Europe's rescue euphoria threatened as Portugal enters 'Grecian vortex'

Monetary contraction in Portugal has intensified at an alarming pace and is mimicking the pattern seen in Greece before its economy spiralled out of control, raising concerns that the EU summit deal may soon washed over by fast-moving events.

Data released by the European Central Bank show that real M1 deposits in Portugal have fallen at an annualised rate of 21pc over the past six months, buckling violently in September.

"Portugal appears to have entered a Grecian vortex and monetary trends have deteriorated sharply in Spain, with a decline of 8.4pc," said Simon Ward, from Henderson Global Investors. Mr Ward said the ECB must cut interest rates "immediately" and launch a full-scale blitz of quantitative easing of up to 10pc of eurozone GDP.

The M1 data - cash and current accounts - is watched by experts as a leading indicator for the economy six months to a year ahead. It has been an accurate warning signal for each stage of the crisis since 2007.

A mix of fiscal austerity and monetary tightening by the ECB earlier this year appear to have tipped the Iberian region into a downward slide. "The trends are less awful in Ireland and Italy, suggesting that both are rescuable if the ECB acts aggressively," said Mr Ward.

A shrinking money supply is dangerous for countries with a high debt stock. Portugal’s public and private debt will reach 360pc of GDP by next year, far higher than in Greece.
The EU deal was not designed to deal with such a threat. The working assumption is that Greece alone is the essential problem, and that other troubles are under control or caused by jittery markets.
Officials hope that debt relief through private sector haircuts of 50pc will be enough for Greece claw its way back to viability, and that spillover effects can be contained by bank recapitalizations, raising core Tier 1 ratios to 9pc with €106bn of fresh capital.

boost in the €440bn bail-out fund (EFSF) to €1 trillion or more - by opaque means - will supposedly create a "firewall" to rebuild market confidence and stop contagion to the rest of Club Med.

This rescue machinery may prove to be a Maginot Line if -- as many economists think -- the danger comes from within Portugal, Spain, and Italy. Like Greece, these countries have lost 30pc in labour competitiveness against Germany since the mid-1990s. That is the root of the EMU crisis. A toxic mix of fiscal tightening, higher debt costs, and now the threat of a eurozone recession risks tipping them over the edge.

The hairshirt summit ignored this dimension of the crisis. Italy was ordered to cut further, balancing its budget by 2013. The mantra was "rigorous surveillance" of budgets and "discipline". There will be laws to enforce "balanced budgets", and EU officials will have extra powers to vet economic policy.

This marks a step-change in the level of EU intrusion. Greece will be subject to a "monitoring capacity on the ground", implying a vice-regal EU presence calling the shots in Athens.

German Chancellor Angela Merkel said the goal is to create a "stability union", not a fiscal union. There will be no joint bond issuance, no shared budgets, no debt pooling, and fiscal transfers. The elevation of EU commissioner Olli Rehn to post of economic tsar does not change this.
Germany has dictated the agenda, vetoing calls to mobilize the ECB’s full firepower to halt the crisis. The Bundestag even ordered Mrs Merkel to insist on ECB withdrawal from existing bond purchases.
Jean-Luc Mélenchon, leader of the French leftist Front, said Europe is now marching to Germany’s drum and "headed for disaster", a view gaining ground across Europe’s Left.
Albert Edwards from Société Générale said the ECB will have to act, over a German veto if necessary. "The increasingly frenzied attempts of eurozone governments to persuade financial markets that they can draw a line under this crisis will ultimately fail."
"The impending threat of a euro break-up will force the ECB to begin printing money, very reluctantly joining the global QE party. The question is whether Germany will leave the eurozone in the face of such monetary debauchery," he said.
Whether the EFSF alone is up to the job of containing the euro crisis may depend on how it is constructed. The apparent plan for "first loss" insurance on bonds concentrates risk, endangering the AAA rating of France and other creditor states that anchor the fund. "It is too complex and potentially dangerous," said RBS.
Japanese investors who bought the first EFSF bonds this year under entirely different assumptions are facing big losses as the instrument loses market credibility. They are angry that the fund has metamorphosed into a high-risk monoline insurer. The fund will in any case cover only new issues of debt. This instantly degrades old debt. There will be abritrage between insured and non-insured countries. Market forces are being profoundly distorted.
China may participate in a special purpose fund to buttress the EFSF, but only as a quid pro quo for industrial and trade concessions. French Green leader Daniel Cohn-Bendit said Europe was making a "dangerous mistake" by going cap in hand to Beijing.
RBS said market euphoria is unlikely to last long. The precedent of de facto default in Greece - which the EU authorities once promised to prevent - will cause investors to "reprice" the sovereign debt of all vulnerable states. "The summit solves one problem by creating another. We expect the market to deteriorate and see the ECB as the only backstop," said the bank.
Europe’s leaders are betting that a reduction of red tape and a radical shake-up of the labour markets will unleash growth in Greece, Portugal, Italy and Spain, a decade hence. In the meantime, the governments of these near helpless countries must soldier on with perma-slump, and riot gear, and pray for a miracle.

