Europe's crisis states should fight back with a 'debtors' cartel'

Public debt levels are rocketing in almost every country of the eurozone periphery. Debt ratios are already crossing the point of no return in Portugal and Italy and are nearing the danger zone in Ireland.

By Ambrose Evans-Pritchard, International Business Editor

8:35PM BST 22 Jul 2013

Public debt levels are rocketing in almost every country of the eurozone periphery. Debt ratios are already crossing the point of no return in Portugal and Italy, and is nearing the danger zone in Ireland.
Portugal's debt has just blown through the upper limits set by the EU-IMF Troika, reaching to 127.2pc of GDP in the first quarter of 2013. Photo: Bloomberg

Portugal’s debt has just blown through the upper limits set by the EU-IMF troika, reaching 127.2pc of GDP in the first quarter of 2013. This is 15 percentage points higher than a year ago – the bitter fruit of austerity overkill. The Portuguese people have suffered year after year of cuts only to find themselves sinking deeper into a debt swamp.
Italy’s debt has hit 130.3pc – compared with 123.8pc a year agorapidly spiralling beyond the safe threshold for a country without its own sovereign currency and central bank.
In Ireland, public debt has leapt by 18 points to 125pc in a single year. This is partly pre-funding” to cover borrowing needs for 2014 but a slide back into recession accounts for a big chunk.
The former head of the IMF’s team in Ireland, Prof Ashoka Mody, has called for “a complete rethinking” of the austerity strategy. He confirmed what the Irish trade unions and others have said all along, that fiscal overkill is self-defeating, especially if compounded by tight money.
Given the debt dynamics, if debt levels remain where they are and growth remains where it is, there is never going to be a reduction in the debt ratio in the foreseeable future. Moving away from austerity at this stage is a sensible course of action,”
he said.

Ireland is certainly not a basket case. It has a fat trade surplus. Exports are 105pc of GDP, compared with 30pc or less for most of Club Med. It is well able to compete at the current exchange rate.

Ireland’s policy of austerity cuts and “internal devaluation” has done wonders for the trade account but only at the cost of an even deeper debt-deflation crisis. This is the fundamental contradiction of EMU crisis strategy in every high-debt country. The more these economies deflate wages, the more they raise the real cost of debt.

In Ireland’s case – as in Spain – this debt burden is the legacy of an almighty credit boom that was itself caused by EMU and years of negative real interest rates. The details are spelled out in a study entitledWhat went wrong in Ireland” by Patrick Honohan, now central bank governor.

“These countries are walking a very fine line,” said Marchel Alexandrovich from Jefferies Fixed Income. Once debt gets to the 130pc level there is a risk that markets will start to wake up. The moment of truth could come as soon as political stability is called into question in any one of these countries.”

Portugal has been flirting with just such a crisis ever since the finance minister and austerity chief, Vitor Gaspar, stormed out three weeks ago.

Portuguese bond yields fell yesterday in a relief rally after the country’s president backed down from threats to call a snap election, agreeing instead to let the crippled coalition of premier Pedro Passos Coelho limp on.

Yields on 10-year bonds fell 42 basis points to 6.2pc, back where they were before the constitutional crisis erupted. Yet it is a strange state of affairs when failure to form a “national salvation government” is greeted with delight by the markets.

“The politics of economic reform in Portugal have become even more treacherous, and it is very unlikely that the political wounds that have opened up can be healed,” said sovereign debt strategist Nicholas Spiro.

Mr Passos Coelho’s authority has now been undermined and aggressive austerity has, in any case, completely failed. The public debt burden is rising at a frightening pace,” he said.

The IMF warned last month that the debt outlook remainsvery fragile” and that any external shock could push the country over the edge. It said a serious crisis could force the state to take on contingent liabilities and push debt to “clearly unsustainablelevels.

The country has to raise 23pc of GDP in funding this year and 22pc next year, when it is supposed to return to capital markets. External debt has reached 230pc of GDP. Nominal GDP has contracted over each of the past two years, causing the “denominator effect” to play havoc with debt dynamics.

Portugal’s denouement is fraught with risk. Europe’s leaders have given a solemn pledge that they will never again impose haircuts on banks, pension funds and other investors holding EMU sovereign debt, tacitly recognising that their experiment in Greece was calamitous.

