Monthly Archives: June 2012

Once again, after a painful learning process and motivated by the best of intentions, European leaders gather in crisis management mode. Important decisions are taken but, again, they appear to fall short of the dramatic breakthrough required to get ahead of a crisis that eats away at the integrity of the region’s historic integration project.

To be clear, there are encouraging signs. First, leaders have recognised the need to identify longer-term reforms that, in addition to addressing the eurozone’s initial design flaws, provide a solid basis for effective short-term stabilisation measures. Second, they wish to improve the functioning of regional firewalls (such as the European Stability Mechanism). Third, this will be used as the context to enable individual countries to strike a better domestic policy balance – including by acting both on the numerator of medium-term sustainability (debt levels and debt service payments) and, critically, on the denominator (actual and potential economic growth).

Progress is not limited to the sequencing and coverage of policy steps. The substance is also more constructive.

Leaders now understand that, especially in the aftermath of the global financial crisis, the eurozone cannot survive on the basis of monetary union alone. It also urgently needs greater fiscal, banking and political integration. They are taking steps to break the disruptive “feedback loop” between weak banks and deteriorating sovereign creditworthiness. And they recognise that, to succeed, all this should be supported by growth-enhancing policies.

This good news exceeds the low consensus expectations in the run-up to the summit. So, initial market reaction will be favourable, especially given end-of-quarter positioning. But, without a dramatic breakthrough, it won’t be long before people worry that, once again, European leaders are not keeping pace with the crisis, let alone get ahead of it.

Signals out of the Brussels summit suggest that the implementation timetable remains too leisurely, especially in light of the increasingly complicated and disruptive conditions on the ground. The concept of a “roadmap” for fiscal union and a single European bank supervisor by the end of 2012 lacks sufficient details and precommitment. Firewalls are too small, do not have robust funding lines and are operationally complex. Countries still disagree about the right balance between financing and reform.

Not surprisingly, some officials are already adopting different narratives. Witness the comments from Finland, Germany and Italy. Also interestingly, creditors and debtors each seem confident that they can continue to play a game of chicken with the other side.

This is but one illustration of the political complications that accentuate economic and financial shortfalls. Having previously failed to inform citizens fully of the gravity of the situation, leaders find it hard to command the domestic political consensus needed for a sustainable regional solution. National agendas do not easily translate back and forth into regional ones; and the lack of credible mutual assurances complicate matters further.

So, once again, a European summit could well disappoint. Should this happen, the consequence is much more than a lost opportunity.

Every delay in getting ahead of the crisis translates into a longer “to-do list” and a more expensive bill. Without further progress, borrowing costs for vulnerable countries will remain too high. Companies’ investment and hiring plans will be delayed, accentuating the economic slowdown. And private capital will remain nervous – thus adding to funding uncertainties and making it more difficult to channel working capital to small and medium-sized enterprises.

With such prospects, the European Central Bank, an institution with much greater policy agility, will again find itself conflicted at its policy meeting next week. If it buys peripheral bonds (directly or through a new longer-term refinancing operation), it will just provide temporary breathing room that again risks evaporating. If it remains on the sidelines, it risks adding to the turmoil.

Without additional measures, it seems inevitable it will only be a matter of time until European leaders gather again for a crisis management meeting; and they will find the challenges even more onerous.

On Thursday a majority of the US Supreme Court upheld the constitutionality of the Affordable Care Act, otherwise known as Obamacare in recognition of its importance as a key initiative of the Obama administration. The big surprise, for many, was the vote by the chief justice of the court, John Roberts, to join with its four liberals.

The decision by Chief Justice Roberts is not without precedent. Seventy-five years ago, another Justice Roberts – no relation to the current chief justice – made a similar switch. Justice Owen Roberts had voted with the Supreme Court’s conservative majority in a host of 5-4 decisions invalidating New Deal legislation, but in March 1937 he suddenly switched sides and began joining with the court’s four liberals.  In popular lore, Roberts’ switch saved the court – not only from Franklin D. Roosevelt’s threat to pack it with justices more amenable to the New Deal but, more importantly, from the public’s increasing view of the court as a partisan, political branch of government.

The move by the current Justice Roberts on Thursday marks a close parallel. By joining with the court’s four liberals who have been in the minority in many important cases – including the 2010 decision, Citizen’s United v. Federal Election Commission, which struck down constraints on corporate political spending as being in violation of the constitution’s first amendment guaranteeing freedom of speech – the chief justice may have, like his earlier namesake, saved the court from a growing reputation for political partisanship.

As Alexander Hamilton pointed out when the constitution was being written, the Supreme Court is the “least dangerous branch” of government because it has neither the purse (it can’t enforce its rulings by threatening to withhold public money) nor the sword (it has no police or military to back up its decisions). It has only the trust and confidence of average citizens. If it is viewed as politically partisan, that trust is in jeopardy. As chief justice, Mr Roberts has a particular responsibility to maintain and enhance that trust.

Nothing else explains Chief Justice Roberts’ switch – certainly not the convoluted constitutional logic he used to arrive at his decision. On the most critical issue in the case – whether the so-called “individual mandate” requiring almost all Americans to purchase health insurance was a constitutionally-permissible extension of federal power under the commerce clause of the constitution – the chief justice agreed with his conservative brethren that it was not.

Chief Justice Roberts nonetheless upheld the law because, he reasoned, the penalty to be collected by the government for non-compliance with the law is the equivalent of a tax – and the federal government has the power to tax. By this bizarre logic, the federal government can pass all sorts of unconstitutional laws – requiring people to sell themselves into slavery, for example – as long as the penalty for failing to do so is considered to be a tax.

Regardless of the fragility of Chief Justice Roberts’ logic, the court’s majority have given a huge victory to the Obama administration and, arguably, the American people. The Affordable Care Act is still flawed – it does not do nearly enough to control increases in healthcare costs that already constitute 18 per cent of America’s gross domestic product, and will soar even further as the baby boomers age – but it is a milestone. And like many other pieces of important legislation before it – social security, Medicare, civil rights and voting rights – it will be improved upon. Every Democratic president since Franklin D. Roosevelt has sought universal healthcare, to no avail.

But over the next four months the act will be a political football. Mitt Romney, the Republican presidential candidate, has vowed to repeal the law as soon as he is elected (an odd promise in that no president can change or repeal a law without a majority of the House of Representatives and sixty senators). He reiterated that vow this morning, after the Supreme Court announced its decision. His campaign, and so-called independent groups that have been collecting tens of millions of dollars from Romney supporters (and Obama haters), have already launched advertising campaigns condemning the act.

Unfortunately for President Obama – and for Chief Justice Roberts, to the extent his aim in joining with the four liberal justices was to reduce the public appearance of the Supreme Court’s political partisanship – the four conservatives on the court, all appointed by Republican presidents, were fiercely united in their view that the entire act is unconstitutional. Their view will surely become part of the Romney campaign.

The author is the chancellor’s professor of public policy at the University of California at Berkeley, and former US secretary of labour under President Bill Clinton

On Monday I had the opportunity to attend the ceremonial swearing-in of two new members of the Federal Reserve Board, economist Jeremy C. Stein and banker Jerome Powell.

In his remarks, Fed Chairman Ben Bernanke noted that this is the first time during his chairmanship that the seven member board has been at full strength. This may have important implications for the future course of monetary policy.

As FT readers will no doubt know, the key policymaking arm of the Federal Reserve is the Federal Open Market Committee, a 12-member group that consists of the 7 board members plus five of the 12 regional Federal Reserve bank presidents.

The regional banks are based in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Their geographical location remains based on the distribution of population and economic power in 1913, when the Federal Reserve System was established, rather than that of today.

The president of the Federal Reserve Bank of New York is a permanent member of the FOMC. The remaining 11 bank presidents rotate annually. At present, the presidents from Richmond, Atlanta, Cleveland, and San Francisco are voting members of the FOMC. However, at FOMC meetings all of the regional bank presidents participate and share their views.

Unlike members of the Federal Reserve Board, who are nominated by the president and confirmed by the US Senate, regional bank presidents are appointed by private boards of directors for each bank. These board members tend to be important local bankers and business people in the community in which the bank is located.

Consequently, regional bank presidents tend to be somewhat provincial and more concerned with representing the views of their well-to-do board members than the general public. Therefore, they tend to be much more concerned with keeping inflation down than bringing down unemployment, even though the Fed is required by law to take both into account when setting policy.

Obviously, the chairman of the Fed exercises his greatest influence over his fellow board members because he sees and confers with them on a daily basis. And since he knows who appointed each member, he has a good idea of where they are coming from, politically, and how best to cajole them into doing what he would like. By contrast, the chairman has no real authority over the regional banks and sees their presidents only every six weeks at FOMC meetings.