Does Redistributing Income Reduce Poverty?


NEW YORK – Many on the left are suspicious of the idea that economic growth helps to reduce poverty in developing countries. They argue that growth-oriented policies seek to increase gross national product, not to ameliorate poverty, and that redistribution is the key to poverty reduction. These assertions, however, are not borne out by the evidence.

Since the 1950’s, developmental economists have understood that growth in GNP is not synonymous with increased welfare. But, even prior to independence, India’s leaders saw growth as essential for reducing poverty and increasing social welfare. In economic terms, growth was an instrument, not a target – the means by which the true targets, like poverty reduction and the social advancement of the masses, would be achieved.

A quarter-century ago, I pointed out the two distinct ways in which economic growth would have this effect. First, growth would pull the poor into gainful employment, thereby helping to lift them out of poverty. Higher incomes would enable them to increase their personal spending on education and health (as seems to have been happening in India during its recent period of accelerated growth).

Second, growth increases state revenues, which means that the government can potentially spend more on health and education for the poor. Of course, a country does not necessarily spend more on such items simply because it has increased revenue, and, even if it does, the programs it chooses to fund may not be effective.

In almost willful ignorance of the fact that the growth-centered model has proved itself time and again, skeptics advocate an alternativeredistributivedevelopmental model, which they believe will have a greater impact on reducing poverty. Critics of the growth model argue that it is imperative to redistribute income and wealth as soon as possible. They claim that the Indian state of Kerala and the country of Bangladesh are examples where redistribution, rather than growth, has led to better outcomes for the poor than in the rest of India.

Yet, as Columbia University economist Arvind Panagariya’s recent work shows, Kerala’s social statistics were better than those in the rest of the country even before it instituted its current redistributive model. Moreover, Kerala has profited immensely from remittances sent home by its émigré workers in the Middle East, a factor unrelated to its redistributive policy. As for Bangladesh, the United Nations’ Human Development Index, admittedly a problematic source, ranks it below India.

In impoverished countries where the poor exceed the rich by a huge margin, redistribution would increase the consumption of the poor only minimally – by, say, a chapati a day – and the increase would not be sustainable in a context of low income and high population growth. In short, for most developing countries, growth is the principal strategy for inclusive developmentthat is, development that consciously includes the marginal and poorest members of a society.

But the political sustainability of the growth-first model requires both symbolic and material efforts. While growth does benefit the poor, the rich often benefit disproportionately. So, to keep the poor committed to the system as their economic aspirations are aroused, the wealthy would be well advised to indulge less in conspicuous consumption.

At the same time – and more importantly – the poor need greater access to education in order to increase their economic opportunities and social mobility. Less excess and more access
must become the principle that guides development policy.
Jagdish Bhagwati is University Professor of Economics and Law at Columbia University and Senior Fellow in International Economics at the Council on Foreign Relations. Co-Chair with President Tarja Halonen of Finland of the UNCTAD Eminent Persons Group on Developing Countries in the World Economy.


