The world financial instability and the Euro zone crisis - Chapter 4 Jacques SAPIR CEMI-EHESS

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The world financial instability and the Euro zone
crisis - Chapter 4Jacques SAPIRCEMI-EHESS
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4 Partial remedies
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• 1. The ECB new financing facilities.
• A partial change in the ECB strategy.
• An evolution toward non-orthodox policy tools was
  obvious since the end of 2007.
• But the change implemented in December 2011 has
  been massive.
• Is it the beginning of a new path or the end of
  the line?
• But the Constitutional roadblock (The Karlsruhe
  Constitutional Court) is still in place.
• The political opposition of the German government
  is much less a problem than it is though.
• The Constitutional argument has been ignored so
  far and could be a major one.

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• The new mechanism and its assessment.
• It works (at short term).
• The REPO mechanism.
• Liquidity flows (489 mlrd E and 529 mlrd E)
• But, it is transforming now quickly the ECB into
  a kind of bad bank.
• Why banks are taking back bonds they have bought
  to the ECB?
• No improvements on the corporate debt market.
• And, it is not solving the main issue that is the
  increasing weight of interests burden on budgets
  through the rise of interest rates. What is
  needed is not just a new liquidity facility but a
  massive reduction of the debt burden.

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• 2. The inter-governmental agreement of December
  9th, and its uncertain future.
• A common disciplinarian frame but no progress
  toward budget federalism.
• Still no progress on budget transfers, and a
  German opposition stronger than ever.
• The legal side of the agreement is to be murky
  (some countries are opposing it).
• It is highly dependent of the willingness of
  national Parliament.
• Political oppositions is now radicalizing against
  this agreement.
• An agreement now partly emptied of its content
  through Exceptions clauses.
• Several countries have made the case for
  exception on exemption clauses.
• A possible conflict is coming with the ECB.

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• 3. Commercial banks response to the crisis.
• Commercial banks are still engaged into a massive
  de-leveraging operation.
• The situation of commercial banks is still very
  weak.
• The uncertainty on banks is linked to the fact
  that nobody knows what is the scenario of the
  next crisis.
• The EZ has accumulated a lag in bank regulations.
• The impact on internal credit in different EZ
  countries.
• The de-leveraging impact on internal credit and
  the coming European credit crunch (Corporate
  bonds are still at very high interest rates).
• Uncertainty on assets.
• The problem of regional banks in Spain and
  Germany.
• A process of re-nationalisation of the
  sovereign debt is threatening to ultimately
  destroy the EZ.

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• 4. The Greek controlled Default
• The mechanism of voluntary swaps.
• The old Bonds and the new Bonds and the
  extension of the swap period (till May 15th).
• -The actual interest rate and depreciation of the
  nominal value of the new bonds. (From 100 to 30
  and from 4 to over 13)
• What impact on the Greek debt?
• A reduction of around 100 Mlrd Euros amounting to
  28,1
• At 124 GDP a 4 IR implies a yearly 5 GDP
  interest payment.
• An end to the CDS market?
• What future for this market?
• What consequences are of disappearing CDS?
• What is the current dynamic.

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• 5. A consolidation of a Ponzi scheme?
• The Ponzi mechanism of the sovereign debt has not
  been modified.
• Total debt x IR gt real growth x inflation
  automatic budget deficit.
• The increase of the Debt/GDP ratio is now
  fostering high interest rates.
• If governments want to reduce quickly this ratio
  they will induce a severe depression and then a
  drop in real GDP which is to destroy the debt
  reduction potential.
• An internal Ponzi mechanism is now developing in
  Spain.
• The central government has reduced subsidies to
  regional ones but regional government are
  increasing the size of budget arrears.
• The central government will have to consolidate
  regional budgets. A 16 GDP deficit?

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• 6. What lies ahead?
• (a) The Euro zone recession and possible
  depression induced by austerity plans.
• Strong depression in Greece and Portugal with
  large GDP drop (-7 and -5 respectively).
• Deepening recession in Spain with a massive (24)
  unemployment problem (-1,7 at best/-3,5
  possibly).
• Recession had already begun in Italy, Belgium and
  France
• A future extremely uncertain till 2015.
• (b) Trade deficit reduction.
• The increase of exports is limited
• The severity of the decrease of internal demand
  Greece (-40), Portugal (-26), France (-10),
  Italy (-8)

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• The severity of the potential Unemployment
  shock.
• Spain 29 (24), Greece 52 (19) Portugal 36
  (20), France 20 (9,7), Italy 16 (11)
• (c ) Short term possible catastrophe.
• Greece the controlled default as a partial
  solution.
• Spain the growing amount of unpaid bills by
  Local and Regional government (Catalunia 10Y
  9,56).
• Italy The new government is more and more
  contested.
• A break-up of the Euro zone is now serious a
  possibility

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• 7. What consequences of an Euro break-up would
  be.
• The International role of the Euro.
• An asymmetric relation.
• The reduction of other currencies share.
• The Euro has still not achieved a dominant role
  versus the USD.
• Would the USD predominance be strengthened by a
  collapse of the Euro?
• There is already a process of return to the
  USD.
• But fundamentals of the US economy are not good.
• The collapse of the Euro could be the first
  signal of a general collapse of the International
  monetary system.

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• What could be opportunities for the development
  of regional reserve currencies (RRC) ?
• The use of proxies for currency.
• Gold.
• Commodities.
• IMF SDR
• Current projects.
• The Russian project of establishing the RR as a
  new RRC.
• Latin-American projects (the Venezuela SUCRE).
• The Australian Dollar.
• What would be the future of the Yuan?
• Would the BANCOR (Keynes, 1944) be the ultimate
  solution?

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• The Crisis in Western Europe is to be a long one.
• It is to affect Central and Eastern Europe.
• It will certainly have an impact on the Russian
  economy.
• However, this could be the prime mover for
• - A rethinking of the Growth path of Russia.
• - The development of new monetary instruments.