Chart of the Day: Germany in Breach of Maastricht Treaty in 8 of 10 Years Since 2002

 

Author: Edward Harrison · July 17th, 2012 · RGE EconoMonitor

A recent story in German magazine Der Spiegel highlights the efforts in 2005 of German Chancellor Gerhard Schroeder to relax the penalties for deficits in breach of the euro zone’s stability and growth pact. It is a good review of the contemporaneous actions of the German government within a wider EU political context. However, I feel there is a lot missing to the article in giving the German context to the present European sovereign debt crisis. Therefore, I am giving you a few tidbits here.

First, here’s the chart I want to focus on:

Sovereign government debt as a percentage of gross domestic product in Germany, Ireland and Spain from 1995-2011

As you can see, in the late 1990s, in the run-up to the euro, Germany had a sovereign government debt to GDP that was lower than either Ireland or Spain, both of which were technically in breach of the Maastricht 60% debt hurdle.

If you recall, for purely political reasons, the Kohl government in Germany assented to watering down this hurdle in the Maastricht Treaty in order to allow Italy entry into the eurozone. Spiegel documented this earlier this year. (See “Spiegel: Kohl-era German documents reveal euro formation was about politics“).

Instead of a hard rule, according to Article 104c(b) of the Maastricht Treaty, the government debt hurdle is a soft one that reads that debt should:

“diminish sufficiently and approach the reference value (60%) at a satisfactory pace”

See my piece from 2010 called “How Belgian debt, Italian anarchy and Greek profligacy lead to economic chaos in Europe“. The point, of course, is that, having added the “diminish sufficiently and approach the reference value” clause to the Maastricht Treaty debt hurdle, Spain and Ireland were fully eligible for membership in the euro zone.

Once the euro was in place, Ireland and Spain prospered as interest rates declined and money from Germany and other eurozone countries with weak domestic economies piled in. Ireland’s sovereign debt levels plunged to 24.8% as a percent of GDP while Spain also saw an impressive decline to 36.3% in 2007. Germany, meanwhile, has been in breach of the Maastricht Treaty in every year from 2002 to present except in 2007 and 2011, the only years in which debt would “diminish sufficiently and approach the reference value” of 60%. However, Germany has been over the 60% hurdle in every single year.

Why Germany Cannot Save the Euro

 

Author: Edward Harrison · June 21st, 2012 · RGE EconoMonitor

As Charles Wyplosz has recently written, the euro zone’s rescue strategy adopted in May 2010 has failed. Like his column, this column argues that it was folly for the euro zone to believe the bailout approach would succeed because the problems in the euro zone run much deeper than just Greece. Further, this column argues that if this approach continues for any longer, the entire euro zone will break apart.

Yesterday, we re-published an excellent piece by Charles Wyplosz that originally appeared at VoxEU. After we published it, I also tweeted an excerpt which I felt representative of the tone of the piece:

“Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right.” bit.ly/Mzew7v“.

I got some pushback, however, from a journalist I respect. She pinged me, writing that she enjoyed my tweets but that the quote of Wyplosz’s piece was misrepresentative of what he was saying.

This article is an extended response as to why I think the Merkel quote is important.

The problem in Euroland

Why Can’t People Understand National Accounting?

 

Author: Edward Harrison · May 29th, 2012 · RGE EconoMonitor

I was on RT’s Capital Account last night talking to Lauren Lyster about the euro zone debt crisis. At the end of the show, we came up against the deficit problem and the question about how it should be solved. I get frustrated by this topic because the whole framing of the problem presented in the media is wrong because it gets cause and effect totally backwards. The question the media asks is “how can government cut the government deficit?” The real question is “why are deficits high to begin with and what should we do about it?” And it’s this question that gets people into trouble.

I’ll let you in on a secret: before this crisis, when I thought about the budget deficit I was like everyone else in that I paid no attention to how the government budget interacted with the private and trade sector balances. This is a big error. If you do that, you treat the government budget deficit in isolation, when the reality is that the government is an integral part of an open economy with households and businesses that trade domestically and abroad. When the government balance changes, the balances for those businesses and households change too. If you are talking about deficits then, you need to know how changes in the government balance affect the rest of the economy.

