Merkel's plan and EURO 2012

This weekend FT editorial says that though it may not be five minutes to midnight for Euro leaders to save the monetary union, the clock is ticking and that if next Friday's summit fails to take decisive correction action, the clock could start ticking faster still.

In the same edition of the FT there is an Opinion piece by Liaquat Ahamed, author of the book: 'Lords of Finance: the Bankers Who broke the World' arguing that the ECB is not being bold enough with unconventional monetary measures needed to address the crisis and by so doing it seems to be forgetting the lessons from the 1930's depression.

Yet Chancellor Merkel seems relaxed and found the time last Friday to enjoy Germany's win against Greece which gave her national football team access to the semi-finals of the EURO 2012.

So what is Merkel's plan? What is she trying to achieve by blocking the necessary measures that would take the monetary system away from the edge from where it could fall in total collapse?

It is best to start by explaining what Merkel does not want rather than what she wants.   She clearly does not want the Euro to collapse.   Germany has been a major beneficiary of the Euro and collapse of the monetary union would hurt Germany more than most.   An abrupt reversion to the Deutsche Mark would have disastrous consequences for the German economy in its immediate impact.    The Deutsche Mark would harden in value against most major currencies including the national currencies of many Euro countries that would have to revert back to their Liras, Pesetas, Escudos, Drachmas  or Francs. German exporters would become uncompetitive in one fell swoop and this would lead to high unemployment as export orders are lost.   But given that the break-up of the Euro could land the European continent and much of the rest of the world to whom German factories traditionally export,  in a harrowing recession bordering on depression, export orders would disappear also because of contraction in demand, irrespective of the loss of competitiveness.

So if Chancellor Merkel does not want the Euro to break up, and she has repeated this often saying that she would do whatever it takes to save the Euro as saving the Euro is equivalent in her eyes to saving Europe and saving Germany, what plans does she has to resolve the Euro crisis?

Here Chancellor Merkel plan is subtle but clear for those who can read her stubbornness in refusing big bazooka monetary solutions for pulling the Euro away from the edge.   Merkel is in no hurry to save the Euro.   Those who argue that it is five minutes to midnight have been saying the same thing for the last 2 years and Merkel has seen great progress in these two years for the execution of her subtle plan.

What progress one may ask if the Euro is still mired in existential threats or worse, ever since the Greece bombshell broke into full view early in 2010?    The first sign of progress is that the Euro is still there, it still exits, has has not fallen to parity with the dollar as many expected and in fact it is at 1.26 higher than its original dollar value of 1.18.

Secondly no one has dared to seriously threaten to leave the Euro so everyone is overtly as committed as ever to keep the union together.  No one takes Berlusconi seriously anymore.

Thirdly many countries, suffering as they are with austerity measures to address their fiscal imbalances and debt accumulation, are now politically much better shaped up to accept measures that would have been unthinkable just before the crisis struck.   These countries rather than resisting more central control of crucial aspects of their sovereignty, they are now clamouring for it.    Who would have thought that France would be prepared to cede control over its banks to a central authority?   Who would have thought that Spain and Italy are arguing in favour of a common fiscal policy with their government losing direct control over the budget?    Who would have thought that many countries, UK excluded, seem to finally realise that European countries must  either hang together or hang separately and thus are willing to put a banking union, a fiscal union, an economic union and finally a political federation as the ultimate objective of the transition from the untenable status quo to a stable European Federation of Independent States.

Fourthly Germany is enjoying the crisis, with clear benefits at the expense of countries in distress.  Germany's competitiveness through the Euro generates substantial balance of payments surpluses.   Unemployment is the lowest in Europe and their budget is heading towards neutrality quicker than expected.   So why try to bring instant solutions to a crisis which is benefiting Germany so much even?  Capital flight to quality is enabling Germany to borrow at near zero rates just when Spain and Italy are forced to pay rates which are unsustainable and which neutralises many of the benefits of their economic adjustment programme.

Fifthly the crisis has enabled Merkel to tactfully choose the country leaders she prefers to work with.   Is it not obvious she prefers Monti to Berlusconi?   She prefers Samaras to Venizelos though she would have preferred Papademos to Samaras.   

