Posts Tagged ‘Angela Merkel’

The Bankruptcy of Austerity Economics

Thursday, January 12th, 2012

Conservative conventional wisdom collided this week with a dose of economic reality, and the winner is reality. For two years, every Republican congressional leader and presidential hopeful has proudly insisted these days that austerity is the cure for a sluggish economy like ours. It is an approach embraced most memorably, of course, by Herbert Hoover, although Angela Merkel also pushes it today for the faltering Eurozone. In fact, austerity in the face of high unemployment, slow investment and weak demand has been decisively refuted by a half-century of economic analysis and policy. The best medicine for a slow economy is usually measures to jump-start investment and consumption funded by more private or public debt.

Congress has refused to let Washington play that role since the 2010 elections, so finally American households are stepping into the breach. Last week, we learned that employment rose sharply in November, and this week we found out why: Borrowing by American households jumped $20.4 billion in November. That’s the largest increase in ten years. This new willingness by Americans to take on new debt is the main reason why consumer spending is finally picking up, which in turn is the main reason why the jobless rate keeps on falling.

It would be rash to read too much into these new data, but they could be a powerful signal of stronger growth ahead. For three years, Americans have saved in order to reduce the burden of their outstanding debts. New Federal Reserve data show that it is working. In 2007, payments on mortgage, consumer and auto debts claimed a larger share of the incomes of an average household than at any time since 1980. But by the third quarter of last year, this household indebtedness had fallen to the lowest levels since 1994, providing a reasonable basis to begin borrowing again.

Moreover, the renewed willingness of average Americans to take on new consumer debt may also signal that housing values have finally bottomed out. Falling housing values — and Washington’s inability to do anything to help stabilize them — have been the single largest obstacle to a strong recovery. When home prices fall month after month, that not only increases the net debt of most homeowners; it also makes American homeowners poorer, month after month. And people who see their assets shrink, month after month and year after year, cut back on their spending. So, recent signs that consumer borrowing and spending are heating up again suggest that housing values may have finally stabilized. If that’s the case, the recovery may finally accelerate.

America’s new acolytes of austerity could still screw this up. In the last year, they tried to block payroll tax relief and extended unemployment benefits, and the truest believers among them even hoped to block an increase in the legal debt limit. All three of these matters will come back to Congress in coming months. The political landscape has shifted, however. The public now holds Congress in such low esteem — and especially House conservatives — that even fervent advocates of austerity may hesitate to repeat their wildly unpopular 2011 performance in an election year.

A stronger U.S. recovery could still fall victim to the European austerity caucus. Merkel continues to press austerity on the Eurozone governments, even as Europe slides into recession. Moreover, piling yet more austerity on economies in recession can only worsen the sovereign debt crisis which already threatens to pull down the Euro and major banks across Europe. Sometime next week or in the next few months, global investors may conclude that Merkel’s attachment to austerity will finally preclude meaningful steps to stabilize Italian and Spanish government debt. If that comes to pass, the ensuing financial crisis almost certainly would short circuit a strong American recovery.

For now, that recovery is in the hands of America’s households. Thankfully, they display more economic sense than many members of Congress or leaders of the Eurozone.

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Will Europe Step Back from the Brink this Week?

Tuesday, December 6th, 2011

On the edge and the eve of a financial market meltdown, Germany seems to now accept that the Eurozone sovereign debt crisis poses the greatest danger to the European, American and global economies since the early 1930s. Yet, the world still is far from out of the Euro-woods. Yes, Angela Merkel’s Chancellery has finally signaled that she and her government will permit the European Central Bank (ECB) to stabilize the value of Italy’s public debt. But first, Italy, France and 14 other Eurozone nations have to prove themselves worthy by accepting German rules for fiscal policy. The clock is ticking: If they don’t agree to those conditions at the European summit later this week, Merkel will nix ECB intervention, and the meltdown will begin.

The gravity of this crisis is genuinely unique. When the U.S. financial market seized up in 2008, the systemic dangers were largely limited to institutions which had used reckless leverage to invest in securities or credit default swaps based on a housing bubble, like Lehman Brothers and AIG. This time, the systemic threat extends to everyone who has trusted in what has long been considered one of the safest assets in the world, the governments bonds of large, advanced European nations. That covers almost all large European banks and companies.

