Europe’s Political Transcendence

KEMAL DERVIŞ

MAY 9, 2014


WASHINGTON, DC – This month, European citizens will head to the polls to select the 751 members of the European to represent 507 million people. The way the election campaign has unfolded marks a small but significant step in the emergence of the first transnational political space in European – indeed, world – history.

To be sure, the European Parliament elections have been bringing smaller shares of voters to the polls: 43% in 2009, compared to almost 60% in 1978-1994. Nonetheless, the participation rate over the last decade is comparable to average turnout in American congressional elections. Given the perceived remoteness of the European parliament and widespread frustration with the European Union’s bureaucracy, the level of participation and the movement toward transnational politics is remarkable.

The transnational nature of the election is stronger this time because the major pan-European political parties have, for the first time, nominated specific candidates for the presidency of the European Commission, and the candidates are campaigning, including in televised debates. The European Council, as mandated by the Lisbon Treaty, will have to take into account the election results in selecting the candidate to put forward for parliamentary endorsement.

The campaign for the Commission’s presidency may turn out to be as significant as the final selection. The first debate, held late last month, included Jean-Claude Juncker of the center-right European People’s Party (EPP), the Green Party’s Ska Keller, Martin Schultz of the center-left Progressive Alliance of Socialists and Democrats, and Guy Verhofstadt of the centrist Alliance of Liberals and Democrats. Alexis Tsipras, representing the Party of the European Left, is expected to participate in the final debate this month.

All of the candidates spoke flawless English – though the debate was translated into 16 languages. Given the United Kingdom’s reservations about European integration, it is somewhat ironic that English is playing such a critical role in facilitating the creation of a transnational political space.

The debate attracted significant social-media attention, with tens of thousands of tweets on the subject reflecting the passion that some Europeans – especially the younger generation – feel about Europe’s political evolution. More generally, while public interest in the campaign remains far below that seen in national political contests, it has become stronger than in recent pan-European elections, despite the rise of nationalism and Euro-skepticism.

In this context, it would be strange if the European Council tried to nominate the Commission president without regard for the public’s response to the campaign. And yet there is a risk that the selection process becomes no more than an exercise in political horse-trading, with Council members awarding leadership positions, including seats on the Commission, purely on the basis of national political considerations. Such an approach would deal a powerful blow to the citizens who took their European ballot seriously – and to the credibility of the EU as a whole.

Could this really happen? Or has the transnational European space – however young – already grown to the point that it cannot be ignored?

Much will depend on the election results. First and foremost, the participation rate will be critical. If it were to fall below the 43% attained in 2009, the Council could more plausibly argue that the preferences of a decreasingly interested public can be largely ignored. A substantial increase, however – say, toward the 45-47% range – would make it much more difficult to ignore the outcome of the campaign.

The relative performance of the pan-European parties will also matter. If, for example, the Socialists won 215 seats, compared to 185 for the EPP, the substantial difference would make their leader, Martin Schultz, a very strong contender, even though no party came close to an absolute majority of 376 seats.

If the outcome turns out to be closer, with a difference of only five or ten seats between the two top parties, it could be argued that neither of the leading candidates had “won.” This would give the Council more space to consider an “outside” candidate (for example, Pascal Lamy, who is closer to the center left, or Christine Lagarde, who is closer to the center right, both of whom are extremely experienced European policymakers whose names have already been raised in the media).

To bolster the legitimacy of such a move, the Council would have to select the candidate more closely associated with the party that gained more votes, however narrow the margin. Moreover, an outside candidate must be likely to generate backing by a sufficiently large coalition in the parliament. Alternatively, with neither of the larger parties able to declare real victory, they could decide as a compromise to indicate preference for one of the other leaders who had campaigned – perhaps Verhofstadt, the liberal centrist.

As Jean Pisani-Ferry has explained, despite the European Parliament’s substantial – and increasing – power, it cannot be the central actor in Europe’s economic-policy debates in the short term. Real decision-making power will remain largely national.

But, given the parliament’s position at the center of a nascent transnational European space that could, over time, transform Europe’s politics and help the continent overcome resurgent and dangerous chauvinism, this first European election with a transnational flavor should not be ignored. When they meet on May 28, European leaders would do well to encourage the strength of European institutions by choosing both competence and legitimacy.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United Nations Development Program (UNDP), is Vice President of the Brookings Institution

THE FED

The Fed's "Growth-Buying" Scheme Is Failing

By SHAH GILANI, Capital Wave Strategist, Money Morning · 

 May 13, 2014


The numbers are in. And they are ugly...
Based on preliminary first-quarter data, U.S. GDP (gross domestic product) growth is 0.1%.

That's not much.

But then again what do you expect for $3.4 trillion dollars of Federal Reserve spending to boost the economy?

So the question is, how is it possible that we've got nonexistent economic growth, or worse, negative growth and possibly another recession looming, when the Federal Reserve since September 2008 has spent $3.4 trillion to prime the economic pump?

This could push the whole economy past the brink...

The Ugly Truth on Fed Intervention

First of all, the preliminary GDP number, which is the total output of goods and services produced by labor and property minus imports, will be revised on May 29, 2014.

A majority of economists are already revising their estimates down into negative territory.

