is 3.2 per cent ahead of New Democracy (27.5 per cent cf 24.3 per cent) although Antonis Samaris remains the preferred prime minister over Alexis Tsipras (35.9 per cent cf to 25.3 per cent).

Other opinion polls paint a similar picture. Syriza’s margin also seems to be falling as the days pass. You can keep track of the opinion polls using this site – Opinion polling for the Greek legislative election, 2015.

The fact that Syriza is ahead leading into the election indicates a massive failure of the Euro project even though the majority of the population want to retain the euro.

This is especially so when you consider the public statements of the party that confound logic. They claim they want to revitalise the Greek economy but intend to keep the fiscal balance neutral and remain in the Eurozone.

None of which has – Buckley’s Chance – of working, which led me to believe there must be a hidden agenda – not a good sign for a democracy.

Please read my blog – Greece – two alternative views – for more discussion on this point.

But the prospect of having a populist party in power, which is claiming it will force the Troika to renegotiate the bailout agreements is clearly causing the Germans to focus their attention on likely scenarios.

The article in Der Spiegel suggests that the German government is:

Entgegen ihrer bisherigen Linie ist die Bundesregierung … bereit, Griechenland notfalls aus der Eurozone ausscheiden zu lassen

Which means that “Contrary to its previous position, the Federal Government is prepared to let Greece withdraw from the eurozone if necessary”. The emphasis is my own.

“Prepared to let” – which makes the German government sound as if it is the gatekeeper, the ruler of Europe and that sort of arrogance lies behind much of the problems that Europe now finds itself entrenched in.

The hypothesis in the article is that the Germans smugly consider the Eurozone is now ‘safe’ from breakup and so Greece is expendable.

They didn’t think this a few years ago. Apparently, they no longer consider that a Greek exit would be contagious because Portugal and Ireland are considered “rehabilitated” (“saniert”), the ESM is now in place to protect the large banks from failure.

The article claims that the German government now considers it inevitable that Greece will withdraw from the monetary union if Syriza is elected and gives up austerity and defaults on the nation’s debt (“Die Bundesregierung hält ein Ausscheiden des Landes für nahezu unausweichlich, wenn Oppositionsführer Alexis Tsipras nach den Neuwahlen die Regierung übernimmt, den Sparkurs aufgibt und die Schulden des Landes nicht mehr bedient”).

I think the Germans might need to do a bit of rethinking on this issue, notwithstanding the position of Syriza to remain in the Eurozone, which I have considered elsewhere (see blog link above).

First, there is not likely to be a fundamental change in the austerity mentality that has Europe in its destructive grip. It appears high levels of unemployment (rising) are not sufficient to destabilise the dominant neo-liberal mantra coming from Brussels or Frankfurt.

Indeed, Jens Weidmann, the boss of the Bundesbank, claimed the other day in an interview with the German newspaper Frankfurter Allgemeinen Sonntagszeitung (December 28, 2014) – Für die Verluste haften am Ende die Steuerzahler – that:

Europa geht es nicht so schlecht wie mancher glaubt.

In English, “Europe is not as bad as many people believe”. I wonder the last time he got out of the tower.

Europe is in such good shape that investors are willing to pay the German government to buy its bonds. On January 1, 2015 – the yields on the German Bund (2- and 5-year) fell below zero. The current 2-year yield is -0.12 per cent (Source)
, which means that investors are paying the Government for a safe haven.

Weidmann was elaborating to FAZ on a recent speech he gave to the International Club of Frankfurt Economic Journalists on December 17, 2014 – Government bond purchases are not a silver bullet.

However, while his antagonism towards quantitative easing by the ECB is motivated by an erroneous logic – an irrational fear of inflation – he is correct is concluding it won’t do much to stimulate the stagnant Eurozone economy.

He claimed that the ECB would incur losses on the bond purchases (presumably when buying the debt of weaker nations), which would end up being borne by the German taxpayer. However, the ECB can absorb any volume of paper losses on assets it holds on its spreadsheet and can operate with negative capital whenever and for as along as it likes.

Equally, it can recapitalise itself instantly without any implications for inflation within the Eurozone.

Please read my blog – The ECB cannot go broke – get over it – for more discussion on this point.

He also noted “that government bond purchases could make finance ministers’ lives easier … [and] … that the consolidation pressure could decrease and possibly curb enthusiasm for reform in the member countries concerned”.

That is, the ECB could easily provide the funds to Member States as it did under the Securities Market Program (SMP), which began in 2010. If it wasn’t so obsesses with austerity conditions, such funding could provide the wherewithal to stimulate growth. Wouldn’t that be a disaster!

But Weidmann’s views appear to be on the outer within the ECB. Last week (January 1, 2015) it was reported in the article – European Central Bank executive says more stimulus may be needed – that a “top official” of the ECB said that:

… measures taken so far to stimulate the eurozone economy might not be adequate and that the central bank might need to do more.

He was concerned that “the steps taken so far might not be enough to raise inflation from a level considered dangerously low because it undercuts corporate profits and makes it more difficult for borrowers to repay their debts”.

