July 3, 2012 7:21 pm
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A step at last in the right direction
©David Humphries

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I was in Ischia, off the coast of Naples, during the latest eurozone summit. Many of the Italians present during the award of this year’s Ischia prizes for journalism thought that Italy had won two victories over Germany: in football, at the European championships, and in economics, at the European summit. Then came the football final, against Spain.


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How much is likely to be left of the summit euphoria a few months from now? The answer, I believe, is: something, but not all that much. The 19th crisis summit was better than many of its disappointing predecessors. But the game has not yet changed.


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Helpful steps were taken. The most important were the agreements to allow the eurozone’s rescue funds to recapitalise undercapitalised banks directly, rather than provide money via vulnerable governments (of particular benefit to Spain and potentially enormous benefit to Ireland) and to buy sovereign bonds in the market (of apparent benefit to Italy and Spain). It was also agreed that loans from rescue funds would not be senior to existing loans, which should reduce the risk of panics by lenders. Leaders also agreed a €120bn ($151bn) package of measures to promote growth. On the principle that support should coincide with control, the European Central Bank is to be given responsibility for a new system of European banking supervision, as a step towards what protagonists hope will be a true banking union.
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Yet what was not agreed is even more important. The list includes any increase in the funds available for the European Stability Mechanism (capped at €500bn); eurozone bonds, in any form; and a eurozone-wide deposit guarantee or bank resolution regime. Beyond this, the challenge of rebalancing competitiveness within the eurozone remains huge and, in the best of circumstances, long-lasting. Meanwhile, it needs to be stressed, the ECB has no intention of being buyer of last resort of sovereign bonds.




Thus the most important positive element is the movement towards breaking the mutually destructive links between banks and sovereigns. This is a step towards the eurozone equivalent of the US troubled asset relief programme, or Tarp. A consequence must be to take the responsibility for supervision out of the hands of national governments. The result is also going to be a huge further increase in the powers of the ECB.


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At the same time, this is only a small step towards a full banking union, which would require a bigger fiscal back-up than anything now available. Rational Spaniards and Italians still cannot regard a euro in one of their banks as being as safe as a euro in a German one, largely because elevated insolvency and break-up risks evidently remain.



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Meanwhile, the growth package, partly illusory and presumably to be spread over some years, is a mere bagatelle, at barely more than 1 per cent of eurozone gross domestic product. The decision to let the rescue funds buy government debt in the market is even less meaningful and could prove destructive, as the Belgian economist, Paul de Grauwe, now at the London School of Economics, argues in a recent article.



The outstanding debt of Italy and Spain is close to €2.8tn, or a little less than six times the size of the ESM. It is well known from the work on currency crises of Paul Krugman, the Nobel laureate, that speculators can bet safely against a fund known to be too small to stabilise a market.



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The only credible stabiliser is an entity with infinite firepower. In the case of sovereign finance inside the eurozone, the only entity able to protect a country against self-fulfilling runs on its sovereign debt is the ECB.


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Since the ECB is unwilling to act in this role and leaders are unwilling to give the ESM the powers to force it to do so, these proposals amount to spitting in the financial winds. Markets may have worked this out: while bond spreads have fallen, they remain dangerously elevated (see chart).



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What makes the agreements seem potentially more significant than on face value, however, are that: first, there was actual progress towards a higher degree of integration; and, second, a coalition formed between France, Italy and Spain. The latter suggests that the political dynamic of the eurozone might have altered with the rise to power of François Hollande. It also seems to confirm that Germany does not wish to seem isolated, provided it does not have to concede on fundamental principles. However these shifts certainly do not show that the path to true fiscal or banking unions now lies open.



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Either would require a far greater sense of solidarity than now exists. For the reasons I advanced last week, I remain sceptical of the feasibility of agreeing such unions or of making them work, if they are agreed.


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In substance, then, these are small steps, incapable of achieving the three necessary conditions for an end to the crisis: a definitive separation of banks from sovereigns; financing of weak sovereigns on manageable terms during the lengthy period of economic adjustment and retrenchment; and, above all, a return to healthy economic growth. Let us not be too grudging: the decision to allow the ESM to recapitalise banks directly is possibly very important, both in itself and for what it portends. It might transform Ireland’s position.


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Nevertheless, the biggest danger is that the economics of the eurozone are deteriorating fast. Joblessness reached 11.1 per cent in May, the highest on record for the zone. Worse, apart from its refusal to intervene in sovereign debt markets on the needed scale, the ECB is hopelessly late in taking necessary monetary action.


