Do the UK's European ties damage its prosperity?

Do the UK's European ties damage its prosperity?

Do the UK's European ties damage its prosperity?

Edited bySimon Tilford

Written by Philip Whyte, 30 April 2015

Annual dinner 2015

Annual dinner 2015

Annual dinner 2015

16 April 2015

With Lord Jonathan Hill, European commissioner for financial stability, financial services and capital markets union

Location info

London

Event Gallery

Vorsprung durch Grexit?

Vorsprung durch Grexit?

Vorsprung durch Grexit?

Written by Charles Grant, Christian Odendahl, 17 April 2015

The German political and bureaucratic class is preparing for Grexit, and thinks the risks are containable. Angela Merkel should resist this emerging consensus in Berlin, and make every effort to keep Greece in the euro.

The brinkmanship between Greece and the euro group is entering a decisive phase. Amidst escalating threats – default by Greece, financial cut-off by the eurozone – the most pressing issue is whether Germany would allow a Greek exit from the eurozone, either on purpose (‘Grexit’) or by accident (‘Greccident’). Most of the key decision-makers in Berlin say that unless Greece starts implementing real reforms, it should leave the euro. But Chancellor Angela Merkel needs to consider the geopolitical dimension, as well as pressure from the US and the ECB to keep Greece in – in addition to the unwillingness of the Greek people to leave. For Europe’s sake, she should go the extra mile to avoid Greece departing the eurozone. But the odds of Grexit happening are rising.

Until the Greek government comes up with a serious plan for structural reform, Germany will continue to block further money for Athens. Given that Greece is finding it increasingly difficult to repay debts, and pay salaries and pensions, a Greek default and possibly exit from the euro is looking more likely with every passing week. “We have never been closer to Grexit, and we are close,” said one senior official in Berlin. Officials say they cannot detect any desire from the Greek government to commit to reforming labour markets, fighting corruption, improving tax collection, strengthening fiscal discipline or attacking vested interests. “Faced with Grexit, Tsipras might do a U-turn, and perhaps change his coalition partner. But we have no idea what he’ll do,” said an official. The German government does not know whether Tsipras is playing chicken and waiting for Germany to blink, or simply unable to control the many factions in his government. Or even whether he really wants to keep Greece in the euro.

Germans who favour Grexit argue that it would be good for the Greek economy. Greece currently has an output gap of around 13 per cent of GDP, according to the OECD; the economy is running at well below its economic potential. Autonomous Greek monetary policy and a weaker currency could therefore speed up the recovery, and avoid the further harm to the economy that a long depression would inflict. But a prerequisite for such a successful outcome would be that the exit be properly managed, with the help of the ECB, and with bridge financing for the Greek government from European institutions, to limit short-term disruptions. What is more, the new Greek monetary policy authorities would need to build up trust quickly, to avoid continued instability and high inflation.

Proponents of Grexit tend to underplay the potential downsides. Leaving the euro is more difficult than giving up a currency peg: millions of contracts would need to be rewritten, and foreign debt (in euros or dollars) would balloon when measured in new drachma, forcing companies and especially banks into default. Inflationary pressure would be strong, hurting consumers. It is not a given that, post-Grexit, the Greek financial system would be stable and inflation manageable. The deeper institutional and structural problems of the Greek state and economy would remain unresolved, leading to slow growth after the economy had returned to its potential output.

Some German officials predict that Grexit could be a gradual, drawn out process. Greece would not be pushed out following a decision by the European Council or European Central Bank, they think. Instead, the government would run out of money and have to issue IOUs as a parallel currency, while imposing capital controls and intervening heavily in the banks to prop them up. This would not be a stable situation; the economy would not grow under such a scenario. As a result, the government would probably think it best in the long run to take the plunge and devalue by formally leaving the euro – then at least the economy would regain monetary autonomy, making it easier to boost demand.

German officials are sanguine about the consequences of Grexit. “It would not be problematic for our budget, financial sector or economic growth,” said one. “And one positive result could be that other countries would do their homework and become more disciplined” – an argument that the German council of economic experts has recently made, too. Tax payers are liable for around €240 billon of Greek debt, of which Germans could lose €70 billion. The officials think that would be manageable.

Most officials think the risk of contagion is minimal. “Spain, Portugal and Ireland would be alright because they have done their homework,” said one. Although Italy and France have not done much homework, he thought their fates – and whether they reformed – would be unrelated to what happened in Greece. In any case, Greece was a special case, he said – there was no longer much bank exposure to it.

