Daily Archives: September 6, 2012

This year, the critical question in Europe has changed from whether policymakers could find the required policy instincts – they have – to whether they are moving fast enough to get ahead of the deleveraging by the private sector.

By announcing a new conditional bond purchase program on Thursday, the European Central Bank took a major step to close what, at one time, seemed a near-insurmountable deficit in this race. It now needs the support of other policymaking bodies to fully eliminate the gap.

European policymakers and politicians were very slow in 2009-10. Insufficient understanding of regional debt dynamics, together with widespread denial that Europe could be on the receiving end of a typical “emerging market crisis,” made it even harder to coordinate policy in a monetary union with very different initial conditions among its 17 member countries. The longer this persisted, the more policies fell behind the exiting of private capital.

As the regional crisis deepened in 2011,  governments and the ECB adopted a policy approach more commensurate with the complexity of the crisis. Namely, seeking to break the link between sovereign credit deterioration and banking sector weakness, trying to change the policy mix for struggling countries and, at the regional level, addressing design flaws in the original monetary union through banking and fiscal unions and closer political integration.

But words came easier than actions. As implementation lagged, private capital outflows broadened and accelerated. Outflows took two distinct forms. Firstly, out of an expanding universe of peripheral eurozone countries and to a very small inner eurozone core. Secondly, out of the eurozone as a whole to the rest of the world, in particular Switzerland and the US.

These outflows did more than increase market volatility, raise financing costs for struggling economies and ration funds to their governments and (especially) companies. They also put in place the seeds for a fragmentation of the single financial market, threatening  structural damage to the very idea of investment in Europe.

The danger to the single financial market and the related increase in “convertibility risk” were cited in the historic remarks made by Mario Draghi, in London on July 28th. They set the stage for a much bolder policy response that, after a summer of intense work and  consultation aimed at reconciling debtors’ demand for financing and creditors’ emphasis on policy conditionality, culminated in what the ECB announced on Thursday.

According to MrDraghi, the ECB will start buying short-dated (up to three-year maturity) bonds issued by government subjecting themselves to appropriate policy conditionality. It will do so with no pre-specified limit, thereby seeking to sustainably lower borrowing costs while removing concerns about these countries’ refunding prospects. According to preliminary information, the policy component of this more transparent new programme will strike a better balance between conditionality and financing – one that, critically, may be more agreeable to both creditor and debtor countries.

Returning to the race analogy, Thursday’s ECB actions can significantly close the gap between private capital outflows and what, until now, have been lagging official policy reactions. They would reduce the tail risk of immediate fragmentation. But it remains to be seen whether this latest policy sprint can totally eliminated the gap, thus putting in place conditions for a reversal in capital outflows.

Our analysis of the underlying drives of financial flows suggests that policy still needs a further nudge to get ahead of the de-leveraging. Specifically, exploiting the window offered to them by bold ECB actions, national and regional policy entities need to implement – rapidly, comprehensively and simultaneously – the list of corrective measures that have been widely discussed in official circles but languish on the drawing board.

If they fail to do so, the ECB will find that it has mis-timed its impressive sprint. Within a few months, policies will again fall further behind the de-leveraging process, and the credibility of Europe’s policymaking process will be dented further. This is a possibility that should be avoided – not just for Europe’s sake but also for that of the global economy.

Having recently declared that I am not likely to vote this year here in the Financial Times, I should have added that that is just how I feel now. I am certainly open to persuasion and my feet are not set in concrete.

Last week’s Republican convention did nothing to encourage me to vote for Mitt Romney. All of the speakers simply recited well-worn conservative talking points that won cheers from true believers in the convention audience, but did nothing to win over the undecided.

Polls universally show that Romney got no “bounce” from the convention and did much worse than John McCain four years ago. Moreover, television ratings for the 2012 Republican convention were well down from those in 2008, suggesting that only party loyalists watched the proceedings.

Thus far, the Democratic convention, which has been meeting in Charlotte, North Carolina since Tuesday, has bested both the Republican convention and Democrats’ expectations. The only Republican speech that was memorable was a rambling, incoherent monologue by the actor Clint Eastwood.

By contrast, Democrats are raving about the speeches by Michele Obama, former president Bill Clinton and other party luminaries. When Barack Obama speaks tonight, I as an undecided voter am primarily looking for one thing: Will the next four years be different than the last four? If so, how? And what reasons do I have for thinking that they will be better?

Obviously, Obama has to walk a fine line between admitting failure in certain respects and talking about the need for change. After all, it is his administration’s own policies are the ones that need changing. At the same time, he must avoid sounding like he is whining about bad luck—of which he has certainly had more than his share in terms of the economy—and all the nasty things Republicans have done to frustrate his policies and ensure their failure.

It is not necessary to remind Democrats that the Republican leader in the Senate, Mitch McConnell of Kentucky, said publicly back in 2010, “The single most important thing we want to achieve is for President Obama to be a one-term president.” Ironically, this may give him an opening for Republicans to work with him in a second term— something independents want to hear. The Constitution limits presidents to two terms, so Obama will be not be able to run again. Therefore, Republicans have no reason to go out of their way to make him into a failure.

Indeed, it may be in their interest to get some of the messy work of fixing the budget accomplished while there is a Democratic president to share the blame for any political pain that will be required. Mr Obama should talk about bringing new leadership into the government. His Treasury secretary, Tim Geithner, has already announced plans to leave after the election. And in any case, a second term is an appropriate opportunity to clean house and bring in fresh blood.

Mr Obama might also talk about opportunities presented by the so-called “fiscal cliff” that will result from automatic tax increases and spending cuts already programmed into law to take effect on Jan. 1. And the expected pullout of all American troops from Afghanistan by 2014 will create new opportunities and challenges for American foreign policy that deserve discussion and will contrast Obama from the unpopular sabre-rattling of the Republicans. In short, there are plenty of ways Obama can promise something different and something better in another term. I, for one, will be listening for them.

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