…We, and many others, expect the banks of all the major OECD economies to collapse over the next few months. This will drag the UK, Eurozone and US down. In other words, and to be absolutely clear:the Eurozone and the world will be dragged down by the banks, not vice versa.

Politicians, advised by deranged and culpable economists, will hasten, and intensify this global private banking collapse by accelerating austerity. It is those policies that will prolong and deepen the global economic crisis.

So prospects are bleak. Unless and until, that is, politicians in the UK and Eurozone get real, and face reality. It is time now to stop blaming the victims – public sector workers, pensioners, single mothers, the frail and vulnerable – for a global financial crisis designed by bankers, technocrats, economists and politicians.

It’s time now to address the solution: first, subordination of the private banking sector to the interests of society; and second, policies for employment. Only jobs can now generate the income needed to revive the economy, to pay down private debts, and to stabilise the global economy. “Look after employment” said Keynes, “and the budget will look after itself.”  (link to article)

…No less a financial publication than the Wall Street Journal has come to the conclusion that “in a perfect world, S&P wouldn’t exist. And neither would its rivals Moody’s Investors Service and Fitch Ratings Ltd. At least not in their current roles as global judges and juries of corporate and government bonds.”[4] As its financial editor Francesco Guerrera wrote quite eloquently in the aftermath of S&P’s bold threat to downgrade the U.S. Treasury’s credit rating: “The historic decision taken by S&P on Aug. 5 is the culmination of 75 years of policy mistakes that ended up delegating a key regulatory function to three for-profit entities.”

The behavior of leading banks and ratings agencies Cleveland and other similar cases – of promising to give good ratings to states, counties and cities that agree to pay off short-term bank debt by selling off their crown jewels – is not ostensibly criminal under the law (except when their hit men actually succeed in assassination). But the ratings agencies have made an compact with crooks to endorse only public borrowers that agree to pursue such policies and not to prosecute financial fraud.

To acquiescence in such economically destructive financial behavior is the opposite of fiscal responsibility. Cutting federal taxes and Social Security payments to obtain a more positive S&P “opinion” would give banks an ability to “pull the plug” and force privatization and anti-labor austerity plans by refraining from rolling over the U.S. debt – and cutting taxes Tea-Party style rather than funding spending by taxation on a pay-as-you-go-basis.

The present meltdown of the euro provides an object lesson for why policy-making never should be left to central bankers, because their mentality is pro-creditor. Otherwise they would not have the political reliability demanded by the financial sector that has captured the central bank, Treasury and regulatory agencies to gain veto power over who is appointed. Given their preference for debt deflation of the “real” economy – while trying to inflate asset prices by promoting the banks’ product (debt creation) – central bank and Treasury solutions tend to aggravate economic downturns. This is self-destructive because today’s major problem blocking recovery is over-indebtedness.

The Mosler Plan for Greece

The Centre of the Universe

Posted by WARREN MOSLER on June 29th, 2011

The Mosler Plan, as previously posted on this website, is now making the rounds in Europe as an alternative to the French Plan that is currently under serious consideration:

Abstract
The following is an outline for a proposed new Greek government bond issue to provide all required medium term euro funding for Greece on very attractive terms.

The new bond issue includes an addition to the default provisions that eliminates the risk of loss to investors. The language added to the default provisions states that while in default, and only in the case of default, these transferable securities can be used directly, by the bearer on demand, at face value plus accrued interest, for payment of any debts, including taxes, owed to the Greek government.

By eliminating the risk of loss, Greece will be able to independently fund all required financial obligations in the market place for the foreseeable future. The immediate benefits are both reduced interest costs that substantially contribute to deficit reduction, and the elimination of the need for the funding assistance from the European Union and the IMF.

Introduction- Restoring National Sovereignty
Current institutional arrangements have resulted in Greece being faced with escalating interest costs when it attempts to fund itself in the market place, to the point where timely funding is not currently available without external assistance. This requirement for external assistance to avoid default has further resulted in a loss of sovereignty, with the EU and IMF offering funding only on their approval of deficit reduction plans by the Greek government that meet specific requirements. Compliance with these demands from the EU and IMF not only include tax increases, spending cuts, and privatizations, but also include aggressive time lines for achieving their deficit reduction goals. It is also understood by all parties that the immediate near term consequences of these imposed austerity measures will include further slowing of the economy, and rising unemployment.

Greece will restore national sovereignty, and regain control of the process of full compliance with the general EU requirements for all member nations, only when it restores its financial independence. Financial independence will allow Greece to again be master of its own destiny, on an equal basis with the other EU members. And the lower interest rate that result(s) from this proposed bond issue will itself be a substantial down payment on the required deficit reduction, easing the requirements for tax increases, spending cuts, and privatizations.

While this proposal restores Greek national sovereignty, and eases funding burdens, we recognize that it is only the first step in restoring the Greek economy. Even with funding independence and low interest rates the Greek government still faces a monumental task in bringing Greece into full compliance with EU requirements and restoring economic output and employment. However, it should also be recognized that financial independence and low cost funding are the critical first steps to long term success.

The Bond Issue- No Risk of Financial Loss
Market based funding at the lowest possible interest rates requires investors who understand there is no ultimate risk of financial loss, and that the promise to pay principal and interest by the issuer is credible. To be credible, a borrower must have the means to meet all contractual euro obligations on a timely basis. For Greece this has meant investors must have the confidence that Greece can generate sufficient revenues through taxing and borrowing to repay its debts.