But there is a limit beyond which Chancellor Merkel knows that she cannot stretch these advantages to eternity and at some point the situation reaches a critical tipping point which forces her to review her position.

This tipping point was reached when she lost her favourite ally Sarkozy and has been forced to do business with new French President Hollande whose political orientation and economic viewpoint is diametrically opposed to her own. The tipping point is also being registered as the pain of other Euro countries is rubbing on to Germany through lower export orders and generation of fear which negatively affects business and consumer confidence.  

So now Chancellor Merkel has to adjust her plan, but very gradually.  She accepts that growth has to be a twin objective alongside austerity and has agreed to launch a grand investment plan on a pan- European basis for infrastructure works of around 1% of the EU GDP equivalent to some EUR 120 billion.   But she refuses instant solutions to pull the Euro from the edge by agreeing to debt mutualisation like Eurobonds on a grand scale, or by authorising the ESM to obtain a banking licence gaining access to the unlimited resources of the ECB and then investing direct equity into  banks in distress to break the negative loop between banks and governments in distress especially in Spain and Ireland.

Chancellor's Merkel's plan is that these objectives have to be a final destination not an interim solution which would take the pressure off governments of periphery countries to continue with their painful restructuring to become economies in the German image.

Her plan is to do just what is necessary to keep the Euro from breaking up but never enough to take the pressure off the government of Spain, Italy, Portugal and Greece ( Ireland seems to have adjusted to the pressure and is moving along on its own steam now) so that these countries will continue to posture their long term thinking in the shape of  Europe as a federation, naturally dominated by Germany.   In her plan, France under Hollande as the new champion for the periphery states will be willing the move away from De Gaulle's thinking to fiercely protect France's independence and to insist on France being the driver of the European motor engine.

What Merkel has seems not to have considered is that if her plan succeeds and each nation will start registering trade surpluses , where will be the corresponding deficits?    Or does Merkel think that China and the US are willing to run eternal deficits with the whole of the EU?   

Perhaps Chancellor Merkel will soon have to accept that as Spain and Italy successfully manage to restructure their economy in German style, Germany itself may have to meet them half way and open up their economy to run higher inflation and bigger internal demand to reduce their strategic surplus.   Meeting half way is always easier for both extremes.

And perhaps meeting half way is what Germany and Italy will have to do in the semis of the Euro 2012.  But that would mean leaving England out in the cold as probably would happen to the UK if Europe makes the next moves to federal status.

Oh how things change!

Yesterday I was on ONE TV's breakfast news show arguing that the charade in Parliament has been going on for too long, that this instability is causing concern among consumers and investors who are postponing any decision that can be postponed and in the process hurting economic activity.  

I argued, consistent with my earlier expressions, that the people would be best served if this indecision is brought to an end, the sooner the better, by calling elections.   Once the mandate given by the people cannot be properly executed and it is murkily unclear in what circumstances government has a majority in Parliament and in what circumstances it does not have such majority, the duty of the government is to restore authority to the people by seeking a fresh electoral mandate.

I argued this is what Alfred Sant did in 1998 in the national interest even though he was still one third into the legislature and it is what Lawrence Gonzi should be doing.  And it should be fairly easier for Gonzi to take this gentlemanly route as he is already 4/5ths down the road of this legislature.
Apparently at the same time on TVAM breakfast show on TVM, President Emeritus Dr Edward Fenech Adami was arguing just the opposite, i.e. that the national interest demand that the government stays on till the end of its term.

Press this link for TIMES report about EFA intervention

Specifically he said:

"that it was the government’s duty to govern to the end of the legislature in the national interest. One, therefore, expected everyone to toe the line."

Oh how things change?   Did he say the same thing to Mintoff in 1998 or did he just instigate the opposite?

And would it not be better if our former Presidents pay due respect to the high post they used to occupy by staying above public political debate and if they have to say anything, which I seriously doubt, they do it in private.   Once a President always a President.    The Americans still refer to ex- officials by their title of tenure: Mr President, Madame Secretary, Mr Chairman etc.

Most tend to respect this prudence but Dr Fenech Adami seems to have reverted to his old political role showing that the Presidency was just a parenthesis.

