June 18, 2012 8:10 pm

Time to act: euro collapse would define our era

Once again good news has had a half-life in the markets of less than 24 hours. Just as news of Spain’s bank bailout rallied markets and sentiment for only a few hours, a Greek election outcome as good as could have been hoped did not buoy markets for even a day. There could be no clearer evidence that the strategy of vowing that the European system will hold together, doing the minimum to address each crisis as it comes and promising to build a system that is sound in the long run has run its course.

Nor is the Group of 20 leading economies, whose leaders conclude their meeting today, likely to change anything soon. Europe’s troubled economies will demand more emphasis on growth, lower interest rates on their official debts and more transfers. The Germans will show sympathy with the aim of reform but will insist that financial integration coincide with political integration. The rest of the world will express exasperation with Europe’s failures and demand more be done. Officials blessed with more diplomatic than economic insight or courage will produce a communiqué expressing a measure of satisfaction with the steps under way, recognising the need to do more and looking forward to continued dialogue. The only good thing is that expectations are so low this will barely disappoint markets.

The truth is that Europe’s debtors and creditors are both right. The borrowers are right that austerity and internal devaluation have never been a successful growth strategy, certainly not when major trading partners are stagnating. In the few cases where fiscal consolidations have preceded growth, they have either involved stagnation relative to previous levels of income (as in Ireland and the Baltics) or buoyant demand associated with surging exports, increasing competitiveness and low borrowing costs (many euro members in the early years). The borrowers are also right to claim that even a previously healthy economy will quickly become very sick if forced to operate for several years with interest rates far above growth rates, as is the case across southern Europe. And experience clearly shows that structural reform is always harder when an economy is contracting and there is no sector to absorb those displaced by reform.

Those wary of institutionalising financial integration without serious political integration are right as well. In a sound system, those with deep pockets who act either as borrowers or as guarantors must have control over borrowing decisions. A system where I borrow and you repay is a prescription for profligacy. This is why there is now so much discussion of eurozone bonds and Europe-wide deposit insurance being linked with much deeper political integration.

But there are two problems lying behind the soft references to greater integration. The first is the question of who really has control. If decisions are genuinely to be made at eurozone level, it is far from clear that there is any majority or even plurality support for responsible policies. If the idea is that the eurozone will be modelled on the European Central Bank – a European facade behind which Teutonic policies are pushed – it is far from clear that this will or should be acceptable across the continent.

The second problem is the scale of the transfers that could be involved. A good guess would be that during the US savings and loans crisis, the American south-west received a transfer from the rest of the country equal to at least 20 per cent of its gross domestic product. Is there a real will to commit to potential transfers of this scale in Europe? Maybe all of this can be resolved but it will surely not happen quickly.

Not all problems can be solved. It is not certain that the full repayment of all currently contracted sovereign debts, sustainable growth for all, and the eurozone retaining all its current members will prove feasible. The private sector is making clear that it recognises this painful reality. Official sector planning needs to recognise it as well. Outside Europe, even as leaders hope for the best they need to plan for the worst, ensuring adequate liquidity and demand in their economies even if Europe’s situation deteriorates rapidly. The fortification of the International Monetary Fund is a start but policy makers need also to consider national policies, trade, finance and social safety nets.

But a eurozone collapse would be a disaster that might define our era. Its prospect must focus the minds of all at the G20 summit on action. Non-Europeans must persuade Europeans that the rules change when the stakes rise. The ECB’s credibility will mean little if there is no longer a common currency.

Setting the right precedent seemed far more important 24 hours before Lehman’s collapse than 24 hours after it. Now is the time for radical cuts in the rates charged by official creditors to European sovereigns; for a willingness to subordinate official debts; and for expansionary monetary policies in Europe that prevent deflation and encourage the growth that can create jobs and reduce debts. Only if the system is preserved can its future be debated.

The writer is a former US Treasury secretary and Charles W. Eliot university professor at Harvard

Copyright The Financial Times Limited 2012


Updated June 17, 2012, 7:25 p.m. ET

A Greek Reprieve

The Germans might have preferred a victory by the left in Athens.

Getty Images
New Democracy party leader Antonis Samaras after the election in Greece on Sunday.

Europeansat least the non-Germansbreathed a sigh of relief Sunday as a plurality of Greek voters took a step back from jumping out of the euro zone. Now we'll see what Europe's leaders can do with their latest reprieve.

