Spain must not become a “roach motel”

Mohamed El-Erian

June 6, 2012

After resisting for months, Spain has made an explicit plea for bank aid from its European neighbours. The immediate objective is to recapitalise struggling banks and minimise the risk of disruptive deposit withdrawals. A major challenge is to avoid this emergency funding turning Spain into a long-term ward of the European state, a phenomenon that has already occurred in the three countries to have already received bail-outs Greece, Ireland and Portugal.

Having botched prior attempts to stabilise its banking system – whether it was the domestic approach based on mergers or the attempt to access a back door to the European Central BankSpain now looks set to tap European funds. This would probably be combined with a more detailed commitment to a domestic economic plan emphasising both budgetary adjustment and structural reform.

This use of an external balance sheet would provide the theoretical possibility of rupturing the disruptive feedback loop between weak banks and deteriorating sovereign creditworthiness. But before we all let out a huge sigh of relief, it is important to understand why Spain for so long resisted what seems to be an obvious response to its banking problems.

So far, emergency European funding has been impossible to exit, like a “roach motel”. Rather than act as a catalyst for crowding in private capital needed to restore growth, and financial viability, public money has provided the private sector with the possibility to exit programme countries at a much lower cost; and exit it did. As a result, governments have become highly dependent on official aid to cover their budget needs, meet interest obligations and roll over maturing debt; and domestic companies have been starved of the oxygen that is so critical for investment and job creation.

No wonder, growth and solvency remain so elusive for the programme countries, including in Ireland and Portugal where citizens have been generally supportive of their governments’ policies. The possibility that the counter factual — i.e., no access to external emergency financing — could have yielded a worse outcome is no excuse for repeating the mistake in Spain. Indeed, this is more than just in the country’s self interest. Given its size and crucial role in any revived eurozone (along with France, Germany and Italy), Europe cannot afford Spain to be a long-term ward of the state.

Success requires, first and foremost, a common understanding and vision of what a stable eurozone would look like in three to five years. Increasingly, this speaks to a smaller and less imperfect union, anchored by the big four and including only countries that are both able and willing to deliver on the revamped joint obligations being discussed in official circlesnamely, reinforcing monetary union with proper fiscal and growth compacts and enhanced political integration.

This critical contextual step would allow for the immediate implementation of measures to stabilise Europe, including through the establishment of a regional bank deposit scheme. It would provide far greater assurances to the ECB that, this time around, its emergency facilities (including another longer term refinancing operation and an enhanced security purchase program, along with strengthened regional fiscal transfers) have a better prospect of being a bridge to a sustainable European destination something that continues to elude an institution that has already expanded its balance sheet to 30 percent of aggregate gross domestic product.

Finally, Spain would need to agree to a proper domestic policy mix. This involves not only avoiding the mistake that Greece made in agreeing to a series of unrealistically-designed and technically-flawed programmes but also enabled to make difficult upfront decisions about the best form of burden sharing (something that Ireland was not allowed to do by its European partners).

Given the increasingly delicate situation of the eurozone – from Greece’s bank jog and election uncertainty to the tensions at the very core between France and Germanygovernments do not have many more chances to get all this right. And the rest of the world has a vital interest in a better response to what now constitutes a major risk to already tenuous growth and employment prospects.

The Accidental Empire

George Soros

07 June 2012

 NEW YORKIt is now clear that the main cause of the euro crisis is the member states’ surrender of their right to print money to the European Central Bank. They did not understand just what that surrender entailed – and neither did the European authorities.

When the euro was introduced, regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital, and the ECB discounted all eurozone government bonds on equal terms. Commercial banks found it advantageous to accumulate weaker countries’ bonds to earn a few extra basis points, which caused interest rates to converge across the eurozone.

.Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. Other countries enjoyed housing and consumption booms on the back of cheap credit, making them less competitive.