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With austerity biting in vulnerable countries, everybody is feeling the pinch: even Germany is not immune to downturns in big trading partners. It is conceivable that the eurozone will struggle through this economic trench warfare over the next several years. However, the costsnot just economic but also political – are likely to be enormous.


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Yes, the eurozone does need a new constitution. But the priority is to get economies moving. Until then, the risks of further crises remain.


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Copyright The Financial Times Limited 2012.


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The Euro’s Latest Reprieve

Joseph E. Stiglitz

03 July 2012





NEW YORKLike an inmate on death row, the euro has received another last-minute stay of execution. It will survive a little longer. The markets are celebrating, as they have after each of the four previouseuro crisissummits – until they come to understand that the fundamental problems have yet to be addressed.


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There was good news in this summit: Europe’s leaders have finally understood that the bootstrap operation by which Europe lends money to the banks to save the sovereigns, and to the sovereigns to save the banks, will not work. Likewise, they now recognize that bailout loans that give the new lender seniority over other creditors worsen the position of private investors, who will simply demand even higher interest rates.


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It is deeply troubling that it took Europe’s leaders so long to see something so obvious (and evident more than a decade and half ago in the East Asia crisis). But what is missing from the agreement is even more significant than what is there. A year ago, European leaders acknowledged that Greece could not recover without growth, and that growth could not be achieved by austerity alone. Yet little was done.


.What is now proposed is recapitalization of the European Investment Bank, part of a growth package of some $150 billion. But politicians are good at repackaging, and, by some accounts, the new money is a small fraction of that amount, and even that will not get into the system immediately. In short: the remediesfar too little and too late – are based on a misdiagnosis of the problem and flawed economics.


.The hope is that markets will reward virtue, which is defined as austerity. But markets are more pragmatic: if, as is almost surely the case, austerity weakens economic growth, and thus undermines the capacity to service debt, interest rates will not fall. In fact, investment will decline – a vicious downward spiral on which Greece and Spain have already embarked.


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Germany seems surprised by this. Like medieval blood-letters, the country’s leaders refuse to see that the medicine does not work, and insist on more of ituntil the patient finally dies.


.Eurobonds and a solidarity fund could promote growth and stabilize the interest rates faced by governments in crisis. Lower interest rates, for example, would free up money so that even countries with tight budget constraints could spend more on growth-enhancing investments.


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Matters are worse in the banking sector. Each country’s banking system is backed by its own government; if the government’s ability to support the banks erodes, so will confidence in the banks. Even well-managed banking systems would face problems in an economic downturn of Greek and Spanish magnitude; with the collapse of Spain’s real-estate bubble, its banks are even more at risk.


.In their enthusiasm for creating a “single market,” European leaders did not recognize that governments provide an implicit subsidy to their banking systems. It is confidence that if trouble arises the government will support the banks that gives confidence in the banks; and, when some governments are in a much stronger position than others, the implicit subsidy is larger for those countries.


.In the absence of a level playing field, why shouldn’t money flee the weaker countries, going to the financial institutions in the stronger? Indeed, it is remarkable that there has not been more capital flight. Europe’s leaders did not recognize this rising danger, which could easily be averted by a common guarantee, which would simultaneously correct the market distortion arising from the differential implicit subsidy.


.The euro was flawed from the outset, but it was clear that the consequences would become apparent only in a crisis. Politically and economically, it came with the best intentions. The single-market principle was supposed to promote the efficient allocation of capital and labor.


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But details matter. Tax competition means that capital may go not to where its social return is highest, but to where it can find the best deal. The implicit subsidy to banks means that German banks have an advantage over those of other countries. Workers may leave Ireland or Greece not because their productivity there is lower, but because, by leaving, they can escape the debt burden incurred by their parents. The European Central Bank’s mandate is to ensure price stability, but inflation is far from Europe’s most important macroeconomic problem today.


.Germany worries that, without strict supervision of banks and budgets, it will be left holding the bag for its more profligate neighbors. But that misses the key point: Spain, Ireland, and many other distressed countries ran budget surpluses before the crisis. The downturn caused the deficits, not the other way around.


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If these countries made a mistake, it was only that, like Germany today, they were overly credulous of markets, so they (like the United States and so many others) allowed an asset bubble to grow unchecked. If sound policies are implemented and better institutions established – which does not mean only more austerity and better supervision of banks, budgets, and deficits – and growth is restored, these countries will be able to meet their debt obligations, and there will be no need to call upon the guarantees. Moreover, Germany is on the hook in either case: if the euro or the economies on the periphery collapse, the costs to Germany will be high.