It is extremely important for the chairman to have absolute confidence of the support of the seven board members going into FOMC meetings if he wishes to move policy in a new direction. It is almost a certainty that he will get resistance from the regional bank presidents regardless of what he proposes. But if they are convinced that the board members stand in unison, the bank presidents are less likely to make waves since they know the chairman has the votes to win.

It is my belief that the Federal Reserve Board vacancies of the last 6 years are a key reason why the FOMC has been so reluctant to act in the face of declining inflation, sluggish growth, and high unemployment. Now that the board is finally at full strength, the stage may be set for the long-awaited move by the FOMC toward aggressive monetary easing, perhaps through unconventional channels.

Related link:
What Do We Know About The New Fed Board Members’ Views on Monetary Policy? – Matthew Yglesias

François Hollande has had the kind of month most politicians enjoy once in a lifetime. After an unexpectedly large victory in the Presidential election, his troops followed up with a remarkable triumph in the legislatives, delivering him an absolute majority in the Chambre des Deputes, without the need to compromise with the Left Front or the Communists. The Socialists now control the Chambre, the Senate, and almost all the regions. It is “La Vie en Rose” across the political landscape, for the first time under the Fifth Republic.

Even the well-publicised spat between his current and former partners has not seriously damaged his triumph. After all, Mr Hollande claimed in the campaign that he would be a “normal” President, and it is normal for there to be a hint of domestic trouble at the Elysee Palace.

In Europe, things are not quite so well-ordered. The all-important Franco-German relationship has stuttered, and there seems to be little positive chemistry between him and Angela Merkel. But Mr Hollande nonetheless seems to be on the right side of the argument about what needs to be done to save the euro and stave off recession. He will surely get some response to his call for a growth agenda.

That may well, however, be as good as it gets, and he should bask in his success while it lasts. Because dark clouds are gathering, and the honeymoon is likely to be very short-lived.

The first major domestic problem will be the deficit. The Cour des Comptes, which audits the government’s books, is reviewing the state of the public finances and is expected to deliver its post-election verdict on 2 July. There are strong rumours that it will identify a ten billion euro gap in 2012-13, and an even bigger one the following year, if France is to meet its deficit reduction commitments.

By British or American standards that may seem small beer. In Washington, $10bn can get lost in a pork barrel. But in France cutting public spending is exceedingly difficult, and tax revenues are not buoyant. Furthermore, Mr Hollande was elected on a programme which involves recruiting an additional 60,000 teachers, and reducing the retirement age to 60 for some public servants.

The cost of that latter commitment is not high, but it is a symbol of the French left’s resistance to spending cuts and labour market reform. As French commentators put it, their Socialist party has never embraced “Schroederisation”. (Blairism is “vieux jeu”, if indeed it ever played at all in France). Hollande’s supporters, and indeed the French nation as a whole, are mentally unprepared for the kind of belt-tightening that will soon be needed. So far he has announced an increased tax on dividend payments, but additional business taxes, while popular with his own supporters, are risky. There will be red carpets all over Europe, not just in London, if French corporate taxation gets seriously out of line.

Nor is there widespread public understanding of France’s unfavourable economic trends –- though the Ministry of Finance is well aware of them. The share of manufacturing output in French GDP is in fact slightly below the UK’s, but almost no French politician can believe that, fed as they have been on a diet of French national champions, with Britain portrayed as an offshore financial centre — a kind of Greater Guernsey .

The comparison that matters more, given the constraints of eurozone membership, is with Germany. A decade ago, French GDP per head was 94.5 per cent of Germany’s; in 2011 it was 89.7 per cent. In the same period, and in spite of the effects of the crisis, Spanish GDP per capita continued to catch up. France has a problem of competitiveness, and of industrial capacity, and one which is getting worse.

Mr Hollande, and his new government, will need to spell out these realities, and set a new course. That will not be easy, as the ground has been ill-prepared. With a powerful mandate, and a solid parliamentary majority, he can afford to make some tough decisions. We will find out very soon whether he has the will to do so.

Related links:
France’s bling bling era is nearing its end – Howard Davies
What to expect from François Hollande – Philippe Aghion

To stop the doom spiral that threatens the eurozone, European leaders must now repair the serious flaws in the design of monetary union that have been revealed by the crisis. At the very least, at this week’s summit of European leaders, they should recognise them, name them, agree on directions for reform, and set a timetable for decisions.

Banking union — the move to a common regime for supervision, deposit insurance and resolution — has emerged as a key component of such a repair strategy. The idea makes sense because it addresses the feedback loop between sovereign weakness and banking weakness. The concept has been endorsed by several eurozone governments (including France who used to be lukewarm about it), by the European Central Bank and the European Commission, by the UK (provided it is not asked to take part) and by the International Monetary Fund. Germany has reservations, but they do not seem to be absolute.

There is however distance from concept to realisation. A banking union entails many choices.

First, who should participate? The EC wants a banking union for the whole of the EU but it is not going to happen. The case for it may exist, but it is overwhelming only for the participants in the euro. Transitional arrangements should be found for countries that intend to join the common currency, such as Poland.

Second, which banks should it cover? It would be simpler to limit it to systemic banks with cross-border activities. But the Cajas at the core of the Spanish crisis are small and domestic. For the banking union to alleviate the fiscal risk, it must be broad in coverage, possibly universal.

Third, who should supervise? Different countries have relied on different models, but there is a strong case for centring supervision at the ECB, which has both legitimacy and effectiveness.

Fourth, what resolution authority should be granted? Bank resolution involves allocating losses between stakeholders. These are intrinsically political choices that cannot be assigned to a central bank. It would be best to create a resolution authority under the umbrella of the European Stability Mechanism.

Fifth, what sort of deposit insurance? A benefit of banking union would be the pooling of insurance. Again, however, there are various ways of doing it, from complete federalisation like in the US to the reinsurance of national systems by a common fund.

Sixth, what sort of fiscal backstop? Banking crises are costly – sometimes horribly so. Even if losses are imposed on shareholders and creditors, they can easily exhaust insurance funds. It is important to make sure that when the accident happens, money is not only theoretically but actually available. There is therefore a need for a fiscal backstop – in other words some degree of fiscal union.

Seventh, what form of governance and accountability? A banking union is an off-balance sheet fiscal union and as such it needs to be underpinned by a form of political union. Taxpayers cannot be asked to commit to put up potentially large amounts of money in the absence of institutions that provide legitimacy.

Moving to a common banking union is a delicate transition. As soon as the possibility arisis to mutualise future losses, states will have an incentive to conceal problems. Here, clarity should prevail: the transfer of supervisory competence to the European level should be preceded by a comprehensive, thorough and intrusive screening of banks conducted by a special task force. All legacy costs uncovered in this assessment should be taken on by current authorities, unless they are or are at risk of being fiscally unable to bear them. In this case, but in this case only, there will be a case for mutualising risks in the form of direct capital injection by the ESM.

The writer is director of Bruegel, the economic think tank. This piece is based on a joint Bruegel report with André Sapir, Nicolas Véron and Guntram Wolff.

Related links:
A real banking union can save the eurozone – Wolfgang Münchau
Germany’s reticence to agree threatens European stability – George Soros

Between the end of the primaries and the start of the conventions presidential campaigns are message wars. Both sides test slogans and proposals, while trying to frame their opponents in memorably unfavorable ways. In this phase, Barack Obama has been the clear winner.

Mr Obama has used the element of surprise, taken risks that seem to be paying off and has put his opponent on the defensive. He first seized the initiative in May, when he endorsed gay marriage, changing his longstanding position. Even some on the Right praised the president for acting on principle when the politics seemed against him.

But the politics of that issue may actually be on Mr Obama’s side. Taking a moral stance on an issue of civil rights reanimated liberal voters who had drifted into disaffection, especially young voters that were crucial to his 2008 victory. Mitt Romney, who didn’t expect the move, found himself in awkward position. With his radical Republican challengers dispatched, conservative positions on social issues were the last thing Mr Romney wanted to emphasise. At a press conference, he called his own opposition to gay marriage “my preference” and declined to criticise Mr Obama for changing his position or pandering to a Democratic special-interest group. Mr Romney’s response was essentially a tactical surrender that underscored the inevitably of liberal victory on the issue.

This same dynamic was at play last week, when Obama issued an executive order that allows illegal immigrants who were brought to the US as children to remain in the country. Mr Obama’s unanticipated move aligned sound policy with good politics, re-awakening Latino supporters who had lost heart over his failure to get a more comprehensive reform of immigration laws through Congress. The decision will play particularly well in swing states such as Florida, Colorado and New Mexico, where Hispanic turnout can be decisive.

With his immigration surprise, Mr Obama showed his ability to act without help from the recalcitrant Republican-led Congress that is likely to remain in place even if he wins a second term. He again stole a march on Mr Romney, who was in the midst of figuring out how to “evolve” from the insincere, hardline anti-immigration stance he adopted in the primaries to something friendlier. On the CBS programme “Face the Nation,” Mr Romney was asked several times whether he would overturn the president’s decision. Each time, he dodged the question and refused to say. A week later, he remains stuck on the issue – reluctant to attach himself to his party’s anti-immigration absolutists, unwilling to concede that the president is right and with no apparent position of his own.