The World from Berlin

Brussels Decisions 'Will Exacerbate the Crisis'

Greek debt was slashed on Thursday morning in Brussels. But is the crisis over?
Greek debt was slashed on Thursday morning in Brussels. But is the crisis over?
The list of measures passed in Brussels on Thursday morning is impressive, with the 50 percent debt haircut for Greece topping the list. But given ongoing concerns over Italian debt, will it be enough? German commentators on Friday are skeptical.
The markets seem convinced. Stock market indexes around the world shot up on Thursday in the wake of the European Union deal to slash Greek debt by 50 percent and boost the euro backstop fund to €1 trillion. And the rally has continued on Friday, with banks leading the charge.

The euro-zone, it would seem, has managed to convince investors that it might be on the path to solving the common currency area's debt problems after all. In addition to the Greek debt haircut, the 17 euro-zone members also agreed on a requirement that European banks increase their core capital ratios to 9 percent, a move that will, it is hoped, help buffer them against the hefty write downs of Greek debt that some will have to swallow.

In addition, the EFSF is to be boosted, transforming the fund with a current lending capacity of €440 billion into one with firepower worth €1 trillion. At that size, it is hoped, investors will no longer be overly concerned about investing in euro-zone sovereign bonds, particularly those from larger area economies like Italy and Spain.
Still, despite the apparent investor euphoria over the deal, there are, for the moment, precious few details about how exactly the new EFSF fund will work. There are two competing models -- one involving an insurance scheme guaranteeing a portion of investments in euro-zone sovereign bonds against loss and another envisioning the creation of an investment fund to attract money from outside the euro zone. But euro-zone leaders won't be making a final decision until November.

'Several Additional Steps'
"The complete lack of details out of the European summit doesn't give investors a great sense of comfort," Fredrik Nerbrand, global head of asset allocation for HSBC, told Reuters.
Likewise disturbing, despite efforts by Chancellor Angela Merkel and French President Nicolas Sarkozy to force Italy to commit to a significant austerity program, markets aren't convinced. Italian Prime Minister Silvio Berlusconi did arrive at the summit with a letter of intent outlining a list of structural reforms he intended to pursue -- including, notably, an increase to the age of retirement in the country -- in an effort to reduce his country's sovereign debt from its current level of almost 120 percent of gross domestic product.
But his key coalition partner, the Northern League, has indicated its opposition to such a measure and Italy's largest union has also vowed to fight stringent austerity. Indeed, while interest rates on Italian bonds initially dropped to 5.7 percent following the end of the euro-zone summit on Thursday morning, they quickly climbed again. Late on Thursday, the interest rate stood at 5.9 percent, near the level which prompted the European Central Bank to step in and begin buying Italian bonds in August.

German Chancellor Angela Merkel acknowledged on Friday that the euro-zone still hadn't put the debt crisis behind it. In comments to the press in Berlin, she said that further measures will be needed to unify European fiscal policy. "I think that we will have to take several additional steps," she said.

German commentators on Friday focus on the deal reached on Thursday morning in Brussels.
The center-right daily Frankfurter Allgemeine Zeitung writes:

