Monday, October 3, 2011

After the Global Crisis

Conjectures about the post-crisis future of the global economy are path-dependent, i.e. they necessarily depend on the course of events envisaged for getting out of the crisis.

The current global crisis was the consequence of financial de-regulation and the general dominance of hyper-liberal policies in the United States, in the UK and in the global economy. It started around August 2007 as a US banking crisis arising from toxic sub-prime assets in banks’ balance sheets; it turned into a credit crisis that depressed enterprise investment; it spread globally through the decline of foreign trade and the slowdown and often reversal of capital flows, including Foreign Direct Investment; and then - with the large scale cost of rescuing financial institutions by government budgets, the rising cost of labour unemployment and the decline in governments revenue - it grew into a fiscal crisis and, ultimately, a widespread crisis of sovereign debt, particularly in the Euro-zone.

Initially the decline in industrial output, foreign trade volume and stock exchange values replicated the scale and the pattern of the 1929-32 crisis. Soon the impact of the crisis and cross-country contagion were mitigated by simultaneous, internationally co-ordinated, monetary expansion and fiscal stimulus, introduced at the end of 2008 and early 2009. But monetary expansion failed to re-launch economic growth, while concern about fiscal sustainability soon led to a simultaneous, premature exit from fiscal stimulus in most countries. Current prospects - apart from those of BRICS (China, Russia, India, Brasil, South Africa, now accounting for 18% of world GDP and the bulk of its growth) - are of widespread stagnation and double-dip, indeed of a second and even more serious recession.

The macroeconomic policies followed appeared to have a keynesian flavour, stimulating aggregate demand via tax cuts, monetary expansion and low interest rates. But keynesian remedies would have required public investment instead, whereas tax cuts temporarily fuelled private consumption, and the effectiveness of low interest rates - which mostly were not passed on to borrowers and simply involved higher profits for financial intermediaries - was limited by liquidity preference.

The rescue of financial institutions involved a massive transfer of wealth from taxpayers to bank creditors, including depositors and shareholders. This solution was clearly inferior to any of the alternatives, whether support for bank debtors, or partial nationalization of supported financial institutions, or outright loss-taking by imprudent lenders. Income inequality, whose depressive effect on effective demand had been reduced by credit expansion - one of the contributory factors of the crisis - increased further as a result of labour unemployment and continued payment of managerial super-bonuses awarded mostly to those responsible for the financial debacle not by markets but by a semi-feudal process of self-serving decisions by a managerial caste.

The current generalized advocacy of strict fiscal discipline, demanded by international financial institutions and often enshrined in national constitutions as a balanced budget obligation, is particularly anti-keynesian, and is bound to be counter-productive in the middle of a recession.

First, a balanced budget is neither sufficient nor necessary to the sustainability of government debt, because a primary surplus (net of interest payments) may or may not be necessary to debt sustainability - depending on whether the economy grows at a rate slower or faster than the average interest paid on government debt.

Second, the keynesian lesson has been forgotten or ignored, that the balance of government expenditures minus revenues, plus the balance of private investment minus savings, plus the external balance of exports minus imports, must necessarily add up to zero as a matter not of theory but of accounting consistency. Therefore the budget balance cannot be a policy instrument, but only a target that may or may not be achievable depending heavily also on the behavior of national economic agents and of global trade partners (including the elimination or large reduction of Germany’s trade surplus vis-à-vis the rest of Europe, and China’s gigantic trade surplus). Generalized efforts by all governments to balance their budgets simultaneously might actually result in a perverse combination of budgetary (and trade) imbalances as well as a lower level of employment and income worldwide than would be the case without such efforts.

By the same token, generalized efforts to promote employment and growth via higher international competitiveness - whether achieved by external devaluations or by domestic deflation of wages and prices - can also be competitively self-defeating: another clear keynesian lesson is that lower wages can raise employment through higher exports in one country, but cannot resolve unemployment as a world problem. Nor can world unemployment necessarily be reduced by a generalized reduction of employment tenure and other labour welfare provisions, or the replacement of collective bargaining by firm-level bargaining: the only certain effect of such policies, also very popular in anti-crisis policy packages under the pretext of “structural reforms” (e.g. see the European Central Bank’s guidelines to the Italian government in their letter of 5 August 2011) is the deterioration of the quality of work and labour incentives.

Often it is believed that the impelling necessity of environmental improvements, required by the reduction of global warming and of general pollution, and the forthcoming exhaustion of natural resources, will create a new important opportunity for investment and growth. However - apart from the observably controversial nature of global warming - these are all opportunities for public or public-funded investment, desirable in itself (not absolutely but up to some point) but competing with alternative uses of scarce public funds whose expenditure today is supposed to be kept under control in the interests of fiscal sustainability.

The chances of world leaders suddenly learning keynesian lessons, and implementing them with the speed and on a scale adequate to propel the global economy out of stagnation are remote, indeed would amount to a miracle. Even those who would like to do it are prevented by the electoral challenge of populist competitors (as is Barack Obama by his Tea-Party Republican challengers). By comparison the prospect of Wealth Sovereign Funds coming to the rescue of highly indebted governments might seem a more normal occurrence, but this would be the true miracle and is simply not going to happen: it worked in 2008 to the advantage of financial stabilization, but now WSFs have run out of trust.

The fact that the US can always “print” the dollars it owns to pay its creditors does not make the US debt indefinitely sustainable: at some point the resulting dollar inflation will make dollar bonds unpalatable at less than crippling interest rates so high that they would necessarily involve eventual insolvency. Other countries face even stricter debt sustainability conditions, without the same initial room for manoeuvre. Where private wealth largely exceeds the difference between current debt and its sustainable level, it is always possible to apply a once-and-for-all or recurring wealth surcharge to achieve solvency. Italy, for instance, has a public debt of euro 1,900 bn, but in 2008 it had a household wealth of euro 8,600 bn, 45% of which was concentrated in the top 10% of households; but wealth taxation is unpopular and the political will to introduce it is scarce. Privatization of public assets is often considered as a way to reduce sovereign debt, but the potential revenue obtainable from this source is usually overstated with respect to the depressed values realizable during a crisis, when it is infelicitously timed.

An insolvent country, like Greece, has only three alternative options: 1) instant orderly default with significant “hair-cuts” negotiated with creditors; or 2) instant dis-orderly default; or 3) delayed default, whether orderly or dis-orderly, preceded by roll-over of debt with the assistance of international financial organizations (like the IMF, or the European Financial Stability Fund soon to become the European Stability Mechanism, or the European Central Bank with its controversial purchases of government bonds in secondary markets) followed eventually by actual default, as in all schemes of pyramid banking, to which such rollover of uncovered debt has been likened.

The three default options are ranked above in order of increasing cost. However it should be remembered that non-default by insolvent debtors is also very expensive, as witnessed for instance in the large scale fall (of the order of 25%-30% in just one quarter in mid-2011) in the capitalization value of stock exchanges in temporarily solvent Euro-zone countries with uncertain longer-term solvency.