The credit worthiness of any loan begins with the default provisions. While there may be unconditional promises to pay, investors nonetheless value what their rights are in the event the borrower does not pay. Corporate debt often includes rights to specific collateral, priorities in specific revenues, and other credit enhancing support.

The new proposed Greek bond issue, with its provision that in the event of default the bonds can be used at face value, plus interest, for the payment of taxes by the bearer on demand, gives the bond holder absolute assurance that full maturity value in euro can always be achieved. And with this absolute assurance that these new securities are necessarily ‘money good’ the ability to refinance is established which dramatically reduces the risk of the default provisions actually being triggered. And, again, should there be a default event, the investor will still get full value for his investment as the entire euro value of the defaulted securities can be used at any time for the payment of Greek taxes. So while this discussion concerns the case of default, the removal of the risk of loss means there will always be demand for them at near risk free market interest rates, and that the default discussion is, for all practical purposes, hypothetical.

These new Greek government bonds will be of particular interest to banks, which, again, encourages bank ownership, which makes default that much more remote a possibility. This is because, in the case of default, a bank holding any of these defaulted securities will be able to use them for payment of taxes on behalf of bank clients (using that bank for payment of their taxes). Under these circumstances, a bank depositor client making payment of euro would, in effect, simultaneously buy the defaulted securities from the bank and use them to pay the Greek government taxes due. Again, the fact that the bank would be fully paid for its defaulted securities in the process of depositors paying their taxes means there will be no default in the first place, as these favorable consequences mean there will be continuous demand for new securities of this type at competitive market interest rates, to facilitate all Greek refinancing requirements.

The new ‘money good’ Greek bonds will be attractive to all global investors, both private and public. This will include international banks, insurance companies, pension funds, and other private investors, as well as sovereign wealth funds and foreign central banks which are accumulating euro reserves.

Fiscal Responsibility
As a member in good standing of the European Union, Greece, like all the member nations, is required to be in full compliance of all EU requirements. Therefore, while this proposal will restore national sovereignty, financial independence, and lower interest rates for Greece, austerity measures will continue to be required to bring Greece into EU compliance. However, Greece will gain substantial flexibility with regard to timing and other specific detail, and will be able to work to achieve its goals in an organized, orderly manner, without the continued pressures of default risk and without the specific terms and conditions currently being demanded by the EU and the IMF. Nor will the ECB be required to buy Greek bonds in the market place, obviating those demands as well.

Will Greece let EU Central Bankers Destroy Democracy?

Monday, June 6, 2011

Will Greece let EU Central Bankers Destroy Democracy?

(cross-posted with CounterPunch)

The Greek bailout provides an opportunity for privatization grabs

When Greece exchanged its drachma for the euro in 2000, most voters were all for joining the Eurozone. The hope was that it would ensure stability, and that this would promote rising wages and living standards. Few saw that the stumbling point was tax policy. Greece was excluded from the eurozone the previous year as a result of failing to meet the 1992 Maastricht criteria for EU membership, limiting budget deficits to 3 percent of GDP, and government debt to 60 percent.

He ends his tour de force describing the financial conquest of the European peoples thus..

..But ECB intransigence leaves little alternative to breakup. Europe’s payments-surplus nations are waging financial war against the deficit countries. Without a common union based on mutual support within a mixed economy – one capable of checking financial aggression – the European Central Bank replaced the military high command. Its bold gamble is whether the Greeks will be as stupid as the Irish, not as smart as the Icelanders. (link to article)

 

Tuesday, June 7, 2011

ECB President Trichet Praised Ireland as the Model for the EU to Follow

By William K. Black

(Cross-posted with Benzinga)

This is the second in a series of articles about the ECB/EU/Euro crisis. Ireland is not like Greece. It ran a budgetary surplus during its boom. It privatized and reduced work restrictions. Its budgetary crisis would be serious because it suffered from one of the worst bubbles (relative to GDP) in history and it lacks a sovereign currency. Ireland’s budgetary crisis is crushing because its political leadership, gratuitously, decided that a nation of four million people should bail out the creditors of Irish banks even though it had no legal or moral obligation to do so and was incapable of doing so. The Irish banks’ creditors were primarily foreign, particularly foreign banks. Absent the Ireland’s failed and quixotic attempt to bail out the German banks Ireland would not be in a sovereign debt crisis. (link to article)

 

Thursday, June 2, 2011

Randall Wray Interviewed on The Real News

Randall Wray was interviewed recently for The Real News. Video below.

More at The Real News

The eurozone confronts a choice between two intolerable options: either default and partial dissolution or open-ended official support. The existence of this choice proves that an enduring union will at the very least need deeper financial integration and greater fiscal support than was originally envisaged. How will the politics of these choices now play out? I truly have no idea. I wonder whether anybody does.

Here is the data and reasoning that brings him to that depressing conclusion…

The ESCB’s finance flows via the euro system’s real-time settlement system (“target-2”). Huge asset and liability positions have now emerged among the national central banks, with the Bundesbank the dominant creditor (see chart). Indeed, Prof Sinn notes the symmetry between the current account deficits of Greece, Ireland, Portugal and Spain and the cumulative claims of the Bundesbank upon other central banks since 2008 (when the private finance of weaker economies dried up).

Government insolvencies would now also threaten the solvency of debtor country central banks. This would then impose large losses on creditor country central banks, which national taxpayers would have to make good. This would be a fiscal transfer by the back door. Indeed, that this is likely to happen is quite clear from the striking interview with Lorenzo Bini Smaghi, a member of the board of the European Central Bank, in the FT of May 29 2011.