He acknowledged that if the financial markets asked for a premium before lending to other eurozone countries as a result of Grexit, Germany would have to consider further eurozone integration, such as tighter fiscal discipline or the introduction of ‘economic reform contracts’. “In that case we would need to move fast, so hopefully we would be able to avoid changing the EU treaties.” He may be too nonchalant: if the markets were panicking about the euro’s viability it is highly unlikely that modest steps towards policy-integration or risk-sharing would reassure them.

Is there a difference between the approaches of Finance Minister Wolfgang Schäuble and Angela Merkel? Officials say that on the fundamentals, there is not, even though Merkel’s rhetoric is softer. They both want to keep Greece in the euro, but not under any circumstances, and not if the Greek government cannot get its act together. Some of their officials take a harder line. “As an economist, I am not sure if Greece should stay in the euro; it is structurally uncompetitive and could become a second Mezzogiorno,” said one. He noted that Latvia, Lithuania, Spain and Ireland had known they needed to change, and therefore taken painful decisions, but he thought that sometimes pressure to reform did not work. He worried that keeping Greece in at all costs would undermine European cohesion.

Inevitably, Merkel thinks more about the geopolitical context than Schäuble. She is under discreet pressure from the Obama administration, which worries about the risk of a Greek-Russian rapprochement. The IMF, the European Commission, France and Italy also want to find a way of keeping Greece in. A lot of European governments would be reluctant to make a visible write-down of their loans to Greece. The SPD – Merkel’s coalition partner in Berlin – says in private, though not in public, that Germany has overdone the austerity during the eurozone crisis, and it is against Grexit. Another reason for keeping Greece in the euro is that if it grew strongly outside the currency, anti-euro voices elsewhere would grow bolder.

The ECB, too, remains opposed to Grexit. For now it is taking a hard line on Greece, limiting the ability of Greek banks to fund the Greek government. Yet it was the (still untested) promise of Mario Draghi to do “whatever it takes to preserve the euro” that ensured the single currency’s survival in the summer of 2012. The ECB and others worry that in a future political crisis in another member-state, financial markets might start doubting the commitment of the core countries and the ECB to preserve the integrity of the euro. At that point, the eurozone would be thrown back into the self-fulfilling crisis mode that policy-makers have scrambled to leave behind during the past few years. The ECB would not risk the unravelling of that promise over Greece, unless put under considerable political pressure.

Within Greece, too, it should not be forgotten that a recent poll found 84 per cent of Greeks in favour of keeping the euro. Syriza does not have a mandate to negotiate an exit, and its high approval ratings could soon tumble if the country took steps to prepare for leaving the euro, such as capital controls and bank closures. It may well be that a Greek government which embarked on a path towards Grexit would fall before the event.

One key point for Merkel, apparently, is that Germany should not be blamed for Grexit. One visitor reports her line as being: “If Grexit happens, people will see the cause was that Greece failed to do its homework, not that we withheld solidarity.” In this blame game, Merkel is currently succeeding. It is astonishing how those who agree with Greece that the eurozone has overdone the austerity – like France and Italy, and to some degree the European Commission and the IMF – have been alienated by Syriza’s chaotic and confrontational style of governing, its extreme rhetoric and its inept diplomacy. As a result, Paris, Rome and Brussels are not speaking out on Greece’s behalf. And there are some eurozone governments, notably Finland, the Netherlands, Slovakia and Estonia, which are encouraging Germany to take a hard line. Even the Spanish and the Portuguese, having ‘done their homework’, are in this camp.

But this blame game could easily shift if Germany facilitated or actively pushed for a Greek exit. Not only the US, the IMF and the international press but also probably France and Italy would ultimately criticise Germany for its handling of the euro crisis – during which Greece has suffered from a depression of similar magnitude to that of Germany in the 1930s, the eurozone economy has failed to recover to its pre-crisis size, and the political extremes in Europe have gained much ground. The US has long understood that in its role of the transatlantic alliance’s hegemon, it must accept some costs for the greater good of the alliance’s stability. It expects as much from the EU’s hegemon, Germany, and in the event of a Grexit would hold Berlin largely responsible.

The threats from the Greeks to default on eurozone rescue loans, and from the Germans and their allies to push the Greeks out, are part of a game of brinkmanship: both sides need to be seen as fighting for their voters. A smooth and early agreement would raise suspicion among both sides’ electorates that their politicians could have achieved more from the negotiations. This does not mean, however, that neither Greece nor Germany will step over the brink.

There is no doubt that many powerful voices, within Europe and further afield, will try to prevent Grexit. But Berlin plays a decisive role in eurozone crisis management, and in Berlin key decision-makers believe that Greek membership of the euro is becoming unsustainable. Germany’s friends should help it to see the bigger picture.

Charles Grant is the director and Christian Odendahl is the chief economist at the Centre for European Reform.


