Today Europe’s leaders took another step towards the edge of the cliff

Summary:  The conference of Europe’s leaders concluded with little results, a failure judged by the expectations they had set.  They don’t have time for many more such failures as conditions worsen, the financial contagion spreads across Europe, and their credibility diminishes.  Here we conduct a post-mortem on the Summit.

Today the leaders of Europe concluded their 14th meeting during the 21-month-long crisis, their last opportunity to produce specific proposals for the G-20 meeting at Cannes on November 3-5.  They failed to agree upon specific and substantial measures to contain the growing economic stress — now reaching Italy (which has the world’s 3rd largest government debt) — and treat Greece’s problems (now the most afflicted sick man of Europe).  The few measures they did agree upon are of dubious effect, much like the austerity programs they have prescribed for the PIIGS (now pushing most of them into long-term contractions).

Does anyone give much weight to their expressions of resolve and large promises for future action?  While they talk, the rot spreads.

Update:  To measure in real-time the results of the euro-plan, watch the yield of Italy’s ten-year government bond to measure the effect of Europe’s latest rescue plan.  A rising yield means the plan is failing; falling means success.  Over 6% is bad.  Whenn the total cost of Italy’s sovereign debt (mostly financed with shorter, cheaper bonds) reaches 6% (the tipping point into insolvency) then the end game has began.  See Bloomberg for this data.

Contents

1. The announcements from the Summit
2. The effect of these agreements
3. China to the rescue!
4. What about those lazy profligate Greeks?
5. Updates: For more information
6. Other articles on the FM website about Europe’s crisis

(1)  The announcements from the Summit

The European  Council has resolved to do great things in the future, but today made few or no actual  decisions.  Details for future actions to come in November.

• Statement of EU Heads of State or Government
• Remarks by Herman Van Rompuy, President of the European Council, after the meeting of EU Heads of State or Government

Reuters provided additional information on the pitifully meager accomplishments of the meeting (red emphasis added):

The euro zone aims to leverage its 440 billion euro bailout fund, the EFSF, “several fold” but finance ministers will only agree the details of how that will be done in November, according to a draft statement to be issued after a summit on Wednesday.  The statement, obtained by Reuters, says two options are being considered to leverage the fund, one involving it issuing risk insurance and the other built around it taking part in a special purpose investment vehicle. Both models could be deployed simultaneously, the draft statement said.

The Eurogroup of finance ministers will be asked to finalize the terms and conditions for how the EFSF will operate under the leverage schemes in November, the statement said.

In addition, it said the EFSF’s resources could be further enhanced, possibly via cooperation with the International Monetary Fund.

The draft statement also called on Spain to do more to bring its budget into line, while praising it for the steps taken so far.  A paragraph on Italy, which is under pressure to do more on pension and other reforms, was left blank but is expected to be added later.

(2)  The effect of these agreements

(a)  Probably not much more money for Greece, other than the existing programs.  Perhaps aid for its banks, and to rollover its government debt.

(b)  A large write-down of privately held Greek government debt (which is aprox 200B euro of its 350B debt), two or perhaps even three times the 21% reduction in its net present value agreed upon on July 21st.  This would reduce Greek government debt to a still-fantastic 140-150% of GDP (depending on the terms; see this report for details).  But Greek banks and pension plans hold much of the this debt.  Update:  they agreed to 50% cut; see Reuters.

In the short-term this will weaken the banks; only large-scale aid will keep them alive.  Long-term this threatens the solvency of Greece’s pension system.  Unless accompanied by substantial aid, the net relief might be small.

(c)  Europe’s banks will need to raise substantial amounts of new capital from private sources.  This might prove difficult to do until Europe’s leaders agree upon long-term and large-scale reforms to stabilize Europe’s government finances and (most important) the internal trade imbalances which have caused these problems.

(d)  Most importantly, Europe’s leaders appear to have abandoned (at least for now) their attempts to address the causes of Europe’s problems.  The announcement concern only band-aids.  They neither fix Greece nor prevent the contagion to continue spreading — as it has for the past 21 months.  How the heat has spread to Italy, and even French sovereign yields are rising.