Prof Sinn makes three other points. First, this backdoor way of financing debtor countries cannot continue for very long. By shifting so much of the eurozone’s money creation towards indirect finance of deficit countries, the system has had to withdraw credit from commercial banks in creditor countries. Within two years, he states, the latter will have negative credit positions with their national central banks – in other words, be owed money by them. For this reason, these operations will then have to cease. Second, the only way to stop them, without a crisis, is for solvent governments to take over what are, in essence, fiscal operations. Yet, third, when one adds the sums owed by national central banks to the debts of national governments, totals are now frighteningly high (see chart). The only way out is to return to a situation in which the private sector finances both the banks and the governments. But this will take many years, if it can be done with today’s huge debt levels at all.

Debt restructuring looks inevitable. Yet it is also easy to see why it would be a nightmare, particularly if, as Mr Bini Smaghi insists, the ECB would refuse to lend against the debt of defaulting states. In the absence of ECB support, banks would collapse. Governments would surely have to freeze bank accounts and redenominate debt in a new currency. A run from the public and private debts of every other fragile country would ensue. That would drive these countries towards a similar catastrophe. The eurozone would then unravel. The alternative would be a politically explosive operation to recycle fleeing outflows via public sector inflows.  (link to article)
What is the MMT response to this bombshell?

The best option for Ireland is to default and exit

Today is the first blog I have written that is exclusively done on an iMac running OS X. It is a nice environment but for a long-time linux and windows user it takes a little getting used to. I have been thinking of writing a Modern Monetary Theory (MMT) guide to debt restructuring for non-sovereign nations such as those in the Eurozone who are now essentially insolvent if we exclude ECB assistance. Several readers have asked me to tease out what the implications of a major debt default in say Greece would be for aggregate demand and private wealth. I will write about that more fully another time but one thing that is certain. MMT does not consider it feasible to run a national economy in a way that advances public purpose at all times if the national government has surrendered currency sovereignty in any way. The point is that default has to accompany EMU exit (in the case of the Eurozone nations). In thinking about that I focused my attention on some interesting data from Ireland that I have been looking at for the last week. What is clear is that Ireland has no real future while remaining in the Eurozone. It might stagger along and grow again some day. But it will be so severely damaged from dragging out the recession for its fourth year now and will similarly collapse when the next negative demand shocks hits the zone that it would be better defaulting now and restoring its currency sovereignty. The best option for Ireland is to default and exit.

In thinking about a restructuring scenario for the Eurozone nations it would not be consistent with an understanding of MMT to advocate default without exit. The EMU nations have to exit as they default and the restructuring of loans has to be in terms of their newly established local (national) currencies.

In that way, the newly sovereign national government can ensure the banking system remains liquid (in the new currency) and that workers do not lose their bank deposits etc.

Anyway, the Economist Magazine provoked me into action today. It ran a story this week (May 26, 2011) – Ireland’s chances of recovery – which carried the sub-heading “A return to decent growth is essential”.

Well you don’t have a recovery without a return to growth so I thought the title etc was somewhat twee! (not the Dutch 2).

I have written about the Irish disaster before – in this blog The Celtic Tiger is not a good example and this blog – The sick Celtic Tiger getting sicker – which both document the steady decline in the Irish economy that is being stage managed (that is, caused) by the irresponsible macroeconomic policies being pursued by the Irish national government.

The Economist writes:

According to a report from the IMF on May 20th, Ireland’s public debt, which was just 25% of GDP in 2007, is already 96% and is due to reach 111% this year … A seemingly model fiscal pupil is now at the back of the euro-area class because of the cost of rescuing Irish banks, which has reached 42% of GDP, and a collapse in national output and property-dependent tax revenues.

Thereafter followed “horrific” IMF debt projections which were described as “dismal”. There was no mention of the horrific unemployment rates in Ireland that are getting worse by the month and are now edging 15 per cent.

The following table is taken from the Irish Central Statistics Office and shows the monthly seasonally adjusted unemployment rate from January 2006 to April 2011.

For a government of an advanced nation (well any level of development really) to willingly impose this level of unemployment on its citizens is the headline story. All the scary headlines about public debt are sideshows.

It is clear that the Irish government faces insolvency because it is using a foreign currency and requires bond markets to lend to it to fund its deficits.

All the problems that have arisen since the property market collapsed can be attributed to it not having currency sovereignty. I realise there are many people who consider the Euro to be an inconsequential part of the story. But if the Irish government was using the “punt” then it could have restored the capital of the ailing banks (by nationalising them) without the need to impose a harsh domestic deflation.

It could have offered all the unemployed a job at a living minimum wage and kept many workers solvent and allowed them to maintain their debts in good standing.

I am not suggesting a major property crash is without consequence. But once it happened, the Euro became the story.

The Economist doesn’t agree. It says:

Even more wrenching fiscal austerity is needed to bring the budget deficit down from the 10.6% of GDP forecast by the IMF this year towards more manageable levels. That in itself will hold a recovery back, unless Ireland’s exporters can overcome the downward pull from a beaten-up domestic economy. This is not impossible.

But highly improbable especially with one of its major trading partners mired in a self-produced downturn again (Britain). Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

The last thing the Irish economy needs is “more wrenching fiscal austerity”.

The Irish labour market is self-destructing because there is not enough aggregate spending and the fiscal austerity is making matters much worse.

