Capturing the ECB

Joseph E. Stiglitz


NEW YORK – Nothing illustrates better the political crosscurrents, special interests, and shortsighted economics now at play in Europe than the debate over the restructuring of Greece’s sovereign debt. Germany insists on a deep restructuringat least a 50%haircut” for bondholders – whereas the European Central Bank insists that any debt restructuring must be voluntary.

In the old daysthink of the 1980’s Latin American debt crisis – one could get creditors, mostly large banks, in a small room, and hammer out a deal, aided by some cajoling, or even arm-twisting, by governments and regulators eager for things to go smoothly. But, with the advent of debt securitization, creditors have become far more numerous, and include hedge funds and other investors over whom regulators and governments have little sway.

Moreover, “innovation” in financial markets has made it possible for securities owners to be insured, meaning that they have a seat at the table, but noskin in the game.” They do have interests: they want to collect on their insurance, and that means that the restructuring must be a “credit event” – tantamount to a default. The ECB’s insistence on “voluntaryrestructuring – that is, avoidance of a credit event – has placed the two sides at loggerheads. The irony is that the regulators have allowed the creation of this dysfunctional system.

The ECB’s stance is peculiar. One would have hoped that the banks might have managed the default risk on the bonds in their portfolios by buying insurance. And, if they bought insurance, a regulator concerned with systemic stability would want to be sure that the insurer pays in the event of a loss. But the ECB wants the banks to suffer a 50% loss on their bond holdings, without insurancebenefits” having to be paid.

There are three explanations for the ECB’s position, none of which speaks well for the institution and its regulatory and supervisory conduct. The first explanation is that the banks have not, in fact, bought insurance, and some have taken speculative positions. The second is that the ECB knows that the financial system lacks transparency – and knows that investors know that they cannot gauge the impact of an involuntary default, which could cause credit markets to freeze, reprising the aftermath of Lehman Brothers’ collapse in September 2008. Finally, the ECB may be trying to protect the few banks that have written the insurance.

None of these explanations is an adequate excuse for the ECB’s opposition to deep involuntary restructuring of Greece’s debt. The ECB should have insisted on more transparency – indeed, that should have been one of the main lessons of 2008. Regulators should not have allowed the banks to speculate as they did; if anything, they should have required them to buy insurance – and then insisted on restructuring in a way that ensured that the insurance paid off.

There is, moreover, little evidence that a deep involuntary restructuring would be any more traumatic than a deep voluntary restructuring. By insisting on its voluntariness, the ECB may be trying to ensure that the restructuring is not deep; but, in that case, it is putting the banks’ interests before that of Greece, for which a deep restructuring is essential if it is to emerge from the crisis. In fact, the ECB may be putting the interests of the few banks that have written credit-default swaps before those of Greece, Europe’s taxpayers, and creditors who acted prudently and bought insurance.

The final oddity of the ECB’s stance concerns democratic governance. Deciding whether a credit event has occurred is left to a secret committee of the International Swaps and Derivatives Association, an industry group that has a vested interest in the outcome. If news reports are correct, some members of the committee have been using their position to promote more accommodative negotiating positions. But it seems unconscionable that the ECB would delegate to a secret committee of self-interested market participants the right to determine what is an acceptable debt restructuring.

The one argument that seems – at least superficially – to put the public interest first is that an involuntary restructuring might lead to financial contagion, with large eurozone economies like Italy, Spain, and even France facing a sharp, and perhaps prohibitive, rise in borrowing costs. But that begs the question: why should an involuntary restructuring lead to worse contagion than a voluntary restructuring of comparable depth? If the banking system were well regulated, with banks holding sovereign debt having purchased insurance, an involuntary restructuring should perturb financial markets less.

Of course, it might be argued that if Greece gets away with an involuntary restructuring, others would be tempted to try it as well. Financial markets, worried about this, would immediately raise interest rates on other at-risk eurozone countries, large and small.

