July 15, 2012 6:49 pm

IMF faces balancing act over eurozone

A man begs in Barcelona©Reuters
Austerity: a man begs in Barcelona. One of the fears is that Spain will need an international bailout

The great shadow over the world economy is the fear that Italy or Spain will need an international bailout. But it is also an ominous prospect for the International Monetary Fund, an institution that would have to respond with speed and conviction.

A rescue for a large European economy would be so big that, once begun, it would be almost impossible to back away from. That would pose certain challenges to the fund: how to enforce the terms on which it lends; how to satisfy developing countries while committing so many resources to Europe; and how to avoid setting precedents that could haunt it when other countries need programmes in the future.

It is the old axiom about bank borrowing, scaled up a few orders of magnitude: if you owe the IMF a billion dollars then that is your problem; if you owe a hundred billion then it may be the fund’s. “There is this very delicate balance to strike between staying involved and staying credible,” says Eswar Prasad, a former head of the IMF’s China department and now a senior fellow at the Brookings Institution in Washington.

If a big European country were to ask the IMF for help then it would have an obligation to respond. “The IMF should not turn its back on members individually or collectively,” says Ted Truman, a former senior official at the US Treasury, now at the Peterson Institute in Washington, echoing a view that is widely held within the institution.

The unusual nature of the eurozone’s woessovereign debt crises but within a single currency area makes the challenge especially complicated. In Europe, the fund is just one part of the “troikamanaging the crisis, alongside the European Central Bank and the EU.

Inability to devalue a currency such as the Greek drachma means that the eurozone’s ills will take more time and more pain to cure. The IMF’s credibility is therefore being tested especially hard, most obviously by Greece, which has wriggled and wriggled over the terms of its deal and will struggle to sustain debt payments even if it does everything that it is supposed to.

After initial missteps, where the fund seemed to be led along by its European partners, Mr Prasad gives it good marks. “The IMF has managed to stay credible by being quite forceful in asserting its positions about what Europe has to do,” he says.

Another challenge for the fund in a future eurozone programme would be to keep developing countries such as China and Brazil on side even as it deploys much of its resources in the wealthy eurozone.
Officials from the large developing countries still think that the eurozone should be doing more to help itself, but at the same time they recognise the damage the crisis is doing to their own economies, and see the fund as one of their only policy tools to respond. If they are going to commit resources to Europe via the IMF, however, they want that to translate to greater power within the institution.

“I think there is serious concern amongst the major emerging markets that although the IMF and its leadership are committed to governance reform, they may not be able to navigate all of the political constraints,” says Mr Prasad.

For example, the last round of IMF quota changes have still not come into effect, and any increase to IMF resources is unlikely to get through the US Congress during an election year.

Copyright The Financial Times Limited 2012.

Green Domestic Product?

Bjørn Lomborg

13 July 2012

SANTIAGOOne of the recurrent themes at the United Nations’ spectacularly unsuccessful Rio+20 summit in June was the need to change how we measure wealth. Many argue that we must abandon our “obsession” with Gross Domestic Product and develop a newgreenaccounting standard to replace it. In fact, doing so could be a serious mistake.

GDP is really just an account of the market value of all goods and services. This sounds like a good indicator of wealth, but, as is frequently pointed out, it includes things that do not make us richer and leaves out things that do.

For example, if people are not compensated for the harm done by pollution, its adverse effects will not be included in GDP. If we pay to clean up pollution, this increases GDP, but no wealth has been created. Likewise, there is economic value produced when wastewater is naturally cleaned by wetlands, but no transaction has occurred, so it is not counted in GDP.

It is worthwhile to consider these limitations of GDP as a measure of wealth. And it could make sense to produce a better GDP, which adds uncounted benefits, subtracts the costs of externalities, and excludes activities that generate no wealth. Unfortunately, many of the proposedgreensubstitutions, however well intentioned, may not address these limitations adequately and could, in fact, produce worse outcomes.

One prominent example reported in the run-up to Rio+20 and used to supportgreeningGDP centered on the Nakivubo Swamp in Uganda’s capital, Kampala, where wastewater flows from the city toward Lake Victoria. Without the swamp’s purification services, a study showed, Kampala would need a sewage plant costing at least $2 million a year.

