Daily Archives: September 29, 2011

Financial markets are driving the world towards another Great Depression with incalculable political consequences. The authorities, particularly in Europe, have lost control of the situation. They need to regain control and they need to do so now.

Three bold steps are needed. First, the governments of the eurozone must agree in principle on a new treaty creating a common treasury for the eurozone. In the meantime, the major banks must be put under European Central Bank direction in return for a temporary guarantee and permanent recapitalisation. The ECB would direct the banks to maintain their credit lines and outstanding loans, while closely monitoring risks taken for their own accounts. Third, the ECB would enable countries such as Italy and Spain to temporarily refinance their debt at a very low cost. These steps would calm the markets and give Europe time to develop a growth strategy, without which the debt problem cannot be solved.

This is how it would work. Since a eurozone treaty establishing a common treasury would take a long time to conclude, in the interim the member states have to appeal to the ECB to fill the vacuum. The European Financial Stabilisation Fund is still being formed but in its present form the new common treasury is only a source of funds and how the funds are spent is left to the member states. It would require a newly created intergovernmental agency to enable the EFSF to cooperate with Europe’s central bank. This would have to be authorised by Germany’s Bundestag and perhaps by the legislatures of other states as well.

The immediate task is to erect  the necessary safeguards against contagion from a possible Greek default. There are two vulnerable groups – the banks and the government bonds of countries such as Italy and Spain – that need to be protected. These two tasks could be accomplished as follows.

The EFSF would be used primarily to guarantee and recapitalise banks. The systemically important banks would have to sign an undertaking with the EFSF that they would abide by the instructions of the ECB as long as the guarantees were in force. Banks that refused to sign would not be guaranteed. Europe’s central bank would then instruct the banks to maintain their credit lines and loan portfolios while closely monitoring the risks they run for their own account. These arrangements would stop the concentrated deleveraging that is one of the main causes of the crisis. Completing the recapitalisation would remove the incentive to deleverage. The blanket guarantee could then be withdrawn.

To relieve the pressure on the government bonds of countries such as Italy, the ECB would lower its discount rate. It would then encourage the countries concerned to finance themselves entirely by issuing treasury bills and encourage the banks to buy the bills. The banks could rediscount the bills with the ECB but they would not do so as long as they earned more on the bills than on the cash. This would allow Italy and the other countries to refinance themselves for about 1 per cent a year during this emergency period. Yet the countries concerned would be subject to strict discipline because if they went beyond agreed limits the facility would be withdrawn. Neither the ECB nor the EFSF would buy any more bonds in the market, allowing the market to set risk premiums. If and when the premiums returned to more normal levels the countries concerned would start issuing longer-duration debt.

These measures would allow Greece to default without causing a global meltdown. That does not mean that Greece would be forced into default. If Greece met its targets, the EFSF could underwrite a “voluntary” restructuring at, say 50 cents on the euro. The EFSF would have enough money left to guarantee and recapitalise the European banks and it would be left to the International Monetary Fund to recapitalise the Greek banks. How Greece fared under those circumstances would be up to the Greeks.

I believe these steps would bring the acute phase of the euro crisis to an end by staunching its two main sources and reassuring the markets that a longer-term solution was in sight. The longer-term solution would be more complicated because the regime imposed by the ECB would leave no room for fiscal stimulus and the debt problem could not be resolved without growth. How to create viable fiscal rules for the euro would be left to the treaty negotiations.

There are many other proposals under discussion behind closed doors. Most of these proposals seek to leverage the EFSF by turning it into a bank or an insurance company or by using a special purpose vehicle. While practically any proposal is liable to bring temporary relief, disappointment could push financial markets over the brink. Markets are likely to see through inadequate proposals, especially if they violate Article 123 of the Lisbon treaty, which is scrupulously respected by my proposal. That said, some form of leverage could be useful in recapitalising the banks.

The course of action outlined here does not require leveraging or increasing the size of the EFSF but it is more radical because it puts the banks under European control. That is liable to arouse the opposition of both the banks and the national authorities. Only public pressure can make it happen.

The writer is chairman of Soros Fund Management and founder of the Open Society Foundations

Response by Gavyn Davies

A radical plan that would take Europe all the way to economic union

George Soros has certainly recognised the seriousness of the eurozone crisis , and has suggested  a really radical plan of action. But it faces enormous obstacles.

Under these proposals the eurozone would become a genuine nation state, at least from an economic viewpoint. Fiscal policy would eventually be set by the zone as a whole. The banks would be forcibly recapitalised, using common funds from the EFSF. These banks would then be required to make loans as directed by the ECB, which would take on the role of a super regulator of the entire eurozone banking system. Finally, the ECB would provide liquidity to the banks, enabling them to fund Italian and Spanish budget  deficits by buying those countries’ treasury bills.