The mainstream commentators seem to ignore path dependency. In the real world, booms in activity stimulates on-the-job training opportunities and raises potential output above the level that would have persisted had the economy remained at low levels of activity. Alternatively, as activity falls due to demand failure, both training opportunities decline and actual skills are lost, as workers lie idle. The potential capacity level falls as a result.

The longer the Irish economy is stranded in its policy-induced recession the worse will be the longer-term consequences. Potential growth rates are now being damaged. So even when growth resumes at some future time, the losses will still be evident in lower than otherwise growth.

Further, the damage to skill development will be severe. Unemployment stifles skill development and denies younger workers the opportunity to gain training and experience which sets them up for the future. The negative consquences of this policy folly on the 15 year olds in Ireland will be profound and that alone warrants the people overthrowing their elected officials and demanding policy action that immediately provides jobs.

The point that most people do not understand and certainly the neo-liberals do not advertise is that the national government with its own currency can always employ any workers who are without work.

In this respect the article in the New York Times (May, 29, 2011) – Against Learned Helplessness – by Paul Krugman is excellent. He says that:

Unemployment is a terrible scourge across much of the Western world. Almost 14 million Americans are jobless, and millions more are stuck with part-time work or jobs that fail to use their skills. Some European countries have it even worse: 21 percent of Spanish workers are unemployed.

Yet a strange thing has happened to policy discussion: on both sides of the Atlantic, a consensus has emerged among movers and shakers that nothing can or should be done about jobs. Instead of a determination to do something about the ongoing suffering and economic waste, one sees a proliferation of excuses for inaction, garbed in the language of wisdom and responsibility.

So someone needs to say the obvious: inventing reasons not to put the unemployed back to work is neither wise nor responsible. It is, instead, a grotesque abdication of responsibility.

That is it in a nutshell.

There is never a shortage of jobs available – just a shortage of funding to make them operational. Any national government with its own currency can introduce a Job Guarantee to ensure anyone who wants to work can find it.

Krugman says that:

The core of our economic problem is, instead, the debt — mainly mortgage debt — that households ran up during the bubble years of the last decade … [and] … there are a number of things that could be done about it.

For example, we could have W.P.A.-type programs putting the unemployed to work doing useful things like repairing roads — which would also, by raising incomes, make it easier for households to pay down debt.

That should be the policy priority in all nations. For EMU nations they first have to exit the Eurozone or vote for a supra-national fiscal authority to subvert their national rights and deficit spend up to the point that the last worker who wants a job has one.

All the faux issues about public insolvency have sidetracked us from that reality – the national government chooses the unemployment rate. If that choice involves a decision to surrender currency sovereignty then it is harder to undo. But never tell me that a national government intent on advancing public purpose cannot do so.

The bond markets cannot stop such a government.

The ECB cannot stop such a government.

The IMF and OECD cannot stop such a government.

All that is stopping national governments is their own mis-guided perception of macroeconomics aided and abetted by entrenched vested interests who are profiting from the malaiase.

I read yesterday (link has evaded me today) that corporate profits in the US are now soaring and well beyond the pre-crisis levels whereas the real wages of workers in the US are going backwards. That tells me that there is something fundamentally wrong with the policy mix in that nation (and all nations).

The Economist magazine is still hanging out the “export-led” recovery hat. But with forecasters (other than the IMF which is always optimistic and always wrong) are predicting Ireland will stay mired in recession – the “fourth year of contraction”. My understanding of the Irish data tells me that exports are not going to be strong enough to offset the on-going contraction in consumer spending, private investment and a retrenched public sector.

There is no other way to achieve growth – spending creates income.

Now is the time for the Irish government to abandon its ideological torture of its own people and exit the Eurozone and restore its policy choices. It will be relatively smoother sailing once it makes that very monumental decision.