Partly the probability of default, assessed by Rating Agencies (like the oligopolistic three: Standard and Poor’s, Moody’s, Fitch), reflected in the interest spreads with respect of bonds regarded as totally secure (like German Bunds) and in the price of insuring bonds against default by buying Credit Default Swaps, expresses political as well as economic judgments (as in the recent case of Italy, handicapped by a corrupt, disreputable and divided government short on credibility).

Of course Rating Agencies have proven to be highly fallible and often biased, for they have their own agendas to drive forward, have positions of conflict of interests (“issuer pays” instead of “buyer pays”) and opportunities for insider trading. Alternative, public Rating Agencies have been advocated, for instance in Europe, but such institutions could not be regarded as independent and therefore their credibility would be low. Better still, “the use of ratings in financial regulations should be significantly reduced over time” (as was suggested in the de Larosière Report of 2009 under Recommendation 3, but never acted upon by European authorities).

In order to contain the unavoidable disruption and turmoil involved by a country’s default, it would be essential to anticipate its adverse effects and counteract them beforehand, by re-capitalizing commercial banks exposed to the cross-effects of default, including central banks and above all the European Central Bank that has been acting (probably exceeding its mandate) as Lender of Last Resort to the governments of “peripheral” (meaning “high spread”) countries. An experience of default is bound to depress the price of, and thus raise yields on, old and new government bonds for the whole area; therefore contagion would worsen the sustainability conditions of debt, and therefore slow down the speed of subsequent recovery.

Furthermore, a post-crisis global economy should have renewed efforts to establish some form of global governance rather than have in place the many and inadequate ad hoc institutions cobbled together to, at present, provide some semblance of governance. But in order to be established global government now would have to be universally accepted not only in its initial form, but also in all its rules for the continuous adjustment to future, unforeseen and unforeseeable, circumstances: such acceptance now is probably out of the question. Besides, the demotion of the nation state is not necessarily desirable. For the nation state provides a layer of authority that can protect citizens from global corporations as well as from a necessarily monopolistic global governance authority that could easily misbehave out of democratic control, and without any remaining territory to which one could run for cover.

Eventually the post-crisis economy - sooner or later - will begin to recover, thanks to the profitability of production and investment being raised by depressed wages (due to mass unemployment), the accumulation of new profitable technical inventions and opportunities, the progressive depletion of existing inventories and production capacity. Once started, recovery would tend to be amplified by indirect effects, such as the usual interaction between multiplier and accelerator, until potential capacity constraints are met again and some cyclical mechanism is set in motion again in reverse. Such is the inexorable logic of the market economy. But reliance simply on market self-regulation will most probably lead to recovery much later than possible with government intervention and jump-starting. It is unfortunate that the inadequate policy responses of 2008 and their premature withdrawal should have grossly diluted their effectiveness thus making the implementation of growth policies harder today.

Changes must also be attempted in order to prevent the operation of factors that facilitated the last global crisis, or to better cope with them. The increase in banks’ capitalization, envisaged by the Basel-3 new rules, will have an initial adverse effect on the volume of lending but longer term benefits for financial stability. A new composite currency is bound to emerge, in place of the US dollar or the euro.

Regulations on the separation of credit and investment operations of banks (à la Glass-Steagall Act) are bound to be reintroduced, as already proposed in the UK by the Vickers Commission. The Over The Counter derivatives trade might be subjected to stricter regulations, such as the requirement of an underlying “insurable” interest for taking up a position in that market, or the prohibition of short-selling, temporarily introduced in the European Union on shares and government bonds. The traditional principle of Central Bank independence in the exclusive pursuit of inflation targeting - based on the now discredited theory of rational expectations and the consequent de-coupling of inflation and unemployment - is bound to change into the even more independent pursuit of multiple targets including employment and competitiveness. We might witness attempts to protect domestic industries and stop immigration - largely unsuccessful in view of the irresistible force of underlying trends.

Currently, by and large, the economic system emerging from the crisis is bound to be substantially very similar to the pre-crisis one, improved in some respects, but worsened by large scale cuts in welfare expenditure made necessary by the (debatable) purpose of achieving fiscal balance. The post-crisis system will be more conflictual and insecure, more unequal and less cohesive, less rather than more “green” - basically a more unpleasant world in which to live. It need not be so.

Saturday, June 18, 2011

Los Indignados

These days indignation is a right and proper, indeed compelling, not to say compulsory, sentiment. It was forcefully advocated by Stéphane Hessel, the 93-year-old former French resistance fighter, in his influential though somewhat over-rated pamphlet Indignez-Vous (2010). “ In this world of ours – Hessel writes - 'there exist intolerable things… Indifference is the worst of all possible attitudes… One of [man’s] indispensable capacities is the capacity to feel outraged, and the commitment that derives from it”. Gramsci said it long before him.

In Spain at the beginning of March, a minor social network connected via e-mails, Facebook and Twitter, that called itself Democracia Real Ya, gathered mounting consensus and called on its adherents to take to the streets on 15 May. Which they did, punctually and massively, over 60,000 of them, in spite of the extant prohibitions due to the coming administrative elections of 22 May. They became El Movimiento 15M; they called themselves Los Indignados. In Madrid they occupied Plaza del Sol, in Barcelona Plaza de Catalunya, as well as the main squares in most of Spain’s provincial cities. They responded to provocations with peaceful and orderly meetings, discussions and free collective catering. They left on the last week-end, after cleaning up the square after themselves, but planning repeat action.

On 15 June they met again in front of the Catalan parliament in Barcelona. El Pais reported that “the protests were among the most violent since the restoration of democracy”, but a
Youtube video provides incontrovertible evidence that the violent demonstrators were agents provocateurs. An identifiable small group of young people who turned nasty, in the end left 'under police escort' (sic); the peaceful demonstrators had chanted at them “Secreta, idiota, te crees que no se nota” [You are from the secret police, you are idiotic if you think we don’t know].

Who are Los Indignados? They are “the excluded” ( Los excluidos) – mostly educated, unemployed youth and those in precarious short-term employment – and their sympathizers. Los mileuristas (as christened by Espido Freires) and los zero-euristas, i.e. those earning 1,000 euro a month, or nothing at all. El Pais celebrated cartoonist El Roto – who is also a very good economist judging from his take on the global crisis - sums it up thus:

- The excluded are rebelling
- Sack them!
- No way, they don’t have jobs

- Cut their subsidies!
- We can’t, they don’t get any
- Demolish their homes!
- Impossible, they haven’t one

- Then, we are lost!

The socialist government led by Zapatero since 2004 initially made good economic and political progress, with a booming economy, high employment, secular distance from the Catholic Church, the protection of civil rights, and income redistribution. But in 2009 the global crisis hit Spain particularly hard, in spite of its earlier record of virtuous fiscal policies (as was Ireland’s). It was its worst setback since EU accession: real estate and the construction boom came to an abrupt end, investment fell by a quarter, consumption and exports were badly hit. In 2009 GDP fell by 3.6%, in 2010 GDP growth was only 0.8%; the Economist predicts 0.6% in 2011 and 1.1% in 2012.