Parliament no longer supreme

I don't know if it was a correct procedure for parliament to take a vote of no confidence in a non-politician, an ambassador, a government functionary.

If I were the Minister responsible for such functionary I would have objected to the vote and insisted that the vote of no confidence be taken on the functionary's political master, the minister, as ultimately it is the minister that has political responsibility for the actions of his subordinates.   That is the practice all over the world of parliamentary democracies.

But once parliament went ahead and decided there was no confidence in such functionary, in this case Malta's ambassador to the EU or technically Malta's permanent representative for the EU, who through ad hoc arrangements also attends cabinet meetings but has no vote at the table, what parliament decided has to be noted and adopted.

Firstly by the Minister concerned, in this case the Prime Minister or the Minister of Foreign Affairs ( it is not clear to whom the Perm Rep is politically responsible whether to the Minister of Foreign Affairs like all other ambassadors or to the Prime Minister given the special status of the EU which is not a foreign country and the fact that the person concerned has a permanent seat at the cabinet table by the invitation of the Prime Minister) accepting political responsibility for their subordinate and resign.   Remember Profumo?   Remember Willy Brandt?.

Secondly by having the Perm Rep immediately vacating his position once he is operating without the confidence of parliament, the highest institution of the country.

Yet in Malta not only nobody takes political responsibility for parliament's thumb's down, but the functionary is invited to stay in position for some more time until a replacement could be found.   And if not found?  

This is taunting the authority of Parliament.

Why is this functionary so special?   Why has the PN forced ex - Minister Carmelo Mifsud Bonnici to resign immediately after parliamentary no-confidence vote but for RCC different rules apply?   Why did the  PN  not issue a statement of condemnation to Franco Debono when he voted with the Opposition in case of CMB's vote of no confidence but soon issued such statement of condemnation against Pullicino Orlando, Mugliett and of course had to include Debono but only after RCC's vote where after all Debono voted with the government?

There is something so special about RCC which lends credence to those who always argued that he is really the power behind the throne.   And that is not the right spirit for a proper democracy.

