The pressure on Germany is rising

A common theme in my recent posts regarding the Euro crisis, or really the crisis of the countries that have been bailed out and have to absorb substantial austerity measures at a time of sharp economic contraction, has been that these countries cannot bear the adjustment pain all on their own.

I have repeatedly stressed the point that Germany and other countries in the German bloc ( including Austria, Finland , Netherlands, and possibly Poland) need to reflate their economies to create stronger internal demand and create rising deficits which can absorb the run down of deficits in the austerity countries.

In particular one can refer to my two recent posts:

Anti austerity revolt

and

Both wrong

There is a rising chorus of senior economists making the same argument and warning Germany that their attempt to create A Europe in the German image will backfire with dire consequences.

See this quote from an article titled ' The German model is not for export', published in The Financial Times of 8th May 2013 written by Martin Wolf , their senior economic editor:


The implications of the attempt to force the eurozone to mimic the path to adjustment taken by Germany in the 2000s are profound. For the eurozone it makes prolonged stagnation, particularly in the crisis-hit countries, highly likely. Moreover, if it starts to work, the euro is likely to move upwards, so increasing risks of deflation. Not least, the shift of the eurozone into surplus is a contractionary shock for the world economy. Who will be both able and willing to offset it?

The eurozone is not a small and open economy, but the second-largest in the world. It is too big and the external competitiveness of its weaker countries too frail to make big shifts in the external accounts a workable post-crisis strategy for economic adjustment and growth. The eurozone cannot hope to build a solid recovery on this, as Germany did in the buoyant 2000s. Once this is understood, the internal political pressures for a change in approach will surely become overwhelming.
Europe will not become a bigger Germany. It is foolish to believe it ever could. The eurozone will either achieve a better-balanced resolution of its difficulties or break up. Which of the two will it be?

That remains the big unanswered question.

But the question has to be answered soon after the Germans choose their next Chancellor, whether to re-mandate Merkel or offer Steinbruck the SPD challenger a chance to avoid the great dangers of continuing with Merkel's austerity above all policy. 

The Germans must learn to re-embrace Keynes, or the Euro has no future.

And on the fore-front of the necessary change of course there must be the European Central Bank (ECB).   President Draghi must continue showing his mettle to extract his organisation from domination of German thinking and ensure that the ECB acts as central bank is designed to act when facing an existential threat for its currency.  Otherwise the ECB will be like a fire-engine without water in its tanks.  Who needs one?

Growth needed to avoid the pain in Spain

This article was published in The Malta Independent on Sunday - 05 May 2013

The PN refused government’s invitation to participate in the Action Committee for Economic Growth.  They maintained that such participation would go against the constitutional role of the Opposition in a parliamentary democracy.   They did so whilst emphasising their commitment to contributing constructively for Malta's constitutional, economic, social, and cultural development.

It is strange that the PN parliamentary group has decided this before the leadership election which is due imminently. For prudence sake one would have expected them to allow the elected leader to have the final say rather than have his hands tied before he is elected.

I find it contradictory to refuse to participate in such broad based consultative organ yet declare commitment to contribute constructively for economic development.

Long term policies for economic growth are very much the business of the party in Opposition. As an alternative government they should wish to influence the economic scenario they would one day find when the wheels of democratic alternation place the responsibility of governing back on their shoulders.

Economic growth requires productive investments. And even the best and most calibrated investments will take several years to analyse, plan and execute and several more years after that to start delivering the expected returns.

If PL in opposition had adopted the same reasoning when the PN in government wanted its co-operation to develop the financial services industry on the basis of consensus, we would not have the successes registered to date in this sector.

The government is there to govern for the term of the legislature. The Opposition is there to constructively oppose and watch over the government. So the Opposition’s stance would have been  understandable if they were offered any executive role.  But nothing should stop government and opposition working together especially on policies which span several legislatures and where consistency is needed especially in the eyes of foreign investors who demand stability of policies irrespective of which party is in charge to execute them.

I still remember when in the heat of the summer of 1998 in my role as Chairman of Mid-Med Bank we were working with HSBC on the IPO on international markets of the then Maltacom . The instability of Mintoff voting against the Labour government in parliament started undoing the good work we had done in the road shows with foreign investors.

