Wednesday, November 30, 2011

Compulsory exercise

Eurozone finance ministers’ agreement on the leverage options for the EFSF did
not bring any surprises. The work is not over, yet.

Eurozone finance minister did what they had to do. Yesterday evening, finance ministers approved the next installment of the Greek bailout loan (8bn euro). Without that money, Greece would have run out of cash before Christmas. Moreover, ministers agreed on the two leverage options for the EFSF. The exact size of the leverage remains unclear. As EFSF chairman Klaus Regling said yesterday evening, it will depend on the interest of foreign investors.

Two options will be available to achieve the leverage. 1) A credit enhancement to primary sovereign bonds issued by Eurozone countries. This is the so-called sovereign insurance mechanism in which 20 to 30% of a potential loss could be guaranteed by the EFSF. 2) The creation of Co-Investment Funds (CIF) to purchase bonds in the primary and/or secondary market. There would be three separate "tranches" of this CIF: the EFSF would contribute to the private investors could invest in a "participating" tranche, and the IMF could provide funding for the last tranche.

The weaknesses of these two options are well-known. The success of the EFSF leverage
is highly dependent on investors’ appetite. Moreover, only the CIF option could eventually take countries off the market. With the latest increases in government bond yields for most Eurozone countries, even a successful leverage could be too little to calm markets.

With yesterday’s decisions, Eurozone finance ministers did what they had to do. Nothing more and nothing less. They framed out the leverage option as decided at the October summit. However, with yesterday’s decisions, discussions on further ECB involvement have not been hushed. The search for a credible and loaded bazooka will

Friday, November 25, 2011

Frau Nein? No, it is Ms Conditionality

Yesterday’s meeting with Sarkozy and Monti did not change German chancellor Merkel’s mind. She remains opposed to Eurobonds.

Merkozy has turned into M&MS. At yesterday’s regular meeting between French president Sarkozy and German chancellor, new Italian Prime Minister Monti joined the high-level lunch. Unlike before, this entre-nous of the biggest Eurozone countries’ political leaders did not produce any new initiatives. It was a quite prelude to a probably summit- intense month December. After the meeting, chancellor Merkel stressed her opposition to Eurobonds, while the two gentlemen remained politely silent. All three European leaders agreed to give no more comments on the role of the ECB. This does not mean that the ECB will refrain from more bond purchases. It only means that politicians will not ask for it or comment on it.

With Merkel’s or better the German strict “no” against the ECB as a lender of last resort and common Eurobonds, “Frau Nein” or “Madame Non” has staged a comeback. Even if some market participants argued that the disappointing bond auction on Wednesday could lead to German reconsiderations, the German position will not change easily. Why is “Frau Nein” so unbending?

The answer to this question is not only the German obsession with central bank independence, hyperinflation or ruthlessness. The core of the German opposition is a different one: it is all about conditionality. Chancellor Merkel is not willing to open German taxpayers’ pockets without quid pro quo. This is not new. The principle of conditionality has dominated the German crisis management since the beginning of the crisis. In fact, the Eurobond-type bailout packages for Greece, Ireland and Portugal were constructed with a high degree of conditionality. No money without austerity measures and structural reforms. At the current juncture, the German government is afraid that more ECB bond purchases would lead to moral hazard and so reduce the pressure on peripheral countries to reform. Eurobonds would, in the German view, create the same moral hazard problem.

Does the return of “Frau Nein” mean that Eurozone crisis management has again entered a dead end? No, not necessarily. Reading between the lines shows that the German “no” is not a categorical rejection. It is all about the sequence of events and decisions. The German government does not believe in a quick fix of the crisis, only in structural changes. In fact, chancellor Merkel has recently made several pleas for more political integration in the Eurozone. However, it is obvious that the German government first wants to see more political integration before it would give structural access to German money. This explains the German emphasis on Treaty changes.

Recent weeks have shown that chancellor Merkel is in favour of a fiscal union, not a transfer union. If the Eurozone succeeds in agreeing on more political integration with clear consequences for breaching fiscal and economic rules, the German government should eventually give up its resistance to Eurobonds. Maybe recent developments have not marked the return of Frau Nein but rather the emergence of Ms. Conditionality.