Then came the crash of 2008. Governments had to bail out their banks. Some of them found themselves in the position of a developing country that had become heavily indebted in a currency that it did not control. Reflecting the divergence in economic performance, Europe became divided into creditor and debtor countries.

When financial markets discovered that supposedly riskless government bonds might be forced into default, they raised risk premiums dramatically. This rendered potentially insolvent commercial banks, whose balance sheets were loaded with such bonds, giving rise to Europe’s twin sovereign-debt and banking crisis.

.The eurozone is now replicating how the global financial system dealt with such crises in 1982 and again in 1997. In both cases, the international authorities inflicted hardship on the periphery in order to protect the center; now Germany is unknowingly playing the same role.

The details differ, but the idea is the same: creditors are shifting the entire burden of adjustment onto debtors, while the “centeravoids its own responsibility for the imbalances. Interestingly, the terms center” and “periphery” have crept into usage almost unnoticed. Yet, in the euro crisis, the center’s responsibility is even greater than it was in 1982 or 1997: it designed a flawed currency system and failed to correct the defects. In the 1980’s, Latin America suffered a lost decade; a similar fate now awaits Europe.

.At the onset of the crisis, a breakup of the euro was inconceivable: the assets and liabilities denominated in a common currency were so intermingled that a breakup would have led to an uncontrollable meltdown. But, as the crisis has progressed, the financial system has become increasingly reordered along national lines. This trend has gathered momentum in recent months. The ECB’s long-term refinancing operation enabled Spanish and Italian banks to buy their own countries’ bonds and earn a large spread. Simultaneously, banks gave preference to shedding assets outside their national borders, and risk managers try to match assets and liabilities at home, rather than within the eurozone as a whole.

If this continued for a few years, a euro breakup would become possible without a meltdown, but it would leave the creditor countries with large claims against debtor countries, which would be difficult to collect. In addition to intergovernmental transfers and guarantees, the Bundesbank’s claims against peripheral countries’ central banks within the Target2 clearing system totaled €644 billion ($804 billion) on April 30, and the amount is growing exponentially, owing to capital flight.

.So the crisis keeps growing. Tensions in financial markets have hit new highs. Most telling is that Britain, which retained control of its currency, enjoys the lowest yields in its history, while the risk premium on Spanish bonds is at a new high.

.The real economy of the eurozone is declining, while Germany is booming. This means that the divergence is widening. The political and social dynamics are also working toward disintegration. Public opinion, as expressed in recent election results, is increasingly opposed to austerity, and this trend is likely to continue until the policy is reversed. Something has to give.

In my judgment, the authorities have a three-month window during which they could still correct their mistakes and reverse current trends. That would require some extraordinary policy measures to return conditions closer to normal, and they must conform to existing treaties, which could then be revised in a calmer atmosphere to prevent recurrence of imbalances.

It is difficult, but not impossible, to identify some extraordinary measures that would meet these tough requirements. They would have to tackle the banking and the sovereign-debt problems simultaneously, without neglecting to reduce divergences in competitiveness.

The eurozone needs a banking union: a European deposit-insurance scheme in order to stem capital flight, a European source for financing bank recapitalization, and eurozone-wide supervision and regulation. The heavily indebted countries need relief on their financing costs. There are various ways to provide it, but they all require Germany’s active support.

That is where the blockage is. German authorities are working feverishly to come up with a set of proposals in time for the European Union summit at the end of June, but all signs suggest that they will offer only the minimum on which the various parties can agreeimplying, once again, only temporary relief.

But we are at an inflection point. The Greek crisis is liable to come to a climax in the fall, even if the election produces a government that is willing to abide by Greece’s current agreement with its creditors. By that time, the German economy will also be weakening, so that Chancellor Angela Merkel will find it even more difficult than today to persuade the German public to accept additional European responsibilities.