It also seems that the commercial banks would be heavily “encouraged” to finance budget deficits in the weakest economies.The eurozone would therefore have a common fiscal policy; part or wholly-nationalised banks; a single financial regulator; and a central bank which would indirectly monetise the budget deficits of several member states.

If Europe were a genuine nation state already it might have already implemented parts of this plan, somewhat like the US actually did in the dark hours of 2008. But the Soros proposal would require Germany and France to accept the principle of making some very large fiscal and monetary transfers to the periphery. They would also need to accept the monetisation of budget deficits, and (to say the very least) a dirigiste approach to commercial bank ownership and regulation.

If they were ready to do any of this, the crisis would already have been solved. And even in the eurozone, surely none of this could be done without reference to the electorate. After all, it would take the zone’s economic policy all the way to that of a full political union.

The writer is a macroeconomist, co-founder of Prisma Capital Partners and former head of the global economics team at Goldman Sachs


Martin Wolf talks to Lawrence Summers about the European crisis

The European Commission has not distinguished itself during the eurozone crisis. Such leadership as we have seen has come from national governments, or indeed from Washington, where both Christine Lagarde, International Monetary Fund president, and Tim Geithner, US Treasury secretary, have shown initiative and urgency,  rather than from Brussels. Now, in what looks to be a make-or-break week for the whole euro project, commissioner Michel Barnier’s contribution has been to propose extending the French system of joint audits across the continent. Fiddling while the Treaty of Rome burns doesn’t quite capture it.

José Manuel Barroso, European Commission president, now seems to have an answer to the “what did you do in the war, daddy” question. He has proposed, for the umpteenth time, a financial transactions tax.  The tax would raise, he assumes, about €50bn, half of which would go back to member states, and half would end up in his own pocket at the commission.

How good an idea is this? And if it is a good idea, is this the right time to advance it? To take the timing point first, it is clear that Mr Barroso needed to have something to say to the European parliament in his “state of the union” address. Leaving aside the folie de grandeur aspect of this packaging, the timing has otherwise little to commend it.

The tax cannot be a realistic part of the new settlement needed to save the single currency; indeed it plays into the hands of those who argue that European policymakers simply do not understand the pace of events. And since Mr Geithner has made it clear that the US wants no part of such a tax, there is a risk of further damage to transatlantic relations, already poor, at a time when a coherent global response to the economic slowdown is of paramount importance.

So the time is not ripe, but what of the principle? There is a Colbertian appeal to Tobin taxes. Why not take a tiny sliver off every financial trade? The golden goose will  hardly notice and its hisses will be drowned out by the boos of the crowd baying for bankers’ blood. It seems likely to throw sand in the wheels of some potentially dangerous financial activity, notably high frequency trading, surely one of the dullest ways of making a living that mankind has so far devised.

Yet  you cannot take €50bn out of the economy without a significant economic impact. James Tobin distanced himself from those who wanted to adopt his tax as a disguised revenue raiser. Mr Barroso clearly sees it as an added tax, not a redistribution of the burden. And he has not offered a solution to the avoidance obstacle. If there is no parallel imposition in New York, the cost to Europe of displaced activity could be large.

If these problems could be overcome, a financial transactions tax might be a useful addition to the Treasury’s armoury. After all, stamp duty has not destroyed the London equity market. But Barroso’s presentation of the idea in this way, at this time, will do nothing to advance the cause.

The writer is a former chairman of the Financial Services Authority, former deputy governor of the Bank of England and former director of the London School of Economics. He is now a professor of practice at Sciences Po in Paris.


Response by Tim Leunig

A very low level Tobin tax is a proposal worth considering

A Tobin Tax (opposed, of course, by Tobin) is back on the agenda. For many, support for or against is an article of faith. Yet as others have noted, stamp duty is the equivalent of a Tobin Tax on share trading in Britain. It offends economic theory, the market doesn’t like it, but London survives perfectly well.

The reality is that London’s other advantages outweigh the disadvantage of stamp duty. The question is whether this holds for European forex trading as well as it holds for share trading in London. The answer is basically yes. Time zones matter and Europe’s forex trading is unlikely to move en bloc either east or west and there is no strong financial centre to the south.

A small Tobin tax is therefore feasible. Note the word “small”. Every tax has a Laffer curve. If you tax the poor too heavily, they choose to live on benefits. If you tax forex transactions too heavily, some trade and traders will move away. That matters: traders earn a lot of money, and pay a lot of income tax.

Over a quarter of UK income tax receipts come from the highest earning 1 per cent. Scaring the golden goose away does not make sense. Once they have gone, it is hard to get them back. For that reason any Tobin tax should begin at a very low level, say one tenth of the level suggested by Barroso. That is a proposal that would be worth considering

Whether the money should go to the UK government, the European government or to development is a separate matter. One imagines that Osborne’s objections might be more limited were the money to arrive in his coffers, allowing him to cut other taxes that we know harm the economy.

The writer is chief economist at CentreForum, the liberal think tank

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