A Sunday of elections – hostages to Greece

This Article was published in The Malta Independent on Sunday on 17 June 2012 Three crucial elections are being held today. In France, President Hollande hopes to see his socialist party take control of Parliament, as this will give him better prospects for pursuing his electoral pledges of budgetary discipline through economic growth. These are often conflicting objectives, at least in the shorter term. Hollande will need the backing of a socialist controlled Parliament to stay the course and operate with the necessary flexibility. In Egypt, there will be the run-off for the first free presidential election where many spring revolutionaries are dismayed at being forced to choose between the mosque and the military. But the election that is attracting most international attention is being held in tiny Greece, the second time in six weeks that the Greek electorate has to vote. They voted on 6 May but on that day the result was inconclusive and they have to try again. On 6 May, the Greeks showed clearly what they do not want. They gave a hard beating to the two main parties, New Democracy to the right and Pasok to the left, which governed Greece since it emerged from military rule and which, between them, created the economic mess their country is now in. The political space vacated by the traditional political parties was filled by new parties from the extreme left and the extreme right, which, free from the guilt baggage of incumbency could promise illusionary relief from the pain of austerity suffered since the country’s financial deficits were exposed and access to international funding dried up except through toughly conditioned bailouts from the IMF and the EU. This time the Greeks have to choose what they want, not just what they do not. They have to choose whether to elect a coalition government that would respect the bailout agreement and gracefully and tactfully negotiate a growth package to run in parallel so that the population can be offered some light at the end of the long and painful austerity tunnel. Or whether to elect a government that cancels the bailout agreements and goes its own way by bullying the EU to continue bankrolling Greek inefficiency for eternity, merely to avoid contagion spreading to other countries like Ireland, Spain, Portugal and Italy that are determinedly undertaking tough austerity programmes to redeem their country from a debt trap that is threatening their economic survival. Basically, Greeks have to choose between staying with the euro or leaving it: indeed, by implication whether to stay in or exit the EU. The outcome of the Greek elections remains highly uncertain till the end. Many voters remain undecided and the prevalent wish of a large majority of the population to stay in the euro may finally force protest votes of 6 May to vote for the future rather than simply vote to condemn the past. It is unfortunate that we had to arrive at this tragic point. It was clear from the very beginning that an austerity recipe on its own would never be enough to heal Greece’s economic ailments. In an article in this series published more than two years ago entitled “Something has to give” (TMIS, 7 March 2010), I had said: “Greece and others, however, cannot do it on their own. The adjustment cannot be extracted solely from oppressive fiscal measures. Economic growth has to be a key feature in the recovery plan. The problem is that fiscal oppression impacts negatively on economic growth. Domestic demand shrinks, as people lose income, pay more tax and get generally uncertain about their future. Growth can only be achieved through external demand but this can only grow very gradually, as the country recovers its competiveness. “It is here that the big rich countries in the euro area have to support Greece. The rules of the monetary union need to be re-jigged and an exit route for those countries that cannot live by the rules has to be created. The absence of a threat of being forced out of the euro has led to moral hazard, as undisciplined countries thought they could get away with lax fiscal management. Secondly, euro rules have to include progressive sanctions for countries that register structural intra euro area payments imbalances, surplus as much as deficit. “The Germans should not claim the high moral ground of fiscal prudence. They benefited from Greece’s indiscipline by enjoying structural balance of payments surpluses. The weakness that the Greek crisis inflicted on the euro exchange rate has benefited Germany much more than Greece as it is Germany that exports most to countries outside the eurozone, rather than Greece or its Mediterranean peers. “North European powerhouses have a strong moral obligation to stimulate their economies to create demand and growth opportunities for Mediterranean economies, as they undergo compression of internal demand and painful fiscal adjustments.” All this went unheeded for two years where round after round of austerity continued to crush Greece’s economy rather than help it recover competitiveness. It is only in the last six weeks, since Hollande won the French presidential election, that thinking has started to change. Finally, many woke up to admit what ought to have been clear from the start − that restructuring without growth becomes democratically impossible to deliver. German Chancellor Merkel seems to be the last (wo)man standing, preferring austerity to growth and in denial that German surpluses are as destabilising as Greek deficits and both have to be addressed concurrently. In so far as we are concerned, Malta is highly exposed to these events. Headlines like Der Spiegel’s “Europe’s Future Hangs in Balance”, The Economist’s “Dithering in the dark – Europe dithers at the edge of an economic abyss” and a UBS research paper “Greek election preview: Fasten your seatbelts” give a taste of how serious the situation is and what could happen if the Greeks put the wrong foot forward. We are exposed to whatever happens around us, and if the confusion following a Greece disorderly exit from the euro leading to an outright default causes contagion, a financial meltdown and a long recession would be probable. These are things we can do little about and just have to be prepared to take the blows on the chin and push forward as we have done before in the face of adversity. Unfortunately however, we are making life even more difficult for ourselves. Rather than using euro membership as a credential to boost economic growth and attract foreign direct investment, we are pathetically allowing these events to entangle us in unfair commitments which could strategically impair the solidity of our financial structures. The euro we decided to join in 2008 had clear provisions that all countries had to play within the rules of fiscal prudence and that every country had to remain responsible for its own debts. The financial crisis that hit soon after we joined, meant that many countries did not abide by the fiscal rules, either because like Greece, Portugal and Italy they were too fiscally lax in the good times, or because like Ireland and Spain their banking system was crushed from massive exposure to real estate development, and the state had to take on private sector debts to save the banking system from total collapse. Many of these countries needed bailouts to avoid default as they were shut out of the commercial capital markets. Why Malta, as a newcomer to the Euro has to carry the same bailout obligations, on a pro rata basis like core Europe, simply escapes me. If we had known that it would come to this, it would have paid us better to adopt the euro through a currency board without actually being part of the euro area. It is basically what Switzerland is doing at present when it officially hinged the Swiss France to a 1.20 rate for every euro and its Central Bank intervenes regularly in the market to defend this rate from market pressure to revalue. Malta’s lending so many millions to Greece, with very high probability we will have to write-off their recovery sooner than most think, and committing another one hundred million euro to support the recapitalisation of Spanish banks through the Spanish sovereign is forcing us to take very unfair risks. I am not saying that these countries in distress should have been cut off and their bailout requests denied. What I am saying is that we should not have agreed (and here I am also including the Opposition in my criticism as they assented to these things too readily and uncritically) to carry the same, or worse, pro rata burden as the founder countries of the euro. These founder members, the core Europe, are directly responsible for admitting Greece when it was clearly not yet ready to take on euro obligations. They set a bad example when they forced their way to break the rules with impunity when their own economy slowed down. They looked the other way while Greece was evidently cooking the books. They received great economic advantages from their euro membership as the loss of competitiveness of the peripheral countries actually boosted the core’s internal and international competitiveness. As new members to the euro we have not shared in this bonanza when Greece was spending as if there was no tomorrow. They were buying French military equipment and German luxury cars. They certainly were not buying Maltese honey. The burden sharing should have exempted countries that joined just a short time ago. Unfortunately, no one seems keen to defend our sovereign interest the way any self-respecting nation should do. We are allowing ourselves to become hostages to whatever the Greeks decide today and that is unappetising.