Furthermore, in the 2008 – 2009 crisis, governments had powerful tools — bailouts, new guarantees, stimulus, and interest rates cuts — to contain the worst of the crisis to those reckless financial institutions. For this second round, coming out of the first meltdown, governments everywhere have very few tools left to prevent the crisis from badly damaging entire economies.

So, if the ECB and Eurozone governments fail to act in the next few days and weeks, the results will be devastating. Most of the huge sovereign debt of Italy, the epicenter of the systemic threat, is held by German, French, Italian, and Spanish banks. The value of Italian bonds already has fallen sharply, eating away at the capital of those banks. That’s why lending by large Eurozone banks has virtually stopped, pushing most of Europe back into recession. That’s also why “interbank loans” in Europe — the billions of Euros or dollars in overnight loans that keep the banking system there liquid from day to day — also dried up.

To ease these liquidity pressures, the Federal Reserve and the ECB, along with the central banks of England, Japan, Switzerland and Canada, joined hands and stepped in last week. They cut by half the price they charge banks in their own countries to borrow dollars from their central banks, which the Fed has agreed to supply as required. Stock markets everywhere rallied, hoping this move would buy the Eurozone enough time to put in place a real solution. But the new loans cannot do more than that. The liquidity squeeze they address is only a symptom of the real problem, which is that the holdings of Italian government bonds by Europe’s big banks could bankrupt them. If those bonds fall in value much more, it will wipe out their capital.

If that weren’t bad enough, European governments may find themselves unable to contain the meltdown to banks with large holdings of Italian bonds. In 2008, the U.S. and European governments averted bank runs by quickly guaranteeing the money market accounts where most corporations keep their operating funds. But when the problem is the credit of governments themselves, who will believe them if they pledge to guarantee money market or other accounts — and where would they find the funds to do so if investors won’t buy their debt?

The good news for the United States is that American banks and companies got rid of most of their investments in Italian and other Eurozone government bonds over the last year. The bad news is that no one knows how many credit default swaps they hold against the default of those Italian bonds, or against the default of the corporate bonds of the Eurozone banks that actually hold most of Italy’s debt, or the corporate bonds of Eurozone companies that depend on those banks.

Europe sidestepped the danger of the credit default swaps against Greek debt by convincing the large institutions that held most of Greece’s bonds to voluntarily accept a 50 percent write-down. This 50 percent “haircut” is comparable to what usually happens when a government formally defaults. But because the write down of Greek bonds was technically voluntary, it didn’t trigger the credit default swaps.

The same approach won’t work for Italy, because its outstanding debts are just too large: Eurozone banks could not accept a 50 percent write-down on Italian bonds without becoming insolvent. And if the big financial institutions outside Europe — Goldman Sachs, Bank of America, Barclays and Bank of Tokyo-Mitsubishi, for example — have substantial European based credit default swaps, the fallout will threaten the global financial system. The sudden insolvency of European banks could damage the American economy in other ways as well. For instance, American banks and corporations are engaged in hundreds and perhaps thousands of deals today with large European banks. If those banks go down, all of the existing deals will be thrown into doubt.

If the crisis does hit the Eurozone and then spreads to the United States, most of the steps that policymakers took to contain the damage in 2008 – 2009 will not be available. Voters are very unlikely to tolerate another big bank bailout or large stimulus. And with interest rates already near zero, the Fed won’t be able to cut those rates enough to meaningfully support a sinking economy. The only move left will be to print money. To be sure, that’s what Europe faces today in an ECB intervention. Yes, it may lead to a steep devaluation of the Euro, which ultimately could unravel the currency union.

In a world in which better options are no longer available, the only course left is to address crises, one at a time.

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Is This the Final Countdown to a Global Financial Calamity?

Wednesday, November 9th, 2011

Ground zero of the European sovereign crisis has moved from Greece to Italy, and that’s very bad news for Europe, the United States, and most everywhere else. For a year, Angela Merkel and Nicholas Sarkozy have looked for some way to both prevent Greece from defaulting outright and reassure bond investors that Italy’s sovereign debt will remain sound. This week, the price that Italy pays to borrow money soared as global investors determined that holding Italian bonds is increasingly risky. The salacious Silvio Berlusconi is on his way out, but that won’t change the market’s judgment that Merkel and Sarkozy’s stratagems have failed. Europe now faces a real and present danger that major banks across Germany and France, along with Italy and Greece, could fail soon. Such a meltdown would take down the American expansion with it.