The president has seldom been a risk taker; he has operated within the boundaries of the possible, avoiding postures that yield no results. But he and his campaign have cleverly recognised that Mr Romney’s slow-footedness and lack of imagination presents an opportunity for them to shine in contrast. They have reversed the usual dynamic of reelection campaigns, highlighting the challenger’s stodginess while making Mr Obama’s into a nimble incumbent.

These stratagems show every sign of paying off. Mr Obama’s positions convey a Reaganesque sense of optimism about social change, while associating Mr Romney’s views with fear and the past. Mr Romney, whose approach to politics has always been to rearrange his views in relation to the next election, has thus far been stymied by this rabbit-punching. He has been on the defensive, landing few blows of his own and failing to come up with any memorable proposals. His strategy seems to be to trumpet increments of bad news about the economy. That is not only a risk-averse strategy, but also a sour one. This week, Mr Romney’s campaign reportedly asked Florida’s Republican governor to stop trumpeting his state’s economic recovery, lest the credit accrue to his opponent.

Mr Romney’s likely vice-presidential choices point further in the direction of playing it too safe for his own good. Taking the wrong lesson from John McCain’s reckless choice of Sarah Palin, Mr Romney is by various accounts looking to a boring Midwestern white man such as Minnesota governor Tim Pawlenty or Ohio senator Rob Portman to be his running mate. These choices would generate minimal excitement for a campaign that badly needs some.

Pity Ben Bernanke and his colleagues on the Federal Reserve’s main policymaking committee. Once again they felt compelled to do something to be seen as countering a renewed slowing of the domestic economy that is compounded by a deepening European crisis and less buoyant emerging economies. But in continuing to act on its own, all the Fed will do is buy some time that will again be wasted by the country’s politicians. Meanwhile, collateral damage will mount, making the next policy steps even more excruciating.

It is not so long that the Fed was discussing how to exit the unconventional policy phase initiated in the midst of the 2008 global financial crisis. Instead, and having already ballooned the balance sheet to 20 per cent of US gross domestic product, it will now exchange even more of its short-term Treasury holdings (up to 3 year maturities) for longer-dated (6-30 year) bonds. This extension of “operation twist” has, as an intermediate objective, repressing market interest rates to push investors to assume more risk, trigger the wealth effect and reignite animal spirits. The ultimate objective is, of course, to promote non-inflationary growth.

While the Fed has been able to normalise market functioning and boost valuations, it has repeatedly failed to deliver on its desired economic outcomes. Unfortunately, there is little to suggest that things will be any different this time around.

Whether you are worried about insufficient demand or the economy’s sluggish supply response, it is hard to argue that what ails the US is in the domain of Fed tools. The most it can do is buy time while trying to inform and —  at the margin — influence steps that can only be taken elsewhere.

The Fed can again try to slow the inevitable deleveraging of over-indebted parts of the private sector. But, given the liquidity trap, it won’t meaningfully counter lower government spending, consumers’ debt overhang and less dynamic export markets. It cannot get congress to agree on fiscal reform, nor will it remove the housing inventory, revamp housing finance, boost infrastructure, and enhance labour retraining and retooling.

What this continued Fed activism will do is to continue altering the functioning of markets, contaminate price discovery and distort capital allocation. Already, the viability of several segments – from money markets to insurance and from pension provision to suppliers of daily market liquidity, all of whom provide financial services to companies and individuals – has been undermined. The Fed has also conditioned many market participants to believe in a policy put for both equities and bonds. And other government agencies are relieved to have the policy spotlight remain away from their damaging inactivity.

Yet, judging from Wednesday’s decision, the Fed remains undeterred. This is not due to a lack of recognition of the increasingly unattractive balance between what Chairman Bernanke called in August 2010 the “benefits, costs and risks” of unconventional policies. Instead, I suspect that Fed officials feel a moral obligation to act when others won’t; they worry that their flexibility will erode as they get closer to the November elections; and the last thing they want is to inadvertently contribute to a sluggish US economy that would accentuate the synchronized slowing now taking holding of the global economy.

The Fed also remembers last summer when political brinkmanship over the debt ceiling took the country to the edge of a technical default and contributed to the loss of a triple-A sovereign rating. Now, due to the serial postponement of key congressional decisions, the US faces the menace of an end-year fiscal cliff – a disorderly contraction of some 4 per cent of GDP through arbitrary spending cuts and across-the-board tax increases – at a time when the economy as a whole is on course to deliver at best just 2 per cent in annual growth.

Wednesday’s decision signals that America is falling further behind its first best policy responses. And while the Fed should be commended for trying to deliver a second best, net benefits will prove even more difficult to secure. In the process, look for greater distortions that will take years to resolve.

Pakistan’s President Asif Ali Zardari is unlikely to challenge the Supreme Court’s decision to dismiss his Prime Minister Yusuf Raza Gilani and deprive him of being a member of parliament for five years. However Mr Zardari’s attempt to avoid a confrontation with the courts that could result in country-wide violence and the return of the army stepping, could also open the door to his own judicial dismissal.

For four years there has been a steady and increasing rise in conflict between Chief Justice Iftikhar Chaudry and the ruling Pakistan’s Peoples party. The courts have failed to try and dismiss Mr Gilani and Mr Zardari. Mr Gilani was convicted on April 26 for protecting Mr Zardari in a corruption case, but also for refusing to accept the court’s interference and jurisdiction in the constitution. Pakistan’s parliamentary democracy and constitution gives the power of sacking a prime minister to parliament — not to the courts.

Given the economic, social, foreign policy and political crises faced by the government, Mr Zardari and the PPP have decided not to block this second attempt by the Supreme Court to sack Mr Gilani. There have been three days of widespread rioting in the Punjab province due to massive cuts in electricity just as summer temperatures are soaring, there is a severe economic crisis, a state of civil war in Balochistan province and the continued terrorist actions by the Pakistani Taliban. Meanwhile Pakistan’s relations with the US and its Nato allies are not improving.

What happens next? In these dire circumstances a confrontation between the courts and the government over whether Mr Gilani should resign or not, in which ultimately the courts call upon the army to intervene on their behalf could easily lead to the country’s fifth martial law. Mr Zardari may be trying to avoid that by calling upon his party to show calm and quickly nominating a new prime minister from the PPP, who will easily get sworn in by Parliament because the PPP and its political allies hold the majority.

However that is unlikely to satisfy the opposition parties — led by politicians such as Imran Khan and Nawaz Sharif — who are demanding early general elections (these are due in spring 2013 but could be bought forward to the end of 2012). The opposition has broad support for its demand because of the multiple failures of the government. It may be Mr Zardari’s best bet to agree to early elections and take his party to the hustings as a martyr in the cause of the democracy. It would keep the army in its barracks and sustain the democratic process despite its heavily tainted appearance right now.

If the PPP wishes to fulfil its full term until 2013 there are likely to be more bruising conflicts between the courts and Mr Zardari. One issue that is hanging over Pakistani heads is the so called Memogate affair in which a judicial commission formed by the Supreme Court found former Ambassador to the US Hussain Haqqani guilty of treason. Mr Haqqani, who now lives in the US, vehemently denies the allegations. That judgement is now in the hands of the Supreme Court, which is likely to send it for a full trial in the weeks ahead. If that happens the case will also try and implicate Mr Zardari and other government figures for treason. Avoiding such an outcome would be best for everyone and early elections is the only possible way that Pakistan could get back on the rails.

Related links:
Pakistan coverage – FT
Waking up to war in Balochistan – Ahmed Rashid (BBC News)

Leaders of 19 countries plus the European Union are still gathered at the Mexican resort of Los Cabos with a long list of things to do. Do not expect there to be much consensus in the conclusion — for the following five reasons.

First, it is difficult enough to forge agreement on complicated questions among five negotiators, as meetings of the UN Security Council have demonstrated for decades, but 20 is just too many. The 2008 financial crisis and the global slowdown which followed made plain that institutions dominated by the advanced industrialised democracies no longer reflect the world’s true balance of political and economic power. Attempts to bolster the global economy without support from China, India, Brazil, Russia, Gulf states and others had become impossible. Hence the Group of 20. Yet, it has since become apparent that only when each member feels threatened by the same challenge at the same moment and to more or less the same degree could an organization as unwieldy as this one produce anything more substantive than broad declarations of principle.

Second, the issue is not simply the number of negotiators. It is the wide range of political values and interests represented around the G20 table. It is not the “rise of the rest” that has shifted the terms of debate but the “rise of the different”. In the 1950s and 60s, the world saw the emergence (really the re-emergence) of West Germany and Japan. Though Japan’s surge created genuine anxiety in the US during the 1980s, fears were limited by the recognition that the Japanese, like the Germans and all other G7 members, were believers in free market democracy. There is no such consensus among today’s rising powers. As importantly, G20 members stand at quite different levels of development. Even where they have common political and economic values, poor countries have quite different hopes, fears, needs and plans from rich ones.

