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Spain, Debt and Sovereignty
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By George Friedman
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June 12, 2012 | 0900 GMT


Stratfor




Eurozone countries on June 9 agreed to lend Spain up to 100 billion euros ($125 billion) to stabilize the Spanish banking system. Because the bailout dealt with Spain's financial sector directly rather than involving the country's sovereign debt, Madrid did not face the kind of demands for more onerous austerity measures in exchange for the loan that have led to political instability in countries such as Greece.



There are two important aspects to this. First, yet another European financial problem has emerged requiring concerted action.


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Second, unlike previous incidents, this bailout was not accompanied by much melodrama, infighting or politically destabilizing threats. The Europeans have not solved the underlying problems that have led to these periodic crises, but they have now calibrated their management of the situation to minimize drama and thereby limit political fallout. The Spanish request for help without conditions, and the willingness of the Europeans to provide it, moves the European process to a new level. In a sense, it is a capitulation to the crisis.




This is a shift in the position of Europe's creditor nations, particularly Germany. Berlin has realized that it has no choice but to fund this and other bailouts. As an export-dependent country, Germany needs the eurozone to be able to buy German products.


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Moreover, Berlin cannot allow internal political pressures to destabilize the European Union as a whole. For all the German bravado about expelling countries, the preservation and even expansion of the existing system remains a fundamental German interest. The cycle of threats, capitulation by creditors, political unrest and then German accommodation had to be broken. It was not only failing to solve the crisis but also contributing to the eurozone's instability. In Spain, the Germans shifted their approach, resolving the temporary problem without a fight over more austerity.




The problem with the solution is that it does nothing to deal with the larger dilemma of European sovereignty and debt. Germany is taking responsibility for solving Spain's banking problem without having any control over the Spanish banking system. If this becomes the norm in Europe, then Germany has moved from the untenable threat of expelling countries to the untenable promise of underwriting them. Europe, in other words, has accommodated itself to the perpetual crises without solving them.



In our view, the root of the problem is the struggle to align the world's second-largest exporter with a bloc of nations that ought to be enjoying positive trade balances but are instead experiencing trade deficits. Germany, however, views the root of the problem as undisciplined entitlement and social program spending that leads to irresponsible borrowing practices.



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Thus the Europhiles, led by Germany, don't look for solutions by redefining the European trading system, but rather by disciplining countries, particularly within the eurozone, on their spending and borrowing practices.



.According to a report in German magazine Der Spiegel, European Central Bank President Mario Draghi, Eurogroup President Jean-Claude Juncker, European Council President Herman Van Rompuy and European Commission President Jose Manuel Barroso are drafting a plan to stabilize the system. Under the purported plan, all eurozone members would be required to balance their budgets. Borrowing would be permitted only if approved by a Europe-wide finance minister, a position that would have to be created and supported by a select group of eurozone finance ministers. If approved, money could be borrowed by issuing eurobonds.


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The report appears to be well grounded, with European leaders confirming that the four individuals are working on a plan (though they did not confirm the plan's details). The approach outlined in the report would attempt to resolve Europe's problems by increasing the Continent's political integration -- a concept that has been discussed extensively, particularly by the Germans and Europhiles. Given the circumstances, this would seem to be a reasonable position. If all of Europe is going to be responsible for sovereign debt issued by member countries, then the stakeholders who have the most invested in the European project must have control over borrowing. The moral hazard of de facto guarantees on borrowing without such controls is enormous.


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There are two problems inherent in this approach. The first, as we have said, is the assumption that Europe's core problem is irresponsible borrowing and that if borrowing were controlled, the European problem would be solved. Irresponsible borrowing is certainly part of the problem, but the deeper issue is trade.



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The European Union is built around Germany and therefore the sort of economic dynamism that Germany enjoyed in the 1950s and 1960s, when the country benefited from access to the U.S. market while retaining some protection for its own emerging industries. Eurozone countries' inability to cover debt payments stems in part from their inability to compete with Germany.


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Under normal circumstances, the economies of developing countries grow through exports driven by lower wage rates, but the shared currency prevents developing European countries from taking advantage of low wages. Borrowing may be too high, but Germany's dependence on exports makes it impossible for Berlin to allow a Greece or a Spain the time and space to develop critical economic sectors in the way that the United States allowed Germany to develop after World War II.