It’s still premature for a post mortem. But for the past year, domestic European politics, not international finance, has squeezed the acceptable options to solve the Eurozone’s metastasizing sovereign debt problems. Merkel and Sarkozy have long known that their countrymen and women would pick up pitchforks if their governments moved to bail out big banks a second time. If that wasn’t enough to inspire street demonstrations, the contemplated bailout this time would go to stabilize financial conditions in other countries. So Merkel and Sarkozy came up with a plan that appeared to spare French and German taxpayers. Unfortunately, it also couldn’t pass a laugh test by worldwide investors:  The plan has Eurozone financial stabilization board raising $1 trillion from those investors to back up Italy’s debt, with a pledge that Eurozone governments would guarantee the first 20 percent of any losses. Think about it: Italy, Greece, Ireland, and Portugal , all hanging by a thread or worse, would help the rest of the Eurozone cover the initial losses from bonds used to bail out Italy, Greece, Ireland and Portugal — and if things go south, probably Spain as well.

The $1 trillion commitment kept a meltdown at bay for a few days, much as the Bush Treasury’s commitment to spend $700 billion to bail out Wall Street staved off a market collapse after Lehman failed. The original Paulson plan also didn’t pass the laugh test, but no one doubted that the U.S. Government could raise the $700 billion. This time, the Eurozone’s $1 trillion commitment has bought them at most a few weeks of breathing space, as investors wait for Merkel and Sarkozy to come up with a real plan to raise it. But those investors already are eyeing the exits. Interbank lending to Europe’s biggest institutions dried up this week, just as it did here in the days before Lehman sank. And interest rates on Italian bonds are now so high that, according to the industry’s financial models, Rome will be unable to service its debt much longer.

All of this means that neither global investors nor European taxpayers are prepared to bail out the Eurozone. Even at this very late date, however, there are ways out of this mess:  Under the least bad of the options left, the European Central Bank (ECB) would become the Eurozone’s bond buyer of last resort.  The ECB could pay for them by printing enough Euros, for starters, to stabilize Italian bond markets. It wouldn’t be pretty. The Euro would weaken. European interest rates might edge up as Europe slowed. And the ECB would have to come up with another credible plan to withdraw the excess Euros once the crisis passed. But the alternative is much worse.

In a period of worst case scenarios, here’s what could well happen later this month. Start with the fact that Italy alone has $2 trillion in outstanding government debt. Most of those bonds are held by Italian, French and German banks, including the biggest banks in the world. Anything approaching an Italian default would wipe out the capital of those banks, leaving them insolvent; and most of the Eurozone economies would grind to a halt.

It gets worse, because a financial meltdown centered on sovereign debt is much more dangerous than one triggered by mortgage-backed securities. In effect, a sovereign debt crisis strips sovereigns of their ability to act to contain the crisis. With Italy and Greece in default, for example, who will believe those governments as they move to head off general bank runs by, say, guaranteeing money market balances as the United States did successfully in the days after Lehman?  And if the biggest banks in France and Germany go down, Sarkozy and Merkel wouldn’t have the credibility to do much about it either.

The bad news doesn’t end with Europe. Our own big financial institutions, along with those in Britain and Japan, have thousands of deals going that involve the major banks in Germany, France and Italy. Overnight, all of those deals become suspect, which could spread financial panic beyond the Eurozone. And remember the credit default swaps that destroyed AIG?  No one knows precisely how many of those “guarantees” are out today against Italian government bonds and the commercial paper of French, German and Italian banks. The fact that no one knows could be a big problem in itself, since that, too, could breed a broader financial panic. In any case, there’s little doubt that those credit default swaps involve, at a minimum, hundreds of billions of dollars, Euros and pounds. That would leave American, European and Japanese financial institutions on the hook for those losses. And if they can’t make good on them, they could go down as well. Their only hope would be another bailout — if Congress could approve one before the Tea Party and Occupy Wall Street folks pick up their pitchforks.

All this is not yet inevitable. But much of it might well unfold, and probably in a matter of weeks, unless the Eurozone’s leaders face the grim music and finally find their way to a real program to head it off.