A lack of consensus can sometimes be overcome if a commonly recognized leader can set and drive an agenda. Leaders have the muscle, money and influence to persuade other governments to take actions they would not otherwise take. They pay the bills that others cannot afford and provide services no one else will pay for. The third reason why we cannot expect substantive results from the G20 is that, at least for the time being, the US will not provide the consistent leadership it has in the past, because American voters are telling pollsters that they want their elected leaders focused on American, not foreign, problems.

In fact, there is now greater public demand for a sharply reduced US role in the world than at any time since the end of World War II. The United States is the world’s only military and economic superpower and will remain so for years to come, but a 2011 survey of “long-range foreign policy priorities” conducted by the Pew Research Center found that the only priorities winning majority support from US respondents were protection of American jobs, protection of the homeland from terrorist attacks, and reduction of US dependence on imported energy. The percentage of those who favored “reducing the US military commitment overseas” surged from 26 per cent in September 2001 to 46 per cent in May 2011. “Promoting democracy abroad” won support from just 13 percent of respondents, and nearly half said the US “should mind its own business internationally”. With less US leadership, the challenges facing G20 leaders will only be more formidable.

The fourth reason that the G20 will accomplish little in years to come is that America’s most capable and reliable allies will not pick up where America leaves off. Europeans will be preoccupied for years with the bid to restructure European economic and financial governance to restore confidence in the eurozone and in the longer-term credibility of the broader European idea. Japan still has the world’s third largest economy, but it has also had 17 prime ministers in 23 years, complicated domestic reform questions to resolve, and last year’s triple disaster from which it is still recovering.

Finally, rising powers like China, India, Brazil, Russia, Turkey and the Gulf states face far too many complex development problems at home to accept unnecessary responsibilities abroad. In addition, the new players have comparatively little experience in managing the risks that arise from deeper involvement in global politics. Advanced industrial democracies have produced governing institutions, militaries, bureaucracies, companies, investors, lenders, NGOs and leaders with broad experience of international relations. Not so the emerging markets.

If America, Japan, and China will not make a major financial contribution to help refloat the eurozone, why will the European decision-makers that matter—in Berlin, Brussels, the European Central Bank, Madrid, and Athens—care what non-European leaders think they should do? How will developed and developing states agree on how to divvy up the risks and sacrifices that come with substantial reductions of carbon emissions? How can they agree on what do about Syria?

Don’t expect substantive answers to any of these pressing questions from this summit—or from G20 gatherings to come.

So, huge sighs of relief all round. Greece’s New Democracy party, led by Antonis Samaras, managed in Sunday’s elections to head off growing support for the radical left wing Syriza alliance. Mr Samaras looks set to become Greece’s next Prime Minister.

The Athens ATMs won’t run dry, there will be no sudden reintroduction of drachmas and Greece will happily be able to persuade itself that it remains firmly held in the bosom of Europe. The euro lives to fight another day.

Mr Samaras will now attempt to form a ragtag government including more or less everyone except Syriza. At the very least, that means a coalition involving both teh centre-right New Democracy and the socialist Pasok party, hardly the cosiest of bedfellows. They have, after all, been at each other’s throats for the past few decades.

Still, both New Democracy and Pasok claim to be both pro-euro and pro-austerity, so Greece’s European partners and the wider world should be able to breathe a sigh of relief.

In the midst of the euphoria that will doubtless dominate financial markets in the days ahead, a few choice facts will be conveniently pushed to one side. New Democracy was, arguably, the party that got Greece into its current mess in the first place, having been in office between 2004 and 2009. Pasok was the party in charge of putting things right between 2009 and 2011. During that period, the Greek economy collapsed, too many austerity promises were broken and the Germans and French eventually ran out of patience, warning Greece that, if it didn’t behave, its days in the euro were numbered. And Greece has no real history of cosy coalition politics: it may just be possible to form a government after Sunday’s election but how long it will last is another matter altogether.

Mr Samaras, meanwhile, will doubtless be hoping to renegotiate Greece’s austerity obligations once again. In that regard, the mainstream Greek parties are not so different from Syriza, much to the irritation of Greece’s European partners. The Troika’s ongoing frustration with Greece, after all, has been the yawning credibility gap between promise and delivery with regard to both austerity and long-run structural reform.

So before we all drink too much celebratory retsina, it’s important to recognise that Greece still has mountains to climb. True, there have been big improvements in the fiscal position over the last year or so but Greek access to international capital markets is non-existent, the economy has already contracted 16 per cent and is set to shrink further, and its creditors expect to see a lot more reform than has so far been delivered.

The eurozone, meanwhile, has its own Mount Olympus to conquer. While the Greek elections have reduced the chances of an early Greek exit, they have only papered over the cracks that have emerged over the last two or three years. The battle between northern European creditors – who, until recently, lent far too generously – and southern European debtors, who invested the loans far too stupidly, is set to continue. Thanks, initially, to the sub-prime crisis, levels of economic activity across Europe are much lower than was anticipated just five years ago, making it that much more difficult for debtors to repay their creditors. Whatever one thinks of Greece’s behaviour in recent years, it’s not the only country having difficulty accessing capital markets.

Pre-euro, we know what would have happened. Countries in the south would have devalued against their northern rivals. The Deutsche Mark value of, say, peseta debt would have dropped and Spain would have achieved a “default by stealth” alongside a big improvement in competitiveness.

Life in the euro is not so easy. No one, as yet, has found a convincing answer for dealing with excessive debts or with southern Europe’s lack of competitiveness. In the absence of currency moves, what kind of adjustment is needed? Austerity hasn’t worked, no one wants a wave of defaults and, as yet, the Germans are dead against fiscal transfers.

At the end of the month, European leaders meet in Brussels to discuss the next steps with regard to the eurozone’s governance. The French want a banking union first of all, reasoning that, without it, Spain’s problems – and contagion effects to eurozone banks more generally – will only worsen. Germany, however, insists that, as a banking union is the first step towards a fiscal union, it cannot be allowed to happen without the eurozone first of all creating some kind of political union.

Logic is perhaps on Germany’s side. Time, however, is not. Even with longer-term refinancing operations and Spanish bank bailouts, the bank and sovereign runs that have undermined the euro’s integrity have only accelerated. The Greek election results will doubtless slow the process temporarily but they hardly represent a handbrake turn.

The good news is that there is no imminent Greek exit. The eurozone’s structural integrity remains intact for now. The fear of break-up will fade and the sell-off of peripheral debt should reverse.

But most of the big questions remain unanswered. Can a monetary union survive without a fiscal and political union? Probably not. Can the southern European nations improve their competitiveness? Yes, but only very slowly. In the meantime, will they need a helping hand from German taxpayers? Yes, but Berlin doesn’t want to foot the bill.

One smaller question also needs to be addressed. Will a New Democracy-led coalition really administer the tough medicine demanded by the Troika? History suggests otherwise. Beware, then, Greek voters bearing gifts.

Judging from the growing number of official remarks, central banks – in a standalone capacity and jointly – have been discussing what to do in the event of major disruptions to the European payments and settlement system. The immediate focus is, of course, Sunday’s highly uncertain election in Greece. But the contributing factors go well beyond this as they are entwined in Europe’s increasingly messy debt and banking circumstances.

In welcoming such signs of responsible contingency planning, it is important to distinguish between what central banks can deliver and what they are incapable of doing. In the context of today’s complex crisis in Europe, these critical institutions have essentially been reduced to the role of fire brigades. They can try to reduce the risk of a fire and, should one occur, stand ready to fight it and contain damage. But, acting on their own, they are unable to alter materially the behaviour of those who place whole neighbourhoods at risk.

Through both emergency liquidity operations and the willingness to stand as a solid counterparty in dysfunctional markets, central banks can offset (but not eradicate) disruptions to the payments and settlement system. Most critically, they can reduce the devastating impact of market “sudden stops,” which are the equivalent of economic and financial heart attacks for capitalism.

Recent statements from a host of officials – including Mario Draghi, European Central Bank president, Mervyn King, Bank of England governor, and Timothy Geithner, US Treasury secretary – suggest this is indeed on the to-do list of major central banks. And the output, should it be necessary, would come in the form of both individual measures and globally co-ordinated ones.

But central banks are not the reason why Europe faces the tail risk of catastrophic disruptions. If anything, they have been working hard to prevent Europe from getting into the mess it finds itself in today. This, in turn, speaks to the critical policy distinction between willingness, ability and effectiveness.