According to economist Pavan Sukhdev, the former head of the United Nations’ Green Economy Initiative, the point was simple: “It’s going to cost $2 million per year to do what the swamp was doing for free, and they don’t have that money.” Thus, swayed both by the uncounted benefits from wastewater treatmentestimated at up to $1.75 million a year – and the potential outlay to build a sewage plant, Kampala decided to protect the area. “Economic logic prevailed,” says Sukhdev.

The Nakivubo Swamp is an excellent example of the need for careful valuation of the environment. Such information is crucial for making good decisions. For example, if the wetland were to be destroyed to make way for a new district, we know that its benefits would have to be at least $1.75 million higher than the costs.

But there is also a significant risk of political misuse of such information. Kampala’s decision-makers decided to protect the area. In other words, they rejected ever considering alternative possibilities for the area.

Green campaigners often seek such outcomes, but they are entirely unjustified. The swamp is close to the city center and its industrial center, and there is a land shortage in Kampala. In all likelihood, the net benefits of job creation and economic growth that could result from creating a new district (in place of the swamp) would be dramatically higher than the $1.75 million. There is a reason why few large, rich cities, if any, have undeveloped wetlands in their midst.

If green measures are used to shortcut the political process, we can actually end up worse off, because countries will be deprived of jobs, wealth, and welfare, while relatively small environmental benefits will be achieved. The Nakivubo Swamp is not a case of economic logic prevailing, but exactly the opposite – a failure to consider all options and choose the best.

Imagine if our ancestors had made a similar valuation in the past, deciding to protect swampland at all cost. Much of lower Manhattan would still be a swamp, rather than being turned into the powerhouse of New York City, at a huge cost to society.

In general, green accounting may end up being more biased than conventional GDP measures. Green GDP does include uncounted losses, so it avoids the problem of overestimating our wealth, but it fails to account for the potentially much larger benefits of innovation.

For example, the World Bank claims that in order to be green, we need to take into account that consuming fossil fuels will deprive future generations of those resources. In reality, burning fossil fuels over the past 150 years has enabled us to be free to create and innovate an amazingly richer world of antibiotics, telecommunications, and computers. These will further enrich the future, but are not counted.

Moreover, as we have burned fossil fuels, we have simultaneously found new resources and discovered new methods, such as horizontal fracturing, which has dramatically increased the availability of natural gas while driving down its cost. All of this leaves future societies amazingly richer – but would be missed in green GDP measures.

In practice, green accounting might easily have led our forefathers not to cut down forests, because this would entail losing a valuable resource. But converting forests to agriculture led to cities and civilization. Innovation and substitution followed, which ultimately produced many more calories and much more wealth.

Most policymakers still focus on GDP, because, while not perfect, it is strongly correlated with highly prized real-world outcomes. A country with higher GDP generally has lower child mortality rates, higher life expectancy, better education, more democracy, less corruption, greater life satisfaction, and often a cleaner environment.

So, while green accounting certainly can play a role, we must not allow it to become a roadblock to development.

Bjørn Lomborg is an adjunct professor at the Copenhagen Business School, where he founded and directs its Copenhagen Consensus Center, which seeks to study environmental problems and solutions using the best available analytical methods. He is the author of the bestselling book The Skeptical Environmentalist and Cool It, the basis of an eponymous documentary film.

Markets Insight

July 16, 2012 12:10 pm

US dollar is no haven from the eurozone

Crises are always going to happen, but they are less stressful when sound institutional processes are in place. The most positive takeaway of the recent eurozone summit was the announcement of an integrated supervisory mechanism as a precondition to any bank bailout. A European guarantee of Spanish bank deposits without a corresponding handover of banking supervision would only perpetuate bad habits.

It should not be too much to ask for a process. Using European Central Bank president Mario Draghi’s words, policy makers in the eurozone must “define roles, deadlines and conditions to be satisfied.” Yet, since last summer, the modus operandi in managing the crisis has generally been to take two steps back with each step forward.