Greetings again from Ireland. One of the many mysteries about the current crisis is why anyone listens to the IMF or anyone that supported its anti-regulatory policies. Prior to the crisis, even the IMF had begun to confess that its austerity programs made poor nations’ financial crises worse. In the lead up to the crisis the IMF was blind to the developing crises. It even praised nations like Ireland during the run up to the crisis, missing the largest bubble (relative to GDP) of any nation, an epidemic of banking control fraud, and the destruction of any pretense to effective Irish banking regulation.
Crises reveal many deficiencies and one of the most glaring was the European Central Bank (ECB). The ECB was set up, unlike the Federal Reserve, to have only one mission and one function – securing price stability through monetary policy. The Fed has three missions and three primary functions. The missions are systemic financial stability, price stability, and full employment. The functions are conducting monetary policy, serving as the lender of last resort, and acting as a financial supervisor. The crisis revealed that both dominant forms of central banking could attain their most fervent goal – near total “independence” in determining and conducting monetary policy – and fail abjectly.
The crisis revealed that the ECB’s narrow mission and function left the EU helpless to deal with a severe economic crisis. The ECB could not save Europe. Only the Fed could, and did, save Europe through currency swaps, serving as a lender of last resort (often on the basis of chimerical collateral) to major European banks, and providing liquidity backstops to myriad financial markets.
The central financial crisis caused a series of national crises in the European periphery, initially in Iceland and Latvia. Individual European nations whose creditors were most at risk joined with the IMF to “bail out” these initial failures. The “bail outs,” however, followed the old, destructive IMF playbook. Greece then slid abruptly into crisis when the new socialist government revealed that its predecessor conservative government (sometimes with the aid of God’s dragoons – Goldman Sachs) had been lying about Greece’s budget deficit for years. The bond markets were not amused and demanded far higher interest rates on Greek debt. Far higher interest rates, for a nation already in deep deficit and lacking any sovereign currency, could only create a destructive feedback cycle that would end in default. The EU’s leaders believed that the future of the euro and perhaps the EU were at risk, so they demanded that the ECB step forward to save Greece.
The ECB could not, under its long-held view of its own rules, save Greece. The ECB reinterpreted its rules to create a second mission and a second function to (belatedly) respond to the EU’s sovereign debt crisis. The ECB became a lender of last resort to euro members. (EU members that retain sovereign currencies with floating values such as the UK are not subject to any involuntary default risk. They can always pay debts denominated in their own currency.)
The ECB managed to get nearly everything wrong in its dealings with Greece. Even the IMF is distressed by the ECB’s response to the crises of the periphery. The first problem was the most understandable. The ECB took too long to respond to the Greek crisis. Delay was inevitable because the ECB did not have a “lender of last resort” program and had taken the position that it could not and should not have such a program because its sole mission and function were achieving price stability through monetary policy. Nevertheless, delay was very harmful. Greece twisted slowly in the wind, taking substantial economic damage. The ECB appeared to lack decisiveness. Speculation arose that other nations on the EU periphery would also need help from the ECB, which led to attacks on their sovereign debt issuances and damage to their budgets and economies.
The ECB compounded the problem by “aiding” Greece by making it loans. Greece’s problems included excessive debt and no sovereign currency, so the ECB’s aid deepened its debt crisis. The ECB did not give Greece grants, which is what it needed. Giving Greece real financial aid, rather than loans was a bridge too far for the ECB. Greece popped a second EU bubble. The second bubble was hyper-inflated by hot air from European politicians (particularly the French and Germans) claiming that the EU and euro were leading the member nations to ever greater political integration and, ultimately, a true “union.” Well, no. Not even close. The EU is moving in the opposite direction. As the Irish columnist David McWilliams aptly observed, it turned out that the Germans didn’t think of the Greeks like the rest of America thought of New Orleans when it was devastated by Hurricane Katrina. They weren’t fellow citizens entitled to draw on the nation’s resources to recover. The French and Germans, the leading proponents of ever greater European unity and solidarity, viewed the crisis as the Greeks’ fault and they believed that the Greeks should pay a stiff price for resolving the self-inflicted crisis.
The ECB’s third error was to “channel” IMF policies and demand that Greece – a nation is serious recession – adopt financial austerity during the recession. This, predictably, intensified a recession. The ECB insisted on the same medicine for Ireland and Portugal – and increased unemployment in both nations. Spain, which the ECB is pretending is sound, is covering up its banking crisis. By keeping its real estate values massively inflated Spain is preventing the markets from clearing. Unemployment is 20 (29% in Andalusia and 45% for you young adults). The ruling Socialist party was just crushed in a series of regional elections and will likely fall once national elections occur. Ireland’s and Portugal’s ruling parties fell. Economic stability generates political instability.
One of the great paradoxes is that the periphery’s generally left-wing governments adopted so enthusiastically the ECB’s ultra-right wing economic nostrums – austerity is an appropriate response to a great recession. Even neoclassical economists know that the ECB’s policies towards the periphery are insane. The IMF and ECB impose pro-cyclical policies that make recessions worse. Embracing theoclassical economics isn’t simply harmful to the economy, it’s also political suicide. Why left-wing parties embrace the advice of the ultra-right wing economists whose anti-regulatory dogmas helped cause the crisis is one of the great mysteries of life. Their policies are self-destructive to the economy and suicidal politically. Lemmings don’t really follow each other and jump off cliffs – that’s fiction. Left-wing European governments, however, continue to support the ultra-right wing policies that the ECB pushes even when they know those policies will harm the economy and cause the left-wing party to be crushed in the next general election. They watch the ECB’s policies fail and their sister parties lose power and then they step forward to do the same.
Fianna Fail, Ireland’s ruling party during the initial crises is only vaguely left-wing, but it won the prize for the worst response to a banking crisis in modern Europe. It remains so clueless that last I checked its website it still boasted:
“The measures we have taken have been commended by international bodies such as the European Central Bank, the European Commission, the IMF and the OECD and the approval of the international markets.”
The old, and very true, line is that there is always at least one fool in a poker game and if you cannot identify the fool within five minutes of joining the game it’s because you are the fool. Ireland has played the fool in its response to the banking and sovereign debt crises. Fianna Fail, gratuitously, turned a banking crisis into a budgetary and sovereign debt crisis and a severe recession into a economic trap that threatens to make Ireland a mini-Japan. Fianna Fail – even after it performed disastrously and was crushed in the general election – thinks it’s a good thing that the ECB and the IMF “commended” Fianna Fail’s policies. Fianna Fail would think it was a good thing if its poker rivals “commended” how well it played poker. Unfortunately, the Irish people provided Fianna Fail’s stakes in this real-world poker game with the Irish banks’ creditors, the ECB, and the IMF. Fianna Fail still thinks the ECB is Ireland’s friend. “Naïve” is inadequate as a descriptor.