.Europe has great strengths. Its weaknesses today mainly reflect flawed policies and institutional arrangements. These can be changed, but only if their fundamental weaknesses are recognized – a task that is far more important than structural reforms within the individual countries. While structural problems have weakened competitiveness and GDP growth in particular countries, they did not bring about the crisis, and addressing them will not resolve it.


.Europe’s temporizing approach to the crisis cannot work indefinitely. It is not just confidence in Europe’s periphery that is waning. The survival of the euro itself is being put in doubt.


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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.


07/03/2012 10:25 AM
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'Fear and Uncertainty'
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The Euro Endangers German Economy
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The common currency union was supposed to benefit the economy of the entire European Union. Now that the euro is struggling, however, it is bringing growth down with it. Germany's economy, once seemingly immune to the crisis, is now facing mounting difficulties. By SPIEGEL Staff







When the board of Commerzbank met last Tuesday, Stefan Otto was supposed to make an appearance. The chairman of Deutsche Schiffsbank, a Commerzbank subsidiary based in Hamburg that is focused on the shipping industry, had been summoned to Frankfurt to present the bank's financial results. But the presentation was cancelled; Commerzbank had no need for the numbers, having previously decided it no longer wanted anything to do with German shipping.




.The executive board of Deutsche Schiffsbank was not notified in advance of the parent company's reversal. The supervisory board was also taken by surprise. Only three months earlier, Commerzbank CEO Martin Blessing had declared the financing of ships and commercial real estate to be part of the bank's core business. And although it was expected to shrink, Germany's second-largest bank intended to create a separate segment for the business.




.But the executives had underestimated the risks that the European sovereign debt crisis presents to Commerzbank, and how much capital the ship and commercial real estate business ties up. Now Blessing has slammed on the brakes. Deutsche Schiffsbank Chairman Otto characterized the parent company's about-face as the "decision of a cautious businessman and not of a skydiver."




.Commerzbank has recently made a huge effort to satisfy and even exceed the capital requirements set by the European Banking Authority (EBA). But if the euro crisis worsens, new gaps could soon open up, say banking industry insiders.


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Potential Defaults


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In Spain alone, Commerzbank is exposed to the tune of €14.2 billion ($17.9 billion) via investments in banks, companies and the government. The lower the rating agencies assess the creditworthiness of these borrowers, the more capital the bank will have to place in reserve for these investments in the future -- to say nothing of potential defaults.



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Commerzbank isn't alone with such problems. The euro crisis and the higher capital requirements being imposed by regulators have adversely affected almost all European banks. And because of growing fears within the banks of a collapse of the euro zone, they are preparing for the worst by withdrawing to their home markets and winding down many investments.




.This has serious consequences for the economy, not just along the periphery of the euro zone, but also in Germany, which had proved to be crisis-proof and was in fact booming until recently.
Companies had been banking on the assumption that growth in emerging economies would offset weakness in the euro zone. But now even those markets are no longer as promising. Growth is weakening across the board in the emerging markets, a Citigroup study concludes.



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Last week, chipmaker Infineon shocked the industry when it issued a profit warning. Siemens CFO Joe Kaeser told investors that tougher times are ahead, and even economists are slowly abandoning the conviction that Germany could remain an island of the blessed in a sea of crisis-ridden euro-zone countries.
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.The German economy will stagnate by this fall because of the euro crisis, Hans-Werner Sinn, president of the Munich-based Ifo Institute for Economic Research, said recently. The Macroeconomic Policy Institute (IMK) sees the German economy stagnating both this year and next. "The crisis in the euro zone, the strict austerity policies and the associated recession in many EU countries" have taken hold of the German economy, says the IMK. The economists at Citigroup expect a recession in the euro zone in 2012 and 2013.




'Serious Implications'



In a situation reminiscent of the autumn of 2008, after the bankruptcy of investment bank Lehman Brothers, ailing banks are infecting the rest of the economy. "Cross-border financing is declining in Europe," says Michael Keller, managing partner of the Frankfurt-based management-consulting firm Keller & Coll.




.Investment bank Morgan Stanley says that Europe's banks are undergoing a "Balkanization" that will have "serious implications" for the availability of loans and for growth in some countries. The euro, which was intended to stimulate growth in Europe, is becoming a divisive force in the crisis.



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Particularly along the edges of the EU, weakened banks are bringing companies down with them. "Companies are only doing business in the peripheral countries of the euro zone if they can obtain the necessary financing locally," says consultant Keller.



