When The Red Light Turns Green

The so-called soundings between the SPD, Greens, and FDP have been a success and the three parties are ready to start formal coalition talks, subject to a Green elected officials’ conference today and an FDP executive committee meeting tomorrow. They will kick off from a heads-of-agreement paper that Der Tagesspiegel published here.

The content of this twelve-point plan is not particularly surprising especially in the light of this Handelsblatt op-ed, published the day after the election, by economist Jens Sudekum. Sudekum argued first of all that a traffic light coalition was unavoidable because neither the Greens or the SPD nor really anyone else would agree to a government led by Armin Laschet or Friedrich Merz, and given that, the only remaining option with a majority was the traffic light.

The major barrier to it, something everyone has been talking about for months, is the FDP’s insistence on keeping the kinda-sorta balanced budget amendment and no new taxes, and having the finance ministry to make sure they get it. This is both difficult for the SPD’s social policy goals, and maybe even more difficult for the Greens, whose very purpose requires far-reaching changes that must be expressed in terms of infrastructure. The wider, global shift of emphasis in climate policy from cap-and-trade or tax-and-rebate options to infrastructure-based change makes this conflict even more jarring. Further, sheer personal power is at stake – implementing the Greens’ vision would require a powerful ministry with a large discretionary budget to push the projects through, and giving that to the Greens implies that the FDP must get something comparable.

Sudekum pointed out that there was a potential fix. The FDP likes the idea of the pension system investing in assets, like a sovereign wealth fund. This implies capitalizing the fund up-front, and hence the government borrowing money. The party squares the circle by excluding this from the deficit target on the grounds that the state is acquiring an equivalent amount of assets, ones that could be expected to grow, and therefore its net indebtedness hasn’t increased. As sauce for the goose could be sauce for the gander, perhaps the capital programme could be treated the same way? Further, although the FDP had been promising tax cuts all round for businesses, they had also shown willingness to accept more generous capital allowances instead of basic rate cuts.

Yesterday’s document looks a lot like the fix is in. The fund is in there, as are the capital allowances. So is the return to budget balance, although pushed off another year into the future under the emergency pandemic exemption. The Green, or green, investment programme is there, as is a big slug of public housing investment, the €12/hour minimum wage, and sweeping changes to the welfare state. As everyone has already noticed, this pretty much requires a lot of fudge in the financing, with things like new income under the global minimum tax regime, unspecified involvement of private investors, cuts to subsidies, and a crackdown on fraud and error (now there’s an old classic), as well as the expected post-pandemic revival of growth all chipping in.

This piece points out that the document promises to guarantee the necessary investments in climate policy, digital, education, research, and infrastructure, within the framework of the balanced budget amendment, and that this would cover anything from an investment carve-out, providing the lawyers could come up with a form of words to deal with the predictable appeal to Karlsruhe, or just using the whole of the emergency authorisation for 2022-2023 to pre-fund the programme, something which in itself could go as high as €100bn.

Robert Habeck, interestingly, gave an interview in which he said that the talks were more advanced on the financing issue in private than the heads-of-agreement reflected, perhaps a signal that he has a surprise up his sleeve. Perhaps the proposed sovereign wealth fund could even invest in the projects itself?

ECB Taper News

What Business Insider’s Mike Bird somewhat ironically calls #euroboom2015 seems to be well and truly with us.

The WSJ’s Simon Nixon spelled  it out for us in his “QE is Working Better than the ECB Dared Hope” article:  “one month into the ECB’s €1 trillion ($1.06 trillion) quantitative-easing program, and ECB President Mario Draghi was only too happy to take credit for a remarkable turnaround in the economy’s fortunes at Wednesday’s news conference.” And he goes on to give examples:

“Growth forecasts have been continually revised up since January when the program was announced: the International Monetary Fund said this week it now expects the eurozone to grow by 1.5% in 2015. Business and consumer confidence are the highest since 2007. Bank lending is finally picking up.”

“The strongest growth is coming from former crisis countries: Spain is forecast to grow by up to 3% and Ireland up to 4% this year. Meanwhile German policy makers fret that with growth likely to hit 2.5%, the economy may overheat.”

 Naturally, as he also says, “not all of this can be traced to quantitative easing.” But then, here comes the point: “Indeed, if the ECB had delayed its decision on quantitative easing until March, as the Bundesbank had urged, it may have concluded it didn’t need to buy any bonds at all.” Continue reading

When Will The ECB Start To Taper?

What matters isn’t what you think should happen, it’s what others think will happen that counts.

Funny days these, the world seems to be constantly turning upside down. I could be talking about the arrival of negative interest rates in many European economies, but I’m not. What I have in mind is the crossover that seems to be taking place in the perceived fortunes of the US and the Euro Area economies. At the end of 2014 it was all “Europe bad, USA good” to the point that most observers were expecting an imminent rate rise from  the Federal Reserve, even while the Euro was in such a bad state that ECB was being steadily pushed – kicking and screaming – towards a full blown programme of sovereign bond buying QE. Continue reading

Does The Arrival Of Negative Interest Rates Change the Attractivess of EMU?