Comments

Added on 23 Apr 2015 at 18:17 by Georg Boomgaarden

My feeling is that the Greek government does everything leading to Grexit even if other member countries try the best to keep them in. The approximation to Russia (and China) is a failure, and even if Russia would finance Greece this would only weaken both countries. The US has always seen the EU as a strategic asset, sometimes forgetting that this would no longer be the case if the EU as a whole fails. Finland, the Baltic States, Poland, Sweden and the Netherlands are strategically more important than Greece, not to mspeak of Germany. To press too hard for Greece winning a chicken game would explode the Norther rim of the EU (see the last Finnish elections) - I would even not exclude a strong anti-EU turn in Germany comparable to the British position of the actual Tory government. This is also the bigger picture. The whole process of Grexit may indeed take enough time to give the Greek people a chance to decide themselves if they want to continue with a government that leads them into troubled waters. The description of the Greek situation is somewhat skewed: it is true that many people suffer under a deep depression, but before that the Greek people had accumulated the highestr rate of increase of wages in the Eurozone over 30%. If this increase payed by debt and not reflecting an increase in productivity is corrected by the markets - this can never be avoided. The problem is that the cost of this correction is mainly put on those who cannot defend themselves. But to say it is only banks that are saved is wrong. The banks (often recklessly) financed excessive wage increases for all Greeks - so if anybody is to blame it is banks and those who benefitted from this unreal economy together.
It is also not true that the opinion that austerity was overdone is widespread. It is widespread between those who held this opinion from the start, but have no recipee how to get the markets to continue to finance Greece for sustainable interest rates.
Berlin does NOT play the decisive role in the crisis management, but the countries who are grown up enough to handle their own rescue - like Spain that did the homework as a sovereign country. This is a difficult way - and simplistic gurus from Krugman to Podemos would criticise this but it works. If the people elect a government that does it in a different way and fails this has all democratic legitimation, but this includes that the people have to bear the consequences of a failing policy as well.
I am convinced that Greece has fallen so far outside of the European way to make the economy work that a Grexit would really be the best way to rescue the country (in a way Argentina made it, first with success then falling back into the old habits) - and if Greece keeps the old habits it should also leave the EU.
Georg Boomgaarden

Germany’s rising wages bode well for global economy

Germany’s rising wages bode well for global economy

Germany’s rising wages bode well for global economy

By Simon Tilford, 13 April 2015
From The Wall Street Journal

Link to press quote(s):

http://www.wsj.com/articles/germanys-rising-wages-bode-well-for-global-economy-1428861139

Merkel drängt Athen nicht aus dem Euro

Merkel drängt Athen nicht aus dem Euro

Merkel drängt Athen nicht aus dem Euro

Written by Christian Odendahl, 09 April 2015
From n.tv

Putin tempts Tsipras with promise of lucrative gas deals… but can Russia really save Greece’s skin?

Tsipras

Putin tempts Tsipras with promise of lucrative gas deals… but can Russia really save Greece’s skin?

By Christian Odendahl, 09 April 2015
From The Independent

Link to press quote(s):

http://www.independent.co.uk/news/business/news/putin-and-tsipras-meet-in-moscow-but-can-russia-save-greece-10162817.html

The low-hanging fruit of European capital markets

The low hanging fruit of European capital markets

The low-hanging fruit of European capital markets

Written by Christian Odendahl, 08 April 2015

The planned capital markets union in Europe faces many obstacles. Commissioner Hill was right to start with the lower-hanging fruit but it will not help the eurozone in the short term.

Europe’s economy is too dependent on bank finance. A greater reliance on capital markets would help to boost the region's economic growth and resilience in future financial crises. To this end, the European Commission is aiming to create a capital markets union (CMU) in an effort to lower Europe’s dependence on bank finance and encourage the integration and deepening of its capital markets. But there are plenty of obstacles. Jonathan Hill, the EU’s finance commissioner, is sensibly focusing on the lower hanging fruit. But even these ‘early action’ measures will take time to implement, and as such will not improve Europe’s short-term economic prospects.

Contrary to the US, banks provide the bulk of financing to businesses in Europe. To some extent, this reflects the fact that US firms are on average larger: almost 60 per cent of American employees work for firms with a staff of more than 250; the corresponding figure in Europe is just a third. Participants in capital markets are less willing to invest in smaller firms, because it is relatively more costly to acquire the information needed to determine the risks of lending to them. Banks, with their closer relationship to customers, usually possess that information. Europe's bank dependence also reflects underdeveloped capital markets in Europe.