The consensus view expects the revised or "second" GDP number will actually show the economy contracted by 0.5% to 1% in the first quarter.

Not that the second quarter is expected to be bad just because of a slow first quarter. In fact, a majority of pundits, including the Federal Reserve itself, are saying because the first quarter was so bad the economy will bounce robustly in the second quarter.

But if they're wrong and the second quarter shows negative growth, that's really bad.

It's bad because two consecutive quarters in a row of negative GDP growth is the definition of a recession.

Why has the Fed intervention failed so miserably in spurring growth? It's an ugly truth but needs to be told.

Since the credit crisis, which spawned the Great Recession, the Federal Reserve has been trying to build a bridge to growth. The truth is they've spent trillions on their bridge efforts, but they can't deliver the destination.

Here's what's frightening: What seems like misguided Federal Reserve policies to stimulate economic growth by printing egregious amounts of money was never a misguided policy of trying to stimulate the economy. It was a massive liquidity and profit-making program designed to first save, then enrich, the nation's biggest banks.

Economic growth was the expected byproduct of the Fed's "trickle-down" banking bonanza.

Why It Didn't Work

The reason we're not seeing that trickle-down growth is because the banks aren't lending as they were expected to.

They aren't lending robustly into the economy because they've had to pay out billions of dollars in fines and legal costs.

That plus their former freewheeling speculative trading gambits with depositor money are being shut down thanks to Dodd-Frank and the Volcker rule, and they are facing their worst free-market enemy, a flattening yield curve.

It's common knowledge that all the nation's too-big-to-fail banks would have all failed if the Fed hadn't bailed them out. Any one of them collapsing, after what happened when Lehman Brothers imploded, would have brought down all of them like a professional bowler throwing a 50-pound ball down an alley with gutter guards.

It's impossible for there to be any economic activity if there are no banks. So, the Fed did what it had to do to save the big banks.

It flushed them with trillions of dollars.

To get their footing back, the Fed took bad loans off their books and opened up its discount window to all comers for all they needed.

They also took in underwater mortgage-backed securities (MBS) and bad loans as collateral for the cash they lent them. To ensure their return to massive profitability, the Fed then embarked on quantitative easing, or QE.

QE is another giveaway program for the big banks. The Fed buys tens of billions of dollars a month in treasuries and MBS from the banks.

The banks in turn get cash, and they lend overnight at the fed funds rate. The Fed set the fed funds rate to essentially zero, and with their borrowed cash the big banks buy more treasuries and MBS to sell next month to the Fed.

It's a great way to make risk-free money and for the big banks to improve their capital ratios and reserves and profits. All of which makes them flush enough to raise dividends, which makes their equity stock look better to investors. And the icing on the cake is that they get to raise dividends to entice more investors. It's a great game.

Too bad the banks are the only ones benefiting directly. The whole trickle-down thing isn't working.

What Has the Big Banks Terrified

Besides hoarding money to pay ongoing and future fines for criminal activities, all the big banks are terrified of the shape of the yield curve.

The yield curve is a graphical representation of interest rates. On the vertical left axis are interest rates rising from zero to whatever height they attain. The horizontal axis is time, with one day all the way on the left and going out to 30 years on the right end of the axis.

Banks borrow from each other, usually for a day at a time, at the fed funds rate, which is a market rate but a rate that the Fed largely controls. The fed funds rate is somewhere between zero and .025% now, as that's where the Fed manipulated it to. As the line that traces interest rates moves to the right, it trends higher. That's because you pay a higher interest rate to borrow money you intend to pay back over a longer time.

Normally the yield curve slopes upward steadily, so that interest rates to borrow for a day might be .25% (on an annualized basis) and 5% or 6% or more for a 30-year mortgage.

But the yield curve is flattening, not steepening, for a few reasons.

Investors are buying 10-year and 15-year and 30-year bonds because their yield is better than what they would be paid if they bought shorter maturity bonds.

One reason that longer-term interest rates aren't as high as they are expected to be is because rates are so artificially low (courtesy of the Fed' manipulation) that investors are going further out on the "risk spectrum," meaning they're willing to lend out money for longer to get more yield.

But another reason there's so much interest in longer-dated bonds is that investors are seeking a safe place to park their cash in anticipation of falling yields because of a market crash or some global macro-event that panics markets.

In other words, investors are fearful.

One of the reasons is that they don't believe the Fed's low interest rate policies are creating growth and that the economy could fall back into recession, which would cause yields to fall even further.

So they want to lock in whatever higher yields they can get now.

The flattening of the yield curve is bad for banks.

When they lend out for a long period of time, they want to charge as much interest as they can.

But if the yield curve is flat and investors are willing to take less interest, they can't charge as much interest as they would like.

If you're a bank and you make loans, you price them according to your risk of being paid back and how long you're making the loan for.

Banks don't want to make long-term loans and not get paid; that's too much risk. That's why they're not making loans hand over fist, even though they have the money to lend.

Thanks to the Fed's QE, banks are better off doing business with each other and the Fed than the public. If there's no credit, there's no economic growth.

And that's the dilemma we're facing.

And most frightening of all, the consequences of no growth and the Fed's money printing are about to devastate equities (again), some bond investments, commodities, real estate (again), and other asset classes.