Searching for solutions to the European crisis

Cross-posted from Credit Writedowns

As I have said in prior posts, I am a bit of a eurosceptic. It is my view that the Euro is a political construct just as the expanded European Union has been and just as the reunification of East and West Germany on a 1 for 1 currency basis was. When politics come before economics, bad things happen.

Did joining the eurozone bust Ireland?, Jul 2008

I am still very much behind those remarks now three years later. Yes, I am a eurosceptic and have always been. But we are here now. The euro exists. And that does change things.

It would easy for me to say something like, “see I told you so. The euro is an abomination and the peripherals should simply leave or be tossed out of the euro zone.” I even remember suggesting the Irish should threaten this to get the most leverage before their banking sector imploded:

Ireland must threaten to leave now if it wants to maximize any EU help it expects to receive, before the scope of other EU banking crises become apparent. Weakness in the financial sector has infected all of the Eurozone members. I have mentioned that Austria has a weak banking system…. But, there is even growing evidence that Germany too has a fragile banking system. To be clear: this is an ‘every nation for itself’ strategy pitting Eurozone members against each other, where those nations savvy enough to request help sooner are likely to benefit at the expense of others.

The Eurozone and the spectre of banking collapse, Jan 2009

Ireland didn’t do that. In fact they did the opposite:

This is the core of the problem in Ireland. The housing bust. Prices are falling and will continue to fall for some time. Ireland has seen the fastest housing growth in the developed economy over the past 10 years. Their housing sector will fall more than others.…

In the end, all of this will pass. Ireland will go through its own lost decade much as Japan and Germany did after their own property bubbles in the 1980s and 1990s. However, the underlying dynamism of the Irish economy will help to pull Ireland out of its funk sooner than either Japan or Germany with their statist-lite economic paradigms.

What would be a cause for concern is if Ireland began to intervene in the unwind process, propping up zombie companies and bailing out the financial sector. The U.S. seems on this road as we speak. Hopefully, Ireland will not follow its example. If the calls for government to do something, anything, lead to a statist model of dealing with the bust, expect a very long and difficult decade.

Ireland: the bust after the boom, Jun 2008

But, again, we are here now. The political imperatives for closer European ties that created the single currency are still with us. And the negatives of abandoning it are many, both politically and economically – in the periphery and the core. I recognize this.

I read a post in the Irish Independent this morning by Gary O’Callaghan on “the top 10 misconceptions of the euro crisis”. I still think repudiating Irish bank debt is a viable option and O’Callaghan thinks “the Morgan Kelly proposition that Ireland can reject responsibility for bank debt and still maintain a good sovereign reputation” is bunk. O’Callaghan is promoting a pro-European view. Nevertheless, on the whole, I found his list quite reasonable.

So when I talk about the euro zone these days, despite my euroscepticism, I am not pushing an anti-Euro line. It is just the opposite; I am suggesting ways the euro zone can best remain intact despite the political and economic impediments.

That’s why I have said the ECB is the difference. As I said yesterday: “The problem here is that as more and more countries keep getting plucked off and put into the penalty box, there are fewer and fewer players left to skate.” Spain and Italy are already in the penalty box and Belgium and France will be too in due course. That leaves Germany as the only enforcer left to skate.

But the ECB is a player too. The ECB is acting as if it has retired from the game. But I think they will have to come back for one pivotal season. As Goldman’s Dirk Schumacher says:

This is a liquidity, rather than solvency, crisis for Italy and Spain. We have discussed in the past on several occasions the solvency of Italy and Spain, and we remain of the view that it is feasible for both countries to stabilise their debt and return to a sustainable fiscal path. The concern now is a self-reinforcing run on sovereigns that, in our view, does not reflect any new fundamental information on either of these two countries.

I know some people think Italy is insolvent. But, the point still holds that this is a liquidity crisis and the way to deal with liquidity crises is by providing liquidity. The only player left on the ice that can credibly provide that liquidity is the ECB. Once the liquidity concerns are dealt with, the euro zone can move to deal with its structural deficits. But if the ECB doesn’t step in, the euro zone won’t have the opportunity.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. kaj

    What keeps the Euro aloft is China, much to the detriment of the Euroland. I don’t know how long it can keep doing that, because destroying he Euroland in the long run will cause a seizure in its future exports to the EU. Even Germany’s current technology led export surpluses will end in a matter of at most 10-15 years. A mercantilist policy has its limits.

  2. sean

    ..”What would be a cause for concern is if Ireland began to intervene in the unwind process, propping up zombie companies and bailing out the financial sector. The U.S. seems on this road as we speak….”

    Unfortunately this is exactly what we got and consequently the real economy is in a nosedive here in Ireland.
    Your assessment from 2008 has been exacting and spot on regarding Ireland.