Conclusion:  Europe’s leaders are playing Russian Roulette,  Each failed conference, each inadequate solution is like pulling the trigger.  Each attempt burns time and credibility.  Eventually they’ll get a loaded chamber, with the bang initiating the disorderly circumstances they fear.  But perhaps only such turmoil will generate the political will to take decisive measures — but it will increase the cost of the measures and making success more difficult.

(3)  China to the rescue!

Despite the evident failure of the Summit, excitement spread from a rumor that China would make large loans to Europe, perhaps through the IMF.  It’s a mark of the West’s desperation that we greet this foolish story — which has made several appearances this year — with such enthusiasm.

(a)  China announced back  in January they they would buy EFSF bonds (which are AAA).  Both Japan and China have already done so.

(b)  The latest rumor originated in China Daily (see here via  AFP):

China and other emerging powers have agreed to help eurozone countries facing a debt crisis by taking part in a bailout fund, the China Daily said   Wednesday, citing a source close to EU decision makers.  The state-owned English language   newspaper said leading emerging economies would help to finance the rescue   fund through the International Monetary Fund, which would boost their voting rights in the Washington-based lender.The agreement may be written into the final document at a second   emergency summit of European leaders, due to begin later Wednesday, the   unidentified source told the newspaper.

Reuters published a denial a few hours later:  “China  diplomat: nothing concrete on investing in EFSF vehicle“.

(c)  Europe runs a current-account surplus, and so does not need foreign funds to bailout Greece.  If China’s loans are in addition to existing flows, they will depress the RMB (the yuan) vs. the Euro — boosting the competitiveness of China’s exports vs. manufacturers in Europe.  Why then seek the funds?  Europe’s leaders probably want China’s funds because they do not want to take on the risk themselves of lending to the PIIGS.  That of course will not excite China.  For more about this see BRICs to the rescue, Michael Pettis (Finance Professor at Peking U; bio here), 6 October 2011.

(d)  The previous rumors are discussed in Every day the new world emerges, yet we see it not.  Like today, as Europe begs China for loans, including what China will ask in exchange for doing this favor to Europe.

(4)  What about those lazy profligate Greeks?

To keep Americans dumb and happy, foreign news must be repackaged as simple morality plays.  As has been done with Greece’s problems.  In fact they result from stupidity of Greed borrowers and German/French lenders — both locked into a system which depresses Greece’s competitiveness vs. Germany.   For a look at the internal dynamics of Greece see The Myth of Greek Profligacy & the Faith Based Economics of the ‘Troika’, “Marshall Auerback and Rob Parenteau, Naked Capitalism, 24 October 2011 — Excerpt:

Rather, the heart of the problem is in the antiquated revenue system that supports that state, which results in a budget shortfall consistently about 10% of GDP. The top 20% of the income distribution in Greece pay virtually no taxes at all, the product of a corrupt bargain reached during the days of the junta between the military and Greece’s wealthiest plutocrats. No wonder there is a fiscal crisis!

So it’s not a problem of Greek profligates, or an overly generous welfare state, both of which suggest that the standard IMF style remedies being proposed here are bound to fail, as they are doing right now. In fact, given the non-stop austerity being imposed on Athens (which simply has the effect of deflating the economy further and thereby reducing the ability of the Greeks to hit the fiscal targets imposed on them), the Greeks really are getting close to the point where they may well default and shift the problem back to those imposing the austerity. This surely can’t be much worse than the slow execution they are facing today.

In reality, the Greeks have one of the lowest per capita incomes in Europe (€21,100), much lower than the Eurozone 12 (€27,600) or the German level (€29,400). Further, the Greek social safety nets might seem very generous by US standards but are truly modest compared to the rest of the Europe.

… Furthermore, if one looks at total social spending of select Eurozone countries as a per cent of GDP through 2005 (based on OECD statistics), Greece’s spending lagged behind that of all euro countries except for Ireland, and was below the OECD average. Note also that in spite of all the commentary on early retirement in Greece, its spending on old age programs was in line with the spending in Germany and France.