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The second problem is the more serious one. The ability to manage a national budget, including the right to borrow, is a central element of national sovereignty.


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If the right to borrow is transferred from national governments to unelected functionaries appointed by a multinational entity, a profound transformation of democracy in Europe will take place. The European Union has seen transfers of sovereign rights from national governments and their electorates before, but none as profound as this one. Elected governments will not be able to stimulate their economies without approval of this as-yet-unnamed board, nor will they be able to undertake long-term capital expenditures based on the issuance of bonds. This board thus will have enormous power within individual countries.




This prospective solution involves more than simply an attempt to solve banking and debt problems. It reflects a fundamental principle of European political philosophy: the belief that disinterested officials are likely to render better decisions than interested politicians. This idea derives from deep in European intellectual history. Georg Hegel, a German philosopher, made the argument that the end of history was its full rationalization, represented by the rational and disinterested civil servant. Jean-Jacques Rousseau distinguished between the general will and the popular will. He argued that the latter did not represent the interests of the people but that the general will, the source of which was not altogether clear, did.



There is a strand of thought in Europe that regards the disinterested professional as both safer and likely to make better decisions than the popular will and its politicians. This is not an altogether anti-democratic view, but it is a view that says that politics must be moderated by disinterested experts. This idea heavily influenced the structure that was created to manage the European Union and is clearly behind the idea of a European budget board.



.The question of the budget is central to a democracy and a highly politicized process. It is one of the places in which the public and its representatives can debate the direction in which the nation should go. The argument has been made that the public and its politicians cannot be trusted with absolute power in this area and that power should be limited to unelected people. In a sense, it is the same argument that has been made for central banks, with even greater power.




The problem, of course, is that the decisions made by this board will be highly political. First, the board must be appointed. The selection of the chief eurozone finance minister and the finance ministers represented on the board will be determined in some process that likely will not take the views of average European citizens into account. Second, the board will make decisions that will determine how the citizens of individual nations live. The board derives from a political process and shapes national life. It is apolitical only in the sense that its members don't stand for election by the populations they oversee and thus are not answerable to them.



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There was a similar agreement before the current crisis called the Stability and Growth Pact, which said that the national deficit of a European nation could not exceed a certain percentage. If the deficit did, the nation would pay massive fines. The French (and even the Germans) consistently exceeded these limits but did not pay fines. They were too powerful to be sanctioned, so the system broke down.



Today, we see a concept that goes far beyond the Stability and Growth Pact. The idea is that nations will have no deficits without the permission of an appointed board and that any debt they do take on will be issued through an EU mechanism. That mechanism will eliminate the option of cheating. It may be possible to issue unauthorized bonds, but without a European guarantee, the market would charge a country like Greece prohibitively high interest rates.



But the core problem is the decision about who will and will not be allowed to borrow. Ideally, this decision would be completely transparent and predictable. In practice, the differences and needs of different countries will be so vast that the board will have to make some decisions. Given that the board will be composed of the finance ministers of some eurozone countries -- and that they will have to go home after a decision -- the question of who will be denied permission will be perceived as highly political and, in some cases, as extremely unfair. In some cases, both will be true.



The ultimate issue has nothing to do with economics, save for the trade issue. It is a question of the extent to which European publics are prepared to cede significant elements of national sovereignty in exchange for secured lines of credit, subject to the authority of people they never elected. For EU supporters, the notion that political leaders must be selected by the people they govern is not an absolute.


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Rational governance by disinterested leaders is an alternative and, at times, a preferred alternative. This is not entirely alien to the European tradition. In practice, however, it could create an explosive situation. The board will determine its willingness to grant deficits based on its own values. It may not permit deficits to fund hospitals for the poor. It may allow borrowing to fund bank bailouts. Or the reverse.



In any event, by taking power from the electorate, it risks a crisis of legitimacy.



The system has evolved to a point where, to some Europeans, this crisis of legitimacy may be preferable to the current cycle of endless crises. It may work for a time. But the first time a nation's government is thwarted from borrowing to fund a project while another nation is allowed to borrow for its project, a new crisis will emerge. Who in the end will determine which deficit is permitted and which is denied? It will not always be the representatives of the country denied. And that will create a crisis.