Barring an accident like the Lehman Brothers bankruptcy, Germany is likely to do enough to hold the euro together, but the EU will become something very different from the open society that once fired people’s imagination. The division between debtor and creditor countries will become permanent, with Germany dominating and the periphery becoming a depressed hinterland.


This will inevitably arouse suspicion about Germany’s role in Europe – but any comparison with Germany's past is quite inappropriate. The current situation is due not to a deliberate plan, but to the lack of one. It is a tragedy of policy errors. Germany is a well-functioning democracy with an overwhelming majority for an open society. When the German people become aware of the consequencesone hopes not too late – they will want to correct the defects in the euro's design.

.It is clear what is needed: a European fiscal authority that is able and willing to reduce the debt burden of the periphery, as well as a banking union. Debt relief could take various forms other than Eurobonds, and would be conditional on debtors abiding by the fiscal compact. Withdrawing all or part of the relief in case of nonperformance would be a powerful protection against moral hazard. It is up to Germany to live up to the leadership responsibilities thrust upon it by its own success.

George Soros is Chairman of Soros Fund Management and Chairman of the Open Society Institute. A pioneer of the hedge-fund industry, he is the author of many books, including The Alchemy of Finance and The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means

The Price of Inequality
Joseph E. Stiglitz
05 June 2012

NEW YORK America likes to think of itself as a land of opportunity, and others view it in much the same light. But, while we can all think of examples of Americans who rose to the top on their own, what really matters are the statistics: to what extent do an individual’s life chances depend on the income and education of his or her parents?

Nowadays, these numbers show that the American dream is a myth. There is less equality of opportunity in the United States today than there is in Europe – or, indeed, in any advanced industrial country for which there are data.

This is one of the reasons that America has the highest level of inequality of any of the advanced countries – and its gap with the rest has been widening. In the “recovery” of 2009-2010, the top 1% of US income earners captured 93% of the income growth. Other inequality indicators – like wealth, health, and life expectancy – are as bad or even worse. The clear trend is one of concentration of income and wealth at the top, the hollowing out of the middle, and increasing poverty at the bottom.

It would be one thing if the high incomes of those at the top were the result of greater contributions to society, but the Great Recession showed otherwise: even bankers who had led the global economy, as well as their own firms, to the brink of ruin, received outsize bonuses.

A closer look at those at the top reveals a disproportionate role for rent-seeking: some have obtained their wealth by exercising monopoly power; others are CEOs who have taken advantage of deficiencies in corporate governance to extract for themselves an excessive share of corporate earnings; and still others have used political connections to benefit from government munificence – either excessively high prices for what the government buys (drugs), or excessively low prices for what the government sells (mineral rights).

Likewise, part of the wealth of those in finance comes from exploiting the poor, through predatory lending and abusive credit-card practices. Those at the top, in such cases, are enriched at the direct expense of those at the bottom.

It might not be so bad if there were even a grain of truth to trickle-down economics – the quaint notion that everyone benefits from enriching those at the top. But most Americans today are worse off – with lower real (inflation-adjusted) incomesthan they were in 1997, a decade and a half ago. All of the benefits of growth have gone to the top.

Defenders of America’s inequality argue that the poor and those in the middle shouldn’t complain. While they may be getting a smaller share of the pie than they did in the past, the pie is growing so much, thanks to the contributions of the rich and superrich, that the size of their slice is actually larger.

The evidence, again, flatly contradicts this. Indeed, America grew far faster in the decades after World War II, when it was growing together, than it has since 1980, when it began growing apart.

This shouldn’t come as a surprise, once one understands the sources of inequality. Rent-seeking distorts the economy. Market forces, of course, play a role, too, but markets are shaped by politics; and, in America, with its quasi-corrupt system of campaign finance and its revolving doors between government and industry, politics is shaped by money.

For example, a bankruptcy law that privileges derivatives over all else, but does not allow the discharge of student debt, no matter how inadequate the education provided, enriches bankers and impoverishes many at the bottom. In a country where money trumps democracy, such legislation has become predictably frequent.