In fact, Greece has one of the most unequal distributions of income in Europe, and a very high level of poverty, as the following table shows  (source: OECD and Papadimitriou, Wray and Nersisyan).   The evidence is not consistent with the picture presented in the media of an overly generous welfare state.

… The country, however, is truly stuck:  they can’t devalue, they can’t pay their own way because they do not have a sovereign currency, and nobody will voluntarily finance them. So they must exit and devalue or drop their domestic prices. The massive default, though inevitable, is just a step along the way.

To make the problem worse, export earnings also seem to face their own structural cap that is consistently exceeded by import spending, which means that the debt that finances the government shortfall is increasingly held abroad. The debt is issued under Greek law, but now it is payable in Euros which Greece, as a user of euros, can’t create, given the surrender of its currency and consequent fiscal sovereignty. In this sense, ironically, the fiscal crisis is a consequence of Greece’s success, after a long preparation, in joining the European Union, and hence giving up its own currency, as Professor Perry Mehrling has noted.

The point is that, if this analysis of the source of the problem is correct, then standard IMF austerity policy is unlikely to do much to help. And, as the increasingly intensifying riots on the streets are vividly demonstrating, the patient might not willingly accept the medicine.  Despite attempts to turn the country into an economic colony of the EU, Greece is still, after all, a democracy and if one is to judge from the growing unrest in the country, it is far from clear whether Greece (or any other euro zone member for that matter) is really willing to cut spending and raise taxes rates to any degree which will satisfy the Fiscal Austerians dominating economic policy in the euro zone today without at the same time provoking an ungovernable failed state, right in the middle of the euro zone.

(5)  Updates:  For more information

(a)  “EMU summit leaves €1000 billion to be raised“, Gavyn Davies, Finanical Times, 27 October 2011 — Excerpt:

The deal does not, and was not intended to, have any effect on the core problems facing the eurozone. There is still an urgent need to restore growth to economies which are hamstrung by uncompetitive business sectors, and continuous fiscal tightening. Recession still looms, especially in the southern economies.  What the deal is intended to provide is adequate medium term financing for sovereigns and banks which have been facing urgent liquidity problems. On that, it is notable that the summit has not really raised any new money …

(b)  How the latest emergency euro summit addresses the sovereign debt crisis, Edward Harrison (economist), Credit Writedowns, 27 October 2011

(c)  “Eurozone Leaders Agree a Few Rescue Details, Like 50% Haircut on Greek Bonds; Plan to Develop a Plan Gooses Markets“, Yves Smith, Naked Capitalism, 27 October 2011 — “When failure is too painful to contemplate, any halting motion in something resembling the right direction will be hailed as success.”

(d)  “China could play key role in EU rescue“, Financial Times, 27 October 2011 — “China is very likely to contribute to the eurozone’s bail-out fund but the scope of its involvement will depend on European leaders satisfying some key conditions, two senior advisers to the Chinese government have told the FT.”   The price will be high!

(e)  “Half measures and wishful thinking do not a solution make“, Wolfgang Münchau, Financial Times, 27 October 2011 — “The day may yet come when the eurozone finally agrees a comprehensive package to end the crisis, but this was not the day.”

(6)  Other articles on the FM website about Europe’s crisis

1. The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
2. Can the European Monetary Union survive the next recession?, 11 July 2008
3. The periphery of Europe – a flashpoint to the global economy, 8 February 2010
4. A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
5. Governments cannot go bankrupt, 2 April 2010
6. Our government’s finances are broken. How do we compare with our peers?, 8 April 2010
7. The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
8. About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
9. Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
10. The Fate of Europe, nearing the point of decision, 13 September 2011
11. Europe drifts towards the brink of a cataclysm, 26 September 2011
12. Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
13. Every day the new world emerges, yet we see it not.  Like today, as Europe begs China for loans, 15 September 2011
14. Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
15. We see the outlines of the next cure for Europe.  Will it work?, 14 October 2011