The euro crisis

Damned with faint plans

Euro-zone government bonds have not been made safe—and the euro project remains in peril

Dec 17th 2011 .

THERE were hopes, however faint, that Europe’s leaders might, in the space of a few days, manage to persuade investors that euro-area government bonds were safe assets, not toxic waste, thus putting paid to fears that the currency zone would disintegrate. The verdict, a week after meetings of the European Central Bank (ECB) and European Union leaders on December 7th-9th, is that they failed.

The new measures that emerged from these meetings fell short of what is required to save the euro, though they may be enough to support the zone’s stricken banks and sovereigns for a while. The bond markets’ initial response is not encouraging. Yields on the ten-year bonds of Italy and Spain, the big euro-zone countries that investors are most wary of, have risen again after falling in the run-up to the summit (see chart).

The euro has also dropped to its lowest level (below $1.30) against the dollar since January. The likeliest trigger for the next stage in a deepening crisis is a blanket downgrade of euro-zone government bonds, which would strip France and even Germany of their prized AAA credit rating.

The gatherings in Frankfurt and Brussels did not deliver the “comprehensivesolution to the euro’s ills that was billed, but optimists point to some modest progress. The ECB lowered its benchmark interest rate from 1.25% to 1%, the second quarter-point cut in as many months, to try to mitigate the coming recession. It agreed to provide unlimited cash to commercial banks for up to three years, at its main interest rate, to replace the medium-term funding that private investors are unwilling to extend.

The central bank will now accept higher-risk asset-backed bonds as well as loans as security for cash, and it has lowered its reserve requirements for banks to ease their funding pressures.

Such measures will help to address a shortage of liquidity in the euro-zone banking system. But they are unlikely to avert a nasty credit crunch, because banks are inclined to shed assets, rather than make new loans, as they strive to comply with new capital rules by next June. And although the ECB is now an aggressive lender-of-last-resort to banks, it will not extend the same privileges to governments. The bank’s president, Mario Draghi, scotched the idea that the ECB might step up its “limitedpurchases of the bonds of troubled euro-zone countries if a binding fiscal pact were to be agreed by governments at the Brussels summit. The EU treaty forbids monetary financing of governments, said Mr Draghi, thus ruling out large-scale bond purchases as illegal.

If the ECB is squeamish about funding governments, it is quite content to provide banks with cheap, long-term cash that might be used to buy sovereign bonds. Yet the ECB’s offer of unlimited liquidity to banks is not a close substitute for direct bond purchases.

The ECB’s qualms put the onus on governments to bolster the euro zone’s rescue resources to stem a self-fulfilling run on the bond markets of Italy and Spain. But the EU summit fell short of what was required, just as all previous such gatherings had. Much diplomatic effort was wasted on securing a new fiscal compact”, which tries to build upon the rubble of the failed stability and growth pact. The new pact commits euro-zone members to a structural budget deficit (ie, allowing for the economic cycle) of no more than 0.5% of GDP a year. This fiscal rule is to be hard-wired into each country’s constitution to make compliance likelier. Fines for breaching the “old pact’s limits of a 3% of GDP budget deficit will be automatic, unless voted down by the bulk of the euro zone.

Hello kitty

The pact’s rigidity would make recessions worse, and the new fiscal rule would not have kept Ireland or Spain out of trouble. The commitment to the compact might at least have eased bond-market tensions if it were presented as a staging post to a fiscal union or to common bonds. Sadly, there was no mention of Eurobonds in the summit’s final communiqué. Nor was there enough progress in increasing the rescue funds for troubled sovereigns.

The summit pledged up to €200 billion of new money for the IMF to deal with the crisis in the hope that other contributions from outside Europe might follow. The euro zone’s permanent rescue fund, the European Stability Mechanism (ESM), may come into operation as soon as June, a year earlier than planned, and will be able to respond to a new emergency as soon as 85% of the euro zone (by voting weights) gives it clearance. But any increase in its €500 billion kitty will not be considered until March.

Even if the summit’s pledge of €200 billion to the IMF is matched by others and then combined with the €250 billion or so that is left in the euro zone’s temporary rescue fund, the money available would be barely enough to cover the borrowing needs of Spain and Italy over the next two years. It is well short of what was needed to persuade sceptical investors that big euro-zone countries are safe from runs on their bond markets. And though the Brussels summit ruled that private-sectorinvolvement” (ie, losses) would not be mandatory were a country forced to tap the ESM, reliance on IMF funds to augment the euro zone’s own resources will make investors nervous. The IMF usually gets its money back first, leaving private investors to take any losses.