These three ECB errors combined with the inherent dangers that the euro poses for the periphery. A nation that gives up its sovereign currency by joining the euro gives up the three most effective means of responding to a recession. It cannot devalue its currency to make its exports more competitive. It cannot undertake an expansive monetary policy. It does not have any monetary policy and the EU periphery nations have no meaningful influence on the ECB’s monetary policies. It cannot mount an appropriately expansive fiscal policy because of the restrictions of the EU’s growth and stability pact. The pact is a double oxymoron – preventing effective counter-cyclical fiscal policies harms growth and stability throughout the Eurozone. The additional dangers include the German desire for a very strong euro, which makes it harder for the nations of the periphery to recover through exports. Germany’s ability to export even under a strong euro makes it even harder for the periphery to export. The one area of financial sovereignty that remains for the periphery is debt, and that can easily become a severe threat because, unlike a nation with a sovereign, floating currency, a nation that uses the euro can prove The surging interest expense can cause a feedback into budgetary pressures (brought on by the recession – and aggravated by the ECB austerity) that causes recurrent crises in individual nations and, through contagion, much of the periphery.
The ECB has recently compounded these inherent problems of the euro through six additional blunders. It has ruled out debt restructuring and made the argument against restructuring one of morality. The truth is that Greece and Iceland are insolvent. They cannot repay their liabilities. Trying to make them repay their liabilities will further harm their economies and increase ultimate losses. This is why we have bankruptcy laws. It is why the U.S. has non-draconian bankruptcy laws that allow a “fresh start.” This is one of the acts of American genius. It greatly increases entrepreneurial activity by individuals and businesses. It has allowed tens of millions of Americans and tens of thousands of businesses a second chance. Keeping a nation in a grinding economic crisis for a decade is pointlessly inhumane (particularly in a continent that claims to prize European solidarity). It is also self-destructive. It harms the periphery and the core by reducing economic growth and causing a wide range of severe social problems. It is a terrible policy for those that believe in the expansion of the EU to the remaining candidate states. Allowing a fresh start by restructuring debts (a euphemism for partial default) is simply good business. The ECB was foolish to take the best option off the table and to stigmatize it as a moral failure.
The ECB then made things worse in a third way by charging Greece and Ireland too much to borrow. The ECB could have finessed the entire “default” and “morality” rhetoric by providing Greece and Ireland with extremely low interest loans repayable over an extremely long time period. This, of course, would have provided a substantial subsidy to Greece and Ireland, which is exactly what they needed (and what the core needed to escape the crisis that was largely created by the core). Instead, the ECB has charged Greece and Ireland relatively high interest rates. Combined with their recessions, budgetary crises, loss of effective sovereign means to counter the recession because they were members of the euro, and the crippling effects of the ECB’s demands for austerity, the effect of the ECB loans has been to make Greece and Ireland’s debt burdens even more unsustainable.
The ECB’s fourth blunder was blaming the crises overwhelmingly on the periphery. That is overstated in the case of Greece and absurd in Ireland’s case. Ireland ran budgetary surpluses during the height of the lead up to the crisis. It has a budgetary crisis for three reasons. The primary reason is the Irish government’s gratuitous guarantee of the Irish banks’ debts. The secondary reason is the effect of a severe recession triggered by the banking crisis and exacerbated by the ECB’s demands for austerity. The banking crisis was largely the product of accounting control fraud by leading Irish banks. I will develop that analysis in future columns. The tertiary reason is the cost of repaying the ECB and IMF debt. Foreign banks played a dominant role in funding the Irish banking crisis and some of the fraudulent Irish banks. Foreign creditors, particularly foreign banks, were the leading beneficiaries of the insane decision by Fianna Fail to have the Irish people guarantee the Irish banks’ debts to these creditors. The ECB “bailout” of Ireland is in truth primarily a bailout of non-Irish creditors of Irish banks. Those non-Irish creditors are overwhelmingly financial institutions and disproportionately German financial institutions. I trust the reasons why Prime Minister Merkel has continued to support the “Irish bailout” despite the political damage it causes her party is now clear – the “Irish bailout” could more aptly be termed the “German bank bailout.”
The ECB should have explained these realities whenever it discussed the Irish crisis. What should have happened in Ireland, at the minimum, is that the four large, insolvent banks should have been treated as insolvent banks, which was the reality. Bank debts represent contracts. The contract that the Irish banks’ lenders entered into with the banks had these basic terms.
1. We recognize that the loans we make to the Irish banks are not protected by deposit insurance except to the extent we make actual deposits in amounts less than or equal to the deposit insurance limit. (It is important to understand that several of the largest Irish banks were exceptional in how few insured deposits they had.)
2. As to insured deposits, the contract was that Ireland, in the event the bank failed, would repay us the full amount of our deposit up to the insurance limit. In return, as insured depositors we accepted a lower interest rate from the banks because deposit insurance reduced our risk of loss if the bank failed.
3. To the extent that we lend money to the bank other than through insured deposits we are at greater risk of loss if the bank fails so we are compensated for that risk by receiving a higher rate of interest than do insured depositors. If the bank fails we only get repaid a portion of our debts. That portion depends on how insolvent the banks prove to be. If the banks’ losses on assets are 60% (roughly the loss rate at the worst three Irish banks), then we will receive under 40 cents on the euro (because the administrative expenses of receivership will reduce the pro rata recovery of unsecured creditors). The recovery rate for general creditors becomes even smaller when the bank has secured creditors or other creditors with higher priorities (which can include depositors in the U.S. context). The Irish banks’ general creditor, therefore, already received compensation in the form of higher yield that they deemed adequate recompense for the taking the risk of catastrophic loss in the event the bank failed. To pay general creditors in full when the bank is deeply insolvent is to provide them with a windfall – and to create perverse incentives that would further erode “private market discipline” and make future crises more likely and more severe. The Irish banks’ creditors were supposed to suffer catastrophic losses when the banks failed – that was the deal they made and they decided that the extra yield was sufficient. No one made the creditors loan to the Irish banks. The creditors voluntarily did so to make a lot of euros.
4. To the extent that we lent money to Irish banks on a subordinated basis the deal we made was that we would be wiped out entirely if the bank became insolvent. Indeed, that is why subordinated debt is allowed to be treated as tier II capital under the Basel accords. Again, neoclassical economists have claimed that subordinated (“sub”) debt provides the ideal form of capital because it self-selects for financially sophisticated lenders who have superb incentives and ability to provide effective private market discipline precisely because they know they will lose everything if the bank becomes insolvent. In practice, sub debt never provides effective private market discipline, but neoclassical economists cannot admit that. Neoclassical economists, therefore, argue that bailing out sub debt creates perverse incentives and makes future crises more likely and more destructive. Ireland provided a governmental guarantee that covered even the great bulk of the sub debt. (One potentially confusing term from the U.S. perspective used in Ireland is “senior debt.” Irish reports on their banks use this term to refer to general creditors’ claims that have no special priority. They are “senior” only relative to sub debt, not other general creditors.)
The overall impact of all of this is that if the ECB insists on talking in terms of morality and honoring contracts the uninsured creditors should have been the ones to bear the overwhelming bulk of the losses caused by the Irish banks’ insolvency. That’s what their contracts provided. Instead, they are reaping a massive windfall at the direct expense of the Irish people.
I must mention in passing a new analysis by Goldman Sachs related to this issue that is so exceptionally bad that it demands response.