But the riskiest countries already have been shut out of financial markets, so the possibility of a panic reaction is of limited consequence. Of course, others might be tempted to imitate Greece if Greece were indeed better off restructuring than not doing so. That is true, but everyone already knows it.

The ECB’s behavior should not be surprising: as we have seen elsewhere, institutions that are not democratically accountable tend to be captured by special interests. That was true before 2008; unfortunately for Europe – and for the global economy – the problem has not been adequately addressed since then.

Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.

Copyright: Project Syndicate, 2012.

Markets Insight

February 6, 2012 11:57 am

Zero-based money is at risk of trapping the recovery

Isaac Newton may have conceptualised the effects of gravity when that mythical apple fell on his head, but could he have imagined Neil Armstrong’s hop-skip-and-jumping on the moon, or the trapping of light inside a black hole? Probably not. Likewise, the deceased economic maestro of the 21st centuryHyman Minsky – probably couldn’t have conceived how his monetary theories could be altered by zero-based money.

Minsky, originator of the commonsensicalstability leads to instabilitythesis; the economist with naming rights for 2008’sMinsky Moment; the exposer of the financial fragility of modern capitalism; probably couldn’t imagine the liquidity trap qualities of zero-based money, because who could have conceived 30 or 40 years ago that interest rates could ever approach zero per cent for an extended period of time? Probably no one.


Nor, more importantly I suppose, can Ben Bernanke, Mario Draghi or Mervyn King. In their historical models, credit is as credit does, expanding perpetually after brief periods of recessionary contraction, showering economic activity with liquid fertiliser for productive investment and inevitable growth.

If they were to adopt Minsky’s framework, they would visualise a credit system expanding from “hedge” to “securitised” to “Ponzifinance, pulling back after 2008 to the stability of the less leveredsecuritisedsegment, but then expanding again as government credit substituted for private deleveraging, providing a foundation for future growth of the finance-based economy.

Well, maybe not. In modern central bank theory, liquidity traps are a function of fear and unwillingness to extend credit based upon the increasing probabilities of default. This world is the second half of Will Rogers’ famous maxim uttered in the Depression: “I’m not so much concerned about the return on my money, but the return of my money.”

But what if the return on Will’s money could come into play as well? What if liquidity could be trapped by zero-based policy rates and the absence of yield across much of the triple-A yield curve?

What if money could be stashed in a figurative mattress because it didn’t earn anything? What if there was a liquidity trap duality of too much risk and too little return? That would be quite different to our “Minsky Moment” of three years ago.

The modern capitalistic model depends on risk-taking in several forms. Loss of principal – as in defaultnecessitates the cautious extension of credit to those that presumably can use it most efficiently. But our finance-based Minksy system is dependent as well on maturity extension. No home, commercial building or utility plant could be created if the credit liability matured or was callable overnight. Because this is so, lenders require and are incentivised by a yield premium for longer term loans, historically expressed as a positively sloping yield curve.

A flat yield curve, by contrast, is a disincentive for lenders to extend intermediate or long-term credit unless there is sufficient downside room for yields to fall and bond prices to rise, resulting in capital gain opportunities.

Historically, because nominal and real yields have been high and substantially positive, flat curves have been successfully followed by economic and asset price expansion as central banks and markets have followed the capitalistic precondition of credit and maturity risk extension. The well observed liquidity trap of default risk and until now unobserved liquidity trap of “zero-bound yield” have always been successfully overcome, because yields have had room to fall.

When all yields approach the zero-bound, however, as in Japan for the past decade and in many developed economies today, then the dynamics may change.

What incentive does a US bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed? What incentive does Pimco or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is two per cent of par and the downside substantially more?

Maturity extension for Treasuries, and then for corporate and private credit alike, becomes riskier. The Minsky assumption of rejuvenation once the public sector stabilises the credit system then becomes problematic. Instability may slouch back towards stability, but that stability may resemble more closely the zero-bound world of Japan over the past 10 years than the dynamic developed economy model of the past half century.