I organised a conference call with such investors and invited Mr John Dalli, then the main opposition spokesman for the economy and finance, to re-assure investors that if there a change of government the IPO terms would be honoured. John Dalli did not think twice accepting and helped us save the IPO from failure.

The country's interest should come above those of any political party. Economic growth is everybody's business.   We must never allow our country to be dogged by political pique that is causing so much pain to stronger and bigger countries, like Spain and Italy.  It is not co-incidental that where the government and opposition co-operated overtly in the national interest as in Germany following the re-unification, such countries are now economically dominating others where long term economic policies were not co-ordinated across party lines in the national interest.

Consider the situation in Spain.  Spain is suffering from all the illnesses that make the current crisis so difficult to resolve.   It has to deal simultaneously with the fallout from a real estate bubble, a credit crunch, the clean-up of its banking sector and all this whilst undergoing a crushing internal devaluation to regain international competitiveness and severe fiscal tightening to return public finances to a sustainable path.  As a result Spain is in the 5^th year of what seems an interminable recession, have an unemployment rate of over 27% (which is not worse only because immigrants returned to their home country and increasingly young graduates are seeking careers abroad) and are experiencing a sharp contraction in consumption demand (and by consequence a sharp deterioration in the average of standard of living).    What a contrast to Spain before the crisis of 2008 when it had one on the highest consumption growth rates, a fiscal surplus of 4% of the GDP and a very low level of national debt.

Spain was living an illusion and none of the political parties, in government or in opposition, had the courage to tell the truth to their people.   Nobody wanted to take the punchbowl away as the party was running wild.   Being locked in a monetary union their Central Bank could not use the interest rate policy tool to calm down property speculation.  It could have imposed quantitative and qualitative credit control on its banks, but it failed.   Spanish banks found it easy to borrow on the cheap on the wholesale financial market to fuel the credit binge of property speculators.

Private households turned property speculators taking on leveraged credit risk which could only be justified if one believed that property prices would continue to rise eternally above the rate of retail inflation. The economy lost its balance as everyone found it easier to avoid hard work involved in manufacturing and innovation and instead jumped on the gravy train of easy property speculation where quick profit could be made on borrowed money without too much hard work.

Government itself enjoyed swelling revenues from taxes on property transactions and booming consumption.   It helped to keep public sector debt and deficit low.   But all this changed once the property bubble burst.   The construction and property industry that had become the motor of the economic engine went into reverse gear.   Property prices collapsed rendering many bank loans uncovered, unserviceable and irrecoverable.  The Banking sector suffered heavy losses which turned banks into under-capitalised zombies incapable of servicing the economy through new credits.  Government finances went into large fiscal deficit as revenues collapsed and social expenditures for unemployment and social assistance were triggered just when government needed to finance recapitalisation of its banks to save them from total collapse.

Now compare that to Germany where there was cross-party collaboration for social spread of the pain to integrate the Eastern former communist part of the country; where the Socialist government under Schroeder engineered Agenda 2010 giving a high dose of flexibility to the German Labour market with the collaboration of the Unions and without suffering piques from political opponents that could have instigated  the electorate to refuse short term pain as an investment for long term gains.

Certain policy decisions need to be modelled to span several legislatures and need cross party political collaboration for the country to take the unpopular decisions that sometimes it has to take to keep it sustainable for the long term.   The Action Committee for Economic Growth could have been a perfect forum for modelling such action plans with wide support from the political class, the economic profession, social partners and civil society.   It could have been the right forum to sensitise current generation on the need to keep a balanced economy and the need to avoid over-consumption of resources that may be needed by future generations to ensure that we leave them a better world.

Should we worry about Spain and its pain?   Not only we should, but in addition we must never allow our economy to fall into a Spanish type of disequilibrium.  Through the EU we must help Spain to overcome its problems, as given its size and the adjustment process that still lies ahead of it, the Eurozone of which we form part, can never resolve its debt crisis before Spain recovers.

It is doubtful whether interest rate reduction that was announced by the ECB this week will be a tangible way to help ease the pain in Spain and elsewhere, as given the already low level of interest rates and the broken transmission mechanism in the European financial system, such reduction may not travel down the pipes to where it is needed.

ECB President Draghi has every cause to feel frustrated by the broken financial transmission mechanism but it is useless blaming banks for it.   Many European banks are sick and sick patients may lose taste even if offered the best food.   Banks need healing which can only come from cleansing of insolvency by enforcing losses on debt holders followed by substantial recapitalisation  through a programme to be monetised by the ECB though the ESM so as to break the pernicious link between the banking system and the sovereign fiscal account which continue to exert mutually reflexive distress.