http://www.independent.ie/business/irish/state-default-would-wipe-out-irelands-banks-2660640.html

State default would wipe out Ireland’s banks
Goldman figures show banks would take €12bn hit
By Nick Webb
Sunday May 29 2011
“IRISH banks would be all but wiped out if the Government was to default or restructure the State’s borrowings because of their vast holdings of Irish bonds and sovereign debt.
Bank of Ireland and Allied Irish Bank could face loses of as much as €11.4bn if a major haircut was part of any deal, according to a new report from Goldman Sachs, which has been obtained by the Sunday Independent.”
The only thing that these figures on Irish bond holdings demonstrate (which Goldman misses entirely) is what I have been explaining. The Irish government gratuitously bailed out massively insolvent Irish banks. The direct beneficiaries of this bailout included many foreign creditors, particularly banks, and more particularly German banks. The Irish government, because it lacks a sovereign currency and because it has guaranteed these massive debts, is short of euros. The Irish government, therefore, gave the banks Irish bonds. The Irish banks already had some Irish bonds in portfolio. Irish bonds have large market losses because Ireland is insolvent and if it follows the ECB’s austerity dictates it will become more insolvent. (Eurozone bank stress tests excluded sovereign debt risks because they were designed not to be very stressful.)
The title of the article, therefore, is misleading. Ireland’s insolvent banks were “wiped out” years ago when they made epic bad and fraudulent loans. Ireland is insolvent and it does not have a sovereign currency; it cannot afford to convert currently its sovereign debt held by its banks into euros. Ireland’s problem, therefore, is not the consequences of defaulting, but the consequences of failing to default.
Goldman is doubly wrong about a debt default causing the failure of the banks. I’ve explained why this claim reverses causality. One, it was the failure of the banks and the insane guarantee that caused the budgetary and sovereign debt crisis and the greatly increased “funding” of the banks with Irish bonds. It was the failure of the banks and the guarantee that made Ireland insolvent and (absent real aid from the EU) makes some form of Irish default inevitable.
Two, an Irish debt default would not cause the banks to fail (assuming counterfactually that they hadn’t already failed). If Ireland leaves the euro and reestablishes a floating, sovereign currency the Irish banks’ holdings of Irish bonds will be irrelevant. The fact that AIB and the Bank of Ireland hold Irish debt does not impose any net cost on the Irish government of repudiating debt. Ireland, should it find it desirable, can simply provide AIB and the Bank of Ireland with new Irish bonds or with the new, sovereign Irish currency. The only real issue is whether, and to what extent, it makes sense for the Irish government to subsidize AIB and the Bank of Ireland and what it should receive in return for such aid.
The fifth EU blunder has not been limited to the ECB. A series of EU representatives and parliamentarians of individual nation states have decided to demonize the periphery and to “suggest” that the periphery act in a manner designed to humiliate the nations, impair their sovereignty, and create intense enmity towards the core nations. Greece has been told to sell it islands and beaches. This has led to media speculation that it is being asked to sell its national archeological treasures. Prominent representatives of the core nations regularly deride the purported national character flaws of the periphery. The ECB strategy for the recovery of the periphery is for those nations to engage in a “race to the bottom” of wages to “restore competitiveness.” The core has consigned the periphery to a second track – and their track is the road to Bangladeshi salaries.
The sixth EU blunder is to threaten not only the periphery but other EU and transnational institutions. The ECB, last week, threatened to cut off all credit to the periphery if Greece entered into a debt restructuring deal brokered by the G-8 or any similar group. The ECB, the least democratic institution in the EU system, seeks to arrogate to itself unprecedented power over EU member nations when they are in crisis. This will produce riots, mass protests, and the return of anarchism in many parts of Europe. The one thing that the citizens of the core and the periphery share is the conviction that “the other” is acting wretchedly and in contravention of ideals underlying the formation and expansion of the EU. Neither the core nor the periphery understands the others’ perspective. The ECB has no idea how much rage it has created in the periphery and the passionate divisions it is creating among Europeans. If the ECB is not curbed it will destroy the European project. The ultimate irony is that it will be the Germans and French who dominate the ECB and represent the two nations that have been the strongest proponents of an ever closer union, who will fracture the union unless they give up their theoclassical dogmas.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

…So, let’s play out a scenario. The Greeks default. This means that the ECB has to take a loss on its ‘balance sheet’ of €50 billion. For a normal bank, this would mean the bank would be bust. But the ECB’s balance sheet is a strange beast. The ECB makes its balance sheet balance, not the other way round.