The global economy’s quest for a modern day Keynes or Minsky may be frustrated by zero-based money that rations credit just as fiercely as it does risk. Minsky’s economic theory is now at the zero-bound.

Bill Gross is founder and co-chief investment officer of Pimco

Copyright The Financial Times Limited 2012.


The Electoral Pact.

Crisis Desperation Drives Merkel to Campaign for Sarkozy

Chancellor Angela Merkel's move to help President Nicolas Sarkozy in his bid for re-election is unprecedented. But so too is the European debt crisis. Berlin is driven by the fear that a Socialist president in Paris may overturn its strategy to rescue the euro. But Merkel's campaign assistance poses risks. By SPIEGEL Staff

It looked almost as if it could have been a wedding when German Chancellor Angela Merkel and French President Nicolas Sarkozy walked into the conference hall of the European Council building in Brussels last Monday. They nodded at each other and exchanged pecks on the cheek, the other heads of state and government moved aside.

The two, of course, were not in Brussels to be betrothed. Rather, they were the main characters at yet another European Union summit. This time, they were seeking support for their fiscal pact, which together they had hammered out in the hopes that it could contribute to saving the EU and its common currency.

Once the pact had received the necessary backing, Merkel was visibly pleased -- and she made no attempt to hide her affinity for Sarkozy. "My political views are well known," she said following the summit. And then came a sentence that had been previously unimaginable for a German chancellor. "Nicolas Sarkozy supported me during my campaign. In the same way, I will now pay back that which he gave me."

The sober chancellor and the peripatetic president have established a pact, the likes of which has never before been seen in the Franco-German relationship. Merkel has decided to openly campaign for her partner in Paris. For Sarkozy, she is discarding the reserve that chancellors have for decades felt proper when it comes to democratic elections outside German borders. When Sarkozy begins stumping, she will be standing next to him on stage -- at least that is the plan.

Sarkozy, for his part, plans to present his partner from across the Rhine as a shining example. The German debt brake, the German social reforms, the German productivity -- France should try to emulate all of it. Last week, during a one-hour interview on television, Sarkozy mentioned the word Germany fully 15 times. Even close party allies feel that Sarkozy's weakness for Germany is becoming an obsession.

Thinking Without Borders?

One could interpret the bond between Merkel and Sarkozy as a new level in the friendship between Berlin and Paris. What is wrong when two leaders merge to form a kind of ruling duo? Konrad Adenauer and Charles de Gaulle hammered out the Elysée Treaty, also known as the Friendship Treaty. Helmut Kohl and Francois Mitterrand held hands over the graves of Verdun. And "Merkozy" are now making real what the supporters of a united Europe have long dreamed of: European domestic politics, thinking without borders.

That, at least, is the charitable version of the situation, a point of view which both Berlin and Paris have been seeking to promulgate. "It is a sign of European integration when Chancellor Merkel campaigns with President Sarkozy," says Ruprecht Polenz, a foreign policy specialist with Merkel's Christian Democrats (CDU).

In truth, however, Merkel and Sarkozy are being driven by desperation. The president would seem to be hopelessly behind his challenger Francois Hollande in surveys. A repeat of the German job miracle in France -- Sarkozy is hoping that such a promise will attract voters.

Merkel, for her part, is horrified at the prospect of a President Hollande. The Socialist is in favor of euro bonds and opposed to the anchoring of a balanced budget amendment -- the so-called "debt brake" -- in the French constitution. Hollande also doesn't think much of Merkel's fiscal pact, which she recently managed to push through in Brussels. Should Sarkozy's re-election bid fail, then Merkel's European strategy could fail as well, the Chancellery fears.

Merkel's Equal

As a result, a kind of secret diplomacy has been underway for months between the CDU headquarters in Berlin and the offices of Sarkozy's UMP party in Paris. Indeed, the CDU is expending a similar amount of energy on the election as it might on an important regional election in Germany.