Two flaws of the Euro

The rescue package of EUR 100 billion to fund the Spanish government to recapitalise its zombie banks does nothing to address the two great flaws of the Euro.  Both these flaws could be potentially fatal.

Flaw No 1:  Lack of fiscal union or confederation

Flaw No. 2:   Lack of a credible lender of last resort often referred to as absence of a banking union.
The Greek crisis has been a stark manifestation of the first flaw.  The crisis in Spain is a manifestation of the second flaw.

A lot has been said and discussed about the need to impose budgetary discipline through a fiscal union to avoid Greek style sort of fiscal recklessness.   But even a fiscal union on its own will not be sufficient to restore stability in the Euro system.    Without a common banking system with a single regulator and a central lender of the last resort the problems will recur.

An integrated banking system would require three conditions:

1. a single lender of last resort and a single provider of rescue capital at a Euro area level.

2. A single Euro area financial regulator to provide an appropriate counter-point to the single source of capital/liquidity.

3. The Euro regulator must have the ability to close financial institutions as it considers appropriate even overruling the wishes of the national governments on such matters.

The Spanish bank bailout has not made any contribution for the achievement of these objectives.  The political obstacles that must be overcome for the achievement of such union are formidable.  It involves a system where banks in one country can claim revenues from another country.  It means a French Bank being closed down by a non-French regulator against the wishes of the French government.

How are Euro area governments, let alone their people, going to accept that their tax revenues be used to make good for the failures of other Euro countries who choose to retire at 60 as against say 67 as in Germany and Netherlands?

So a banking union and a fiscal union are only feasible if there is a plan for a full political union where social services are also harmonised.

Are Europeans ready for that?   And if not how can we continue with the current system where banks are no longer lending to each other and the ECB is more and more becoming the clearing house for inter-bank liquidity where banks that do not trust each other use the ECB to carry the counter-party exposure risks they are unwilling to carry.

Yet governments in Europe are not preparing their citizens for the large and urgent compromises that have to be made to take the EU to the next level of integration.  Failure to do so would give rise to extreme movements, of the left and of the right, who are already making their presence felt through the democratic process of elections.  Such extreme forces once they obtain power through  democratic channels are generally apt to stop playing by the rules of democracy and protect their newly acquired power through non-democratic means.   Is next Sunday's election in Greece the spark to start the fire?

Something has to give and pretty soon.

The Paradox of the EU (2)

Start the engines - Angela

The first article with this title was published on this blog on 9th February 2012 as per link hereunder:


Click here for - The Paradox of the EU (1)


The time for Chancellor Merkel to decide has arrived.    Until some weeks back what was good for the Euro area was not perceived as good for Germany, though even this was debatable if one took a longer term view.   But now we are really at the edge.   If the Euro is not saved Germany would be the biggest loser.   So now yes, whatever point of view one takes, short, medium or long term,  what is good for the Euro area is also good for Germany, at least as the choice of the lesser evil.

The front article in this week's Economist makes this stark assertion.    Its title 'START THE ENGINES - ANGELA'  says there is no more time for dithering or dangerous brinks(wo)manship.

