Tag: Greece

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Saving the eurozone? Saving the world? (Part C)

Well they say that a day is a long-time in politics – that an awful lot can happen within 24 hours. The two days of the G20 summit have seemed like a lifetime. The meeting took place in Cannes from 3 to 4 November, 2011. It was the sixth such meeting of the G20: the 19 largest developed and developing countries plus the European Union.

As chair of the meeting, President Sarkozy of France had planned to address the two key global issues of securing a sustained global recovery and strengthening the global banking system. He also wanted to address other issues, such as climate change, commodity price volatility, social inclusion, corruption and corporate governance. But although these issues are covered in the final communiqué, what took centre-stage for the whole summit was the crisis in Greece and its impact on the eurozone.

The drama began on Monday 31 October. The Greek Prime Minister, George Papandreou, decided to call a referendum on the agreement reached at the eurozone summit in Brussels the previous week. In return for banks being required to take a loss of 50% in converting existing Greek bonds into new ones, Greece would have to continue with its tough austerity measures: measures that have caused the Greek economy to implode.

With worries that (a) the referendum would create several weeks of uncertainty, (b) that the agreement might then be rejected, (c) that the government might fall, stock markets plunged. French and German markets fell by over 5%. The Athens stock market fell by 7 per cent. The yield on Italian bonds passed 6%, amidst fears that if Greece defaulted, so too might Italy. But if the eurozone could survive a Greek default, it might not survive an Italian one. Even though several members of Mr. Papandreou’s Pasok party demanded his resignation, he stuck to his guns that an agreement had to have the consent of the Greek people. That was Tuesday.

The next day, Wednesday, was the start of the two-day G20 conference. What was to have been a meeting addressing wider issues of the global economy, was now having to focus on the Greek crisis. President Sarkozy and Chancellor Merkel made it clear that the next tranche of bailout money to Greece would not be paid until the deal agreed in Brussels was accepted by Greece. They gave the first indications that they might accept Greece’s withdrawal from the eurozone.

On Thursday afternoon, Mr Papandreou signalled that he would back down from the referendum if the opposition New Democracy party would join him in supporting the Brussels deal. He would not resign. But the opposition leader, Antonis Samaras, said that his party would not join with Mr Papandreou and that the Prime Minister should indeed resign. He did not resign, but abandoned the calll for a referendum.

With the Greek crisis dominating the meeting, little concrete agreement was reached. One important outcome, however, was the recognition that the financing of the IMF should be strengthened. As the final communiqué states:

We will ensure the IMF continues to have resources to play its systemic role to the benefit of its whole membership, building on the substantial resources we have already mobilized since London in 2009. We stand ready to ensure additional resources could be mobilised in a timely manner and ask our finance ministers by their next meeting to work on deploying a range of various options including bilateral contributions to the IMF, SDRs, and voluntary contributions to an IMF special structure such as an administered account. We will expeditiously implement in full the 2010 quota and governance reform of the IMF.

But despite this recognition of the key role of the IMF, the agreement was essentially that an agreement would be needed!

Articles

Eurozone crisis: yet another twist to Greek farce keeps leaders on edge of seats The Telegraph (4/11/11)
G20 summit: the main issues at Cannes The Telegraph (3/11/11)
Quick! More sandbags (filled with cash) The Economist, Charlemagne’s notebook (4/11/11)
The burning fuse The Economist, Charlemagne’s notebook (4/11/11)
G20 leaders agree to boost IMF resources BBC News (4/11/11)
G20 summit fails to allay world recession fears Guardian, Patrick Wintour and Larry Elliott (4/11/11)
G20 summit: roll call of doom for a dysfunctional family Guardian, Angelique Chrisafis (3/11/11)
Euro zone finds no new money for debt crisis at G20 The Economic Times of India (4/11/11)
Shares jump after referendum ditched New Zealand Herald (5/11/11)
Bunds rise on EFSF worries, Italy under pressure Reuters (4/11/11)
Eurozone crisis: The possible resolutions BBC News (4/11/11)
The G20 aren’t running to Europe’s rescue BBC News blogs, Stephanie Flanders (4/11/11)
Is the euro about to capsize? BBC News, Laurence Knight (4/11/11)

Final Communiqué

Meeting of Finance Ministers and Central Bank Governors: final communiqué G20–G8 France 2011 (4/11/11)