While certainly willing and partially able, central banks have not been effective in severing the major “feedback loops” that erode on a daily basis the integrity of the eurozone, discourage private capital inflows and undermine the wellbeing of the global economy. Specifically, acting on their own, they do not have enough instruments to stop the bad interactions between weak banks and deteriorating sovereign creditworthiness. They have even fewer tools to stop individual country problems from contaminating what is an increasingly synchronised global slowdown. And they are powerless when it comes to breaking the adverse feedback loop between bad economics and bad politics.

Simply put, if they are not joined by more effective responses on the part of politicians and other government agencies, the best central banks can do is to slow marginally the steadily eroding impact of the west’s triple threat – of too little growth, too much debt and excessive political polarisation. And in pivoting from crisis prevention to crisis management, they can (and are) on alert to clean up the mess, but cannot counter all of the damage.

This reality is yet another indication of the extent to which the west has become hostage to a never-ending series of emergency tactical responses when what is critically needed is also a set of coherent strategic decisions. This leaves central banks in the role of a consistently scrambling fire brigade. And the longer they are in this role, the greater the erosion in their effectiveness to deal with an ever increasing number of fire threats.


Exit from the euro by Greece, or by any other member state, has become a fashionable topic for academics, commentators and market participants. The analysis is most often conducted on the basis of the economic costs and benefits, and the possible social and political consequences of such an exit for Greece and for the rest of the euro area. Most recognise that, under prevailing circumstances, the costs are too high. Even Alexis Tsipras, leader of Greece’s Syriza party, who wants to renegotiate the terms of the International Monetary Fund and EU programme, has committed in the FT to keep Greece in the euro.

It is generally taken for granted, including by Mr Tsipras, that Greece can exit the euro if it decided to do so and adopted a new currency. It is, however, not that simple.

First, it would be very difficult for any Greek government to impose on its citizens the use of a new legal tender, such as the new drachma. The value of the new currency would depreciate substantially against the euro and be eroded by high inflation, given that money creation would be the only way to finance the budget deficit and to recapitalise the failed banking system. As experienced in several other Balkan countries, such as Bulgaria or Montenegro, households and companies would immediately try to protect themselves against currency debasement by indexing their contracts to the euro, and using the existing banknotes in circulation as a parallel currency. Of the three main functions of money – as a medium of exchange, store of value and unit of account ‑ the new drachma would most likely perform only the first one, and for only a fraction of the transactions, while the euro would retain the other two. Greece would have a de facto euro-based economy.

Second, by exiting the euro Greece would violate the Lisbon treaty. When adopting the euro Greece committed to a series of obligations, including the renouncement to its own currency, which is irreversible. The European Commission, as the guardian of the treaty, or any other of the 26 signatories of the treaty, could sue the Greek government at the European Court of Justice if they felt that the decision to exit the euro had materially damaged them or any of their citizens. Citizens of any EU states – in particular creditors whose contracts were redenominated in the new currency – could sue Greece in their respective courts, which most likely would defer to the ECJ. Greece could also be sued in the European Court of Human Rights for violating property rights. Any judgment issued by the ECJ or the ECHR would have to be taken into consideration by local courts in EU countries, including Greece. This could give rise to sanctions by the European authorities in case of non-compliance.

Greece could avoid these sanctions only by disavowing the authority of the supranational institutions. This would mean that Greece would exit not only the eurozone but also the European Union as a whole. There is no exit for the euro without exit from the EU, as explained in a 2009 working paper by Phoebus Athanassiou, a lawyer at the European Central Bank.

The only alternative would be for Greece to negotiate with the other 26 EU countries a new treaty, allowing Greece to adopt a new currency. Even assuming that the other countries were willing to accept entering such a negotiation, developments in Greece would practically make that impossible. As soon as the negotiations were made known, or even the intention to hold them, Greek citizens would immediately begin a run on their banks to withdraw euros and transfer their accounts abroad.

This could not be accommodated by the European authorities. Bank holidays and capital controls would have to be imposed, preventing Greek citizens from cashing in their savings and taking them abroad. All loans to Greek residents would be frozen immediately, including to the state. The country, therefore, would not have the means then to pay for basic expenditures, such as pensions, health care, civil servant wages. Conditions would rapidly become chaotic.

If Greece remained democratic, the government would most likely lose support from its own citizens for its request to leave the euro. It would then have to start negotiating with its partners on the terms for staying, rather than leaving, the euro from a much weaker position.

Exiting the euro is an economic and political nightmare and thus practically unfeasible. The reason is that the eurozone is not only an economic and monetary union; it is also a political union, albeit imperfect.


Aung San Suu Kyi is being royally feted in Europe. And she fully deserves to be feted. During the 21 years of house arrest and various other forms of harassment she refused to bend to the will of the military regime and insisted that Myanmar had to return to democracy. In the end, her courage and determination were vindicated. The military regime compromised, released her and allowed partial democratic elections in which her party, quite naturally, triumphed. No one should begrudge Ms Suu Kyi the royal treatment she is receiving in Europe.

Yet even as she walks through the admiring throngs, she should heed the wisdom of victorious Roman  generals, who when parading through Rome supposedly had a slave to whisper in their ear  ”remember you are mortal”. They were being reminded that they could make mistakes. And Ms Suu Kyi could make serious errors in Europe.

Her first mistake would be to believe that Europe can save Myanmar. Europe today is a deeply wounded continent and likely to remain so for a while. Its people are frightened for their own future. Saving others is their last priority, no matter how noble the cause. She will hear fiery speeches. She will receive few real commitments. Ms Suu Kyi should realise that history has turned full circle during her years of house arrest. When she went into confinement in 1989, Europe was triumphant. At the end of the cold war, Europe thought it had reached “the end of history” and believed it had only to continue on autopilot. When she emerged in 2010, Europe had crashed. It’s failure to adjust and adapt as history turned a corner and power shifted to Asia led to inevitable grief. The Eurozone crisis is only the first symptom of a deeper plight.

The regional organisation that can truly help Myanmar is the Association of South East Asian Nations, not the EU. Asean has been remarkably wily in adjusting to geopolitical shifts. Today, it provides the only reliable platform for the Asia-Pacific powers to meet. Hence, while Ms Suu Kyi is courting Europe, the world is courting Asean. The group has been blessed with free trade agreements with China, India, Korea, Japan, Australia and New Zealand. More recently, even the US has woken up and is trying to expand the trans-Pacific Partnership throughout the region. Asean’s total trade with the world grew from $302bn in 1990 to $2tn in 2010, during the period of Ms Suu Kyi’s confinement.

Ms Suu Kyi is right to dream of a better future for her people, especially the young. However, attending a U2 concert in Dublin will not bring them hope. Few young people in Europe feel optimistic about the future. Many in Asean do. They know that they are living at the dawn of the Asian century where explosive changes are coming. Today, 500m Asians enjoy middle-class standards. In barely eight years the number, according to some estimates, is set to explode to 1.75bn. Myanmar can be lifted to great heights by the rising tide of prosperity all around it.

For this to happen, Ms Suu Kyi may have to change her mental maps. She has to look at Asian case studies and not attend European concerts. Several Asian nations have emerged from decades of isolation and poverty to grow from strength to strength. Japan was first. South Korea, Taiwan, Hong Kong and Singapore came next. Then China and India exploded by copying them. All the models for Myanmar to grow and succeed are in Asia. None are in Europe.

To be fair, the years of isolation that Ms Suu Kyi suffered deprived her of the opportunity of learning how the wheels of history had turned. Hence, when the celebrations are over in Europe, she should quietly visit some Asian countries. There will be no fanfare. But there will be deep lessons to be learned on how quiet Asian pragmatism continues to deliver steady economic growth while Europe languishes. The same pragmatism has also preserved, by and large, ethnic harmony in the Balkans of Asia. So if Ms Suu Kyi wishes to promote rapid economic growth or put out ethnic conflict between Rakhine Buddhists and Rohingya Muslims, the place to go to for lessons is Asean, not the EU.


Barack Obama is clearly fighting an uphill battle against Republicans in his efforts to stimulate the American economy. Indeed, Republicans have held the upper hand throughout his presidency. A key reason, I believe, is that they have a simple, plausible explanation for the cause and cure of the economic crisis: it was caused by big government and will be cured by slashing government, they say repeatedly.

Republicans have been so successful in selling their austerity cure for all that ails us because they have a theory that rings true to unsophisticated minds. They argue that government is no different from the family – prosperity financed with debt is false and unsustainable. The solution is to relentlessly cut back on spending until there is a surplus from which debt can be repaid. Only then can prosperity re-emerge.

A corollary to the conservative mantra is that monetary policy plays no positive role whatsoever; at best it is passive. Active monetary policy is per se destabilising. Excessive money creation enabled the run-up of debt and sows the seeds of inflation, from which a future economic crisis inevitably will spring.

By contrast, there is no simple, coherent explanation from the left for either the cause of the crisis or its cure. I think Mr Obama has hurt himself badly by not putting forward such an explanation early in his administration that would frame his policies and enable his allies to amplify and reiterate it so that it is as widely understood as the competing conservative model.