The crisis had a devastating impact on the labour market. In the last three years Spain, with a population of 46 million, has lost more than 2 million jobs - 623,000 in 2008, 1.21 million in 2009, and 238,000 in 2010. By the end of 2010 Spain had 20.3% unemployed, or 4.69 million – more than twice the European Union average of 9.6%. In the first quarter of 2011 Spain had 21% unemployment, and youth unemployment reached 45% (860,000 people among 16-29 year-olds; 15% of youth in the 16-24 age bracket are the "ni-ni generation”, short for ' ni estudian, ni trabajan' —neither study, nor work). Those employed hold precarious, short-term jobs. They are educated, they are “the lost generation”. In their view, power is in the hands of “markets” and the bankers (as exemplified by Santander President Emilio Botin), in whose hands, they believe, politicians are simply puppets.

Zapatero’s expenditure cuts (recortes), aimed at reducing the government deficit from 11.1% in 2009 to 5.5% by the end of next year, have destroyed the confidence of the Indignados. Furthermore, in 2010 pensions were frozen and retirement age raised from 65 to 67, civil servants salaries were cut, the cheque bebé of €2500 and a planned €426 increase in unemployment benefits were shelved. A labour legislation reform that made layoffs easier to carry out generated Zapatero’s first general strike last September. The long-term viability of the banking system, and especially the savings banks (the cajas) is in doubt. The rich become richer, while there is no money for education and health. The Partido Popular would be no better. On the eve of the elections Zapatero declared that Spain would “very probably” have needed a bail-out by the European Union last year without the government’s imposition of a harsh austerity plan, but the Indignados did not accept that this was the case.

Is there contagion from the North-African Arab spring? Avenue Habib Bourguiba in Tunis, Tahrir Square in Cairo, and the Pearl Roundabout in Bahrain provide images similar to those of Madrid’s Plaza del Sol, but there is a significant difference: “In the Arab world, they are demanding the vote,” former Socialist prime minister Felipe González said on Spanish television. “Here they say there is no point in voting.” As in Italy, in Spain voters cannot pick and choose among individual candidates.

Their slogans are telling:

Adopt a politician. Educate him!
Violence is 600 euro per month.
We are excluded by neo-liberal decree; we are rebels by human dignity.
They piss on you then tell you it’s raining.
When the doors of justice close, those of revolution open.
Democracy now is voting for those you despise to stop government by those you fear.
Parliament is on brain strike.
Politics for the people, but … without the people?
To kick them out, do not vote them.
Wanted – a decent politician.
Bankers!!! As we did not vote for you, why do you govern us?
Problems do not arrive by boat, they arrive in limousines.
If you don’t let us dream, we won’t let you sleep.
We are not anti-system, we want system-change.

What do they want? At first they didn’t know. Slowly they hammered out some kind of manifesto in their open assemblies, committee and sub-committee meetings and working groups. On 19 May, Los Indignados put up their proposals to re-generate Spain, calling for: the elimination of the privileges of the political class; measures against unemployment; housing rights; quality public services; control of banking; a more egalitarian taxation; greater participation, and reduced military spending.

Some of their proposals are straightforward and desirable, such as the expropriation of unoccupied houses to be let out at a controlled rent, or the proposals on the elimination of privileges for the political class: sanctions for absenteeism and dereliction of duty by political appointees, abolition of privileged tax regimes, pension and pensionable services, indexation of their salaries to the average wage, abolition of immunity for actions taken on duty, and of proscriptions for corruption charges. But nobody really knows how to limit corruption of politicians. Should they be banned from working in the private sector (as so many do) once they leave office? The US have a two-year ban, which really does not achieve much. Perhaps they should be banned for life, but this creates a real caste of politicians, like in India and Greece, which is no better.

Some of the proposals are ambiguous, if not outright economically naïve, for instance work-sharing and a reduction of working hours to reduce unemployment – without specifying a parallel earnings reduction without which higher unit labour costs would raise unemployment instead of reducing it. Most proposals are expensive: the welfare state of Western Europe of the 1960-70s, i.e. 40 years ago, has been unsustainable for some time, given both globalization, i.e. the mobility of capital and the willingness of poor people elsewhere to work for much lower real wages, and the public debt accumulated by maintaining the welfare state under such adverse conditions. Some complaints are contradictory: you cannot have Europe and complain of a European democratic deficit and then ask that every EU decision be subjected to a national referendum. And what does “street democracy” (democracia de la calle) mean? Are we to reproduce Soviets? And how on earth can abstentions and spoiled ballots achieve “representation in the legislature”?

Four comments are in order:

First, the Spanish Indignados mis-timed their demonstrations terribly, just in the run up to administrative elections in which they could – and many did – demonstrate their feelings without occupying public space.

Second, there were large scale abstentions (34%) and the number of spoiled ballots doubled to 4% representing the third largest “party” in Spain after the Socialists and the People’s Party, which contributed to the PP victory.

Third, the Spanish electorate – as happened virtually everywhere after the crisis, with the exception of Turkey – was not particularly discerning and did not match its votes with its aspirations. Indiscriminately electorates have voted against the incumbent government, right or left, in debtor as in creditor countries (in Greece, Ireland, Portugal, as well as in Germany and Finland), supporting, instead, parties which were most unlikely to pursue their desiderata. They cut off their noses to spite their faces. Thus in the regional and municipal elections of 22 May José Luis Rodríguez Zapatero’s PSOE lost 19% of votes with respect to the previous round, and was resoundingly defeated by the opposition conservative People’s Party led by Mariano Rajoy, that gained 7% involving a 10% lead that gave them control of 9 out of 17 regional governments, and 36 out of Spain's 50 provincial cities, including several traditional PSOE strongholds like Barcelona and Seville and the regions of Castilla La Mancha and Aragon; while in the Northern Basque country a new radical separatist party, Bildu, won 25% of the vote. Last April Zapatero had announced that he would not lead his party into the general election next year, but any repeat performance by the PP is bound to hand them a parliamentary majority.

Fourth, Los Indignados did not really know what they wanted and – as indicated above – most of their proposals were vague, or infeasible, or outright contradictory.

These may sound highly critical, even adverse comments on Los Indignados, but they are not. Their approach and strategy may be debatable, but are perfectly legitimate and right and proper political behaviour. Lack of intra-party democracy debases the contest between parties leaving the electorate feeling unrepresented and frustrated. Abstentions and spoiled ballots are a wasted opportunity – and there is little point claiming that they should be counted and count – but, again, a perfectly respectable strategy, though not one that most voters (including me) would advocate. Alternation in power facilitates renewal of the political class – though not enough by itself; Gordon Brown's re-election would have been as much a tragedy for the British left as his self-imposition, and for Great Britain at large, though Brown’s protégé Ed Miliband has yet to learn any lessons from Labour’s defeat. At least Zapatero has not, like Blair/Brown Labour, launched an imperialistic war, presided over increasing inequality, liberalized and subsidized the financial sector and attacked civil rights, but he has certainly failed to honour the social contract with those who have elected him. And dissenters have no duty (though it would be in their interest) to provide well-developed credible alternatives: this is what parties, professional politicians and their think-tanks are supposed to provide, garnering and formulating as policy the wishes of their electorate.