Tallies as we went to press Sunday indicated the center-right New Democracy party won some 29.5% of the vote, up from its 18.8% showing last month. New Democracy told voters it wants to remain in the euro zone while claiming it would be better able to renegotiate the terms of the Greek bailout provided by the rest of the Europe.

Trailing New Democracy was the hard-left Syriza coalition with 27.1%up substantially from its count from last time. The center-left Pasok, which dominated Greek politics for a generation and won the 2009 elections, was slated to take a mere 12.3%. Pasok polled only slightly more votes than the combined tally for the Communists and the neo-Nazi Golden Dawn.

New Democracy leader Antonis Samaras has a better chance at forming a government than he did two months agoif only because failure would mean repeating the protests and violence that seem to increase with each Greek election. Pasok leaders have been coy about joining a New Democracy government, but that may change if the alternative is another election or more chaos.

As for Syriza, it may be just as happy losing this round, figuring it can pick up the pieces if the center-right fails again. Its tub-thumping leader, 37-year-old Alexis Tsipras, has been the great beneficiary of Greek rage at an economic program, misleadingly dubbed "austerity," that has managed to avoid neither recession nor default.

But the apparent plurality vote for New Democracy also suggests that Greeks aren't eager to follow Mr. Tsipras off the socialist cliff, especially if it means daring the rest of Europe to stop writing bailout checks. Perhaps more Greeks are coming to understand that German Chancellor Angela Merkel might have preferred a Syriza victory as an excuse to cut Greece out of the euro zone.

The Germans are beginning to conclude that Greece may be unreformable. A Syriza victory would have been seen as Greece pulling the plug on its own euro membership.

Mrs. Merkel will still face a difficult decision if Mr. Samaras forms a government and then seeks to renegotiate the bailout because he lacks the cash to fulfill its terms. Would the German Chancellor dare to say no, thus becoming the proximate cause of a first euro exit? That would be a terribly painful result for Greece, but as a lesson to the rest of Europe to shape up or suffer the same fate, it would have considerable utility. By itself, the high price of floating sovereign debt doesn't seem to be scaring straight either the Spanish or Italians.

The tragedy of Greece, and much of the rest of Europe, is that it overborrowed during the euro's first decade to finance a higher standard of living than it could afford. Now the debtors have to adjust.

The best way to do so is with supply-side reforms in taxes, pensions and labor markets that will lure investment and make Europe's economies more competitive. They need austerity for government but growth for the private economy. Without that, the Greek reprieve will be merely another opportunity lost.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Samaras’ victory offers relief but no answers

Stephen King

June 18, 2012

So, huge sighs of relief all round. Greece’s New Democracy party, led by Antonis Samaras, managed in Sunday’s elections to head off growing support for the radical left wing Syriza alliance. Mr Samaras looks set to become Greece’s next Prime Minister.

The Athens ATMs won’t run dry, there will be no sudden reintroduction of drachmas and Greece will happily be able to persuade itself that it remains firmly held in the bosom of Europe. The euro lives to fight another day.

Mr Samaras will now attempt to form a ragtag government including more or less everyone except Syriza. At the very least, that means a coalition involving both the centre-right New Democracy and the socialist Pasok party, hardly the cosiest of bedfellows. They have, after all, been at each other’s throats for the past few decades.

Still, both New Democracy and Pasok claim to be both pro-euro and pro-austerity, so Greece’s European partners and the wider world should be able to breathe a sigh of relief.

In the midst of the euphoria that will doubtless dominate financial markets in the days ahead, a few choice facts will be conveniently pushed to one side. New Democracy was, arguably, the party that got Greece into its current mess in the first place, having been in office between 2004 and 2009.

Pasok was the party in charge of putting things right between 2009 and 2011. During that period, the Greek economy collapsed, too many austerity promises were broken and the Germans and French eventually ran out of patience, warning Greece that, if it didn’t behave, its days in the euro were numbered. And Greece has no real history of cosy coalition politics: it may just be possible to form a government after Sunday’s election but how long it will last is another matter altogether.

Mr Samaras, meanwhile, will doubtless be hoping to renegotiate Greece’s austerity obligations once again. In that regard, the mainstream Greek parties are not so different from Syriza, much to the irritation of Greece’s European partners. The Troika’s ongoing frustration with Greece, after all, has been the yawning credibility gap between promise and delivery with regard to both austerity and long-run structural reform.