Mr Obama’s theory could build on the well-established work of John Maynard Keynes, which would attribute the slowdown principally to a fall-off in aggregate demand resulting from the bursting of the housing bubble and other factors. Under such conditions, government consumption and investment spending can compensate for the decline in private spending, taking advantage of unused economic capacity (such as idle plants and unemployed workers) to cheaply build and finance necessary public works that will pay dividends far into the future.

Mr Obama could also explain that monetary policy is severely constrained when interest rates approach zero and requires an active fiscal policy to get money to circulate, increase velocity (the speed at which money circulates) and stop the downward pressure on prices that are paralysing private economic activity.

This is a harder explanation to get people to understand than the conservative alternative. This was true in the 1930s as well. But eventually economists accepted that Keynes was right and the conservatives were wrong.

Mr Obama has already wasted more than three years on ad hoc responses to the crisis without an apparent strategy. But it is not too late. A big economic speech that clearly lays out his economic philosophy and ties together the seemingly disconnected strands of his policies would help him electorally and plough the ground for additional and more effective stimulus.


Dictatorships and tyrannies may be casual about spilling their people’s blood, but not democracies. When the people get to decide whether to go to war, they rarely do so willingly. This was why Immanuel Kant said the spread of democracy was the best guarantee of world peace. As he wrote in 1795, “if the consent of the citizens is required in order to decide that war should be declared nothing is more natural than that they would be very cautious in commencing such a poor game”.

When contemporary thinkers such as Michael Doyle have tested Kant’s intuition, they have had to add a significant caveat: democracies may not like fighting each other – which is why war has become unthinkable between EU and Nato countries – but they can be very warlike indeed towards tyrants and ethnic cleansers.


On this story

On this topic

IN Opinion

Drones and cyberwarfare, the latest revolution in military technology, will force us to revise still further Kant’s connection between democracy, peace and war. Virtual technologies make it easier for democracies to wage war because they eliminate the risk of blood sacrifice that once forced democratic peoples to be prudent.

Virtual war in Kosovo meant piloted F-18s and precision air strikes. In Afghanistan, too, the Taliban was routed initially with precision air strikes guided by forward air controllers. Libya was the same story. Now democracies do not even have to put their pilots in harm’s way. Cyberwar and drones offer Nato democracies enticing prospects of cheap, risk-free warfare – and not just democracies. A new arms race is already under way.

Before succumbing to these technologies, leaders should remember how little virtual war has actually accomplished. Kosovo is still a corrupt ethnic tyranny; Libya will take years to put itself back together; and no one can see a stable state in sight in Afghanistan. Virtual war turned out to be the easy part. Democracies have little staying power for the hard part.

Looking at the options in Syria, drone attacks on regime tank formations and a cybercampaign to immobilise Bashar al-Assad’s command and control would be the easy part. Creating a Syria free of sectarian warfare and ethnic political domination would be very hard.

If war is the continuation of politics by other means, the chief factor limiting the use of these new weapons will be whether they help leaders to attain their political ends. Where these ends seem unattainable or futile, as in Syria, the weapons will remain unused.

The larger problem is that these new weapons are bound to escape political, and therefore democratic, control. Previous revolutions in military affairs, such as the coming of nuclear weapons, strengthened the hand of presidents and prime ministers. Drones and cyberwar technologies are so cheap that it will be impossible to keep them under the lock and key of the sovereign. The age of the super-empowered, and therefore super-dangerous, individual has arrived.

In deciding how to control drone and cybertechnologies, it is worth remembering that democracies are resilient because they are free. Our cybersystems are now under constant attack and it is in responding to these attacks that they become more secure. States will have to allow the global community of coders and engineers who built and maintain the internet the freedom to keep the malware at bay and keep the system open for the rest of us.

The new technologies are so easy and cheap to produce that the best international law and state action can hope for is to generate a limited set of shared norms to prohibit their most harmful uses. Even with these in place, drones and malware will fight our wars for us and serve our eternal human desire to inflict harm without consequences. They will be the mercenaries of the 21st century.

In thinking about what can keep these technologies under control, we need to remember Kant’s original bet on human prudence. Kant’s insight was that human beings who can freely choose and reason know full well that if you inflict harm, it will come back to hurt you. Everything must be paid for. If you hit Iran with Stuxnet, you render your own nuclear systems vulnerable to the next hacker, individual or state. If you perfect the killing of individuals with drones, you had better confine your acts to bona fide enemies of your state; otherwise you expose your population as a whole to the same heaven-sent vengeance.

These new technologies promise harm without consequence. Kant tells us there is no such thing. In this shared human understanding, even between adversaries, lies prudence, and in prudence – caution, care and restraint – lies hope.

The writer teaches human rights at the University of Toronto and is author of ‘Virtual War’

Everyone hopes that the €100bn bailout of Spanish banks will calm the eurozone financial crisis and buy enough time for the further fiscal, banking and other integration that is required.  That is possible but, unfortunately, it isn’t likely.

There are three reasons why not.  The first involves the structure of the bailout itself.  While details remain sketchy, the weaker Spanish banks need new equity, but, apparently, senior secured loans are being made.  That is not a real solution.  It may also subordinate existing lenders and thus disincentivise other financing for eurozone banks.

Then, the €100bn is being loaned to the Spanish government for downstreaming to the local banks.  This reflects the lack of a eurozone mechanism, like the US Troubled Assets Relief Program, for injecting capital directly into banks. But it results in another sub-optimal feature.  Spain, already at risk of losing its own access to borrowing, may be further weakened by this loan. After all, this new loan will push its debt to 90 per cent of its gross domestic product.

Further, the downstreaming approach makes it harder to attach conditionality.  We don’t know whether necessary restrictions will be imposed on the recipient banks, relating, for example, to their dividends, capacity to acquire even more Spanish sovereign debt, and the like.

The size of this bailout also illustrates that the emerging €750bn European Stability Mechanism is too small. Emergency financing already extended to Greece, Ireland and Portugal amounts to nearly €250bn. Adding this new commitment for Spanish banks would leave only €400bn for other, emergency needs.  That is not nearly enough.  If either Spain or Italy lost access to bond markets, the amounts needed could overwhelm the ESM.

Second, this Spanish bank bailout does not solve the issues at the heart of the eurozone crisis; namely, the disconnect between the currency union, on the one hand, and the lack of a fiscal or banking union, on the other.  The imbalances among member states in competitiveness, national deficits and debt and banking soundness can blow the eurozone apart unless there is such integration. Global capital markets remain sceptical that the eurozone’s leaders are prepared to implement it.

Third, the pattern of big financial crises, like this eurozone one, is that they flare, then abate and then flare again.  Like a hurricane, the crisis itself passes through several phases in the markets. We saw this phenomenon in both the Asian financial crisis of 1997-98 and the great credit market collapse of 2008-09.  Initially, markets often react positively to a move like this bank rescue.  But, after consideration, they determine that it is not enough, the crisis psychology reasserts itself and the situation is back on the brink.  That is probably going to happen here.

It is healthy that the eurozone leaders took this step to rescue Spain’s banks and committed to an aggressive amount.  I hope that I am wrong, but this isn’t likely to be a turning point in the crisis.

“It was the credibility of the euro that won,” said Mariano Rajoy, Spanish prime minister, introducing the €100bn bailout of Spain’s banks over the weekend. “This shows the euro area is ready to take decisive action,” proclaimed Olli Rehn, European commissioner,  at the same time.

These statements are worrying. Does anyone on the planet think that problems surrounding the credibility of the euro have been solved by this emergency action? Does any overseas investor believe that a corner has been turned, when the German government continues to set its face against the mutualisation of debt?

We can only hope that Mr Rajoy and Mr Rehn are, as politicians are wont to do, treating the public with contempt in trotting out these bromides. The alternative explanation, that they really believe the problem has been solved, is far more worrying.

Of course the deal is a step forward. For once, the scale of the funding put in place is above the worst market estimates. After months of denial, the Spanish government has obeyed the first law of holes – when in a deep one, stop digging. They have accepted that they cannot resolve their banking problems unaided. But the Spanish system still needs a fundamental overhaul. The old system of political cronies running regional savings banks, channelling savings into politically driven development projects, has hit the buffers. It is only weeks since Rodrigo Rato was removed from the chairmanship of Bankia. Will the government have the courage to clean out the other stables? This raises difficult national/regional issues, always fraught in Spain. There is a brand new Bank of Spain governor who will need to assert himself quickly.

And at European level the picture remains clouded. The Germans say they will only envisage debt mutualisation, and other key aspects of a banking union, if there is a decisive move to political union. The French government rejected German chancellor Angela Merkel’s proposals at once. There is still no consensus about what concrete steps need to be taken to solve Europe’s banking problem and in which order. The European Commission is working hard to produce a package by the end of the month. It is a tall order. There is only one clear consensus view to be found among the Treasuries of Europe: the less the British government says on the subject, the better.