Democracy allocates votes to alternative political ends - like markets allocate resources to the production of alternative competing goods and services. And just like markets, democracy can function too slowly or too fast, over- or under-react, produce cycles and unwanted results. At least democratic processes, at their simplest, are égalitarian, one person one vote, in theory, while markets are equivalent to multiple voting weighted by wealth; though in practice income and wealth inequality naturally biases and perverts democratic processes. But both markets and democracy - though defective - are the best instruments we have to organize our societies.

Indignation has proven to be contagious. The Spanish example has been followed across Europe: young people, though in much smaller numbers, have taken to the streets in Hamburg, Vienna and Rome. The lost generation has voiced its indignation in Lisbon, Paris, Athens and elsewhere. In Paris 2,000 young demonstrators occupied the entrance to the Bastille Opera and half the Place de la Bastille, demanding "démocratie réelle" and measures against a 20% rate of youth unemployment. Eventually they were dispersed by tear gas.

In Portugal as early as 12 March, 200,000 people marched down the Avenida de Liberdade in Lisbon - the biggest demonstration in Portugal since the 1974 Carnation Revolution. Again, it started with an appeal on Facebook by students of Coimbra University, calling upon the Geração [à] rasca (or the “troubled generation") to join together in protest. "We, the unemployed, the underpaid and the interns, are the best educated generation in the country's history," they wrote. "We are protesting so that those responsible for our precarious situation quickly change this untenable reality." (See “The Rage of the 'Indignants' - A European Generation Takes to the Streets”, Spiegel Online, 7 June). “Portugal is the fourth-poorest country in the euro zone. Even in Greece, the per capita gross domestic product is higher. Unemployment has almost doubled to 12.6 percent in six years; among people under 25 the jobless rate is 27 percent. Of those who do have jobs, more than half are working in temporary positions. Many are pseudo self-employed, earn very little and must pay a tax rate of up to 50 percent. They receive no social insurance benefits.” (Ibidem).

In Greece resistance to the austerity measures forced on Papandreu’s Socialist government by EU authorities and the IMF, to reassure financial markets, last Sunday elicited the eleventh general strike. More than 50,000 protesters, self-professed “Indignant Citizens” after the Spanish model, gathered around Syntagma Square and were involved in violent clashes. It is certain that this kind of resistance will raise the interest rate spread on Greek sovereign debt over German bonds (already of the order of 15%), and the probability of sovereign default. Yet if this is the cost of popular sovereignty, which is what democracy means, it is still cheap at the price.

Sunday, May 29, 2011

Two Generations and Democracy

Branko Milanovic, who contributed a recent guest post on Inequality and the Global Crisis, spent the last month in Madrid, living at a stone’s throw from La Puerta del Sol. He contributed this guest post on the current rebellion by Los Indignados. This is to start the ball rolling, no doubt others will wish to argue. By all means comment via e-mail if you must, but it is much preferable to comment directly on the post.

Several weeks ago the Spanish newspaper “El Pais”, one of the leading dailies in the world, held a party to celebrate the 35th anniversary of its foundation. "El Pais" has appeared in the days of the Spanish "transition" from Franco's dictatorship to democracy, and has throughout remained consistently pro-democratic and center-left. The daily perhaps best reflects the period of remarkable transformation of Spanish society from dictatorship to one of the most tolerant democracies in the world; from the country of emigrants to the country in which foreigners, coming literally from everywhere, account for 12 percent of the population; from a middle-income and in some respects even an underdeveloped country to an affluent country with first-rate quality railroads and highways. In a display of commitment to democracy and tolerance, the “El Pais” party was attended by all Spanish prime ministers since the transition, whether of the left or the right. The tone of speeches was celebratory and somewhat smug. Praise for democracy and the transformation in Spain was not excessive, considering what was achieved in the previous three decades, yet perhaps a bit deafening", reminding one of rather formulaic declarations about the importance of democracy that can be heard in the United States on every 4th of July. I thought that, except for Poland, the Czech Republic and perhaps the Baltic states, it would be difficult to imagine such optimistic tones on similar occasions in Eastern Europe. The reason is simple: democracy is a good thing and there is reason to celebrate it, but only if it goes together with economic development and higher incomes. And in that Spain was indeed very successful, so the generation that has accomplished this historic feat had many good reasons to celebrate. Or so it seemed.

But just ten days after the celebration and on the eve of local and regional elections in Spain, thousands of young people began rallying in the main squares of Spanish cities. The largest gathering, which attracted the attention of world media, took place on the central square in Madrid, La Puerta de Sol, just a kilometer or so from the headquarters of "El Pais" and the building where its party took place. Young people´s discontent was driven not only by the fact that youth unemployment hovers around 40 percent, that most of those who are employed hold very precarious jobs (working on time-limited contracts), or that salaries are stagnant, but by discontent that has spread to the democratic system itself, as it functions in practice. In contrast to the praise we heard at the "El Pais" gathering, now the speeches were very different: democracy ignores the opinions and interests of a large part of citizenry who have become alienated and no longer participate in the process; all political parties, regardless of their name and professed affiliation, pursue similar economic policies; the real power is in the hands of big capital and bankers who finance all political parties, not in the hands of “people”. These are all criticisms that would be subscribed by most young people throughout both “old” and “new” Europe. So, one might think, there is really something deeply flawed with democracy as we know it, and one of key slogans of los indignados said precisely this: "Real democracy-now!". In other words, "partocracy" and "bancocracy" are not acceptable.

But while the young were attacking the current Spanish "system" from the left, the Spanish right, which, because of the economic crisis and high unemployment which it blames on the socialist government, expected a major victory in the elections, retorted with its own slogan, published on the election day on the front page of a newspaper close to Partido Popular: "Real democracy-today." The message to the youth was clear: if you want to have your voice heard and believe that you have a majority, this is your moment, defend your ideas as everybody else does, go to the polls and see if you can win. "People" is not just you: “people” is others as well.

A lot of young people chose not to go to the polls and these unexpressed votes, that would normally go to the Socialists, made a difference and gave a huge victory to the right. Zapatero´s government is on its deathbed, he will not run again, and early general elections may be called. Here, then, the weaknesses in the position of los indignados began to be revealed. While they, on their posters, did not associate themselves with the soixante-huitards (of which they strongly reminded me) but to the demonstrators in Cairo and Tunis, the differences between them and the Arab youth were glaring. Demonstrations in Cairo and Tunis had a clear objective: to end dictatorships and allow for a meangful universal suffrage, multiparty system, and freedom of speech and association. These were clear and simple demands. The protesters knew what they wanted, and eventually won in both Egypt and Tunisia. But the demonstrators in Madrid were not able to clearly say what they wanted: indeed, they desire a better democracy, but what exactly does it mean? Of course, they also want a less corrupt “system" but this is what we all want. How to achieve it is a problem, and they offered no solution. When los indignados finally formulated their 8 theses, all of them except perhaps two (on changing the electoral system and the financing of political parties) were so general in nature, lacked any clear "addressee" responsible for them, or indication of the way in which things need to be improved, that they were made in fact irrelevant. Anyone would sign on these demands any time, and nobody could do anything with them.