Thursday, November 24, 2011

Ifo surprises in November

Last crisis antagonist? Today’s Ifo index illustrates that German crisis resistance is stronger than expected. In November, the Ifo index increased surprisingly to 106.6, from 106.4. While the current assessment remained unchanged from October, expectations rebounded to 97.3, from last month’s 97. Particularly the small increase of the expectations component bodes well for our main scenario that the German economy is not falling off a cliff.

The Ifo increase comes after a longer period of market worries about the strength of the German economy. In fact, with yesterday’s disappointing bond auction, some market participants already welcomed Germany in the debt crisis club. The lack of investor’s appetite for German government bonds was by some market participants even considered as a vote of no confidence against Germany. Time to put things into perspective.

Without any doubt, the German economy is cooling off. Most confidence indicators are pointing southwards. And indeed, there are at least three major risks for the German economy in the coming months. Obviously, the Eurozone debt crisis comes in at top of potential risks. With bigger trading partners having to engage in austerity measures, external demand looks set to weaken. Don’t forget that France is Germany’s single most important trading partner, accounting for roughly 10% of all German exports. Second, a further drop in sentiment, particularly by just recently awakened consumers, could lead to a significant loss of momentum. Finally, bank recapitalisations and restructurings could lead to a credit crunch in the coming months.

However, on a more positive note, even after yesterday’s bond auction, absolute rate levels are historically low, the absolute levels of most confidence indicators is still above recessionary levels, a further stabilization of the US economy could at least to some extent offset weakening Eurozone demand and latest lending data show do not confirm any credit crunch concerns, yet. In fact, credit to the private sector has actually increased over the last couple of months. Moreover, German companies are benefitting from low interest rates as the high dispersion of bond yields across the Eurozone is also reflected in bank interest rates. Finally, with the strong labour market and high backlogs for companies, economic fundamentals still put a strong safety net under the economy.

The debt crisis has sent the Eurozone economy into recessionary territories. The German economy will not be able to escape these general recessionary tendencies. However, today’s Ifo index shows that if policymakers get a grip on the crisis management, Germany could get off more lightly than most other countries. Thanks to sound fundamentals, any growth slowdown in Germany should feel like a soft patch, rather than recession.

Last golden memories?

Golden memories. Today’s second estimate of German 3Q GDP growth confirmed an excellent growth performance. The German economy grew by 0.5% QoQ, from 0.3% QoQ in 2Q. Compared with 3Q 2010, the economy grew by 2.6%. Today’s release also presented the growth decomposition, showing that the recovery is more balance than many people think. Third quarter growth was broadly balanced. In fact, private consumption was the main growth driver with a significant rebound of 0.8% QoQ. Net exports, government expenditures and investment also contributed to growth. Only the construction sector disappointed. However, there was one warning signal: the first inventory correction for more than a year, reflecting weakening new orders.

With the latest drop in confidence indicators and fiscal problems in France and Italy, two important German trading partners, concerns about the strength of the German economy have increased. Yesterday’s disappointing bond action added to these concerns. Nevertheless, the German economy should not fall off a cliff as it did in 2008. The economic fundamentals are solid and the combination of low inventories and high backlogs should put a safety net under the economy.

Despite all recent recession fears, today’s numbers should not mark the end of an almost golden period for the German economy. The economy should re-emerge after a soft patch. The length of the soft patch will to a large extent be determined by the management of the debt crisis. Let’s hope that today’s golden memories are sufficient to bridge the dire straits.

Monday, November 21, 2011

Eurobonds - next try

The European Commission looks determined to come up with a next attempt for a common Eurobond. It is still a long shot and will not alleviate the ECB any time soon, but it could play an important role on the road towards more integration.

Back again. According to media reports and leaked documents, the European Commission will present a so-called Green Paper on common Eurobonds on Wednesday. A Green Paper proposal will be followed by public consultations with relevant stakeholders and interested parties. This means, it is not a proposal that can be quickly adopted by Eurozone Member States.