The decisive link between the two parties is French Agricultural Minister Bruno Le Maire, an expert on Germany within the French government. In recent months, he has traveled to Berlin twice for meetings with CDU General Secretary Hermann Gröhe. Once, he met with Peter Altmaier, the senior CDU politician who is one of Merkel's most important advisors. Le Maire's meetings focused on the overall strategy for Operation Campaign Aid with the UMP deputy general secretary, Hervé Novelli, responsible for the details.

The French visitors explained Sarkozy's campaign strategy in detail. The president wants to appear as a leader who gets things done, as an architect of the efforts to save the European common currency. The French should see him as a man who is Merkel's equal. They are desperate to avoid having him be seen as just another European leader forced to beg Brussels for billions to shore up their dismal budget -- a request which not only infringes on national sovereignty but also on dignity.

But how is that goal to be achieved? Just recently, the rating agency Standard & Poor's withdrew France's triple-A credit rating. Even worse from a French point of view, Germany was allowed to keep its top rating. In addition, the French economy is suffering mightily, making it difficult for Sarkozy to claim that France is in the same league as Germany.

A List of Possible Dates

German and French advisors quickly agreed that, if the numbers aren't quite right, then at least the images should be. That was the origin of the plan to send Merkel to France to have her appear with him on the campaign trail. The chancellor of a booming Germany (until recently at least) should fill Sarkozy's tired campaign with life. That is the idea.

The cooperative campaign kicks off on Monday, with a joint Sarkozy-Merkel television interview to be broadcast on Germany's ZDF and the French station France 2. The Salon Murat inside the Elysée Palace, with its chandeliers and golden pillars, where the interview will be filmed, will lend the occasion its required elegance.

And that's just the beginning. As yet, no concrete dates have been set, but Sarkozy's strategists are in the process of working out the details. When CDU General Secretary Gröhe travelled to Paris for the launch of the UMP campaign just over a week ago, his French colleague Jean-Francois Copé presented him with a list of possible dates.

Merkel is looking forward to joint appearances with the president, Gröhe said during his speech to the UMP delegates to frenetic applause. The next day, the French daily Journal du Dimanche bore the headline: "Merkel Votes for Sarkozy."

The Dangers of Merkel's Strategy

A few years ago, such a headline would have been unthinkable. At the start of his presidency, Sarkozy didn't get on well with the rational, reserved German chancellor, who in turn was irritated by the French president's nervous hyper-activity and his tendency to keep on touching whoever he was speaking to. But then came the euro crisis, and it welded them together. And now that bond is being reinforced by the presence of a common enemy in the form of the Socialist Hollande. He describes himself as a "pragmatic leftist" but his campaign manifesto is so full of expensive promises that even the center-left Social Democrats in Germany have their doubts about him. The SPD helped to raise the German retirement age to 67 while Hollande thinks even 62 is an unacceptable imposition.
Hollande's European policy is causing Merkel particular concern. So far, she has primarily been able to push through her vision of European austerity only because she knows Sarkozy is on her side.

Hollande, however, has already stated clearly that he will overturn the fiscal pact, the heart of Merkel's European policy. Merkel's aides are murmuring that Hollande will come to his senses if he gets elected. But that could be wishful thinking. "It is unbelievable if we're told that a newly elected Socialist president shouldn't be permitted to want to change anything about this pact. In that case you may as well tell us not to bother holding an election," says Hollande's campaign manager Pierre Moscovici. And he cites the example of a government leader who managed to get her own way against the rest of Europe, even if Hollande doesn't want to follow this extreme case. Margaret Thatcher, Moscovici, points out, once said: "I want my money back."

Hollande knows of course how Merkel feels about him. The Socialist visited the SPD in Germany in December and said: "We'll win together." Merkel was not amused. But Hollande is shocked at how demonstratively Merkel is now siding with Sarkozy. After all, the Socialist would have liked to adorn his election bid with a visit to the Berlin chancellery. The pale Monsieur Hollande could do with a bit of diplomatic polish. But the Socialists' request for a date have been left unanswered for weeks. "It is up to Ms. Merkel to decide when and if such a meeting could take place," says Moscovici.