So what will they do when the time comes? Do they impose tangible losses on German, Dutch, and French taxpayers for the first time? Does German finance minister Wolfgang Schäuble ask the Bundestag to write a line into the budget worth €10bn (£8.6bn) or €15bn markedLosses in Portugal”, admitting at last that EMU bail-outs cost real money?

Or do the creditor states resile from this pledge – as they have resiled from others – and set off panic flight from Spanish debt, with instant knock-on effects in Italy?

Besides, having now imposed the “Cyprus template” of losses on bank depositors above €100,000, as is the case with all bond-holders, if lenders get into trouble, how can they hope to contain systemic banking crisis in Portugal if investors start to fear that the situation is getting out of hand again?

Societe Generale says EU leaders may be tempted, unwisely, to think it is safe to impose private haircuts on the grounds that northern banks have greatly reduced their exposure to these countries. This is how accidents happen.

There ought to be a point in this wretched saga when it is clear to the victim states, if it is not clear already, that solidarity rhetoric from the northern powers is contemptible deception, that the North still refuses to accept its joint responsibility for capital and trade imbalances that lie behind the EMU debacle, and still refuses to recognise that excess northern savings flooded Club Med, with the complicity of the European Central Bank.

There is condign retort to the creditor cartel. The peoples of southern Europe could at any time choose to form their own debtors’ cartel and turn the tables.

They could confront the creditors with a stern ultimátum. Either you change the entire structure of EMU crisis policy, agree to a reflation strategy and accept your share of the clean-up costs for this collective disaster or we repudiate out debts.

Either you meet us half way or we take long-overdue steps to protect our societies against mass unemployment and to protect our industrial base.

The current batch of Club Med leaders are too embedded in the EU Project to embrace such an idea and are still seemingly persuaded that recovery is nigh, so they allow themselves to be picked on one by one by the creditors’ cartel.

The current course is untenable. Markets may tolerate EMU debts of 130pc for a while but they are unlikely to tolerate levels nearing 140pc, or even any prospect of it.

The harsh truth is that Europe failed to use the five years of largesse created by the US Federal Reserve and the Chinese credit system after the Lehman crisis to resolve its internal mess.

It needlessly pushed southern euroland into a double-dip recession and ran a 1930s contraction policy.

It is time for Southern Europe to look after its own interests once again.

July 23, 2013 7:27 pm
US should support a trade deal with Japan
Currency manipulation suspicion is based on distant, isolated episodes, says Adam Posen
©Ingram Pinn
Shinzo Abe’s clear victory in Japan’s upper house election last weekend is a turning point for world trade. The Japanese prime minister has made commitments at home and abroad that, if allowed, his country would enter the Trans-Pacific Partnership trade negotiations and make the structural reforms needed for it to be a fair and full participant.
Pledges to open up Japanese agriculture and insurance, among other sectors, bravely ran ahead of what cynics thought the Japanese electorate would support. Mr Abe has gone way beyond the gaiatsu, the publicly reluctant utilisation of outside pressure to reform, of past Japanese leaders. He is following the examples of China’s Zhu Rongji and Mexico’s Ernesto Zedillo; Mr Abe has embraced international economic integration to drive significant domestic reform.
This matters, and not just for Japan itself. Its participation in the TPP strongly increases the prospects for an agreement of high-quality fit for the 21st centuryone that emphasises trade in services as much as in goods; one that has high standards for intellectual property protections as well as for the environment; and one that looks beyond old-fashioned tariffs to focus on investment flows and non-tariff barriers (such as government procurement).
Most importantly, including Japan in the TPP would open up opportunities for a range of less developed economies while reassuring advanced economies on standards. This kind of quid pro quo offers some of the largest direct gains from trade. Analysis by Peter Petri and Michael Plummer, professors at Brandeis and Johns Hopkins respectively, finds that a TPP agreement including a Japan that opened up in agriculture and other sectors would result in Chile gaining about 1 per cent of gross domestic product a year by 2025, Malaysia 5 per cent and Vietnam 10 per cent. Japan itself would gain 2 per cent of GDP a year and the US almost 0.5 per cent via increased cross-border investment and access to rising demand for services.
Sadly, if predictably, the opposition to Japan’s participation in TPP negotiations has come from interest groups within the US, despite the major gains to be had for American companies and consumers. The “Detroit Threecar companies and the United Auto Workers union have expressed the greatest concerns. Leaving aside narrow, if partially valid, complaints about access to the domestic Japanese car market and about light truck tariffs (being addressed in a US-Japan auto side agreement anyway), they have made one big demand: that the Obama administration include some form of protection against currency undervaluation or manipulation by Japan. This has picked up some support in Congress.
Whether trade agreements in general should include unilateral currency provisions in the absence of systemic reform addressing global imbalances is a thorny issue. Since there are no robust widely acceptable definitions of currency undervaluation, any current legislation would have to be written in terms of manipulation. The irony of the stated concerns, however, is that any such practical definition of currency manipulation would not implicate Japan at present but instead could compel confrontational countermeasures against China and South Korea – and would still let off the most aggressively mercantilist major economy with the most undervalued currency: Germany.
Japan has not engaged in sustained one-sided intervention in currency markets to weaken the yen since April 1 2004, except when the yen jumped in value in the aftermath of its tsunami and nuclear disaster of 2011 (it stopped when the Group of 20 complained about excess intervention). The Abe government has bound itself by the agreement of December last year for G20 nations not to talk down their currencies or otherwise intervene unilaterally.