Judging from the draft document, the European Commission has become more pragmatic and realistic, pointing to preconditions that have to be met before engaging in the now so-called Stability Bonds. According to the Commission, “additional safeguards to assure public finances would be warranted”. This could go beyond the recently adopted six-pack, with new rules on budgetary discipline and economic competitiveness.

The European Commission has come up with three proposals for a Stability Bond. Two options would carry “joint and several” guarantees, making Eurozone countries responsible for other countries’ debt. While option 1 foresees a full substitution of Stability Bond issuance for national issuance and would in fact deliver a fully-fledged single bond market (with the biggest moral hazard risk), option 2 only envisages a partial replacement of national bonds. The partial replacement in option 2 follows the well-known red-blue proposal, splitting the bond market into a Stability Bond market and a national bond market. A third option would be for the partial replacement of national government bonds with euro bonds carrying ”several” but not joint guarantees. In this approach, Stability Bonds would be underpinned by pro-rata guarantees of Eurozone countries and countries would retain liability for their respective share of Stability Bond issuances as well as for their national issuances. For all three options, no numerical ceilings have been proposed, yet.

Eurobond proposals have been presented more often over the last decade. Chances to actually get them have probably never been higher than currently. The biggest opponent of Eurobonds, Germany, is gradually changing its stance. In a reaction to yesterday’s reports, the German government did not come with its categorical rejection but with a milder “we will look into it”. In addition, the German council of economic advisers also endorsed a plan for a common Eurobond a couple of weeks ago. However, it was a Eurobond proposal for the “fiscally challenged” countries. In the German proposal, countries with government debt over 60% of GDP will be able to jointly finance the debt exceeding this level via a so-called European Redemption Fund. Joining the fund would require acceptance of certain automatic tax and spending restrictions and would require the country to put down 20% of its borrowing in gold or foreign exchange collateral.

The discussion has gained new momentum. Even if this time around chances for a successful Eurobond project are higher than with past attempts, it is still a long way to go and no quick fix for the current crisis. It is hard to see that the latest proposals can alleviate the ECB. Nevertheless, the latest Eurobond proposals have brought some new ideas as they clearly combine the lender of last resort function with anti-moral hazard measures. With such a construction, a common Eurobond could play an important and facilitating role on the way towards more political integration within the Eurozone.

Monday, November 14, 2011

Last sign of crisis resistance – German GDP grew 0.5 in 3Q

The last sign of crisis resistance. According to the first estimate of the German statistical agency, the Eurozone’s largest economy enjoyed an impressive comeback in the third quarter, growing by 0.5% QoQ. At the same time, 2Q growth was revised upwards to 0.3% QoQ, from 0.1% QoQ. Compared with 3Q10, the German economy grew by 2.6%. GDP details will only be published with the second estimate, but available monthly indicators point to widely spread growth in the third quarter. The months July and August were simply too strong to have disappointing September numbers spoil the growth party.

With today’s numbers, an annual growth rate of 3% for the entire year 2011 is still possible. Of course, third quarter numbers come after an exceptionally weak second quarter, in which the shutdown of eight nuclear power plants had probably shaved off some 0.3 percentage points from the quarterly growth rate. Nevertheless, even if strong 3Q growth is partly driven by a technical rebound, it also reflects the solid fundamentals of the German economy.

Looking ahead, sentiment indicators point to a significant growth slowdown, a contraction of the economy towards the end of the year is possible. The reason for this slowdown is the sovereign debt crisis. For a long while, the German economy has been one of the few beneficiaries of the sovereign debt crisis. A weaker euro, very accommodative monetary policy and low funding costs have contributed to strong and solid economic growth. With the latest stage of the debt crisis and France and Italy seemingly drowning in the maelstrom of the debt crisis, the German economy has lost its immunity. Austerity measures in France and Italy will also hurt German exporters.

Nevertheless, the German should not fall off a cliff as it did in 2008. The economic fundamentals are solid and the combination of low inventories and high backlogs should put a safety net under the economy. Moreover, there is a final trump card. Flight-to-quality in bond markets is still spoiling the German government with unexpected revenues. According to our own estimates, this flight-to-quality impact on German yields enabled the German government to save almost 9bn euro on its bond issuances of these two years. Interestingly, this is already more than the recently announced tax relief for 2013 and 2014.

