Wednesday, January 06, 2010

Stark Raving Mad?

Not necessarily, but he is causing one hell of a fuss today. The Stark in question here is, of course, ECB Executive Board member Juergen Stark, who stated in an interview with the Italian Newspaper Il Sole 24 Ore that, in his opionion, the European Union would not help bail out Greece if the need were to arise. Certainly the initial reports of his statements sent shock waves round the globe. The euro dropped as much as 0.5 percent to $1.4282 after the remarks before laterrecouping its losses, and the yield on Greece’s 10-year government bond rose 4 basis points to 5.672 percent. Essentially it is hardly surprising that this should be the case, since following what happened in Dubai, two questions seem to have been in the forefront of investors' minds: i) who is going to pay for all that surplus second residence property that has been built all along Europe's periphery (from Ireland, to the Baltics, to Hungary, to Bulgaria, to Greece, to Sovenia, to Spain, and to Portugal); and ii) are the core European states really going to prop up the peripheral ones (in extremis) or will they follow the example of Abu Dhabi, and pick and chose what they will support and what they won't. More than anything else it is uncertainty on these two points which lies behind all the earth tremors currently shaking the monetary union.

In the interests of clarity, and before commenting further, I am reproducing the relevant extract in its entirely below, first in Italian, and then as a rough and ready English translation.

Il Sole 24 Ore: Il caso Grecia continua a tenere banco, nonostante le assicurazioni di Atene su una rapida riduzione del deficit. Non crede che un salvataggio debba considerarsi necessario o forse anche inevitabile?

Juergen Stark: La Grecia è in una situazione molto difficile: non solo il deficit è a livelli molto elevati, ma il paese ha anche sofferto una grave perdita di competitività. Questi problemi non sono legati alla crisi globale, ma sono stati creati in casa. E devono essere affrontati con le dovute misure economiche nell'interesse dei cittadini greci e nel rispetto delle responsabilità che il governo ha nei confronti della moneta unica e dei paesi partner. Le regole, ribadite in una dichiarazione dell'Ecofin a Cardiff nel 1998, sono chiare: la partecipazione all'Unione monetaria non consente alcun diritto a rivendicare sostegno finanziario da parte di uno Stato membro.

Il Sole 24 Ore: Ma appartenere all'Unione monetaria non significa anche solidarietà, oltre che responsabilità? Gli stessi Trattati permettono «un'assistenza finanziaria» nel caso di «gravi difficoltà» e in «circostanze eccezionali».

Juergen Stark: È vero, ma i Trattati dicono anche che queste circostanze devono «sfuggire al controllo» del paese in questione. Non è il nostro caso. Come ho appena detto, i problemi della Grecia sono prettamente greci, come ha ammesso lo stesso premier George Papandreou. In questi anni, il paese non ha tenuto sotto controllo i conti pubblici, né ha lavorato per migliorare la competitività. I Trattati prevedono la clausola di non salvataggio e le regole vanno rispettate. È un aspetto cruciale per garantire il futuro di un'Unione monetaria tra paesi sovrani con bilanci nazionali. I mercati si illudono quando pensano che a un certo punto gli altri Stati membri metteranno mano al portafoglio per salvare la Grecia.

Il Sole 24 Ore: The Greece situation continues to be a focus of attention, despite assurances from Athens on a rapid reduction in the deficit. Do you not believe that a rescue might be considered necessary or perhaps even inevitable?

Juergen Stark: Greece is a very difficult situation: not only is the deficit very high, but the country has also suffered a serious loss of competitiveness. These problems are not related to the global crisis, but were created in-house. And they must be addressed with appropriate economic measures in the interests of both Greek citizens, and with respect to the responsibilities that the Greek government has with both the euro and its EU partners. The rules, as set out in an Econfin statement in Cardiff in 1998, are clear: the monetary union does not allow any right of any Member State to claim financial support.

Il Sole 24 Ore: But doesn't belonging to a monetary union also imply solidarity, as well as responsibility? The very same treaties allow "financial assistance" in case of 'serious difficulties' and 'exceptional circumstances'.