So before we all drink too much celebratory retsina, it’s important to recognise that Greece still has mountains to climb. True, there have been big improvements in the fiscal position over the last year or so but Greek access to international capital markets is non-existent, the economy has already contracted 16 per cent and is set to shrink further, and its creditors expect to see a lot more reform than has so far been delivered.

The eurozone, meanwhile, has its own Mount Olympus to conquer. While the Greek elections have reduced the chances of an early Greek exit, they have only papered over the cracks that have emerged over the last two or three years. The battle between northern European creditors – who, until recently, lent far too generously – and southern European debtors, who invested the loans far too stupidly, is set to continue.

Thanks, initially, to the sub-prime crisis, levels of economic activity across Europe are much lower than was anticipated just five years ago, making it that much more difficult for debtors to repay their creditors. Whatever one thinks of Greece’s behaviour in recent years, it’s not the only country having difficulty accessing capital markets.

Pre-euro, we know what would have happened. Countries in the south would have devalued against their northern rivals. The Deutsche Mark value of, say, peseta debt would have dropped and Spain would have achieved a “default by stealthalongside a big improvement in competitiveness.

Life in the euro is not so easy. No one, as yet, has found a convincing answer for dealing with excessive debts or with southern Europe’s lack of competitiveness.

In the absence of currency moves, what kind of adjustment is needed? Austerity hasn’t worked, no one wants a wave of defaults and, as yet, the Germans are dead against fiscal transfers.

At the end of the month, European leaders meet in Brussels to discuss the next steps with regard to the eurozone’s governance. The French want a banking union first of all, reasoning that, without it, Spain’s problems – and contagion effects to eurozone banks more generally – will only worsen. Germany, however, insists that, as a banking union is the first step towards a fiscal union, it cannot be allowed to happen without the eurozone first of all creating some kind of political union.

Logic is perhaps on Germany’s side. Time, however, is not. Even with longer-term refinancing operations and Spanish bank bailouts, the bank and sovereign runs that have undermined the euro’s integrity have only accelerated. The Greek election results will doubtless slow the process temporarily but they hardly represent a handbrake turn.

The good news is that there is no imminent Greek exit. The eurozone’s structural integrity remains intact for now. The fear of break-up will fade and the sell-off of peripheral debt should reverse.

But most of the big questions remain unanswered. Can a monetary union survive without a fiscal and political union? Probably not. Can the southern European nations improve their competitiveness? Yes, but only very slowly. In the meantime, will they need a helping hand from German taxpayers? Yes, but Berlin doesn’t want to foot the bill.

One smaller question also needs to be addressed. Will a New Democracy-led coalition really administer the tough medicine demanded by the Troika? History suggests otherwise. Beware, then, Greek voters bearing gifts.


Predators and Professors

Simon Johnson

18 June 2012

WASHINGTON, DCAre America’s great universities still the stalwart custodians of knowledge, leading forces for technological progress, and providers of opportunity that they once were? Or have they become, in part, unscrupulous accomplices to increasingly rapacious economic elites?

Towards the end of Charles Ferguson’s Academy Award-winning documentary Inside Job, he interviews several leading economists regarding their role as paid cheerleaders for the financial sector’s excessive risk-taking and sharp practices in the run-up to the crisis of 2008. Some of these prominent academics received significant sums to promote the interests of large banks and other financial-sector firms. As Ferguson documents in the movie and in his recent sobering book, Predator Nation, many such payments are not fully disclosed even today.

Predation is an entirely appropriate term for these banks’ activities. Because their failure would traumatize the rest of the economy, they receive unique protections – for example, special credit lines from central banks and relaxed regulations (measures that have been anticipated or announced in recent days in the United States, the United Kingdom, and Switzerland).

As a result, the people who run these banks are encouraged to assume a lot of risky bets, which include pure gambling-type activities. The bankers get the upside when things go well, while the downside risks are largely someone else’s problem. This is a nontransparent, dangerous, government-run subsidy scheme, ultimately involving very large transfers from taxpayers to a few top people in the financial sector.