As a result, the yen appreciated from a low of Y102 against the dollar in mid-May to Y93 in mid-June without any direct response. Yes, Japan’s vast foreign exchange reserves, second only to China’s, point to a long history of currency manipulation, but that has indeed become history.

Despite some unjustified claims, quantitative easing and other forms of expansionary monetary policy are not currency manipulation. Actual manipulation involves intentional cross-border policy with effects that unambiguously shift trade, with any growth coming at others’ expense. As my colleague Joseph Gagnon and I have consistently argued, QE is domestic policy with domestic goals, and has ambiguous net spillovers on other economies. For large and relatively closed economies such as Japan or the US, trading partners probably gain in increased exports to those countries more than they lose from any decline in competitiveness caused by currency depreciation.
Some US companies’ suspicions of Japanese currency manipulation are based on increasingly distant and isolated episodes. In any event, unilateral efforts to weaken the yen are successfully precluded by a well-monitored G20 agreement. 

Those who wish to see application of these principles to more recent and aggressive currency manipulators than Japan in Asia and beyond require a strong stomach for putting other trade and foreign policy goals in danger. There is no justification for risking the TPP negotiations, however, and Japan’s globally beneficial full participation in them, out of fear of yen manipulationlet alone of QE.

The writer is president of the Peterson Institute for International Economics

Copyright The Financial Times Limited 2013.

07/24/2013 12:10 PM

(Sm)art Investing

Rich Move Assets from Banks to Warehouses

By Christoph Pauly

Photo Gallery: Warehouses Become the New Tax Havens

To avoid paying taxes, the rich are emptying their bank accounts in Switzerland and investing in art. This has spawned a new business of storing such works tax- and duty-free in warehouses across the world.

One of the world's most valuable art treasures is being stored in an extremely ugly place, a six-story concrete building known as the Geneva free port. Instead of windows, much of the façade of this giant safe for the world's wealthy is covered with gray panels.

Anyone hoping to get into the walk-in lock boxes of this very special Swiss tax haven must first surmount a number of hurdles. At the first door, an employee has to type the right combination of numbers into a small screen. The next hurdle is a large steel barrier that has to be rotated counter-clockwise until it snaps into place, followed by a heavy steel door that resembles a submarine bulkhead. Behind it is a drab corridor with doors on both sides. Only the renters have keys to these doors.

The employee of Geneva Free Ports & Warehouses Ltd. remains discreetly in the background while the owners of the locked-up treasures count their gold bars or examine their collection of paintings being stored in the warehouse.

The Nahmad dynasty of art dealers reportedly has 300 Picassos in storage in Geneva. Countless Degas, Monets and Rothkos are also stored on the inhospitable premises. The estimated value of the works is in the billions. Hardly any museum can boast such a valuable collection.

Those who use the warehouse are genuinely wealthy. According to the Capgemini World Wealth Report, there were 12 million millionaires in the world last year, with combined assets of $46.2 trillion (35 trillion), or 10 percent more than in the previous year.