So the next few weeks will be fraught with danger. It seems probable that, in Greece, fear of the unknown may prevent a Syriza-led government emerging. Voters will hold their noses and vote for New Democracy and Pasok in sufficient numbers to avert calamity. But the Greeks are, nonetheless, unlikely to be able to meet the terms of their latest bailout and, Oliver Twist-like, will come back for more. Will the troika be sympathetic? If so, on what terms? And if they decline, is there a plan B in place for a eurozone departure?

So the victory declarations this weekend look as misplaced as Manchester United’s premature Premier League victory celebrations a month ago. There is much more to do and very little time in which to do it.

Keynesian economists blame the sluggish US growth and lack of job creation on the insufficiency of stimulus measures. If only Congress had agreed with President Obama to greater stimulus, they say, the current US recovery would have been much stronger. This is a dubious proposition. The deeper problem lay in the limitations of fiscal stimulus as a response to the 2008 crisis.

Stimulus spending has been sizeable. According to the International Monetary Fund’s measurement of these things, the fiscal stimulus has been large and persistent. The IMF looks at “general government structural balance as a percent of potential GDP,” which measures the general government budget balance net of automatic stabilisers — spending that kicks in during downturns, such as unemployment benefit.  In 2007, the structural deficit was 2.8 per cent of gross domestic product. This rose to 5.0 per cent of GDP in 2008, mainly because of tax cuts implemented by the Bush administration at the onset of the crisis. With Mr Obama’s stimulus program, the structural deficit rose further to 7.5 per cent of GDP in 2009, and stayed at roughly that level through 2011.

Thus, the structural fiscal expansion was more than 4 per cent of GDP on a sustained basis during 2009-11 compared with 2007. The actual deficit including automatic stabilisers and the Troubled Asset Relief Program (bank bailout) funds was far larger, rising from 2.7 per cent of GDP in 2007 to 13.0 percent of GDP in 2009, 10.5 percent of GDP in 2010, and 9.6 percent of GDP in 2011. Net public debt as a share of GDP soared from 48.2 per cent of GDP in 2007 to 80.3 per cent of GDP in 2011, according to IMF data.

Fiscal stimulus, in short, has been tried, but did not succeed in spurring a robust recovery. Advocates of stimulus bemoan the idea of reversing the fiscal expansion now, in view of the weak economy, and argue that it be prolonged and expanded. The original idea of the stimulus, however, was as a temporary measure that would make a bridge to self-sustaining private-sector-led recovery.

The Keynesian interpretation in late 2008 and early 2009 was that the economic downturn was a cyclical matter. A housing boom had turned temporarily to bust. Consumer spending was temporarily down. Temporary tax cuts would boost consumer spending while a temporary boost in government spending would create temporary jobs in construction and preserve jobs in cash-strapped state and local governments. By 2010 or 2011, a natural recovery would replace the temporary fiscal boost, and allow it to be withdrawn.

Yet the cyclical recovery proved to be anaemic. The national accounts suggest some reasons why. First, the housing bust did not reverse itself. As of the first quarter of 2012, real investments in residential structures remained 55 per cent below the 2005 level. Yet this was not surprising. It was neither possible nor desirable to re-inflate the housing bubble.

Second, the fiscal stimulus was at least partially offset by a rise in household saving. Economic theory and experience teaches that temporary tax cuts and transfers to households, of the kind implemented repeatedly in recent years, are partly or wholly saved. Households pay down their debts rather than making new outlays on consumer goods.

Many state and local governments apparently used the federal transfers to replace rather than augment their own revenues and to replenish their own financial balances, rather than to reverse their plans for layoffs and investment cutbacks. There was no rise in overall government investment (i.e. federal, state, and local) spending as a share of GDP. The stimulus was almost all in the form of tax cuts and transfer payments rather than outlays for investment projects.

Two major implications of the Keynesian interlude are the following. First, and most importantly, there has been no new dynamic growth sector in the US economy to replace the defunct housing boom. Consumer spending did not surge; housing did not return; private investments in industry did not take over; and public investments did not fill the gap. Second, the multipliers on short-term Keynesian stimulus measures proved to be low and variable rather than high and predictable. The continuation of the Keynesian option at this stage is therefore unappealing: a further build-up of public-sector debt with little guarantee of job creation or a reliable exit strategy.

The tragedy is that the Republican opposition to the Obama-led stimulus measures is even wider off the mark. The Republican strategy would make the temporary tax cuts permanent, and even create new tax breaks for top earners, to be paid by swingeing cuts in programs for job training, education, infrastructure, the environment, and support for the poor. The Republicans live in a world in which the rich are the only worthies in the society (the “job creators”), the unemployed and poor should fend for themselves, and public goods do not exist. And they do so despite thirty years of failed trickle-down policies that have created unprecedented inequality, deepening poverty, and no solutions to the loss of jobs.

There is another way, not represented by either US political party. It would be based on the following four premises.

First, the US (and Europe) needs a new source of long-term growth, not a short-term Keynesian bridge to consumer-led growth.

Second, the highest social returns can be achieved by bringing the new technologies – information, communications, transportation, materials, and genomics – to bear on the problems of sustainability and the quality of life. Long-term growth (and quality of life) should be based on an investment-led transition to a low-carbon, low-pollution, and high-amenity built environment, drawing upon the cutting-edge advances of science and engineering.

Third, the transition to sustainability requires a mix of public and private investments. As one example, private investments in low-carbon energy (wind, solar, nuclear) need to be linked to public investments in long-distance transmission grids. Similarly, the transition to smart electric-powered urban mobility will require a mix of private investments and public infrastructure. The public investments should be financed in part through long-term borrowing backed by dedicated future revenue streams (e.g. public-sector tariffs and gradually rising carbon taxes).

Fourth, rather high levels of taxation as a share of national income (as in the highly successful economies of northern Europe) are needed to keep budget deficits low while also ensuring adequate public revenues for universal coverage of high-quality public services and human capital investments that span early childhood through public education, apprenticeships, and job training.

While there are absolutely urgent short-term matters to face — notably putting out the fire of bank runs in the eurozone — the deep solution to the crisis of the high-income countries lies in a long-term vision of sustainable development, one that promotes a mix of complementary public and private investments. To get there, we need to move beyond the stale US political debate pitting short-run Keynesian stimulus on one side versus trickle-down economics on the other.

Related posts:
Larry Summers is playing economic Jeopardy! – Glenn Hubbard
Romney must release a credible budget – Lawrence Summers

After resisting for months, Spain has made an explicit plea for bank aid from its European neighbours. The immediate objective is to recapitalise struggling banks and minimise the risk of disruptive deposit withdrawals. A major challenge is to avoid this emergency funding turning Spain into a long-term ward of the European state, a phenomenon that has already occurred in the three countries to have already received bail-outs – Greece, Ireland and Portugal.

Having botched prior attempts to stabilise its banking system – whether it was the domestic approach based on mergers or the attempt to access a back door to the European Central Bank – Spain now looks set to tap European funds. This would probably be combined with a more detailed commitment to a domestic economic plan emphasising both budgetary adjustment and structural reform.

This use of an external balance sheet would provide the theoretical possibility of rupturing the disruptive feedback loop between weak banks and deteriorating sovereign creditworthiness. But before we all let out a huge sigh of relief, it is important to understand why Spain for so long resisted what seems to be an obvious response to its banking problems.

So far, emergency European funding has been impossible to exit, like a “roach motel”. Rather than act as a catalyst for crowding in private capital needed to restore growth, and financial viability, public money has provided the private sector with the possibility to exit programme countries at a much lower cost; and exit it did. As a result, governments have become highly dependent on official aid to cover their budget needs, meet interest obligations and roll over maturing debt; and domestic companies have been starved of the oxygen that is so critical for investment and job creation.

No wonder, growth and solvency remain so elusive for the programme countries, including in Ireland and Portugal where citizens have been generally supportive of their governments’ policies. The possibility that the counter factual — i.e., no access to external emergency financing — could have yielded a worse outcome is no excuse for repeating the mistake in Spain. Indeed, This is more than just in the country’s self interest. Given its size and crucial role in any revived eurozone (along with France, Germany and Italy), Europe cannot afford Spain to be a long-term ward of the state.

Success requires, first and foremost, a common understanding and vision of what a stable eurozone would look like in three to five years. Increasingly, this speaks to a smaller and less imperfect union, anchored by the big four and including only countries that are both able and willing to deliver on the revamped joint obligations being discussed in official circles — namely, reinforcing monetary union with proper fiscal and growth compacts and enhanced political integration.

