EUCOM Economic Analysis - Part I

[Surferbeetle]

Banks to be forced to boost liquid assets, by Brooke Masters, chief regulation correspondent, October 9, 2011 7:08 pm, Financial Times, www.ft.com

Global banking regulators will press ahead with the first worldwide effort to force banks to hold more liquid assets and cut back the industry’s reliance on short-term funding, despite complaints that the rule changes could damage the broader economy, the new chairman of the Basel Committee on Banking Supervision has warned.

“It is going to be all about implementation in as uniform a way as possible. Balkanisation of the rules over the long term is not in anyone’s interest,” Mr Ingves said.

The committee plans to publish “heat” maps that show which countries are in compliance. It will also send out teams of experts to look at whether each country’s implementation laws and regulations live up to the letter of the agreement.

Belgium Said to Get Approval to Buy Dexia Unit, By Francois de Beaupuy, Jacqueline Simmons and Fabio Benedetti - Oct 9, 2011 1:03 PM MT, Bloomberg News

Rescuing Dexia -- the first victim of the debt crisis at the core of Europe -- has become critical to preventing contagion in the region’s banking industry. Dexia’s balance sheet, with total assets of about 518 billion euros at the end of June, is about the size of the entire banking system in Greece and larger than the combined assets of financial institutions bailed out in Ireland in the last 2 1/2 years.

Fate of Eurozone bailout rests on Slovak politician Richard Sulik, October 07, 2011, By Henry Chu, Los Angeles Times

The Slovak parliament is scheduled to vote Tuesday on a plan to beef up Europe's bailout fund for financially strapped nations such as Greece. Most experts agree that broadening the fund's powers is a crucial, if limited, step in taming the debt crisis that has had financial markets somersaulting and fed worries about a double-dip recession.

Fifteen of the 17 nations that use the euro currency, including heavyweights Germany and France, have signed on to the plan, with Malta expected to approve it within days. But it requires approval by all the Eurozone countries, and a thumbs up from Slovakia, which will probably be the last to vote on the measure, is in grave doubt.

The torpid response has given ammunition to those in Brussels who yearn for a more federalist setup in which centralized institutions such as the European Parliament could make quick, binding decisions, instead of relying on getting each member state's government to sign off on policies.

Imagine the difficulties in the United States, critics say, if legislation affecting the entire country had to be approved by the government of every state, rather than by Congress.

BNP, Socgen deny reported plan to raise $9.4 billion, PARIS | Sun Oct 9, 2011 5:13pm EDT, Reuters

The Journal du Dimanche report, which did not cite sources, follows one in German daily Frankfurter Allgemeine Zeitung saying that the top five French banks had agreed to receive 10 to 15 billion euros in fresh capital from the French state as long as Deutsche Bank (DBKGn.DE) agreed to a government capital injection as well.

[Surferbeetle]

Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.

He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.

Schizophrenia about debt, October 9, 2011 4:10 pm by Gavyn Davies, Financial Times, www.ft.com

German Finance Minister Schauble has graphically described his own attitude to the debt crisis. “You cannot”, he says, “cure an alcoholic by giving him more alcohol.” Maybe not, but the alternative of cold turkey does not seem to be working all that well, either. Like it or not, the global economy needs a mixture of policies which write off debt in some cases, pay off debt in others, and extend debt in still others. A one-size-fits-all approach which encourages the simultaneous deleveraging of all sectors at maximum speed could cause a genuine economic calamity.

If the debt is transferred to the government balance sheet, these risks come in the form of higher rates of taxation in the long term. If transferred to the central bank balance sheet, they come in the form of higher inflation. All this is justified on the grounds that the alternative is worse, for everyone.

Not everyone agrees with this. In the 1920s, Friedrich von Hayek wrote that the rapid expunging of debt would rid the economic system of what he called “malinvestments”.

Most recently, these malinvestments have been made in finance and real estate. Allowing them to fail, Hayekians believe, will encourage a fresh start. (Robert Skidelsky, Keynes’ biographer, discusses the Hayekian view in an excellent piece in the New Statesman this week.) Those who believe in Schumpeter’s notion of “creative destruction” may be tempted down the same path.