Support for further ECB action is also coming from Eurozone academics. The ever-present French economist Jean Pisani-Ferry published an Op Ed article (December 30, 2014) – Helping the ECB Cross the Rubicon – claiming that:

… that ECB President Mario Draghi and his colleagues will finally cross the Rubicon and announce the launch of a large-scale program of quantitative easing (QE) – in other words, high-volume purchases of government bonds.

I should note that Pisani-Ferry has a particularly unedifying track record when it comes to the Eurozone. For example, in 1992 he co-authored a study, which presented simulations that claimed that the new EMU would not need a large federal budget because sufficient ‘stabilisation’ (via automatic stabilisers) would be forthcoming at the national level.

[Italianer, A. and Pisani-Ferry, J. (1992) ‘Systèmes budgétaires et amortissement des chocs régionaux : implications pour l’union économique et monétaire’, Economie prospective internationale, 51, 49-69].

In a related paper, Pisani-Ferry et al. (1993), using what they admitted was a “highly simplified” model (p.519), concluded that the “model responses followed as expected the standard neo-Keynesian pattern, so there is no need to comment upon simulation results” (p.521).

In other words, as a result of the assumptions and parameters employed in the simulation, the authors basically knew what the results would be before the fact. This was typical of the Groupthink that choked any reasonable debate. These models were not questioned and the results became the gospel for the neo-liberals.

What do the likes of Pisani-Ferry think now? Pisani-Ferry et al. (2012: 3) noted that while all:

… federations have sizeable federal budgets … the founders of Europe’s monetary union … eventually decided that in Europe, stabilisation policy could be exercised at the national level.

[Reference: Enderlein, H., Bofinger, P., Boone, L., de Grauwe, P., Piris, J-C., Pisani-Ferry, J., Rodrigues, M.J., Sapir, A. and Vitorino, A (2012) ‘Completing the Euro. A road map towards fiscal union in Europe’, Notre Europe, Jacques Delors Institute, June].

The calculations they used assumed that:

… automatic stabilisers could fully react to a 6 percent decline in output before the 3 percent Maastricht deficit level was reached. It was judged that a 6 per cent decline in GDP was very unlikely (p.3).

They have now acknowledged that the GFC has proven these assumptions were incorrect and:

When bad times … came … the buffer proved too small. In the course of two years, from 2007 to 2009, Spain moved from a 2 per cent GDP surplus to an 11 percent deficit; Ireland went from balance to a 14 percent deficit (p.2).

The experience clearly demonstrated the validity of the insights that were first articulated formally in 1968 by Wallace Oates, a consultant to the MacDougall Report, and are basic to Keynesian understanding.

Relying on regional governmental units to provide fiscal support when a nation is hit with a major decline in spending will fail to militate against recession.

If these flawed neo-liberal models had not been relied on by the European Commission in the early 1990s and the conclusions from Keynesian economists had not been vilified and excluded by the Groupthink that dominated the Maastricht process, then the observations produced by Pisani-Ferry et al. (2012) would have been obvious to all the delegates at the Maastricht conference in 1991.

The economists that worked outside the Monetarist Groupthink clearly understood in the early 1990s that the Eurozone was being set up to fail. Pisani-Ferry was Commission aparatchik who was trapped within the Groupthink.

In a 2011 paper, Sapir and another regular European Commission consultant, Jean Pisani-Ferry, who was one of the so-called ‘experts’ that produced the sycophantic Sapir Report in 2003, acknowledged that the EMU was beset with destructive imbalances (Darvas et al., 2011).

The 2003 Sapir Report’s victory claims for the Eurozone were the equivalent of George W. Bush’s ‘mission accomplished’ speech on Iraq. Premature to say the least.

[Reference: Darvas, Z., Pisani-Ferry, J. and Sapir, A. (2011) ‘A Comprehensive Approach to the Euro-Area Debt Crisis’, Bruegel Policy Brief, 2011/02, February].

The benefit of hindsight one might say! However, as they waxed lyrical about the way forward for Europe, they largely ignored the role played by Modell Deutschland and, instead, chose to blame nations such as Greece, Ireland, Portugal and Spain, for living “beyond their means by accumulating private and/or public debt and running large current account deficits” (p. 2).

They failed to emphasise that the peripheral nations were buying French and German exports using large swathes of capital supplied by German financiers, who were diverting funds away from the stagnant German domestic market.

None of the EU cabal thought to tell Greece to stop buying ageing German military equipment to satiate their territorial paranoia about Turkey.

What is often forgotten is that for every ‘over-spending’ importer there has to be an ‘over-supplying’ exporter.

And now, he is advocating QE as a walk across the Rubicon! My my!

He claims there are “many reasons to launch QE”:

1. No threat of inflation – as if there was 5 years ago! And as if QE causes accelarating inflation – take a lesson in history!

2. Financial markets have already factored it in. So what? Well according to Pisani-Ferry “Should the ECB disappoint expectations, bond and foreign-exchange markets would confront an abrupt and damaging unwinding of positions: long-term interest rates would rise, stock markets would sink, and the exchange rate would appreciate.”