One problem with bank lending is that it tends to be pro-cyclical, growing strongly during booms and contracting during busts, thus amplifying the business cycle. There are two reasons for this. First, a financial crisis leads to losses and reduces a bank’s capital. Since banks have to finance a share of their loan book with their own capital rather than with deposits or bonds, they need to rebuild their ‘capital ratio’, which often leads them to curtail lending. Second, regulation tends to tighten after crises: often regulators demand that banks finance a larger share of their loan books with their own capital, or change the amount of assets that banks need to hold to remain liquid. Such changes in regulation often lead to further cuts in lending.

To some extent, pro-cyclical regulation is inevitable, but it is more painful in a bank-based economy. Since the crisis, European firms have struggled to access funding because the region’s banks have reined in lending and capital markets were underdeveloped. Regulation was also tightened unduly, for example regarding securitisation. And monetary and fiscal policy failed to offset the negative impact of pro-cyclical bank lending on the economy. Some of these mistakes are being corrected: macroeconomic policies have become less contractionary; and regulation has been relaxed in areas where the post-crisis response went over the top, though arguably not enough.

A fully-fledged CMU would broaden the funding base for firms and infrastructure projects, making the European economy less bank-dependent and more robust. Larger and deeper capital markets would also help the European Central Bank (ECB) to conduct monetary policy: when a central bank lowers interest rates, there are two ways through which they can be transmitted to firms, via bank interest rates and via the cost of funding on capital markets. Moreover, the ECB would have a wider choice of assets (beyond government bonds) to buy in future ‘quantitative easing’ programmes.

However, a fully-fledged CMU requires politically and legally difficult measures like the harmonisation of insolvency, corporate and tax laws – which will take years to implement, if they are ever agreed at all. What is more, the reform momentum is currently strong and should not be spread too thinly over too many projects. The Commission is therefore right to set out three priorities for early action.

First, it wants to make it easier for firms based in one member-state to find investors in others. This requires that information about companies be easily accessible and in a form that analysts all around Europe understand. The prospectuses, the key documents that contain information about an asset such as a corporate bond, are costly to produce and need to be harmonised and simplified. Credit scores should also be made easily available and comparable across the EU.  The Commission is calling for a consultation on the existing prospectus directive and credit scores framework to start the reform process. It also wants to support the growth of the so-called private placement markets in which medium-sized companies can market bonds in volumes that would be too small for public offerings.

Second, the Commission aims to rebuild the European market for securitisation. Securitisation allows banks and financial markets to work together: banks have superior knowledge of local small and medium-sized enterprises (SMEs) and households, and can provide loans to financially sound borrowers; financial markets are eager financiers of such loans but only if they come in the right shapes and sizes. Securitisation allows banks to bundle loans together, and sell tranches to investors. Banks therefore have an incentive to extend more loans if they can sell bundles of them; participants in financial markets, including pension and insurance funds, can invest in SMEs and other assets that are too small to invest in individually; and the ECB has a large asset class that it can buy in its monetary policy operations.

Securitisation has an image problem as it is seen by many in Europe as a cause of the financial crisis. But just as Greek public finances were not the reason for the euro crisis, securitisation was not the reason for the 2008-9 crash: highly leveraged banks, overly complex securitisation, faulty risk models and a run on the refinancing markets of banks and shadow banks all worked together to create a perfect storm. Simple securitisation, on the other hand, was largely blameless. This is especially true in the EU, where the default rate of all ‘structured finance products’ was only 1.6 per cent between mid-2007 and mid-2014, compared to almost 20 per cent in the US. The key is to make the process of securitisation transparent and comparable across the EU. This is what the Commission aims to help achieve, and has started a consultation process on the issue.

The last ‘early action’ aims to boost long-term investments, especially the use of European long-term investment funds (ELTIFs). In essence, ELTIFs are a new regulatory class of funds which allow issuers to ‘lock up’ investors’ money for a long time, and market them across Europe. The aim is to make it easier for capital to flow across borders into long-term projects such as infrastructure. Here again, the Commission is consulting on how to support the use of these instruments.

These three measures are realistic first steps: they focus on relevant issues (access to funding, securitisation and long-term investment); and they cover areas where there is a role for the Commission to drive the process forward. Moreover, the Commission has a powerful ally in the ECB, especially on securitisation, and the support of the German and British governments. But even plucking the lower hanging fruit of the CMU will take time. For example, a new regulatory framework for securitisation could take two years until it is fully operational. The construction of the CMU is a long-term goal, not a solution to Europe’s immediate economic problems.

Christian Odendahl is chief economist at the Centre for European Reform.

Disunited Kingdom: Why ‘Brexit’ endangers Britain’s poorer regions

Disunited Kingdom: Why ‘Brexit’ endangers Britain’s poorer regions

Disunited Kingdom: Why ‘Brexit’ endangers Britain’s poorer regions

Written by John Springford, 07 April 2015

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