Circularity

Spain's government sells 10 year bonds at 6.5%. These are mostly bought by Spanish banks who take the bonds to the ECB to discount them at the repo window at less than 2%. Spanish banks make a nice clean turn of 4.5% but have to carry a strong maturity mismatch as ECB funds are for term much shorter than 10 years. With the money from sale of bonds the Spanish government can bail out Spanish Banks without having harsh austerity conditions that would apply from an IMF/EU bail out. Spanish banks receive money twice; once from Spanish government as share capital increase and once from the ECB through repo. They pay out once when they purchase the bonds. So Spanish banks improve their capital and liquidity. If this circularity is repeated many times it could solve everybody's problem as money is created by the ECB until they get scared that it Is creating inflation and roll it back. Then the house of cards falls flat. That's circularity!

Dissett dissected

Dissett of Saturday 3rd June 2012 tackled the claim for compensation by former shareholders of the National Bank of Malta where I was invited to defend my views expressed in this blog that no such compensation is properly and equitably due.

Unfortunately it was not possible to debate in a calm manner.   Out of a programme exceeding 71 minutes ( including commercial break) I had the microphone for about 13 minutes and many of these were amid interruptions from my debating colleague who appeared more interested in preaching the 'truth' that Mintoff stole their shareholding rather in debating how and why the National Bank was facing a crisis of confidence from its depositors and what its true worth was on takeover.

Dissett can be streamed through this link:

Dissett 03 06 2012

Yet two important points managed to emerge from monologue that my debating colleague tried to enforce on the programme:

Firstly that the Central Bank Governor at the time, about  a week before the run on the Bank started had, during a game of golf, verbally warned Frank Cassar Torreggiani, then Chairman of the National Bank, to 'put his house in order as it will happen'.   Given that the Central Bank had been conducting inspection on the way the National Bank was operating this warning was nothing if not showing concern that the National Bank was a house out of order and that such state of affairs was creating a strategic threat to the stability of the institution.   Any other interpretation, including that the Governor was warning of a foul takeover plan being engineered by Mintoff, is a figment of imagination that bear no proof in fact whatsoever.

The other point was that if the Central Bank in denying lender of the last resort facilities as it was legally obliged to do if in its judgement the National Bank's problem was one of simple and temporary lack of liquidity, was making an implied statement that the Bank was insolvent and needed a fresh injection of capital that in those circumstances only the government could provide, then the Central Bank should have conducted studies to persuade the Board of the National Bank of their state of insolvency.

This shows poor knowledge of what can be done during a crisis when decisions are needed fast to put out a fire and there would be no time for studies and detailed reporting.    With depositors waiting in line to withdraw their money, the Central Bank needed to make a judgement there and then whether to extend lender of the last facilities appropriate for temporary illiquidity problems, or given their knowledge of the bank through their inspectorate,  whether in their judgement the problems at the bank were more structural needing an infusion of fresh capital.

The Central Bank made the latter decision but it is unthinkable that this decision was not explained in meetings between the Central Bank and the Management of the Bank who surely must have been briefed of the findings of the inspection exercise.   The Central Bank Governor at the time still refuses to comment publicly on the matter saying that as the case is sub judice he has given his views on this matter to the Courts.   Unfortunately the Courts are still deliberating.

But anyone who expected the Central Bank to hesitate about their decision while depositors were queueing at the doors does not know what he is talking about.   The Bank of England did exactly what the Central Bank of Malta did when in 2008 they were faced with a run on Northern Rock.

The issue of what compensation was due to the former shareholders of Northern Rock was not, and could not, be settled at the time when the crisis was peaking with depositors panicking.    The situation was only calmed after government intervened guaranteeing all Northern Rock deposits and essentially nationalising it.

Subsequently reports were drawn up by independent parties to see what compensation if any was due to the Northern Rock  former shareholders.

These reports may be accessed on this web-site:

Northern Rock compensation documents

All studies showed that no compensation was due to former Northern Rock shareholders.    It could hardly be otherwise as when a Bank loses the confidence of its depositors it has practically lost the very foundation on which it is built.

Two points come out from these documents.  Firstly they were more elaborate and independent than the ones done subsequently by The Central Bank and audited by Deloitte on the basis of which it was decided that no compensation was due to National Bank shareholders.   Obviously it should be borne in mind that financial regulations and governance standards in 2008 were much more developed than they were in 1973.