Juergen Stark: True, but the treaties also say that these circumstancesmust be "out of control" of the country in question. Is not the present case. As I just said, the problems in Greece are purely Greek, as was admitted by the Prime Minister George Papandreou. In recent years, the country has not kept public accounts under control, nor has it worked to improve competitiveness. The treaties provide for a "no bail out clause" and these rules must be respected. This is crucial to ensure the future of a monetary union between sovereign countries with separate national budgets. The markets are deluded if they think that at some point the other States will put their hand in their wallets to save Greece

Well, a lot of points arise here. In the first place the ECB simply is not the competent authority to take decisions on whether or not to bail out a country. Decisions of this order would need to be taken by the EU Council (which essentially means the collectivity of individual States) and would involve financial intermediation in which the ECB may or may not participate. Secondly, Juergen Stark is an elected politician, and his view do NOT necessarily represent those of the present German government

As Laurent Bilke, economist with Nomura International says:

"ECB officials tend to consider themselves as the guardian of the temple of fiscal discipline, but Juergen Stark pushed maybe the argument a bit far this time. The ECB is just not in the business of bailing out countries. It is not competent to dispose (or not) of EU states, European Commission or IMF funds. Juergen Stark also sounded more alarmist than his fellow ECB colleagues have recently and this may not be very opportune in the current context. That is hitting where it hurts. The ECB President, in contrast, stressed that he was confident that the Greek government would do what is required, a more positive message."

But there is another detail which most of the press corps who jumped on the story seem to have missed, and that is that a bail out is not in question at the present time, and even if it was, EU institutions would find solutions to go round the problem, like a joint Eurobond issuance or some appropriate funding from the European Commission. Further, it is very important to note that Juergen Stark does not rule out common support in a country where the situation had gotten "out of control". This may, or may not, happen at some point with Greece, the only real reading you can put on Stark's statement is that we haven't gotten there yet. He could also be seen as giving a warning shot to the Greek authorities in the current situation - "sort the problems out yourselves".

Certainly Greek Finance Minister George Papaconstantinou seems to have got that part of the message, since he was very quick to jump in and point out that his government doesn’t need outside help to cut its budget deficit. “Frankly we don’t need that clarification,” Papaconstantinou told Bloomberg Television. “We don’t expect to be bailed out by anybody as, I think, is perfectly clear we’re doing what needs to be done to bring the deficit down and control the public debt.”

But doubts still remain, since while Papaconstantinou talks about correcting the budget deficit, everyone else is talking about deep structural reform and restoring competitiveness, and it isn't clear that the Greek government is single-handedly able to assume responsibility for this inside the country. As Jonathan Tepper of Variant Perception puts it:

The problems Greece faces are not problems the ECB can solve. Greece's problems are problems relating to competitiveness, real effective exchange rates, and fiscal budgets. The Greeks must address these structural problems themselves. If they were to seek outside help, the IMF would be the logical organization charged with helping countries in fiscal binds that are making structural adjustments. The ECB simply doesn't have the power or ability to do that. I'm afraid we'll likely see more internal civil unrest, as the necessary adjustments for Greece will be painful.

Mark Pittaway, Senior Lecturer in European Studies at the UK Open University goes even further, by adding a CEE dimension:

"If the zone does lock weaker economies into 'competitive disinflation' vis-a-vis an export-oriented Germany, why is it in the interests of 'peripheral countries' to say in the Eurozone at all? Why is it in the interests of CEE countries to attempt to join in the first place, since if Martin Woolf is right, it would mean Hungary and other states abandoning their long-term goal of having living standards like those in western Europe?"

"Given that political legitimacy in many European states is all about welfare, and 'European' legitimacy is about the alleged social superiority of a 'European model' over its Anglo-Saxon equivalents (whether this is actually true is irrelevant, the point is that many European believe it to be true), then the potential size of this crisis is quite big. And one thing is clear, that Brussels and others will have to do some fairly serious re-thinking if they want to go forward."