And since real democracy took place on the election day and the right won overwhelmingly, while the demands of protesters appeared so general and vague, the demonstration turned into a fiesta, young people having good time in the central city squares, discussing, chatting, drinking beer, smoking marijuana, listening to jazz and rock music for most of the day and night. At 3 a.m., La Puerta del Sol was full of young men and women who enjoyed themselves the way they enjoy themselves at any music festival. Love blossomed—which is indeed excellent, except that it had nothing to do with politics.

And while some youngsters were speaking passionately about the evils of the "system", at the edges of the square, real poor people slowly emerged trying to sell beer or cigarettes, and to make some extra euro. And so it turns out that the older generation, gathered at the "El Pais" party, was indeed right - although when one looks at these young people, in a good mood, kind, pleasant and decent, and compares them to the well-situated, smug and self-congratulating democratic bourgeois, one is torn between sympathy and reason. But the twentieth century has taught us not to trust what our heart tells us.

Wednesday, May 25, 2011

Oh! Calcutta!

The French magazine Le Point reported that Dominique Strauss-Kahn’s last words, before being hauled off the Air France AF023 flight to Paris by two New York Port Authority detectives, were addressed to one of the air hostesses “loudly and openly” and in front of witnesses: “Quel beau cul!”.

Admittedly this utterance sounds better in French than in English. Camille Clovis Trouille (1889-1975) - a minor part-time painter and decorator, Surrealist and anti-clerical – used a pun on that kind of French remark to name his painting of a naked woman’s buttocks: “Oh! Calcutta! Calcutta!”. And Kenneth Tynan used both that title and that painting in his 1969 Broadway show, featuring extensive scenes of total nudity, that at the time became the longest running and is said to be still today the sixth-longest running in Broadway’s history.

Nevertheless, the remark is not endearing or charming, but gross and aggressive. DSK is sub judice and the courts will decide whether he is guilty and of what. But there can be no doubt, regardless of the courts’ eventual ruling – especially if it is the case that his line of defence is the consensual nature of sexual acts with the Sofitel chambermaid - that he is “a man with a problem that may make him ill-equipped to lead an institution where women work under his command”. These are the words used by a colleague of his, with whom he had an affair, in a letter she addressed to the IMF Executive Board in 2008. A public external enquiry on that case cleared DSK because there had been “no harassment” but ruled that he had made “a serious error of judgment”. The Fund lacked - and still lacks - “clear and protected arrangements for reporting possible misconduct” and “clear disciplinary arrangements” to deal with it if it occurred.

Unfortunately, DSK’s latest little error of judgment has already had the most devastating consequences, not only for him and his family but for the IMF, which in the three and a half years of his tenure he had steered to a larger scale and to a greater role in global governance during the greatest world economic crisis since 1929; for the sovereign debt crisis in the Eurozone and the future of the euro; for the French presidential elections in which he had been a frontrunner who could have led the Socialists to their first victory since Mitterand’s 1988 re-election.

DSK is a Keynesian, like his Chief Economist Olivier Blanchard (from MIT). He persuaded IMF shareholders to raise $500bn additional capital thus trebling its resources. At the emergency summit of G-20 leaders on 15 November 2008 he proposed, and obtained, a large scale global fiscal stimulus of the order of 2% of global GDP, and encouraged a parallel monetary expansion. He opposed calls for an early exit strategy (for instance by the German Chancellor Angela Merkel and the ECB President Jean-Claude Trichet), which he viewed as premature, and above all a collective exit strategy considered by the G-8 of 8-10 July 2009 at L’Aquila, which would have been disastrous.

He junked the old “Washington Consensus” that had inspired IMF operations in the 1980s in Latin America and in the 1990s in the post-socialist transition economies. He was well aware of debt sustainability issues, but was also very conscious of the impact of fiscal austerity on poverty and distribution. Under his leadership there was concern for gradualism, and for client countries’ ownership of stabilization programmes. He aimed higher than he could reach, just to make progress; an instance would be his argument for a new role for the IMF as a global Lender of Last Resort, which was inappropriate, for which he never really developed a case and let drop.

His revolution was unfinished. He was acknowledged to be a very good diplomat, who listened to both North and South; was trusted by the Greeks, was the only non-German with an influence on Angela Merkel.

He is virtually irreplaceable. The problem with Christine Lagarde is not the Tapie affair, of which she is likely to be cleared on 10 June, but – as Martin Wolf puts it in the FT of 25 May – “her limited knowledge of economics”. DSK’s letter of resignation as IMF Managing Director ended, incongruously, with the words “Au revoir”. Sadly, he clearly meant “Adieu”.

Thursday, May 19, 2011

Cuba’s Pre-Perestroika

On 16-19 April 2011 the Cuban Communist Party PCC held its sixth Congress since the 1959 revolution, the first since 1997. The date is historic: on 16 April 1961 Fidel Castro proclaimed the socialist character of the revolution, the next day a contingent of Cuban exiles attacked the Bay of Pigs, two days later they were routed. The timing of this year’s Congress might be taken to suggest that Cuban socialism is in danger now as it was then; on Christmas’ Eve last year the party paper Grandma stated that «it [was] no longer the coming year but the coming country».

If so the frequency of Party Congresses leaves a great deal to be desired: one every almost-nine years, 14 years since the last one, in a period that saw the fastest and most complex changes on the planet, do not say much about the quality of democracy under Cuban socialism, even in its diluted form of «democratic centralism», prevailing on the island. Especially since the Cuban population is aware that Fidel Castro has transferred the Presidency of the country to his brother Raúl in 2008, but discovered only on 22 March 2011 that he had transferred to him also the direction of the Cuban Communist Party five years earlier (Renaud Lambert, «Ainsi vivent les Cubains», Le Monde Diplomatique, April 2011). A Party secret secretary seems bad form, to say the least.

Cuba today – mutatis mutandis - has reached the stage of economic and political development that the Soviet system had reached on the eve of Gorbachev coming to power in March 1985: a gerontocratic leadership, moreover transferring power within the family in North Korean style; an authoritarian political system; much talk of price liberalisation but continued generalised shortages of goods in excess demand at state prices, with rationing for the last 52 years; a dual currency, an unconvertible peso and a convertible one that replaced the dollar in 1994 (something that the Soviets thought of but fortunately refrained from doing); special economic zones to attract foreign investment; long-term leases of state assets in the tourism sector; leases of uncultivated land to landless farmers (about 140,000 leases in the last year); and endless talk about free private enterprises, still in practice restricted largely to self-employment (200,000 new licences since last October) and family firms in the service sector.

