The world financial instability and the Euro zone crisis -

Chapter 4

Jacques SAPIRCEMI-EHESS

4

Partial remedies

• 1. The ECB new financing facilities.• A partial change in the ECB strategy.

– An evolution toward non-orthodox policy tools was obvious since the end of 2007.

– But the change implemented in December 2011 has been massive.

– Is it the beginning of a new path or the end of the line?

• But the Constitutional roadblock (The Karlsruhe Constitutional Court) is still in place.

– The political opposition of the German government is much less a problem than it is though.

– The Constitutional argument has been ignored so far and could be a major one.

– The new mechanism and its assessment.– It works (at short term).

» The REPO mechanism.» Liquidity flows (489 mlrd E and 529 mlrd E)

– But, it is transforming now quickly the ECB into a kind of “bad bank”.

» Why banks are taking back bonds they have bought to the ECB?

» No improvements on the corporate debt market.– And, it is not solving the main issue that is the increasing

weight of interests burden on budgets through the rise of interest rates. What is needed is not just a new liquidity facility but a massive reduction of the debt burden.

• 2. The inter-governmental “agreement” of December 9th, and its uncertain future.

• A common disciplinarian frame but no progress toward budget federalism.

– Still no progress on budget transfers, and a German opposition stronger than ever.

– The legal side of the agreement is to be murky (some countries are opposing it).

– It is highly dependent of the willingness of national Parliament.– Political oppositions is now radicalizing against this agreement.

• An agreement now partly emptied of its content through “Exceptions” clauses.

– Several countries have made the case for exception on “exemption” clauses.

– A possible conflict is coming with the ECB.

• 3. Commercial banks response to the crisis.– Commercial banks are still engaged into a massive de-

leveraging operation.– The situation of commercial banks is still very weak.– The uncertainty on banks is linked to the fact that nobody knows

what is the scenario of the “next” crisis.– The EZ has accumulated a lag in bank regulations.

– The impact on internal credit in different EZ countries.– The de-leveraging impact on internal credit and the coming

European “credit crunch” (Corporate bonds are still at very high interest rates).

– Uncertainty on assets.– The problem of regional banks in Spain and Germany.

– A process of “re-nationalisation” of the sovereign debt is threatening to ultimately destroy the EZ.

• 4. The Greek “controlled Default”– The mechanism of “voluntary” swaps.

– The “old” Bonds and the “new” Bonds and the extension of the swap period (till May 15th).

– -The actual interest rate and depreciation of the nominal value of the new bonds. (From 100 to 30 and from 4% to over 13%)

– What impact on the Greek debt?– A reduction of around 100 Mlrd Euros amounting to 28,1%– At 124% GDP a 4% IR implies a yearly 5% GDP interest

payment.

– An end to the CDS market?– What future for this market?– What consequences are of disappearing CDS?

– What is the current dynamic.

• 5. A consolidation of a Ponzi scheme?– The Ponzi mechanism of the sovereign debt has not

been modified.– Total debt x IR > real growth x inflation: automatic budget

deficit.– The increase of the Debt/GDP ratio is now fostering high interest

rates.– If governments want to reduce quickly this ratio they will induce

a severe depression and then a drop in real GDP which is to destroy the debt reduction potential.

– An internal Ponzi mechanism is now developing in Spain.

– The central government has reduced subsidies to regional ones but regional government are increasing the size of budget arrears.

– The central government will have to consolidate regional budgets. A 16% GDP deficit?

6. What lies ahead? (a) The Euro zone recession and possible

depression induced by austerity plans.– Strong depression in Greece and Portugal with large GDP

drop (-7% and -5% respectively).– Deepening recession in Spain with a massive (24%)

unemployment problem (-1,7% at best/-3,5% possibly).– Recession had already begun in Italy, Belgium and France– A future extremely uncertain till 2015.

(b) Trade deficit reduction.• The increase of exports is limited• The severity of the decrease of internal demand: Greece (-

40%), Portugal (-26%), France (-10%), Italy (-8%)

The severity of the potential Unemployment shock.Spain 29% (24%), Greece 52% (19%) Portugal 36% (20%), France 20% (9,7%),

Italy 16% (11%)

(c ) Short term possible catastrophe.• Greece: the controlled default as a partial solution.• Spain: the growing amount of unpaid bills by Local and

Regional government (Catalunia 10Y = 9,56%).• Italy: The new government is more and more contested.

A break-up of the Euro zone is now serious a possibility

• 7. What consequences of an Euro break-up would be.

– The International role of the Euro.• An asymmetric relation.• The reduction of “other currencies” share.• The Euro has still not achieved a dominant role versus the

USD.– Would the USD predominance be strengthened by a

collapse of the Euro?• There is already a process of “return to the USD”.• But fundamentals of the US economy are not good.• The collapse of the Euro could be the first signal of a general

collapse of the International monetary system.

Share of different currencies in Central Banks reserves from 1995 to 2009

USD Euro Deutsche Mark

French Franc

Others (including British pound and

Yen) 1995 59,00% 15,80% 2,40% 22,50% 1996 62,10% 14,70% 1,80% 21,10% 1997 65,20% 14,50% 1,40% 18,60% 1998 69,30% 13,80% 1,60% 15,00% 1999 70,90% 17,90% 10,90% 2000 70,50% 18,80% 10,50% 2001 70,70% 19,80% 9,10% 2002 66,50% 24,20% 8,80% 2003 65,80% 25,30% 8,60% 2004 65,90% 24,90% 9,00% 2005 66,40% 24,30% 9,20% 2006 65,70% 25,20% 8,90% 2007 64,70% 25,80% 9,80% 2008 63,60% 26,40% 9,90% 2009 62,20% 27,30% 10,70%

• What could be opportunities for the development of regional reserve currencies (RRC) ?– The use of “proxies” for currency.

– Gold.– Commodities.– IMF SDR

– Current projects.– The Russian project of establishing the RR as a new RRC.– Latin-American projects (the Venezuela “SUCRE”).– The Australian Dollar.– What would be the future of the Yuan?

– Would the “BANCOR” (Keynes, 1944) be the ultimate solution?

• The Crisis in Western Europe is to be a long one.

• It is to affect Central and Eastern Europe.

• It will certainly have an impact on the Russian economy.

• However, this could be the prime mover for:

- A rethinking of the Growth path of Russia.- The development of new monetary instruments.