This package was supposed to save the euro but is clearly inadequate. Unless a more impressive cure for the euro’s ills is agreed soon, it is hard to see it surviving the next year intact.

The sad death of multi-lateralism makes way for a more sinister trend

Like much of what passes as agreed policy in Europe these days, the deal announced only last weekend to address the eurozone's gathering debt storm is fast unravelling. Happy families?

G20 finance ministers pose for a family photo in Cannes this October. Photo: EPA

By Jeremy Warner, Associate editor

8:38PM GMT 15 Dec 2011

Key objections have been raised in national parliaments to the fiscal disciplines that the new, and spectacularly mis-named, "stability union" imposes on members of the eurozone, while the beefed-up financial backstop to halt further market contagion already looks pretty much dead in the water.

Nor is it just within the narrow confines of the eurozone that the financial crisis is testing multilateral solutions close to destruction. Who could in any case regard the vicious programme of austerity measures prescribed by multilateral arrangements as any kind of solution?

Most shareholders in the International Monetary Fund, including Britain and the US, are balking at the idea of coughing up yet more money to bail out Europe's monetary union.

At the World Trade Organisation (WTO), the director-general, Pascal Lamy, has warned of growing protectionist pressures as governments put national priorities before international ones. "We are in a vicious circle where crisis erodes the capacity of governance to co-operate even as the necessity of co-operation increases," he said.

As ever, European leaders appear to have presumed too much in promising an additional €200bn (£168bn) in bilateral loans to the IMF to fight the crisis. In Germany, the Bundesbank has said that the loans would be problematic unless other, non-euro, central banks participate.


In Britain, the Bank of England is baffled by the idea that it should in any way be expected to cough up the moneyno one has apparently yet consulted Sir Mervyn King on the matter – while the US, Japan and China have already ruled out any further contributions. Nor does the UK government have any intention of providing the €30bn eurozone leaders have pencilled in for Britain's contribution.

All UK quota contributions to the IMF are bankrolled through the foreign exchange reserves. As detailed in the last Budget, these are being topped up to the tune of £6bn this year to meet potential calls from the IMF. The UK Government couldn't legally go further without a parliamentary vote.

This would be most unlikely to give the go-ahead to any more than a token rise in quota.
And with good reason. It's affecting everyone badly, but the eurozone crisis is in truth an entirely internalised affair which can ultimately only be resolved via burden-sharing within the region of national debts. Most of what was agreed last weekend was entirely irrelevant to this underlying imperative.

Like many others, I have found myself at a loss to explain why it is that European policy-makers refuse to face up to the reality, and either do what is necessary or throw in the towel and reconstitute the single currency accordingly.

A prime example of this state of denial comes in the shape of remarks by Christian Noyer, governor of the Banque de France. Referring to the threat of a downgrade of France's triple A credit rating, he said that it was not justified "when considering economic fundamentalsotherwise they would start by downgrading Britain, which has more deficits, as much debt, more inflation and less growth than us and where credit is slumping".

Mr Noyer is not the sharpest tool in the central banking shed, but even by his own standards, this is an extraordinarily naive remark. The reason France has a problem and Britain doesn't is not just because France will soon have a socialist president likely further to bolster an already unaffordable entitlements system, but because countries which don't have their own sovereign currencies cannot monetise their debt.

For Britain, the default risk is minimal to non-existent, whereas for France it remains quite high. The "economic fundamentals" may or may not look better than Britain's, but the constraints of the single currency make debt sustainability look a whole lot worse.

But Mr Noyer's comments are also symptomatic of a rather more sinister trend – a retreat into petty nationalism and finger-pointing. If the euro eventually comes apart at the seams, there is no doubt who will get the blame. It won't be that as a triumph of political hubris over sound economics, the project was flawed from the start; to the likes of Mr Noyer, it will be because of Anglo-Saxon finance.

Already, the retreat into national solutions is well under way. With every G20 summit, there is the customary commitment to banish the forces of protectionism. Yet though there is as yet nothing to compare with the famous Smoot Hawley tariffs of the inter-war years, creeping protectionism is strongly on the rise.

According to data compiled by the University of St Gallen's Global Trade Alert, the number of protectionist measures rose dramatically with the onset of the crisis three years ago. As St Gallen's Simon Evenett points out in a recent paper, many of these measures are not caught by conventional WTO prohibitions.