What stock markets do is another matter and largely irrelevant to stimulating or undermining economic recovery. The long-term interest rate is under the control of the ECB, with or without QE. This is just scaremongering. The ECB could offer standing facilities (it already does) to ensure the interest rate was whatever they wanted it to be at whatever maturity length it desired (long or short).

That claim is pure scaremongering.

But, Pisani-Ferry considers that the ECB might become “hostage” to Member State governments, an accusation he launches at the Bank of Japan, which he claims “has taken full control of the market for government paper. With annual purchases amounting to twice the deficit, it has become hard to speak of a “market” for government debt. In fact, the BOJ sets the price”.

Hostage is an emotional word. Playing a role within the consolidated government sector to ensure the economy maintains financial stability and is not choked to death by austerity is not what I would call being taken hostage.

Setting a low yield on public debt is not what I would call being taken hostage.

He claims that unless the Japanese government cuts its fiscal deficit sharply, the BOJ will be stuck with bad debts as a result of the purchases it has been making. Echoes of Weidmann there.

It is irrelevant whether the nominal value of government debt holdings within the BOJ rise or fall. Gains or losses to the currency-issuer have no meaning in the conventional sense (which applies to private commercial banks).

The BOJ could go on funding the Japanese Ministry of Finance until the cows come homeand nothing serious would occur as long as the fiscal deficits were of the order necessary to fill the spending gap left by non-government overall saving (including any external deficits should they arise).

But using his spurious logic, Pisani-Ferry claims that the ECB is walking on dangerous ground because the trust necessary to ensure the Member State governments continue to implement austerity as the ECB buys up their debt “is missing in Europe”:

Despite an accumulation of legal texts and procedures, the EU fiscal framework lacks credibility and does not give the ECB confidence that governments will continue to pursue sustainability after its bond purchases shelter them from market pressure even further.

So we are back to the fundamental issue that led to the flawed design of the monetary union in the first place and the continued dysfunction of the Eurozone economy – the Brussels political elites do not want the national states to have sufficient fiscal flexibility to meet large asymmetric negative spending shocks which undermine growth.

That obsession led to the Stability and Growth Pact, the various innovations since (Fiscal Compact etc) and the pernicious austerity that is ruining the whole project.

Unless that changes growth will not be sustainable – QE or not.

Pisani-Ferry finishes by adding a new condition to ensure QE is effective – on-going fiscal austerity. Somehow, the lower long-term interest rates (already very low), will stimulate a massive private investment binge, at a time where sales are flat, unemployment is high, and consumers are cautious. I don’t think so.

Which brings me to the second reason the Germans might need to do a bit of rethinking on how a Greek exit will no longer undermine the on-going viability of the Eurozone.

I am sure they believe that Portugal and Ireland are rehabilitated in the German mould. Perhaps that is true. But what would happen if Greece was sensible enough to exit?

First, there would be some short-term chaos. But one can hardly imagine it getting worse than it already is.

Second, the new exchange rate would likely depreciate somewhat if the example of Argentina in 2002 and Iceland, more recently is anything to go by. There would be a tourist boom within 12 months.

Third, the government freed of neo-liberal austerity Groupthink (and that is an essential condition to ensure that exit would be beneficial in net terms) could stimulate domestic demand immediately.

It would have its own currency back, could instruct its own central bank to fund the rising fiscal deficit, and it could introduce mass job creation schemes which would underpin a private spending revival within 2 quarters (think Argentina in 2002-03).

Greece would return to fairly robust growth rates fairly quickly and prove the point that austerity creates stagnation and currency sovereignty provides opportunities.

What would France and Italy, which are both still heading into stagnation themselves, think of all of that? The next French national election is likely to be a showdown between the conservatives and the ultra right, with the Socialists pushed into the nether world of irrelevance, given how bad their performance has been.

Would these large Euro nations tolerate the sort of internal devaluation that has been forced onto Greece by the Troika? I doubt it. Italy is less politically stable than France but there are tolerance limits in both political systems and I cannot imagine the populations buying into the Troika-style solution to the fiscal parameters that the monetary union rules demand.

These nations would observe that a freed up Greece, with the exchange rate able to absorb the external imbalances, was in much less pain than before. They would also soon realise that not having that exchange rate and currency flexibility was the reason for their own domestic pain.

There would be an ineluctable pressure on them to join the freedom train. I think Germany is underestimating that attraction by overestimating the net costs of exit on Greece.

Conclusion

The ECB meets on January 22, 2015 to decide on QE. The outcome will be largely a sideshow although it will dominate press headlines in the days following.

Just until the Greek election a few days later. Then we will see what Syriza is made of. But then the actual dynamic will come from the Germans, who seem to think Greece is now expendable.

They will ‘allow’ Greece to exit at their own peril though because just like Argentina showed in 2002, Greece will become the anti-euro poster nation and Italians and the French will be watching jealousy as robust growth returns.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.