December 11, 2011 7:41 pm

Snags, diversions – and the crisis goes on

By Wolfgang Münchau

The European Union last week destroyed the illusion that the eurozone and the UK could happily coexist inside the EU. That may have made it a historic summit. But the decision to set up a fiscal union outside the European treaties will do nothing whatsoever to resolve the eurozone crisis.

There are different notions of a fiscal unionsome more integrated, some less so, some obsessed with fiscal discipline, others with a joint bond. But whichever your preference, this is not something you would wish to do outside European treaties. The existing treaties form the legal basis for all policy co-ordination of monetary union. It gets very messy when you try to circumvent them.


Changing a treaty is a big deal and I understand why there is not much appetite. Everybody still remembers the failed constitutional treaty of the last decade.


What is now known as the Lisbon treaty took almost 10 years from inception to ratification. A new treaty requires every member’s consent, a convention, an intergovernmental conference, a final agreement by the European Council and the European parliament, and then ratification by each country, some by referendum.

Germany understood perfectly well that its proposals would require a full-blown treaty change. The involvement of the European Court of Justice as an enforcer of fiscal rules cannot be achieved otherwise. I disagree with the content of the German proposals and the one-sided fixation on fiscal discipline. But I agree with the legal judgment: if you want a fiscal union, nothing less than a full treaty change will do. If the EU had accepted the idea, a treaty convention might have produced a much more balanced fiscal union that the one Germany and France now want to create in a fast-track separate treaty.

Now David Cameron has blocked the option of changing the European treaties, the Brussels machinery is working hard at finding a legal way of making a separate treaty among eurozone members possible. One candidate is a procedure calledenhanced co-operation”.

Introduced in the 1990s and later amended, it is intended to give a group of at least nine member states the right to go it alone. But this is more a treaty-within-a-treaty procedure. It has been invoked only for the single European patent and, fittingly, for a common divorce law. One might wonder, therefore, whether it is possible to use enhanced co-operation as a legal basis to create a fiscal union. Could it even be used as a portal into the outer space of another treaty that interacts with the existing one?

I think this is very unlikely. For a start, the procedure requires unanimity. So if Mr Cameron blocked a treaty revision because he does not want a strong fiscal union that discriminates against the City of London, he surely would not accept a fiscal union set up by enhanced co-ordination either.

Furthermore, the procedure is not intended to change current treaty provisions. It is meant for member states to co-operate on areas not yet covered by the treaty.

Another possible legal basis is Article 136, under which the eurozone member states are allowed to “strengthen the co-ordination and surveillance of their budgetary discipline” and to “set out economic policy guidelines for them”. This is the legal basis for eurozone members to co-ordinate tax policies, improve the functioning of labour markets or send a joint representative to the International Monetary Fund. But Article 136 is not intended as a wormhole to outer space either.

A fiscal union set up outside the European treaty would face severe legal and practical limitations. Unless a trick is found, it cannot make recourse to the resources and institutions of the EU. Nor can it issue eurozone bonds. The only conceivable counterparty for a eurozone bond is the EU itself.

More important even, a fiscal union created through a legal trapdoor would not help solve the crisis.

The eurozone is facing a generalised loss of confidence. Investors no longer trust its crisis management, the solidarity of its citizens, even the ability to conduct sensible economic policies. The EU is not going to restore confidence through legal gimmickry that will face numerous court challenges.

Leaders should have admitted on Friday that the summit had simply failed, or perhaps have given it a few more days. Negotiations might have produced a compromise. With the fake pretence of another treaty, that is no longer possible.

Remember what everybody said a week ago? To solve the crisis, the eurozone requires, in the long run, a fiscal union with a prospect of a eurozone bond and, in the short run, unlimited sovereign bond market support by the European Central Bank. What we now have is no treaty change, no eurozone bond and no increase either in the rescue fund or in ECB support.

Policy changes the ECB announced last week will help banks directly and governments indirectly. But the EU fell short on every element of a comprehensive deal. On Friday, investors reacted positively to what was sold to them as a “fiscal compact”. But once the implications of a separate treaty are understood, I fear disillusionment will set in.

Last week, Europe’s leaders created a diversion. We will be talking about the UK for a while. The crisis, meanwhile, goes on.

Copyright The Financial Times Limited 2011.

December 11, 2011 10:01 pm

OECD warns on global funding struggle

By David Oakley in London

Markets and governments face an uphill struggle to fund themselves next year amid extreme uncertainty over the eurozone and the global economy, as new figures reveal that the borrowing of industrialised governments has surged beyond $10tr this year and is forecast to grow further in 2012.