James Grant’s latest “Interest Rate Observer” contains an interesting account of what happened the last time a policy of outright cold turkey was tried in the US, which was in the depression of 1920-21. In the face of a deep slump, credit growth was stopped in its tracks. The Fed, under Benjamin Strong, raised interest rates and the Treasury, under Democrat Carter Glass, ran budget surpluses. “The Treasury has no money to lend. It is not in the banking business, and should not be”, said Secretary Glass. Deflation was treated as inevitable. “No-one could have stopped it…in our opinion, it was bound to come” said Chairman Strong.

The unemployed, deliberately it seems, were left to fend for themselves, even when the jobless rate increased eight-fold to over 12 per cent in 1920. Policy did not change. The public books were balanced, and the Fed even repelled an influx of gold which might have ended the downturn quicker. So did cold turkey work?

James Grant says it did. The recession was over by 1922, and unemployment was back down to 2.4 per cent by 1923. But in the meantime, real GDP fell by over 8 per cent, industrial production was down by 23 per cent, and consumer prices fell by 22 per cent.

That, says Grant, is better than a policy of endless stagnation. But surely we can find a better way.

Creative destruction, From Wikipedia, the free encyclopedia

Creative destruction is a term originally derived from Marxist economic theory which refers to the linked processes of the accumulation and annihilation of wealth under capitalism. These processes were first described in The Communist Manifesto (Marx and Engels, 1848)[1] and were expanded in Marx's Grundrisse (1857)[2] and "Volume IV" (1863) of Das Kapital.[3] At its most basic, "creative destruction" (German: schöpferische Zerstörung) describes the way in which capitalist economic development arises out of the destruction of some prior economic order, and this is largely the sense implied by the German Marxist sociologist Werner Sombart who has been credited[4] with the first use of these terms in his work Krieg und Kapitalismus ("War and Capitalism", 1913).[5] In the earlier work of Marx, however, the idea of creative destruction or annihilation (German: Vernichtung) implies not only that capitalism destroys and reconfigures previous economic orders, but also that it must ceaselessly devalue existing wealth (whether through war, dereliction, or regular and periodic economic crises) in order to clear the ground for the creation of new wealth.[1][2][3]

From the 1950s onwards, the term "creative destruction" has become more readily identified with the Austrian-American economist Joseph Schumpeter,[4] who adapted and popularized it as a theory of economic innovation and progress. The term, as used by Schumpeter, bears little resemblance with how it was used by Marx. As such, the term gained popularity within neoliberal or free-market economics as a description of processes such as downsizing in order to increase the efficiency and dynamism of a company. The original Marxist usage has, however, been maintained in the work of influential social scientists such as David Harvey,[6] Marshall Berman,[7] and Manuel Castells.[8]

[Surferbeetle]

Financial contagion has continued it’s visible advance into the core of the 17 member Eurozone. On 19, September 2011 the S & P downgraded the Republic Italy’s credit rating to A/Negative/A-1 citing concerns regarding economic and political weakness. (1) (2) Since this report the Kingdom of Spain’s banking industry rating, has been downgraded to Group 4 (Group 1 is the strongest and group 10 the weakest). (3) Spain's resultant banking peer group includes the Czech Republic, Israel, Korea, Mexico, and the Slovak Republic. Both the Republic of France (AAA/AAA/AAA) and the Federal Republic of Germany (AAA/AAA/AAA) currently maintain their sovereign credit ratings (Local Currency Rating, Foreign Currency Rating, Transfer and Convertability Assessment), however the viability of France’s credit rating is being questioned in some financial quarters. (4) (5) (6) In the context of the third quarter of 2011, Standard and Poors has downgraded 119 credit issuers who have floated $3.1 trillion USD in debt. (7) Although history seems to suggest that select sovereign’s consider war as a viable way to solve economic problems, it is of interest to note that the G-20 can be viewed as actively seeking a political and economic solution (which may include focused action with respect to as many as 50 systemically important banks). (8)(9) Nonetheless, with respect to actual concrete solutions, skeptics and transnational institutions do not yet appear to be convinced. (10) (11)