To protect the scheme’s continued existence, global megabanks contribute large amounts of money to politicians. For example, JPMorgan Chase CEO Jamie Dimon recently testified to the US Senate Banking Committee about the apparent breakdown of risk management that caused an estimated $7 billion trading loss at his firm. OpenSecrets.org estimates that JPMorgan Chase, America’s largest bank holding company, spent close to $8 million in political contributions in 2011, and that Dimon and his company donated to most senators on the committee. Not surprisingly, the senators’ questions were overwhelmingly gentle, and JPMorgan Chase’s broader lobbying strategy appears to be paying off; “investigations” of irresponsible and system-threatening mismanagement will likely end up as whitewash.

In support of their political strategy, global megabanks also run a highly sophisticated disinformation/propaganda operation, with the goal of creating at least a veneer of respectability for the subsidies that they receive. This is where universities come in.

At a recent Commodity Futures Trading Commission roundtable, the banking-sector representative sitting next to me cited a paper by a prominent Stanford University finance professor to support his position against a particular regulation. The banker neglected to mention that the professor was paid $50,000 for the paper by the Securities Industry and Financial Markets Association, SIFMA, a lobby group. (The professor, Darrell Duffie, disclosed the size of this fee and donated it to charity.)

Why should we take such work seriously – or any more seriously than other paid consulting work, for example, by a law firm or someone else working for the industry?

The answer presumably is that Stanford University is very prestigious. As an institution, it has done great things. And its faculty is one of the best in the world. When a professor writes a paper on behalf of an industry group, the industry benefits from – and is, in a sense, renting – the university’s name and reputation. Naturally, the banker at the CFTC roundtable stressedStanford” when he cited the paper. (I’m not criticizing that particular university; in fact, other Stanford faculty, including Anat Admati, are at the forefront of pushing for sensible reform.)

Ferguson believes that this form of academicconsulting” is generally out of control. I agree, but reining it in will be difficult as long as the universities and “too big to failbanks remain so intertwined.

In this context, I was recently disappointed to read in The Wall Street Journal an interview with Lee Bollinger, President of Columbia University. Bollinger is a “class Cdirector of the Federal Reserve Bank of New York – appointed by the Board of Governors of the Federal System to represent the public interest.

In what was apparently his first-ever interview or public statement on banking-reform issues (or even finance), Bollinger’s main point was that Dimon should continue to serve on the board of the New York Fed. He used surprisingly nonacademic languagestating that “foolishpeople who suggest that Dimon should resign or be replaced have a “false understanding” of how the system really works.

I am currently petitioning the Board of Governors to remove Dimon from this position. Nearly 37,000 people have signed the on-line petition at change.org, and I am optimistic that I will have a meeting soon with senior Washington, DC-based Board staff to discuss the matter.

Bollinger’s intervention may prove helpful to Dimon; after all, Columbia University is one of the world’s best-regarded universities. On the other hand, it could also prove productive in advancing the public debate about howtoo big to failbankers sustain their implicit subsidies.

I have written a detailed rebuttal of Bollinger’s position. I hope that Bollinger, in the spirit of open academic dialogue, replies in some public formeither in writing or by agreeing to debate the issues with me in person. We need a higher-profile conversation about how to reform the unhealthy relationship between universities and subsidized global financial institutions, such as JPMorgan Chase.

Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-author, with James Kwak, of White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You


Copyright Project Syndicate - www.project-syndicate.org

Does Gold Keep Up In Hyperinflation?
By Alena Mikhan and Jeff Clark

Inflation is a natural consequence of loose government monetary policy. If those policies get too loose, hyperinflation can occur. As gold investors, we'd like to know if the precious metals would keep pace in this extreme scenario.

Hyperinflation is an extremely rapid period of inflation, but when does inflation (which can be manageable) cross the line and become out-of-control hyperinflation? Philip Cagan, one of the very first researchers of this phenomenon, defines hyperinflation as "an inflation rate of 50% or more in a single month," something largely inconceivable to the average investor.

While there can be multiple reasons for inflation, hyperinflation historically has one root cause: excessive money supply. Debts and deficits reach unsustainable levels, and politicians resort to diluting the currency to cover their expenses. A tipping point is reached, and investors lose confidence in the currency.

"Confidence" is the key word here. Fiat money holds its purchasing power largely on the belief that it is stable and will preserve that power over time. Once this trust is broken, a flight from the currency ensues. In such scenarios, citizens spend the money as quickly as possible, typically buying tangible items in a desperate attempt to get rid of currency units before they lose value. This process increases the velocity of money, setting off a vicious cycle that destroys purchasing power faster and faster.