We may have broken out of this downward spiral with the latest summit. But too many questions remain: for example, will the new bank regulator have a strong resolution authority, and be able to seize and liquidate insolvent Spanish banks? Will the influence of national bank regulators be reduced, in part to disallow banks to treat the debt of their own governments as risk-free? Banks are in the business of managing risk and indeed lend to risky customers all the time by unbiasedly pricing in that risk. But when their own regulators indicate that something is risk-free when it is not, risky assets are not properly priced and the banking system malfunctions.

And while Spain is in the limelight, it would be helpful if regulators of strong countries, such as Germany’s BaFin, also ceded control to help root out bad habits. Last summer, when the European Banking Authority (EBA) demanded the publication of sovereign debt holdings, BaFin balked. It was market pressure that “encouragedGerman banks to be more transparent. Simply put, national regulators have proven inept at managing their conflicts of interests.

In depth

Eurozone in crisis
As the debt storm spreads Europe’s leaders battle to save the eurozone

Well-defined processes help markets to function, as buyers and sellers negotiate market-based values of assets. In contrast, guarantees ultimately increase volatility as asset prices become more correlated: everything will be safe until the guarantor is deemed unsafe, crashing the whole system.

A credible strategy must be in place for investors to regain confidence. Spain is particularly disappointing to investors. Here is a case where a government enjoying an absolute majority at times appears to put more emphasis on negotiating lower borrowing costs than on structural reform that would lower the amounts that need to be borrowed in the first place. This crisis will not end as long as debt is merely shuffled around.

Having said that, a lot has been achieved already. In some ways, we already have a United States of Europe: when a weak country asks for help, it receives aid in return for ceding sovereign control over budgeting. The main difference to the emerging vision of Europe is that budgets ought to be reviewed before a crisis erupts. We are inching towards the vision in a typically European piecemeal fashion, with weak countries taking the lead, incentivised by market pressures.

Investors don’t need guarantees. Investors need to be properly compensated for the risks they are taking on. But, at this stage, they also need to take into account the risk that rules of engagement are constantly changing. And to add insult to injury, if an investor lends money to Spain at 7 per cent they might be labelled a dreadful speculator trying to benefit from Spain’s suffering. So why bother?

In the meantime, central bankers around the world, fearing further fallout, are hoping for the best, but planing for the worst. In the eurozone, it means Long Term Refinancing Operations and lower interest rates; in the UK it means quantitative easing; in Japan, it means introducing an inflation target above the current rate of inflation; in the US, it means “Operation Twist”. Indeed, even as we are encouraged that pieces of a process are finally coming together, we simply cannot ignore the tail risks in the eurozone.

Meanwhile, there are opportunities elsewhere. However, we don’t agree with the conventional wisdom that the US is the safe haven to flee to, not least because of the unsustainable fiscal situation and our expectation of further Fed easing.

Our favourite substitute for the euro while we ride out the storm in the eurozone is the Singapore dollar. While commodity currencies might be prime beneficiaries of the increased trigger friendliness at major central banks, such currencies are historically rather volatile. The Monetary Authority of Singapore has shown the utmost restraint in recent years. In many ways, the Singapore dollar behaves like a European currency without the tail risks. It fulfils that role better than Scandinavian currencies that tend to amplify whatever happens to the euro due to the dependency of their economies on the eurozone.

Axel Merk manages the Merk Funds

Copyright The Financial Times Limited 2012


Updated July 16, 2012, 9:43 a.m. ET

When Pockets of Strength Just Aren't Enough


America's Great Plains and Midwest regions are rebounding from the recession faster than other parts of the country, but economists say their recoveries aren't enough to lift the rest of the economy out of the doldrums.

Private-sector workers in the Great Plains and Midwest have seen the sharpest rise in income since the end of the recession in mid-2009, Commerce Department data show. Plains states such as North Dakota, Texas and Nebraska are reaping the benefits of growing demand for oil and food commodities in expanding economies like China. Turnarounds by the U.S. auto sector and other manufacturers, meanwhile, have reinvigorated America's industrial strongholds of Michigan, Ohio and Indiana.
Yet despite this success, the two regions that make up the nation's midsection contribute much less to the broader economy than do California and New York. Some Great Plains states are sparsely populated. That means that locals whose fortunes have improved thanks to oil and soaring crop prices can't be counted on to boost national consumer spending, which fuels two-thirds of the economy. North Dakota, Wyoming, Montana and Nebraska, for example, contribute only about 1.4% of the country's gross domestic product—roughly equal to Connecticut's share.