Also to be noted is the speed with which decisions were taken by the Independent Valuer and by the Upper Tribunal and the transparency with which such process has been conducted.

These events re-affirm my views that no compensation is equitably due to the former shareholders of the National Bank.  But justice needs to be done and needs to be seen and perceived as being done.

An out of court settlement would defy the perception of justice being done as it would reward the shareholders at the expense of the taxpayers without undergoing fair process.   But we have much to learn from such instances about how matters should be handled expeditiously and where necessary through the appointment of ad hoc technical tribunals rather than through the slow machinations of the courts of law.

The six recommendations

This article was published in The Malta Independent on Sunday on 3rd June 2012

__________________________________________________________________ 

The European Commission, commonly referred to as Brussels, has just given Malta several warnings about the vulnerability of our economy and made the following six recommendations:

• Reinforce the budgetary strategy in 2012 with additional permanent measures to ensure adequate progress towards the medium-term budgetary objective and keep the deficit below three per cent of GDP without recourse to one-offs. Implement, by end of 2012 at the latest, a binding, rule-based multi-annual fiscal framework.

• Take action, without further delay, to ensure the long-term sustainability of the pension system, comprising of: a significant acceleration of the progressive increase in the retirement age compared to current legislation; a clear link between the statutory retirement age and life expectancy; and measures to encourage private pension savings.

• Take steps to reduce the high rate of early school-leaving. Pursue policy efforts in the education system to match the skills required by the labour market. Enhance the provision and affordability of more childcare and out-of-school centres, with the aim of reducing the gender employment gap, and at the same time, reducing the effects of parenthood on female employment.

• Take the necessary further steps to reform, in consultation with social partners and in accordance with national practices, the system of wage bargaining and wage indexation to better reflect developments in labour productivity and reduce the impact of prices of imports on the index.

• Reduce Malta’s dependence on imported oil, step up efforts to promote energy efficiency and increase the share of energy produced from renewable sources by carefully monitoring the existing incentivising mechanisms and by prioritising the further development of infrastructure, including by completing the electricity link with Sicily.

• Strengthen the banking sector, take measures to mitigate potential risks arising from the large exposure to the real estate market. Take measures to further strengthen the provisions for loan impairment losses.

Not everything Brussels says is solid gold.    There is a tendency for Brussels to overlook our peculiarities and to recommend standard book solution that are not necessarily appropriate for our circumstances.     Still, what Brussels say should be given due weight and government should maintain open dialogue with its citizens to inform how much of the Brussels prescription can be taken on board.

I dedicate this article to what I think we should make of Brussels admonishments.

Budgetary Strategy – The EU is basing its criticism on the basis of the 2012 Budget submissions as originally proposed.   But that Budget is dead in the water.    The published figures for the first 4 months of 2012 show that rather than fiscal consolidation, we are experiencing serious fiscal slippage.   You can’t expect better in a pre-election year, of course.   The primary deficit (all revenues less all expenditure before payment of interest) has exploded from EUR 70 million in the first four months of 2011 to EUR 162 million in same period of 2012.   That’s more than 130% increase.    Some consolidation!!

Government debt has increased by more than 9% over the 12 months to April 2012 whereas the economic growth in nominal terms around 5%.   So rather than taming our debt growth the trajectory is still for a higher ratio of GDP.   Government budget has gone off track and that could have very serious consequences.

Pensions – I take it as a given that government will have to cap the maximum benefits under Pillar 1 at the present  real values and to do this it would have to continue reducing the eligibility for Pillar 1 pensions by linking retirement age and contribution period to the changes in longevity.   It is also a given that for anyone earning more than  twenty thousand  Euro annually before retirement, they  will on retirement suffer a drop in standard of living if they depend only on pillar one pensions.

The Maltese are among some of the best savers by world standards and many of them have not been waiting for government to launch pension initiatives.  They have been  saving for retirement even in the absence of fiscal incentives.   So I don’t think the problem is as acute as Brussels make it.   So much so that I would completely skip pillar two pensions, which risks raising our productive cost base and eroding our competitiveness.  I would move directly to Pillar 3 with fiscal incentives for personal savings for retirement for those still in time to do it (basically those born after 1972).