Here’s the thing: when we exchange goods and services with each other, from an accounting perspective, it’s a wash; if you buy my goods, you get money and I get goods of equivalent value. If you pay for those goods with an I.O.U., with a debt, your liability, your deficit in the year we made the transaction, is exactly equal to the asset on my balance sheet and my surplus for the year. I mean this is basic accounting, folks. There’s no hocus pocus. Any person’s, any household’s, any business’s, any group’s, any government’s debt is someone else’s asset. Any person’s, any household’s, any business’s, any group’s, any government’s deficit is someone else’s surplus. Again, it’s basic accounting.

Europe Edges Closer to the Endgame

 

Author: Edward Harrison · May 8th, 2012 ·RGE EconoMonitor

Later this week, I plan to write a more comprehensive post on the European sovereign debt crisis to incorporate what we have learned since the French and Greek elections. Here’s a short preview of what I will have to say.

For me the details and the minutiae can be distracting. When analysing situations like the European sovereign debt crisis that have the potential to cause seismic shifts in the economic landscape, one must develop a macro framework that produces discernable outcomes and then re-analyse the details as they come to light to understand whether that framework fits and how the details change the picture. I have argued for 18 months now that there are only three options for the euro zone: monetisation, default, or break-up. And while a lot of analysts have not shared this macro view, I believe they are coming to my way of thinking because all of the events since I developed this frame are bearing this view out.

The euro zone is unworkable in its present form because it is predicated on harmonised national fiscal and economic policies that are supposed to obviate the flexibility that a sovereign national currency affords. That harmonisation has never existed for the euro member states nor do I believe it ever will. And that means that the euro zone will always be beset by crises during economic downturns. Why?

On Spain’s Coming Under the Watchful Eye of the Troika in 2012

Author: Edward Harrison  ·  March 28th, 2012  ·  RGE EconoMonitor

This is a thematic post, I am also putting outside the paywall because there is a lot of chatter today about Spain needing to tap EU bailout funds this year. The messaging in the analyst community follows the thematic prediction I made in October 2010 about periphery countries missing targets and this creating a renewed crisis in the euro zone. Just to quote briefly to fix on how this will proceed, I wrote On the Troika’s Coming Occupation of the Periphery:

Translation: continue fiscal austerity until you reduce your deficits significantly. If the depression this creates causes you to miss your fiscal targets, redouble your efforts under the watchful eye of the Troika.Portugal is out making additional cuts and increasing taxes (link in Spanish). Nevertheless, Olli Rehn has already indicated that Portugal runs the risk of not making its 2011 fiscal targets (link in Portuguese). Even Spain, not under an IMF program, will miss fiscal targets. So, it is only a matter of time before what is happening in Greece happens at a minimum in Portugal and probably in Ireland as well.

The Political Economy of a Greek Default (and euro zone exit)

Author: Edward Harrison · RGE EconoMonitor

In the CNBC video below, Christian Menegatti of Roubini Global Economics says Greece will have a tough road to hoe just getting back to 120% government debt to GDP. Moreover, the country will be locked out of the public debt markets for years to come, irrespective of how well they implement their austerity programs and make structural reforms.

Does the political will exist to keep Greece on EU life support all that time? What if it misses targets, will the will exist then? My answer to these questions is no. And so the logical conclusion of Menegatti’s discourse is that Greece will be forced into an untenable situation where exit from the euro zone is likely. This is what I have already written. Menegetti seems to hint at this as well.

Before you watch the video, let me make a few comments first.

For the time being, European policy makers must continue down the present path of austerity/non-default defaults because they are deathly afraid of committing policy mistakes given the weak financial sector and high private sector indebtedness. Most importantly, if things go pear-shaped, they know they will be blamed because they have no mandate to break up the euro zone (yet).

How and Why Greece Will Leave the Eurozone

Also, ich muss schon sagen: Was die Herren Harrison, Auerback und Münchau (übrigens ein Deutscher, FT London) zu Griechenland und Italien zu sagen haben, überzeugt mich mehr als europäische idealisierte Realitätsverweigerungen. Oder kann jemand wirklich beweisen, dass Griechenland nun solvent wird? (hfk)

Author: Edward Harrison · February 13th, 2012 ·RGE EconoMonitor

This post is a continuation of the ideas for a Greek exit for the euro zone that I published on Friday. This post, however, also incorporates specifics that Marshall Auerback has laid out in a separate post and demonstrates why exit is the likely option.