    What is disturbing is the political and business elites continue down their suicidal path.Suicidal that is for us but not them .They still continue to make money on the backs of our misery.
    Check out the blog ‘namawinelake’ which details these elites that feast on the body of the Irish taxpayer,many of whom were involved in stoking the property inferno.
    They include legal and auditing firms which are paid massive amounts for advising NAMA, the state vehicle where all the rotten property loans are festering.

    1. Greg

      It’s suicide if you kill yourself. It’s murder if they kill you. If your elites are intent on murdering you, you should perhaps object. Of course, in the longer run, its probably a murder-suicide. But that’s what were having here, in the US. I object, but don’t quite know how to express it.

  3. Jim Haygood

    ‘This is a liquidity, rather than solvency, crisis for Italy and Spain.’ — Ed Harrison

    While I’m agnostic about Spain, I do believe that Italy is insolvent.

    What’s so grim about Italy’s plight is that like Russia and Japan, it has transitioned to population decline. Like all rich countries, Italy offers social benefits which implicitly depend upon a growing working-age population for funding. When its demographics got thrown into reverse, the negative net worth of Italy’s unfunded promises became crushing.

    Italy’s insolvency vise already was tightening inexorably. Now as its bond yields escalate past 6 percent, you can almost hear the gears grinding as Italy writhes and screams on the financial rack.

    Engaging the ECB to provide liquidity, when insolvency is the real issue, will only produce a bigger almighty bang when the inevitable restructuring becomes unavoidable.

    Nevertheless, ‘kick the can’ is the only plan on the table for now. So Ed Harrison’s strategy is indeed what the foundering, floundering authorities will attempt. But it’s an error of monumental proportions, which ultimately will destroy the ECB.

    Don’t go down with the ECB’s sinking ship, Ed. Grab yourself a dinghy and paddle away from that Ship of Fools.

    1. Edward Harrison Post author

      I never said Italy is solvent. Read closely and you will see that’s not my comment. I said this is a liquidity crisis.

      I would say, though, that Greece is the only obviously insolvent debtor at this point. Others COULD be insolvent if it goes on like this.

      1. IF

        I tend to agree with you that it should be the ECBs responsibility to provide serious liquidity to Italy given all we know so far. Not an easy call. But considering how poorly it acted during the Greek crisis it seems to be a bit in a pickle. Overall it might have been easier on the PR front if the Italians had gotten rid of Berlusconi first. I don’t think the Italian system is as dysfunctional as the Greek, but they surely know corruption (with all its consequences to actions taken by the ECB). I guess it is too late to ponder all this.

  4. okie farmer

    Ed, There is much to nit-pick with you here, but the comments you quote and endorse from Jody Clark in the 2008 article on Ireland:

    “Recessions, as the economist Joseph Schumpeter pointed out, are a necessary evil in a capitalist economy. They clear out the unnecessary fat that’s built up over years of prolonged economic growth, and are thus the price we must pay for that growth.”

    merely demonstrate the shallowness of neo-liberal thinking about how capitalism must be regulated if its to avoid its boom and bust proclivity. Captialism screams out for countercylical tax policy, but policies only exists as a one-way option everywhere on neo-liberal earth; ie, in good times govts cut taxes, when they should raise them, and in bad economic times govts cut taxes. Horrible tax policy is the root casue of all of capitalism’s problems. Without regulating greed with extremely steep marginal rates, a la Eisenhour era, the kind of meltdown we’ve just witnessed and the kind of massive”meltdown” that led to the great depression is absolutely inevitable.

  5. Philip Pilkington

    Politics always comes before economics.

    On another note, just to clear up a point there — me being a little bit familiar with (what passes for) economic debate in Ireland:

    “…the Morgan Kelly proposition that Ireland can reject responsibility for bank debt and still maintain a good sovereign reputation…”

    The Morgan Kelly proposition was actually batshit insane and only two or three people in the media actually noticed. I wrote something on it ages ago:

    Kelly is big in the Irish mediasphere because he called the housing bubble. But I’ve corresponded with him (to try and get him to plug the Mosler tax-backed bond plan in the media) and I found him to be VERY weak on a lot of the key issues.

    But general debate in Ireland is not much better. Me and a politico friend of mine are trying to get the Mosler plan out there and, I’m telling you, it’s not easy. I hate to denigrate my fellow countrymen and play into long-held stereotypes, but an awful lot of Irish people — at least those in positions of power — are not only remarkably unoriginal, but they’re also a bit dim.

  6. TG

    Ed –

    I’m surprised you would argue that this is a liquidity, not solvency crisis. The immediate issue may indeed be liquidity, but the fundamental problem facing all debtor nations at this point is, without a doubt, solvency. They have spent more than they have taken in.