Questions

  1. Why might the ‘game’ between the eurozone leaders and George Papandreou be seen as a prisoner’s dilemma game? What are the payoffs?
  2. Why might increasing the bailout for Greece represent a moral hazard for the eurozone leaders?
  3. Trace through market reactions between the 31 October and the 4 November and explain the movements.
  4. How crucial is the IMF in achieving global stability and economic growth?
  5. Assess the success of the Cannes G20 conference.
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Saving the eurozone? Saving the world? (Part B)

At its meeting on 26 October, the eurozone countries agreed on a deal to tackle the three problems identified in Part A of this blog:

1. Making the Greek debt burden sustainable
2. Increasing the size of the eurozone bailout fund to persuade markets that there would be sufficient funding to support other eurozone countries which were having difficulties in servicing their debt.
3. Recapitalising various European banks to shield them against possible losses from haircuts and defaults.

The following were agreed:

1. Banks would be required to take a loss of 50% in converting existing Greek bonds into new ones. This swap will take place in January 2012. Note that Greek debt to other countries and the ECB would be unaffected and thus total Greek debt would be cut by considerably less than 50%.

2. The bailout fund (EFSF) would increase to between €1 trillion and €1.4 trillion, although this would be achieved not by direct contributions by Member States or the ECB, but by encouraging non-eurozone countries (such as China, Russia, India and Brazil) to buy eurozone debt in return for risk insurance. These purchases would the form the base on which the size of the fund could be multiplied (leveraged). There would also be backing from the IMF. Details would be firmed up in November.

3. Recapitalising various European banks to shield them against possible losses from haircuts and defaults. About 70 banks will be required to raise an additional €106.4 billion by increasing their Tier 1 capital ratio by 9% by June 2012 (this compares with the Basel III requirement of 6% Tier 1 by 2015).

On the longer-term issue of closer fiscal union, the agreement was in favour of achieving this, along with tight constraints on the levels of government deficits and debt – a return to something akin to the Stability and Growth Pact.

On the issue of economic growth, whilst constraining sovereign debt may be an important element of a long-term growth strategy, the agreement has not got to grips with the short-term problem of a lack of aggregate demand – unless, of course, the relief in markets at seeing a solution to the debt problem may boost business and consumer confidence. This, in turn, may provide the boost to aggregate demand that has been sadly lacking over the past few months.

Certainly if the reaction of stock markets around the world are anything to go by, the recovery in confidence may be under way. The day following the agreement, the German stock market index, the Dax, rose by 6.3% and the French Cac index rose by 5.4%.

Articles

Eurozone crisis explained BBC News (27/10/11)
Leaders agree eurozone debt plan in Brussels BBC News, Matthew Price (27/10/11)
Eurozone agreement – the detail BBC News, Hugh Pym (27/10/11)
10 key questions on the eurozone bailout Citywire Money, Caelainn Barr (27/10/11)
European debt crisis: ‘Europe is going to have a very tough winter’ – video analysis Guardian, Larry Elliott (27/10/11)
Eurozone crisis: banks agree 50% reduction on Greece’s debt Guardian, David Gow (27/10/11)
The euro deal: No big bazooka The Economist (29/10/11)
Europe’s rescue plan The Economist (29/10/11)
European banks given just eight months to raise €106bn The Telegraph, Louise Armitstead (26/10/11)
EU reaches agreement on Greek bonds Financial Times, Peter Spiegel, Stanley Pignal and Alex Barker (27/10/11)
Unlike politicians, the markets are seeing sense Independent, Hamish McRae (27/10/11)
Market view: Eurozone rescue deal buys time FT Adviser, Michael Trudeau (27/10/11)
Greece vows to build on EU deal, people sceptical Reuters, Renee Maltezou and Daniel Flynn (27/10/11)
Markets boosted by eurozone deal Independent, Peter Cripps, Jamie Grierson (27/10/11)
Has Germany been prudent or short-sighted? BBC News blogs, Robert Peston (27/10/11)
Germany’s Fiscal union with a capital F BBC News blogs, Stephanie Flanders (27/10/11)

Questions

  1. What are the key features of the deal reached in Brussels on 26 October?
  2. What details still need to be worked out?
  3. How will the EFSF be boosted some 4 or 5 times without extra contributions fron eurozone governments?
  4. Why, if banks are to take a 50% haircut on their holdings of Greek debt, will Greek debt fall only to 120% per cent by 2020 from just over 160% currently?
  5. On balance, is this a good deal?
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Saving the eurozone? Saving the world? (Part A)

As European leaders gather for an emergency summit in Brussels to tackle the eurozone debt crisis, we consider the issues and possible solutions. In Part B we’ll consider the actual agreement.

