European post-war security, the Cold War and the rhetoric surrounding its announcement provided the necessary political framework, but the economics of the Marshall Plan was fundamentally about a country with a huge current account surplus providing funds to countries with high growth potential and limited access to international capital markets. The funds were provided conditioned on the recipient countries agreeing on democratic institutional reconstruction, free trade and international co-operation which, incidentally, led to the creation of the Common Market and to economic prosperity.
Is Germany now going to act as the US did in 1947? After all, Germany has a huge current account surplus and a few countries in Europe are struggling with large external deficits. And European integration needs to be enhanced - through a credible and long standing rescue of the euro, and the reestablishment of growth in the worse affected areas of the currency union.
Be sure that peripheral countries such as Greece and Portugal are ready to respond to more stringent fiscal rules. After all, that was why governments there joined the euro: to get the strength to fight internal pressures for more spending. But peripheral governments also need to deliver growth – and that’s where Germany (and France) needs to step in.
Tuesday, 9 March 2010
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The possibility of a sovereign default in the Eurozone has been worrying not only the countries in question, but also European authorities and the global financial system. CDS spreads (or risk premiums) on European sovereign debt have widened dramatically in the last 6 months. In February, the situation deteriorated further and European sovereign CDS traded higher than companies rated close to the “junk” level! The main suspects for sovereign default would be Ireland and Greece with the risk premium around 250bp (over Germany) and to a lesser degree Spain and Portugal; but, even Germany (the benchmark EU sovereign), Austria and Belgium have suffered from the widening of CDS spreads.
ReplyDeleteSo, what are the main reasons for this dark scenario? The causes, of course, lie in the unfolding of 2007-08 financial crisis and range from current account concerns to government deficit financing, passing on export demand and external finance problems. This year was already a scheduled year with huge sovereign bond issuance in which has been piled up with new finance needs, mainly stemming from banking bailout plans.
However, the role of ECB interventions to shore up the European money market has not been fully highlighted by the media and analysts as one of the main causes of widening on European risk premiums. Since the beginning of crisis, the ECB has decreased the quality of credit collateral in its repo-operations and other lending operations with the banking system. Basically, the banking system has been allowed to access the ECB’s standing facilities using securities with lower ratings or, even worse, with no trading at all. In simple words, the banking system has raised its finance needs through financial operations where they pump their bad assets into ECB’s balance sheet. In the end, it has effectively created an over supply of prime rated securities in the market and mostly important for European countries there has been a kind of crowding out between “toxic” banking securities and sovereign bonds. Financial investors can transform a “frog” into a “princess” through the ECB’s standing facilities so what would be the reason of buying a “princess” if you can buy much cheaper a “frog” and.…..
In the traditional economic theory, the solution to deal with the problem is straight forward, increased labour market flexibility! The relative price of wages would be the only adjustment mechanism in these countries given that devaluation is not possible within a single currency. So, it is clear that we have a great asymmetry between banking and sovereign debt! The result is that European states have to raise funds to cover their banking recapitalisation plans at a much higher fiscal cost and this is partly caused by its own central bank’s interventions!!
George Soros raised a related point in the FT, he claims the creation of Eurozone government bond market would help deal with the government finance problem. The problem is that right now the implementation of a European Treasury would only reinforce the financial interests managing the banking recapitalisation and not meet the needs of European population as might at first appear to be the case. The promises in public social investments coming with this new authority would be only carrots, in the end the sticks would be on our heads!