"Whoever believes that the crisis has now passed its zenith is terribly mistaken. ... It is unlikely that the 'firewall' against market volatility that European leaders had hoped for has now been put in place. It is, of course, encouraging that Italian Prime Minister Silvio Berlusconi was forced to present the outlines of a reform plan. But his letter of intent speaks of the distant future. It is unlikely that risk premiums on Italian bonds will begin to sink. Against this background, it could be that portions of the Brussels compromise pushed through by Chancellor Merkel could have a short half-life. Europe is no longer speaking of allowing the European Central Bank to continue with 'unconventional measures' -- meaning the purchase of sovereign bonds. The idea of granting the EFSF a banking license has also been discarded for now. But as soon as the need arises once again, that will change quickly. And nobody will presume to claim that the new agreements will result in a lasting resolution to the crisis. On the contrary. The question is, rather, when the next crisis summit will take place."
The left-leaning daily Die Tageszeitung writes:
"Above all, €1 trillion simply won't cut it, because not even €2 trillion would be enough. The crisis now has a life of its own and has eaten its way into the heart of the euro zone. A real inability of Europe's debt-laden countries to pay back the money they owe would mean mass panic among financial investors. Meanwhile, Italy and even France are seen as potential candidates for insolvency, which is absurd. The countries possess two of the world's strongest economies."
"The euro crisis will only be over when the euro has become a normal currency like the yen, the dollar or the pound. This includes a European Central Bank able to buy up government bonds, much like the Bank of England routinely does."
"Such a solution remains distant, however. Chancellor Merkel continues to rely on state-level solutions like the so-called 'debt brake.' Each country is to tighten its purse strings in order to calm the financial markets. No one even talks about the alternative: that rich people could pay more taxes. The prescribed cuts will deepen the recession, which in turn produces deficits and sends investors into a whole new cycle of panic. The decisions from Brussels weren't harmless -- they will exacerbate the crisis rather than solve it."
The Financial Times Deutschland writes:
"Just weeks and days ago, many thought it was all unattainable. European leaders, meeting late into the night, deserve praise for making it happen."
"But that doesn't mean that there aren't major doubts about the latest summit decisions: Would the markets still be reacting with such euphoria if the technical details of the 'voluntary' debt haircut were understood? How much in risk premiums will investors demand for government bonds that are only partially guaranteed by the EFSF? And then there is still Greece, this country without a business model, which is expected to reduce its debts down to 120 percent of its gross domestic product by 2020. It remains questionable as to whether this still enormous mountain of debt will be more manageable for the country (or more acceptable for the capital markets). But without stronger growth -- probably also fueled by EU aid -- this goal remains fiction."
The conservative daily Die Welt writes:
"The Italian problem did not go away. The country could come under even greater pressure in the coming weeks and the reform paper quickly assembled by the weak head of government Silvio Berlusconi is not likely to convince market participants. As a result, capital market pressure to finally outfit the euro backstop fund with endless guarantees and no ceiling will only continue to intensify. Merkel has to fight against that pressure. But the chancellor is increasingly pinned between her responsibility to the German taxpayer and her historic responsibility for Europe's crisis-ridden countries. It is an incredibly difficult -- and potentially crushing -- position to be in. So far, however, Merkel has managed well."
"But what does the euro crisis now mean for Europe? It will change the union down to its very foundation. Relations among the member states are likely to become more difficult and battles over resources more intense. The history of Europe has thus far been marked by permanent expansion and increased integration. Despite occasional friction, it has been a success story. Now, however, it threatens to drift apart and may even face an internal split. The task of those with political responsibility is to limit these destructive forces.... In a sentence, it is no longer about saving the euro, rather it is also about saving the European community as a whole."

The business daily Handelsblatt writes:
"Winston Churchill uttered the words: 'The Americans will always do the right thing… after they've exhausted all the alternatives.' One can say the same thing about Europeans today. After they have spent more than a year tinkering with all of the problems of the debt crisis, always presenting half-hearted measures to buy more time, now they are finally adjusting the right screws, in order to at least get the acute crisis under control. Better late than never. At least that's how the markets reacted yesterday. The summit fulfilled their narrow expectations, causing enough relief for a rally...."
"The fact that banks absolved Greece of half its debts is without a doubt the most important result of the summit. One could complain that it releases Greece from accountability for its catastrophic financial policies. But without this debt relief, Greece would have had no chance of getting back on its feet."
"Berlin is especially proud of the fact that the European Central Bank (ECB) is to be left out of the rescue of the highly indebted nations. This promise will be difficult to keep, at least in the short-term. As long as the EFSF is not yet fully functioning with sufficient 'firepower' at its command, the ECB will still have to jump in as the 'lender of the last resort.' Designated ECB President Mario Draghi knows that, and therefore deliberately left the door open to further buying up of government bonds."
The center-left Süddeutsche Zeitung writes:

"European leaders were able to restore confidence in the EU. Europe lives, and it is strong enough to handle its problems. Nevertheless, it is a fundamentally changed Europe that the world will now have to deal with. The power structure in the EU has permanently shifted. France, which for a long time dominated European integration, has been pushed back into second position behind Germany. The tempo and methods of the crisis management have been, and will continue to be, determined by Berlin. Because the French have not modernized their economy and their social system, they themselves are under distress. A France, though, that has to fear for its international creditworthiness, is left with no alternative but to follow the course of those with the economic power and financial potential to pull the euro out of the danger zone."

"Germany has, for understandable reasons, always sought to avoid playing a solitary leadership role in the EU. But ... because there is no other country that can take it over, Germany must do so. It would be to the EU's advantage if Berlin cleverly and confidently assumed this role -- but in doing so, the German government must resist the temptation to confuse German and European interests."
"Angela Merkel has proven how that can work by successfully persisting against massive resistance and showing that changing EU treaties should not be taboo, if lessons are to be drawn from the crisis. Because overcoming the current crisis is important, but essential to the [euro's] survival is that it not fall back into old inefficiencies. The best remedy against that is a new reform debate."
-- Charles Hawley


OCTOBER 28, 2011, 11:54 A.M. ET

Global Trade Faces a Financing Crunch


If trade is the engine of the global economy, then trade finance is the oil that keeps the engine running smoothly. But this $10 trillion to $12 trillion business, which underpins world trade by providing exporters and importers products like letters of credit, loans and guarantees, is under pressure, a victim of both the European banking crisis and the global regulatory reform effort. At a time when the global economy is already slowing, that's worrying.

The situation isn't yet as bad as it was during the U.S. subprime crisis, when world trade fell 19% in the 12 months to May 2009; about 10%-15% of that slump was attributable to a drop in the availability of trade finance, the World Trade Organization estimates. But prices have been rising since the summer and could reach post-financial crisis levels in the coming weeks, according to the International Chamber of Commerce. That is especially bad news for small and midsize exporters that rely on the cash flow insurance trade finance provides. Estimates of the cost of trade finance as a proportion of doing business are hard to find, but margins above risk-free rates on letters of credit issued in developing countries rose nearly 30-fold in 2008-2009, the WTO estimates.

The current problem lies with European banks, traditionally important players in trade finance, which support an estimated 80% to 90% of trade. But they are struggling to obtain the dollar funding they need, given that around 75% of world trade is greenback-denominated. Some, notably BNP Paribas and Societe Generale, are also reducing their trade lending as part of their broader de-leveraging. Overall trade finance lending is down 6% year-on-year, according to Dealogic figures. As a result, prices are rising.

That should create opportunities for other banks to increase market share. Instead, the supply of funding risks being further curtailed by the new Basel III capital rules. Despite the low-risk nature of the businessonly 3,000 out of 11.4 million trade finance transactions worth more than $5 trillion defaulted between 2005 and 2010, according to the International Chamber of Commerce—it is likely to be hit by higher risk weights and new bank leverage ratios. That could encourage banks to switch to more profitable lines, pushing up prices even higher.

True, the industry has wrung some concessions from the Basel Committee this week, which agreed to cut the risk weights for short-dated trade finance deals and those with low-income countries. But higher risk weights remain for other trade deals. Meanwhile, the committee has refused to budge on exempting trade finance from the leverage ratio: Since it is a low-margin, high-volume, balance sheet-intensive business, those banks subject to a leverage ratio are less likely to participate, one reason why the industry is dominated by European banks.

Regulators are right to argue that if they start watering down the rules for one line of business, it could open a can of worms. Besides, the industry has provided little precise detail on what extra costs Basel III will impose. But one thing is certain: The cost of doing trade internationally is set to riseanother unwelcome headwind for the global economy.

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