In its most recent assessment, the WTO was typically self-congratulatory. "The multi-lateral trading system was instrumental in helping governments resist intense protectionist pressures during the recent global recession," it said. Mr Evenett's analysis finds this judgment to be largely self-delusion.

In difficult economic circumstances, governments create new forms of protectionism that circumvent existing multi-lateral trade rules. The most obvious of these since the onset of the crisis have been in the form of government subsidy and procurement policy, but there are many others. Apparent compliance with existing WTO rules conveniently excludes many areas of fast-growing discrimination.

Most disturbing of all, Mr Evenett finds that WTO rules may be insufficient to prevent the adoption by many governments of more overt tariff increases on the scale of Smoot Hawley. It requires only one to break ranks, and the whole system collapses.

With the possibility of renewed global recession now looming, it seems highly likely we are approaching such a moment. A sharp slackening of growth in China will inevitably result in wide-scale dumping and further mercantilism. The US and others won't take such actions lying down.

Multi-lateralism, it seems, is no more than a fairweather friend. With the storm clouds gathering anew, it is failing to provide solutions. The retreat into national alternatives is already upon us.

Global Market Overview

Last updated: December 16, 2011 10:03 pm

Moody’s downgrades Belgium

Trader at the New York Stock Exchange
Friday 21.50 GMT. The euro has erased its slim gains on the day after a downgrade of Belgium’s credit rating and amid wariness over the damage from the eurozone fiscal crisis on global growth.

Moody’s Investor Services lowered Belgium’s sovereign credit rating by two notches, from Aa1 to Aa3, citing the uncertainty over its political future and the risks that a shrinking national balance sheet would pose to its banking system. The outlook remains negative.


In light after-hours trading, the euro gave up already meagre gains to trade below $1.3030, leaving it unchanged on the day. S&P 500 futures were pointing to an opening next week 0.1 per cent below the Friday close.

Earlier, Fitch Ratings had placed a number of eurozone countries on rating watch negative, the list including Belgium, Spain, Slovenia, Italy, Ireland and Cyprus. Fitch added that the euro area country ceiling of triple A was unaffected and affirmed France’s triple A rating, but revised the outlook to “negative”.

Though market reaction was muted, US bank shares came off their high levels on the news, and two-year swap spreads, a key measure of bank counterparty risk, jumped 5 per cent higher to 49 basis points. That is their biggest one-day rise in three weeks.
The euro clung to gains until the Moody’s action, but trading was conspicuous, coming as short interest on the single currency rose to an all-time high – any gains could be dismissed as covering that position.

Bearish futures bets against the euro versus the dollar hit a record $19bn this week, according to US Commodity Futures Trading Commission figures, while bullish bets on the dollar index were near an all-time high at $17bn.

“The development is not surprising considering the fall in confidence as sovereign credit downgrade fears loom amid concerns over funding needs in 2012,” said Camilla Sutton and Eric Theoret, strategists at Scotia Capital.

Most risk assets rallied as investors took heart from better than expected US economic data. The FTSE All-World equity index rose 0.2 per cent, as industrial and energy commodities were stronger. Gold rose 1.8 per cent to $1,597 an ounce.

Wall Street’s S&P 500 largely erased an early rise of 1.3 per cent and was up just 0.2 per cent. Europe was unable to follow Asia higher, however, with the Stoxx 600 down 0.4 per cent.

Other gauges of risk appetite point to a lack of bullish conviction. US benchmark bond yields are down 6bp to 1.85 per cent. The dollar index, which tends to display a fairly tight negative correlation to broader market optimism, is 0.1 per cent weaker.

Stresses in eurozone bond markets also eased somewhat, with Italian 10-year yields lower by 1bp at 6.51 per cent, according to Bloomberg data.

Bulls looking for an end-of-year bounce will be welcoming the market’s ability to embrace improving US economic data rather than succumb again to chronic eurozone debt fears.

Hopes for a recovery in the world’s largest economy increased after Thursday’s data showed US initial jobless claims unexpectedly fell to a three-year low and Federal Reserve gauges of manufacturing in New York and Philadelphia topped estimates.

Nevertheless, credit worries lurk. Christine Lagarde, the International Monetary Fund’s managing director, has warned of a 1930s-style threat to the global economy and urged international help in resolving the debt problems.