With today’s numbers, the German economy has returned as the economic powerhouse of the Eurozone. Even if in the current circumstances skeptics could be tempted to call it one-eyed among the blind. Either way, one thing is clear: with the latest stage of the sovereign debt crisis, today’s numbers are as good as it gets for the German economy. At least for a short while.

ECB remains involuntary fire brigade in euro crisis

Thread packing? The ECB continues its role of euro crisis fire brigade but only at half speed. According to its latest press statement, the ECB purchased government bonds for 4.5bn euro last week, down from 9.5bn euro one week earlier. This brings the total amount of purchased bonds since May 2010 to 187bn euro.

The ECB remains stuck in a catch-22 situation. As long as the official ECB stance gives the impression that the SMP is only implemented half-heartedly, the ECB might end up buying more bonds than if it would come out with a numerical target or fully-fledged commitment. However, an end to this catch-22 is not in sight. First of all, resistance from core Eurozone central banks, above all the Bundesbank, against the bond purchases is rather increasing than decreasing. Today, Bundesbank president Weidmann reiterated his criticism of the bond purchases and called the German public an ally of the Bundesbank. Moreover, even if theoretically, the ECB’s role as an unconditional lender of last resort for the Eurozone makes sense, it can only work if the economic governance is right. An unconditional lender of last resort would need a strong fiscal counterpart at the Eurozone level to ensure conditionality and to avoid moral hazard. The ECB is simply not a political institution that can enforce conditionality on member states.

Despite last week’s slowdown of bond purchases, the controversial debate on the ECB’s SMP will continue. The Eurozone is still in need of an unconditional lender of last resort. A possible short-term fix to take the burden off the ECB’s shoulders could be the European Stability Mechanism (ESM). With a credit line at the ECB, the ESM could impose conditionality on member states and would at the same time have the ECB’s fire power. However, any steps in this direction still need time. For the time being, the ECB remains the involuntary fire brigade of the Eurozone.

Saturday, November 12, 2011

De Kapla-blokken van de Eurozone

Ooit waren de Kapla-blokken een van de favoriete spelletjes van mijn kinderen. Met veel geduld en fantasie probeerden we bekende en onbekende constructies en gebouwen op te trekken, maar het leukste was de stabiliteitstest. Hoeveel blokken kunnen eruit zonder dat de constructie instort? Onlangs hebben we de blokken weer uit de kast gehaald. Ons nieuw Kapla-project heet de eurozone.

De jongste politieke ontwikkelingen in Italiƫ en Griekenland hebben de markten opnieuw een sprankel hoop gegeven dat de eurozone toch een stabiel project kan worden. Maar let op, de kater na het feest komt bijna zeker. Griekenland moet nog steeds een hele lange adem hebben en ook met ex-ECB'er Lucas Papademos als premier wordt de schuld niet automatisch houdbaarder. En Italiƫ moet eerst bewijzen dat het doortastender is zonder Silvio Berlusconi. Na een referendum dat er nooit een was, een dreigement dat slechts bluf bleek en het einde van het tijdperk van de crisispremiers, is de belangrijkste conclusie dat de spelregels veranderd zijn. Niet Frau Merkel, het Duitse grondwettelijk hof of het Duitse parlement beslissen over de toekomst van de eurozone, wel de Zuid-Europese, ontvangende, landen. Als de bereidheid om te bezuinigen en structurele hervormingen door te voeren een luchtspiegeling blijkt, kan Frau Merkel trapezeacts uitvoeren, maar zonder succes. 22 jaar na de val van de Berlijnse muur, krijgt 'wir sind das Volk' een nieuwe betekenis.

De eurozone heeft de afgelopen maanden veel nieuwe instrumenten voor de crisisbestrijding ontwikkeld. Toch is er geen instrument of middel om onwillige landen bezuinigingen op te leggen. Niemand kan voorkomen dat een land ervoor kiest volledig failliet te gaan in de eurozone. Waarom uit de eurozone, als het binnen toch veel warmer is met toegang tot het ECB-geld en de interne markt? Er is geen juridische mogelijkheid om een land aan de deur te zetten. Daarom was het dreigement van Merkel en Sarkozy grote bluf. Bij de Grieken heeft de bluf gewerkt, maar op een gegeven moment prikt een land daar doorheen. En wat dan?