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But the Deutsche Schiffsbank example shows how problems in the financial sector could also infect the rest of the economy in Germany. The bank no longer wants to lend any fresh money at all to shipping companies. The roughly €20 billion in shipping loans still on the bank's books are to be reduced to zero, and even good customers are finding it difficult to extend their loans.




.There is growing displeasure within the German government, which owns 25 percent of Commerzbank. Although he doesn't want to criticize the decision, says Hans-Joachim Otto, a member of the pro-business Free Democratic Party (FDP) and the federal government's coordinator for the maritime economy, "I am, of course, not delighted; this is an inopportune signal." Ship owners are already finding it very difficult to borrow money, because other banks are also turning them down.




-But for Otto, the shipping industry's borrowing dilemma is only part of a more serious problem. "It's becoming increasingly clear that all long-term projects have financing problems," says Otto. "This affects the energy turnaround, infrastructure investments and extraction of raw materials" -- all areas that are expected to contribute to future growth.




.Nevertheless, Germany's showcase industries until recently seemed unaffected by the euro crisis and weak growth in other countries. The auto industry, on which one in eight jobs in Germany depends, has sailed through 2012 so far, as if it were invincible. BMW, Daimler and the VW Group are reporting record sales and profits. Mercedes-Benz sales and marketing chief Joachim Schmidt says that in 2012 his brand will "sell more vehicles than ever before."


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Not the Whole Story


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The three companies owe their strength to two unique factors. First, they generally produce cars for the somewhat higher price segment, in which demand is not as heavily dependent on the economy. Most of all, however, they have benefited from the growth markets in China, India, Russia and Brazil.




.But that's not the whole story. The industry also includes Opel, a subsidiary of US auto giant General Motors. Opel employs more than 20,000 people at its plants in Kaiserslautern, Eisenach, Bochum and Rüsselsheim. And because Opel does almost all of its business in Europe, the company has been hit hard by the crisis. Sales are plunging, losses are growing and it seems inevitable that Opel will have to cut several thousands jobs in Germany in the coming years and perhaps even close its plants in Bochum and Eisenach.
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The crisis has also affected VW. Its Spanish subsidiary SEAT faces problems similar to Opel's, with SEAT selling almost exclusively in Europe. The brand, which has accumulated losses of almost €1 billion in the last five years, faces an uncertain future. VW is still reluctant to draw the consequences and close the SEAT chapter, but if the crisis continues in Europe, the company will hardly be able to avoid it.




.German mechanical engineers are likewise no longer particularly optimistic. "Of course we sense the reluctance to spend money in the euro zone," says Olaf Wortmann, an expert on the economy with the German Engineering Federation (VDMA). Some investors have become wary and are postponing contracts, Wortmann explains. The decline in demand in the Chinese market has also had an impact on the industry, with German machine builders seeing a 9 percent year-on-year decline in new orders for the period of February to April.
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.While the main objective last year was to be able to guarantee fast delivery, "price has played a stronger role once again in negotiations in recent weeks," says Hans-Gert Mayorse, chairman of Gesco, a medium-sized holding company. For now, however, Gesco does not anticipate a crisis like the one that occurred in 2009, when many companies had to apply for short-time work benefits -- at least as long as the euro zone doesn't collapse, says Mayorse.



'Filled with Fear and Uncertainty'



The euro crisis hasn't yet reached the German labor market. Last week, Frank-Jürgen Weise, head of the Federal Employment Agency (BA), announced a new jobless low: With 2.8 million people out of work, the unemployment rate had declined to 6.6 percent, the lowest level in 21 years. But in the economic cycle, the labor market is considered a "trailing" indicator. In other words, when things go up or down in the economy, it takes up to six months before jobs are affected.




.Indeed, even though the German job market remains robust, BA head Weise says he sees "signs of weaker development." Month after month, the BA surveys all 176 employment agencies throughout the country about early indicators, so as to forecast labor market developments for the coming months. According to these indicators, the jobs situation will not deteriorate until autumn. But "we are nervous about 2013, because of all these risks relating to sovereign debt in the euro zone," says BA chief Weise.




.Fears of job cuts are already spreading at Commerzbank. More than 1,000 employees work at the Eurohypo real estate bank and at Deutsche Schiffsbank, both of which are now to be liquidated. Labor representatives are pushing for talks with management.




.More moves, however, may be on the way. The executive board is subjecting all areas to a strategic review. "The hallways are filled with fear and uncertainty," says a Commerzbank employee.



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BY MARKUS DETTMER, KATRIN ELGER, DIETMAR HAWRANEK, MARTIN HESSE and ISABELL HÜLSEN



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Translated from the German by Christopher Sultan