Monthly Archives: June 2011

A default could have led to a dramatic unravelling of the European economy, and even beyond. Many of my colleagues in academia have blithely called upon Greece to default, and thereby force an involuntary restructuring of its debts. I find such advice to be naive. Nobody can guarantee a managed default in today’s global financial system.

Many of those who argue for the inevitability of default claim that Greece can never repay its mountain of debt. Fortunately, that dire forecast is not necessarily right. Greece need not pay anything near to that level if the financial crisis is better handled from this point forward. Here is how. 

With today’s vote in favour of a medium term fiscal plan, Greece has just escaped the immediate danger of financial collapse. But this will prove a shortlived victory for the Greek government. Greek Prime Minister George Papandreou’s problems begin again tomorrow, with a second parliamentary vote on the implementation of the plan barely agreed today.

Public fury against the government is unlikely to abate. Greece’s bureaucracy inspires little confidence that it’s up to this job. Today’s vote has bought the government several months, but by the end of the year, Greece will probably have new elections. And this is where the real problems begin.  

The daring night-time raid on one of one Kabul’s best-known hotels by Afghan militants on Tuesday, underlines once again how much depends on the secret talks with the Taliban . However the recent leaks by government officials in Washington, Kabul and London, are extremely dangerous and could scuttle the talks just as they enter a critical phase.

At stake is not just peace for Afghanistan, but the entire region including a deeply precarious Pakistan. The talks are premised on the essential realisation that neither a successful western withdrawal from Afghanistan nor a transition to Afghan forces can take place. In an attempt to avoid further speculation, I am laying out the bare facts of the talks as western officials have described them to me. 

I remember sitting in a meeting at the International Monetary Fund back in the 1980s, debating the meaning of a small annotation in the margin of a memorandum that had just returned from the office of the managing director. It was just a squiggle; yet we debated possible interpretations for a full half an hour!

This is a small example of what is well known to IMF insiders – the post of managing director is not to be taken lightly in an institution that operates like a well-disciplined army, with staff looking up to the unquestioned general for decisive leadership.

This is why the resignation of Dominique Strauss-Kahn has been so disruptive to the functioning of the IMF. It is also why Christine Lagarde – who following Tuesday’s public backing from Tim Geithner, US treasury secretary, will assume the post shortly barring any legal complications – must move on five key issues in her first few months at the helm. 

The pressure on Lorenzo Bini-Smaghi to resign from the executive board of the European Central Bank is a fundamental challenge to the bank’s independence and to its ability to represent European interests rather than those of individual countries.

When the ECB was being created, European politicians said it would be a truly European institution, making decisions for the benefit of the eurozone as a whole. But with the French government apparently succeeding in forcing Mr Bini-Smaghi to resign in order to make way for a French appointment to the ECB executive committee, the ideal of the bank’s independence has been destroyed, and Europe will be the worse for it.  

As Winston Churchill once said of the US, European leaders can be trusted to do the right thing for the euro area’s financial stability only after exhausting all other possibilities.

But they would be well-advised to spend their summer holiday contemplating ways to complete the clean-up of the banking sector; to deal with insolvent countries; and to make better use of the EU’s funds and crisis management facilities.  

This is not the moment to abandon seven decades of building union in Europe. It undoubtedly remains a huge challenge to complete the project. In a world that is fast tilting away from its postwar Atlantic centre of gravity, Europe needs more than ever to come together and maximise its competitive strength and market power.

The basic logic and European belief in union will prevail. But it is going to be a rocky and hard fought road and advocates of greater union will need to be more honest with the public, and more sure of their arguments, than they have been in the past. 

Many of the world’s oil consuming nations, led by the United States, shocked oil markets this week as the International Energy Agency agreed to release 60m barrels of oil from strategic reserves over the coming month. The move was intended to offset price pressures brought about by Libya’s supply cut and comes in response to Opec’s recent inability to formally endorse new supply increases. The IEA action is also an example of growing concern over higher oil prices in Washington, where the White House is managing political fallout from high gasoline prices as next year’s presidential elections loom just over the horizon.

Yet, a year from now, we’re likely to look back on this moment and find that fears for supply have diminished. 

On Wednesday the US president announced that he would order a gradual troop withdrawal from Afghanistan. On a superficial level there is nothing surprising about this decision. Barack Obama is simply implementing what he had promised the American people in 2009 when he agreed to honour General Stanley McChrystal’s request for more troops in Afghanistan.

A second glance at the president’s speech reveals something more interesting than the high cost of the war. In between the lines, what Mr Obama said amounts to an elimination of a key component in the Afghanistan and Iraq wars, namely the counter-insurgency programme, and the elevation of a minor practice, namely drone attacks. 

A default by the Greek government is inevitable. With a debt to gross domestic product ratio of more than 150 per cent, large annual deficits and interest rates more than 25 per cent, the only question is when the default will occur. The current negotiations are really about postponing the inevitable default.

But Greece is not alone in its insolvency and a default by Athens could trigger defaults by Portugal, Ireland and possibly Spain. The resulting losses would destroy large amounts of the capital of banks and other creditors in Germany, France and other countries. There would be a drying up of credit available to businesses throughout Europe and there could be a collapse of major European banks. 

In the past two months the world economy appears to have lost considerable momentum, reawakening similar fears to the early summer of 2010. Is the much feared yet anticipated “double dip” on its way?

Apart from the return of past culprits, two new factors have emerged this year. First, some of the “growth economies” are slowing because their policymakers are deliberately trying to slow growth from above trend. This is especially true for China. Second, and the really intriguing one, the supply chain consequences of the Japanese earthquake and tsunami. In this regard, what happens to the fortunes of the Japanese chipmaker Renesas Electronics might be one of the more important things to watch in coming weeks. 