The Organisation for Economic Co-operation and Development, which represents the leading industrialised nations, will warn in its latest borrowing outlook, due to be published this month, that financial stresses are likely to continue with the “animal spirits” of the markets – their unpredictable nature – a threat to the stability of many governments that need to refinance debt.


Hans Blommestein, head of public debt management at the OECD, said: “[On occasion], market events seem to reflect situations whereby animal spirits dominate market dynamics, thereby pushing up sovereign borrowing rates with serious consequences for the sustainability of sovereign debt.”

For the foreseeable future it will be a “great challenge” for a wide range of OECD countries to raise large volumes in the private markets, with so-called rollover risk a big problem for the stability of many governments and economies.

Rollover risk is the threat of a country not being able to refinance or rollover its debt, forcing it either to turn to the European Central Bank in the case of eurozone countries or to seek emergency bail-outs, which happened to Greece, Ireland and Portugal. The OECD says the gross borrowing needs of OECD governments is expected to reach $10.4tr in 2011 and will increase to $10.5tr next year – a $1tr increase on 2007 and almost twice as much as in 2005. This highlights the risks for even the most advanced economies that in many cases, such as Italy and Spain, are close to being shut out of the private markets.

While borrowing was higher in 2009 and 2010, the risks are greater than ever because of rising borrowing costs in turbulent, unpredictable markets.

The OECD says that the share of short-term debt issuance in the OECD area remains at 44 per cent, much higher than before the global financial crisis in 2007. This, according to some investors, is a problem as it means governments have to refinance, sometimes as often as every month, rather than being able to lock in more debt for the longer term that helps stabilise public finances.

The OECD also warns that a big problem is the loss of the so-called risk-free status of many sovereigns, such as Italy and Spain, and possibly even France and Austria. The latter two have triple A credit ratings but investors no longer consider them risk-free.

Copyright The Financial Times Limited 2011.

Central banks fire the second barrel of QE

December 11, 2011 5:47 pm by

Gavyn Davies

The financial markets are becoming ever more dependent on the continuing willingness of the central banks to use their balance sheets to rescue the global economy. The central banks are not flinching from their task. In fact, they are in the process of firing their second barrel of quantitative easing at the global crisis. It could prove to be as large as the first barrel in 2008/09.

The dependence of the markets on the central banks is, of course, nothing new. But nor has it ever been greater than it is now. At the time of the 2008/09 crisis, the provision of unprecedented amounts of liquidity by all of the central banks to the financial sector was an essential component of the policy response which stabilised the crisis. And the precipitous cuts in interest rates which followed, along with the first experiments in quantitative easing, helped the global economy to recover in 2009/10.

But at that time the central banks were not acting alone. Governments also used their balance sheets to cushion the depth of the recession, as the private sectors took urgent steps to reduce debt.

Now, governments are trying to reduce the growth of their balance sheets by tightening fiscal policy, leaving the central banks as the only remaining actor in the rescue operation.

The scale of recent central bank action is extraordinary, by any historic standard other than that of late 2008. The first graph shows what the major developed central banks have been doing recently, and makes some assumptions about what they may do next.

At the Fed, there has been no increase in the size of its balance sheet since QE2 ended in July, but Operation Twist started in September. This is commonly estimated to have the same impact on monetary conditions as QE2 had via an increase in the balance sheet.

In the graph, the low estimate for the Fed makes no allowance for Operation Twist, and assumes that there will be no announcement of QE3 in the first half of next year. The high estimate assumes that Operation Twist is the equivalent of a $600 billion increase in the balance sheet. Alternatively, the result would be the same if we make no allowance for Operation Twist, but assume that the Fed’s new programme of dollar swaps turn out to be worth $300 billion, and that the Fed also undertakes purchases of mortgage securities worth $300 billion in the first half of next year.

For the ECB, I assume that the rate of expansion in the balance sheet which has been observed since early August is broadly maintained up to mid 2012. This might prove to be too conservative, given the scale of the liquidity injections announced last week, and the possibility that the size of bond purchases under the SMP may be stepped up following the fiscal compact reached at the latest summit. Of course, we can expect the ECB to deflect attention away from the growth of its balance sheet by claiming that the impact on monetary conditions is being sterilised, but this is not very convincing. Only if the Bundesbank throws its body across the tracks will the estimates in the graph prove markedly too high.

At the Bank of England (always the prime enthusiasts for quantitative easing) , I have assumed that the current £75 billion programme of gilt purchases is completed by February, and that an identical further programme is then implemented between February and June. This assumes that the economy achieves no growth between now and mid 2012, and that headline inflation soon starts to fall very rapidly. For the Bank of Japan, which is the laggard among the major central banks when it comes to QE, I have assumed that the slow rate of increase in its balance sheet since mid-2010 will be maintained over the coming 6 months.