Diplomatic Damage

According to Jean-Marc Ayrault, Hollande's adviser on relations with Germany, the German ambassador to Paris assured the Socialists that it was customary for a chancellor to meet the most important challenger in a French presidential election. But Merkel's people are looking for a way to reject Hollande's request without causing too much diplomatic damage.

No decision has been taken yet, but Merkel's campaign help for Sarkozy is raising fears that it might damage future German-French relations. How is the chancellor going to work together with a president whom she snubbed during the election campaign?

Merkel's aides aren't even trying to hide their dislike of Hollande. "The conflict between Sarkozy and Hollande is a clash of two fundamental concepts," says CDU General Secretary Gröhe. "Strengthening competitiveness or left-wing redistribution."

Some in the governing coalition are starting to grow uneasy about Merkel's bias. "The German government isn't a party in the French election campaign," Foreign Minister Guido Westerwelle of the pro-business Free Democrats said when asked if he too planned to get involved. It was a clear signal that Germany's top diplomat doesn't approve of Merkel's strategy.

No German government leader has ever intervened so openly in a foreign general election, and Merkel herself has always placed a lot of emphasis on neutrality, even if she now says she is acting in her capacity as leader of the CDU.

A Little 'Old Fashioned'

When Barack Obama was running for president and sought permission to hold a speech in front of the Brandenburg Gate in the summer of 2008, Merkel refused and forced him to appear before the less symbolic and less famous Victory Column. One may call that "old-fashioned," she said at the time. But only elected presidents were allowed to speak in front of the Brandenburg Gate, she added.

When she now says Sarkozy himself helped her in her election campaign, that's only half the truth. When Sarkozy visited her in Berlin in May 2009, four months before her re-election bid in September, the event was hosted by the youth organisations of the CDU and his UMP party -- and wasn't a pure campaign event.

Former Chancellor Helmut Kohl confined his electoral support to subtle gestures. In 1995, he visited the French conservative presidential candidate, Edouard Balladur, during the latter's winter holiday in Chamonix and called him "cher ami."

Kohl once permitted his political friend Francois Mitterrand to use the famous 1984 photo showing the two leaders holding hands in a gesture of reconciliation at the French World War I cemetery in Verdun. But that wasn't for Mitterrand's re-election campaign, it was for a European election.

Perhaps Hollande should silently savor Merkel's intervention because it may end up helping him more than Sarkozy. At the moment, at least, her support appears to be counter-productive. Many French voters are fed up with their president, who is constantly citing Germany as a shining economic example for France.

In the legendary French satirical program "Les Guignols de l'Info," a red-faced puppet with a strong German accent is a firm fixture. It represents Angela Merkel and is introduced as "President of the French Republic," and she always ends her snappy speeches about the lack of French discipline with the exclamation: "Arrbeiit!"

When Luxembourg's foreign minister, Jean Asselborn, recently rang Hollande, the conversation quickly turned to Merkel and her planned campaign help for Sarkozy. Asselborn told him not to worry about it. "That's the best thing that could happen to you."


Translated from the German

February 5, 2012 8:05 pm

The reality of American decline

Matt Kenyon illustration

Something puzzling just happened in Washington: a liberal American president who opposed the invasion of Iraq endorsed one of its chief neoconservative advocates. By embracing Robert Kagan’s essay,The Myth of America’s Decline”, Barack Obama has done the author a turn. The essay is excerpted from Mr Kagan’s book, The World that America Made, which comes out later this month.

America is back,” Mr Obama said in his State of the Union address 10 days ago. Anyone who tells you America is in decline or that our influence has waned, doesn’t know what they’re talking about.” Mr Obamaloved” the Kagan essay, Tom Donilon, the national security adviser, later revealed on the talkshow presented by Charlie Rose. The president had gone over it point by point at a White House meeting.