Inevitably, at the beginning of September 2010 even Fidel Castro recognised and stated, in an interview to the US monthly The Atlantic, that the Cuban model «does not work anymore». In mid-September the Cuban Workers Union CTC announced the suppression of 500 thousand public sector jobs by March 2011 (as already anticipated by Raúl on 1 August 2010). This was justified by «the need to raise production and the quality of services, to reduce the enormous social expenditures, to eliminate free benefits and excessive subsidies». The half a million are only 12% of public sector workers (who make up 80% of the active population, i.e. 4,400 thousand) one out of each four of them being regarded as redundant by Raoul, thus making total re-deployment from the public sector affect as much as 20% of active population (the figures are provided by Janette Habel, «Changement de cap a Cuba», Le Monde Diplomatique, October 2010; they add up only approximately. The FT of 24 April puts public employment at 85%, i.e. about 5 million). But bureaucratic impediments, lack of credit and of necessary material supplies, crippling turnover taxation, remain the main obstacles to the absorption of redundant workers through the growth of small scale private sector. The quality of education has suffered as a result of teachers leaving underpaid jobs; only 14% of the population uses Internet.

“We are convinced that the main enemy we face and will continue to face is our own shortcomings,” Raúl Castro said at the end of the Congress, echoing what Gorbachev might have said in 1985. The preliminary lineamientos (over 300 directives) of the Party Congress aimed at legalising what was already discrete current practice, such as price-fixing according to market principles (there has been a free peasant market for agricultural products since 1994, promoted by Raúl in spite of Fidel’s opposition), links between wages and productivity, greater autonomy for state enterprises. Above all there is a perceived urgency to open the economy, following the example of Vietnam and China. With the economic collapse of the Soviet economic and political system, Cubans lost their former benefactor and GDP fell by 35% during the «Special Period» of 1991-2000; today Venezuela’s subsidised oil in exchange for Cuban teachers and doctors is not enough to replace former Soviet support. Cubans now have to contend with the harsh reality of global markets, though they prefer to blame their aggravating economic backwardness not on globalisation but on their being denied access to it by the US trade embargo - perhaps the most myopic and counterproductive policy ever adopted by the United States towards a weak opponent.

There are bright spots. Since 1950, average life expectancy has risen from 58 to 77 years (as it did in Russia under Gorbachev). A recent issue of Foreign Affairs stressed that «Cuba is the only poor country in the world that can claim that health does not represent a fundamental problem for its population. Its success in this field is unrivalled». But tourism and nickel, the most dynamic sectors of the economy, were severely hit by the 2008 crisis; in the same year three successive hurricanes destroyed infrastructures worth $10 bn, equivalent to 20% of GDP. In 2009 agricultural production fell by 7.3%; the country imports 80% of its food, up from 50% in 2004, a growing vulnerability given the volatility of food prices over the last couple of years. Lending to Cuba by international financial institutions has been falling over the last four years, but total debt has been accumulating fast, from just over $16bn in 2006 to $20bn today, mostly towards China. (FT, 24 April 2011)

The ration card (tableta de abastacimiento) had some egalitarian merit in the distribution of basic goods, as an exceptional, temporary measure during short emergencies when established supply channels are suddenly disrupted by wars or natural calamities. Otherwise its continued persistent use since 1962, and the associated black/grey/multicoloured markets in which scarce goods are re-traded (whenever this is physically possible) at a premium, is a tragic misunderstanding of socialist values. Socialist planning ought to be capable of balancing supply and demand at stable prices, but if it fails it is much preferable to let prices do the rationing through price rises, at the same time subsidising the monetary incomes of the poorer groups of the population in order to support their real consumption levels. Yet the redistributive effects of market-clearing prices – in the absence of re-distributive, compensatory measures – are clearly undesirable. Urban poverty – i.e. inability to cover basic needs - is said to have risen from 6.3% in 1988 to 20% in 2000 (Mayra Espina, quoted by Jeanette Habel, «Cuba en quête d’un modèle socialiste renouvelé», Le Monde Diplomatique, January 2009).

Raúl recognises that the tableta is «irrational and unsustainable» but expresses vocal concern for the dangers of inequality, growth of the informal sector and the black market, themselves being generated in part by the rationing system: such concern should lead to generalised income subsidies rather than place a major drag on price-liberalisation. For without market-clearing prices you cannot imitate China and play with markets, with private entrepreneurship, hard budgets and export-led growth. A set up only too familiar from the last days of the Soviet régime.

o O o

In December 1969-January 1970 (the year of the 10 million tons of sugar) I visited Havana from Cambridge to lecture on investment planning at the Institute of Economics, following up on Richard Stone who had just been there to lecture on input-output models. In my course I tried to legitimise the use of an interest rate in investment selection, which was regarded then by Cuban economists as an exploitative bourgeois practice to be rejected. I pointed out that even Soviet Academician Stanislav Strumilin had advocated an interest rate within the Marxian Theory of Value, as the growth rate of labour productivity that reduced the labour value of future goods. I also argued that there was an implicit, shadow interest rate in investment choice in Soviet-type systems in the form of a minimum «recoupment period» within which additional investment costs had to be recovered by yearly savings in current operating costs.

I was curious to see what had been discussed in Cuban journals in the years immediately after 1959, and did some research in the Institute library. I was surprised to discover that the peak of the debate was a discussion between Che Guevara and Charles Bettelheim on whether or not the concept of value required a contradiction (sic). Bettelheim might as well have been sent to Cuba by the CIA, and perhaps he had been, to divert Cuban energies from the real tasks of building a socialist economy.

It was a memorable trip. Cubana Airlines from Madrid, stopover in Zander, Newfoundland, 17 hours on a propeller plane to Havana, stopover in the Canaries in the 17 hours on the way back to Madrid. Staying at the Hotel Nacional, together with large numbers of Russians and of the most gigantic multicoloured insects; lobster at every meal for a while, until I would have given anything for a sausage. Privileged access to free meals on a card and subsidised hotel shops, also for the spy-chaperon who was shadowing me all the time.

I visited Barradero beach (then deserted and to die for), Hemingway's house, a cigar factory, the most luxurious villa formerly belonging to the Rockefellers, with vast expanses of Carrara marble, beautiful succulents exotic flowers and colibri birds. I saw parts of the Cuban interior, including the Sierra, Santiago and its open sewers, sugar cane plantations where students and professors cut cane painfully and inefficiently at week-ends with dangerous looking machetes, a crocodile farm and the most over-built over-expensive cattle farm.

Empty shops everywhere, which two Italian town planners working there were planning to convert into cultural centres, and were horrified at my suggestion that it would be desirable to fill them with goods. Rationing for everything, not even tropical fruit was available for sale, though everything was available on the black market. An amazing display on the public roads of ancient-antique US cars, often cannibalised into the most curious hybrids. Buses (uauas) were driven around at terrifying speed, but I had a chauffeur-driven Alpha Romeo at my disposal, which Cuba had imported directly from Italy through a barter deal for nickel. I asked to be taken to the Bay of Pigs and, faced with vague promises, I went on strike i.e. refused to go on any other local trip until they did take me.