During the U.S. Civil War, the future of the Union was challenged by the secession of the South. The decisions were made on the battlefields where men were willing to die either for the Union or to break away from it.


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Who will die for the European Union? And what will hold it together when its decisions are unpopular? The concept of extended integration can work, but not without the passion that moves a Greek or a German to protect his and his country's interest.


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Without that, the glue that holds nations together is missing in the European Union. The greater the integration, the more this will reveal itself.



June 12, 2012 7:30 pm
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I will keep Greece in the eurozone and restore growth
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By Alexis Tsipras

Lest there be any doubt, my movementSyriza – is committed to keeping Greece in the eurozone.
President Barack Obama was right when he said last Friday: “Let’s do everything we can to grow now, even as we lock in a long-term plan to stabilise our debt and our deficits, and start bringing them down in a steady, sensible way.” That applies to my country, too. The need for giving Greece a chance for real growth and a new future is now more widely accepted than ever.


I strongly believe we will get a clear democratic mandate from the people of the Hellenic Republic on Sunday. With that mandate we will take immediate action to end Greece’s corrupt and inefficient political and regulatory systems that have ravaged our economy over the past decades. The people of Greece also expect us to take immediate responsibility for averting the country’s evolving humanitarian crisis.



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Syriza is the only political movement in Greece today that can deliver economic, social and political stability for our country. The stabilisation of Greece in the short term will benefit the eurozone at a critical juncture in the evolution of the single currency. If we do not change our path, austerity threatens to force us out of the euro with even greater certainty.



Only Syriza can guarantee Greek stability because we do not carry the political baggage of the establishment parties that have brought Greece to the brink of ruin. It is for this reason that voters support our commitment to pulling our country back from the edge of destruction. We will set Greece on a new path to growth through transparent government. A renewed Greece will contribute to the new foundations of a closer, more unified Europe. Developments in Spain at the weekend confirm that the crisis is pan-European, and the way it has been handled so far has been completely ineffectual.




The people of Greece want to replace the failed old memorandum of understanding (as signed in March with the EU and International Monetary Fund) with a “national plan for reconstruction and growth”. This is necessary both to avert Greece’s humanitarian crisis and to save the common currency.



The systemic fiscal problems of Greece are, in large part, a problem of low public revenues. Myriad tax concessions and exemptions granted to special interests by previous administrations, along with a low effective tax rate on personal income as well as capital, explain much of the problem. So too does the highly ineffective method of tax collection.


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According to Eurostat, Greece lags behind the eurozone average of government revenue as a percentage of gross domestic product by 4 per cent. The two-party political system has spent decades conveniently ignoring the dire need for effective tax reform. It has focused its tax collection efforts on the one exhaustible source of income tax: middle and low-income households.



Under our plan for reconstruction and growth, we are committed to following a programme of pragmatic and socially just fiscal stabilisation. The structure of this programme consists of: stabilising public expenditure at approximately 44 per cent of GDP and reorientating this expenditure to ensure it is well spent; increasing revenues from direct taxation to the average European levels (by more than 4 per cent of GDP) over a four-year period; and reforming the tax regime so as to identify the wealth and income of all citizens, and to distribute equitably the burden of taxation.



Lack of financial transparency prevails, even as Greek banks are being recapitalised with loans from the troika (the EU, IMF and European Central Bank). We will ensure that viable banks are recapitalised transparently and in a way that is fully compatible with the public interest. That is the only way to ensure that the entire financial system is returned to full stability.



Arthur Miller once wrote that “an era can be said to end when its basic illusions are exhausted”. The basic illusion of good Greek government under the old regime of a two-party system has been exhausted. It is now totally incapable of ensuring our country’s return to growth and full participation in the eurozone. This Sunday we will bring Greece into a new era of growth and prosperity.



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The new era begins on Monday.



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The writer is president of Greece’s Syriza coalition


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Copyright The Financial Times Limited 2012

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Markets Insight

June 12, 2012 1:51 pm

We must avoid an accidental Greek exit

Acropolis Greece showing flag





Greece returns to the polls on Sunday in another attempt to elect a viable government, and the outcome of the election remains highly uncertain. Despite the broad-based support for euro membership among all major Greek parties and the general public, S&P is of the view that there is at least a one-in-three chance that Greece will exit.