But growing inequality is not inevitable. There are market economies that are doing better, both in terms of both GDP growth and rising living standards for most citizens. Some are even reducing inequalities.

America is paying a high price for continuing in the opposite direction. Inequality leads to lower growth and less efficiency.

Lack of opportunity means that its most valuable asset – its people – is not being fully used. Many at the bottom, or even in the middle, are not living up to their potential, because the rich, needing few public services and worried that a strong government might redistribute income, use their political influence to cut taxes and curtail government spending. This leads to underinvestment in infrastructure, education, and technology, impeding the engines of growth.

The Great Recession has exacerbated inequality, with cutbacks in basic social expenditures and with high unemployment putting downward pressure on wages. Moreover, the United Nations Commission of Experts on Reforms of the International Monetary and Financial System, investigating the causes of the Great Recession, and the International Monetary Fund have both warned that inequality leads to economic instability.

But, most importantly, America’s inequality is undermining its values and identity. With inequality reaching such extremes, it is not surprising that its effects are manifest in every public decision, from the conduct of monetary policy to budgetary allocations. America has become a country not “with justice for all,” but rather with favoritism for the rich and justice for those who can afford itso evident in the foreclosure crisis, in which the big banks believed that they were too big not only to fail, but also to be held accountable.

America can no longer regard itself as the land of opportunity that it once was. But it does not have to be this way: it is not too late for the American dream to be restored.


Joseph E. Stiglitz, a Nobel laureate in economics, has pioneered pathbreaking theories in the fields of economic information, taxation, development, trade, and technical change. As a policymaker, he served on and later chaired President Bill Clinton’s Council of Economic Advisers, and was Senior Vice President and Chief Economist of the World Bank. He is currently a professor at Columbia University, and has taught at Stanford, Yale, Princeton, and Oxford.He is the author of The Price of Inequality: How Today’s Divided Society Endangers our Future

How to have growth beyond stimulus
Jeffrey Sachs
June 7, 2012

Keynesian economists blame the sluggish US growth and lack of job creation on the insufficiency of stimulus measures. If only Congress had agreed with President Obama to greater stimulus, they say, the current US recovery would have been much stronger. This is a dubious proposition. The deeper problem lay in the limitations of fiscal stimulus as a response to the 2008 crisis.

Stimulus spending has been sizeable. According to the International Monetary Fund’s measurement of these things, the fiscal stimulus has been large and persistent. The IMF looks at “general government structural balance as a percent of potential GDP,” which measures the general government budget balance net of automatic stabilisersspending that kicks in during downturns, such as unemployment benefit. In 2007, the structural deficit was 2.8 per cent of gross domestic product. This rose to 5.0 per cent of GDP in 2008, mainly because of tax cuts implemented by the Bush administration at the onset of the crisis. With Mr Obama’s stimulus program, the structural deficit rose further to 7.5 per cent of GDP in 2009, and stayed at roughly that level through 2011.

Thus, the structural fiscal expansion was more than 4 per cent of GDP on a sustained basis during 2009-11 compared with 2007. The actual deficit including automatic stabilisers and the Troubled Asset Relief Program (bank bailout) funds was far larger, rising from 2.7 per cent of GDP in 2007 to 13.0 percent of GDP in 2009, 10.5 percent of GDP in 2010, and 9.6 percent of GDP in 2011. Net public debt as a share of GDP soared from 48.2 per cent of GDP in 2007 to 80.3 per cent of GDP in 2011, according to IMF data.

Fiscal stimulus, in short, has been tried, but did not succeed in spurring a robust recovery. Advocates of stimulus bemoan the idea of reversing the fiscal expansion now, in view of the weak economy, and argue that it be prolonged and expanded. The original idea of the stimulus, however, was as a temporary measure that would make a bridge to self-sustaining private-sector-led recovery.