In addition, rating agency Fitch has downgraded seven global banks, warning of “increased challenges” in financial markets.
Earlier, in Asian trading, the FTSE Asia Pacific index rose 0.8 per cent. The region’s economic outlook appeared to improve after Singapore’s exports exceeded economists’ forecasts and Indonesia regained an investment-grade rating for its sovereign debt at Fitch after 14 years.


Trading Post.

It doesn’t matter how much sentiment towards an asset may have deteriorated, there is always the chance of a short-term bounce as selling is temporarily exhausted, writes Jamie Chisholm.


And if that asset is being used as a gauge of general risk appetite, its rejuvenation may have implications for the broader market.
Traders should bear this in mind when they note technical issues relating to gold and the euro, arguably the two assets most encapsulating the recent stock market wobble.

The euro’s relative strength index (against the dollar) on Wednesday broke below the 30 mark that signalsoversoldconditions.
The last time the euro did this, at the start of October, it was followed by a 10 cent rally over four weeks.

The RSI of gold almost touched 27 on Wednesday at the height of selling that saw the bullion at one point extend its losses for the week to nearly $150 an ounce.
Sure enough, at the time of writing, both gold and the euro have stabilised, with buyers nibbling.

That may embolden risk asset bulls. But traders remain tense. Friday’s quadruple witching” of futures and options expiry threatened more volatility in thinning markets.


Reporting by Jamie Chisholm in London, Song Jung-a in Seoul and Telis Demos and Michael Mackenzie in New York

Copyright The Financial Times Limited 2011.


DECEMBER 16, 2011

The 'God Particle' and the Origins of the Universe

The search for a unifying theory is nowhere near over.


Physicists around the world have something to celebrate this Christmas. Two groups of them, using the particle accelerator in Switzerland, have announced that they are tantalizingly close to bagging the biggest prize in physics (and a possible Nobel): the elusive Higgs particle, which the media have dubbed the "God particle." Perhaps next year, physicists will pop open the champagne bottles and proclaim they have found this particle.

Finding this missing Higgs particle, or boson, is big business. The European machine searching for it, the Large Hadron Collider, has cost many billions so far and is so huge it straddles the French-Swiss border, near Geneva. At 17 miles in circumference, the colossal structure is the largest machine of science ever built and consists of a gigantic ring in which two beams of protons are sent in opposite directions using powerful magnetic fields.

The collider's purpose is to recreate, on a tiny scale, the instant of genesis. It accelerates protons to 99.999999% the speed of light. When the two beams collide, they release a titanic energy of 14 trillion electron volts and a shower of subatomic particles shooting out in all directions. Huge detectors, the size of large apartment buildings, are needed to record the image of this particle spray.

Then supercomputers analyze these subatomic tracks by, in effect, running the video tape backwards. By reassembling the motion of this spray of particles as it emerges from a single point, computers can determine if various exotic subatomic particles were momentarily produced at the instant of the collision.

The theory behind all these particles is called the Standard Model. Billions of dollars, and a shelf full of Nobel Prizes along the way, have culminated in the Standard Model, which accurately describes the behavior of hundreds of subatomic particles. All the pieces of this jigsaw puzzle have been painstakingly created in the laboratory except the last, missing piece: the Higgs particle.

It is a crucial piece because it is responsible for explaining the various masses of the subatomic particles. It was introduced in 1964 by physicist Peter Higgs to explain the wide variation. Until then, a theory of subatomic particles had to assume that the masses of these particles are zero in order to obtain sensible mathematical results. This was a puzzling, disturbing result, since particles like the electron and proton have definite masses. Mr. Higgs showed that by introducing this new particle, one could preserve all the correct mathematical properties and still have non-zero masses for the particles.

While physicists cannot yet brag that they have found the Higgs particle, they have now narrowed down the range of possible masses, between 114 and 131 billion electron volts (over a hundred times more massive than the proton). With 95% confidence, physicists can rule out various masses for the Higgs particle outside this range.

Will finding the Higgs boson be the end of physics? Not by a long shot. The Standard Model only gives us a crude approximation of the rich diversity found in the universe. One embarrassing omission is that the Standard Model makes no mention of gravity, even though gravity holds the Earth and the sun together. In fact, the Standard Model only describes 4% of the matter and energy of the universe (the rest being mysterious dark matter and dark energy).