This is the second in a series of posts (first one here) in  which I try to argue that the balance between costs and benefits of belonging to the European monetary union has shifted in the post crisis world, especially for heavily indebted countries such as those to be found on the European periphery. Continue reading

Stocks, Flows, GDP Warrants, Negotiating Constraints, Inter-Blogger Tension: Greece

So, if we were to make a little leap of faith, how could SYRIZA and the troika, or eurogroup, or shall we just say the Euros, come to an agreement?

The first issue, I think, is that any agreement needs to pass two tests. It needs to be both acceptable, or it wouldn’t be agreement, and it needs to be effective, or it would be pointless. The red-lines on both sides are pretty clear. SYRIZA went to the polls demanding some measure of debt relief. I take that to mean a reduction in the face value of the outstanding stock of debt to the Eurozone, plus the ECB, plus the IMF. Angela Merkel has stated that no further “haircut” is acceptable. Everyone assumes she is the ultimate veto actor on the Euros’ side.

On the other hand, as everyone seems to think, the debt service, i.e. the interest on the outstanding stock of debt, isn’t a big deal and therefore the stock of debt isn’t either. What matters is the primary surplus, the net transfer from Greece to the Euros, that the current agreement requires every year from here on in. The test of an effective agreement is whether it reduces this enough to restart the Greek economy. The Euros’ target is 4.5% of GDP. Yanis Varoufakis, Greek finance minister and everyone in the blogosphere’s new best mate, wants to cut it to between 1 and 1.5%. Clearly, agreement is possible somewhere between the two values, especially as nobody on the Euros’ side has committed to veto any particular number.

Ironically, the parties can agree on quite a few different options that would work to a greater or lesser extent, but they can’t accept them politically. This is of course better than the other way around. Arguably, the other way around is what we’ve had so far – acceptable, but ineffective.

A lot of people would also agree that the outstanding stock of debts is not really very important. It is, per Krugman, an accounting fiction, per Daniel Davies, the means by which the Euros try to control the Greek government budget, in order to impose something called “structural reform”. Alan Beattie, in a superb blog post, points out that the phrase “structural reform” is nonsensical.

First of all, there is no such thing as “reform” as such. You can’t ring up and order 20 40′ containers full of reform. Reforms are, more than anything else, inherently specific and context-dependent. The enterprise of structural reform is based on the idea that the market knows best, as it embodies the diffuse wisdom of those most concerned. But the reforms are meant to be chosen and delivered by civil servants parachuted (or rather, airlanded) in from some other country, usually isolated from everyone but the airport-to-hotel cab driver. This is at least ironic, and arguably perverse.

Second, reform has goals and in this case the goal is the delivery of the 4.5% annual primary surplus. Looking at this from a sectoral-balance point of view, if the public sector is to net-save 4.5% of GDP, either the private sector must take on a similar amount of net debt, or else the country must run a similar current-account surplus. So far, Greece has tried to reduce its CA deficit by demand destruction, or in other words, cutting down trees around Athens to save on fuel oil. What the structural reformers have in their heads, though, is that Greece increases its exports.

This implies both that somebody else imports them, and also that the Greek private sector increases its capacity. Firms expand by using more capital, one way or another. This seems unlikely in the context of debt-deflation. Reform very often costs money; when Germany carried out what it now thinks of as structural reform in the early 2000s, it blew its budget deficit targets with the Euros quite comprehensively.

Also, the difference between Alan Beattie and Daniel Davies is that Alan accepts that structural reform can be, and often is, stupid. Beattie’s archetypal Christmas-tree program includes a mixture of ideas anyone could agree with, ideas that are impossible to implement, and ideas that in context are insane, but might, tragically, be implemented. Capacity has to go up but demand has to go down. The private sector needs to borrow to invest, but credit has to be tighter. Pensions must be cut to increase the pensioners’ competitiveness in the cut-throat business of retirement. Daniel Davies’ Aunt Agatha doesn’t just want you to do language classes; she also wants you to wear earplugs during them, and also attend the right sort of church like the right sort of people, just to show willing, like.

There is surely a case that the Greeks are the best placed to know what their problems are, and further that SYRIZA is the party that is least complicit in keeping the problems that way. That means, of course, that the reforms must be acceptable to them.

But we already know that the level of the primary surplus is negotiable. We’ve established that. The point is how to deliver something that amounts to debt relief in Greece, but not to a write-off at face value. How can we get to yes?

Here’s an important chart, showing the annual repayments in euros for the various official loans.


You’ll notice that in the short term, the IMF predominates. You’ll also notice that a lot of the repayments are in the really long, we-are-all-dead run, out to the 2040s and 2050s. This is the very definition of a political number. And who owns it? You might be surprised.