A Greek exit could be brought about almost by accident. A Syriza-led government that fundamentally rejects the reforms agreed with the “troika” – the International Monetary Fund, European Commission and European Central Bank – could lead to a suspension of external financial support.




Deprived of its last source of credit, the government would be forced to balance its cash budget immediately. Given Greece’s structural problems of raising tax revenues, the government may have little choice but to cut spending even more vigorously and to run up mounting arrears.




In such an environment, Greece’s economic decline is likely to gain speed, with additional job losses and the political and social crisis worsening. And where hopelessness and despair prevail, populist policy measures, such as a eurozone exit, may come to pass.




From an economic perspective, adopting a national currency is likely to be very costly for the Greek population. While temporarily reducing the cost of Greek exports relative to trading partners, an exit would not in itself sustainably cure any of the Greek economy’s fundamental problems: its small export base, lack of competitiveness and large external imbalances.




A moratorium on foreign debt service would initially improve Greece’s current account deficit via a reduction of outward interest payments. But the remaining underlying trade deficit might prove extremely difficult to finance at an acceptable cost. The main export earner, tourism, is unlikely to create much additional revenue despite a cheaper drachma. This sector might suffer a reputational setback from the economic crisis and dissolving social cohesion.



Any sign of a Greek government seriously considering a eurozone exit is almost certain to lead to a run on deposits at Greek banks as savers try to avoiddrachmafication”. This will bring down the remnants of a debilitated Greek financial system, with state finances in no condition to prop up banks.



The introduction of a new currency would also lead to a likely wave of personal and corporate bankruptcies as debtors fail in their struggle to service euro-denominated obligations on devalued drachma incomes. While Greek lawmakers could legislate a currency conversion of private loans made under Greek law, this may be contested in overwhelmed courts and lead to problems at the creditor level.




In any case, the Greek private sector has accumulated a large stock of foreign debt, payable in euros irrespective of decisions taken in Athens. The same holds true for the cash-strapped government which would be very likely to default yet again: since the debt exchange earlier in the year, almost all government debt is under foreign law payable in euros. Shut off from access to trade financing and import insurance markets, Greece could find it challenging even to finance the import of basic necessities, such as food, energy and medicine.



With the financial sector insolvent, private sector bankruptcies and litigation paralysing economic activity, the country would face increasing risks of prolonged economic depression. Tax revenues would likely erode further, forcing the government to find additional savings. In other words, a euro exit scenario is likely to foster the downward spiral of economic contraction and fiscal austerity that the critics of the troika-inspired adjustment programme hope to avoid.

 

It is unlikely that any other eurozone member would follow were Greece to exit. Witnessing the Greek economic and social maelstrom expected to follow drachmafication would likely strengthen the resolve of other EU-IMF programme countries to pursue reforms and avoid the negative economic consequences of an exit.




We would also expect the European partners and the IMF to take a very supportive and lenient stance to prevent additional departures. But it remains unclear whether these efforts would be perceived as sufficient. It is plausible to assume a Greek exodus would establish an understanding among investors that eurozone membership is reversible, implicitly reintroducing currency risk. This might create new market pressures for the peripheral member states, necessitating a swift and forceful European policy response.




Our assumption is that such a response would be forthcoming. But if it were to prove inadequate to restore depositor and investor confidence, economic and financial problems in the eurozone could escalate. And that could have further negative implications for sovereign creditworthiness.


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Moritz Kraemer is head of Emea sovereign ratings at Standard & Poor’s Ratings Services


Copyright The Financial Times Limited 2012


June 12, 2012
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Germans, the Euro and the Painful Truth
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By CHARLES GRANT



Will the Germans save the euro? Many people within the European Union and further afield are urging Berlin to take bold steps to secure the currency’s future. They have become frustrated by the Germans’ apparent inaction.


.But the view of German policy makersconveyed to me on a recent visit to Berlin — is that the government will do what is necessary to save the euro. What it will not do, they say, is spell out in public the measures they are prepared to take, lest that encourage the euro zone’s problem countries to slacken efforts to curb budget deficits and enact reforms.