In Havana I met by chance an interesting young man, Carlos Vidali, a personal guest of Fidel’s being the son of Vittorio, the prominent Italian Communist who had traveled extensively in Cuba before and after the Revolution. Carlos arranged for me to meet the economy supremo Carlos Rafael Rodriguez, who firmly criticised my starry-eyed égalitarianism on pragmatic grounds. Only after my return to Europe did I learn that Carlos’ father was reputed – rightly or wrongly – to have had a role in organising Trotsky’s assassination.

According to Wikipedia
Vittorio Vidali – also known as Enea Sormenti, Jacobo Hurwitz Zender, Carlos Contreras, "Comandante Carlos" – was a colourful figure, a founding member of the Italian CP, Comintern agent and finally Communist MP in the Italian Parliament. He «was definitely involved in the May 24, 1940 failed frontal assault on Trotsky's residence in Mexico City, along with [Iosif] Grigulevich and Mexican painter David Alfaro Siqueiros. Vidali is thought to have been involved with the insertion of assassin Ramón Mercader into Trotsky's inner circle – Mercader was to kill Trotsky later that year», though the Italian version claims that Vidali’s presence in Mexico at the time of Trotsky’s assassination may have been «a sheer coincidence».

o O o

The shocking thing is that in over forty years since my 1970 visit not much has changed in Cuba by all accounts; not much is different from the Soviet days just before and just after the beginning of Perestroika, and a self-selected self-perpetuating small group of dogmatic and decrepit old men have been repressing the development of an entire country and its people for over half a century without having the slightest idea of what they are doing and why, heading for total and unmitigated disaster not only for themselves but also for the people they have taken it upon themselves to rule.

Friday, May 13, 2011

Cucumber season

The Silly Season, or Cucumber Season as it is called in several European languages – the diffusion of frivolous news to compensate for the mid-summer rarefaction of real events – has begun early this year. On 6 May Der Spiegel reported that Greece Considers Exit from Euro Zone” with a view to re-introduce the Drachma, negotiating to that effect with EC and Eurozone authorities at “a secret crisis meeting in Luxembourg” that evening. The fact that the meeting was at first officially denied by Luxembourg Premier Jean-Claude Juncker, then admitted ("When it becomes serious, you have to lie"), lent credibility to the story. The euro lost 2 cents overnight with respect to the dollar.

No Exit

This non-scoop is utter nonsense, and not just because there is no provision for exiting the Eurozone other than by leaving the European Union – a drastic and traumatic step in nobody’s interest. Nor just because this would annihilate the Greek banking system (and heavily damage German and other European banks, including the ECB), or because Euros in the hands of the Greek public would continue to circulate – possibly curtailed by the amounts that the Greek public might be unable to recover from their banks (though they have already salted away €30bn abroad as a result of the crisis). Nor just because Greece would lose the financial support already committed by European institutions (half of €110bn, which have not yet been disbursed), and support lined up in the near future (there is current talk of another €60bn).

Greek exit from the euro is nonsense primarily because the re-introduction of the drachma would not allow Greece to reduce its debt denominated in euro through drachma inflation. The euro debt would rise in terms of drachma through drachma devaluation to compensate for drachma differential inflation with respect to the euro, and remain exactly the same as before the exit.

True, the possibility of drachma devaluation – beginning with the re-introduction of the national currency – might make Greece more competitive and make it prosper to the point of re-gaining solvency. But if a devaluation was 1) politically acceptable (unlikely, after 10 general strikes since the first austerity measures were introduced by the Socialist government) and 2) economically effective (in terms of import and export elasticities with respect to devaluation), the Greek government could replicate its effects via a Latvian-style domestic deflation without the additional costs and turmoil of leaving the Euro.

Which is why Greek exit from the euro is a non-starter, pace Der Spiegel’s news and Hans Werner-Sinn’s advocacy. The only other two possibilities are: a bail-out, or a default: Quartum non datur, to coin an expression.

No Bail-Out

When a debtor is solvent but illiquid, a bail-out involves temporary assistance, perhaps by European institutions on terms friendlier than those that might be offered otherwise by financial markets, with full later re-payment. But there is an increasing consensus that certainly Greece – at any rate, leaving aside the similar cases of Ireland and Portugal – is not illiquid but insolvent. The provision of additional loans to allow Greece to repay outstanding loans as they mature, at an interest rate higher than the likely growth rate of the country's GDP (taking both either in nominal or real terms) is a recipe for bankruptcy – unless there is a commitment, on the part of European institutions, to continue to provide non-repayable loans until Kingdom Come.

Paradoxically, this kind of approach appears to have a Keynesian connotation. In “Economic Possibilities for our Grandchildren” (1930) Maynard Keynes quotes approvingly a passage from a book by Lewis Carroll, 1889, [Ch. 10, The other Professor]:

“Let me remind you of the Professor in Sylvie and Bruno:”
[“Come in!”]
“Only the tailor, sir, with your little bill,” said a meek voce outside the door.
“Ah, well, I can soon settle his business,” the Professor said to the children, “if you’ll just wait a minute. How much is it, this year, my man?”
The tailor had come in while he was speaking.
“Well, it’s been a-doubling so many years, you see,” the tailor replied, a little grufy, “and I think I’d like the money now. It’s two thousand pound, it is!”
“Oh, that’s nothing!” the Professor carelessly remarked, feeling in his pocket, as if he always carried at least that amount about with him.
“But wouldn’t you like to wait just another year and make it four thousand? Just think how rich you’d be! Why, you might be a king, if you liked!”
“I don’t know as I’d care about being a king,” the man said thoughtfully. “But it dew sound a powerful sight o’ money! Well, I think I’ll wait-“
“Of course you will!” said the Professor. “There’s good sense in you, I see. Good-day to you, my man!”
“Will you ever have to pay him that four thousand pounds?” Sylvie asked as the door closed on the departing creditor.
“Never, my child!” the Professor replied emphatically. “He’ll go on doubling it till he dies. You see, it’s always worth while waiting another year to get twice as much money!”

The trouble is that this approach can hold only in Lewis Carroll’s Wonderlands, for in the real economy there simply may not exist an interest rate such as to make a creditor, or the financial market as a whole, willing to renew a mature loan in its entirety for another period – let alone another and another. The creditor is more likely to want to cash in at least some of his credit and of the accrued interest, and re-lend only the rest. Clearly Maynard Keynes was not being serious, he was only amusing himself with literary references, as he might have done in conversation with fellows and guests at High Table dinner or over Wine Room drinks.

Bail-outs as Ponzi Schemes

The nature of European bail-outs has been well understood and demonstrated in an article in the Financial Times of 5 May by Mario Blejer – former Governor of Argentina’s Central Bank and director of the Centre for Central Banking Studies at the Bank of England. Blejer likens financial support for Greece, Ireland and Portugal to a giant pyramid or a Ponzi Scheme. Ponzi paid insustainably high interest rates out of new deposits, before running away with the residual loot. European bail-outs involve the accumulation of non-sustainable interest rates without the possibility of their ever being paid together with the original loans. The principle is the same.