The Keynesian interpretation in late 2008 and early 2009 was that the economic downturn was a cyclical matter. A housing boom had turned temporarily to bust. Consumer spending was temporarily down. Temporary tax cuts would boost consumer spending while a temporary boost in government spending would create temporary jobs in construction and preserve jobs in cash-strapped state and local governments. By 2010 or 2011, a natural recovery would replace the temporary fiscal boost, and allow it to be withdrawn.

Yet the cyclical recovery proved to be anaemic. The national accounts suggest some reasons why. First, the housing bust did not reverse itself. As of the first quarter of 2012, real investments in residential structures remained 55 per cent below the 2005 level.
Yet this was not surprising. It was neither possible nor desirable to re-inflate the housing bubble.

Second, the fiscal stimulus was at least partially offset by a rise in household saving. Economic theory and experience teaches that temporary tax cuts and transfers to households, of the kind implemented repeatedly in recent years, are partly or wholly saved. Households pay down their debts rather than making new outlays on consumer goods.

Many state and local governments apparently used the federal transfers to replace rather than augment their own revenues and to replenish their own financial balances, rather than to reverse their plans for layoffs and investment cutbacks. There was no rise in overall government investment (i.e. federal, state, and local) spending as a share of GDP. The stimulus was almost all in the form of tax cuts and transfer payments rather than outlays for investment projects.

Two major implications of the Keynesian interlude are the following. First, and most importantly, there has been no new dynamic growth sector in the US economy to replace the defunct housing boom. Consumer spending did not surge; housing did not return; private investments in industry did not take over; and public investments did not fill the gap. Second, the multipliers on short-term Keynesian stimulus measures proved to be low and variable rather than high and predictable. The continuation of the Keynesian option at this stage is therefore unappealing: a further build-up of public-sector debt with little guarantee of job creation or a reliable exit strategy.

The tragedy is that the Republican opposition to the Obama-led stimulus measures is even wider off the mark. The Republican strategy would make the temporary tax cuts permanent, and even create new tax breaks for top earners, to be paid by swingeing cuts in programs for job training, education, infrastructure, the environment, and support for the poor. The Republicans live in a world in which the rich are the only worthies in the society (the “job creators”), the unemployed and poor should fend for themselves, and public goods do not exist. And they do so despite thirty years of failed trickle-down policies that have created unprecedented inequality, deepening poverty, and no solutions to the loss of jobs.

There is another way, not represented by either US political party. It would be based on the following four premises.

First, the US (and Europe) needs a new source of long-term growth, not a short-term Keynesian bridge to consumer-led growth.

Second, the highest social returns can be achieved by bringing the new technologiesinformation, communications, transportation, materials, and genomics – to bear on the problems of sustainability and the quality of life. Long-term growth (and quality of life) should be based on an investment-led transition to a low-carbon, low-pollution, and high-amenity built environment, drawing upon the cutting-edge advances of science and engineering.

Third, the transition to sustainability requires a mix of public and private investments. As one example, private investments in low-carbon energy (wind, solar, nuclear) need to be linked to public investments in long-distance transmission grids. Similarly, the transition to smart electric-powered urban mobility will require a mix of private investments and public infrastructure. The public investments should be financed in part through long-term borrowing backed by dedicated future revenue streams (e.g. public-sector tariffs and gradually rising carbon taxes).

Fourth, rather high levels of taxation as a share of national income (as in the highly successful economies of northern Europe) are needed to keep budget deficits low while also ensuring adequate public revenues for universal coverage of high-quality public services and human capital investments that span early childhood through public education, apprenticeships, and job training.

While there are absolutely urgent short-term matters to facenotably putting out the fire of bank runs in the eurozone — the deep solution to the crisis of the high-income countries lies in a long-term vision of sustainable development, one that promotes a mix of complementary public and private investments. To get there, we need to move beyond the stale US political debate pitting short-run Keynesian stimulus on one side versus trickle-down economics on the other.