Sunday, June 17, 2012

A glimmer of hope?

Weekend Update.

On Monday the Greeks decide whether to vote for the Easter Bunny or Santa Claus to solve their fiscal problems. What is Europe planning to do next?

Sunday's New York Times had an unusually cogent article on European events over the weekend, reporting on events with thoughtful analysis:
The head of the European Central Bank and other euro zone leaders worked on Saturday on a grand vision... the plan will push for countries to remove the regulations and layers of bureaucracy that inhibit competition, keep young people out of the work force or make it difficult to start a new business....

Over the years, countries have repeatedly pledged to clear the rules that hinder competition and led to chronically anemic growth. If the euro zone grew faster, tax receipts would rise and the debts of countries like Spain or Italy would seem less daunting
Halelujah! Growth -- the classical, growth-theory, higher productivity, bend-up-the-trendline, long-run kind of growth, not the quick espresso stimulus kind of growth (if that even works) -- is the only hope for Europe to repay debt rather than face the awful choices of default or inflation. At least we understand this is the central answer and without it, all the rescue plans will fail.

For years the mantra has been, stimulus and crisis management today, and "structural reform program" to be implemented in the vague far off future. They've figured out it won't work. Decades of previous good times did not bring structural reform. 
“There is a long-standing agenda on growth,” Mr. Draghi told a gathering of economists on Friday in Frankfurt. “It is time to implement it.”

But it is unclear whether yet more pledges of reform, which would face significant hurdles, will calm financial markets.

The euro zone has no shortage of plans and pacts intended to end years of sluggish growth and impose discipline on its 17 members.

The challenge for Mr. Draghi and the plan’s authors....will be to package their plan in a way that makes investors believe something will get done.

The most difficult task for Mr. Draghi and the other leaders may be to establish a binding timetable, to ensure that political leaders do not drag their feet.
Correct. Quite a challenge, I'd say. How do you establish a "binding timetable?"
The leaders are “only capable of acting at gunpoint” — when markets force them to, Willem H. Buiter, chief economist at Citigroup, said...
But once markets "force them to" act, by a huge bank run, refusing to buy government debt, running from the currency, it will be too late for a structural reform plan to have any chance.


What about the immediate problem, the bank run, no longer "imminent" but gaining steam every day?
Under the plan, euro zone leaders will seek to establish the central bank as supreme bank regulator with broad powers, in place of the relatively toothless European Banking Authority.

Countries would also create a deposit insurance program to augment national programs. The goal would be to reassure ordinary depositors and prevent bank runs, an imminent danger in Spain as well as Greece. But any sharing of financial burdens almost automatically encounters opposition in Germany.
Catch 22. We've got a bank run. How to stop it? Ah, deposit insurance! But who is going to pay for that? "Countries" are not credible. The whole problem is that "countries" used their banks as piggy banks, stuffing them with sovereign debt. So, if the countries default on their sovereign debt, the banks go under, and the same "countries" obviously don't have the money to guarantee deposits.

A cross-national deposit insurance scheme, while banks are already stuffed with sovereign debt, is back to Plan A, run for the exit and stiff Germany with the bill. Which "automatically encounters opposition in Germany."

A Supreme Bank Regulator  to stop banks from gorging on sovereign debt in the first place might have been  good idea, perhaps. (The concept "sovereign debt is risky" isn't necessarily beyond the ability of national regulators to comprehend, even with Basel rules denying it.) But it's way too late for that now.

Bottom line: Waffling again. No serious plan to stop the bank run already in place. You can't stop the crisis by saying you'll invent a totally new regulation regime to keep the banks from taking risks.


What about looming sovereign defaults?
For now, the most important new tool is a half-dozen rules known as the Six-Pack, which took effect in December. In coming months, the European Commission will be able to impose fines on euro zone countries of up to 0.2 percent of their gross domestic products if they flout rules on public debts and deficits.
Oh yeah, right. The same Spanish government you just lent 100 billion euros to pour down the rathole of its banks, that one. You're going to tell them to pay you a fine of 0.2 pct of GDP because they're borrowing too much money..from you?

The one big lesson to learn from this debacle is that deficit limit rules do not avoid sovereign defaults. A currency union without fiscal union needs to allow sovereign default.

As far as quelling the panic, good luck that "we really mean the deficit targets this time" will have any effect.


What are they going to do now, to stop the unraveling that is likely to happen in weeks?
Mario Draghi, the president of the central bank and one of the authors of the plan, said Friday that it would be unveiled within days, ahead of a meeting of European leaders at the end of June.
Well, that's good. I hope there still is a euro at the end of June.


Bottom line. Mr. Draghi is saying the right words on growth. But these plans to address bank runs and sovereign defaults are not realistic. And the pace of events is quickening. The time to actually implement a pro-growth policy, and stop financial panic by convincing markets it will really happen, is getting shorter and shorter.