Everyone always says Germany, but out of the €194bn owing to Eurozone sovereigns, €104bn came from France, Spain, and Italy together. When the history is written, it should take note that Spain in its troubles put its hand in its pocket for serious amounts of money. At the time, there was a lot of talk that the EFSF-and-then-EFSM-and-then-ESM had no credibility because they stood behind it. The record shows they came through. Of course, this makes the idea of a southern front against austerity so much more difficult, as they can afford to lose the money so much less.

This is, I think, where there is a bit of play in the mechanism. The Greeks are floating the idea of linking the debt repayments to growth, like an income-contingent student loan or perhaps more like a debt-for-equity swap. This is, of course, rather like the GDP warrants proposal that was fashionable a couple of years back.

In context, this means that the payoff comes through if the reforms actually work; a discipline never before imposed on such a programme, although of course they always want it for everyone else. This is substantially better than the other option, which is just to extend-and-pretend again.

Although the payoff structure is equity-like, it’s still an obligation of the same face value, so it does not constitute a write-off in the strict sense. As it doesn’t require a cash transfer until some target is reached, though, it is debt relief in a very important sense from a Greek point of view. In an accounting sense, of course, it is – the risk-adjusted net present value would be lower by some percentage depending on your guess about the path of Greek GDP in the fairly distant future.

The further out you go, of course, the easier this is, but then again, the test of effectiveness is what happens to the primary surplus requirement – right? And a swap of bonds for warrants with terms out in the 2040s is a better bet, I think, than hoping for a European fiscal union with actual transfers and without balanced-budget amendments. For additional information about investing visit SoFi.

As for the IMF, well, will this mean another story about the Europeans hoping the Americans will lend a hand?

Swiss time was running out

The reviews are in on the Swiss National Bank (SNB) abandoning its CHF 1.2 per Euro minimum peg and they are unfavourable. It seems people are shocked that Switzerland might act in a unilateral fashion and without seeing the need to coordinate with other countries.

Anyway, the departure point for many analyses seems to be an assumption that nothing was especially wrong with the peg. Sure, the SNB was committed to buying unlimited quantities of foreign currency, and thus unlimited growth in its balance sheet, but what exactly was the constraint on that? Well, for one thing, it was producing some economic outcomes that Swiss voters — remember those people? — didn’t seem to especially like, not least rapid growth in asset prices such as housing and questions about huge holdings of foreign currency assets.

But let’s take the liquidity trap diagnosis at face value. Switzerland has been at risk of deflation, and the tendency of investors to pile into its currency at the same time forces it to appreciate, making the deflation problem even worse. The peg was supposed to solve that, but the domestic politics around that was turning sour. One way to break the deflationary cycle: get people thinking that the SNB might be just a little crazy and liable to do things at short notice which make investing in the currency not such a good idea. And furthermore, realizing that your peg is going to crack at some point in the future, acting abruptly now in a way that causes the exchange rate to, er, “overshoot” its true higher long run value so that investors expect it to depreciate over the foreseeable future, meaning rising prices and … more incentive to spend today!

Yes. it sounds crazy. But the liquidity trap is itself crazy. This particular exit option just might fit the times.

It’s Baaack: Looming Greek Elections Threaten To Re-ignite the Euro Crisis

If at first you don’t succeed, try, try again……  aka third time unlucky.

The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts – one in July around the collapse of the Portuguese Banco Espirito Santo, and another in October over the state of the Greek bailout negotiations – the announcement this week that the Greek presidential decision was being brought forward to December has sent the markets reeling off into a complete tizzy. Continue reading

The Japanisation Of Europe

By now it should be clear that the monetary experiment currently being carried out in Japan (known as “Abenomics”) is fundamentally different from the kind of quantitative easing which was implemented  in the United States and the United Kingdom during the global financial crisis. In the US and the UK QE was implemented in order to stabilize the financial system, while in Japan, and now the Euro Area (EA) the objective is to end deflationary pressures and reflate economies which are arguably caught in some form of liquidity trap. Continue reading

Secular Stagnation Part III – The Expectations Fairy

“So what’s going on here? Well, it might sound like a hokey religion, but central banking is really a Jedi mind trick. Just saying something can be enough to make it happen. That’s because the power of the printing press gives their words a distinct power. Well, that and the fact that the economy is already one big self-fulfilling prophecy.” – Matt O’brien,  “Abenomics has only worked because foreigners think it willContinue reading

What Is The Risk The Euro Crisis Will Reignite?

The euro zone crisis is not back — at least not yet.

Recent movements in global markets following concerns about Portugal’s Banco Espirito Santo really had as much to do with market nerves after a long spell of repressed volatility as it did with the state of the bank’s balance sheet. Despite the current calm, everyone knows that volatility will return one day, and no one wants to be caught on the back foot when it does arrive. So the initial response is to hit the “sell” button and then ask questions.

Beyond this context, there is a lack of certainty in the market about which way bond yields for the so-called “peripheral” euro zone countries are heading in the near term — and what exactly the risks associated with holding them really are. Riding the yield compression, in the case of the Portuguese 10-year bond from over 7 percent to under 3.5 percent was a one-way-bet no-brainer once the impact of Draghi’s July 2012 speech became crystal clear. Continue reading