The recovery of the U.S. manufacturing and auto sectors, meanwhile, doesn't fully offset their collapse during the global economic crisis. Job cutbacks have kept Michigan's unemployment rate at 8.5% in May, well above the 6.9% rate the state saw in May 2007. Ohio's jobless rate, 7.3% in May, was 5.6% five years ago.
"It's not enough to have pockets of industrial rebirth," said Jim Diffley, chief regional economist at IHS Global Insight. States like Michigan and Ohio "are not going to be pulling everyone else along, though it's great that they're gaining. We still need to have consumers and banks complete the process" of whittling away bad debts in order to start spending and lending more, he said.

The U.S. recovery has been slower than past economic comebacks. It also has been uneven. States that specialize in areas such as energy and food production, manufacturing and technology, have thrived, while others reliant on housing, construction, services and finance have struggled under the weight of consumer debt.

To enlarge click here
Private-sector workers in North Dakota, which is second only to Texas in oil production, saw the biggest rise in personal income between the end of the recession and the first quarter of 2012. The state's unemployment rate is 3%, the lowest in the country and well below the national rate of 8.2%. In the Midwest, soaring prices of corn and soybeans—though partially due to a drought in the region—have boosted farm states like Nebraska and Iowa, where unemployment is among the nation's lowest.

"As rising global incomes drive more demand for protein, it creates a runway of opportunity that expands for more than a decade," said Hugh Grant, chief executive of seed company Monsanto Co. MON +0.73% on a call with analysts last month. Monsanto, of St. Louis, reported a 35% jump in profit in its fiscal third quarter, driven partly by farmers planting more corn across the U.S. heartland.

Yet California's economy, which accounts for about 13% of U.S. GDP, grew much more slowly than the country as a whole between the end of 2009 and that of 2011, Commerce Department data show. Its unemployment rate, at 10.8%, is the third-highest in the country, after Nevada and Rhode Island.

California illustrates the recovery's unevenness. Its technological hub, Silicon Valley, is home to one of the U.S. economy's most prized assets.

YouSendIt Inc., a Campbell, Calif., digital file-sharing firm, has hired 50 people this year, expanding its payroll to 212. It is looking to add 25 more workers and find additional office space in San Francisco to accommodate and attract job-seekers. "Back in 2008, when the economy started to slow down, the company did pause for a bit, but we've been in a rapid growth mode ever since," says Renee Budig, the company's chief financial officer.

Yet Oakland—a city less than 10 miles from San Francisco—is struggling with a 9% unemployment rate. "Silicon Valley's social-media boom may have propelled it once again into the ranks of the fastest-growing employment centers, but the nearby Oakland area lags near the bottom," analysts at research firm Praxis Strategy Group said in a recent report.

For the economy to really pick up steam, more regions have to start firing on all cylinders—a tall order given that key sectors such as housing and finance likely won't return to their precrisis levels of growth and employment. That means what is needed across America is more production of goods—from food and energy to electronics and cars.

—Patricia Minczeski contributed to this article.

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

07/16/2012 12:57 PM

Tense Times in Madrid

Spain Awaits Cash Injection As Reforms Fall Short

Spain needs to make significant spending cuts and see a major boost in state revenues -- but its most recent reforms apparently fall short by some nine billion euros. As tensions rise, the country still awaits the approval of 100 billion euros in emergency aid.

Spain is tinkering with a comprehensive reform package to help the deeply indebted country get itself out of a severe financial crisis. But its new belt-tightening measures will apparently only go so far -- bringing in almost €9 billion ($11 billion) less than what had been announced.


The program presented last week envisions savings of €56.4 billion over the next two and a half years, according to a report published Saturday on the website of Spain's leading daily, El Pais. Citing government sources, the paper said that roughly €29 billion of this would come from tax increases and some €27 billion from spending cutbacks.

.But on Wednesday, Prime Minister Mariano Rajoy had held out the prospect that tax increases and cuts in spending could inject €65 billion into empty state coffers. The El Pais report states that the €8.6-billion difference in these figures could come from other savings measures, such as the new energy-sector taxes announced this month.