The bail-outs raise total debt and its share of GDP. “A case in point is the €78bn ($116bn) loan to Portugal. It is equivalent to more than 47 per cent of its gross domestic product in 2010, possibly increasing Portugal’s public debt to about 120 per cent of GDP.”

“It could be claimed that this mechanism is helping the countries involved since the official loans, although onerous, carry better conditions than the ones that need to be serviced. But the countries’ debts will increase (as a percentage of GDP the debts of Greece, Ireland, Portugal and Spain are expected to be higher by the end of 2012 than at the start of the crisis). The share of debt owed to the official sector will also increase (in addition to the bond purchases by the European Central Bank, which reportedly owns 17 per cent of these countries’ bonds with a much higher percentage held as collateral).”

“Some of the original bondholders are being paid with the official loans that also finance the remaining primary deficits. When it turns out that countries cannot meet the austerity and structural conditions imposed on them, and therefore cannot return to the voluntary market, these loans will eventually be rolled over and enhanced by eurozone members and international organisations. … “… this “public sector Ponzi scheme” is more flexible than a private one. In a private scheme, the pyramid collapses when you cannot find enough new investors willing to hand over their money so old investors can be paid. But in a public scheme such as this, the Ponzi scheme could, in theory, go on for ever. As long as it is financed with public money, the peripheral countries’ debt could continue to grow without a hypothetical limit.”

Except that there is a political limit to solvent countries’ willingness to take on the debt of those insolvent: “We are starting to observe public opposition to financing this Ponzi scheme in its current form, but it could still have quite a way to go. It is apparent that, if not forced sooner by politics, the inevitable default will only be allowed to take place when the vast part of the European distressed debt is transferred from the private to the official sector. As in a pyramid scheme, it will be the last holder of the “asset” that takes the full loss. In this case, it will be the taxpayer that foots the bill, rather than the original bondholders that made the wrong investment decisions.”

Blejer points out that the desirability of this approach depends entirely “on how one assesses the value of the time gained. Would a bank crisis now be more damaging to the European economy than a future debt write-off? Or, alternatively, is recognising reality and accepting a debt restructuring now preferable to increasing the burden on future taxpayers? At the end, it is a political decision, but it would be refreshing if things are called by their name. Euphemisms may be useful in the short run, but one finally recognises a Ponzi scheme when it persists.”

No Default?

The undesirability and ineffectiveness of exit from the Eurozone, and the Ponzi-like nature of continued assistance to insolvent sovereign debtors, leaves only one option: default – preferably consensual, negotiated with creditors rather than unilaterally declared and abrupt; in the form of lengthening debt maturity, interest rate haircuts, as well as debt reduction, but default nevertheless. There is no way “No Exit, no Bail-Outs, no Default”, or immovable objects and irresistible forces, can co-exist other than in a Wonderland.

Richard Portes (who was involved in Poland’s 1981 default) makes a powerful case for the restructuring of Ireland’s debt: “A reasonable target would be a debt reduction of €40-50 billion, in present value. That is on the order of 30% of GDP and would bring the debt ratio down to a sustainable 80% or so. The required haircuts would be in line with current market valuations of Irish sovereign debt.”… “Of course, there is a way for Ireland to escape responsibility. Just wait for Greece to restructure its debt, at which point there will be general confusion and the markets will shun Ireland anyway. Then restructure, when it will be widely accepted as unavoidable. Maybe that is the unspoken strategy. If so, there may not be long to wait.”

Martin Wolf (in his FT Column of 11 May) works out that with a debt/GDP ratio of 160%, and with very optimistic assumptions of a 6% interest rate (less than half of the current 15%, or the 25% on two-year bonds), and a 4% nominal growth rate, even to stabilize debt Greece would need to run a primary surplus (before interest payments) of 3.2%; and a 6% primary surplus would be necessary to reduce the debt/GDP ratio down to the Maastricht Treaty ceiling of 60% by 2040. “Every year, then, the Greek people would need to be cajoled and coerced into paying far more in taxes than they receive in government spending.” “What might persuade investors that this is sufficiently likely to justify funding Greece? Nothing I can imagine. But remember that 6 per cent would be a spread of less than 3 percentage points over German bunds. The default risk does not need to be very high to make this extremely unappealing.”

Wolf recommends “a pre-emptive restructuring of the debt, perhaps next year. Since market prices tell us that this is what investors expect, it should not come as a shock to them. A restructuring ought to raise the country’s creditworthiness and increase the incentives to sustain a programme of stabilisation and reform. Moreover, with a planned, pre-emptive restructuring the authorities could also prepare the needed support for banks, both inside Greece and outside it.” “Overindebted countries with their own currencies inflate. But countries that borrow in foreign currencies default. By joining the eurozone, members have moved from the former state to the latter. If restructuring is ruled out, members must both finance and police one another. More precisely, the bigger and the stronger will finance and police the smaller and the weaker.”

What used to be isolated voices contemplating default are turning into an increasing chorus. “A Reuters poll finds that investors and economists believe Greece will have to restructure its sovereign debt, with 14 out of 15 fund managers and 26 out of 28 economists polled. Opinions are more divided when it comes to the timing. Half of these economists and a third of the fund managers believe it will happen after April 2012. From those 11 economists and 8 fund managers believe restructuring will happen through haircuts, while a majority believes it will happen through extending maturity and lowering interest rates.” (, 13 May). “FT Alphaville picked up on a paper by Barclays Capital, which looked at the haircut needed by Greece to achieve a primary balance - which is 67% in 2012 – based on a primary balance of minus 2.5% this year. It goes into a great detail about recovery values to conclude that the situation is really messy.” (Ibidem).

The most vocal opposition to any talk of default comes from Lorenzo Bini Smaghi, at present a member of the ECB Executive Board. Bini Smaghi’s solution of the sovereign debt crisis is the issue of European sovereign bonds, that would compete with US Treasury Bonds, lowering interest rates and financing the bail-outs. It is immensely naïve to believe that a EU institution, backed by a tiny budget of just over 1% of EU GDP and a built-in zero primary surplus might successfully compete with the US Treasury, with a tax revenue of over 35% of GDP out of which it is conceivable that a primary surplus sooner or later might be sufficiently high to service its debt.

With Mario Draghi’s coming appointment as ECB President, after Angela Merkel’s endorsement, Bini Smaghi is expected to have to leave his ECB post to make room for a Frenchman, and was considered to be in a strong position for a bid to succeed Draghi as Governor of the Bank of Italy. But other frontrunners for the post, Vittorio Grilli (Director General of the Italian Treasury and the president of the EU’s economic and financial committee), Fabrizio Saccomanni (the Director General of the Bank of Italy) and Ignazio Visco (his deputy), are less committed to Bini Smaghi’s agenda. Certainly Draghi has already stated firmly that there can be no European sovereign bond ahead of Fiscal Union. Maybe he will also be more open to orderly but unmitigated defaults, before the sovereign debt crisis becomes unmanageable.