De toestand van de eurozone blijft angstaanjagend fragiel. De eurozone lijkt zo steeds meer op de Kapla-torens van mijn kinderen. Waarschijnlijk blijft alleen nog de vlucht naar voren. De vlucht naar een politieke unie, met de exit uit de monetaire unie als ultieme straf en een wettelijke onvoorwaardelijke 'lender of last resort' in Frankfurt. Als dat niet lukt, blijft de toren uiterst wankel en wordt het aftellen naar wie het volgende blok eruit mag halen. En sinds deze week weten ook de landen uit de periferie van de eurozone dat ze aan de blokken mogen trekken.

Dit stuk verscheen vandaag in het Belgische dagblad De Tijd

Friday, November 4, 2011

German new orders disappoint

CGerman new orders dropped unexpectedly sharp by 4.3% MoM in September, from a 1.4% drop in August. It was the third consecutive monthly drop. On the year, new orders are only up by 2.4%. The drop was driven by both domestic and foreign demand, with demand from other Eurozone countries falling by a shocking 12.1% MoM. Looking at the different sectors, only demand for German consumer goods increased.

Today’s drop in German new orders completes a week of yet another rollercoaster ride in the Eurozone. The financial turmoil and the economic slowdown in other Eurozone countries have obviously spoiled the appetite for goods “made in Germany”. For the time being, the safety net for the German industry of high backlogs and low inventories is still holding but today’s numbers make it thinner. The German industry has finally caught the crisis virus.

Thursday, November 3, 2011

Super Mario jumps ahead of the curve

What a starter. Today, the ECB cut interest rates by 25 basis points to 1.25%. The worsened economic situation and the prospect of a mild recession were the main drivers of the ECB’s decision. Following the well-established tradition of his successor Jean-Claude Trichet, new ECB president Mario Draghi did not give any hints on further rate changes. The never-precommitment phrase is still around.

The biggest change in the ECB’s macro economic assessment was in the economic analysis. According to the ECB, there were signs “that previously identified downside risks have been materialising”. With a weakening of domestic and external demand and a worsening of hard and soft data, the ECB is now expecting a mild recession towards the end of the year.

Of course, the ECB’s main objective is to maintain price stability and not to support economic growth but at the current juncture, growth seems to be the main concern and inflation is considered to be a second-round effect. According to the ECB, the weaker economic prospects have reduced inflationary risks. For the first time in a long while, the ECB talked about inflation rates returning to levels below 2%. Nevertheless, at least after today’s cut, the ECB still (or again) considers the risks to the medium-term outlook for price developments as broadly balanced. All in all, there was probably no single event which triggered today’s rate cut. It looks as if the ECB already considered a rate cut last month and just needed more evidence of a weakening economy to walk the walk.

Of course, there is no ECB press conference without questions on the sovereign debt crisis. Asked to comment on recent developments in Greece and the Eurozone reply, Draghi said it was hard to comment on such a fast evolving situation. Moreover, Draghi recalled the European Treaties which do not provide for an exit from the monetary union.

Interestingly, Draghi drew a more distinct line between monetary policy and the sovereign debt crisis than his predecessor Trichet had done in the past. While Trichet sometimes had given rise to speculation that the ECB could beef up its bond purchasing programme, Draghi was more explicit in pointing to the limits of the programme. According to Draghi, the ECB’s bond purchasing programme followed three principles: it was temporary, limited and purely justified by the monetary transmission mechanism. He also remarked that the main responsibility was with national governments, not with any kind of external support. In Draghi’s view, it was also impossible to keep bond yields artificially low for a sustained period. Bottom line is that the ECB is not eager to take over the role of unconditional lender of last resort any time soon.

All in all, new ECB president Mario Draghi was not thrown in at the deep end but rather jumped with a lot of verve. The ECB has a new communication style but no new monetary policy strategy. It is obvious that the ECB has caught the crisis virus and is trying everything it can to prevent a full-fledged recession.