There are three key short-term issues that the leaders are addressing.

1. The problem of Greek debt

With fears that the Greek debt crisis could spread to other eurozone countries, such as Italy and Spain, it is vital to have a solution to the unsustainability of Greek debt. Either banks must be willing to write off a proportion of Greek debt owed to them or governments must give a fiscal transfer to Greece to allow it to continue servicing the debt. Simply lending Greece even more provides no long-term solution as this will simply make the debt even harder to service. Writing off a given percentage of debt is known as a ‘haircut’. The haircut on offer before the summit was 21%. Leaders are reportedly considering increasing this to around 60%.

2. The size of the eurozone bailout fund

The bailout fund, the European Financial Stability Facility (EFSF), stood at €440 billion. This is considered totally inadequate to provide loans to Italy and Spain, should they need a bailout. France and other countries want the ECB to provide extra loans to the EFSF, to increase its funds to somewhere between €2 trillion and €3 trillion. Germany before the meeting was strongly against this, seeing it as undermining the rectitude of the ECB. A compromise would be for the EFSF to provide partial guarantees to investors and banks which are willing to lend more to countries in debt crisis.

3. Recapitalising various European banks

Several European banks are heavily exposed to sovereign debt in countries such as Greece, Italy and Spain. It is estimated that they would need to raise an extra €100 billion to shield them against possible losses from haircuts and defaults.

But there is the key longer-term issue as well.

Achieving long-term economic growth

Without economic growth, debt servicing becomes much more difficult. The austerity measures imposed on highly indebted countries amount to strongly contractionary fiscal policies, as government expenditure is cut and taxes are increased. But as the economies contract, so automatic fiscal stabilisers come into play. As incomes and expenditure decline, so people pay less income tax and less VAT and other expenditure taxes; as incomes decline and unemployment rises, so government welfare payments and payments of unemployment benefits increase. These compound public-sector deficits and bring the possibility of even stronger austerity measures. A downward spiral of decline and rising debt can occur.

The answer is more rapid growth. But how is that to be achieved when governments are trying to reduce debt? That is the hardest and ultimately the most important question.

Articles

Brussels summit: the main issues to be resolved The Telegraph (25/10/11)
EU crisis talks in limbo after crucial summit is cancelled The Telegraph, Louise Armitstead (25/10/11)
Euro zone summit likely to give few numbers on crisis response Reuters, Jan Strupczewski (25/10/11)
Factbox: What EU leaders must decide at crisis summit Reuters (24/10/11)
Hopes low ahead of EU summit Euronews on YouTube (25/10/11)
Euro crisis: EU leaders hope to reach debt plan BBC News (26/10/11)
The deadline Europe cannot afford to miss BBC News, Nigel Cassidy (26/10/11)
Why EU summit is crunch day for the eurozone BBC News, Paul Mason (26/10/11)
Southern European banks need most capital BBC News blogs, Robert Peston (23/10/11)
Will Germany insure Italy against default? BBC News blogs, Robert Peston (26/10/11)
Plan B for the eurozone? BBC News blogs, Stephanie Flanders (26/10/11)
‘No such thing as Europe’ BBC Today Programme, Stephanie Flanders and Martin Wolf (26/10/11)
Markets to eurozone: It’s the growth, stupid BBC News blogs, Stephanie Flanders (24/10/11)
Fears euro summit could miss final deal Financial Times, Peter Spiegel, Gerrit Wiesmann and Matt Steinglass (26/10/11)
Time to unleash financial firepower or face euro breakup Guardian, Larry Elliott (25/10/11)
The Business podcast: eurozone crisis Guardian, Larry Elliott, David Gow and Jill Treanor (25/10/11)
Why is Germany refusing to budge on the eurozone debt crisis? Guardian blogs, Phillip Inman (26/10/11)

Questions

  1. In terms of the three short-term problems identified above, compare alternative measures for dealing with each one.
  2. To what extent would the ECB creating enough money to recapitalise European banks be inflationary? On what factors does this depend?
  3. Does bailing out countries create a moral hazard? Explain.
  4. What possible ways are there of achieving economic growth while reducing countries sovereign debt?
  5. Would you agree that the problem facing eurozone countries at the moment is more of a political one than an economic one? Explain.
  6. What are the arguments for and against greater fiscal integration in the eurozone?
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Central banks to the rescue?