This critical contextual step would allow for the immediate implementation of measures to stabilise Europe, including through the establishment of a regional bank deposit scheme. It would provide far greater assurances to the ECB that, this time around, its emergency facilities (including another longer term refinancing operation and an enhanced security purchase program, along with strengthened regional fiscal transfers) have a better prospect of being a bridge to a sustainable European destination — something that continues to elude an institution that has already expanded its balance sheet to 30 percent of aggregate gross domestic product.

Finally, Spain would need to agree to a proper domestic policy mix. This involves not only avoiding the mistake that Greece made in agreeing to a series of unrealistically-designed and technically-flawed programmes but also enabled to make difficult upfront decisions about the best form of burden sharing (something that Ireland was not allowed to do by its European partners).

Given the increasingly delicate situation of the eurozone – from Greece’s bank jog and election uncertainty to the tensions at the very core between France and Germany – governments do not have many more chances to get all this right. And the rest of the world has a vital interest in a better response to what now constitutes a major risk to already tenuous growth and employment prospects.

Related posts:
Eurozone banks must be an international concern – Lorenzo Bini Smaghi
To save the eurozone, save the banks – Jeffrey Sachs

The way in which the Bankia – and other – cases have been managed over the past few weeks confirms that banking supervision in the euro area cannot continue to be implemented in a decentralised way. The incentives of the national authorities to free ride are simply too high and undermine the stability of the entire euro financial system.

The traditional argument put forward in defense of conducting prudential supervision at the national level is that supervisory authorities have to be accountable to taxpayers, who ultimately bear the economic consequences of bank failures. As long as bank rescue operations are financed by taxes collected at the national level, so goes the argument, supervision should remain national.

In a monetary union, however, the decisions taken by a national supervisor impact not only the country’s residents but also the taxpayers and savers of the other countries. Recent events have shown how the uncertainties surrounding the restructuring of Bankia have negatively affected the banking system of the whole euro area and spread to other segments of the financial market, including in countries which had taken action with a view to put their own banking system in order.

The channel of transmission to the other eurozone countries has several dimensions. First, the contagion through the sovereign risk market increases government bond yields, thus also raising the implicit tax burden in other countries. Second, the high cross-border correlation of banking risk depresses the value of bank capital in other parts of the eurozone, fuelling a credit crunch. Third, if domestic funds are not sufficient to ensure adequate bank recapitalisation, as was the case for Greece, Ireland and Portugal, the European facility has to be tapped, which commits other countries’ taxpayers.

Decentralised supervision in the euro area also provides incentives to underestimate risks and to shift the burden of adjustment to the other countries’ taxpayers. The confidential nature of the information collected by supervisors on their respective banks is often used as a reason for not sharing it with the other countries, thus increasing the probability of underestimating the gravity of the situation and the cross-border implications of crises. Decentralised stress-tests have allowed for different amounts of rigour across countries, undermining the credibility of the entire European supervisory structure. The benchmarks and deadlines for recapitalisations have been set primarily with a view to accommodate national preferences rather than to restore stability across the board.

The current system of cooperation among national supervisors under the European Banking Authority is weak and has no sanctioning mechanism to avoid the risks mentioned above. It is paradoxical that while the governments of the eurozone member states have accepted to subject themselves to strict rules and to a sanctioning regime, as foreseen in the fiscal compact, national supervisors can operate with much fewer restrictions. As a result, the incentive to act is linked to market pressure, which experience shows as being the best recipe for doing too little too late.

The current decentralised system of supervision also puts an undue burden on the ECB. The latter relies on the assessment of the national supervisors to judge whether banks are solvent, and can thus be accepted as counterparties for monetary policy operations. This fuels the temptation by national supervisors to understate solvency risks and to address problems through the provision of central bank liquidity rather than capital increases. Only in countries under IMF-EU programme have national supervisors been requested to share all the required information. This may be a reason why resorting to an IMF-EU programme tends to be rejected, until it becomes unavoidable.

In a monetary union the supervisory authorities should give account of their actions – and inaction – not only to the citizens of their own countries but also to the others. In the current EU institutional framework, it’s not clear how such an accountability can be ensured. Financial stability is still largely considered as a national responsibility, which is somewhat paradoxical in a single financial market with a single currency. The role of the European Commission is unclear. In theory, the supervisory and fiscal authorities of the other countries should put pressure on each other to ensure such accountability, but in practice they are reluctant to do so, fearing of having one day to abide by the same requirement.

The cost of such an inefficiency is mainly borne by the taxpayers.

The solution is to centralise bank supervision at the euro area level, especially for systemically relevant institutions. There are two ways to achieve this. The first is that the political authorities of the member states take the initiative and agree to implement a more efficient integrated supervisory system. The second way is that the ECB stops relying only on national supervisors and starts conducting its own assessment on the solvency of major banks, before granting them eligibility to monetary policy operations.

The writer is a visiting scholar at Harvard’s Weatherhead Center for International Affairs and a former member of the ECB’s executive board

Friday’s weak US employment report confirms a disappointing historical pattern: after an encouraging start to the year, job creation has again hit a soft patch. To make things worse, there is a distinct possibility that, absent major policy initiatives on both sides of the Atlantic, the US economy may not accelerate as quickly as many hope – thus increasing America’s vulnerability to the deepening crisis in Europe.

The report again highlights the vulnerability of the employment situation. Net job creation in May amounted to only 69,000, well below consensus expectations of 150,000 and nowhere near the pace needed to address the large shortfall that persists more than three years after the global financial crisis. The unemployment rate inched up to 8.2 per cent, with the employed to adult population ratio at a worrisomely level of only 58.6 per cent.

The disappointing news is not limited to quantities. Composition of employment, duration of unemployment and stagnant earnings remain stubborn challenges.

Long-term joblessness rose to 42.8 per cent of those officially out of work. The average duration of unemployment is still more than twice the historical norm. And those fortunate enough to work are coping with flat earnings growth and declining hours worked.

We have been here before – twice in just the last two years. And on both occasions, the second quarter weakness was reversed later in the year.

Count me among those wishing for a repeat of the rebound, if not a much, much better outcome. Yet this hope comes wrapped in heightened worry. It will be much tougher going this time around given how economic, financial and political factors are converging in a worrisome manner.

Concerned by the never-ending crisis in Europe, a major export market for many companies, CEOs are cautious about hiring; and it does not help that emerging economies, the other source of meaningful external demand, are slowing sharply. Just look at Friday’s fall in China’s manufacturing indicator.

Sluggish job creation and earnings mean that heavily-indebted consumers will remain under pressure. And with the household savings already low, too many families are exhausting their emergency cash.

All this is consistent with the data released earlier in the week suggesting that the private sector is losing vitality – from the unexpected large fall in the ISM purchasing managers’ survey to higher weekly jobless claims and the downward revision in first quarter GDP. Then there is the prospect of a year-end fall in the government’s contribution to economic activity on account of both spending cuts and tax hikes – the so-called “fiscal cliff”.

With the November elections getting closer, it would be foolish to expect politicians to agree to the grand policy bargains needed to reinvigorate the US economy and to encourage companies to get their cash off the sidelines. However, we can hope that they will avoid making a bad situation worse. This requires they pursue two policy initiatives without further delay.

First, Congress needs to get going on measures to reduce the risk of the fiscal cliff. As stressed by Federal Reserve chairman Ben Bernanke and others, the economy is in no position to absorb such a large hit to aggregate demand. Moreover, the blunt nature of the expenditure and tax measures – not the result of coherent fiscal reform but, rather, due to the lack of responsible decision making – would aggravate a budget that is already structurally inefficient and unfair.

Second, the Obama administration needs to work closely with the Fed and congressional committees on contingency measures to counter collateral damage from Europe. Up to now, American officials have been keener on lecturing their European counterparts – with neutral, if not negative consequences – than specify what could be done to navigate the aftermath of potentially messy outcomes on the other side of the Atlantic.

There is only one thing worse than preparing for a crisis that does not happen; and that is not preparing for a crisis that does. It appears that American politicians not only lack plans to deal with adverse European contagion but are also on course to expose the country to additional self-inflicted challenges. Friday’s disheartening data are a timely reminder that these are enormous risks to take with what is already a very fragile employment situation.

The A-List

About this blog Blog guide
Welcome. This blog is available to subscribers only.

The A-List from the Financial Times provides timely, insightful comment on the topics that matter, from globally renowned leaders, policymakers and commentators.

Read the A-List author biographies

Subscribe to the RSS feed

To comment, please register for free with and read our policy on submitting comments.

All posts are published in UK time.

See the full list of FT blogs.

What we’re writing about

Afghanistan Asia maritime tensions carbon central banks China climate change Crimea emerging markets energy EU European Central Bank George Osborne global economy inflation Japan Pakistan quantitative easing Russia Rwanda security surveillance Syria technology terrorism UK Budget UK economy Ukraine unemployment US US Federal Reserve US jobs Vladimir Putin


Africa America Asia Britain Business China Davos Europe Finance Foreign Policy Global Economy Latin America Markets Middle East Syria World


« May Jul »June 2012