The most famous case of hyperinflation is the one that occurred in Germany during the Weimar Republic, from January 1919 until November 1923. According to Investopedia, "the average price level increased by a factor of 20 billion, doubling every 28 hours."

One would expect gold to fare well during such an extreme circumstance, and it did - in German marks, quite dramatically. In January 1919, one ounce of gold traded for 170 marks; by November 1923, that same ounce was worth 87 trillion marks. Take a look. (Click here to enlarge)

Inflation was at first benign, then began to grow rapidly, and quickly became a monster. What's important to us as investors is that the price of gold grew faster than the rate of monetary inflation. The data here reveal that over this five-year period, the gold price increased 1.8 times more than the inflation rate.

The implication of this is sobering: while hyperinflation wiped out most people's savings, turning wealthy citizens into poor ones literally overnight, those who had assets denominated in gold experienced no loss in purchasing power. In fact, their ability to purchase goods and services grew beyond the runaway prices they saw all around them.

One can't help but wonder how the people whose wealth evaporated in Germany during this time felt. In effect, they were robbed by the government - they were on the losing end of a massive transfer of wealth. Of course, there are two sides to the story, as those who held significant amounts of gold and silver were the recipients.

Could the US experience a wealth transfer like the one that wracked the Weimar Republic? While the federal government and most so-called economic "experts" dismiss the notion, the economic data suggest that it's already started.

We can't help but speculate about whether most citizens dismissed the idea of inflation during the calm period in 1920-'21. Did respected economists scoff at the idea that Germany could suffer hyperinflation, just before it struck? Did some politicians proclaim that "a little inflation would be good?"

Those who today argue that our obscene debt levels, runaway deficit spending, and money-printing schemes are sound strategies and believe they won't lead to out-of-control inflation might want to rethink those beliefs. We've seen this movie before: it doesn't have a happy ending.

The historical record is clear on what happens when countries embark on fiscal and monetary paths today's leading economies are embracing. If gold's recent price performance is anything like the calm before Germany's hyperinflationary storm, this is a time to be accumulating more gold.

Keep in mind that hyperinflation is not a rare event. Since Weimar Germany, there have been 29 additional hyperinflations around the world, including those in Austria, Argentina, Greece, Mexico, Brazil, Taiwan, and Zimbabwe, to name a few. On average, that's one every three years or so.

While hyperinflation devastates those who experience it, there is a healing aspect to it. Since the responsibility for this type of disaster lies solely at the feet of government, there may be some Darwinian justice to the way hyperinflation purges the perverse fiscal and monetary imbalances from an economy. After the Weimar Republic hyperinflation, the second half of the 1920s was a strong period for Germany, with low inflation and steady growth.

It's no secret that many currencies around the world, including the US dollar, are choosing the path of inflation. If we were to slip into hyperinflation, there will be disastrous consequences for those unprepared. Given that the US dollar is the world's reserve currency, the problems would spread to practically every country on earth. Hyperinflation will shake people's confidence not only in the US dollar, but in the paper currency system as a whole.

What will actually come to pass, we don't know. What we do know is that the measures to cure hyperinflation include tying the currency to a hard asset or even replacing it with one. When creditability in fiat money dissipates, gold may be the only viable option left standing.

Again, the investment implication is obvious: continue to accumulate gold.

How much is enough? Well, how many ounces do you own in relation to your total assets? Anything less than 5% will not offer you a sufficient level of protection in a high inflationary environment.

Another way to look at it is this: how many ounces do you need to cover your monthly expenses? In Weimar Germany, inflation rose uncomfortably for two years - and then pinched harder, spiraling into a destructive hyperinflation for another two. Consider what it would take to maintain your standard of living for a couple years instead of just a couple months.

And don't listen to any government's ongoing pronouncements of confidence in the current system, along with the mainstream media's noisy and frequently inaccurate portrayals of the gold market. (For example, these two headlines appeared on the same day: Gold Edges Lower as Worries over Europe Simmer; and Gold Settles Higher on Spanish Bailout Plans.) In a world awash in ignorance about real money, if not deliberate obfuscation, you have to study the relevant history, draw your own conclusions, and stick with them.