Elimination of early school leaving, and achieving higher female participation in the employment market  are a must.   We are doing a lot but not enough.   Youth must be studying or working, never idle.   Mothers must have access to a good social infrastructure that permits them to further their professional career whilst knowing that their children are being taken care of through family arrangements or reliable childcare and after school arrangements.

Wage bargaining – COLA  across the board increases have long outlived their purpose.   They should be rendered applicable only to the minimum wage.    Where collective agreements are in place wage setting should be the entire preserve of unions and employers.   In case on non-unionised  sectors wage order regulations should be used to adjust wages.

Dependence on foreign oil – incentives for installation of domestic and industrial renewal  energy sources must be rolled out wider and longer.

On the banking sector exposure to the real estate market these are unnecessarily false alarms.    We have enough problems;  Brussels should not create additional ones unnecessarily.   Banking is based on trust and confidence and misplaced comments could create problems even where none exists.   It is true that property values are falling and that banks are nursing higher levels of non-performing loans.    But thankfully our banks are highly liquid, have more deposits than they can lend out and are not dependant on any wholesale funding from foreign sources.   On the contrary our banks have to invest a good portion of their surplus liquidity in foreign securities.

Furthermore what is heartening is that our households, unlike the situation in Spain or Ireland, have a strong balance sheet  with little debt and have a strong culture to ensure that they honour their debt commitments come hell or high water.   Obviously this depends on support from the wider family when needed, and on unemployment remaining stable.  People out of job will be hard put to repay their debts, whatever their nationality.

So the health of our banking sector is not so much dependent on property values, but is more exposed to our ability to preserve the health of household balance sheets and maintaining unemployment at stable levels.   This of course does not remove the need for our banks to adopt dynamic debt provisioning and to adopt more prudent dividend policies to preserve as much capital as possible for future challenges.

In summary we have substantial problems with our public sector deficits and debts,   and some frank and serious re-orientation and approach is necessary.  Certainly off-balance securitisation funding is no reliable solution.   But for as long as government deficits remain internally financed and for as long as our households sustain their savings culture, then our problems are not as acute, at a national dimension including the private sector, as Brussels tend to make them.

The major challenges of vulnerability for our economy are exogenous.   What the Greeks will decide on 17^th June concerns us.   The pain in Spain will not be anybody’s gain.  If their banking system collapses, nothing and nobody is safe.

Grexit..... Gerexit..... All exit!

The Euro is melting away on the forex markets.    Deposits are melting away from the banking system of countries in distress, especially in Greece and Spain.   Asset vales on most equity markets are melting away - an average of 7% loss since the result of the Greece election of May 6th.    Consumer confidence is melting away.


What's not melting away is the financial crisis.  On the contrary it is getting worse by the hour.   It looks we are past the tipping point and Euro depositors in Greece and Spain are playing it safe transferring their deposits either to Euro cash in their mattresses or in German Bunds even though none of these pays any interest.

The scare level among investors has now reached levels were investors care more about the return of capital rather than the return on capital.

Shall we be having Grexit  = Greece exit from the Euro?
Shall we be having Gerexit = Germany exit from the Euro?
Shall we be having both Grexit and Gerexit?
Or shall we be having All exit = Euro blowing up and all countries reverting to their domestic currencies     or separate into smaller but distinct common currency groupings, say a hard Euro for the North and a soft Euro for the south?

All exit is the default do nothing option.   EU politicians have been behind the curve since Greece  exposed the true state of its books in 2010.    Now they are far far behind the market which is unlikely to allow two weeks till the next Greece election on 17th June that EU politicians are banking upon for confidence restoration.   

How long will the ECB accept to continue pumping liquidity into the banking system of Spain and Greece as their own national depositors flee their own country?   How can we Maltese continue to increase our indirect exposure to the losses from Grexit, Gerexit or all exit when the Greeks and Spanish themselves are fleeing away?

Something has to happen and pretty soon.    I had explained what's necessary in my past posts:

http://alfred-mifsud.blogspot.com/2012/05/superstate-or-separate.html

or

http://alfred-mifsud.blogspot.com/2012/05/can-this-slow-motion-euro-train-wreck.html

Time is running out!