(1) Republic of Italy, September 19, 2011, Global Credit Portal, Standard and Poors, http://img.en25.com/Web/StandardandP...licofItaly.pdf

(2) Italy’s Rating Cut One Level by S&P as Greek Crisis Fans Contagion Concern, By Jeffrey Donovan - Sep 20, 2011 8:58 AM MT, Bloomberg News, http://www.bloomberg.com/news/2011-0...bt-mounts.html

(3) Spain Banking Industry Country Risk Assessment Revised To Group 4 From Group 3 On Heightened Economic Risk, 13 October, 2011, Standard and Poors, www.standardandpoors.com

(4) Sovereigns Ratings List, Standard and Poors, www.standardandpoors.com

(5) U.S. Money Funds Reduced Lending to French Banks by 44% in September, By Radi Khasawneh - Oct 13, 2011 5:01 PM MT, Bloomberg News, http://www.bloomberg.com/news/2011-1...ast-month.html

(6) Governments and banks locked in fatal embrace, October 11, 2011, by John Plender, Financial Times, www.ft.com

(7) Credit Trends: Downgrades Outpaced Upgrades in The Third Quarter in the US., Europe, Emerging Markets, and The Other Developed Regions, 13 October, 2011, Standard and Poors, www.standardandpoors.com

(8) Mearsheimer, John J., The Tragedy of Great Power Politics, 2001, W.W. Nortin Inc, New York, New York

(9) Europe Crisis Plan Wins Global Backing, By Simon Kennedy and Cheyenne Hopkins - Oct 15, 2011 4:00 PM MT, Bloomberg News, http://www.bloomberg.com/news/2011-1...23-summit.html

(10) Why Europe’s officials lose sight of the big picture, by Wolfgang Munchau, October 16, 2011, Financial Times, www.ft.com

(11) Global Financial Stability Report, Grappling with Crisis Legacies, September 21, 2011, International Monetary Fund, http://www.imf.org/External/Pubs/FT/...1/02/index.htm

[Surferbeetle]

Two viewpoints...

Germany will never leave the eurozone, by Dr. Ian Bremmer, 18 October 2011, A-List, Financial Times, www.ft.com

Germany accounts for little more than one per cent of the world’s population – and nearly nine per cent of its exports. A common currency ties its strength to the eurozone’s relative weakness. The shared euro is significantly weaker than the standalone German currency would be. This subsidises German exports, making them more affordable internationally.

Without Germany, the European Union would disintegrate. When the dust settles, the country would end up with less friendly neighbours from an economic and from a security perspective. In the near term, unpredictable global contagion and crisis aside, we’d see a flight to German bonds, putting immense pressure on the real exchange rate and crippling exports and competitiveness. The bottom line: people would buy Bunds instead of Benzs. A new D-Mark would follow the trajectory of the Swiss franc’s recent rise, only to a greater order of magnitude.

While the liberal Free Democratic Party has complicated Germany’s pro-euro strategy, its outlier stance matches its dwindling support (it won 15 per cent of the vote in 2009 – now it often polls below the 5 per cent required to enter parliament). Overall, the constellation of German political parties supports deeper integration to solve the debt crisis. Politicians are overwhelmingly pro-euro and pro-eurozone, even if they will drag their feet before putting Germany’s money where its mouth is. Business leaders also advocate more euro integration.

September 2011 Policy & Markets Note, by Dr. Pippa Malmgren, http://www.pippamalmgren.com/77.html

The markets are focused on the imminent default by Greece. But, this is not the most important issue now. The historic development the markets have not priced in as that Germany is preparing to exit the Euro. The markets are very likely to have to contend with the re-introduction of Deutsche Marks in the near future. This is bound to mean a collapse in the value of the Euro for those countries that will remain in it (devaluation for the rest of Europe). This step may seem unthinkable but, I believe that the German government is telling us in multiple ways that there is no other solution from their point of view. It is also why you will hear various policymakers at the G7 meeting his weekend echo Christine Lagard’s comment that the world economy is entering a "dangerous new phase."[i] This was certainly the atmosphere at Jackson Hole where policymakers openly talked about entering a period of history where we would face challenges beyond the scope of anything we have seen in our careers.