    We can argue whether a sovereign is beholden to these laws, but at some point when you are upside down in debt, the system collapses. That is precisely what we’re witnessing now: too much debt.

    1. Jim Haygood

      After today’s 5 percent drop, the FTSE MIB Italian stock index is off a swingeing 30.4% from its Feb. 2011 high.

      If the S&P 500 were off 30 percent, the TBTF banksters would be screaming apocalypse.

      Never mind illiquidity or insolvency — the question which confronts Italian investors is whether their market will even open tomorrow.

      Sell — TO WHOM?

    2. Huh?

      “the fundamental problem facing all debtor nations at this point is, without a doubt, solvency. They have spent more than they have taken in.”

      In the late 1980’s, would it have made any sense to analyze, say, Poland in isolation? No, because the other Communist countries were collapsing. It was a systematic failure. So while Poland might have had some problems that were unique to it, all the other Communist countries were in bad shape and were collapsing under their own weight. It was, again, a systematic failure.

      Ireland committed itself to the very “market reforms” that destroyed Latin America (which is why the IMF is the dirtiest word in the region now and why government after government has been elected opposing IMF style policies). Iceland went in the same direction. All countries went in the same direction as far as economic policy, and it didn’t matter if it was the Greek Socialist Party, New Labour or the Republicans in the US. Individual income taxes were reduced, as were corporate taxes, there is more trade and financial liberalization, all countries privatized industry and resources, all economies were financialized.

      Countries lead by left wing, right wing and centrist governments did this. Low, middle and high income countries did this. They didn’t go as far or start from the same point, but they all went in the same direction.

      How is this not a systematic failure? What stops people from realizing the fact that the neo-liberal philosophy that guided this movement has systematically failed?

      Besides, how many of these countries are in this position because of the economic crash? Look at Spain or Ireland’s public debt to GDP ratio before and after the crash. It shows really that what built the economy up in the first place after the neo-liberal reforms was what Soddy called “virtual wealth”.

      I also wonder why people don’t analyze debt overall. What stops people from noticing the explosion in HOUSEHOLD debt. The Fed said it doubled between 1975 and 2005, and that was with an increase of two working people within households. How about the explosion in the debt of financial capital? Why is all of society, not just the government, drowning in debt? Could it have anything to do with the decades long stagnation of wages, the financialization of the economy, our horrible trade deals and wealth inequality?

    3. Edward Harrison Post author

      One issue at a time. What we are experiencing is a market panic and that means liquidity is the first order of the day. This is a classic liquidity crisis developing.

      The solvency issues are medium term issues. Even the obviously insolvent Greece has yet to give principal haircuts to creditors. So liquidity can tide the market over until the panic passes and then that’s when the solvency issues need to be dealt with.

      So, yes it IS a solvency crisis but the liquidity issues are the pressing ones right now. That’s what I mean here.

      1. Jim Haygood

        Even the obviously insolvent Greece has yet to give principal haircuts to creditors.

        This is what is so disturbing. If Greece is obviously insolvent today, its insolvency was equally obvious 15 months ago when the first rescue plan was hatched.

        Yet the authorities remain in denial about Greece’s insolvency to this day. Their latest plan, featuring 21% haircuts, is far from adequate to restore Greece to sustainability.

        Providing liquidity in a crisis has been an accepted principle since the time of Walter Bagehot. But Bagehot made a strict distinction between solvent and insolvent institutions, viewing lending to the latter as merely subsidizing moral hazard.

        In any case, this is a very timely subject, with Italian bank stocks having been sold down to their March 2009 levels, and rumors circulating about a systemic run. The hypertrophied Swiss franc is very suggestive of capital flight from euro-region banks. Tune in tomorrow morning for some Roman fireworks!

    4. Jim

      TG, I’m surprised as well.

      Based on some of his (Ed’s) comments, I don’t see how the southern European nations can grow themselves out of economic malaise, not with the Euro as their currency.

      How much would Italy have to grow in the next 10 years for its debt/GDP to stabilize, and how much would exports have to grow to achieve this target?

      I imagine that many bondholders are asking themselves that question, and that’s why they’re selling.

  7. Jamie

    It could be that Europe need a supranational government with the power to raise money through taxation and pass laws needed to fix its problems. But the Germans will never go for that now..

  8. rps

    We’ve heard of Christmas in July, well, we now have October in August; DOW down 403.09 Bernanke still at lunch? Where’s the “pump it up” or is that pimping up?

  9. rps

    Bloomberg: Morgan Stanley Chief Gorman Buys $2.06 Million of Shares as Price Declines

    Awwwww man, I’m smelling a Lehman and/Bear Stearns rotted dead zombie fish

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