Spain's Ministry of Finance initially declined to comment on the report. As of Friday, it still wasn't willing to release a more detailed breakdown of the reform measures.


Spain must reduce its budget deficit by €65 billion if it hopes to get it under the European Union's upper limit of 2.8 percent by the end of 2014. The country is already grappling with its ailing banks, unemployment of nearly 25 percent and the consequences of a real-estate bubble collapse. But now it must also struggle to push through these reforms and regain the confidence of the EU and the financial markets.

Four Cash Injections and a 'Bad Bank'

Spain's belt-tightening measures will soon be supplemented by money from EU coffers, though. On June 9, the finance ministers of the 17 euro-zone countries agreed to lend the Spanish government €100 billion to help its troubled banks. According to a confidential proposal of the leaders of the temporary euro rescue fund, the European Financial Stability Facility (EFSF), obtained by SPIEGEL, the funds will come from the temporary euro rescue fund in four tranches. Plans call for the first of these, worth €30 billion, to be in Spain already by the end of July.


Two-thirds of the funds in this initial tranche will be made available to ailing credit institutions than might need short-term capital injections. The remaining €10 billion will serve as what the document describes as a longer-term safety buffer. The document states that plans call for the three other tranches, each worth €15 billion, to come in mid-November and late December 2012, as well as at the end of June 2013.


The document adds that plans also call for a "bad bank" to be set up in late November to handle problematic assets. Up to €25 billion will reportedly be made available to the new institution.


The aid program for Spain will reportedly run until 2028, at the latest. The EFSF document states that, in order to ensure that Spain continues to have access to the financial markets, the rescue funds will not be calculated as part of the country's overall debt burden.


Contingent on State Approvals

The legally binding loan agreement will only be approved at a further Euro Group meeting on July 20. But before the loans can be made, national governments or parliaments must first approve it, including the German parliament, the Bundestag, which will vote on the matter in a special sitting on Thursday.


In an interview with the German public broadcaster ZDF aired on Sunday night, German Chancellor Angela Merkel said she was confident of getting the simple majority of parliamentary votes needed to approve the Spanish aid package. "We always get the majority we need," she stated.

At the same time, Merkel reiterated her position that German support for efforts to help troubled euro-zone countries was contingent upon their taking tough austerity measures and agreeing to close European monitoring from a new oversight body agreed upon in recent weeks. "All attempts to say 'oh, let's practice solidarity and nonetheless have no supervision and no conditions' will stand no chance with me or with Germany," Merkel said.


Despite her confidence, Merkel still faces opposition within the ranks of her own conservative Christian Democratic Union (CDU) and its Bavarian sister party, the Christian Social Union (CSU). In late June, she needed support from opposition parties to win parliamentary approval of two key pillars of her efforts to calm the euro storm: the fiscal pact, which commits countries to stricter budgetary rules, and the European Stability Mechanism (ESM), the €700-billion permanent bailout fund designed to replace the EFSF.

Widespread Resistance


However, a recent SPIEGEL ONLINE survey revealed that a narrow majority of Germans are opposed to any more bailouts. Indeed, among respondents who support the CDU and CSU, 52 percent said it was almost pointless for Germany to continue fighting for the single currency.

Perhaps the chancellor's biggest headache, however, comes from her conservative allies in Bavaria. Horst Seehofer, the state's governor and head of the CSU, warned in an interview in early July with the newsmagazine Stern that "at some point we will reach a point where the Bavarian state government and the CSU will no longer be able to say yes." He added: "And without the votes of the CSU, the coalition no longer has a majority."

Merkel also has another hurdle to surmount. Although plans had called for the ESM to succeed the EFSF on July 1, this has been blocked by a temporary injunction imposed by the German Federal Constitutional Court. The court is hearing a case brought by plaintiffs who argue the ESM and fiscal pact will force Germany to give up too much sovereignty and undermine the power of its democratically elected parliament to determine what happens with taxpayers' money.


On Monday, the court announced that it will publish its ruling on the measures on Sept. 12. The long delay threatens to become what some have dubbed an "endurance test" for the euro.


jtw -- with wire reports