All of this would amount to an enormous further increase in the overall size of central bank balance sheets.

The second graph shows that the scale of this second episode of QE could rival that of the first episode in 2008/09. The calculation shows the 12-month change in the total central bank balance sheet for the four main developed economies, weighted by shares in GDP and expressed as a percentage of the normal size of these balance sheets before 2008. This method of calculation enables us to compare the size of the two monetary injections more meaningfully than the simple percentage increase in the balance sheet.

On the high estimate for Fed easing, which seems the more relevant of the two estimates, the 12 month global injection will, by mid 2012, be similar in scale to the post-Lehman injection. On the lower estimate for the Fed, which gives no weight to Operation Twist, and which assumes no further round of QE from the Fed, the overall global monetary injection will be about half as large as in 2008/09.

Either way, it is clear that central bank balance sheets will have increased in a completely unprecedented manner from 2008 to 2012, unless we count previous episodes of hyper-inflation, such as the German experience in 1923. The rise in the balance sheets of the big 4 central banks over the 2008-12 period will amount to about 15 per cent of GDP, which is equivalent to over 50 per cent of the cumulative budget deficit of these countries over the same period. Who knows what would have happened to bond yields in the absence of this action.

Because this behaviour is so unprecedented, it is hard to predict the medium term consequences of such a massive dose of QE. Many economists argue that, in the absence of any rise in inflation expectations, central bank balance sheets are in effect infinitely large, and can be used as needed to combat the crisis.

Given the outsize scale of what the central banks are now doing, this argument needs increasingly careful examination in future blogs. But one conclusion already seems clear. If this strategy does not work, there will be little else left in the locker of the emergency services.


December 9, 2011 7:28 pm

US heads for class warfare election

It is a sure bet that when the name Roosevelt is mentioned by a Democratic president – whether it is Teddy or Franklinallegations of class warfare will follow. On Tuesday, Barack Obama evoked Teddy Roosevelt when he spoke at Osawatomie, Kansas, where his predecessor had called for a new age of progressivenationalismmore than a century ago.

Mr Obama was no less ambitious. In a speech that set out the guts of his 2012 campaign, the president called for a society where “everyone gets a fair shot, when everyone does their fair share, when everyone plays by the same rules”. Blaming the Great Recession on the “breathtaking greed” of the financial elites, Mr Obama called on the wealthiest to pay a higher share in taxes.

Unlike his forebears, Mr Obama stopped short of branding opponents as “economic royalists” or “malefactors of great wealth” – and he gave no hint he would “welcome their hatred”. But Republicans lost no time detecting a new era of class warfare in which the president will scapegoat America’s wealth creators for his own failings. And thus are the 2012 battle lines being drawn.

This should be both welcomed and feared. Welcomed because America needs an election focused on the economy. Mr Obama is neither a “Kenyan anti-colonial”, as Newt Gingrich has said, nor the “apologiser-in-chief” for America, as Mitt Romney believes. These are bizarre distractions. But the two sides do have legitimate disputes on how to dig America out of what is turning into a prolonged phase of economic anaemia.

It is also the debate voters want. Whether you look at the polls, in which economic concerns outweigh all, or the streets, where the Tea Party and Occupy Wall Street shout out a mostly economic list of grievances, it is the economy which stirs debate. That is useful for the parties to fire up their grassroots: on Tuesday Mr Ob­ama came close to endorsing the 99 per cent mindset of OCW, and Republicans have long since taken up the Tea Party’s anti-tax populism.

Yet there are grounds to fear that the debate may generate more heat than light. To be sure, the wealthiest could easily revert to the 39.5 per cent tax rate they paid under Bill Clinton from the 35 per cent rate that holds now. But a higher top rate of marginal tax will not solve America’s problems.

On the fiscal front, America needs a grand compact that would deliver medium-term discipline, which should include both higher taxes and lower spending. In theory it should not be hard. In practice, the climate is too polarised for consensus. Just as important, but far tougher to fix, is America’s competitiveness crisis in which large swathes of its labour force are being outcompeted in a rapidly integrating global economy.

Mr Obama is not a class warrior. But he has not yet found a compelling way to address what lies behind America’s deepening inequities. The Republicans are even further from a solution. Let us hope class warfare marks only the starting point for a conversation.

Copyright The Financial Times Limited 2011.

December 10, 2011

In Euro Era, Opening Bell Is a 2:30 A.M. Alarm


As the European debt crisis roils the markets, American traders who once awoke at dawn are now rising in the dead of night to gain an edge when business begins in London, Paris and Frankfurt.