By this, I mean the ECB looks at its liabilities and creates assets to match. It really is that simple. So if the ECB finds itself taking a €50 billion loss, it can go to its member central banks and ask them to get the money from their governments. Or it can write €50 billion into the assets side of its balance sheet and bother nobody about the loss.

This is what Ben Bernanke, chairman of the Federal Reserve, has done in the US – and the world hasn’t ended there. It is what the ECB should do here, and you can bet that the world won’t end here either.

But the really worrying thing is that you have central bankers who don’t seem to understand central banking – now that is a problem.

When you print the cash, you are the boss, you can do whatever you like to solve a crisis.

For example, our central bank in the 1980s continued to accept government debt for cash, even when the government was issuing debt as if it was going out of fashion. The ECB can do the same thing.

The issue is not about rules and regulations any more, it is about a mindset shift. The ECB top brass has to understand that the world has changed.

They have to see the world not as they would like it to be, but as it is. Then once they have done this they need to stop panicking and appreciate that the solution is in their hands.

The ECB should stop shouting stupidly at politicians and begin to behave like the true, credible institution it so desperately craves to be.  (link to full article)

From Mr Ralph Musgrave.

Sir, According to Martin Wolf, Lawrence Summers (Barack Obama’s former chief economic adviser) is not sure whether an “expansionary fiscal contraction” is expansionary (“Why British fiscal policy is a huge gamble”, April 29). But it is worse than that: the economics profession is not even sure how expansionary an expansionary fiscal policy is, because of crowding out. This would be funny if the consequence were not millions of homes repossessed worldwide and lives wrecked.

I suggest that the solution to this farce is to abandon the distinction between fiscal and monetary policy, as advocated by Modern Monetary Theory. Under this regime, government simply creates new money and spends it (and/or reduces taxes) in a recession. Conversely, when inflation looms, government reins in money via extra tax (and/or reduced public spending) and “unprints” it, or extinguishes it. As to government debt, that becomes near irrelevant: it can gradually be whittled down to near zero and be left at that level.

Ralph Musgrave,

Durham, UK

The Case for an Irish Default

All roads to solvency lead through debt restructuring. It’s time for the Irish government to take heed.

By RICHARD PORTES

The woes of Irish banks, unlike those at peer institutions elsewhere in Europe’s suffering periphery, are not a concern merely for the banks’ own solvency. They are a national solvency problem, too—or at least they became one when the government decided to insure bank creditors in September 2008.

It is this, more serious aspect of the Irish crisis that remains unaddressed in the government’s new bailout plans. Ireland’s public debt is clearly unsustainable. The projections contained in the International Monetary Fund’s bailout program see gross debt peaking in 2013, at 120% of GDP. Repeated infusions of taxpayer funds have not done much to convince the markets that those obligations will be repaid: Sovereign spreads are today about the same as they were in November, before the IMF program, and the latest plans have led at least one ratings agency to downgrade Irish sovereign debt.

Continued fiscal belt-tightening will help, but alone it can only take the country part of the way back to health. The government has already made heroic discretionary cuts since 2008, but the further turnaround required by the IMF is more self-sacrificing still: Under the terms of the bailout agreement, the primary fiscal balance is expected to move by 2015 to a surplus of 2% of GDP from last year’s deficit of 9%.

That requirement assumes, however, that the interest rate will exceed the growth rate by only two percentage points over the next four years—highly optimistic given that Ireland’s 10-year bond rate currently stands at about 10%. If, as is only slightly more plausible, the interest rate were to outpace GDP growth by six percentage points, the required primary surplus for 2015 would be 7% of GDP: a shift of 16 percentage points. And all that merely to stabilize the debt at 120% of GDP—to say nothing of reducing it.

Where, moreover, would growth come from? With ongoing fiscal consolidation, domestic demand will remain depressed. Trade will not provide much of a boost, either: Ireland’s real effective exchange rate, a measure of its import competitiveness, has already fallen by more than 10%. “Internal devaluation” cannot go much further, and given the European Central Bank’s present monetary-policy strategy, the euro is not likely to depreciate significantly.

The right policy is to restructure the debt, negotiating haircuts that would reduce its present value. A reasonable target, one in line with current market expectations, would be to cut the present value of the debt by €40-50 billion, or some 30% of GDP. That would bring the debt ratio down to a more sustainable 80% or so.

There might be contagion effects from this—on Greece, Portugal and perhaps Spain. But this is debatable, especially since the markets are already discounting debt restructuring at least for Greece. In any case, “solidarity” goes only so far when a fundamental national interest is at stake. The “solidarity” of Ireland’s partners in the euro zone is also limited, at least when it comes to the interest rate on the Irish borrowing and Ireland’s tax regime.