Mr Kagan, who also wroteAmericans are from Mars, Europeans are from Venus”, the provocative post-Iraq book, has written a clear and powerfully-argued essay. But Mr Obama might want to scan it more closely.


Start with its economic facts. Mr Kagan says that in 1969 the US had “roughly a quarter” of the world’s income. “Today it still produces roughly a quarter,” Kagan wrote. “America’s share of the world’s GDP has held remarkably steady.”

That would seem pretty conclusive. Here are more precise measures. In 1969, the US accounted for 36 per cent of global income at market prices, according to the International Monetary Fund’s World Economic Outlook. America’s share had fallen to 31 per cent by 2000. Then it started to plummet. By 2010, the US accounted for just 23.1 per cent of world income. In one decade America lost 7 per cent of world share. More than half that loss occurred before the Great Recession.

China’s economy, meanwhile, was barely an eighth the size of the US’s in 2000. Today it is 41 per cent – and that is based on current exchange rates. Were Beijing to float the renminbi, China’s economy could be valued considerably higher. Far from being “remarkably steady”, the shift over the past decade has been uniquely rapid by any historic measure. Another decade like that and America’s pre-eminence will look very shaky. Indeed, as Arvind Subramanian writes, China would surpass the US within 12 years even if its growth slowed to 7 per cent a year and the US hit an unlikely annual pace of 3 per cent.

But the book’s real subject is American exceptionalism. Mr Kagan believes that it is largely up to Americans to decide whether their country’s dominance will continue.

In a clear echo of the author’s criticisms of Bill Clinton in the 1990s, Mr Kagan fears the US is losing its will for muscular world leadership. “In the end, the decision is in the hands of Americans,” he writes. “Decline, as Charles Krauthammer [a commentator] has observed, is a choice.”

And here we arrive at the book’s main puzzle. Mr Kagan denies America is in relative decline – and mistakenly insists there is no economic evidence for it. Yet he argues that America’s decline is being actively willed by unnamedpoliticians and policymakers”. They are “in danger of committing pre-emptive superpower suicide out of a misplaced fear of declining power”.

It is a tension that runs through the book. If America isn’t declining, who cares? If, on the other hand, America is willing its decline, who are these lemmings exactly? One clue would be Mr Obama. Here is an even richer clue from Mitt Romney (to whom Mr Kagan serves as a senior foreign policy adviser): “Our president thinks America is in decline,” the Republican frontrunner recently said. “It is if he [Obama] is president. It is not if I am president.”

It would be only a mild exaggeration to take Mr Romney’s following words as a summary of Mr Kagan’s core thesis. President Obama believes America’s role as leader in the world is a thing of the past,” Mr Romney said in Florida last week. “I will insist on a military so powerful no one would ever think of challenging it.”

In practise, Mr Obama has negotiated a modest, and arguably illusory, trim to the US defence budget8 per cent in the next decade from a generous baseline. US military spending will still be far higher after the cuts have gone through than it was on the eve of September 11. Mr Romney promises to reverse them.

Mr Kagan believes America’s future will hinge largely on taking a very different turn to the one in which US foreign policy and the Pentagon is apparently headed. The continuation of the international liberal order depends on the presence of a strong and active US, he argues.

Imagine a scenario where China became the top dog, he says. Would it uphold the system that got it there? Mr Kagan answers by way of a fable. A frog agrees to carry a scorpion on his back across the river on the promise he will not be stung. “How can I sting you when I would also drown?” asks the scorpion. As the frog drowns, it asks why the scorpion broke its word: “Because I am a scorpion,” comes the reply.

With that Mr Kagan pretty much dismisses two generations of China strategy. The wealth China has earned by global integration, and the numbers lifted from poverty, may in the end count for little against its true nature, he suggests. Which brings us back to the main quandary: the book’s real target is American declinists; yet America’s declinist-in-chief loves its thesis. Who knows, perhaps it is one of those instances of co-option at which presidents excel. In which case, it is fair to ask who is carrying whom?

Copyright The Financial Times Limited 2012.