Christine Lagarde’s speech at Jackson Hole revealed the recognition that there was a risk that Germany might not “write a check” to bailout the Eurozone members. She said, to paraphrase, “somebody needs to write a check or we are going to have historic multiple bank failures.” Everyone in the audience understood that no check is coming. The ESFS is not yet funded and a number of the contributors will not hand over cash if there is no collateral. Of course, the only collateral available is the insufficient gold reserve, or handing over ownership of the nations industrial assets[iv], which amounts to having a nationalization of industry, which is then put under the control of a foreign government. So, there really is no meaningful collateral. Also, there is no international party, including China, that can write a check large enough to fill the cumulative debt hole that exists across the various Eurozone countries.

Past as prologue? German reunification

[Fuchs]

I may be slightly confused in regard tot he detail of macroeconomics at times (I studied it a decade ago, details got lost) - but the basic premise of the first quote seems to be wrong.

Net exports equal net capital export. A capital flight to Germany would equal a net capital import of Germany. So either he asserts that Germany would get a trade balance deficit with the DM (unlikely; it's more like a halved surplus - similar to the yr 2000 situation) or he's inconsistent.

My 50 Euro cents are on the latter.


Besides, a stronger economy also means considerable advantages - not only disadvantages. Imports (such as oil, gas and microelectronics) would become cheaper and Germans could make even more vacations in foreign countries.
We have IIRC even a law (since the 60's) that in theory demands a policy towards a balanced trade. It's been ignored (Germany nurtures the myth that a budget surplus is a great thing) and is being considered to be obsolete from an economic science point of view. No parliament is going to cancel a law that's named "stability law", though...



Surferbeetle; I strongly recommend a look at the optimal currency area theories in detail (there are about 7 iirc). They're the key to looking beyond the superficialities of politics in regard to the Euro crisis. The great experiment has settled the late 1990's debates about those theories and the conclusions are now quite inescapable unless you insist on looking the other way (as many politicians do).

[Fuchs]

Slightly related to topic:
A google translate version of a FAZ.net (one of the big German national newspapers) article.

How to save us Knax foxes made - Finance - FAZ.pdf

It gives a good idea of the German opposite of the U.S. credit card and "consumption drives the economy" culture.

[Surferbeetle]

If one is living abroad and being paid in a currency that is stronger than the local currency, after paying ones local expenses in local currency, one can save more. Similarly, if one manufactures a competitive item for a cost effective price, in local currency, and sells it in a stronger currency a greater profit is possible.

Let's run the numbers for these two cases:

Case 1

• Monthly living expenses in Deutsche Marks (DM prior to 1 Jan '99) = 2,000

• Exchange rate: 2 DM to 1 USD

• Resultant monthly living expenses in USD = 1,000

• Exchange rate: 1 DM to 1 USD

• Resultant monthly living expenses in USD = 2,000

Case 2

• Production cost in Deutsche Marks (DM prior to 1 Jan '99) for a hypothetical product = 1,000 DM = manufacturing cost + labor cost + overhead cost + profit cost

• Typical product pricing in USD, for hypothetical product = 1,000

• Exchange rate: 2 DM to 1 USD

• Production Cost in USD = 500 USD. Potential additional profit per item, 500 USD

• Exchange rate: 1 DM to 1 USD

• Production Cost in USD = 1,000 USD. Potential additional profit per item, 0 USD

In a real world example of the effects of currency fluctuations from this year, recall that the Swiss Franc was acting as a 'haven currency' due to the low political and economic risk associated with Switzerland.

Due to the resulting currency appreciation, Swiss manufacturers were having difficulties selling their products globally, for a profit. On 6 September 2011 the Swiss National Bank pegged the Swiss Franc to the Euro at 1.2 Swiss Francs to the Euro. This means that the SNB may be printing money in order to devalue the Franc to maintain this peg.

The Economist ran an informative article regarding the effects of currency interventions entitled How to Stop a Currency War on 14 Oct, 2010