The debts of many countries in the eurozone are becoming increasingly difficult to service. With negative growth in some countries (Greece’s GDP is set to decline by over 5% this year) and falling growth rates in others, the outlook is becoming worse: tax revenues are likely to fall and benefit payments are likely to increase as automatic fiscal stabilisers take effect. In the light of these difficulties, market rates of interest on sovereign debt in these countries have been increasing.

Talk of default has got louder. If Greece cannot service its public-sector debt, currently standing at around 150% of GDP (way above the 60% ceiling set in the Stability and Growth Pact), then simply lending it more will merely delay the problem. Ultimately, if it cannot grow its way out of the debt, then either it must receive a fiscal transfer from the rest of the eurozone, or part of its debts must be cancelled or radically rescheduled.

But Greece is a small country, and relative to the size of the whole eurozone’s GDP, its debt is tiny. Italy is another matter. It’s public-sector debt to GDP ratio, at around 120% is lower than Greece’s, but the level of debt is much higher: $2 trillion compared with Greece’s $480 billion. Increasingly banks are becoming worried about their exposure to Italian debt – both public- and private-sector debt.

As we saw in the news item “The brutal face of supply and demand”, stock markets have been plummeting because of the growing fears about debts in the eurozone. And these fears have been particularly focused on banks with high levels of exposure to these debts. French banks are particularly vulnerable. Indeed, Credit Agricole and Société Générale, France’s second and third largest banks, had their creidit ratings cut by Moody’s rating agency. They have both seen their share prices fall dramatically this year: 46% and 55% respectively.

Central banks have been becoming increasingly concerned that the sovereign debt crisis in various eurozone countries will turn into a new banking crisis. In an attempt to calm markets and help ease the problem for banks, five central banks – the Federal Reserve, the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank – announced on 15 September that they would co-operate to offer three-month US dollar loans to commercial banks. They would provide as much liquidity as was necessary to ease any funding difficulties.

The effect of this action calmed the markets and share prices in Europe and around the world rose substantially. But was this enough to stave off a new banking crisis? And did it do anything to ease the sovereign debt crisis and the problems of the eurozone? The following articles explore these questions.

Articles
Central banks expand dollar operations Reuters, Sakari Suoninen and Marc Jones (15/9/11)
Europe’s debt crisis prompts central banks to provide dollar liquidity Guardian, Larry Elliott and Dominic Rushe (15/9/11)
From euro zone to battle zone Sydney Morning Herald, Michael Evans (17/9/11)
Global shares rise on central banks’ loan move BBC News (16/9/11)
Geithner warns EU against infighting over Greece BBC News (16/9/11)
How The European Debt Crisis Could Spread npr (USA), Marilyn Geewax (15/9/11)
No Marshall Plan for Europe National Post (Canada) (16/9/11)
Central banks act to help Europe lenders Financial Times, Ralph Atkins, Richard Milne and Alex Barker (15/9/11)
Central Banks Seeking Quick Fix Push Dollar Cost to August Lows Bloomberg Businesweek, John Glover and Ben Martin (15/9/11)
Central banks act to provide euro zone dollar liquidity Irish Times (15/9/11)
Central banks pump money into market: what the analysts say The Telegraph (15/9/11)
Central banks and the ‘spirit of 2008’ BBC News, Stephanie Flanders (15/9/11)

Central Bank statements
News Release: Additional US dollar liquidity-providing operations over year-end Bank of England (15/9/11)
Press Release: ECB announces additional US dollar liquidity-providing operations over year-end ECB (15/9/11)
Additional schedule for U.S. Dollar Funds-Supplying Operations Bank of Japan (15/9/11)
Central banks to extend provision of US dollar liquidity Swiss National Bank (15/9/11)

Questions

  1. Explain what is meant by debt servicing.
  2. How may the concerted actions of the five central banks help the banking sector?
  3. Distinguish between liquidity and capital. Is supplying extra liquidity a suitable means of coping with the difficulties of countries in servicing their debts?
  4. If Greece cannot service its debts, what options are open to (a) Greece itself; (b) international institutions and governments?
  5. In what ways are the eurozone countries collectively in a better economic and financial state than the USA?
  6. Is the best solution to the eurozone crisis to achieve greater fiscal harmonisation?
  7. What are the weaknesses of the European Financial Stability Facility (EFSF) as currently constituted? Should it be turned into a bank or special credit institution taking the role of a ‘European Monetary Fund’?
  8. Should countries in the eurozone be able to issue eurobonds?