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Forget about Spending and Get Serious about the Economy

Thursday, March 31st, 2011

Washington today, especially the Congress, has a textbook case of cognitive dissonance. A confluence of black swan developments may well threaten the American and global recoveries. There’s the civil war in Libya and unrest across much of the Middle East that could disrupt world energy supplies, the natural catastrophes in Japan may upend the world’s third largest economy, and several European governments are flirting with junk-bond status. On top of all this, recent data on housing, investment, and consumer spending all point to a still-fragile U.S. expansion. Yet, with all of this, Congress spends its time bickering over funds the federal government needs week to week just to keep operating.

This debate has become almost willfully wrong-headed. An economy not yet recovered fully from a historic financial meltdown and deep recession, and now facing possible major shocks from three directions, is no candidate for budget cuts. In fact, a new National Journal survey of 44 Washington economists and “economic insiders,” Democratic and Republican, found only one of the 44 who sees immediate spending cuts as the highest priority. (Full disclosure: I am one of the 44 surveyed.) If there are still any doubts about what happens when governments ignore this basic economics, consider Great Britain and Germany. Both embraced the austerity snake oil and plowed ahead with sharp spending cuts and tax increases. Two quarters later, the recoveries in both countries are stumbling badly.

Of course, these debates are not about economics at all. Here and in Europe, they’re driven by anti-government factions inside the base of each country’s conservative party. Congressional Republicans might take note, however, that this approach no better politics than it is economics. After enacting their programs, the governments of David Cameron and Angela Merkel find themselves hemorrhaging public support.

There is a time for serious debate about the role of American government in our economy and daily lives. The 2012 elections could provide a platform for real public deliberation about how much the government should do in the future to provide health care for elderly and poor people, ensure access to higher education for young people unlucky enough not to be born into affluence, or support the weapon systems, manpower and womanpower needed to wage multiple wars. At a minimum, the campaign should include some serious talk about whether the Obama administration did the right thing in driving health care coverage for most Americans.

Right now, however, is the time to focus on the clear and present dangers to the jobs and incomes of average Americans. The President made a good start this week with proposals to make the U.S. economy less energy intensive and especially less dependent on imported oil. Dealing with the continuing problems in Japan and Europe will be tougher. As we outlined last week, if the crisis in Japan persists for another month or longer, it will disrupt production here of everything that uses parts or elements made-in-Japan, from automobiles and electronics to medical equipment and even pharmaceuticals. Congress should take this time to consider steps that will help our manufacturers keep their U.S. workforces intact through such supply chain disruptions — for example, a temporary tax break on foreign earnings brought back home by manufacturers who expand their U.S. jobs. If Japan’s crisis deepens, it also will absorb all of Japanese saving, and then some. That development would likely drive sales of U.S. stocks by Japanese investors and sales of U.S. government securities by the Japanese government, creating new downward pressures on U.S. stock prices and new upward pressures on our interest rates. All of this means that the Federal Reserve and Treasury should take this time to prepare for another round of quantitative easing.  

A new debt crisis in Europe would threaten the balance sheets of our large financial institutions, yet one more time. They don’t have large holdings of Greek, Irish, Portuguese, Belgian or Spanish government debt, all of which now hang in the balance. But our big banks do have hundreds of billions of dollars in normal business with the large European banks that do carry huge portfolios of those bonds — and which might find themselves unable to carry out their contracts with our banks if another crisis hit. That’s what happened, in reverse, in September 2008, when American banks couldn’t honor their contracts with many European banks in the post-Lehman panic. Today, instead of arguing about PBS funding, congressional leaders should be quietly talking with the administration about ways to contain another financial crisis without bailouts which the public would never support again.

If the Congress and administration could refocus their current debate around these real and pressing issues, perhaps they could then move on to the longer-term problems that matter to most Americans outside the Tea Party. To begin, what can Washington do to help American businesses create new jobs at the vigorous rates we all considered merely normal, until the last decade?  There might even come a time for a serious public discussion about what steps might help reverse the corrosive income patterns of the last 30 years, which have seen a small minority of very rich and very highly-skilled Americans capture nearly all of the nation’s income gains, while middle class people stagnated and poor people lost ground.

And one point should be very clear: Budget cuts are no more of an answer to these long-term issues than they are for the more immediate problems facing the American economy.

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