But even if the world's rich are getting richer, many of them are also worried. The financial crisis isn't over yet, and tax havens worldwide are under pressure to disclose the identities of people whose assets are parked in their banks.

Recently, even Swiss bankers have been sending letters to their clients, asking them to cooperate with tax authorities and consider turning themselves in. This only heightens fears of the tax authorities. "We assume that a total of hundreds of billions of francs will flow out of Switzerland," said the head of the asset management division of UBS, a major Swiss bank, in late 2012.

From Banks to Warehouses

But not everything the banks are losing is actually leaving Switzerland. Customers are admittedly emptying out their accounts and safe deposit boxes.

But partly as a result of the many uncertainties in the financial markets, a growing share of the money is being invested in tangible assets, such as art, wine and classic cars. A total of $4 trillion has reportedly been invested in "treasure assets," a category including various kinds of precious objects.

What the Rich are investing in these days
This requires warehouse space that satisfies the most stringent security requirements. Swiss military bunkers blasted deep into Alpine rock are in great demand. But the free ports in Geneva and Zurich are even more popular because they offer what Swiss banks used to: the freedoms of a tax haven and maximum discretion.

"Scared customers are currently transferring their assets from the banks to the city's warehouses," says a pleasant woman at the Geneva free port. So far, she adds, only Swiss customs has shown an interest in the contents of the warehouses, while foreign tax authorities' chances of gaining access to lists of stored property are slim. Tax evasion, she notes, is not a crime in Switzerland.

"Unfortunately, I can't offer you a bigger safe. We are fully booked," she says. All she has left is a 10-square-meter (108-square-foot) room, one of the smallest lock boxes at the facility, at an annual rent of 22,000 Swiss francs (17,800 or $23,500).

For renters, the real challenge is getting adequate insurance coverage for the riches being stored in the warehouse, with its 140,000 square meters (1.5 million square feet) of storage space. "We have no additional insurance capacity for the warehouse. It's a huge problem for our customers," says Ulrich Guntram, chairman of Axa Art Insurance Corporation, the leading art insurer. Other Swiss insurance companies are also declining to offer coverage.

No one knows the exact value of the property being stored in the warehouses. A fire in Geneva is seen as the greatest potential loss scenario in the art world. Partly in response to pressure from insurers, an additional six-story building that will be reserved exclusively for art is now being built in the Geneva free port.

The warehouse company, of which the Canton of Geneva owns 86 percent, offers a special Swiss service: The country's customs agency, which has an office in the warehouse, doesn't charge import duties, export duties or even value-added tax. The valuable objects are brought to the warehouse directly from Geneva's airport. Later, they can be sold and sent abroad discreetly and without additional costs at any time.

In fact, the facility offers a solution for every problem. Classic car aficionados can rent special garages, while wine lovers are offered storage space with controlled temperature and humidity. Providers like Stockbridge, a British asset management company, advertise that gold is completely safe in Switzerland, even when a country can confiscate other types of assets held there. Switzerland is the world's largest importer of gold, bringing in even more than huge countries, such as India. Four of the world's major refineries for the precious metal are in Switzerland.

Partly as a result of its duty-free warehouses, Switzerland has developed into a commercial hub for anything that glitters and is expensive. This has not escaped the attention of big- or small-time criminals. On February 18, heavily armed thieves disguised as police officers held up an armored security truck parked in front of a Helvetic Airways plane at the Brussels airport. They carried off $50 million in diamonds en route from Antwerp, the Belgian gem center, to Zurich.

Insiders refer to the planes that travel between Belgium and Switzerland as "diamond bombers." The police have managed to arrest most of the Brussels airport thieves, and a portion -- albeit a tiny one -- of the loot was located in Geneva.

Massive amounts of money are involved. German citizens reportedly have up to €200 billion in undeclared earnings in Swiss bank accounts. "Withdraw the money in cash and put it into a private box," bankers advise their customers. In fact, Swiss National Bank, the country's central bank, can hardly keep up with the demand for new 1,000-franc bills, the most popular currency denomination among tax evaders.

But the truly wealthy prefer to invest in art.