Gone are the days when traders showed up to work just before the New York Stock Exchange opened at 9:30 a.m. Now, Wall Street has an unofficial opening bell: the 2:30 a.m. alarm clock.

“We have a new credo: carpe noctem seize the night,” said Douglas A. Kass, a hedge fund manager who routinely sets his alarm for precisely that time to scan the headlines coming out of Europe. All last week, the musings of the German chancellor, Angela Merkel, and other European leaders put the markets on edge. “You are almost forced to get up and watch the goings-on,” he added.

The nest of night owls is growing more crowded. Senior executives at the Pacific Investment Management Company, the giant bond-trading house, wake up at 1 a.m. in Southern California, to check their BlackBerrys for updates from colleagues in Europe.

“Your nerves are twitching,” said Christian Stracke, Pimco’s global head of credit research.

Michael Mayo, a longtime bank stock analyst, said he was working the lobster shift so often just to keep up with the latest International Monetary Fund rescue or Slovenian parliamentary vote that he might as well call himself a 24-hour-a-day research shop. Who would have thought we would have to be looking at Italian sovereign debt yields to figure out what Morgan Stanley’s stock will do?” he said.

For traders, there is too much to lose if they sleep through history.

That’s why Craig Gorman, a partner at First New York Securities, routinely monitors his trading positions in the middle of the night. He turns on CNBC and fires up the Bloomberg terminal with six screens at the foot of his bed. “With the TV and all my monitors on, it gets a little bright in there,” he said. “My wife is not thrilled about it.”

The other downside? It is hard to fall back asleep once the adrenaline from trading starts pumping. Even so, Mr. Gorman said it was worth the price: “You can’t get the same feel for market psychology looking back at the charts in the morning as when you are up,” he added.

News organizations and brokerage firms see an uptick in early-morning activity, too. Bloomberg reports at least a 30 percent jump from a year ago in the use of its mobile applications, which allow customers to remotely log into the trading terminal at their office desk. The biggest spikes have occurred well before the New York markets open, between 5 and 7 a.m., when traders wake up and commute to work, as well as between midnight and 3 a.m., when trading in Asia winds down and the European markets open, according to company officials.

CNBC has recorded a 50 percent increase in the tiny audience watchingWorldwide Exchange,” which broadcasts between 4 and 6 a.m. Traffic on its Web site between 2 and 5 a.m. has risen about 30 percent compared with a year ago.

There are also signs that predawn trading by American retail investors has increased. TD Ameritrade, which caters to individual investors, said customer trading volume in S.& P. futures — a bet on the coming day’s direction in the market — has more than doubled between 3 and 6 a.m. over the last year.

Wall Street has long been the land of the early riser, and plenty of fixations in high finance have come and gone. In the late 1970s and 1980s, traders obsessed over the state of the money supply; in the late 1990s, they focused on rapidly rising Web page views of the leading dot-com companies. Last year, traders acted like armchair engineers in deep-water drilling as they monitored images of the BP oil spill gushing into the Gulf of Mexico.

Whether or not Europe’s new plan struck on Friday to achieve budgetary discipline brings market stability, some suggest that the current middle-of-the-night frenzy heralds a lasting change for an industry that coined the termbankers’ hours.”

“It is now making people aware that they can become a global trader,” said J. J. Kinahan, the chief derivatives strategist for TD Ameritrade. “They don’t have to rely on the hours of the New York Stock Exchange” between 9:30 a.m. and 4 p.m. Eastern time.

Several forces are at play. The convergence of mobile technology and financial information allows investors to trade on news anywhere, anytime. The markets, meanwhile, have grown so interconnected that what happens with sovereign bonds can quickly affect equities.

Any whiff of trouble in Europe can send markets into a tailspin and easily overwhelm the hard-earned edge a trader might have gained by digging deep into the financials of an individual stock.

“The degree to which asset prices are connected is off the charts,” said Dean Curnutt, the president of Macro Risk Advisors and another early riser.

That is the main reason that Brad Alford, the chief investment officer of Alpha Capital in Atlanta, rolls over in bed, grabs his iPad and glances at the Bloomberg market feeds with one eye, sometimes two, before the sun comes up. Or why Mr. Kass trudges over to his poolside home office in Palm Beach, Fla., to e-mail hedge fund friends about the latest troubled country du jour. “There is a pretty active cabal in those early hours,” he said.

It is also why Al Moniz, a European bond fund manager at Fore Research and Management in New York, has been waking up at 2 a.m. at least several times a month, and expects even more bleary-eyed nights next year.

“It is probably going to get worse,” he said. “I don’t think there is any end in sight.”