At the roots of the eurozone crisis lies of course the past
 indiscipline of specific member states. But 
such indiscipline could simply not have occurred without two
 widespread failings by governments as they sit at the table of the 
European Council: an unhealthy politeness towards each other, and
 excessive deference to large member states.

This week will tell us whether this lesson – which is even more
 important for the future of the eurozone and the European Union than a “solution”
 to the Greek crisis – has been learnt. The events to watch are the
 Ecofin Council on Monday and the European Council meeting of EU leaders on Thursday
 and Friday. 

From day one, immense challenges faced the coalition of international institutions that opted for a liquidity approach to address Greece’s debt solvency problems. Now that this coalition is stumbling and bickering publicly, the outlook for Greece has taken a significant turn for the worse.

Responding properly to all this is an engineering nightmare and a political headache. Critically, it now requires giving up on at least one, and more likely at least two, of the three principles that have underpinned the coalition’s approach to Greece: avoiding a debt restructuring, a currency devaluation, and a change in the fiscal set up of the Eurozone.  

Greek Prime Minister George Papandreou is out of ammunition. The embattled leader has been gradually losing control of his socialist party for some time, but the trend has sharply accelerated this week, as larger and angrier crowds take to the streets. He now plans to form a new government, but hopes that he can win passage in coming weeks for a new fiscal plan — needed to ensure the next European Union / International Monetary Fund loan tranche, and any future bailout package — are all but dashed. European leaders need to think about what to do next, and quickly. 

Finally, America is on the verge of a major step towards reducing its dangerous and long-term fiscal deficits. This was seen as impossible six months ago. But, a combination of growing public antipathy to deficits, and, in particular, fierce opposition to raising the federal debt limit this summer has changed the environment and put Congress into a bind. It must raise the debt ceiling to enable continued national borrowing and avoid a catastrophic default. So, for political protection, its members now want to deliver a simultaneous, large deficit reduction package. Negotiations focus on $1,000bn-$2,000bn of reduction over 10 years, against an August 2 deadline on the debt limit. It may occur at the midnight hour, but an agreement is likely.

But this impending agreement should include two additional features which, until recently, would have been unnecessary. The first concerns the year in which deficit reduction kicks in. Remember that it is, in theory, contractionary. This suggests that the start date should be deferred. Instead of immediate reductions, an effective date of 2013 makes more sense, in the expectation of a stronger economy. Second, the three one-year stimulus measures passed in last winter’s special Congressional session should be extended one more year. 

Lawrence Summers, former US treasury secretary, and Martin Wolf, the FT’s chief economics commentator, kick off a new series of video discussions on global finance, economics and politics. This week: how the US can avert a lost decade.


 

Just a few weeks ago, Barack Obama’s re-election bid was beginning to look like an easy downhill jog. The daring raid that the President ordered delivered Osama bin Laden to the bottom of the Indian Ocean. Economic prospects looked brighter. Perhaps most helpfully, the Republican Party seemed to be indulging some kind of collective death-wish, putting Donald Trump first in the polls and Representative Paul Ryan’s budget cutting at the top of its legislative agenda.

Mr Obama’s spring peak came at the White House Correspondent’s Dinner in late April, when he jovially deflated Mr Trump, while the Navy Seals were en route to Abbottabad. But since then, the political weather has turned less favourable. Unemployment rose to a treacherous 9.1 per cent, while the Dow fell nearly 1000 points from its peak. Most alarmingly, the Republican Party appears gradually to be going sane. 

China’s announcement today that inflation in May hit a three-year high of 5.5 per cent and industrial expansion exceeded expectations will buttress those who see an inevitable economic crash coming. But even those who remain confident that a soft landing is possible seem to agree that China’s economic growth is unbalanced, with these imbalances widely blamed for trade surpluses with the west. This view, however, is much exaggerated.

The conventional view leads many to propose a standard solution to “rebalancing”: China must increase consumption and dampen investment. This problem is this view is static. Growth, however, is inherently unbalanced. What matters are not indicators pointing to imbalances, but the direction of change.  

The muddle-through approach to the eurozone crisis has failed to resolve the fundamental problems of economic and competitiveness divergence within the union. If this continues the euro will move towards disorderly debt workouts, and eventually a break-up of the monetary union itself, as some of the weaker members crash out.

The Economic and Monetary Union never fully satisfied the conditions for an optimal currency area. Instead its leaders hoped that their lack of monetary, fiscal and exchange rate policies would in turn see an acceleration of structural reforms. These, it was hoped, would see productivity and growth rates converge. The reality turned out to be different.  

Even with the 2008-2009 policy effort that successfully prevented financial collapse, the US is now halfway to a lost economic decade. In the past five years, our economy’s growth rate averaged less than one per cent a year, similar to Japan when its bubble burst. At the same time, the fraction of the population working has fallen from 63.1 per cent to 58.4 per cent, reducing the number of those in jobs by more than 10m. Reports suggest growth is slowing.

Beyond the lack of jobs and incomes, an economy producing below its potential for a prolonged interval sacrifices its future. To an extent once unimaginable, new college graduates are moving back in with their parents. Strapped school districts across the country are cutting out advanced courses in maths and science. Reduced income and tax collections are the most critical cause of unacceptable budget deficits now and in the future. 

The A-list … an exciting new comment section featuring agenda-setting commentary on global finance, economics and politics.

Starting on Monday June 13, the FT A-List will publish exclusive and original daily comment from its network of globally renowned leaders, policymakers and commentators. Topics will range from economics and finance to world politics and diplomacy, with the headline commentary accompanied by at least one response from a related expert.