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However, the best intentions of German policy makers do not guarantee the euro’s survival. Whatever measures they deem necessary will have to clear the Bundestag, where many members oppose greater German generosity to Southern Europe, and then the constitutional court, which tends to cavil at more powers for the European Union.


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The court of public opinion also counts, but German leaders have seldom explained to voters how the euro underpins their prosperity. And in the event of a financial panic, perhaps prompted by a Greek exit from the euro, could Germany’s politicians respond quickly enough?


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According to one senior German official, the key people in the Chancellery and Finance Ministry have little understanding of financial markets. Berlin is around 450 kilometers from Germany’s financial center, Frankfurt, whereas in London and Paris politicians, officials and financiers live in close proximity. This may lead the German government, the official warns, to underestimate the speed with which markets can move, and their destructive potential.


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German officials know that a healthy euro requires deeper euro-zone integration. They recognize the need for some sort of “banking union.” They accept that they will have to talk abouteuro bonds” — pooled borrowing for the euro zone — but say that a fiscal union enforcing budgetary discipline must come first. They want an “economic union” that would push the euro zone’s weaker members to become more competitive. That would mean giving the European Commission the means to cajole governments to alter policies in areas such as pensions, labor markets, privatization and company taxation.


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Such changes would affect only euro zone countries, but require all 27 E.U. member-states to agree to amend the Union treaties. German officials worry that Britain might block a new treaty, as it did last December, forcing the other countries to set up parallel structures alongside the E.U. Such a result, they believe, would weaken both the single market and Britain’s sway within the Union. Given that Britain’s contribution to resolving the crisis has been sermons rather than money, the Germans do not think they owe London any favors.


.When “Anglo-Saxoncommentators criticize Germany for imposing excessive austerity, the response can veer toward paranoia. One key individual, when told that many G-20 countries agreed with the criticism, said that that was because Anglo-Saxons dominated the global media. One hears similar words in Beijing and Moscow.


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Britain may be a bother, but the country that causes the biggest worries is France. François Hollande has turned out to be harder to handle than expected, for example by repeatedly calling for euro bonds.


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.German officials fret that the French Socialists do not understand their country’s economic weakness, and that they are not serious about either structural economic reform or cutting the budget deficit. “If the markets see that France and Germany disagree on the euro, they will have more doubts about the currency, so the French should stop their propaganda wars against Germany,” one official said.


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The Germans are particularly annoyed that France has teamed up with Italy and others advocating a softening of austerity. Several months ago the Germans were fans of Mario Monti, Italy’s economist prime minister. But his public criticisms of German policy on the euro, combined with his lackluster labor-market reforms, have upset his erstwhile friends in Berlin.


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The divergence on how to handle the euro crisis between Germany (and allies such as Finland and the Netherlands), and a group led by France and Italy suggests an obvious compromise. France and the southern Europeans should accept structural reform, budgetary discipline and a loss of sovereignty over some aspects of economic policy making. Germany should give member states more time to reach budget targets, let the southern Europeans write off more debt, and accept some debt mutualization.


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Might Germany embrace such a grand bargain? Perhaps, one official said. “Some people around Hollande see what France must do, but it might be politically difficult for the French to accept fiscal union.” This bargain would be politically difficult for Germany, too.


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Even some admirers of Chancellor Angela Merkel admit that she lacks vision, dislikes grand ideas, is extremely cautious and has little emotional connection to the E.U. She resents being told what to do by foreigners and thinks their advice may be self-serving. But she is also a consummate political tactician who does not want to be the chancellor who allowed the euro to collapse.


.Hans Eichel, a former finance minister of the opposition Social Democratic Party, said the S.P.D. would support Merkel in doing what it takes to save the euro. “The Germans are skeptical about the euro but don’t want to return to the Deutsche mark, so if Merkel is brave enough to take Germany toward more Europe, the S.P.D., business and the trade unions will follow — but she must lead.”


,.Many Germans hope that the euro zone’s ailments can be cured without their having to pay very much. But some top officials in Berlin understand that Germany will have to pay a heavy price. If Merkel and other political leaders can explain this painful truth to the people, the euro’s prospects will improve.


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Charles Grant is director of the Center for European Reform and the author of the C.E.R. report “Russia, China and global governance.”