From a strictly aesthetic point of view, the Standard Model is also rather ugly. The various subatomic particles look like they have been slapped together haphazardly. It is a theory that only a mother could love, and even its creators have admitted that it is only a piece of the true, final theory.

So finding the Higgs particle is not enough. What is needed is a genuine theory of everything, which can simply and beautifully unify all the forces of the universe into a single coherent whole—a goal sought by Einstein for the last 30 years of his life.

The next step beyond the Higgs might be to produce dark matter with the Large Hadron Collider. That may prove even more elusive than the Higgs. Yet dark matter is many times more plentiful than ordinary matter and in fact prevents our Milky Way galaxy from flying apart.

So far, one of the leading candidates to explain dark matter is string theory, which claims that all the subatomic particles of the Standard Model are just vibrations of a tiny string, or rubber band. Remarkably, the huge collection of subatomic particles in the Standard Model emerge as just the first octave of the string. Dark matter would correspond roughly to the next octave of the string.

So finding the Higgs particle would be the beginning, not the end of physics. The adventure continues.

Mr. Kaku, a professor of theoretical physics at CUNY, is author of "Physics of the Future: How Science Will Shape Human Destiny and Our Daily Lives by 2100" (Doubleday, 2011).
Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved

The Worst and the Best of Austerity

Jean Pisani-Ferry


BRUSSELS – In June, it was Greece. In August, it was France, Italy, Spain, and Portugal. In September, it was Greece again – and Spain. In November, France took another turn, before Italy again in December, this time in a major way. Every month, despite an ever-darker outlook for economic growth, countries announce new spending cuts and tax hikes in the hope of restoring confidence in the bond markets. Only Germany stands out, having recently announced a tax cut, albeit a modest one.

In other words, while all indicators point to a severe economic downturn in Europe, the eurozone’s current interest-rate spreads are provoking a shift to austerity. It looks like a no-brainer: accelerated budget cuts are preferable to a lethal interest-rate surge on public debt, even if the cuts increase the risk of recession. But there are caveats.

First, while indiscriminate austerity may be the only option for those eurozone countries that no longer have access to capital markets, others have more choice of policy options. Consolidation is required, but governments are responsible for its speed and its design.

Second, a sound fiscal strategy requires establishing, on the basis of prudent economic assumptions, an ambitious budgetary target for the medium term, determining what mix of taxation and expenditure cuts are required in order to achieve it, and then sticking to the plan throughout economic fluctuations. This allows the so-calledautomatic stabilizers” – lower receipts in a slowdown, higher in a boom – to come into play, preventing the economy from overheating at the top of the business cycle and providing stimulus at the bottom.

Third, headlong consolidation is not always the best way to reassure markets, which may worry more about growth. Italy is a case in point. The country’s budget deficit this year, at 4% of GDP, is far below that of Spain or France. Indeed, it was not the country’s deficit that finally led investors to shun Italian bonds, but rather a forbidding cocktail of high debt, desperately slow growth, and political paralysis. In a situation like this, nibbling at the edges of a deficit is at best a sideshow. The markets are demanding reforms that lift growth rates durably and an approach to fiscal consolidation that is consistent with higher potential growth.

Fourth, the cost of rushed austerity is that it generally relies on immediate fixes, such as indiscriminate spending cuts and tax hikes that are expected to yield revenue in the short term, but that have an economically damaging impact. Smart consolidation should, instead, minimize short-term economic damage and foster longer-term growth.

Governments know this only too well. At the end of 2010, most eurozone countries were penciling spending cuts into their consolidation programs while preserving the most productive areas, such as education and infrastructure. Moreover, they were planning to broaden the tax base rather than raise rates.

But, since this summer, governments have done the opposite. Rather than focus on spending, they have zeroed in on tax measures, for the most part increasing existing rates. This is a bad sign for growth.

What should they be doing instead? Fiscal consolidation is unavoidable, but that is a medium-term process. Instead of undertaking knee-jerk cuts, eurozone governments must first reestablish their credibility through policy rules enshrined in national legislations, as recently decided by the European heads of state and government.

Second, they should design and implement smart consolidations, even if they take a little more time to design and a little more time to implement. This entails finding the optimal balance between spending cuts and tax increases, and identifying the least harmful measures over the medium term. Doing so will take time, thought, and an iron will.

Jean Pisani-Ferry is Director of Bruegel, an international economics think tank, Professor of Economics at Université Paris-Dauphine, and a member of the French Prime Minister’s Council of Economic Analysis.