Art as Investment

Now that the Chinese have discovered the art market as a way to invest their money, the global art business has grown exponentially, reaching estimated sales of €43 billion in 2012. "In the top price segment, art functions as an investment. The rich want to protect their assets," American collector and author Ethan Wagner ("Collecting Art for Love, Money and More") said in an interview with the German weekly newspaper Die Zeit.

There is no better place to do this than in Switzerland, where, unlike in Germany, exported art is exempt from value-add tax. This is one of the reasons Art Basel has become a global hub for art and home to its most important fair.

Every year, in mid-June, up to 300 private jets touch down at the Basel-Mulhouse-Freiburg Airport for the first day of the fair, when galleries invite customers to their exclusive previews. This year, many of the billionaires interested in art, such as Russian business tycoon Roman Abramovich, had to make a detour to a nearby airport because French air traffic controllers were striking.

But even that didn't hurt business. The works of artists who have become global brands in their own right are especially successful at art fairs known for attracting large amounts of money.

On the preview day, a mobile by Alexander Calder sold for $12 million. Each of the five copies of "Not Yet Titled (Kleine Marokkanerin)," the new sculpture by German artist Georg Baselitz, sold for just under €1 million.

New York gallerist David Zwirner asked $3.5 million for an early painting by Gerhard Richter -- and it sold immediately. "We are undoubtedly in a high-price period," Zwirner says, "and yet the market seems absolutely healthy and sound."

Sam Keller, director of Fondation Beyeler, a Basel museum, is also stunned by the development. "Artists now attract the same attention as rock stars used to get," says Keller, who headed Art Basel for a long time. But he also sees nothing wrong with the global elite's choosing to spend their money on art.

A Vehicle for Money Laundering

It is widely acknowledged that many of these artworks promptly disappear into art warehouses. Dealers are also quietly aware of how the international art trade can be used to launder money.

In April, the FBI searched the Helly Nahmad Gallery on Madison Avenue in New York. US authorities accuse Nahmad, one of the members of a family of collectors, of money laundering and other crimes, which he denies. The New York gallery had a prominent booth at Art Basel this year, as it does every year.

In 2008, the Swiss federal police office summed up its assessment of how well-suited the art industry is to money laundering: "On the whole, discretion and a lack of transparency prevail in the art trade, and transactions are often settled in cash." The issue is also frequently addressed in the Swiss National Council, the lower house of the country's parliament, but nothing has been done about it yet. Proposed legislation that would make the Swiss art market subject to the country's money laundering law has been repeatedly delayed.

UBS is the main sponsor of Art Basel. It has the largest lounge in the VIP area, where it invites its best customers to special exhibits. Art is big business in Basel. "The target audience falls within the highest segment of the wealthy," says Swiss attorney Karl Schweizer, who has developed the business for UBS. "You can make incredible customer ties with art."

Deutsche Bank, Germany's largest bank has also entered the business of art warehouses. It already has its own large art collection and is the main sponsor of London's Frieze Art Fair, which also has a sister event in New York. Now the bank is building its own warehouse in London and, like UBS, has leased storage space for 200 metric tons of gold in Singapore.

Getting In on a New Business

The Christie's auction house maintains a presence at the Singapore Freeport, a sleek, futuristic building located at the airport. The Asian city-state has copied Switzerland's successful strategy with the help of a Swiss adviser. It also offers complete discretion and tax exemption.

The Luxembourgers are also vying for a spot in this lucrative business. An upscale high-security warehouse with an elegant stone façade is currently being built at Luxembourg's main airport. Instead of a six-story, uninspired structure like the one in Geneva, the warehouse in Luxembourg will make the world's wealthy feel comfortable by being an object of art itself. "It will be a fortress of art," David Arendt, the head of Luxembourg Freeport, promised at a presentation in June. It will be surrounded by three-meter (10-foot) walls, he added, and its guards will of course be armed.

The Luxembourgers have also amended their tax laws to accommodate their freeport, which is scheduled to open in September 2014. In the VIP area of Art Basel, officials from Luxembourg sought to entice a well-heeled clientele by touting the new facility -- in various languages, including Russian -- as "your tax-free emporium."

Indeed, this tiny country in the heart of the European Union has big plans. At a conference on the future of Luxembourg as a financial hub, Arendt said: "We no longer wish to focus on the Belgian dentist and the German butcher."

Translated from the German by Christopher Sultan