Basically, personally, I haven't that much to add at this stage to what I said yesterday, the big difficulty we have right now is making it clear who is authorised to do what, and then doing it.

Basically, what seems to be going on here is a huge poker-style game of brinksmanship, with none of the various parties (the Greek government, the EU Commission, the IMF, and the Credit Ratings Agencies - to name but a few - really absolutely clear about what the others are up to, or what they really want. You could even add-in more “stakeholders” (in terms of parties who will have to assume ownership of any final agreement) if you want, the French and German governments, for example, the EU Finance Ministers, the Greek Socialist Party, the Greek Trade Unions, the list, in fact, is well nigh endless.

This is really far from a desireable state of affairs for a team of people who collectively are going to have to try and solve one of the most complex problems to have emerged from the recent economic and financial crisis, and do it quickly, since there is a clock ticking away in the background. Evidently the Greek government should be having to negotiate with everyone else, but the others should have one common voice, and this is far from being the case, which is what leads to all the confusion, and is why Belka says the EU needs to put a mechanism in place to handle this kind of situation - a uniform mechanism which treats all EU members - whether inside or outside the Eurozone - fairly, and where the rules and procedures are clear to all. This mechanism, should, as I have suggested, include powers for the EU Commission to intervene over the heads of national parliaments (a need which is already evident in the Latvian case), and implement hard and unpopular solutions when they are in the interest of the entire community of Europeans. We cannot have one minority interest after another playing themselves off against the rest, it makes the Union harder to manage than a “hung” parliament.

Actually the FT's Ralph Atkins turns this amibguity into a virtue:
"Mr Stark’s comments fit with Europe’s policy of “constructive ambiguity” towards Athens - by which policymakers are deliberately being vague about what would actually happen if the worst came to pass. Pressure is thus being maintained on Greece to make good its pledges of fiscal discipline."

I am not convinced, I think all this ambiguity is more disconcerting than it is constructive, it isn't like keeping markets guessing before a rate-setting meeting. I think what everyone needs is some assurance that EU authorities are aware of the depth of the problem, have solutions ready, and are hell bent on implementing them. That is the message the financial markets need to hear, and they need to know who is going to be leading this operation.

Finally, I want to emphasise that my argument here shouldn't be read as saying that I don’t wish the EU was equipped to do the necessary and start to shoulder responsibility for Greece. My view is a more practical one: I simply think the EU is not yet sufficiently prepared to go in and tell Greece what to do, in part because Greece are one of the old EU15 and this makes everything more difficult. I simply think it is more practical to get the IMF go in and do the job. You don’t want “good boys” here, you need “nasty people”, with smoothly polished teeth, and indirectly this could give a weak Greek government the strength it needs to sell the changes to a reluctant citizenry.

It’s like taking a child to the dentist. Maybe they scream when the drill comes out, but ultimately they need the filling. But I also accept that the IMF has no magic bullet. I do however hope that the IMF is capable of learning from its recent experiences in the East.

One of the key issues which clinches it for me is the collateral rating issue. Do the ECB say no Greek bonds after the next downgrade (this certainly will cause some chaos, since half Greek bonds are held out of Greece)? It would be chaos, but it would be manageable. Or should the ECB keep the lower level criteria - then what happens to Italy, since this rule was made for Italy, and never forget, Italy is also slippin-and-a-slidin steadily into the default danger zone?

The thing is, my view is that the problem of not having the ECB take your bonds does become a serious one, since it will make it much more difficult to sell debt, interest rates rise, GDP falls, nominal GDP falls further, and debt to GDP keeps rising, as a result of which interest rates rise further, and eventually there is no alternative to default. On the other hand, if the ECB say don’t worry, we will take the bonds anyway, then there is little incentive to do anything, as we have seen over the last decade.

In essence, were the IMF managing a programme in Greece, then the ECB could make an exception, and then say to Italy - “you want to be an exception, then go to the IMF first, or better, put your house in order before you are forced to do so".

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