Now, the Greek exit scenario I outlined on Friday is identical to the one I proposed in November for Italy when serious policy makers were toying with the idea of letting Italy enter a Greek-style death spiral. In Italy’s case, the country is too big to fail. Anyone who has tried running through Italian default scenarios understands immediately that Italian default equals a global Depression. This is why questioning Italy’s solvency leads inevitably to monetisation. The ECB has now stepped in and monetised the debt and will continue to do so.

Before we continue to Greece, I do want to flag something about the Italian situation that I wrote when explaining the monetisation route we are on in November.

Italy’s problem is this: Italian government debt is almost 120 percent of GDP, behind only Greece within the euro area. Meanwhile, Italy pays 6.5% for its long-term debt. If interest rates were to remain at current levels for an extended period, Italy would need to run a primary budget surplus (excluding interest payments) of about 5 percent of GDP, merely to keep its debt ratio constant.

More on What I Think Will Happen in Europe

Edward Harrison RGE Economonitor· December 2nd, 2011

About a month ago, as the crisis in Italy became acute, I wrote that I believed the path was clear; the euro area countries would move to tighter fiscal integration, which may or may not eventually include Eurobonds. The alternative, an implosion in Italy, would mean economic Depression. Since that time, despite the impression that some serious policy makers believed letting Italy default is a justifiable policy choice, the prevailing view amongst euro area policy makers seems to be that saving Italy from default is necessary and that the only politically justifiable way to effect this rescue is to move to fiscal integration. All of the statements by leading euro area politicians now point in this direction.What I said a month ago bears repeating here:

Does the ECB want to lose its trump card in dealing with Italy? No. That’s why they aren’t offering an explicit backstop. But if they don’t backstop Italy, Italian yields will remain elevated, Italy will default, all of the German and French banks with those bonds will be insolvent, and we will have a Depression. Italy is too big to fail.If the ECB does backstop Italy credibly and fully, then yields will fall and investors will pile in again. However, this is nothing more than a temporary patch, a medium-term liquidity solution only. Clearly, the issue for the Dutch and the Germans is that Italy would have no reason under this arrangement to make reforms or move to fiscal consolidation. They fear Italy (and Portugal and Greece) would become permanent ‘free riders’, mooching off of Germany and the Netherlands’ fiscal probity, making the euro a weak currency. The right way to deal with that fear is to choose between greater fiscal integration or breaking the eurozone up at some point in the medium-term (say 2-5 years).My conclusion: the ECB will eventually move to a lender of last resort role. The question is how much damage will be done before they do so.Europe is already in a double dip recession and the sovereign debt crisis has already moved from Greece to Portugal to Ireland to Spain and now to Italy. Belgium, with its lack of a permanent government and 100% sovereign debt to GDP is next on this list. They would be followed by France and its implicit guarantee for a poorly capitalised banking system and Austria and its implicit guarantee for a banking system highly leveraged to central and eastern European debtors. Eventually, every country will feel the impact because a fixed exchange rate system with no lender of last resort is inherently unstable unless you have fiscal integration and/or compatibility.The ECB’s backstopping Italy and Spain for fear of German and Dutch banks’ insolvency is like the Fed’s backstopping California and New York for fear of Bank of America, Wells Fargo, Citigroup and JPMorgan Chase’s insolvency. It is not a very palatable solution longer-term. Therefore, in the medium-term, the euro area will move to tighter fiscal integration. This may or may not include Eurobonds.However, not all members will come along for the ride. Angela Merkel, admitting that leaving the euro zone is politically and legally possible during her commentary addressing the Greek referendum in Cannes, has already broken the taboo. Now everyone knows that it is possible to default, leave the euro zone and re-gain competitiveness in a move to a devalued currency. Given the lack of economic harmonisation in the euro area, some euro members will be forced to leave and choose this path. I predict that when Europe moves to change its constitution to include greater fiscal integration, it will also include explicit mechanisms for countries to leave the euro area.–Why questioning Italy’s solvency leads inevitably to monetisation

Bailouts: Catching a Falling Knife

Edward Harrison

Jan 25, 2010 3:45PM

Back in June before real panic struck, I outlined my thinking on the financial services sector in a post called “Financials: catching a falling knife.” My basic point at the time was that investors – especially sovereign wealth funds (SWFs) and hedge funds – were seriously underestimating future losses in the financial services. I suggested that buying financials was like catching a falling knife and that things would only improve when these investors gave up and went home.