Draghi’s frustration should be directed towards those that are denying ECB to function properly and use whatever non-conventional measures are necessary to protect the EU from an endless recession or outright depression, especially now that we have evidence of inflation falling well below the benchmark 2%. The hinted negative rates are not the answer.   Their collateral damage would be too high.   The answer is monetisation to undertake restructuring and recapitalisation of Europe’s zombie banks provided this is followed by a Banking Union and Common Deposit Insurance.   Strong countries cannot rightly accept banking union before banks are cleaned up, losses forced on debt holders where insolvency is proven, and then properly recapitalised.

Under such scenario the monetisation and recapitalisation will be capable of being reversed in the medium term as banks are restored to health and profitability and the ESM can privatise its possibly at a profit.

Anti-Austerity revolt

Albert Einstein is reported to have defined insanity as  doing the same thing over and over again and expecting different results.    It seems that many in the EU, but not all, are realising their own insanity in trying to solve Europe's never ending recession by further rounds of austerity.

Italy finally has a new government that is committed to reverse some austerity measures to give  chance to the economy to grow.   They join the crusade started a year ago through the election of Hollande to French Presidency meant to shift German dictated EU policy from total focus on austerity to restructuring with growth policies.

Hollande relationship with Merkel is reportedly quite chilly and France is quietly building alliances with countries sharing anti-austerity feelings in order to force the issue with Germany after the elections due there in September.

He seems to be succeeding.  Apart from having Italy's new PM Enrico Letta clearly under his wings, this week Hollande won new allies.   Ireland's  Head of State, Michael D Higgings,  warned that the EU must drop its 'hegemonic' economic model or risk social upheaval and loss of popular legitimacy.   Slovakia Prime Minister Robert Fico quipped how was it possible to cut public finances and expect government to have enough resources to support economic growth.

This follows surprisingly clear pronouncements from the EU Commission President Barroso that the policy of austerity had reached its practical limits.

It is only Germany and its northern allies who remain steadfast in their belief that austerity and growth are two sides of the same coin.

But even assuming that one can declare victory for the anti-austerity protesters, the obvious question is ' after austerity, what?' as the Economist is asking this week.

Nobody should run away with any idea that uncontrolled government spending, even if it were possible ( which it is not, especially for those countries under bailout conditions), is an effective solution.    The monetary union can only be salvaged if there is fiscal discipline and the 3% to GDP maximum deficit and the zero deficit ultimate objective must remain in force even if applied flexibly to allow countries under bailout more time to reach the fiscal objectives through growth not just austerity.

But economic restructuring in order to regain international competitiveness must not be abandoned.   The Agenda 2010 objective launched by former German Chancellor Schroeder and which converted Germany from a sick economy to a very competitive outfit should be a blueprint for other EU countries.    Excessive job protection to those already in employment must not work to keep the unemployed out of the labour market.   Social solidarity must be offered to those truly needing it as otherwise it cultivates dependency rather than efficiency and effectiveness.

However most of all the ECB has to be re-tooled to function as Central Banks normally do.   Who needs a fire-engine if its bowsers are dry or cannot use the water to put out the fire?

Europe will not re-discover growth before they clean up their zombie banking systems. 

Arguments for a banking union and a common deposit insurance scheme will fail before such clean up takes place.   Who will accept shared responsibility for insolvent banks?

The ECB should be mandated to force write-off of debt holders in such insolvent banks and then to recapitalise such restructured banks by large scale monetisation through the ESM.   Burdening the sovereigns with such recapitalisations is useless.  It would simply reinforce the pernicious link between the sovereigns and the banks and will reinforce their reflexive mutual distress.

The ECB has to be mandated to use non-conventional monetary measures to protect the EU from the risk of deflation, following what seems a never ending recession, and should be implementing such non-conventional measures with urgency when they see the inflation departing so materially to the downside from their target 2% inflation benchmark.

ECB President Mario Draghi said yesterday that he is frustrated seeing the banking mechanism broken and failing to transmit the signals of the ECB to ultimate borrowers.  He should be frustrated with those who are prohibiting the ECB from acting as a proper central bank.